Running a company together is not always smooth sailing, business partners might disagree with the direction the company should take, or simply wish to exit or retire on differing timelines.
When you want to continue and grow your business, whilst other shareholders wish to depart, it is important to plan and action this efficiently to enable you to expand going forward.
The buy out
The simplest options might be for the other shareholder/s to buy the leaving party’s shares off them directly.
One of the key difficulties here may be the availability of funds, as the other business partners will need the personal funds to purchase the shareholding from the leaver.
For Capital Gains Tax (CGT) purposes, business partners are considered as ‘connected parties’, and therefore the disposal of the leaver’s shares will need to take place at Market Value. Where companies are not listed on a stock exchange, the valuation of a company can be relatively ambiguous. It would therefore be important that a formal valuation of the business is acquired to determine the value of the departing individual’s shares.
If the current shareholders do not have the funds required, they may decide to introduce an external buyer to remove the leaving shareholder.
The leaving individual would need to report and pay tax on the gain realised on the disposal of their shares. Business Asset Disposal Relief (BADR) may be available – read more here.
A Holding Company purchase
Where the current shareholders do not have the funds to buy out the leaving shareholder, a Holding Company structure may be able to assist in the exit of the leaving party to defer the requirement for the funds.
Step 1
The shareholder/s that wish to remain will form a new company (“New Co”).
Step 2
New Co will make an offer to all shareholders in the original company to acquire 100% of the issued share capital.
Step 3
The remaining shareholder/s will exchange their shares for the same shares in the New Co. For example, 10 Ordinary £1 Shares in the original company, they would receive 10 Ordinary £1 newly issued shares in the New Co.
Step 4
The departing shareholder would receive the agreed consideration, which can be split into instalments over a few years, to enable the company to raise funds to pay for the exit.
The departing shareholder would be liable to CGT on the full amount of cash they would receive at the date of disposal. Please read consideration and earn-outs for more information on this, BADR may also apply.
The remaining shareholders should qualify for ‘share for share’ treatment and not be liable to CGT on the disposal. However, Stamp Duty of 0.5% will be due in respect of the whole value of the transaction (100% of the value of the original company).
With a Holding Company, to ensure the remaining shareholder/s do not realise a gain for CGT purposes on their share for share exchange/s, clearance should be sort, and received, from HMRC.
The share buyback
When it comes to the company buying back the shares, the default position, for tax purposes, is the repurchase is treated as an income distribution. Specific criteria must be met to ensure the Company Purchase of Own Shares (CPOS) receives the capital treatment for the leaving individual. The repurchase must meet the criteria of either Condition A or B.
Condition A
- The company must be an unquoted trading company
- The repurchase must be made wholly, or mainly, for the purpose of benefiting the trade carried on by the company, or any of its 75% subsidiaries
- The leaving individual must be a UK resident
- The leaving individual must have owned the shares for five years or more (this can be reduced to 3 years if acquired under a Will or Intestacy)
- The shareholding of the leaving party must be substantially reduced, with their interest in the company less than 75% prior to the buyback
- The leaving party (and their associates) must not be connected to the company after the buyback. Therefore, they must not hold more than 30% of the share capital, loan capital, voting rights, or assets at winding-up
- The repurchase does not form part of a scheme with the main purpose being that the leaving party receive a distribution of profits without being taxable to dividends.
Should all these conditions be met, the departing shareholder may be entitled to receive capital treatment on their disposal and may be able to claim BADR.
Condition B
- All, or nearly all, of the money is applied to the seller’s Inheritance Tax (IHT) liability
- The IHT was charged on death
- The money is used to pay the IHT within two years of the death
- The IHT could not have been paid without undue hardship
Other considerations
Assuming the transaction can satisfy all of Condition A or B, you must also make sure the company can suitably complete the transaction:
- The company must have distributable reserves to be able to complete the transaction
- The company must be able to repurchase the shares in cash
- The articles of association of the company must allow the transaction
There may also be other requirements of the company to ensure a CPOS can be completed.
The transaction must be reported to HMRC within 60 days of the buyback, and Stamp Duty will be due of 0.5% of the consideration (unless the repurchase is less than £1,000).
When a CPOS is planned with the intention of getting the capital treatment, it is always suggested that formal Clearance is applied for, and received by, HMRC prior to the transaction.
