The ‘normal’ treatment for a company purchase of own shares is the income treatment, meaning the difference between the amount paid by the company and the original subscription price of the shares is treated as an income distribution to the outgoing shareholder.
Provided that certain conditions are met, found at s.1033-1048 CTA 2010, it is possible for the capital treatment to apply instead, which has the effect of treating the amount received by the shareholder as a capital distribution on the disposal of their shares. The general conditions that need to be satisfied include:
- The trade benefit test (1033(2) CTA 2010)
- Requirements as to residence of the shareholder (1034 CTA 2010)
- Requirement as to period of ownership (1035 CTA 2010)
- Requirement as to reduction of seller’s interest as shareholder (1037 CTA 2010)
- Ongoing connection test (1042 CTA 2010)
The sale of the shares in tranches through a multiple completion contract has implications for both the trade benefit test and the ongoing connection test.
Trade benefit test
The trade benefit test will only be satisfied if the company’s sole or main purpose in the acquisition of the shares is for the benefit of its own, or a 75% subsidiaries, trade. HMRC statement of practice 2/1982 goes into detail on their perspective of the trade benefit test, and shows that it is unlikely that the test is satisfied if the shareholder retains a shareholding after the purchase:
“If the company is not buying all the shares owned by the vendor, or if although the vendor is selling all his shares, he is retaining some other connection with the company – for example, a directorship or an appointment as consultant – it would seem unlikely that the transaction could benefit the company’s trade, so the trade benefit test will probably not be satisfied.”
There are various exceptions to this rule, including where a retiring shareholder maintains a holding of not more than 5% for sentimental reasons. It is also possible to still meet the trade benefit test where the company purchases as many shares as it can afford, with the intention of buying the rest of the shares at the earliest possible date. This means the trade benefit test could be met in your client’s scenario where as much of the reserves as possible is used in purchasing the fathers shares, and the company shows a clear intention to purchase the rest of the shares once they can afford to do so.
Ongoing connection test
Your client must not be connected with the company, or a member of the same group, immediately after the purchase of own shares. The client will be connected with a company where he possesses, or is entitled to acquire, more than 30% of (s.1062 CTA 2010):
- The issued ordinary share capital of the company,
- The loan capital and the issued share capital of the company, or
- The voting power of the company
Even if a multiple completion contract is used to dispose of all of the beneficial ownership in the clients shares, staged over multiple disposals, it is still possible that the ongoing connection test could be failed. HMRC explained their view to the CIOT on the meaning of the word ‘possesses’ for the purpose of this test through an explanatory note. They take the view that this refers to the client’s legal ownership in the shares, as opposed to their beneficial ownership, and so if a multiple completion contract is used it will be relevant to ensure the client is immediately taken below the 30% limit after the first tranche is disposed of. HMRC also consider this point in manual CG58655 which looks into further detail at using a multiple completion contract.
“Is the person still connected to the company after every stage that a tranche payment has been made? – although the contract to purchase shares has been signed, the shareholder has not relinquished shares until the date of payment, and when conducting in stage payments, at each stage CTA10/S1042(1) would need to be satisfied. This is because the connected test follows the legal ownership rather than the beneficial ownership.”
It is recommended to seek clearance from HMRC under s.1044 CTA 2010, which requires HMRC to notify the applicant of their decision within 30 days of receipt. It is also recommended to seek advice from a company law specialist regarding the various legal requirements of a purchase of own shares.
Please share this article with your clients
