To Buy Back or Not to Buy Back?
Are you considering a company buy back of shares?
A company purchase of its own shares is a useful way of exiting shareholders from a company.
However, with the rates of Dividend tax increasing, it is more important than ever to be aware of the pitfalls so as to ensure that there are no nasty surprises.
Benefits of a company buy back of shares:
- The repurchase is funded from retained and/or future profits of the company;
- Removes the need to extract funds from the company via tax inefficient dividends;
- The remaining shareholders do not have to personally borrow funds to buy out the exiting shareholder;
- Mitigates the risk of the exiting shareholder selling to an unknown investor;
- The company can usually get a Corporation Tax deduction for interest on borrowings to fund the repurchase.
The purchase of own shares is given Capital Gains Tax treatment provided that the qualifying conditions of both the Companies Act 2006 and the Corporation Tax Act 2010 are met. If any conditions are not met then the sums paid for the shares will be treated as a dividend.
So what are the conditions?
Companies Act 2006
For a private company the shares can be either purchased out of capital or out of distributable profits. We would foresee that in most instances the shares would be purchased out of distributable profits, in which case:
- There must be enough distributable profits to cover the premium on the purchase;
- The company’s Articles need to allow for the purchase of its own shares;
- The purchase contract must be authorised by an ordinary resolution before the contract is entered into.
- The shares must be paid for in cash at the time of purchase;
- Unless the shares are to be held as Treasury Shares, they must be cancelled immediately on purchase.
Corporation Tax Act 2010
The company must be an unquoted trading company or an unquoted holding company of a trading group.
- must be for the benefit of the company’s trade, or that of its 75% subsidiary;
- must not be for the purpose of tax avoidance
- Must be a UK resident;
- Must have owned the shares for 5 years prior to the repurchase, or 3 years if acquired as a result of death (including the period of ownership of the deceased);
- The seller’s shareholding must be substantially reduced by the repurchase. Substantially reduced is a reduction of more than 25%. Where company is part of a group, the reduction test must be met in connection with the group as a whole;
- Following the repurchase the seller cannot remain connected to the company. For this purpose being connected means having an entitlement to 30% of the issued ordinary share capital, the loan capital and issued share capital or the voting power of the company.
For Entrepreneurs Relief to apply to the sale, the seller will need to have been an officer or employee of the company and owned more than 5% of its share capital for at least one year prior to the disposal.
Due to the subjective nature of the benefit of the trade test, a company proposing the repurchase of shares can seek prior clearance from HM Revenue & Customs that a Capital Gains treatment is appropriate.
The underlying condition of the Capital treatment is that the purchase of the shares by the company is for the benefit of the company’s trade. Two specific circumstances are considered to be for the benefit of the trade:
- disagreement between shareholders over the management of the company, and
- an unwilling shareholder wishing to end their association with the company.
Where a staged exit is required, care must be taken to ensure firstly that the Capital treatment applies to each tranche and then that the availability to Entrepreneurs Relief is preserved throughout. One possible solution is to use a single unconditional contract with multiple completion dates.
The vendor may not always prefer the Capital treatment. A close review of their affairs should be undertaken and where possible the deal structured accordingly.
There may be tax implications where the company purchase is shown to be other than at market value.
Stamp duty is due at ½% on the purchase.
The company buy back of shares is the perfect tax efficient strategy to exit a shareholder from a trading company:
- Without adding personal borrowings to the existing shareholders, or
- bringing in an external shareholder,
Provided the company:
- has excessive cash, and
- adequate distributable reserves.
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