COMPANY TAX - 08.04.2021

Company has insufficient cash to purchase its own shares

Our subscriber wants to sell her shares and retire from the company. The trouble is the other shareholders can’t afford to buy her out and, while the company could purchase its own shares, it doesn’t currently have the cash. What’s the solution?

Time to sell your shares

As a major shareholder in a private company, exiting the business can be tricky. It’s all very well having built a successful company but turning it into hard cash might not be easy. You’ll either have to sell your shares, or the business, or wind up the company. The other shareholders and directors might not be happy with this and could make your exit difficult. One option is to sell your shares to them, or if they can’t afford them, to the company.

Company law

Company law allows a company to buy its own shares. A key condition is that the company must pay for the shares at the time of purchase. It isn’t allowed to spread the cost by paying in instalments. Doing so would breach company law meaning that the transaction would be invalid.

Tax law

Normally, any money paid by a company to one of its shareholders is treated as an “income distribution”, e.g. a dividend, and is taxed accordingly. However, special rules apply to money paid by a private company to a shareholder to buy back its own shares. The payment can be treated as capital (and so liable to capital gains tax (CGT)) rather than income. This can reduce the tax bill for the shareholder enormously because CGT is charged at lower rates than income tax and extra exemptions and reliefs, e.g. business asset disposal relief, can apply.

Trap. To qualify for capital treatment the purchase of own shares must be valid under company law. This poses a problem if a company doesn’t have the cash to pay for the shares all at once because, as indicated earlier, payment by instalments would breach company law and invalidate the transaction. Tip. It’s possible to get round the Trap by contracting for the purchase to be made in stages. For example, if the shareholder owns, say, 40% of a company’s ordinary shares, it could contract to buy them in, say, three annual tranches. The price should be agreed at the time of the contract to ensure that the shareholder doesn’t gain or lose because of the company’s future performance.

A single versus multiple contracts

The staggered contract works well. By comparison, while it would be possible to make a separate contract for each purchase and achieve a similar result, this would be open to all sorts of problems. For example, changes in the value of the company (and so its shares), extra costs for drawing up multiple contracts, a change of mind by the directors or the selling shareholder. A single staggered purchase contract avoids these.

Additional tax rules

To qualify for capital treatment the terms of the contract must meet additional tax rules:

  • the company is a UK unquoted trading company
  • the purchase is either for the benefit of the trade, or to enable inheritance tax to be paid on the death of a shareholder; and
  • the seller is UK resident in the year of sale, has held the shares for five years (three years if inherited) and is not connected with the company immediately after the repurchase.

Because of the tricky small print we recommend that you get the help of an accountant with a purchase of own shares agreement.

While company law doesn’t allow the purchase of own shares to be paid in instalments, it doesn’t prevent a staggered contract; a single contract with separate completion dates for tranches of the shares. This also meets HMRC’s conditions for capital treatment of the payments, which can reduce the tax bill payable by the shareholder.

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