When a client explains that he is receiving a dividend from an overseas company there is often a temptation to assume it’s taxable to income tax. Alternatively perhaps you’re looking at a distribution on a purchase of own shares (conducted by an overseas company) which wouldn’t qualify for a capital treatment test (five years, trading and so on) – taxable to income tax as a dividend surely?
All very sensible you might think. Sadly not.
s.402 ITTOIA 2005 confirms how a distribution of a non-UK resident company is taxed upon receipt by a UK resident individual – and it excludes ‘distributions of a capital nature’. So what is a capital distribution for these purposes?
Well there isn’t a statutory definition as such. There is however a handful of reasonably old cases which help us. The latest one however was only six years ago in 2010 – the Nationwide case. This case re-affirmed the main principles set by those earlier cases as follows:
- Local tax law (i.e. the overseas tax law) is irrelevant
- The legal form is more important the substance – and its local company law that you need to look for
- Income distributions are generally distributions of the ‘fruit of the tree’, whilst capital distributions are generally distributions of the ‘the tree itself’. Other related concepts involve looking at whether the ‘corpus of the asset’ is left intact or not.
So for example, where a foreign company undertakes a share repurchase, if the local company law says that is a capital event then the receipt is a capital transaction no matter that it does not meet the various requirements laid out under UK tax law for a purchase of own shares to be treated as a capital gain.
This creates something of an un-level playing field – those UK residents who have invested in overseas entities generally find the route to a capital gain much easier than those who invest in UK companies, and that seems slightly odd.