Company forces share buyback
To successfully manage the sale, first we reviewed the relevant documentation. This included the company’s articles of association, shareholders’ agreement and director service agreement. We also advised on making the sale in the most tax efficient way.
Forced share sale when an employee or director departs
We explained that the employer had three options to resolve the sale of the employees’ shares. Each had different tax consequences. The first of the three options was for the employee to remain a company shareholder. Alternatively the company could buyback the employee’s shares and cancel them after the buyback. The third option was for the shares to be sold to a third party or existing shareholder of the company.
It is always difficult to establish a value for shares when selling a private company’s shares, as there is no market.
Employee remains a company shareholder
The employee could have remained a shareholder in the company indefinitely. However, the employer wanted a clean break, believing there would be future growth in the value of the shares. This meant it was in their best interests to reacquire them.
Sell shares to an existing shareholder
We advised that the employee could sell his shares to one or more existing shareholders. This is straightforward from a legal perspective. It would involve signing both a stock transfer form and a short form share purchase agreement.
In addition, as a 15% shareholder, who was still an employee and company director, the employee qualified for entrepreneurs’ relief. His effective capital gains tax rate would therefore only be 10% on the first £1 million of lifetime gains.
However, the main hurdle for this route would be finding any existing shareholder(s) willing to purchase the shares at a reasonable value.
Company share buyback
We advised that if the company purchased the employees shares, more complex legal and tax considerations emerge. However, after approaching existing company shareholders, only the company buyback option was viable.
The support we provided for our client throughout the share buyback process included firstly negotiating the price that the company would pay for the shares.
Reducing tax liability
We also agreed in advance with HMRC that the sum received by our client would be treated as capital, not as a dividend. A dividend would result in a significant tax liability for our client.
Thus, the employee was subject to tax on the same basis as if he had sold his shares to a third party. The employee’s tax position would have been different if either the shares had not been held for five years or there was a part-disposal of the shares.
Qualifying as capital rather than dividend
In order to qualify for capital treatment on a share buyback various conditions need to be satisfied. Firstly, the company buying back the shares cannot be listed on an exchange. The company also needs to have formerly been a trading company. Furthermore, the purpose of the share buyback itself should be to benefit the company’s trade, and it cannot form part of a tax avoidance scheme.
On the part of our client, he needed to have resided in the UK and owned the shares for more than 5 years. He also needed to sell all of his shares, and cease any connection with the company after the sale.
Entrepreneurs’ tax relief and share buyback documentation
Timing was important. To qualify for the beneficial tax rate of 10% available under entrepreneurs’ tax relief, the employee must be employed or a director at the date of the share buyback. Once the purchase price was agreed, we reviewed and negotiated the documentation to effect the sale and cancel the shares. This included the share buyback agreement, the board minutes, the Companies House forms, and the shareholder resolutions.
The share cancellation meant that existing shareholders effectively increased their holdings, in return for allowing the payment out of distributable profits, to buyback the employees’ shares.
Helen Curtis is a member of the employee share plan team. There are many surveys and statistics which show that companies with employee share plans in place out perform those without. We implement a wide range of solutions for a wide range of business needs.
Gannons are consummate professionals who adeptly handled every aspect of this transaction