Chartered Accountants
Company Share Buybacks For Retiring Shareholders
Many family and owner-managed companies face a challenge when it comes to succession planning on the retirement of a shareholder in the company. One common strategy was to use a company share buyback, where the company would buy-back and cancel the shares from the departing shareholder.
The rules are complex, but in principle, a company could buy-back shares from a departing shareholder and, subject to meeting the various conditions, HMRC would grant advance clearance to confirm that the seller would pay Capital Gains Tax (CGT) on the proceeds, usually at the 10% rate by claiming Business Asset Disposal Relief (BADR), rather than paying income tax at the basic rate (8.75%), higher rate (33.75%), or top rate (39.35%).
From the company law point of view, a share buyback must be paid in cash immediately upon completion which presents an obstacle to companies without the cash reserves available to fund the purchase price in full. The most common strategy was to sign a multiple completion contract, where the shares would be bought back in separate tranches by the company, funded out of future profits.
What is the issue?
One of the requirements for CGT treatment is that the seller must not own more than 30% of the ordinary shares or voting rights after the buyback. If the departing shareholder held more than 30% of the voting rights after the sale of the first tranche to the company, HMRC’s opinion was that the CGT treatment would not apply.
Nevertheless, HMRC was prepared to grant advance clearance provided that the remaining tranches of shares (awaiting future purchase) were converted into non-voting shares, thereby allowing the beneficial capital treatment for the departing shareholder to pay CGT at the 10% rate by claiming BADR, rather than income tax at up to 39.35%.
However, a recent internal change within HMRC has led them to reconsider their interpretation of the rules, preventing a company share buyback from being a viable succession strategy in the future.
We have included an example below:
Advance Building Company Limited (ABC) has been trading since April 1979 and is owned by three founder shareholders:
| Shareholder | Number of Shares | Ordinary shares (%age) |
|---|---|---|
| Mr Adamson | 40,000 | 44.44% |
| Mr Brown | 20,000 | 22.22% |
| Mrs Campbell | 30,000 | 33.33% |
| Total | 90,000 | 100.00% |
Having just reached his 70th birthday, Mr Adamson wants to retire from ABC. The shareholders have agreed that the company should buy Mr Adamson’s 40,000 ordinary shares at an agreed price of £800,000. To avoid any adverse impact on the business, the strategy was to adopt a multiple completion contract, as follows:
| Completion Dates | Number of Shares Bought Back | Purchase Price |
|---|---|---|
| 30 April 2022 | 15,000 | £300,000 |
| 30 April 2023 | 10,000 | £200,000 |
| 30 April 2024 | 15,000 | £300,000 |
Mr Adamson’s remaining 25,000 ordinary shares were converted into non-voting shares (awaiting purchase).
HMRC’s historic approach
HMRC had generally been prepared to grant advance clearance, so long as the remaining tranches of shares (awaiting purchase by the company) had been converted into non-voting shares. The departing shareholder was therefore able to enjoy the beneficial CGT treatment by claiming BADR to pay CGT (at the 10% rate where BADR was claimed), which would otherwise attract Income Tax at the dividend basic rate (8.75%), higher rate (33.75%), or additional rate (39.35%).
However, HMRC told the Chartered Institute of Taxation (CIOT) that it appears to have overlooked the ‘possession’ of issued share capital test when granting clearance for transactions. This is likely to have resulted in advance clearance being granted even if the seller was still connected with the company by virtue of their still holding more than 30% of the ordinary shares after the first tranche.
This oversight by HMRC resulted in multiple completion buybacks becoming the prevailing practice for more than 14 years. HMRC has only recently confirmed that this does not represent a new interpretation of the legislation – instead they had not been interpreting the rules correctly in previous advance clearance requests.
What has changed?
HMRC will apply a strict definition of connection, which will prevent many commercially driven multiple completion contracts from attracting capital treatment, which will have a significant impact on the seller’s tax position.
Going forward, clients will have to adopt a more formal management buyout structure by creating a new company (Newco) to acquire all of the shares in ABC Limited.
A Newco buyout would be taxed as a capital gain on the departing shareholder, so they will continue to pay CGT, potentially at the 10% rate if BADR applies. This buyout structure is not ideal, since it involves the creation of an additional company, increased stamp duty charge (reflecting the value of ABC Limited) and so on. On the other hand, it is possible for Newco to issue loan notes for the deferred consideration, which may be secured by a floating charge over the assets of the company, which is likely to be attractive to the seller.
We will further explore succession planning options over the coming months to ensure business owners considering an exit in the near future know what is available to them.
Should you wish to talk to us about a business exit, please get in touch with our EQ Taxperts by emailing [email protected] or call one of our offices.
