Peter Rayney provides some tips for owner-managers using a ‘multiple completion’ purchase of own shares mechanism to facilitate their exit route.
We have seen a fair number of owner-managers seeking to exit their businesses as a result of the challenges created by Covid-19. Under normal circumstances they may have stayed on a little longer, but since they were approaching retirement anyway, the uncertainties and possibly difficult trading conditions have accelerated these plans. This is especially so when the owner-manager is confident in their adult children or senior management to take the business forward.
However, in the current economic environment, owner-managers need to be realistic when negotiating their ‘exit’ sale price values.
Purchase of own shares
Company share buy-backs are frequently used to provide the owner-manager with their ‘exit’ route. Typically, the owner-manager will sell all his shares back to the company under a purchase of own shares (POS) transaction, leaving the next generation or management team in place as the new owners.
Financing the purchase of an owner-manager’s shares can often be problematic. The purchase price must be paid immediately (Companies Act 2006, s 691(2)). However, because of the (often) substantial sums involved for the POS consideration, owner-managers can use a ‘multiple completion’ mechanism to overcome this difficulty. Broadly speaking, a multiple completion POS agreement involves the owner-manager contracting to sell their shares back to the company, but with the legal completion of the buy-back subsequently taking place in tranches, as illustrated below:
A multiple completion contract enables the company to finance the purchase price over a number of years out of its (surplus) trading cash flows.
Tax treatment of multiple completion POS
In carrying out multiple completion deals, tax advisers still place reliance on the (then) Inland Revenue ruling in 1989. In a statement, the Inland Revenue confirmed its agreement to a POS being made in instalments, as reported in the ICAEW technical release 745 issued in April 1989. Paragraph 10 (b) of the release states:
'‘They [the Inland Revenue] take the view that as the beneficial ownership of the shares is regarded as passed at the date of the contract, a disposal for capital gains tax purposes will have taken place by the vendor at that time notwithstanding payments at later dates.’'
Multiple completion POS deals do not involve any form of tax avoidance. The arrangements simply enable the company to 'defer' part of the purchase consideration in a 'Companies Act compliant’ manner. Practical experience has also shown that HMRC has generally given POS tax clearances (under CTA 2010, s 1044) for properly structured POS multiple completion deals.
The CGT disposal date
There has been some recent debate about the correct tax analysis of a multiple completion, particularly in relation to business asset disposal relief (BADR) (formerly known as entrepreneurs’ relief).
It is now accepted that the general rule in TCGA 1992, s 28 – which regulates the time of disposal as the date when an (unconditional) is entered into – does not appear to be in point where there is a POS contract. Section 28 only operates ‘where an asset is disposed of and acquired under a contract’. And there is specific legislation (in FA 2003, s 195) which states that the company does not make any acquisition of the shares under a POS.
The consensus viewpoint now appears to be that the CGT disposal date is determined under general principles, which is when the seller loses their entire beneficial interest in the shareholding. This will normally be when the seller enters into the POS contract (see HMRC’s Capital Gains manual at CG10720). This is the same view that is reached under the TCGA 1992, s 28 analysis but for different reasons. HMRC also agrees that no CGT disposals occur at the date of the various deferred completions.
Business asset disposal relief
Importantly, this means that if the seller shareholder qualifies for the (‘no distribution’) ‘CGT treatment’ and also BADR, the full amount of the POS proceeds should attract the beneficial 10% rate.
Following the Finance Act 2020 changes, BADR is only available on the first £1 million of eligible share disposal gains. The owner-manager must therefore satisfy all the relevant BADR conditions throughout the 24 month period up to the date of the disposal (i.e. when beneficial ownership is lost). This means, for example, that the owner-manager must not resign as director until on or shortly after the POS contract date (see the ruling in Moore v HMRC [2016] UKFTT 115 (TC)). (Note: They will need to resign as a director to satisfy the benefit of trade test under the POS ‘capital treatment’ legislation (see IR SP 2/82)).
Furthermore, the seller owner-manager must ensure that all the relevant ‘capital treatment’ conditions in CTA 2010, ss 1033 to 1043 are met; otherwise they would not be in the CGT regime at all! Thus, the owner-manager must normally have held their shares for at least five years, and so on.
Satisfying the ‘connection’ tests
Various ‘connection’ tests must also be satisfied, which often give rise to particular difficulties in the context of a multiple completion POS. Under such transactions, the selling shareholder gives up their beneficial interest in the repurchased shares on entering into the contract and therefore the ‘substantial reduction’ test does not apply (CTA 2010, s 1048(3)).
The ‘seller’ loses beneficial ownership of all the shares on entering into the contract. They cannot subsequently take dividends or exercise voting rights over the shares. For these reasons, the ‘connection’ tests imposed by CTA 2010, s 1042 and s 1062 should not be in point.
However, HMRC has always insisted that it is not legally possible to give up voting rights via the POS contract. If a shareholder still legally holds the shares, HMRC considers that they are still able to exercise their voting rights at a company meeting.
Assuming this view is correct, the selling shareholder would be ‘connected’ with the company under CTA 2010, s 1062(2)(c) if the voting rights on the residual POS shares (i.e. those still to be purchased) exceed the 30% limit. However, if this is likely to be a potential issue, HMRC also accept that the problem can be corrected by converting the relevant ‘non-completed’ element of the shares into a separate class of non-voting shares.
The subsequent ‘multiple completion’ of the POS of the remaining tranches of shares is simply a legal process and normally has no bearing for tax purposes.
Company law issues
From a company law viewpoint, the company need only have sufficient distributable reserves for the relevant tranche it is completing – not for the entire POS contract. However, at each completion date, it must also have sufficient cash resources to enable it to complete the purchase of the relevant tranche of shares.
At each completion date, all the relevant Companies Act 2006 formalities for the POS must be followed.
Practical point
Sellers will obtain greater protection by ensuring that the POS contract contains appropriate restrictions on the remaining shareholders’ ability to take dividends, limits their salary increases and so on. This will ensure that the company is able to retain sufficient reserves and cash resources to complete the subsequent POS tranches.
