Purchases of own shares: Multiple completion contracts

Company share buy-backs, or purchase of own shares (POS) transactions are an important tool in succession planning.

The typical scenario is that owner managers sell their shares back to the company under a POS transaction which leaves the next generation and/or the senior management team in place as the new owners.

The seller will normally prefer ‘capital gains’ treatment on the sale of their shares but the financing issue cannot normally be solved by arranging for the seller to loan back all or part of the purchase consideration.

Problems with financing a purchase of own shares

Financing a purchase of own shares is not always straightforward. By law, the purchase price for the shares to be bought back by the company must be paid immediately so it is not possible for a company to buy back its own shares for an amount of deferred consideration.

The qualifying conditions for capital treatment on a POS are found at s.1033 – s.1042 CTA 2010 and include the condition that after the purchase the seller must not immediately be ‘connected with’ the company or a company in the same group.

How is ‘connected with’ defined?

“A person is connected with a company if the person directly or indirectly possesses, or is entitled to acquire, more than 30% of:

(a) the issued ordinary share capital of the company,

(b) the loan capital and the issued share capital of the company, or

(c) the voting power in the company.”

What is a multiple completion POS agreement?

Because of the often substantial sums involved for the purchase of own shares consideration, the ‘multiple completion’ arrangement can often be a saving grace.

Simply, a multiple completion POS agreement enables the exiting shareholder to enter into a contract to sell their shares back to the company, but with the legal completion of the POS subsequently taking place in tranches.

A multiple completion POS agreement is generally used where the company has insufficient cash to pay for the shares in full upfront because it is often not possible to simply leave consideration outstanding.

How does a multiple completion POS work?

Where multiple completion agreements are used, the purchase is made by using a single contract with multiple completion dates.

At each separate ‘completion’ date, the company pays the relevant consideration and cancels the relevant tranche of shares being purchased.

In order for a multiple completion contract to work:

• For Capital Gains Tax purposes, there must be an outright disposal of the beneficial interest in the disposal shares at the date of the contract.
• Payment to the seller and transfer back of the shares to the company can then be made in tranches.
• The seller retains legal title, as nominee for the company.

Potential issue (which usually wasn’t an issue in the past!)

A potential issue with multiple completion POS contracts has always been that as the seller holds shares, those shares will still have voting rights. Historically though, HMRC have been prepared to grant clearance provided that the remaining tranches of shares (awaiting purchase) were converted to non-voting shares.

HMRC now to follow the letter of the law

HMRC have issued a note which confirms that going forward they will strictly apply the connection test described above which may result in some applications being rejected. Basically, HMRC are saying that they will now adopt a strict interpretation of the legislation.

The note makes it clear that HMRC consider that the word ‘possesses’ (as highlighted above), refers to legal ownership only.

As the seller will only transfer beneficial ownership at the date of the contract, with the legal title being retained on the ‘non-completed’ shares, in most cases those shares will mean that the 30% limit under the connection test will fail.

HMRC says that this is the case even if those remaining shares are converted to ‘deferred shares’ with no voting or economic rights in the company at the contract date.

What now for multiple completion POS contracts?

Whilst HMRC have confirmed that they will not revoke any previously issued clearances, even though the connection test might not have been met, they will not grant clearance where the seller remains connected with the company for fresh POS applications. They have confirmed that there is no new interpretation of the word possesses but that they have not always correctly applied the strict law relating to the connection test.

Going forward a multiple contract POS transaction might not be viable although, in some cases, there may be scope for adjusting the phasing of the POS completions to ensure that the seller satisfies the ‘connection’ test immediately after the first tranche of shares are purchased.

For others, alternative solutions will need to be explored in order to acquire outgoing shareholders’ shares.

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