Ken Moody suggests an alternative to a company purchase of own shares in certain circumstances where relations between shareholders have become strained.
There is a well-trodden alternative to a company purchase of own shares (PoS) where relations between shareholders have become strained and the company does not have sufficient cash or reserves for an immediate outright buyback.
The two main alternatives for a PoS by an unquoted company in the above circumstances are a phased buyback or a multiple completion contract. A PoS is a distribution for both income tax and company law purposes, but where the requirements of CTA 2010, ss 1033-1042 are met the PoS is treated as a capital gains tax (CGT) disposal. HMRC clearance may be applied for under CTA 2010, s 1044, for which essential guidance is provided by Statement of Practice 2/82.
Is there a trade benefit?
One of the principal requirements is the ‘trade benefit test’ at CTA 2010, s 1033(2)(a). Broadly, HMRC takes the view that the test is not met unless the company buys back the entire holding, apart from up to 5% of the issued capital retained ‘for sentimental reasons’.
However, HMRC accepts that the trade benefit test may be met where the company buys as many shares as it can afford “with the intention of buying back the remainder where possible”. There are potentially some problems, though. There will need to be separate contracts for each purchase, and the Companies Act 2006 requirements must be observed on each occasion, as well as the above CTA 2010 requirements. The retiring shareholder needs some certainty that the rest of their shares will indeed be repurchased at the agreed price when the company has the necessary funds. There may be ways of resolving the issue contractually, but the situation may not be without risk.
Other issues
Additionally, the ‘employment-related securities’ provisions (ITEPA 2003, Part 7, Ch 3D) apply where securities are disposed of for more than their open market value (as defined by TCGA 1992, ss 272-3). In those circumstances, the excess over market value is taxable as employment income. For example, if a price is agreed for a 51% holding, this is almost bound to be more pro rata than the value of a part sale out of that holding.
Under the ‘multiple completion’ route, the beneficial ownership passes on contract, though it is completed in stages. Meanwhile, the vendor must relinquish dividend, voting and other rights on the remaining uncancelled shares. This meets the Company’s Act 2006 requirements that the consideration must be paid in cash on purchase (i.e., on completion of each tranche of the PoS). However, the company must also have sufficient distributable reserves at the relevant times. Again, that exposes the vendor to some element of risk.
All may be well where there is an amicable parting of ways, but where there is a falling out and some animosity between the vendor and the remaining shareholders, the vendor may be unwilling or unwise to accept the risk of either solution.
A different route
Fortunately, an alternative solution is to interpose a holding company which issues shares to the continuing shareholders, while the retiring shareholder usually accepts an up-front cash payment and debentures (normally loan notes) which offer some security in the case of default. This does, of course, mean the remaining shareholders agreeing to a group structure, though there are often sound commercial and tax reasons for such a structure. The shares acquired in ‘Holdco’ are assimilated with the shares in the target company through the combined effect of the share exchange provisions of TCGA 1992, s 135 and the company reorganisation provisions at sections 126-7. Advance HMRC clearance may be sought under TCGA 1992, s 138.
Practical tip
Where deferred consideration takes the form of loan notes, it will usually be appropriate for the vendor to make an election under TCGA 1992, s 169R. Loan notes do not normally qualify for business asset disposal relief. An election under section 169R means the CGT on the whole consideration being payable up front but preserves the available relief.
