Director buy-out
One of your fellow shareholder directors has decided to leave the company and they want you to buy them out. If you can’t put up the money yourself, what are your options?
Scenario
One of your fellow shareholder directors has decided to leave the company. The problem is, he also wants to sell his stake in the company which is now worth considerably more than he paid for it. The simplest thing to do would be for you (and/or any other shareholders) to buy his shares. If you need to borrow money to do this, then any interest charged on the loan will be allowable against your personal tax bill. But this is a big personal risk, so what are your options if you don’t want to put up the money yourself?
Company buy-back
Rather than sell his shares to you (or another shareholder), the departing director could sell them back to the company at their market value. These shares are then cancelled, leaving you (and anyone else with a stake in the company) as the only remaining shareholder(s).
Personal tax bill. The departing shareholder is only likely to agree to this if it minimises the amount of tax he pays on the sale. The problem is that the proceeds of a company buy-back are normally treated as income, whereas he would invariably prefer it to be treated as a capital gain - he should be able to benefit from substantial business asset taper relief, securing an effective Capital Gains Tax rate of just 10% compared to an effective rate of 25% for an income distribution (assuming a higher rate taxpayer).
Capital conditions. However, the proceeds can be treated as capital, provided certain conditions are met; (1) the shares must be held for at least five years (three years if inherited); (2) he must not be connected with the company after the buy-back (i.e. he can’t own more than 30% of the share or loan capital afterwards); (3) the share buy-back must be made for the benefit of the trade, e.g. buying out a disgruntled shareholder who could disrupt the business.
Tip. Get clearance from the Taxman that the contemplated transaction qualifies for capital treatment. It can take up to 28 days to get a reply so factor this into the timing of a deal.
Suitable profits. There are some important procedures to follow to make sure it’s legal.
These are set out at http://companydirector.indicator.co.uk (CD.07.16.06).
A key point is that the company must be able to afford the share buy-back both in terms of profits and cash. But, with the departing shareholder’s agreement, there’s a way around this.
Loan-back
Where a company wishes to buy out a shareholder but has insufficient funds, the departing shareholder may agree to loan part of the proceeds back to the company. However, where the issued share capital of the company is low compared to the market value of the shares, this may then result in the former shareholder becoming connected with the company (i.e. he’ll own more than 30% of the share and loan capital), resulting in the proceeds being taxed as income not capital.
Tip. To avoid a former shareholder being connected after loaning part of his buy-back proceeds to the company, seek professional advice on making a bonus issue to shareholders prior to the buy-back, thus increasing the issued share capital to loan capital ratio.
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