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I act for a successful small company owned 50/50 by two brothers, A and B, who are also the sole directors. A is somewhat older than B and is resentful that he has no children willing to enter the company and succeed him, whereas B has a grown-up son currently working in the business.
A is determined to carry on until his 65th birthday which he considers the 'proper' retirement date, but wants the company to purchase his shares from him on his retirement at that time. The treatment for unquoted companies in
I act for a successful small company owned 50/50 by two brothers, A and B, who are also the sole directors. A is somewhat older than B and is resentful that he has no children willing to enter the company and succeed him, whereas B has a grown-up son currently working in the business.
A is determined to carry on until his 65th birthday which he considers the 'proper' retirement date, but wants the company to purchase his shares from him on his retirement at that time. The treatment for unquoted companies in
TA 1988, s 219 is expected to be used, giving the useful capital treatment in A's hands. Despite the tension, it is considered that a proper working relationship can be maintained until A's 65th birthday, but plainly the company's trade will benefit greatly once A has departed, fully and completely of course.
I am well aware of SP2/82 and its helpful view that if a 'disagreement is having or is expected to have an adverse effect on the company's trade then the purchase will be regarded as satisfying the trade benefit test provided the effect of the transaction is to remove the dissenting shareholder entirely'. However, I was concerned to read of the recent Special Commissioners' case (Allum v Marsh) which rejected SP2/82 and ruled that in that retirement situation the transaction had not been entered into for the trade's benefit and thus the desired capital treatment was refused.
I would be interested in readers' views on my clients' situation, and in their opinion as to whether A's determination to stick it out to precisely age 65 might damage or even destroy his prospect of the advantageous capital treatment.
Query T16,671 — Tiger.
Reply by Thicket:
Capital treatment whereby a company purchase of own shares will be subject to capital gains tax is perennially popular, spurred no doubt by the relatively generous capital gains tax reliefs, such as retirement relief (relevant to the case of the Allum & Allum v Marsh [2005] SSCD 191) and more recently business asset taper relief, which may be available. However, there are a number of conditions to be satisfied before the relief in TA 1988, s 219 is available. The condition which was highlighted in Allum was the requirement that the transaction must be for the benefit of the trade (s 219(1)(a)).
It was this condition which the Commissioner decided had not been met in that case. The taxpayers, Mr and Mrs Allum, were the directors of and owned 100 of 101 ordinary shares in their company. It owned valuable property in north London from which it operated a motor garage selling new and used cars, petrol sales and servicing cars. In 2000, an offer was received for the premises and options for the Allums to retire were considered. The scheme eventually chosen was for the company to sell the property following which the company would purchase their shares. This would leave the Allums' son as sole shareholder and director. (The son's previous shareholding of a non-voting redeemable preference share being converted to meet the requirement for there to be at least one ordinary share after the purchase.) The Commissioner found dis-favour with a number of features of the scheme. That which finally seemed to tip the balance was that the purchase could only have proceeded after the sale of the company's premises. This left the company with nowhere from which to trade, and no money for working capital, as almost the entire proceeds from the sale were used to pay out to the Allums. How could that benefit the trade?
HMRC has given guidance on interpretation of the 'trade benefit test' in Statement of Practice 2/82. The introduction makes it clear that the company's sole or main purpose must be to benefit the trade and this will not be satisfied where the transaction is designed to serve the personal or wider commercial interests of the vending shareholder (although usually he will benefit from it). An example given as usually satisfying the test is the removal of a dissenting shareholder where there is disagreement over the management of the company which is or is expected to have an adverse effect on the trade. There is no indication that SP 2/82 is to be withdrawn. However, my reading of the Allum case is that I have sympathy with the Commissioner's finding to deny relief in that case.
Tiger need not be too concerned for his client. The Allum case turned on its facts and these will not necessarily be the same in his case. The case did not fail on it being a retirement situation, rather that following the purchase of 100 out of 101 issued shares, the company was left without the means to carry on its trade. As long as this is avoided, then I do not see a problem for Tiger.
I have recently carried out a number of share buy-backs for clients including a purchase of two-thirds of the share capital of a successful engineering company from the retiring founding father and mother leaving the son to continue to run the company. Advance clearance was obtained with no queries raised. Again, advance clearance was given for a share buy-back where the vendor was wanting to sell the company to a third party who could not raise sufficient funds to pay the full asking price. That clearance was given in this latter case was surprising, but only goes to show that it may be worth trying for clearance even in marginal instances.
Reply by Hodgy:
Tiger refers to the case of Allum & another v Marsh SpC 446 where it was held that a purchase of shares was not for the benefit of the company's trade and he is concerned that the proposed purchase of own shares to buy out A might not be considered to be for the benefit of the company's trade.
The reason for this concern is that if the purchase is not for the benefit of the company's trade, it will not be taxed as a capital distribution by virtue of TA 1988, s 219(1)(a) and so it will be taxed at an effective rate of 25% instead of 10% if shares in the company qualify for the business rate of taper relief.
In the above mentioned case, the company went from being a strong asset-rich company with the father owning the majority of the shares and the next generation being minority shareholders to being a shadow of its former self with no premises, while the former majority shareholder ended up with a large amount of cash. The Special Commissioners tried to decide for whose benefit the payment had been made and it was decided that it was not the company.
In Tiger's case, A is not even a majority shareholder; he only holds 50% of the shares. In addition, once A retires he will not have common interest with B in that, although A has no children in the business, the wording of the query suggests that he does have children and so any share value would pass to them and not to B or his children. This greatly increases the potential for future conflict.
If B and his son make a mistake, A would be upset because not only is his investment in the family company damaged, but he has his own children to think of and the inheritance that they may receive in due course. On the other hand, if the company thrives, B and his son will come to feel that A is getting half of the fruits of their hard work 'for nothing'.
The purchase of own shares is likely to stretch the finances of the company, but the information on the relationship between A and B suggests that it seems likely to be a price worth paying.
Tiger asks if the timing of the purchase of own shares to coincide with the 65th birthday of A will damage the prospect of securing the advantageous capital treatment. However, the retirement of A is the exact time at which the retirement should take place, because that is the time when the interests of A and of B and his son with regards to the company will diverge.
If A starts to 'coast' knowing that his exit has been agreed, the sale might have to be brought forward for commercial reasons. However, the use of A's 65th birthday should not be a reason in itself that the trade benefit test will not be met. Tiger should remember that a purchase of own shares is simply a mechanism to effect an agreed sale of shares and the agreement is that this sale should coincide with the 65th birthday of A.
Allum and another v Marsh is the sort of case which does create problems because it calls into question 'facts' that we thought that we understood. After all, Statement of Practice 2/82 cites, as a possible example of a situation where the trade benefit test could be satisfied, the retirement of a majority shareholder making way for new management, which was exactly what happened.
As a means of trying to gain reassurance, when submitting the clearance application Tiger might consider including a sentence to say that he has reviewed the case of Allum and another v Marsh, compared it to the facts of this case and that his opinion is still that the trade benefit test is met in this instance. However, it is my opinion that on the basis of the facts provided, the trade benefit test will be met.
