ACCA Advanced Taxation (ATX) Practice Exam

What happens if the conditions for capital treatment on purchase of own shares are not met?

1. It is treated as a loss.

2. It is treated as a capital gain.

3. It is treated as a dividend.

4. It is ignored for tax purposes.

The correct answer is: It is treated as a dividend.

When the conditions for capital treatment on the purchase of own shares are not satisfied, the transaction typically attracts a different tax treatment, which in this case is treated as a dividend. This situation arises because the purpose of the specific capital treatment is to ensure that the return of capital is recognized without being taxed as income. However, if the criteria for capital treatment are not met, the distribution does not meet the requirements to be treated as a capital transaction and therefore is instead categorized as a distribution to shareholders. Such distributions generally carry a different tax implication, being treated as dividends, which are taxed differently than capital gains or losses. This treatment aligns with tax regulations that seek to prevent tax avoidance through the manipulation of capital distributions, instead classifying the transaction in a manner similar to dividend distributions, subject to income tax. Therefore, correctly identifying the non-compliance with the conditions for capital treatment leads to the conclusion that the purchase of own shares will be taxed as a dividend, which may affect the tax position of both the company and the shareholders involved.