PROFIT EXTRACTION - 26.06.2017

Sell your shares back to your company for less tax

Extracting your share of profits

Hopefully, after many years at the top of your company, it will have grown and the value of your shares along with it. Extracting this accumulated profit will usually result in a sizable tax bill. In private companies, especially family ones, the other shareholders might not be in a position to buy you out. The usual solution is for the company to buy your shares.

Transactions in securities

When a company purchases its own shares it must write to HMRC explaining the transaction to show that it isn’t an avoidance scheme. HMRC can also be asked for guidance on how any resulting gain made by the shareholder should be taxed, i.e. as a capital gain or an income distribution (like a dividend). The usual tack is to push for capital gains treatment as, assuming entrepreneurs’ relief (ER) will apply, the rate of tax is just 10%.

Example. Bob is a director shareholder of Acom Ltd. He plans to retire as a director in 2017/18 and sell his shares to his four sons and daughters who are director shareholders. HMRC directs that the gain (£750,000) made by Bob should be taxed as capital. As he qualifies for ER the capital gains tax (CGT) payable will be £73,870. If HMRC had instead directed that the gain should be taxed as income Bob would have to pay tax in the region of £280,000 (see The next step ).

Trap. It’s not well known, but where HMRC directs capital gains treatment you can’t choose the income tax option instead. But looking at the figures above, why would you?

Lower tax alternative

Bob would be well advised to consider his tax position carefully before asking HMRC to confirm capital treatment. He might be better off if he were to sell his shares by instalments as he won’t need all the money at once. In fact, as he’s retiring it would suit him to take it over, say, 15 years, after which he could turn to his pension savings. Working on current rates of tax this could cut his overall tax bill to around £35,000 leaving him nearly £40,000 better off.

Tip 1. You can manipulate HMRC into refusing capital treatment by deliberately failing to meet the conditions it sets. In fact, selling shares by instalments is enough, but there are other steps you can take to make sure (see The next step ).

Tip 2. If Bob were married and his wife only has modest income, he could transfer, say, half his shares to her and Acom could purchase these too. That could reduce the period over which the shares could be sold to the company and cut the tax bill further by making use of his wife’s tax-free allowances, basic and lower rate bands of tax.

Financial planning

Whatever the reasons for getting your company to purchase your shares, don’t automatically assume that capital gains treatment will produce the least amount of tax. Work with your accountant and financial advisor to see if instalment purchases could be more tax efficient.

For the calculations behind the examples and for ways to break the CGT treatment conditions, visit http://tipsandadvice-tax.co.uk/download (TX 17.19.03).