It is possible for shareholders to swap shares and not trigger any tax charges. Share for share exchanges are used for a wide variety of commercial re-organisations. A common example is where a holding company is created for a group structure. We take you through the steps suggesting ideas to improve the process.
Benefits of working with us
We are a specialist law firm with a strong tax capability made up of solicitors, members of the Chartered Institute for Taxation and the Chartered Institute of Accountants. We combine tax law with the practicalities.
- We handle de-mergers, structures with new holding companies, structures designed to ring fence liabilities and related issues. Our clients include accountants who refer this is a specialist area to us.
- Our focus is on private companies, their directors and shareholders and we understand that issues are linked.
- Combing legal with tax means that we can draft the agreements as well as obtain the HMRC tax clearances. We also deal with the shareholder resolutions and filings at Companies House.
Implementation of share for share exchanges
The uses of a share for share exchange are flexible and wide enough to cover many situations. To help you decide if this is the path for you we have set down some of the background considerations.
- Commercial situations where a share for share exchange can work;
- Shareholder considerations; and
- Implementation of a share for share exchange.
Commercial situations where share for share exchanges are used
We implement share for share exchanges in a wide variety of situations. In our experience the most common scenarios include:
- Re-organise a group structure and transfer trades to different subsidiaries;
- Create distributable reserves;
- Streamline ownership;
- Ring fencing liabilities. This is quite popular in IP and tech companies where they wish to protect the IP in the event of business failure/liquidation;
- Manage succession planning;
- Making a business more attractive for sale; and
- Settling shareholder disputes.
Ways of approaching share for share exchanges
The structure for share for share exchanges can be flexible. The approach will vary according to your circumstances. The structures need plotting out under a step list to manage the order of events and to minimise mistakes.
Share for share exchange
A share for share exchange involves the transfer of shares in an existing company to the shareholders of new holding company. The shareholders can be the same in the old and new companies or new shareholders can be introduced.
- The basis of the exchange often needs thinking through to ensure the transaction is tax neutral. For example, one share in company A may be worth 5 shares in company B. All depends upon the facts.
- Often share for share exchanges take place with a transfer of assets from one company to another.
Separation of a business
A separation of the business involves the business separating into two or more businesses and a change of shareholders. The business split can be achieved via cash payments or by a transfer of assets. A transfer of assets is often called a dividend in specie. In addition to tax considerations there are obligations for the directors to consider before deciding on cash or asset payments.
- Dividend in specie are popular as the assets of the business in effect fund the separation.
Scheme of arrangement
A scheme of arrangement is where you cancel the share capital of an old company, transfer the reserves to the new holding company, so the new holding company can issue shares to the old company’s shareholders. A scheme of arrangement is where a court cancels an existing company’s entire issued ordinary share capital.
- A scheme of arrangement does require a court application. For that reason schemes of arrangement are not very common.
Both share for share exchanges or a scheme of arrangement technically involve the disposal of shares in one company and the acquisition of shares in another company. HMRC will be looking to subject the share transfer to tax even though the shareholders do not receive any cash.
However, there are a number of legitimate reliefs available under the tax legislation which enable shareholders to minimise any liability to tax or defer tax until a physical sale of the shares takes place.
Common concerns to consider before implementing the share for share exchange
Depending upon the shareholder base the following concerns may need addressing:
- Can a clearance as to tax neutrality be obtained from HMRC;
- Impact for SEIS and EIS investors under the share for share exchange;
- Is Business Assets Disposal Relief (entrepreneurs’ relief) preserved;
- Should the shareholders complete a hold over elections;
- What is the position for option holders; and
- Is stamp duty payable.
HMRC clearance as to tax status of a share for share exchange
The company can apply to HMRC for a tax clearance to the effect that there is no capital gains tax arising when shareholders swap shares in one company for another company. The clearance can also confirm that there is no income tax liability. We recommend HMRC clearances are obtained as there is no charge made by HMRC and they do provide some degree of certainty for tax payers.
