Company buyback of shares

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Company buyback of shares

A company buyback of shares distributes profit.  Done right, and shareholder payments qualify as capital. Errors cost you entrepreneurs’ relief & personal liability.

There is a process to satisfy.  Done wrong, you lose the tax benefits or void the transaction.  The buyback can:

  • Distribute profits;
  • Create a market for the private company’s shareholders;
  • Generate a lower tax capital payment to shareholders,
    • Rather than higher tax income payments.

Explaining a company buyback of shares

A company buyback of shares is a perfectly legitimate method of extracting cash from a private company. Meet HMRC’s conditions and the payments are treated as capital.

Hence share buybacks are popular with privately owned companies, owner managed businesses and family controlled companies.  We support both companies and shareholders considering a share buyback.

What is a company share buyback?

A share buyback enables a private company to purchase its own shares from an existing shareholder. It returns the company’s surplus cash to a shareholder.

Company share buyback conditions

If certain conditions are met, the shareholder’s payment is taxed as capital. In summary:

  1. The company uses its post-tax distributable reserves to pay for the shares.
  2. The company cancels the shares bought back: all remaining shareholders gain an increase in value as there are fewer shares in issue.
  3. You should satisfy HMRC’s requirements for the payment from the company to the shareholder to be treated as capital.
  4. If the payment does not qualify as a capital payment, then the shareholder is taxed as if he had received a dividend.

Common issues resolved by a company buyback of shares

Common situations that trigger a company buyback of shares:

  • Provide an exit for a shareholder;
  • Departing director is forced to sell his shares by the articles or shareholders’ agreement;
  • Utilise distributable profits.

Solving problem areas with a company buyback of shares

The process has complications set down by both HMRC and under company law. Common problems include:

Loss of entrepreneur’s relief

If the share buyback is incorrectly executed, it is void. The transaction can be unwound. The repurchased shares are treated as still belonging to the original shareholder. However, if the shareholder is no longer employed by the company, the shareholder might lose entrepreneurs’ tax relief.

Personal liability for unlawful distribution

Directors have a common law duty to maintain the company’s capital.  Say the company directors fund a share buyback out of capital. If they don’t follow appropriate procedures, they are making an unlawful distribution.

Now, they are personally liable. If the company cannot pay its debts or bills because of the unlawful distribution, then it’s the directors who pay.

Interest & penalties

Perhaps the share buyback is wrongfully reported as a capital gain.  On the tax return, it should have been reported as an income payment.

So, the tax return is incorrect. HMRC imposes interest and penalties for incorrectly reporting tax.

Company share buyback vs share purchase

A share buyback is a transaction between an existing shareholder and a company.  The company can repurchase its shares at any price, given shareholder’s approval and distributable reserves.   Funding is from the company. After the buyback, the remaining shareholders’ stake increases, since fewer shares are in issue.

A share purchase is a transaction between a shareholder and an independent third party buyer. The purchase price depends upon the buyer’s willingness to pay. Often, the directors must approve the purchase. Funding is from the purchaser. There is no impact on existing shareholders.

Funding the company share buy back

The law does not fix the share price for share buybacks from a shareholder. The price is a matter of negotiation. However, the company must have sufficient distributable reserves to fund the share buy back.

  • Distributable reserves:  are the company’s accumulated profits after tax. It can include trading profits, some investment profits and dividends from group companies.
  • Borrowed money will, generally, not be included in distributable reserves. Planning is required to lend money to repurchase shares.

We will review the source of the distributable reserves to avoid some pitfalls, e.g.

  • If over 20% of distributable profits arise from investment activities, HMRC might not consider the company is ‘trading’ for tax purposes.
  • Groups and individual balance sheets can cause problems.

Buy back from a new share issue

A company can raise money by issuing new shares and using the subscription monies to fund the company share buy back from a departing shareholder. Where the company issues new shares to raise money for the buy back it needs to make it clear that this is the purpose of the share issue. If shares are issued in consideration for the buy back, the buy back will be void and the purchase price will become repayable.

Buy back from borrowing

Funding share buybacks with borrowed money is generally prohibited for private companies. We review and discuss HMRC approved ways to restructure the company before the buyback to get around any problems.

Alternatives to cash

Shares can be repurchased by distribution in specie e.g. maybe the company owns property, and this asset could be distributed to a shareholder. Alternatively, the company could release a shareholder from an existing debt. However, the distribution will not receive capital treatment.

