When you’ve spent time and effort building up your business, there comes a time when you want to move on. Of course, you may choose to do this by selling the business lock stock and barrel to a new owner, or by merger with a similar company, or even by selling off the assets and goodwill piecemeal. All of these routes have their own pros and cons, but in this blog I want to focus on the situation where you have other shareholders and you want to take a back seat (or even retire completely). Depending on your family circumstances, you may be considering disposing of some of your shares by way of gift, or you may be looking for a monetary payment – either way, it will be a disposal and will result in a chargeable gain for Capital Gains Tax.
In an earlier blog on how to qualify to only pay 10% capital gains tax, I looked at the availability of Entrepreneurs’ Relief (ER) which cuts the rate for Capital Gains Tax on any chargeable gain to 10%. You can get this on the sale of shares provided that certain conditions are met.
There’s two routes to disposing of shares in your business and getting ER – either you sell them to your co-shareholders (or to a third party), or you can sell them back to the company itself. Either way, this will of course alter the shareholding ratio after the transaction has taken place, and if this means for example that someone acquires a majority shareholding, or perhaps ceases to have a majority shareholding, then this may have an impact on the value of the shares disposed of. You will also have to take into account that most companies will have in their Articles some form of restriction on transferring shares. There may be a requirement to offer these first to the other shareholders, or there may be a simple statement that the directors are not obliged to register a transfer of shares if they don’t wish to.
The other point you need to take into account if you propose to sell your shares back to the company itself is contained in Section 1088 Corporation Tax Act 2010. In simple terms, where a company pays for or provides consideration for shares, this will be treated as a distribution unless certain conditions are met. Why is this important? Well, if it’s a distribution it will be taxed in the same way as dividends or other similar distributions of profit – ideally you want it to be classed as a capital gain. You can achieve this by ensuring the transaction complies with Condition A of Section 1088, namely that this will benefit the company, and you need to get clearance for this from HMRC (who also have to be satisfied that this is not a scheme for tax avoidance).
The usual scenario is that a director/shareholder who has been actively involved in the company no longer wishes to be so involved and therefore the company proposes to buy back his shares. It follows from this that the director will have to resign his directorship and cease to take an active role, as to do otherwise would be inconsistent. However, retaining a nominal shareholding (amounting to not more than 5% of the share capital after the transaction) will usually be permitted and it may be possible to retain a nominal office if the duties are very slight.
Here’s a handy comparison of how the two alternative routes work:
Route 1 – Sale or disposal to other shareholders (or to third party)
Check Articles (or any shareholders’ agreement) for pre-emption rights or any other restriction of selling or on registering transfer in company’s records
Sale will be a chargeable gain for CGT in the hands of the seller
Entrepreneurs’ Relief (ER) will apply as long as seller has been an employee or an office-holder in the company and has held shares equivalent to at least 5% of the company’s issued shares and at least 5% of the voting rights during the whole of the preceding year (or held option for EMI shares for one year). Company must be a trading company but ER still available if sale takes place within three years of company ceasing to trade
ER is not dependent on shareholder retiring nor on the proportion of shares sold. However if retained shares are less than 5% of total company shareholding then shareholder will not be able to claim ER on the ultimate disposal of these shares.
No HMRC clearance required
Route 2 – Company buys back shares
Check no restriction on company buying shares
If section 1033 CTA 2010 applies then purchase will count as a distribution (not a chargeable gain) unless Condition A applies
Condition A – must be for the benefit of the company and not part of a scheme to enable seller to participate in profits without receiving dividend, or to avoid tax.
If Condition A is met then section 1033 CTA 2010 does not apply and proceeds of sale are a capital gain in hands of seller and ER applies
Generally the benefit to the company will be the reorganisation on the withdrawal of the shareholder from operational role, so the shareholder will have to retire from employment and as a director (and probably as secretary too, unless this is a very minor role). The retention of up to a 5% holding in the new total of issued shares is not likely to be treating as retaining a connection with the company especially if shareholder has been involved for a long time
HMRC clearance for s 1033 required
Special resolution (75% of shareholders) required
If you have any questions then please feel free to get in touch.