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Catch 22: Company purchase of own shares – Multiple buy-backs and Entrepreneurs’ Relief
Company purchase of own shares – introduction
In this article we look at a potential issue – the availability of entrepreneurs’ relief (ER) where there is a multiple completion company purchase (buy back) of own shares. Before exploring the specific issue in detail, we look at the general rules relating to a company purchase of own shares.
There are a number of reasons why a company may wish to buy shares from a shareholder and a shareholder may wish to sell to the company. In the typical SME environment, the company may give a market place for the shares where non would otherwise exist, the remaining shareholders may not want the shares to go to a third party or it is more tax efficient for the company to buy the shares and cancel them than it is for the existing shareholders to buy the shares out of personal post taxed income. A further often important consequence is that as the purchased shares are cancelled (other than where they are taken into treasury) the shareholding ratio between the remaining shareholders does not change although their percentage shareholding does.
From a tax perspective the default position for a company purchase of own shares is that the excess of the capital element (generally the nominal value plus any premium) is treated in the hands of the shareholder as an income distribution, broadly treated as a dividend. Provided, however, that the relevant provisions are complied with the purchase in totality can be treated as giving rise to a capital gain.
Although the focus of this article is upon multiple buy backs and the availability of ER, to set the scene it might be worthwhile briefly looking at the relevant conditions for capital treatment. The legislation is found in ss1033 -1048 Corporation Tax Act 2010 and covers a purchase in two circumstances;
A distinction has to be made between benefitting the company’s trade and for the benefit of the shareholder. In many cases obtaining capital treatment will benefit the shareholder. HMRC acknowledge this and do not normally take the point if it can be clearly established that the buyback is mainly for the benefit of the company’s trade and the benefit to the shareholder is as a consequence of the benefit to the company and not the key motivation. HMRC have given guidance as to circumstances where they will accept a trade benefit, these include;
The other key requirements of the legislation are;
It is beyond the scope of this article to consider the Company Law requirements in detail, however, it is necessary to consider those which impact directly on the tax treatment or HMRC’s approach to this matter;
As a company cannot defer the consideration for the share purchase and where cash is restricted a commonly used approach is a multiple completion contract.
In essence the shareholder enters into a single, unconditional and binding contract to sell his shares with completion taking place in tranches. In other words the company is able to finance the purchase over a number of years out of its surplus trading cash flows.
To obtain HMRC clearance for the transaction it is normally necessary for the departing shareholder to;
As already noted HMRC have a clearance procedure and providing that the relevant facts and considerations for adopting a multiple completion contract are explained HMRC are normally willing to give clearance (subject to the normal criteria being met).
The basic requirements for ER is that the disposing shareholder held 5% of the share and voting power for at least 12 months and is a director or employee at the point of sale.
Until relatively recently the received wisdom is that the date of disposal is the entering into of the multiple completion contract. The contract is at that time unconditional and the seller disposes of his beneficial interest in the shares. HMRC confirmed to the ICAEW that this was their position in 1989 (ICAEW technical release 745).
There is now some suggestion that HMRC are taking a very literal reading of the relevant legislation (s28 TCGA) which fixes the CGT disposal date. In summary HMRC’s argument appears to be that in a multiple completion there is strictly no acquisition by the company.
If there is no disposal and acquisition for the purposes of s28 then it is necessary to look at s22 – capital sums derived from an asset. Both provisions give the date of disposal, however, under s22 this will be when each tranche of shares are purchased. At which time it is unlikely that the departing shareholder will be a director and hence the basic requirements for ER will not apply.
HMRC will give clearance under s1044 CTA and will confirm that capital treatment will apply to the buy back and interestingly even if asked will not express an opinion on the availability of ER. It is only when the return is submitted and after the closure period that there can be any certainty as to the availability of ER and of course the clearance application has told HMRC everything they need to know to challenge the availability of ER.
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