One of the directors of an unquoted trading company proposes to retire. In 2012, he bought 7% of the company’s shares from a leaver at market value and made an election under ITEPA 2003 s 431. In 2006, £250,000 was transferred to a sub-fund of the company’s EBT for his benefit; this has been retained by the trustees and invested and is now worth £600,000. The owners of the company intend to buy back the director’s shares and want to know what the implications of the assets held in the EBT are.
Where senior employees are retiring, there are often a 
number of factors to be considered beyond the obvious commercial imperatives of ensuring a smooth transition to their successors and that a proper handover takes place.
The repurchase of the director’s shares makes commercial sense. Minority shareholders with no ongoing connection with the business can be an unnecessary distraction for a company; the company would need to keep track of changes of address and the rules on guaranteeing the rights of minority shareholders can complicate future decision making, particularly when a transaction is in the offing. However, the repurchase presents a number of key issues for the company.
The most straightforward issue is the price at which the shares will be repurchased. If the price is greater than the shares’ market value, determined in accordance with TCGA 1992 Part VIII, then the difference between the value of the proceeds and the market value will be treated as taxable employment income, which will be subject to PAYE and NICs.
If the person buying the shares from the retiring director is also within the scope of the rules on employment-related securities and the price paid for the shares is less than market value, that person would have income tax charges to settle.
If the intention is that the company itself will buy the shares and has sufficient distributable reserves to effect the purchase, then the rules on company purchases of own shares mean that the director would not enjoy capital treatment. Where a company buys its own shares, the transaction will normally be taxed as if it was a dividend distribution, unless the transaction meets the criteria set out in CTA 2010 s 1033. In this case, the retiring director has not held his shares for the minimum period of five years to qualify for relief.
This means that the retiring director would be taxed as if he had received a dividend distribution equal to the difference between the disposal proceeds and the amounts originally subscribed to acquire the shares, which is often no more than the par value of the shares. While the CGT rules only tax shareholders on the ‘profit’ on the sale of shares, by recognising any costs incurred in purchasing shares, these rules give shareholders no credit for the costs of purchasing second-hand shares. To take an extreme example, if a person bought 100 shares of £1 each from a founder shareholder, who had subscribed at par for the shares, paid £100 per share and then, on the next day, those shares were bought back by the company at the same price of £100 per share, the shareholder would be taxed as if they had received a dividend of £99 per share.
If no other shareholder wishes to buy the shares, then the company could consider establishing an employee share trust (EST) to buy the shares and to hold them with a view to distributing them to other employees. The issues surrounding the establishment and funding of an EST are too involved to explain here, but this can be an attractive route for companies that wish to ‘recycle’ leavers’ shares in their employee share schemes.
A sale of shares to an EST is potentially within the scope of the rules in ITA 2007 Part 1 Chapter 1 on transactions in securities, but if it can be shown that the transaction is being undertaken for genuine commercial purposes and not to avoid income tax, a counteraction notice should not be issued. The company should consider whether to seek clearance for the transaction from HMRC.
As the retiring director made an election under ITEPA 2003 s 431 when he bought the shares, no charges should arise under the rules on restricted securities and the disposal of his shares will not need to be reported to HMRC on form 42.
The final issue to consider is the timing of the purchase of shares. Provided that the company qualifies and that the director’s shareholding confers at least 5% of the voting rights and constitutes 5% of the ordinary share capital of the company (and has done so throughout the year ending on the date he sells the shares), then the director will be able to claim entrepreneurs’ relief on the disposal of his shares, which means that he will pay tax at a rate of 10% on the first £10m of gains that he makes. The director must also be an officer or employee of the company when he sells the shares; if he retires before the date of sale, he will lose out on the relief.
With regard to the assets in the EBT, the company will need to ensure that PAYE is operated on any payments that are made out of the EBT, and NICs will also be in point.
The company will also need to be aware that HMRC takes the view that assets appointed to a sub-fund do not benefit from the reliefs from IHT that an EBT usually enjoys and may seek to levy ten-year charges and exit charges on payments out of the EBT.
If the company has not already done so, it is still possible to approach HMRC to agree a settlement under its EBT settlement opportunity. Depending on the circumstances of the director, this can be very beneficial where there has been growth in the value of assets held in an EBT.
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