When a company pays you a capital distribution, it is normally a part disposal of your shares for Capital Gains Tax. If the amount is small compared with the value of your shares, section 122(2) TCGA 1992 lets you deduct it from your base cost instead, so there is no gain to report now. HMRC accepts a distribution as small if it is 5% or less of the value of the holding, or £3,000 or less.

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What is a capital distribution?

Section 122(5)(b) of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) defines a capital distribution as any distribution from a company, including one in the course of dissolving or winding up the company, in money or money’s worth, except a distribution that is income in the hands of the recipient for income tax. Section 122(5A) extends this to distributions before a dissolution that fall within section 1030A of the Corporation Tax Act 2010.

HMRC’s Capital Gains Manual at CG57800 lists the capital distributions most often seen in practice:

  • distributions by a liquidator in a winding up;
  • cash paid on a takeover alongside new shares or debentures;
  • distributions on a repayment or reduction of share capital;
  • the sale of provisional letters of allotment in a rights issue, which section 123 treats as a capital distribution.

A bonus issue or rights issue is not itself a capital distribution, and a qualifying demerger is treated as a reorganisation instead (CG57800).

How is a capital distribution normally taxed?

Under section 122(1) you are treated as if you had disposed of an interest in the shares in return for the distribution. As no shares are actually sold, CG57800 explains that cost cannot be apportioned by number of shares. The usual part disposal formula in section 42 applies: the cost allocated is A over A plus B, where A is the distribution and B is the market value of the shares you still hold. The date of disposal is the date you receive or become entitled to the distribution. The formula is explained in part disposals.

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When is a capital distribution small?

Section 122(2) says that if the amount distributed is small compared with the value of the shares, the distribution is not treated as a disposal. The statute does not define small. CG57835 sets out HMRC’s practice:

  • HMRC’s long held view is that small means 5% or less of the value of the shares, measured immediately before the distribution.
  • Since Tax Bulletin 27 in February 1997, HMRC also accepts a distribution of £3,000 or less as small, whether or not it is within 5%.
  • In O’Rourke v Binks the courts treated the question as one of fact and degree, so a distribution above 5% can sometimes be argued to be small, and one below 5% may on the facts not be.

The test is applied separately to each shareholding. For a quoted company the value per share is usually the same for everyone; for an unquoted company a valuation may be needed (CG57835, CG57840).

What happens to my base cost?

Where section 122(2) applies, the amount distributed is deducted from the allowable expenditure on the shares. Nothing is reported as a gain at the time, and CG57835 notes that these distributions are ignored in deciding whether you have used your annual exempt amount.

For shares in a section 104 holding, CG57844 explains that the pool of qualifying expenditure is reduced by the distribution. For companies the indexed pool is reduced too, and the distribution is an operative event, so indexation is calculated up to that date. Lower cost means a larger gain when you eventually sell, so the tax is deferred, not removed. Pooling is explained in share matching rules.

What if the distribution is more than my base cost?

You cannot deduct more than you have. Section 122(4) says that where allowable expenditure is less than the amount distributed, or is nil, section 122(2) does not apply. If there is some expenditure, you can elect to reduce the amount distributed by that expenditure, in which case none of it is available on any later disposal. CG57847 explains that, following the Court of Appeal in O’Rourke v Binks, this election can only be made where the distribution is small, and that for a section 104 holding it reduces the pool to nil.

Can I choose to treat a small distribution as a disposal?

Yes. CG57838 recognises that a taxpayer may prefer part disposal treatment because a disposal uses up only a proportion of the cost, whereas section 122(2) deducts the full amount. This helps where the gain would be covered by the annual exempt amount, which is £3,000 for 2026 to 2027. HMRC says this treatment may be acceptable but may consider whether to challenge it in an enquiry. See the annual exempt amount.

If a distribution falls outside the 5% and £3,000 tests but you believe it is small on the facts, CG57839 says the gain or loss should be shown in the list of disposals on the Capital Gains pages with an explanation, but left out of the totals.

How does this work in practice?

Illustration only. Chris holds 20,000 shares in a pool costing £30,000. The company reduces its share capital and pays him £2,500. Just before the payment his shares are worth £80,000, and just after it they are worth £77,500.

  • £2,500 is 3.1% of £80,000 and also under £3,000, so it is small on both HMRC tests.
  • Under section 122(2) there is no disposal. His pool cost falls to £27,500.
  • If he chose part disposal treatment instead, the cost allocated would be £30,000 times 2,500 / (2,500 + 77,500), which is £937.50. His gain would be £1,562.50, covered by the annual exempt amount if he has no other gains, and his pool cost would only fall to £29,062.50.

If his pool cost had been only £1,000, section 122(2) could not apply because the £2,500 exceeds the cost. He could elect under section 122(4) to deduct the £1,000, leaving a gain of £1,500 and a pool cost of nil.

What mistakes come up most often?

  • Ignoring small receipts such as cash for fractions or lapsed rights, so the pool cost is never reduced and the later gain is understated.
  • Applying the 5% test to the whole company instead of the individual holding, or using a value after the payment.
  • Using section 122(2) automatically when part disposal treatment with an unused annual exempt amount would leave more cost for later.
  • Treating each payment in a liquidation as small without checking the size of each against the value of the shares at that time.
  • Treating a sale of rights nil paid as a separate asset with no cost; see bonus issues and rights issues.
  • Reporting income distributions under these rules, when section 122 only covers distributions that are not income.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.