The Chancellor’s October Budget delivered the restraint the market expected, albeit not as exciting as some may have liked. The Office for Budget Responsibility (“OBR”) raised its 2026 growth forecast to 1.2% but cut 2027 from 1.6% to 1%, suggesting that current liquidity issues and financial constraints are here for a while, and that the lower borrowing costs some hoped for are unlikely in the near term.
While much of the press focuses on the reduction in the price of gherkins, garlic, and baked beans, some less talked-about parts of the Budget deserve attention, particularly the use of company capital reductions to avoid tax charges on dividends. This is where shareholders of a trading company with distributable profits exchange their shares for shares in a new holding company, and the holding company then undertakes a capital reduction (outside of the statutory demerger scheme) and returns value to shareholders as a repayment of capital rather than as a dividend, reducing the recipients’ tax charge.
The government will go ahead with its plans to modernise the taxation of company distributions and repayments of capital. For capital reductions, the main change is that, after a share reorganisation, the amount treated as a repayment of capital will be limited to the capital originally subscribed. The effect is to close the capital reduction route as a means of avoiding dividend tax. Nothing changes yet, and a technical consultation with draft legislation will follow in 2027, with the new regime intended to apply from April 2028.
The proposals target individuals and trusts holding shares, not corporate shareholders. Those affected will naturally look for alternative routes, and two are likely to be considered:
- A demerger reconstruction under section 110 Insolvency Act 1986, under which the business is transferred to one or more new companies via a solvent liquidation. This is a well-established statutory process, that has potential tax advantages, but it involves appointing liquidator, attention to dissenting members rights, and to creditors, with the associated costs and timing. Its tax efficiency depends on the reliefs available and requires bona fide commercial reasons (i.e. not a main purpose of avoiding tax) and tax clearance; or
- A statutory demerger by way of exempt distribution under Part 23 Chapter 5 of the Corporation Tax Act 2010. This does not involve liquidation, but the legislation prescribes stringent conditions, including trading requirements, and a prohibition on arrangements to extract value, which must be met for the transaction to be tax exempt. Consequently, such demergers are rare and costly. It is well suited to separating trading businesses, but not to extracting profits.
The government has said that it will look to make the statutory demerger process easier, but there is currently no further detail of how or when. There are also question marks over whether a reformed regime can compensate for the loss of the current capital reduction route, or whether these changes will inhibit genuinely commercial demergers, at a time when the economy can ill afford to lose restructuring flexibility.
In the meantime, will we see a rise in section 110 reconstructions? For genuinely commercial separations, particularly where the statutory demerger conditions cannot be met, I expect so, provided the sums involved justify the costs; for smaller transactions the costs are likely to be prohibitive. Section 110 is not, however, a back door for profit extraction: where the main purpose is to avoid dividend tax, reconstruction relief, and clearance are unlikely to be available, and distributions in a winding up are subject to the targeted anti-avoidance rules (and securities rules).
We have yet to see the detail of the new legislation, and a year is a long time in politics. But groups considering a restructure before April 2028 should review their options now, and take advice early on whether a statutory demerger or a section 110 reconstruction best fits their commercial objectives.
