Tax on share buy back

Acting for an employee of a digital media company who was changing jobs to work for a competitor. We helped the employee to sell his shares in the employer company and negotiate his post-termination restrictions.

Our client had recently resigned as an employee of a digital media company, in order to take up a fantastic opportunity with a competitor. He wanted us to sell his company shares, and negotiate with his employer to reduce his post-termination restrictions. This required reviewing the relevant documentation, including the company’s articles of association, shareholders agreement and director service agreement.

Selling shares for value

The shares had originally been issued upon exercise of EMI options.  We established that our client had several options for selling his shares. Each of these had different tax consequences. This was because, unusually, the articles of association and shareholders agreement did not require a director or employee to sell their company shares when their directorship or employment ceased.

Our client's main options were to: remain a company shareholder; sell his shares to a third party; sell his shares to an existing company shareholder; or allow the company to buy back his shares.

Remain a company shareholder

Under the terms of the EMI option agreement our client could have remained a company shareholder indefinitely. However, he wanted a clean break and to cash in the value of his shares. Additionally, the company would not want a senior employee of a competitor to be a shareholder.

Share sale to third party

The articles of association contained pre-emption rights on share sales to a third party. In any event, our client thought it unlikely that any third party would purchase his 15% minority shareholding.

Share sale to existing shareholder

We advised our client that selling his shares to one or more existing shareholders was straightforward. Legally, it would just involve signing a stock transfer form and short form share purchase agreement.

Done right, he would benefit from Business Asset Disposal Relief, because he was still a company employee and director. This would mean an effective capital gains tax rate of 10% before 5 April 2024 and 14% from 6 April 2024 on the first £1 million of lifetime gains.

However, finding existing shareholder(s) willing to purchase his shares at an agreed price proved difficult.

Selling shares back to a company

Upon reflection, a company share buyback was the most viable option.  This is because if the company buys back its shares the funds are then provided by the company out of distributable profits.  This compares with a regular share purchase where the funds are provided by the purchaser usually from taxed profits. The shares bought back can be cancelled which means the remaining shareholders have an uplift in the % of shares they hold.  As an alternative, the shares bought back can be held in treasury for future use but that was a decision for the directors and did not impact on our client as following the buy back he would no longer be a shareholder.

Company share buy backs are very popular.

Capital versus dividend

Our client was in the highest tax rate bracket and therefore he would have incurred significant tax liabilities if the payment made by the company for his shares was taxed as a dividend.  We worked with the employer to apply to HMRC for confirmation that the buyback satisfied the tax requirements for the payment to be treated as capital (see below). If the payment the employer makes for the shares is treated as a capital payment by HMRC our client would be in the same position as if he had sold his shares to an independent person.  As explained BADR (business asset disposal relief) if available on a capital payment if the conditions are met.

Tax requirements for capital treatment

HMRC required several conditions to be satisfied in order to treat the consideration paid for the shares on buy back as capital.

• Firstly, that the company buying back the shares was an unquoted trading company.
• Secondly, that the purpose of the buyback was to benefit a trade carried on by the company, and did not form part of a tax avoidance scheme.
• Thirdly our client had to be both a UK resident and have held the EMI option for at least two years.
• Finally, our client was to sell all of his shares in the company, meaning he would no longer be connected to the company after the sale.  There is a general rule that at least 75% of the shareholding must be sold and some tricky rules around what that means in practice based on the history of previous disposals made of the shares.
• If the rules for BADR are satisfied the lower rate of CGT applicable under the BADR regime will apply.

Finalisation

Once the purchase price was agreed, we reviewed and negotiated the documentation to make the sale happen. The company’s legal advisers prepared these documents, which included: a share buyback agreement; ancillary documents including board minutes; Companies House forms; and shareholder resolutions.  We also dealt with the settlement agreement issued upon termination of employment.

The company was responsible for payment of stamp duty and once the shares had been bought back by the company, they were cancelled.