A company purchase of own shares (CPOS) can be a useful ‘exit’ strategy for shareholders in the right circumstances. This article looks at the purchase by an unquoted trading company of its own shares from an individual shareholder of a family or owner-managed company.
As a general rule, when the company buys back its own shares from such a shareholder, any ‘premium’ (i.e. payment in excess of the capital originally subscribed for the shares) constitutes a distribution of income (i.e. similar to a dividend). However, if certain conditions are satisfied (in CTA 2010, Pt 23, Ch 3) the vendor is normally treated as receiving a capital payment instead. This sometimes provides individual shareholders with a tax-efficient exit route from the company, particularly if capital gains tax (CGT) entrepreneurs’ relief (ER) is available so that the CGT rate is only 10%.
The conditions for capital gains treatment on a CPOS include a ‘trade benefit’ test and various requirements as to the vendor shareholder’s residence, length of ownership of the shares and the extent (if any) to which he or she remains connected with the company. This article does not cover the qualifying conditions, but highlights a selection of potential pitfalls and issues where a CPOS is being considered.
1. It’s the law
A CPOS must satisfy various company law requirements (which are beyond the scope of this article). Failure to comply with the legal requirements could result in the transaction being void and legally unenforceable, and render the company and its officers liable to sanctions.
A void company purchase of own shares under company law will have its own tax implications, depending on whether or not the shareholder is required to repay the proceeds to the company (e.g. see Baker v Revenue & Customs  UKFTT 394 (TC)).
2. Does it benefit?
One of the conditions for a CPOS to be treated as resulting in a capital receipt rather than income is that the transaction must be wholly or mainly for the purpose of benefitting a trade carried on by the company (or a 75% subsidiary). A purchase of own shares may provide a convenient exit route for the vendor shareholder, but it may not necessarily be beneficial to the company’s trade.
Examples of situations where the ‘trade benefit’ test would normally be regarded as satisfied include disagreements between the shareholders over the company’s management which has (or could have) an adverse effect on the company’s trade, and an ‘unwilling’ controlling shareholder (e.g. retiring director) who wants to make way for new management (see HM Revenue and Customs (HMRC) Statement of Practice 2/82).
3. The ‘right’ trade
The purchasing company must be an unquoted trading company, or the holding company of a trading group, as defined (CTA 2010, s 1048). A trading company under the purchase of own shares rules is a company whose business consists ‘wholly or mainly’ (i.e. more than 50%) of carrying on one or more trades. However, trades of dealing in shares, securities, land or futures do not qualify for these purposes.
4. Not all at once?
For a CPOS to be valid under company law, the company must normally make full payment on purchase (subject to a limited relaxation for private company share purchases in relation to employee share schemes). This requirement can be problematic (e.g. if the company is suffering cash flow difficulties).
It might be possible for a company to enter into a single, unconditional share sale contract with the vendor, with completion taking place on different dates in respect of separate tranches of shares within the agreement. HMRC may be prepared to accept that the multiple completion contract is possible, provided that beneficial ownership of the shares passes at the contract date (ICAEW Technical Release 745). However, care is needed. For example:
• HMRC might take the view that beneficial ownership of the shares is not lost in some cases (e.g. if the remaining (non-completed) shares carry voting rights, such that the ‘no continuing connection’ test between the vendor shareholder and company is breached).
• HMRC has reportedly contended in some instances that the date of disposal of the shares is when each capital sum is received, not the date of contract. On that basis, if ER is to be claimed, the ER conditions would need to be considered at the later date(s), assuming that the CPOS conditions for capital treatment are satisfied.
5. All clear?
A CPOS is a complex matter for tax (and company law) purposes. The above points are by no means exhaustive. There is an advance clearance procedure on a company purchase of own shares, to seek HMRC’s confirmation that the conditions for capital treatment are (or are not) satisfied. HMRC also provides some useful guidance on the CPOS rules, including advance clearances (see tinyurl.com/HMRC-CPOS).
The above article was first published in Business Tax Insider (November 2017) (www.taxinsider.co.uk).