Transactions in securities - will you be paying income tax instead of CGT?

There is particularly tricky anti avoidance tax legislation known as "transactions in securities" (TIS) which HMRC will use to tax capital profits at the much higher income tax rate.  The transactions in securities legislation (TIS) is anti avoidance legislation applied where HMRC think income tax should on a share transaction rather than the lower rate of capital gains tax. HMRC target this at companies where the shareholders are married but also extend the transaction in securities legislation to other relationships where the shareholders can be described as "connected".   The extent of a share transaction is in practice wide. Our role is to see if you can escape income tax by bringing your transaction outside of the transaction in securities TIS rules. 

A shareholder transferring his shares will probably expect to pay capital gains tax on the gain in value since he or she acquired them (so capital gains tax at 18% or for higher rate or additional rate tax payers 24% on the gain. And the Seller may also want to claim Business Asset Disposal Relief (previously Entrepreneur’s Relief) (BADR), assuming the requirements for this are satisfied reducing the rate of capital gains tax to 14% for the first £1m (increasing to 18% from 6 April 2026).  Ideal scenario potentially.

But beware! If the payment received for the shares falls under the transactions in securities rules (TIS) the consideration is subject to income tax as a dividend. And, if that is the case, there will be no Business Asset Disposal Relief to reduce the tax liability.

Which share transfers are at risk of the TIS rules?

The transactions in securities rules (TIS) are intended to prevent tax avoidance. In particular, TIS is  intended to prevent taxpayers from exploiting the attractive capital gains tax rates of tax which are lower than rates of income tax.  Not all share transfers will be caught by TIS anti avoidance legislation.   The legislation is limited to:

• Close companies;
• Cases where the main purpose of the transaction is to obtain a tax advantage by usually avoiding paying the higher rate of tax on a dividend; and
• The shareholders are connected and through that connection collectively retain a significant interest in the shares of the Company before and after the transaction.  Husband and wife shareholders and family members are often caught if they attempt a share buy back and do not present strong arguments as to why the transaction is commercial.

What transactions in shares are included within the transactions in securities legislation?

The legislation is all encompassing as it includes:

• cases where the company is buying back its shares from its distributable profits and the tax payer is hoping to pay CGT rather than dividend tax,
• the issue of new shares at below market value or a discount,
• altering the rights attached to shares to provide better rights such as larger voting, bigger dividend or more capital on sale/transfer,
• repayment of share capital or share premium, and
• distribution of assets including cash on winding up.

Receipt of a dividend is not within the TIS anti avoidance legislation.

Close companies

The TIS Rules only apply to close companies.  A close company exists where the company:

• is UK resident; AND
• it either has five or fewer “participators” (let’s call them shareholders) OR any number of shareholders all of whom are directors; AND
• the shareholders either “control” the Company (as defined in the relevant legislation – so the meaning could be wider than you expect) OR are entitled to acquire or receive to receive the greater part of the assets available for distribution among shareholders if the company were to be wound up.

So, in fact, many family run companies including husband and wife companies are "close companies".

In practice the test of whether a company is close can be complex.  This is an area we can assist with where a transaction is planned.

Exceptions to the TIS rules

The second test for the transaction in securities rules to apply is where the main purpose, or one of the main purposes, of the transaction is “to obtain a tax advantage”. For these purposes the advantage is paying CGT rather than income tax . If you qualify for Business Asset Disposal Relief the tax advantage is even greater because the rate of CGT is lower.

The transaction in securities TIS Rules will not apply if it can be shown that the following circumstances apply.  HMRC looks at not just the main purpose behind the transaction but also the consequences that may be expected to result from the transaction. :-

• There has been a fundamental change of ownership - A transaction which leaves the Seller and any of the Seller’s “associates” (see the very broad definition of associates) controlling less than 25% either directly or indirectly of share capital, dividends or votes in a close company will fall outside of the TIS rules. For these purposes “associates” means broadly speaking, spouses, parents, children, siblings, business partners, trustees of a settlement where the participator was the settlor or a beneficiary, companies controlled by the Seller or any associates etc.  If say a wife sells her shares but the husband still owns at least 25% TIS will bite because she will be deemed to retain a connection with her husband post sale.
• If there are genuine commercial reasons for the transaction - Essentially, this means if HMRC wanted to challenge the transaction and assess consideration to income tax rather than capital gains tax HMRC would need to establish there was no genuine commercial reason for the transaction. We do see the HMRC accept as genuine transactions share transfers as a result of a dispute, divorce, retirement, a change in direction of the business making the input of the relevant shareholder/director are no longer required.
• If the transaction is carried out in the ordinary course of making or managing investments - Again, the aim is to show that there is a reason for the doing the transaction which is not primarily to get a tax advantage.

Are your reasons good enough for HMRC?

To get certainty as to whether HMRC accepts that your reasons for buying back the Seller’s shares in a close company are genuine commercial reasons, it is possible to apply to advance clearance from HMRC. HMRC will want to see the paperwork. Tempting as it is to cut corners, paperwork such as board minutes and evidence of the background reasons for the transaction should be kept.

How much tax can HMRC reclaim?

The amount of tax that can be assessed by HMRC under the TIS rules is limited to the amount that could have been paid out as a dividend. For this purpose a company’s reserves are treated as increased by the distributable reserves of any subsidiaries.

This means that cash rich companies need to review their cash positions very carefully before entering into transactions.   Directors approving transactions between shareholders do have to be aware of the rules.   There may be work arounds available by using company share buy backs or share capital reorganisation.

Apply for clearance

Getting caught under the transactions in security rules (TIS) is nasty for close company shareholders. Tax assessments of up to 45% plus in some case national insurance can be raised instead of the expected assessment to capital gains tax. The safest option is to apply to HMRC for advance clearance before entering into the transaction.  We do deal with these applications so please do get in touch.