A tax-efficient exit strategy

A company’s ability to buy back its own shares can be a very useful, if sometimes overlooked, facility.

Such a strategy means that the remaining shareholders do not have to find the purchase funds. The normal tax treatment is that the shareholder is treated as receiving a distribution which is subject to income tax. However, where an unquoted trading company is involved, there is the possibility of having the share buy-back instead treated as a capital transaction subject to capital gains tax (CGT). If the disposal qualifies for entrepreneurs’ relief, then the tax rate will be only 10%. Of course the company and the transaction must meet various conditions, in particular:

  • The person disposing of the shares must normally have owned them for at least five years.
  • The shareholder must either sell all of their shareholding or the shareholding must be substantially reduced. In this context, ’substantially’ means their holding after the purchase is not more than 75% of what it was before. Any shares held by associates are included in the calculations.
  • The shareholder must not be connected with the company after the buy back. ‘Connected’ here means having a shareholding of more than 30%, and again the inclusion of associates complicates things.
  • The share purchase must be for the purpose of benefiting the company’s trade. Despite the other shareholding conditions, HM Revenue & Customs (HMRC) may only agree that this condition has been met if the entire shareholding is bought back. Common examples are where shareholders disagree about the company’s management or where an unwilling shareholder wishes to end their association with the company. HMRC might allow an exception where the company does not have the resources for a complete buy back at the time of purchase. The trade benefit condition will also not be met if the shareholder remains as a director or is subsequently appointed as a consultant.

Where the company cannot afford to buy back shares in a single transaction, a solution might be a contract with multiple completion dates. If the deal is properly structured, it should meet the CGT treatment conditions and the whole disposal can then qualify for entrepreneurs’ relief. However, the payments for the shares will then be staggered. In some cases, CGT treatment is not always beneficial, especially for small amounts where shareholders are basic rate taxpayers. However, CGT treatment is mandatory if the conditions are met, so get in touch with us if you need advice.