Lee Sharpe warns of a change in HMRC’s stated position, which has taken many by surprise.
Many readers will be familiar with the regime where a company buys back its own shares but, by way of background, a company purchase of own shares (CPOS) is a useful device that can help people exit or retire from a profitable company without the other owners having to lay out significant cash in the process.
Example: Just Dance Limited
Beyoncé and Jason – who are otherwise unconnected – have been equal founding director-shareholders in a successful London dance studio for more than a decade, but Beyonce wants to retire and move to Scotland to pursue a career in viniculture. Her 50% stake in the company is worth around £500,000; Jason is happy to carry on running the business on his own but would struggle to raise £500,000 personally, to buy Beyonce’s stake himself. The company, however, has a strong balance sheet and has the reserves to buy Beyonce’s shares back from her.
Whether Jason pays personally for the shares or Just Dance buys Beyonce’s shares back itself, Jason will end up owning all of the issued share capital in the company. The difference is whether he will take the financial strain directly, or own a company which has taken on that burden (and likely fallen in value as a result).
CPOS: Tax considerations
Usually, if Beyonce were to sell her shares to Jason, she would expect to be able to treat the sale as being subject to capital gains tax (CGT) and hopefully benefit from entrepreneurs’ relief (business asset disposal relief), reducing the tax rate to 10% on as much as the first £1m of eligible gains, on a cumulative lifetime basis.
As an aside, although unlikely in a simple share disposal at full market value, one should still check that the proposed transaction does not trigger income treatment or penalty through either the Transactions in Securities regime (ITA 2007 Part 13) or the Employment-Related Securities regime (ITEPA 2003 Part 7). Pre-transaction clearance is available and, generally, highly recommended.
While Beyonce might expect CGT treatment by default on a direct sale to Jason, broadly, the opposite applies where the company buys the shares, as it will, by default, be considered a distribution (i.e., of income – to the extent that the payment exceeds a return of share capital – see CTA 2010 s 1000 et seq.) unless it satisfies the criteria at CTA 2010 s 1033, broadly summarised as:
- It must be “for the benefit of the trade” and not for the purposes of tax avoidance.
- It must be an unquoted, mainly trading company (or holding company of a trading group).
- The vendor must have held shares for at least five years prior to sale.
- The vendor must be a UK resident in the year of the sale.
- The buyback must represent a substantial reduction in the vendor’s holding.
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The vendor must no longer be “connected with” the company after the sale – the ‘clean break’. (A person is broadly deemed to be ‘connected’ if they, together with their associates, hold more than 30% of the share capital, voting rights, etc., as per CTA 2010 s 1062).
While these conditions might seem quite onerous, Beyonce’s desire to retire completely from the long-established company appears to constitute the necessary ‘clean break’ and would seem comfortably to clear all other hurdles – HMRC accepts that a shareholder wishing to retire can validly be “for the benefit of the trade” (see CG58635). So now, it is just a matter of finding the cash.
There are numerous other requirements, such as separately notifying Companies House and HMRC.
Why does it matter?
If we assume that Beyonce’s salary from Just Dance Limited is £80,000 (and no other income) and that the company buys back the shares, then Beyonce’s additional tax liability on the buyback proceeds being £499,950 after excluding the subscription cost of the original 50 x £1 shares, would in 2022/23 be comparable as follows:
- If by default treated as an income distribution – a dividend – Beyonce would lose £197,163 in additional tax on that ‘dividend income’.
- If all the criteria are met and it was instead treated as a capital distribution (and eligible for entrepreneurs’ relief or BADR as well), Beyonce would lose just £48,765 in CGT.
So, income treatment is broadly four times as expensive, comparing income tax versus CGT.
The clean break: How has HMRC changed things?
Historically, CPOS has been popular, allowing a director-shareholder to retire without placing financial strain directly on the surviving individual director-shareholders. One of the problems – even for companies – has been finding sufficient cash to buy practically all of the shares back ‘in one go’.
To get around this, advisers have commonly drawn up ‘multiple completion contracts’ wherein the company buys the shares in tranches, perhaps using profits generated over time to fund the later stages. The exiting director-shareholder formally agrees to give up all relevant rights (e.g., dividend, voting and capital rights) in all of the shares from day one; in the past, HMRC has been happy to accept that this absolute waiver would suffice to remove the connection, from that first tranche, even if the selling director-shareholder technically still held more than 30% of the shares afterwards.
Only now it seems that, actually, HMRC wasn’t really that happy at all. In fact, HMRC had been quite unhappy with this approach for several years but had simply neglected to tell anyone – including many of its own officers, who had meanwhile carried on clearing the CGT treatment of buyback contracts with multiple completion stages, without challenge.
Earlier this year, HMRC decided it ought to clarify its position. A press release was issued, saying that HMRC’s view is that it is not enough for the exiting director-shareholder just to give up all of their beneficial rights in the remaining shares because they are still the legal owner of every share until its transfer is completed, and that is what really matters. From now on, if the selling director-shareholder still holds sufficient legal interest in the company after that first tranche to exceed the 30% threshold, then CGT treatment will be unavailable.
Reaction to the ‘clarification’
Professional advisers have been quite surprised by this apparent change in stance – HMRC is rather vague on when its position actually changed, only to give the impression that it was some while ago.
Readers may be aware that direct taxation, including income tax and CGT, almost invariably follows beneficial ownership – whoever enjoys benefit from the asset – rather than legal ownership, and there is doubt as to whether HMRC’s newly rediscovered interpretation is actually correct. However, HMRC appears reluctant to press government for a change in the law to ‘clarify’ matters to the satisfaction of taxpayers and agents. The risk is that a case will be taken to overturn HMRC’s new-but-really-old position, only to prompt HMRC to ask government to ‘clarify’ the law the other way.
It seems we should be grateful that HMRC has said it will not reopen historic cases involving multiple completions but will apply the newly clarified approach only going forwards.
Conclusion
On the one hand, we are told that the government dislikes ‘moneybox companies’, and CGT entrepreneurs’ relief and IHT business property relief may be jeopardised by holding too much cash; on the other, we now have another valid reason why a company might want to hold more cash.
This change does not affect all share sales but only those where a company is buying back its own shares. While in some cases, a company may have the funds to buy enough shares to take the vendor under the 30% threshold from the outset, other alternatives may be to transfer legal ownership to a nominee pending completion, or to purchase via another company – adding complexity and probably more holding companies subsequently serving no useful function. It is recommended that readers take advice before such manoeuvres to ensure that there are no tax traps to sour one’s retirement.
