Can I receive tax boost like my golf partner?
QUESTION: During my golf game last Saturday, I was shocked to hear that my golf partner had managed to extract cash from his business and paid only 10 per cent tax. All he had to do was to sell some of his shares back to his own company. He said that HMRC call this tax planning ‘Purchase Of Own Shares' as it involves a company buying back some of its own shares. I checked with my accountant and he said that this is legal and HMRC fully endorse this method of extracting cash from a company, however, it seems just too good to be true. I currently own 100 per cent of the shares in a trading company. Can I really sell some shares back to the company and receive cash at a 10 per cent tax?
ANSWER: Purchase of own shares (POS) tax planning is indeed an excellent tax opportunity for those who fulfil the conditions required to qualify for the capital tax rate of 10 per cent. However, as with all tax planning, the scenario outlined by your golf partner may not be just as simple and straightforward as you've been led to believe.
The current tax legislation provides that where a company buys some of its own shares back from an individual shareholder an income distribution occurs. This therefore results in an income tax charge arising on the individual, at the shareholders dividend tax rate, which can be up to 38.1 per cent. However, where certain conditions are met, the company purchase of shares would not be considered an income distribution and instead capital tax treatment would prevail, meaning that the shareholder may be able to pay tax at only 10 per cent on the proceeds received.
The conditions which must be fulfilled to qualify for the capital tax rates are as follows: Firstly, the buyback of shares must be for the benefit of the trade and must not be for the avoidance of tax. This condition is fairly subjective, but could include purchasing shares from a retiring or dissenting shareholder. The shareholder must be UK resident and must have owned the shares for at least five years. Also, immediately after the share sale the shareholder's interest in the company must be substantially reduced. This means that if your golf partner is still the 100 per cent shareholder after the share buy back the capital tax rate would not apply. Likewise, as you currently have 100 per cent control of your family company, if you were to sell some of your shares back to the company, you would still have 100 per cent control of the company after the share sale. Therefore, you would not fulfil this condition either. Finally, it is important that the shareholder disposing of shares is not connected with the company after the buyback and for this purpose HMRC include shareholdings of spouses and associates when determining the level of connection an individual has with the company after the sale. The connection test will not be fulfilled if the person holds 30 per cent or more of the share capital, loan capital, voting rights or rights to assets in a winding up, after the shares have been sold.
If in any doubt as to whether you fulfil the conditions for the capital tax rate, HMRC allows you to apply for advance clearance that the capital tax rates will apply. Where clearance is granted, HMRC will confirm that they believe the transaction is considered to be for the benefit of the trade and that all the other conditions are met. It is also important to note that there are various capital tax rates, with 10 per cent being the lowest rate. An individual's personal circumstances will determine if the lowest rate of 10 per cent will apply.
Other taxes which may become payable on the transaction, such as stamp duty, should not be ignored and it is also important to consider the legal requirements of the transaction. Before embarking on this type of tax planning it is recommended that specialist legal and tax advice should be sought and advance HMRC clearance should be obtained.
:: Janette Burns (email@example.com) is associate director at PKFFPM (www.pkffpm.com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.