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I act for an investment company, the shares in which are largely owned by various members of a family. Some would like to realise the value of their shares but the other shareholders do not have readily available funds to purchase them.
The company has certain liquid funds but a share buyback with capital treatment does not seem to be available under the legislation. It has therefore been proposed that the shares be converted into redeemable debentures, with a redemption date, say, one year ahead.
I act for an investment company, the shares in which are largely owned by various members of a family. Some would like to realise the value of their shares but the other shareholders do not have readily available funds to purchase them.
The company has certain liquid funds but a share buyback with capital treatment does not seem to be available under the legislation. It has therefore been proposed that the shares be converted into redeemable debentures, with a redemption date, say, one year ahead.
Does this simple manoeuvre circumvent the restrictions in the share buyback legislation?
Presumably section 703, Taxes Act 1988 is the main difficulty, but the company has distributed much of its annual profits each year and some of the value in the shares is attributable to a holding of land which has substantially increased in value but has not yet been sold.
Readers' views on the extraction of funds from the company by means of redeemable debentures would be welcome.
(Query T15,926) – Assetstripper.
This suggestion seems to be based on the premise that if you convert shares into debentures there is not a company purchase of shares. The actual transaction will be that the company buys back and cancels the shares in return for an issue of debentures. A debenture is simply a form of loan from the company and so the proposal is just a company purchase of own shares with payment of the consideration being deferred.
The fact that the payment for the shares is not made at the time that the shares are cancelled also raises a problem in terms of company law. This provides that for the purchase of own shares to be valid, payment for the shares must be made on redemption.
However, given that it would still be a purchase of own shares, the proposal has no merit as capital treatment would not be secured.
An alternative could be for the ongoing shareholders to set up Newco with minimal share capital. Newco would then acquire the entire share capital of the client company. The shares of the ongoing shareholders would be acquired in exchange for shares in Newco. The shares of the outgoing shareholders would be acquired in return for an issue of loan notes by Newco. In view of the potential for taper relief to continue to accrue, even if only at the non-business asset rate, non-qualifying corporate bond loan notes may be preferred. Advance clearance that section 135, Taxation of Chargeable Gains Act 1992 will apply and that section 703, Taxes Act 1988 will not apply should be obtained from the Inland Revenue.
With regard to taper relief, it should be noted that if any of the outgoing shareholders is an officer or employee of the company and that person together with persons connected with him holds no more than 10 per cent of the share capital, those shares in this investment company would qualify for the business asset rate of taper relief from 6 April 2000. By extension, the proposed legislation to extend the number of debentures that qualify for taper relief would be beneficial.
The first issue to resolve could be the financing of the purchase and the connected difficulties surrounding financial assistance for the purchase of own shares. The redemption of the loan notes in a year will probably be financed by the payment of an intra group dividend to Newco by the client company. This would be financial assistance and so it is highly likely that the whitewash procedure would have to be performed. Given that it is an investment company, it may not be too difficult to give the declaration that the client company will be able to pay its debts as they fall due during the year immediately following the date that the assistance is given.
Secondly, the client company and Newco will be associated and so the band for the very small companies rate and the small companies rate will be split between them. If this is likely to result in a significant tax cost, consideration could be given to hiving up the assets of the client company into Newco so that the former becomes dormant. – Hodgy.
Are the shareholders sure that they want capital gains rather than a distribution? It seems unlikely that business assets taper would apply (although it could do, from 6 April 2000 onwards, for an employed shareholder who owns no more than 10 per cent of the company). The effective rate of capital gains tax is therefore likely to be 34 per cent or 36 per cent (15 per cent or 10 per cent taper) for a higher rate taxpayer, or half that for a basic rate taxpayer; the rate on a distribution would be an effective 25 per cent for a higher rate taxpayer, or nothing for a basic rate taxpayer. The capital gains tax route is only preferable if there are other reliefs available which would mean that the higher capital gains tax rate is applied to a much smaller number, such as:
* retirement relief;
* a high base cost, because the shares were acquired relatively recently at more than the original subscription price;
* capital losses which cannot be used elsewhere;
* the annual exemption, if the gains are sufficiently small to be covered by it and it cannot be usefully set against other gains.
Even with a relatively high base cost (and even with business assets taper), a higher rate taxpayer who regularly makes gains may be better off with distribution treatment. Suppose the shareholder bought shares for £10,000 and sells them to the company for £15,000; if the subscription price was £1,000, there is a distribution of £14,000 and a capital loss of £9,000. The distribution is taxed at an effective rate of 25 per cent (£3,500); the loss can obtain capital gains tax relief at 40 per cent (£3,600). This compares favourably with a simple capital gain of £5,000, taxable at 40 per cent less some taper relief.
It is worth examining the numbers carefully before going into a complex scheme which may aggravate the Revenue. – Castlegate.
Extracts from further replies received:
Except for trading companies purchasing back their shares, distributions to shareholders bear an income character under Chapter II in Part VI, Taxes Act 1988.
Reduction of share capital requires complex procedures under the Companies Act 1985. New entitlements would have to be brought about by means of a bonus or rights issue to all members.
The likelihood of the proposal being caught as a tax advantage under section 703, Taxes Act 1988 is borne out by the case of Commissioners of Inland Revenue v Parker 43 TC 396, where there was a bonus issue of debentures, redeemed eight years later. – Bear.
Section 219, Taxes Act 1988 will only allow a purchase of own shares to be treated as a capital payment if the company is an unquoted trading company or unquoted holding company of a trading group.
The suggestion that the shares be converted into redeemable debentures would rely on the 'conversion' not being a disposal of the shares or a distribution so that the ultimate redemption is a capital item.
A brief look at section 209, Taxes Act 1988 might point to a problem. Subsection (2)(c) says that any distribution means any redeemable share capital or any security issued by the company in respect of shares in the company otherwise than for new consideration. As no new consideration will be passing, there will be a distribution of a non-qualifying variety (ibid., section 14(2)) – JWG.
