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Insights // 12 April 2016

Falling Out is Hard to Do - Business Shareholders and Directors and the Tax Position

Partner David Few, head of our Corporate team, discussed the tax position when business shareholders have a falling out or dispute.

David Few

Many private companies are built on longstanding friendships between the shareholders and directors developed over many years. Like any relationship it is therefore sad when those shareholder directors who may have started out on a common venture as good friends, fall out with all the animosity that sometimes can follow. In such situations it is common to think only of the individuals whilst forgetting that the health of the company can particularly suffer.

When there is a breakdown, a common solution is for one of the shareholders to leave the company and to sell their shares. If the other shareholders are unwilling or unable to buy the shares and there is no ready third party prepared to buy (assuming that the articles of association permit a sale to a third party) then a private company may decide to use its distributable profits to purchase the shares of the departing shareholder.

The basic tax position is that when a company re-purchases or ‘buys back’ its own shares, the payment will be treated as if it was a dividend paid to the former shareholder. In the hands of the departing shareholder the receipt will be taxed as income and attract an income tax charge of 25% or more.

However, for private companies there is a more attractive and tax efficient option which will permit a departing shareholder to secure a lower tax bill and therefore keep more of the cash. In such a situation, provided it can be demonstrated that the company’s re-purchase of the departing shareholder’s shares will be to the benefit of the company’s trade, then it should be possible (subject to obtaining a prior clearance from HMRC) to treat the share purchase as if it were a capital payment for which the more favourable capital gains tax regime will apply. There are a number of other requirements that must be met including that the payment must be in cash and the departing shareholder is required to have held their shares for at least five years.

When the former shareholder qualifies for entrepreneur’s relief the effective rate of tax on the payment for his or her shares is reduced to just 10% on any profit in excess of the original cost of the shares (after deducting annual exemptions). The difference between the income tax treatment of the share proceeds and the more favourable capital gains tax treatment will be more marked after 6 April 2016, when new rules will be introduced about the way dividends are taxed and when the tax rate on dividends for higher rate taxpayers increases from 25% to 32.5%.

For further information or legal advice, please contact law@blandy.co.uk or call 0118 951 6800. 

This article is intended for the use of clients and other interested parties. The information contained in it is believed to be correct at the date of publication, but it is necessarily of a brief and general nature and should not be relied upon as a substitute for specific professional advice.

David Few

David Few

Notary Public

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