After years of dedication the time has come to consider retirement from the family business.
The business ownership is split, with controlling shares owned by you, and the rest split between your children.
Fortunately, your children have demonstrated aptitude and commitment, having been integral to the business for several years. This means they are well-suited to take over the business operations.
Having worked for years to build up the value of the business, you may well want to receive physical cash for your shares, therefore so gifting the shares would not be suitable.
You could sell the shares to your children! However there is no guarantee they will have the cash to fund payment for them.
Instead, a viable option is for the company itself to purchase the shares back from you.
This is commonly referred to as a ‘share buy-back’,. This process involves the company acquiring shares from an individual shareholder, typically followed by the cancellation of those shares. Consequently, the remaining shareholders would assume full ownership of the business.
The default treatment of the buy-back for the seller is that the amount paid for the shares (over the amount originally invested) is taxable as a dividend. This will be subject to the dividend rates of tax at 8.75%, 33.75% or 39.35%. This does however depend on the marginal rate of the taxpayer.
However, if the transaction meets certain conditions, the distribution can be treated as capital and instead potentially subject to lower rates of 10% on the first £1 million, if a Business Asset Disposal Relief: Eligibility – GOV.UK (www.gov.uk) claim can be made.
The treatment will only apply to an unquoted trading company or the unquoted holding company of a trading group. This means not an investment company will not qualify, or if there are any substantial non-trading activities within a company.
The transaction therefore must be implemented wholly or mainly to benefit the company’s trade. HMRC view that this test is unlikely to be met if the shareholder still owns 5% or more of the company, after the transaction.
When retiring from the family business the seller must be a UK resident for tax purposes.
The seller must have owned the shares for at least 5 years (or 3 years, if the seller received the shares on the death of a relative).
The seller’s shareholding must have been reduced by at least 25%. This calculation considers two ‘tests’ to determine whether this has occurred being the nominal value test or distributable profits test. In practice given HMRC’s stipulation that the seller must own no more than 5% for there to be a trade benefit this test is often only academic.
The seller (together with their associates) must not be connected with the company immediately after the transaction. This would be if the seller still possessed at least 30% of ordinary shares, loan capital or voting power. For these purposes “associates” includes the person’s husband or wife, their civil partner or any children under 18.
Some requirements when considering retiring from the family business include…
Having sufficient distributable reserves to purchase the shares
Having the requisite power in the articles of association
Ensuring the shares are fully paid for with cash.
Some companies may structure the purchase over many years using a multiple-completion contract if they do not have enough reserves to satisfy the requirement. This type of arrangement should be structured with great care as HMRC have recently changed their view on the interaction between multiple completion contracts and the connection test set out above.
If the purchase of own shares is done via multiple transactions, this can potentially disqualify capital treatment for the following reasons:
However, there is a specific exception to the trade benefit test where the company purchases as many shares as it can afford, with the company showing a clear intention of buying the rest at the earliest possible date.
As for the connection test, HMRC explained their view that it will be relevant to ensure the client is immediately taken below the 30% limit after the first tranche is disposed of.
We strongly recommend clearance is obtained in advance from HMRC to achieve certainty that the conditions for capital treatment have been met. It is also recommended to seek advice from a company law specialist as to the legal requirements. Whether clearance is obtained or not, there is a requirement for the company to report the repurchase to HMRC within 60 days of making the payment.
At ETC Tax, we have the knowledge and expertise to guide our clients through the implementation of a company to purchase of their own shares.
Do you have any questions with regard to passing on a family business. Please do not hesitate to get in touch with us today.
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