Purchase Of Own Shares
The huge difference between the rates of CGT (10% or 20%) and the higher rates of income tax (40% and 45%), is encouraging entrepreneurs to extract value from their companies in a way which is subject to CGT. Where the company needs to continue to trade, capital treatment for a distribution to a shareholder may be achieved if the company purchases its own shares (PoS) from that shareholder.
However, clearance must be applied for in advance from HMRC to confirm that the proceeds will be subject to CGT rather than income tax. To achieve this clearance, the company must confirm these conditions are met:
- Seller has held the shares for at least 5 years;
- Seller is a UK resident;
- The purchase is for the benefit of the trade;
- Company is unquoted;
- The company is trading or holding company of a trading group;
- Seller’s shareholding (including associates’ holdings) are substantially reduced or eliminated by the purchase; and
- seller and his associates are not connected with the company immediately after the purchase.
If the company has the cash available to pay the shareholder the full amount agreed for his shares, the PoS can proceed without further complications. Where the company cant pay the full sales value at the date the sale is arranged, it may need to pay the amount agreed in tranches over a number of years. For this arrangement to be given clearance as a capital distribution, the contract for the acquisition of the shares must contain multiple completion dates which align with dates on which the proceeds are paid.
The shares are sold back to the company on day 1, which is also the first completion date, the date on which the shareholder loses beneficial interest in all his shares, and the date on which he resigns as a director (if applicable). The shareholder continues to hold the remaining shares until the completion dtes for those trances arrive, but he cant exercise voting rights or receive dividends in respective of those shares.
HMRC generally agree to a clearance for a PoS to be completed in this fashion, but they have recently raised an objection to entrepreneurs’ relief applying to the amount paid in tranches. HMRC argue that the company does not ‘acquire’ the shares, because it must cancel the shares returned to it under the PoS. Thus time of disposal and acquisition under contract does not apply. This section fixes the date for CGT purposes as the exchange date of the contract not the competition date or dates.
Instead HMRC argue that the payments are capital sums delivered from assets. Thus the gain is taxed at the time the proceeds are received, not at the contrat agreement/exchange date. If HMRC is correct entrepreneurs relief will not apply on the shares disposed of in the later tranches, as the shareholder will no longer be a director.