A share buyback takes place when a company purchases its own shares from an existing shareholder. For a valid share buyback to take place, it must be completed in accordance with Part 18 of the Companies Act 2006 (CA 2006).
A key requirement of Part 18 of CA 2006 is that the shares being bought back by a private limited company must be paid for in full at the time of purchase, unless the purchase is for the purposes of, or pursuant to, an employee share scheme, which in practice rarely occurs.
The CA 2006 also requires that the payment for the shares is funded out of distributable reserves (which is the most common method), capital (although this carries additional requirements of its own), or the proceeds of a new issue of shares.
Not paying for the purchase of shares in full
In practice, it is easy for a company to fall foul of the CA 2006 by not paying for the shares in full at the time of the purchase. Companies often seek to only pay a portion of the purchase price up front and leave the remainder deferred or to be paid in instalments. Where this is the case, the share buyback is void.
The reason companies attempt to spread out the payment is because they often don’t have sufficient distributable reserves to pay the full purchase price up front, or they are concerned about the cash-flow impact of paying the purchase price in a lump sum.
There are ways in which a share buyback can be structured to ensure it is compliant with the CA 2006 while also ensuring the company has sufficient distributable reserves and preserves cash flow.
Multiple tranche completions
A private company undertaking a share buyback can structure the purchase so that it makes multiple purchases of different portions of the shares at set intervals, rather than purchasing the shares all at once on completion of the share buyback agreement.
Under this structure, a single share buyback agreement is entered into which provides that a portion of the shares will be purchased and fully paid for on completion. The remaining shares will be purchased in a series of tranches and will be paid for in full as and when each applicable tranche is actually purchased.
If the selling shareholder intends that the sale of shares to the company will qualify for capital gains tax (CGT) rather than being subject to income tax and taxed as a distribution (Capital Treatment), it is important that the number of shares sold at completion and at each tranche is carefully calculated to ensure compliance with section 1033 of the Corporation Tax Act 2010.
Business Asset Disposal Relief
In practice, where Capital Treatment applies, the selling shareholder is often eager to make use of the reduced CGT rate applicable under Business Asset Disposal Relief (BADR).
Care must be taken to ensure that the full CGT charge arises on completion as, usually, the selling shareholder ceases to be an employee or director of the company from completion.
There is a risk that an incorrectly structured share buyback agreement could prevent the CGT charge arising in full on completion, which would result in the selling shareholder losing the preferential BADR tax rate for the remaining sale tranches.
To ensure that the full CGT charge arises on completion, there are two key requirements that must be met:
- First, the full beneficial title (meaning all rights to benefit from the shares, such as the right to receive dividends or exercise voting rights) to all of the shares must pass on completion; and
- Second, the share buyback agreement must be unconditional, meaning that it must not contain any conditions which may prevent future tranches from taking place. This is because, for CGT purposes, the timing of a disposal is generally determined by when an unconditional contract is entered into. If the agreement remains subject to conditions, the disposal may not be treated as taking place until those conditions have been satisfied..
A failure to properly structure a share buyback to ensure that shares are paid for in full on purchase will result in a void share buyback, potentially resulting in added costs for the company buying its own shares. Likewise, if tax implications are not fully considered when structuring a share buyback, a selling shareholder may not be able to exit the company as tax efficiently as they may have hoped.
This article is intended for general information purposes only and does not constitute legal, tax or other professional advice. Doyle Clayton does not provide tax advice and it is recommended that the company and selling shareholders should each obtain independent tax advice.
The application of tax legislation depends on the specific facts and circumstances of each case and may change over time. Professional advice should be sought before taking, or refraining from taking, any action based on the contents of this article.
