When Nothing Actually Happened

TREVOR JOHNSON relates how a share buy-back went wrong, but all was not lost.

IN TAXATION OF 25 July 2002, Martin Dawson wrote about share buy-backs and drew attention to the company law requirements which have to be satisfied in order for them to be lawful. Murphy's Law says if it can go wrong, it will go wrong and, if the tax rules are not satisfied, the chances are that the company law requirements are not satisfied either. However, there may be times when Murphy comes to the rescue.

About four years ago, my friend Charlie had a case that went pear-shaped. The chairman and majority shareholder of one of his client companies wanted to retire and realise some cash for his shares. The chairman and his wife held 7,500 out of 10,000 in issue, with the rest being held by their two adult sons.

Intending to make use of the available retirement relief for that year, Charlie arranged for the company to purchase 1,000 shares on 16 June 1998. However, the chairman suddenly decided he wanted more cash, and on 18 July the company purchased another 3,500 shares. Everything went off as planned, until one day the Revenue declared that the buy-backs were distributions, and issued assessments to collect advance corporation tax from the company.

No capital gain

The Revenue was quite correct in refusing capital gains treatment. After the second buy-back, the chairman and his wife still held 3,000 shares out of the 5,500 still in issue, a 54.5 per cent holding. He was therefore still connected with the company and the condition in section 223, Taxes Act 1988 was not satisfied. The chairman was not amused, and Charlie was about to dust off his professional indemnity policy.

This is the kind of job I hate. The battle has already been lost and someone asks you to take up arms in his defence. But someone had to help pay the next instalment on my old gas-guzzler, and so, with a groan, I asked for copies of all the paperwork. By going back to the beginning and checking each stage, maybe, just maybe, there would be a straw to clutch at.

Lucky break

The first stage was to check that the company had the power to purchase its own shares. Unfortunately, in this instance, the articles had been amended on 16 June 1998, so this was one straw that evaded our grasp. Was each buy-back approved by a special resolution? There were certainly documents to that effect, but were they valid?

A special resolution needs 75 per cent of the votes eligible to be cast on the question to be in its favour. The 1,000 shares which were the subject of the buy-back were disenfranchised for this resolution by section 164(5), Companies Act 1985, so the votes eligible to be cast were 4,000 by the chairman, 2,500 by his wife and 2,500 by their sons, a total of 9,000. In the minutes of the meeting of 16 June 1998 where the first resolution was passed, the chairman's wife was not recorded as being present. We had struck pay-dirt! Clearly only 6,500 votes out of 9,000, or 72.2 per cent, could have been cast in favour of the resolution, so it failed.

But what of the second special resolution on 18 July? The votes capable of being cast on this occasion were 500 by the chairman, 2,500 by his wife and 2,500 by his sons, 5,500 in all. The minutes of that meeting record that the two sons were the only people present. They could therefore have only cast 2,500 votes, i.e. only 45 per cent, so that too failed.

But that is not all. Although completion of the two buy-backs was stated to be 16 June and 18 July respectively, the company paid the total consideration in one sum on 26 July. Under section 159(3), Companies Act 1985 the consideration should be paid on completion, not a number of days afterwards. Ergo, this was not a lawful buy-back.

Second attempt

So we had to carefully explain to the Revenue that the purchases which were thought to have taken place actually had not taken place at all, because they were unlawful. All that had happened was that the chairman had received a loan from the company which would trigger a section 419 liability on the company and a benefit in kind on him. He was still the owner of the shares and would pay back the money received. Please could we start again?

This time, however, Charlie made sure that there was only one buy-back and it comprised sufficient shares for the chairman not to be connected to the company. He also made sure that he sought an advance clearance, that he had the right people voting for the resolutions, and that the consideration was paid in full on completion.

As a postscript, I should add that advisers should not expect the Revenue to draw their attention to cases where the buy-back is unlawful. The case of Moody v Tyler [2000] STC 296 is a sorry tale of an individual whose claim for capital gains treatment was turned down by the Revenue, the General Commissioners and the High Court. No one had noticed that the proceeds of this particular buy-back had simply been used to cancel out an outstanding loan account with the company. In other words, the consideration was not paid in full, in cash, on completion; it was not therefore a lawful purchase of own shares.

The moral of the story could be that if you are going to foul up, foul up big time - you might be able to have a second attempt. After all, if Charlie had paid attention to company law, he would have been sunk without trace.

Trevor Johnson is a freelance writer, lecturer and consultant and can be contacted by e-mail at tj@tjassocs.sagehost.co.uk.

Issue: 3871 / Categories: