The usual approach to a tax planning and share buy-back strategy is to ask HMRC to treat the transaction as one within the scope of capital gains tax, but might there be a cheaper option?
HMRC clearance
Whenever a company buys shares in itself it’s required to provide details of the transaction to HMRC as it will want to see that there’s no tax avoidance involved. At the same time it will consider how the money received by the shareholders should be taxed. The usual approach is to ask HMRC to accept the payment as capital rather than income. This means the recipient will pay capital gains tax (CGT) instead of income tax. Typically this will be more tax efficient for the shareholder, but not always.
CGT trouble
Some years ago HMRC introduced anti-avoidance rules relating to entrepreneurs’ relief (now known as business asset disposal relief (BADR)). This has resulted in more cases where CGT (and not income tax) has been the less tax-efficient option for the shareholders selling their shares back to the company. The anti-avoidance rules are triggered where the shareholder intends to be involved in a similar business to that carried on by the company which they are leaving.
HMRC’s bias
HMRC is supposed to consider a company’s request for clearance dispassionately and agree to CGT treatment for a share buy-back where the facts fit. However, we’ve seen more than one case where it’s refused CGT treatment, mainly because it would result in a significantly lower tax bill for the shareholder compared with if the payment was charged to income tax.
Change of strategy
Where the anti-avoidance rules apply, i.e. if you get involved in a similar business to the one you’re leaving behind, it might be better for you to go for income tax treatment. The trouble is that HMRC doesn’t have to play ball. As we’ve said, if the facts fit CGT treatment, HMRC should confirm it, and if it gets a whiff of a possible tax advantage from income tax treatment it will probably encourage this.
Trap. While you’re entitled to challenge HMRC’s decision, it’s notoriously stubborn and in our experience is unlikely to change its mind unless the arrangements for the share buy-back are changed.
Tip. You can force HMRC’s hand into refusing CGT treatment by deliberately failing to meet the conditions for it to apply. There are a few ways to do this, for example, you could structure the buy-back so it’s made by instalments – this has another advantage of helping the company’s cash flow.
Tip. Before blindly going down the route of applying for CGT treatment, consider if income tax might be the cheaper option for the shareholder. You can then structure the arrangement to achieve the preferred ruling from HMRC.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.