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Share buy-backs: a tax efficient way to exit your company?

07 July 2020

There comes a point for most entrepreneurs, when they decide that the time is right to hand over the reins of the business that they have created and enjoy their retirement. Sometimes this can be achieved by selling the whole company to a third party, but often it is the management team, who already own some shares in the company, that are best placed to take over. The problem for the management team however is often a lack of personal cash to fund a purchase of the shares and that taking the cash out of the company to fund the purchase would leave them with hefty personal tax bills.

A more elegant solution is to use the company’s money to buy-back the exiting entrepreneur’s shares and then cancel these shares leaving the management team with 100% of the equity. Potentially, this could however, be a problem for the exiting shareholder as a cash payment from the company for his/her shares could be viewed as a distribution (effectively a dividend) and taxed on him/her at punitive income tax rates of up to 38.1%. Whereas a capital payment for the shares, would have been taxed at the more favourable capital gains tax rates of 10% or 20%. Fortunately, if certain conditions are satisfied, the buy-back payment from the company can be treated as a capital payment subject to the much lower rates of tax.

There are two hurdles in particular to jump to satisfy these conditions that often cause problems:

  • The transaction has to be undertaken for the benefit of the trade and this is interpreted by HMRC to mean that the departing shareholder is severing most of his/her connections with the company, although they are usually prepared to accept a short period during which he/she reduces his/her involvement; and
  • Company law requires that the consideration be paid in full on completion which can, on the face of it, cause apparently insurmountable cash-flow problems for many companies.

Fortunately, the latter issue can sometimes be side-stepped by setting up a “multiple completion” contract where the consideration is paid and the shares cancelled in a few stages.

HMRC clearance is available and essential on certain aspects of a buy-back transaction but with careful planning this can be tax-efficient for everyone involved.

For more information regarding this topic, please get in touch with Steve Theaker or your local UHY adviser.

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