Tax planning with capital reductions

The Companies Act 2006 made reductions of share capital more accessible for private companies, requiring only a special resolution. What circumstances might make these especially attractive to your clients, and what procedures need to be followed to avoid problems?


A reduction of share capital, also known as a capital reduction, is a company law concept contained in the Companies Act 2006 (CA) . It is where the share capital of a company is reduced, and the capital then either returned to the shareholder or transferred into a reserve of the company.

Example. Acom Ltd was once a sizeable business but now only has minimal trading activity. It has £100,000 of ordinary share capital in issue and the directors feel this level of capital is excessive given the reduced trading activity now conducted. The share capital is reduced to £10,000 to bring it down to a level commensurate with the trading activity.

Practice point 1. It is not just the share capital of a company that can be reduced, so too can a share premium account or a capital redemption reserve.

Practice point 2. A capital reduction cannot leave only redeemable shares in issue. There must be at least one non-redeemable share in issue after the reduction.


Prior to the introduction of the CA 2006 , a reduction of capital was only available to a private company by going to court. This was extremely expensive and time consuming and therefore not a route a private company often went down. Since 1 October 2008, a private company can reduce its share capital by passing a special resolution, supported by a solvency statement.

Practice point 1. Each of the directors of the company must sign a solvency statement that they have formed the opinion that there is no ground on which the company could not pay or otherwise discharge its debts during the twelve months following the reduction of capital.

Practice point 2. The declaration of solvency should not be taken lightly. If a director is found to have made it without having reasonable grounds for the opinion of solvency expressed in it, the offence can be punishable by up to two years in prison.


To properly effect a capital reduction the following documents need to be submitted to Companies House within 15 days of passing the special resolution:

  • a copy of the special resolution
  • a copy of the solvency statement
  • a statement of compliance; and
  • a statement of capital.

Practice point 1. The resolution must be approved by not less than 75% of the total voting rights of eligible members (if a written resolution), or not less than 75% of votes cast (if proposed at a general meeting).

Practice point 2. The solvency statement must be signed by the directors not more than 15 days before the resolution is passed. This is what the statement of compliance must confirm.

Practice point 3. The statement of capital must be submitted on Companies House Form SH19 and detail the share capital of the company remaining following the reduction.


One of the most common uses of a capital reduction is to create, or increase, a company’s distributable reserves. This can be extremely useful for your client if they have insufficient distributable reserves available to pay a dividend, but sufficient capital. S.654 CA 2006 states that a reserve arising from the reduction of a company’s share capital is not distributable, although the Secretary of State may specify cases where the prohibition does not apply and the reserve created is distributable.

Practice point. The Secretary of State made such a case in Statutory Instrument 2008/1915 , where it says the reserve is to be treated for the purposes of Part 23 of CA 2006 as a realised profit.

Example. Your client incorporated their company with £50,000 of start-up capital which they introduced as share capital rather than loan capital. The company was profitable to start with but has recently experienced a downturn in trade, which has caused it to make accumulated losses of £10,000. The capital and reserves section of the balance sheet is therefore positive by £40,000; however your client is unable to take a dividend due to having a £10,000 negative profit and loss (P&L) reserve.

By undertaking a capital reduction of, say, £30,000 and transferring it to reserves, the total capital and reserves of the company remain at £40,000, but are split £20,000 share capital and £20,000 P&L reserve. Your client can now take a dividend of up to £20,000.

Practice point. Reducing capital into reserves does not just have to be used to pay dividends, it can have other uses for your client, such as franking a buy back of shares.


The alternative to taking a reduction of capital to a reserve of the company is to return the capital directly to the shareholder. This can be useful where your client has subscribed for a large of amount of share capital on starting up their company, but that level of capital buffer is no longer needed.

Example. Returning to the example of Acom Ltd, the £90,000 reduction of capital would be paid out directly to the shareholder as a cash payment.

Practice point 1. As long as the capital is returned directly to your client and not transferred into a reserve first, the capital reduction cannot be treated as a dividend.

Practice point 2. Providing the capital is reduced on a pound-for-pound basis, there will be no capital gain triggered for your client as the cash will simply be a return of what your client originally paid in.

Even though a capital reduction may simply be a return of originally subscribed capital, HMRC might still object to it in certain circumstances and seek to apply anti-avoidance legislation.


By its very nature a reduction of share capital is a transaction involving a security and therefore within the transactions in securities (TiS) legislation (see Follow up) . Nevertheless, until Finance Act 2016(FA 2016) a reduction of share capital was not specifically listed within the meaning of a TiS.

Practice point 1. The TiS legislation is an anti-avoidance measure designed to prevent close companies from undertaking a transaction involving shares in such a way as to gain an income tax advantage. If invoked, HMRC can counteract the advantage by assessing the transaction to income tax.

Practice point 2. Advance clearance can be sought under s.701 Income Tax Act 2007 that HMRC will not invoke the TiS legislation when undertaking a capital reduction.

