Tax Bite – 10% tax on Purchase of Own Shares which takes place in stages

The Issue

When a company buys back shares, the proceeds will be treated as either an income distribution taxed at an effective rate of up to 30.56% or as a capital distribution, potentially being taxed at 10% if Entrepreneurs Relief (ER) is available.  To qualify for the capital treatment certain conditions must be met.  One of these conditions is that the vendor’s shareholding must reduce by 75%.  A potential problem arises if the company wishes to buy back the shares in tranches because this condition will not be met and the higher income tax charge will result.

If however the company buys back all the shares in one go while making payments in instalments, the capital treatment would still not apply as the shares bought back by a company must be fully paid on purchase.  Therefore this would still result in higher tax rates.

Potential Solution

Another option would be to use a single sale contract with multiple completion dates.  In this situation the vendor disposes of the beneficial interest and the voting rights but retains the legal interest in any shares not yet transferred.  Therefore even though the payments are made in instalments the buy-back will be treated as a single disposal.  Although there will be a tax charge on the full sale price immediately (which is a disadvantage) this approach should secure the 10% tax rate (assuming other ER conditions apply).

Example

Mr X holds 50 shares in a company (a 30% holding).  Mr X wants to leave the company and a buy-back of the shares for £100,000 has been agreed.  If this is done in five equal tranches, the first four will be treated as income and only the last will receive capital treatment.  However, if a multiple completion contract is used, the 10% ER rate would apply, resulting in a tax saving of £16,448.

Sale in tranches:

£

£

Total proceeds

100,000.00

 Each tranche

  20,000.00

 Taxed at 30.56%

     6,112.00

 Four tranches

   24,448.00

 Last tranche at 10%

     2,000.00

 Total tax due

 26,448.00

Multiple Completion:
 Total proceeds

100,000.00

 Taxed at 10%

 10,000.00  

 Tax saving

 16,448.00  

 

 

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