Share buy-backs: the good, the bad and the ugly!
In a private company it may be difficult for the shareholders to exit without a company sale. Management may want to take over but do not have the required cash to buy shares in the company and if shares are gifted to management they will be subject to a large tax bill. One solution is a company purchase of own share (POS).
In essence a POS is simple. There are however numerous rules regarding the POS transaction and many pitfalls for the unwary. The default tax treatment is that the sale is treated as a company distribution which may result in the whole of the value of the shares, in excess of the original subscription price, being taxed as a dividend. Provided certain tests are met, however, the disposal could be treated as a capital gain. The tax difference can be enormous: dividends are taxed at up to 42.5% while capital gains tax can be as low as 10% if the shareholder qualifies for Entrepreneurs' Relief.
Below we summarise the good, the bad and the ugly of POS transactions.
- POS provides an exit mechanism for private company shareholders
- If used with an option scheme such as an EMI a POS can act as the vehicle for an MBO without the management having to borrow large funds to acquire the shares
- Advanced clearance can be obtained from HMRC
- The main purpose of the trade must be to benefit the trade of the Company - not the avoidance of tax
- The shares must normally have been held by the vendor for 5 years prior to the sale
- After the sale a reduction of at least 25% of the vendor's share interest must have occurred, but a greater reduction may be needed in order to show that the transaction is for the benefit of the trade
- After the sale the vendor cannot be connected to the Company: connected in this regard is defined (broadly) as a direct or indirect interest of more than 30% in the share capital or voting power of the company
- Full cash payment must be made at the purchase; deferred payments or instalments are not accepted by HMRC unless each satisfy the above tests
The ugly - getting it wrong
- Losing Entrepreneurs' Relief if the director resigns before the repurchase is complete
- Not checking the articles to make sure there are no provisions, such as pre-emption rights, that could prevent the repurchase
- Not passing a special resolution to authorise the repurchase (an ordinary resolution in the case of a public company purchasing quoted shares from the market), or not circulating the proposed purchase contract at least 15 days before the resolution is passed
- Forgetting to make a return to HMRC within 60 days of the POS with the payment details
Make sure you read next month's newsletter for ways in which some of the above problems can be avoided using an employee benefit trust without falling foul of the new disguised remuneration regulations. If you would like more information on company purchase of own shares then please contact the RM2 team on 020 8949 5522.