Divorce related Share Buyback
We advised a client on a share buyback in a divorce situation where husband and wife were the shareholder owners of the company,
We were recently instructed by the CEO of a digital payment provider (Company) who wanted to buy back the shares of his wife, 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, rather than our client just buying back his wife’s shares. Provided certain requirements were met, the wife could benefit from Business Asset Disposal Relief (BADR) and the husband could potentially use the tax saving gleaned by his wife as a negotiation tool to reduce the amount he would pay as part of the divorce settlement.
How would the buyback benefit the company?
The primary purpose of a buyback must be that it is for the benefit of the Company and clearly it was in this instance, given that two founder directors remaining at the helm whilst going through a divorce is unlikely to benefit the efficient, conflict-free operation of the Company.
Business Asset Disposal Relief (BADR)
In order to make the transaction as tax efficient as possible, by arranging for the Company to buy back the shares and utilise BADR, the wife would only pay 10% CGT on the first million pounds of shares sold, and 20% CGT on the purchase of the balance of the remaining shares. The benefit of being able to use BADR, if it applies, 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. It is important to note that BADR is a lifetime allowance, so it can only be used once during the lifetime of the shareholder selling his or her shares.
How to fund the share buyback?
In order to benefit from BADR in circumstances where the Company did not have sufficient distributable capital reserves to pay for the shares, a series of loan notes (where there will be more than one instalment payable) were issued via a new company structure and then the shares of the exiting shareholder wife were paid for by way of cash and loan note(s) using a Loan Note Instrument (LNI). 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, in order to comply with the complex tax rules which apply in this scenario.
Negotiating security for the Loan Notes
If you are a shareholder exiting a company and want to ensure as much as possible that all payments will be made under the LNI, security in the form of a personal guarantee from the remaining shareholder or more commonly, a fixed and floating charge over the assets of the Company, is advisable. Understandably, our client’s wife and her advisors wanted some security over the assets of the company due to the risk that the Company will not be able to afford the payment(s) 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
The wife had to 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 are:
- 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.
It is for the reason stated in the last bulleted point above that it is advisable to seek HMRC’s approval for the buyback, since 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 can (and usually do) prepare the letter to HMRC and obtain approval on your behalf.
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 purchase agreement
- the board minutes
- the Companies House form
- the shareholder resolutions
- notice to Company’s House to cancel the shares which had been sold
- other ancillary documentation needed.