The taxation implications of company law reform
A discussion document
Annex 2.1: Current Rules for Calculating Paid-Up Capital, Qualifying Share Premium and Excess Return Amount
Section 4A of the Income Tax Act sets out a number of exclusions from the term "dividends". Principal among those exclusions are amounts funded from subscribed capital (being paid-up capital and qualifying share premium) distributed when shares are cancelled or redeemed, and amounts funded from capital gains distributed on the liquidation of a company.
Hence, a dividend for tax purposes is a benefit which is derived by virtue of a shareholder's ownership interest in a company, excluding the return of the original investment and, in the case of a liquidation, capital gain amounts. Under section 4A those excluded amounts are calculated as follows:
Distributions Attributable to Paid-Up Capital
Under the section, the amount per share returnable tax-free as paid-up capital is computed as:
a is the total amount of capital paid up prior to the redemption of the shares of the class being redeemed or cancelled; and
b is the total number of shares of the class that have ever been issued by the company prior to the redemption that are still on issue.
Distributions Attributable to Qualifying Share Premium
Qualifying share premium amounts returnable tax-free are computed according to a similar averaging formula to that outlined in the previous paragraph. However, the amount of tax-free share premium is the actual amount debited to the company's share premium account in respect of the redemption if this is smaller than the amount computed under the averaging rule.
Distributions Attributable to Other Tax-Free Sources on a Liquidation
Distributions funded from certain realised and unrealised capital gains are also non-taxable when distributed on the liquidation of a company. These residual non-taxable amounts are allocated to distributions on a pro rata basis according to total distributions made on a liquidation, other than distributions of subscribed capital. Broadly, the residual amounts distributable tax-free to a shareholder on liquidation are computed as:
a x b
a is the amount of realised and unrealised capital gains available for distribution to shareholders;
b is the distributions received by the shareholder on the liquidation, other than distributions of paid-up capital and share premium; and
c is the total amount of distributions payable to all shareholders on liquidation, except distributions of paid-up capital and qualifying share premium.
Where a distribution exceeds the total amount that can be attributed to tax-free sources, the excess is taxable as a dividend.
The first two formulae operate on a class by class basis for each class of shares redeemed or cancelled. Shares are considered to be of the same class for tax purposes if:
- the shares carry the same rights to exercise voting power and the same rights to distributions; or
- the same amount has been subscribed in respect of each share, the company elects to treat such shares as being of the same class, and the company can distinguish between such shares and other shares.