The December 2015 HMRC consultation paper on Company Distributions (see Follow up ) issued prior to the FA 2016 changes, gave the following example of the type of arrangements involving capital reductions that HMRC was seeking to stamp out using the TiS legislation. HMRC gives the following example.

Example. Two companies both set up with £100 of share capital that have a P&L reserve of £250,000. One company pays a dividend to its only shareholder of the full £250,000.

The other company undertakes a share-for-share exchange to insert a holding company, Holdco, with this issuing 250,000 new shares to the shareholder as consideration. Holdco now has £250,000 of share capital (in addition to the £100 it was incorporated with) which it reduces and pays out to the shareholder, thereby gaining an income tax advantage.

Practice point 3. Whilst the consultation paper said “where a company is returning to the shareholder what the shareholder originally put in, there should not be an income tax charge”, HMRC has been known to not grant clearance in cases where the company has distributable reserves available which could be used to pay a dividend, instead of reducing capital and returning it directly to the shareholder.


HMRC will, however, usually be willing to grant clearance for a capital reduction returned directly to a shareholder where it is part of an exit strategy, even where the capital has been created by inserting a holding company via a share-for-share exchange, as illustrated in the HMRC consultation paper. A buyback of shares would be a common exit strategy for your clients; however this requires sufficient cash and distributable reserves to be available, which might not always be the case. Where a buyback is planned to take place in multiple tranches to help with cash flow, it can difficult to predict the level of reserves at each buyback date. A multiple capital reduction exit strategy could be a more predictable option.

Example. Your client is in business with his two sons but is now approaching retirement age. In order to ensure a smooth handover to the next generation, it has been agreed that your client will exit the company in a phased transition over the next five years, with 1/5th of his shares being acquired by the company each year. The company is owned equally by the three shareholders and is worth £900,000.

A holding company is put in place via a share-for-share exchange, with 900,000 £1 ordinary shares issued equally to the shareholders to reflect the value of the subsidiary company. Your client now holds sufficient share capital to frank the capital reduction, with the first tranche of 60,000 shares reduced and £60,000 cash returned to your client. The same procedure can take place over the next four years with the benefit of the HMRC clearance.

Practice point 1. HMRC will only be willing to grant clearance under the TiS legislation if it is just your client’s shares that are reduced following the share exchange. If the sons also reduce their share capital, HMRC could assess their transaction at the income tax rates.

Practice point 2. A reduction of share capital will apply to all members of the company pro rata to their shareholding, therefore it will be necessary to reclassify your client’s shares into a separate class of share first, before it is reduced.


Another practical use of a capital reduction is to use it to insert a holding company above a trading company, as an alternative to a share-for-share exchange. This can come in handy for your client where the share exchange would trigger a stamp duty liability. Where a share exchange results in the holding company having the same shareholders and share proportions as the trading company has, relief from stamp duty will be granted under s.77 Finance Act 1986 . However, where there are arrangements in place at the time of the share exchange for the control of holdings to change following the share exchange, relief from stamp duty will be denied under s.77A . A reduction of capital can provide a tax-efficient alternative.

Example. Your client and his brother jointly own Tradeco, holding A and B shares respectively. They incorporate a new company, Newco, subscribing for one share each. The capital on the A shares in Tradeco is reduced and cancelled, with Tradeco then issuing shares to Newco, with Newco issuing shares to your client. The same then takes place with the B shares, with the result being your client and his brother own shares in Newco, which in turn owns shares in Tradeco.

Practice point. The cancellation and issue of new shares does not trigger a stamp duty liability as there is no transfer of shares.


A capital reduction demerger of a property company would involve the share capital being reduced, but instead of cash being return to the shareholder, the properties would be returned instead. Usually this is returned indirectly to the shareholder, by transferring a company that owns the properties rather than transferring the actual properties.This avoids the need for a liquidation demerger.

Example. Your client and his brother are the sole shareholders of a property rental company, Propco. After years of being in business together they have decided to go their separate ways and each own half of the properties in their own company. As Propco was only incorporated with £100 of share capital, it will be first necessary to insert a holding company, Holdco, above Propco to create the required capital, which will be equal to the market value of the properties. Once Holdco is in place, half of the properties can be transferred up to Holdco with the other half remaining in Propco. The shares in Holdco will need to be in separate classes, with your client’s shares having rights only to the property assets of holdings, and the brother’s shares having rights only to the shares in Propco. The brother’s shares are then reduced and cancelled, with the shares in Propco transferred to his new company.

* Capital reductions are particularly useful where there are insufficient reserves to pay dividends, or as a way to extract capital on retirement. They can also play a role in share reconstructions and reorganisations. Always apply for HMRC clearance under the transactions in securities legislation before the transaction is undertaken. You will also need to ensure the required documentation is completed and submitted to Companies House within 15 days of the resolution.