Divorce related share buyback

We were instructed by a director shareholder who wanted to buy back his wife's shares, who was also a director and shareholder. They were getting divorced and looking for tax efficient solutions. We suggested that a share buyback by the Company would be the best way to do it. There were many advantages to a buy back by the Company for both individuals. this allowed for the shares to be paid for out of capital held by the Company rather than taxed income in the hands of the husband, as well as providing additional tax advantages for the wife.

How would the buyback benefit the company?

The primary purpose of a buyback must be that it is for the benefit of the Company. In this instance, the advantage too the Company was clear, given that two founder directors remaining at the helm whilst going through a divorce was unlikely to benefit the efficient, conflict-free operation of the Company.

Business Asset Disposal Relief (BADR)

To make the transaction as tax efficient as possible for the existing shareholder we arranged for the Company to buy back the shares and utilise BADR. As a result, the wife would only pay 14% CGT on the first £1m of shares sold. the gain made on the sale of the remaining shares beyond the £1m limit would be charged at the 24% rate of CGT.  The rate will increase to 18% for buy backs transacted after 6 April 2026. The benefit of being able to use BADR where applicable, is that the monies received on the sale of the shares back to the Company will not be treated as dividend income, but a sale of a capital asset and hence only the application of CGT will apply.  BADR is a lifetime allowance, so the relief cna only be claimed up to the value of £1m during the lifetime of the shareholder selling his or her shares.

If the transaction does not qualify as a capital payment, HMRC will assess the payment as a dividend.  The highest rate of tax on dividends is currently 39.35% but lower rates of tax apply for lower rate tax payers.

How to fund the share buyback?

As the Company did not have sufficient distributable capital reserves to pay for the shares, a series of loan notes were issued. This structure enabled for payment in multiple instalments whilst still allowing the exiting shareholder to benefit from BADR. We established a new holding company structure to issue the loan notes, and then the shares of the exiting shareholder wife were paid for by way of cash and loan notes.   As the shares are then cancelled, the remaining shareholder is left with a larger shareholding (in this case, our client’s ownership went from 55% to 100%). The second and any subsequent payment may not be made for at least six months after completion to comply with the relevant tax rules.

Negotiating security for the loan notes

If you are a shareholder exiting a company and want to be certain that all payments will be made under the loan note, it is advisable to arrange a form of security. This could mean obtaining a personal guarantee from the remaining shareholder or more commonly, a fixed and floating charge over the assets of the Company. Understandably, our client’s wife and her advisors wanted some security over the assets of the company due to the risk that the Company would be unable to afford the payments under the Loan Notes. We managed to reduce and resolve the wife’s concerns with other assurances so that the parties eventually agreed to waive any requirement that security be taken as well.

Clean break from the company needed to secure tax efficiency

The legislation required that the wife resign as a director and employee as soon as her shares had been bought back, otherwise she would not qualify for BADR.  Other requirements to qualify for BADR include:

• residency in the UK at the time of the sale
• ownership of the shares for at least five years (if held for more than two)
• disposal of all shares, not just part
• the Company cannot be listed on an exchange and must formerly have been a trading company
• the purpose of the buyback is to benefit the Company’s trade and not be used as part of a tax avoidance scheme.

HMRC Approval

For the reason stated in the last bulleted point above, it is advisable to seek HMRC’s approval for the buyback. Once that is obtained, HMRC cannot determine at a later date that BADR will not apply unless there is clear evidence contradicting what was previously disclosed to HMRC about the transaction. We prepare HMRC clearance letters and are regularly successful in obtaining approval for our clients.

Share Buyback Documentation

Once the purchase price was agreed, we reviewed and negotiated the documentation to effect the sale and cancel the shares.

This included :-

• the share buy back agreement;
• the board minutes;
• the Companies House forms;
• the shareholder resolutions;
• notice to Company’s House to cancel the shares which had been sold;
• other ancillary documentation needed; and
• dealing with stamp duty.