In a previous article we explored share buybacks: how a shareholder could exit from a UK company via a company repurchase of shares.
If the company law aspects can be fulfilled, then the distribution of cash by a company on the purchase of shares may be treated as a capital disposal if all the relevant tax conditions are also satisfied. Otherwise, the seller is instead treated as receiving a dividend on the excess of amounts above the repayment of their capital and therefore higher dividend tax rates of up to 39.25% for 2022/23 would apply rather than capital gains tax (CGT) rates of 20% or 10%.
In this article we look at another way of structuring an exit under which the conditions for capital treatment are likely to be less onerous.
Use of holding companies
As we have seen, using the company as purchaser may not always offer a tax efficient exit route for a shareholder. In particular, HMRC hardened their view on meeting the buyback conditions where a company is unable to raise funds to pay for the shares in full. Strategies designed to defer payment by the company for the shares are, therefore, likely to be challenged and CGT treatment would be in doubt.
As shareholder funds will often be tied up in the business, the other shareholders may not be able to finance a purchase over the timeframe sought by the exiting shareholder. Nor may the other shareholders be willing to take on personal debt in order to finance an acquisition.
We have instead been successful with obtaining the requisite clearances from HMRC to carry out a reorganisation in order to achieve a similar result to that of a buyback. This would involve the insertion of a holding company (HoldCo) above the existing company (TargetCo) from which the funds would arise to fund the purchase of the shares.
It works like this:
- The exiting shareholder would dispose of their shares for cash or loan notes in HoldCo;
- The remaining shareholders would receive shares in HoldCo in consideration for their shares in the transferring company;
- The acquisition of the exiting shareholder’s shares could then be funded by TargetCo, usually through dividends paid up from the subsidiary company to HoldCo.
Tax analysis – to be or not to be… a disposal?
There are five areas to consider: chargeable gains, loans, stamp duty, reporting and HMRC clearance.
Chargeable gains rules applying to the remaining shareholders
For the remaining shareholders, the transfer of shares in exchange for shares or securities in HoldCo should not be treated as a disposal for tax purposes. This is because there are rules in the CGT legislation which mean that provided certain conditions are satisfied – yes, more conditions but that’s tax! –the exchange is effectively ignored. The old shares are treated as the same asset as the new shares. For rules such as those relating to business asset disposal relief (BADR), the clock is not then reset on the requirement to hold shares for a period of two years ahead of any disposal. The base cost of the transferring company’s shares will be inherited by the new shares because there has been… ‘no disposal!’
TargetCo’s shares will be uplifted to the market value of the company at the date of transfer to HoldCo.
Chargeable gains rules applying to the exiting shareholder
For the exiting shareholder, remember we wanted a ‘disposal’ and specifically one which would benefit from CGT treatment. Whilst there is no disposal for the remaining shareholders, for the seller, the proceeds should benefit from capital treatment. After all, the exiting shareholder will receive consideration for their shares.
However, the analysis depends on the form of consideration. If cash can be paid, an immediate chargeable gain will arise. If the conditions for BADR are satisfied and an election made, the seller would then pay tax at only 10% provided they have not already used up their lifetime limit of £1 million. This treatment should also apply if the consideration of a certain amount is left outstanding as a ‘simple’ debt rather than a loan note or debenture. The tax due on the consideration cannot, however, generally be deferred.
The full tax analysis will depend on the nature of any instruments which are issued to the exiting shareholder. The outcome should, however, be that capital treatment would apply but there are beneficial tax elections which can be made to facilitate the claiming of the BADR rate of tax of 10% depending on what category of debt is issued.
Loans made by TargetCo
Where loans are made by closely held companies, corporation tax at 33.75% from 6 April 2022 may be payable based on the amount of the loan. This could be the position if TargetCo makes a loan to HoldCo to pay the vendor. For this reason, it is usually more appropriate for TargetCo to make dividend payments, but each case will be fact dependent.
Stamp duty
On inserting HoldCo, there would be a stamp duty charge at 0.5% payable on the value of the consideration shares issued for the acquisition by the remaining shareholders. Under a share buyback route, the company would have been liable in respect of the shares it acquires and ultimately cancels.
Reporting requirements
Generally we recommend considering whether the acquisition of securities (including loan notes) should be reportable in an annual employment related securities return and whether there are any other implications of issuing securities to persons who would be classed as employees, including directors.
HMRC clearance
We also recommend that clearance is sought from HMRC for any tax-free share exchange. This is because the ‘no disposal’ treatment by the remaining shareholders can be denied if transactions are not carried out for ‘bona fide commercial reasons’ and effected primarily to avoid CGT or income tax.
It is troubling that HMRC have recently been challenging straightforward transactions. However, in our experience, there are strong commercial objectives for using this structuring where the purchase of own share conditions cannot be satisfied. Arguably, structuring an exit in this way is more straightforward. Full information on the background, intended steps and commercial reasons for carrying out a reorganisation should be provided in any clearance application.
Final thoughts
A reorganisation will not suit all scenarios; companies will need to think about the tax and commercial impact of introducing and operating another company. Nevertheless, without a relaxation of the rules to facilitate a tax efficient share buyback, this could offer a useful alternative.
If you are considering a company exit, our tax specialists would be happy to guide you through the tax implications of your options. BKL’s corporate finance experts can provide further support. For more information, please get in touch with your usual BKL contact or use our enquiry form.
