Often the most tax efficient way of having a co-owner retire from a company is by way of buying back his or her shares.

The big attraction is that the company can use its own funds, which is usually preferable to the other shareholders having to fund buying the leaving shareholder out with their own taxed income.

However there are a few boxes that need to be ticked before you can use this method:

• Getting HMRC capital treatment on a buy-back is trickier than on a normal share sale and will require your accountant to write a tax clearance letter to HMRC. Hurdles include:
  • Has the departing shareholder (or current spouse) held his or her shares for 5 years (3 years if they were inherited)?
  • Is the company either a trading company or the parent of a trading group?
  • Can you make out a case that the purpose of the buy-back is either to (a) benefit the trade carried on by the Company or its group or (b) to discharge an IHT liability on death which would otherwise cause undue hardship?
  • Is the seller getting rid of at least 75% of his or her existing interest in capital and profits and, after the buy-back is complete will he or she together with any associates (including spouse) hold less than 30% of the voting power, share capital and capital rights in the Company?

• Does the Company have sufficient distributable profits?
  • This is the distributable reserve figure shown on your Company’s balance sheet and may not bear any relation to whether or not the Company has sufficient cash.
  • If it’s too low your accountants may be able to help increase it by way, for example, of revaluation of fixed assets, share premium reduction or dividend(s) from any subsidiaries.
  • There is an exemption for meeting the distributable profit requirements for very small buy-backs (limited to an annual amount of the lower of £15,000 or 5% of the issued share capital of the Company) so long as the buy-back is specifically permitted in the Company’s articles (if it’s not you will need to amend them) but this is often too low to be of practical use.
  • Buy backs out of capital or out of monies raises by way of a fresh allotment of shares are also possibilities but these are more complex and subject to additional documentation/restrictions.

• Do you have the actual cash?
  • The Companies Act states that the price for any buy-back must be paid in full on completion. The Company can’t pay for its shares on a deferred basis.  If the Company doesn’t have the spare cash and can’t borrow it, there are a couple of work-arounds:
    • The first is some sort of loan-back arrangement from the departing seller – but this needs to be carefully drafted.
    • A second is staggering the buy-back in tranches (which is not ideal for several reasons and would also require specific HMRC approval in the clearance if this meant the usual ‘ongoing interest in Company’ restrictions weren’t being met).

• Can you get shareholder approval?
  • A buy-back out of profits (unless the articles or a shareholders’ agreement provide differently) only requires the approval of the majority of the non-selling shareholders. You can do this in writing.
  • If any class consents are needed (for example from preference shareholders) these would usually require 75% approval of the relevant class.

• The buy-back contract will need to have been drawn up and circulated to shareholders before they approve the same. Contingent buy-back agreements are possible but add complexities to the process.

• The usual Entrepreneurship Relief rules will apply as for a normal share sale so there is a good chance that a departing shareholder will qualify for an exit at the 10% CGT rate. However timing can be important so it’s critical to have your accountant and lawyer ‘singing off the same hymn sheet’ in this regard.

• The Company needs to pay stamp duty at 0.5% (rounded up to the nearest £5) on the buy-back consideration.

If you don’t follow the correct procedures it’s likely that the buy-back will fail and monies paid out to the ‘seller’ will be treated as a loan from the Company (and he or she will retain the shares).

If a buy-back can’t be effected for some reason then the fall-back solution is often to put another company on top of the Company and have that Newco parent buy the departing shareholders shares. This avoids the strict ‘length of time shares have been held’ requirements and other HRMC capital treatment requirements specific to buy-backs, payment can be made by instalments and the distributable reserve issue also disappears, but it does require more or less unanimous consent and increases legal and ongoing administrative costs. Also, as the remaining shareholders will need to exchange their shares in the Company for shares in Newco parent and mirror relief from stamp duty will not be available, there is a risk of additional non-trivial stamp duty cost arising out of a Newco parent solution.

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