What do you do if an employee-shareholder is leaving your company and you want to buy back their shares? The first point to make is that before any employee acquires shares you should first have clearly set out the rules for the buy-back should they leave. If not you could find that taking back those shares is very difficult. This may cut across your remuneration policy as you will not want to pay tax effective dividends to yourself. It could also scupper your future sale of the company.
This month we discuss the points you need to consider with buy-back arrangements and also tell you about some planned changes to company law.
Why are share buy-backs useful?
You may be wondering why a share buy-back should be of any interest to you. Why not simply include a mechanism so that you can buy the shares yourself rather than have the company buy them back?
Well, like many owner-managers most of your capital may be tied up in your company. So in order to buy the shares personally you may need to take money out of your company. This may be expensive to do because of the tax implications of the transaction.
The cheapest way to take money out of your company (from a tax viewpoint) will be via a dividend. If you are a higher rate tax payer it will cost you 25% in dividend income tax to withdraw the money. For a taxpayer paying income tax at the highest rate the net tax on dividends will be 30.56%.
So, if you are to buy back the shares of a former employee for £90,000, the total cost to you could be over £129,000 when your income tax is taken into account.
On the other hand, with a share buy back you use the company’s own money, so there is no tax cost to you. The shares are cancelled and the issued share capital is reduced.
What are the pitfalls with share buy-backs?
You must be careful with a share buy-back to follow the detailed rules set out in the Companies Act 2006. If you do not when you come to sell your company you may find that the buyer is concerned that you do not own all the shares.
Here are the key points to note:-
- The company must have available distributable profits (but see below) to cover the purchase price. If this is not the case you will need to follow a different procedure to buy the shares back out of capital.
- At present (but see below) you cannot pay for the shares in instalments.
- The buy-back must (but see below) be approved by a resolution passed by the holders of 75% of the share capital.
- You should ask the seller to surrender his share certificate or if this is lost provide a replacement for surrender against an indemnity provided by the seller for his missing certificate.
- The seller will generally want his sale proceeds to be treated as a capital receipt and not as a distribution: he may be entitled to entrepreneur’s relief giving him just a 10% tax charge. So he may ask you to obtain a tax clearance for him.
Payment by instalments
Company law does not currently allow a buy-back transaction to be structured so as to allow for payments by instalments. So if you pay by instalments the whole arrangement may be void.
A structure sometimes employed is for “multiple completions”: this means that for each transaction there is full cash (for the tranche of shares concerned) paid on completion. However, for this to be effective for tax purposes the seller must (on day one) give up all of his rights to the shares to be sold. With a seller unable to sue in damages if the company fails to complete he may be legally exposed. If the seller can “rescind” (lawyers’ language for cancel the deal) this may prejudice the beneficial tax treatment.
New rules proposed
The Department for Business, Innovations and Skills (BIS) has recently published its response to a recent consultation on share buy-backs. The following is proposed:-
- A buy-back can be approved by the holders of a majority (50.1%) of the issued share capital instead of a special resolution (the holders of 75% of the shares) being needed.
- Advance approval of multiple share buy-backs will be permitted in connection with employee’s share schemes.
- Private companies can pay for shares in instalments where the buy-back is for the purpose of or in connection with a share buy-back under an employees’ share scheme.
- For small transactions (not exceeding £15,000 or 5% of the share capital) the buy-back does not have to be out of distributable reserves.
- Instead of cancelling shares on buy-back you can allow them to be held “in treasury” for later transfer/sale.
These changes are expected to be introduced in 2013.
Hints & Tips
- In order to avoid problems in the future, or on the sale of your company, you should ensure that before any employee acquires shares you have set out a share buy-back provision in the company’s articles of association or in a shareholders’ agreement.
- You must be careful to follow the detailed rules set out in the Companies Act 2006. Not doing so could mean that the buy-back is void and that the seller still owns the shares.
- Remember that a Form SH03 must be filed at Companies House within 28 days of the buy-back and that stamp duty of 0.5% is payable on the purchase price if it exceeds £1,000, rounded up to the nearest £5.