Corporate Tax Planning
Nolan Gooch, Tax Partner at Haines Watts, discusses the benefits of share buy backs and why they could be the right route for you and your business.
In the wake of the economic turmoil ensued over the last two years, and with more uncertainty ahead, many shareholders are considering whether now is the time to cash out.
Whilst there are many options available to shareholders, share buy backs are becoming an increasingly popular means of exiting a business due to the benefits for both the company and the shareholders.
But with numerous pre-requisite conditions and complex rules surrounding share buy backs, making sure you have all the information at hand is crucial.
What is a share buy back?
If a shareholder is looking to exit your business, the company can use its reserves to buy back their shares.
This can be a more tax efficient strategy than a direct purchase from another shareholder because the purchase consideration comes from the business, rather than the taxed income from another shareholder.
What are the benefits of share buy backs?
For the remaining shareholders, a buyback will increase their holding in the company by reducing the original share count, which can in turn, boost earnings per share.
From a tax perspective, there are huge benefits that come with buy backs too. By default, the proceeds of a share buy back are subject to income tax rates up to 39.35%. However, if certain conditions are met the consideration is treated as a capital receipt in the hands of a seller.
As long as capital treatment applies, the owner of the shares will pay maximum capital gains tax of 20% on their gain, rather than income tax. And if business asset disposal relief (formerly known as Entrepreneurs’ Relief) applies, the rate will be reduced to 10%.
What are the conditions?
There are multiple conditions which must be met in order for capital treatment to apply. The business must be an unquoted trading company and have enough reserves to fund the buy back, and the shares need to be fully paid in cash on completion.
From the shareholder’s point of view, they must be a UK resident and have owned the shares for at least 5 years. After the sale of their shares, they cannot be connected to the business and their interest in the business must be substantially reduced. Connected broadly means holding more than 30% of the company’s share and/or loan capital; substantially reduced means that the sellers shareholding in the company immediately after the buyback must not be more than 75% of the interest immediately before.
In addition, the buy back must satisfy the trade benefit test. This requires that the buy back must mainly be for the benefit of the company’s trade and not for enabling the seller to participate in the profit of the company without receiving a dividend or avoiding tax.
Usually, HMRC will accept that this test is satisfied if a director shareholder exits the business entirely. If the shareholder is continuing in the business as a director or consultant, it’s unlikely that the trade benefit test will be satisfied.
Supporting you with share buy backs
Whilst the benefits of share buy backs can be far reaching for both the business and the exiting shareholder, the process behind the buy back can be complex.
To ensure all conditions are met and the buy back strategy is maximised, we would always recommend consulting a professional advisor on the matter.
Our team of tax experts are on hand to support you with everything from answering your queries and assessing whether a buy back strategy is right for you, to helping ensure all of the pre-requisite conditions are evidence, ahead of clearance from HMRC.