Finance Bill 2015: changes to the tax treatment of B share schemes

The Chancellor of the Exchequer announced, in his Autumn Statement on 3 December 2014, his plans to legislate in the 2015 Finance Bill to remove an apparent “unfair tax advantage” and to treat cash received under a B share scheme in the same way as dividend income. Following the publication of the Finance Bill 2015 on 24 March 2015, companies will, with effect from 6 April 2015, no longer be able to return cash to their shareholders in a way that offers a choice of income or capital treatment. HMRC and HM Treasury expect the measure to bring in revenue of £45 million in 2016/2017 and thereafter £40 million per annum until 2019/2020.

What is a B share scheme?

A common (and, currently, tax efficient) method of returning excess cash to shareholders over and above normal dividend payments is via a “B share scheme”. B share schemes typically involve the creation and issue of a new class of shares (usually designated as B shares although they can be called anything as long as they are distinguishable from the existing share capital of the company) by way of a bonus issue using the share premium account or merger reserve (or similar reserve). The new shares are issued to the company’s shareholders pro rata to their existing shareholdings. To return cash to shareholders the company will either:

declare a dividend on the B shares and, once the dividend is declared and paid, redesignate the B shares as deferred shares of low value;
redeem or repurchase the B shares; or
cancel the B shares by means of a reduction of share capital.
In February 2015, Standard Life plc announced that it was to return £1.75 billion to its shareholders by the issue of B and C shares using its share premium account and merger reserve. Members had the option of a subsequent dividend (income option) or a capital repayment (capital option) of 73 pence per share which would be made between 19 March 2015 and 31 March 2015 (i.e. before the Finance Bill 2015 provisions take effect).

Current advantage of B share schemes

Shareholders can be given the choice to elect to receive the return either as income, or as capital, or a combination of both for tax purposes. The amount of cash (gross) a shareholder receives will be the same whatever form the return takes. Shareholders may also be given a choice over the timing of the receipt to ensure that it falls within a specific tax year.

A number of factors will influence a shareholder’s decision to elect to receive the cash as income or capital. For example, individuals will typically prefer their return to be treated as capital but institutional shareholders may prefer income treatment.

The changes

The Finance Bill published on 24 March 2015 includes draft legislation to amend the Income Tax (Trading and Other Income) Act 2005 so that where shareholders are given a choice as to the nature of the return, the cash received will be treated in the same way as dividend income.

The change will take effect from 6 April 2015 and applies to returns to shareholders on or after that date, even if the choice of receipt was made before that date.

HMRC stated that the legislation will align the tax consequences of making a choice to receive either a dividend or similar amount through an issue of new shares that are subsequently redeemed or purchased by the company so that all shareholders are taxed as if they had received a dividend. The measure is reportedly intended to “support the government’s objectives of tackling avoidance and unfair outcomes in the tax system” by “ensuring parity of treatment with other taxpayers who are not able to choose how they are taxed on their income”.

It is not clear why B share schemes are now in the spotlight. B share schemes have existed for many years and were even included in the General Anti-Avoidance Rules guidance as examples of “situations where arrangements have become embedded into tax or business practice in such a way that it would be wrong now to treat them as abusive” or, put another way, that they were not objectionable from a tax perspective as they were so common and had been accepted as a relatively well established practice.

We understand that the change will only bite where the shareholder is given a choice to elect to treat the return as income or capital. Therefore, “capital only” B share schemes, where the receipt is treated as capital and there is no element of choice for the shareholder, will, for now, be unaffected.

As at the time of writing, if an individual elects to receive a return by way of a capital gain, no tax is payable if the amounts (together with the proceeds of any other taxable disposals by the individual) are below £11,000 and will, therefore, fall within the annual exemption. When the change is effected on 6 April 2015, such gains will be liable to tax as dividends at the effective rates of 25% for higher rate or 30.6% for additional taxpayers.