insideKENT Magazine Issue 25 - April 2014 | Page 151

BUSINESS CAN A COMPANY FUND ITS OWN SHAREHOLDER’S EXIT? IN SUCCESSION PLANNING FOR OUR CLIENTS AND PARTICULARLY FOR OWNER-MANAGED BUSINESSES, IT IS NOT UNUSUAL TO DISCOVER THAT DIFFERENT SHAREHOLDERS, WITH THEIR SEPARATE LIFESTYLES, PERSONALITIES AND AMBITIONS, OFTEN HAVE DIFFERING INTENTIONS WHEN IT COMES TO PLANNING A RETIREMENT FROM THEIR COMPANY. However, even if the shareholders can agree that one (or more) of their number should exit leaving the remainder still holding shares in the company, the practicality of paying an exiting shareholder a market value for their holding can be problematic. The valuation of the shares essentially comes down to the amount which one party is willing to pay and the other is willing to accept, but just agreeing a value does not mean that the remaining shareholders will have the necessary funds available personally to buy their business partner out. The company itself may have sufficient cash or indeed access to funding, but simply borrowing money from a company in order to buy shares from a fellow shareholder can carry with it an onerous corporate tax charge. For an individual to extract the company’s cash as remuneration of course carries with it a tax cost as well. THE MAIN CONDITIONS ARE AS FOLLOWS: Company status – The purchasing company must be either an unquoted trading company or the unquoted holding company of a trading group. Purpose of the payment – Unless the share purchase has been undertaken to meet IHT liabilities, then it must meet the 'trade benefit' test. No ‘scheme or arrangement' – The purchase of own shares must not form part of a scheme or arrangement – the main purpose of which is either to enable the shareholder to participate in the company's profits without receiving a dividend, or for the avoidance of tax. Residence – The vendor must be a UK resident and ordinarily resident for the tax year in which the purchase takes place. Period of ownership – The shares must generally be owned for a minimum of five years. SO WHAT IS THE SOLUTION? In many circumstances, a very simple solution is a company purchase of own shares. The purchase can be made from distributable reserves, provided those reserves are sufficient to cover the amount to be paid. On purchase, the shares are simply cancelled. The implication of this is that the percentage shares held by each remaining shareholder is then affected. For example, if A, B and C hold 50%, 30% and 20% in a company respectively, and the company then purchases the shares of A; B will own 60% and C 40% of the remaining total shares after the re-purchase. As a direct result of the re-purchase, B has become the majority shareholder. There are a number of requirements set out by the Companies Act (2006) regarding the procedure for a company purchase of own shares which must be met. For example, the shares being purchased from the minority shareholder must be fully paid-up shares; the purchase must be approved by a special resolution, and that resolution must be filed at Companies’ House within 15 days of its passing. The company’s Articles no longer need to permit a buy-back; nevertheless, the company must not have any restriction or prohibition in its Articles. So, a company purchase of own shares can be useful in solving a funding problem for remaining shareholders, but can it be tax efficient for the exiting shareholder as well? Substantial reduction in shareholding – The vendor shareholder's remaining interest in the company (if any) must be reduced. No 'continuing connection' – If the vendor shareholder retains an interest in the company, he/she cannot have an interest of sufficient size to be deemed ‘connected’ with the company immediately after the purchase. Advance clearance is available from HMRC, of which can provide full assurance for the exiting shareholder that the transaction – based on the information presented to HMRC – will be subject to capital gains tax and not income tax. Regardless of whether or not advance clearance is sought, the transaction must be reported to HMRC within 60 days of the buy-back. It is worth ending with one final reminder: that one of the conditions for entitlement to entrepreneurs’ relief with its very beneficial rate of tax, is that the vendor must be an employee or office holder of the company for the 12 months leading up to the date of sale. It is therefore imperative that the exiting shareholder does not resign from his position in the company prior to the sale. Thankfully, the answer is often yes. If certain conditions are met, the transaction is treated as a capital sale of shares and not as an income distribution from the company. The normal capital gains tax principles can therefore apply, which with the availability of entrepreneurs’ relief can result in a tax charge for the vendor of only 10%. If you would like to find out more, please contact Mike Swan on 01233 629255 or [email protected]. www.wilkinskennedy.com 151