Working out what road to take is never simple. Decisions are based on many different factors which can produce very different outcomes.
Dealing with the transfer of shares in private companies, the tax and related issues is one of our core specialisms.
What if a shareholder wants to sell their shares? Should the company buy-back the shares, or should the shareholder sell to another buyer, usually an existing shareholder? Generally, company share sales are easier to achieve than a company share buy-back.
Share purchase by existing shareholder or company buy-back
If seller sells to another buy, then the seller is guaranteed a capital gains tax treatment on the sale or gift. Naturally, the buyer funds the purchase. However, the buyer can pay in installments.
A company buy-back may be appropriate if:
- The company does not wish for another shareholder to increase their shareholding; or
- The buyer lacks the funds to purchase the shares.
Private company share buybacks must comply with complex rules and regulations. For the seller, the sale might be treated as income or capital, depending on circumstances. In addition, the company might:
- Lack sufficient profits to pay for the shares;
- Be liable for stamp duty.
Importantly, check the company’s articles of association and shareholder agreement. Hopefully, there are no restrictions on transferring shares or selling them back to the company.
A transfer of shares can either be by way of a sale or a gift.
Private company share sale: tax issues
If the seller transfers the shares at full value, then there may be a capital gains tax charge. The charge depends on the increase in value during his period of ownership.
The seller shareholder might gift or sell the shares to the remaining shareholders for less than full price. However, the seller might still face a capital gains tax charge. The capital gain depends on the market value of the shares, not the sale price.
Various relief apply to the capital gains tax liabilities. These can act to:
- Reduce your liability;
- Defer liability to a later date;
- Pass the tax liability to the buyer.
Private company share buy-back
A private company buying back its shares faces different issues to a public company acquiring its shares on the stock market. Firstly, the private company must have the available funds, which include:
- Retained profits;
- Capital: in some cases;
- Loans: difficult but there can be solutions.
Private company share buy-back: tax issues
If a shareholder sells his shares to the company, then the shareholder may be charged income tax. The profit on the sale is treated like a dividend. However, in other circumstances, the shareholder may be charged capital gains tax.
The conditions are, that the seller must
- Have owned the shares for over 5 years;
- Be selling all his shareholder; or substantially reducing the shareholding, i.e. by over 25%, so holds under 30% of the issued share capital.
Another condition is that the buy-back must be for the benefit of the company’s trade (or to pay inheritance tax from a death). It is often difficult to know whether this condition will be satisfied and so it is possible to apply to HMRC to seek advance clearance that the buy-back will be eligible for capital gains tax treatment.
The seller might choose between income tax and capital gains tax treatment on the buy-back:
If capital gain tax applies, then the seller could use the annual exemption and Business Assets Disposal Relief (entrepreneurs’ relief). In which case the seller would pay 10% capital gains tax.
Income tax might apply if the selling shareholder is a basic rate taxpayer, because the 10% tax credit might mean there is no additional tax.
Articles of association & shareholders agreement
Check the articles of association and any shareholder’s agreement. These documents often contain:
- Provisions that prohibit or restrict the transfer/sale or buy-back of shares;
- A prescribed procedure e.g. pre-emption rights on share transfer, so the shares are first offered to the company.
John solves commercial problems for SMEs and their investors. It is said that he is unbelievably practical and seasoned in finding the right solution without too much fuss. He has an established reputation in the technology, art and media industries.