SEIS and EIS investors
Generally speaking EIS shareholders lose their tax reliefs on disposal within three years of their acquisition. A share for share exchange is a disposal because the shareholders swap shares and end up holding shares in a different company. However, HMRC will not consider the shares to be “disposed”, which may preserve income tax reliefs, if:
- The only issued shares in the new holding company are owned by the subscribers, i.e. those named on the memorandum of association; and
- The new holding company acquires all, not just some, of the existing company’s issued share capital on a share for share exchange or under a scheme of arrangement; and probably
- You obtain HMRC clearance in advance.
Business Assets Disposal Relief (Entrepreneurs’ relief)
You may lose Business assets Disposal Relief (entrepreneurs’ relief) on a share for share exchange if there is a future disposal of the holding company’s shares. However, you can preserve entrepreneurs’ relief on a disposal of the newly acquired shares if:
- The shares before the share for share exchange have been held for at least 12 months and represent 5% of the new holding company’s issued share capital; and
- The company is a trading company or holding company of a trading company; and
- The shareholder is a director, officer or employee of the company, or one or more of the companies in the group.
HMRC has strict rules on what does and does not qualify as a trading company. The conditions are ever changing and currently under HMRC’s spotlight. Hence it is crucial to know their conditions on the transaction date. In cases of doubt an HMRC’s clearance can be obtained on trading status.
Hold over elections to defer any charge to capital gains tax
In some cases, depending upon the facts, we may recommend the use of hold over elections. A hold over election defers a charge to capital gains tax which may arise as part of the share for share exchange until such time as the shares are disposed of and proceeds are received.
Hold over elections to need to be reported to HMRC to be effective and binding. Our service includes advice on HMRC reporting.
You will need to review employee share option plans before implementing a share for share exchange as there may be implications to address.
What happens to share rights of option holders depends on the plan rules and share plan documentation. Both the share for share exchange and a scheme of arrangement might unintentionally be a trigger event. This would cause the early vesting or exercise of rights. If the shares have not realised their planned maturity value on the reorganisation date, then a forced early exercise of share plan rights could be detrimental to the option holder. In some cases the solution is to cancel the option and re-grant in the new company.
HMRC approved share plans
Many HMRC approved share plans, including but not limited to EMI, provide for a roll over of option and share rights following a share for share exchange or scheme of arrangement. This prevents early exercise or disqualification from HMRC approved status.
Stamp duty exemption on a qualifying share for share exchange
Unless an exemption applies, stamp duty is payable by the new holding company at a rate of 0.5%, if:
- A holding company acquires the shares of an existing company;
- In return, the shareholders receive shares in the new holding company.
Exemption from stamp duty
The good news is that HMRC offer a stamp duty relief for the new holding company if:
- The share for share exchange is for commercial reasons and not for tax avoidance; and
- The new holding company acquires all the existing company’s issued share capital; and
- The consideration to the existing shareholders is the granting of shares in the new holding company; and
- The shareholders of the existing company acquire the same percentage and class of shares in the new holding company following completion of the exchange.
How to implement a share for share exchange
For a successful transaction you will need a checklist and timeframe enabling you to prepare and manage expectations. The key requirements to check out are summarised below.
You must obtain shareholder approval for a transaction involving either a share for share exchange or a scheme of arrangement. The articles of association or shareholders agreement may include veto rights which must be factored into the planning process. We manage all compliance issues including board approval and shareholder resolutions.
Documentation for the share exchange
We will deal with all of the documentation and filings required at Companies House. We handle:
- The revised articles or shareholders’ agreement to fit the structure post transaction;
- The consultation with any employees affected as a result of the re-organisation.
- Review of the employment documentation to see if the post restrictions the new structure;
- The clearance application required from HMRC;
- Advertising in the Law Society Gazette if required;
- Shareholder resolutions;
- Stamping documentation and dealing with HMRC;
- Reporting and payment of any taxes to HMRC; and
- Production of ancillary documentation such as stock transfer forms.