A basic legal requirement for a company purchase of own shares (CPOS) is that it takes place for cash out of distributable reserves. This issue is often overcome by having a single share purchase contract with multiple completion dates.
Excalibur Ltd agrees to purchase Arthur’s 40% share in the company for £2m. As it does not have all the necessary reserves, the agreement provides that the contract will be completed for:
• £500,000 in respect of 10% of Arthur’s shares now, and then
• £500,000 for 10% on each of the first, second and third anniversaries.
Crucially, exchange takes place at the outset and so Arthur does not beneficially own any shares once the contract has been enacted but rather holds any ‘non-completed shares’ as a nominee for the company.
For tax purposes we are usually keen to get HMRC to agree that the ‘capital treatment conditions’ of a CPOS are met to allow the recipient to tax any profit as a lower-taxed, capital gain, rather than a dividend (which is the default position).
HMRC have generally been happy to give clearance to multi-completion date CPOSs on the basis that beneficial ownership transfers on day one and therefore all of the conditions can be met. However, they have now changed their minds and altered their guidance accordingly.
The connection condition for capital treatment means that after the CPOS the seller must not be connected with the company, or a company in the same group. The rules here (in section 1062 of CTA 2010) are as follows:
“A person is connected with a company if the person, directly or indirectly, possesses, or is entitled to acquire, more than 30% of
(a) the issued ordinary share capital of the company,
(b) the loan capital and the issued share capital of the company, or
(c) the voting power in the company.”
HMRC has always had an issue with point (c) because they have argued that the legal (although not beneficial) owner of the shares has voting rights. This issue has always been quite easy to bat aside by agreeing that the shares being purchased will become non-voting shares. However, on a similar theme, HMRC are now saying that any shares still legally owned by the seller will be treated as still held by the seller (i.e., they are attacking under point (a)). They had previously accepted that these were not ‘held’ because they were only held by the seller in a nominee capacity for the company. This is a huge change in their position and would mean that in the above example, Arthur would presumably not get clearance on the basis that he would (according to HMRC) possess 30% of the issued ordinary share capital.
HMRC have confirmed that they will not seek to overturn any clearances previously given under the old basis (if indeed they could!).
Forbes Dawson view
It is disappointing that HMRC has suddenly changed its view on something that they have allowed for years. It may, however, be that in practice there are still ways to persuade HMRC to grant clearance in these circumstances. For example, I wonder what their view might be if other shareholders were to ‘swamp’ the shareholding structure with new share subscriptions simultaneously with the CPOS? – thus preventing the 30% test being met. It may be worth sounding HMRC out about such possibilities in the wake of any refused clearance letters. Alternatively, it may now make more sense to structure a shareholder exit through the imposition of a new holding company which gives shares to remaining shareholders and cash to the exiting shareholder(s)…………………
You can use this form to request us to give you a call or if you prefer just leave us a message. Please be sure to leave us a contact number or email address for you and we will get back to you as soon as we can.