Deferred buyback

A deferred buyback means the company pays the shareholder for the shares at a later date and/or in stages, i.e. for deferred consideration. There are restrictions on the in the Companies Act relating to payment for shares.  The result is that the  shareholder must protect himself against the company’s default in paying for the shares upon the buy back. We protect shareholders by drafting guarantees and bespoke default clauses.

Taxation issues arising under a company share buyback

Unless you qualify for capital treatment, shareholders are taxed on the payment received as if it was a dividend. HMRC’s key requirements to treat the buyback as capital include:

Conditions to be satisfied for capital taxation of the proceeds received from the company following the share buy back

  • The shareholder must have held the trading company’s shares for five years;
  • The departing shareholder’s holding must substantially reduce, i.e. by at least 75%;
  • The buy back cannot be a part of a tax avoidance plan.

We will tell you if you meet the above criteria, in which case the share buyback is probably treated as a capital distribution. It is then taxed as capital gains at the rate of 20%.  Meet the requirements for entrepreneurs’ relief, and the capital gains tax rate reduces to 10%.

HMRC clearance to a company share buyback

An HMRC clearance enables shareholders to plan. We often use HMRC’s pre-transaction clearance services to confirm that a proposed share buyback qualifies for capital treatment.

For share buybacks clearance takes 5-6 weeks. The clearance remains binding if there is no material change in buyback company’s circumstances or structure.

Planning for the share buy back

We will plan for your company share buy back and oversee successful implementation.

Before the share buy back

We review the articles of association. We will tell you if there are restrictions that prevent share buybacks, e.g.

  • Prohibition on purchase of own shares;
  • Pre-emptions rights: requires existing shareholders to be first offered the shares, before the company buy them;
  • Restrictions on share transfers;
  • Various rights to capital;
  • Prohibition on financial assistance for acquiring own shares.

Given advance warning, we usually navigate any restrictions.

Shareholder approval to the company share buy back

We will review your requirements for shareholder approval to the company share buy back. If you lack the requisite shareholder approval, the transaction is potentially void.

Drafting the company share buy back documentation

We prepare the documentation needed to implement the company share buy back.  Typically, the documents required for a share buyback include:

  • A share buy back agreement;
  • Board meeting notices for members;
  • Board meeting minutes to seek members’ approval for share buy back;
  • Written resolution to approve share buy back;
  • Stock transfer form; and
  • Company House filings.

If you repurchase shares out of capital, then you require further documents and a Law Gazette announcement to notify potential creditors.

Stamp duty on share buyback

If the purchase price exceeds £1,000, the company pays ad valorem stamp duty on the purchase price of shares.  We will deal with stamping and notifications required to HMRC.

Track record of successful implementation of company share buy backs

A share buyback is a multi-stage transaction. It requires advance planning to be correctly structured, and executed with attention to details. If it goes wrong, the company is embarrassed, and shareholders may face an unplanned tax liability.

  • Our client operated in the optical services industry. One key director/shareholder suffered a stroke. He could no longer participate in the company’s decision making.  The corporate documentation required him to participate in shareholder decisions. Board meeting were inquorate. Unfortunately, the company lacked sufficient cash to repurchase his shares in one lump sum.  To resolve the company’s cash-flow problems, we structured deferred consideration into the buy back. We prepared a schedule of payments and successfully applied to HMRC for clearance.
  • Our client sold security locks, and the company owned many properties. However, one shareholder wished to leave the business. Because of the property portfolio, it was unclear if the company qualified as a trading company for capital gains tax purposes.  We analysed the company’s trading history, and its balance sheet.  We persuaded HMRC that the company did not carry out investment activities to a substantial extent. Hence the company qualified for capital treatment.

Sometimes the buyback arises because an employee or director is leaving the business. We resolve acrimonious situations. We’re skilled at achieving agreement, so shareholders can move on.

  • Structured a shareholder-directors’ exit from an insurance brokerage. We ensured the sale of shares would be treated as capital for capital gains tax purposes;
  • HMRC clearance for 50% shareholder retiring from a chain of opticians;
  • Share buyback documentation for majority shareholder buying out three minority shareholders of golf PR company;
  • Compulsory buyback of employee shares when the employee departed, for Luxembourg-based, property management company. We amended the articles of association.

We execute share buybacks to your maximum advantage, due to our rare combination of commercial and tax expertise.