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Share Buybacks

A Company own purchase of shares is a great way to enable a return of capital to the company’s shareholders. In simple terms a buy back enables a company to purchase its own shares from one or more existing shareholders. Once the buyback has been completed, the shares are cancelled, having the effect that the remaining shareholders gain an increase in value as there are now fewer shares in issue.

The purchase price in a share buyback is generally divided into a capital element and a distribution element for tax purposes. However, if certain conditions are met (and HMRC approval is usually sought in advance) then the payment to the selling shareholder can be taxed on the same basis as if the Seller had sold the shares to a third party buyer and accordingly, the payment would be treated as a payment of capital (taxed under the lower capital gains tax regime). In many cases a Seller may also then be able to benefit from entrepreneurs relief on the sale (attracting a far more favourable tax rate of just 10%).

For the reasons above, it will obviously be important to Sellers to establish that they are entitled to capital treatment on a share buyback. As a brief overview, the main conditions that HMRC require are as follows:-

1. The company must be unquoted.

2. The company must be a trading company.

3. The purpose of the buyback must be to wholly or mainly benefit a trade carried on by the company (note this will include purchasing shares of a retiring proprietor of a company in most cases).

4. The shareholder must have held the trading company shares for five years.

5. The shareholder’s holding must substantially reduce.

6. The buyback cannot be part of a tax avoidance plan.

7. The shareholder must not be connected to the company after the sale.

Although the tax risk is the individual Seller’s, any ongoing shareholders will be keen to ensure the criteria is met, as a buyback is an effective way to purchase shares without obtaining external funding or personal liability. From the company’s perspective, stamp duty would of course be payable on the purchase.

In terms of procedure, the following steps normally take place:-

1. HMRC clearance should be sought for the buyback. Share buyback clearance usually takes around 5 to 6 weeks and importantly the clearance remains binding if there is no material change in the buyback company’s circumstances or structure.

2. Review of the company’s constitution is required to ensure that there are no restrictions in its Articles of Association that would prohibit a purchase of own shares. It may be that the Articles of Association require amendment by resolution prior to the buyback taking place.

3. The documentation would then be put in place to implement the buyback. Typically this would include:-

(a) a share buyback Agreement;

(b) Board Minutes seeking member’s approval for the share buyback;​

(c) Written Resolution to approve the share buyback;

(d) Stock Transfer Forms

(e) Companies House filings.

It is important to note that under a Buyback Agreement you cannot have deferred consideration. This is a common mistake that is made and can have serious consequences for all parties as such a transaction would be invalid.

Where all shares cannot be purchased at once an alternative (and one that is permissible) is to put in place a Buyback Agreement that provides for the purchase of shares by the Company in tranches. Therefore, dependent upon how much distributable reserves the Company has, the Company would purchase as many of the vendors shares as possible on completion and then (taking into account financial forecasts going forward) you would then undertake to purchase the remainder of the shares on or before certain dates set out in the Buyback Agreement.

Although financing a buyback is usually done through distributable reserves it is also possible to fund the purchase through capital or through a fresh issue of shares.

There are advantages for a Seller looking to sell their shares back to the Company, as opposed to a third party buyer. A Seller can avoid the expense and time involved in negotiating a lengthy sales contract. In addition a buyback contract is highly unlikely to contain any warranties other than warranties as to unencumbered ownership of the shares being transferred. This avoids a Seller being put in a situation where he is required to give lengthy and onerous promises about the business he is exiting.

In terms of commercial advantages for the company and ongoing shareholders a buyback has the effect of increasing assets/earnings per share for the remaining shareholders as well as increasing the marketability of the company’s shares and assisting in an employee incentive scheme.

For more information about share buybacks or restructuring your business please contact Patrick Tedstone or Lorraine Smith on 01785 223 440 or email lorraine.smith@orj.co.uk