Tax implications on disposal of shares by a shareholder

Introduction

In the May 2012 In Practice article, 'Purchasing a company from an unconnected party', we looked at the tax implications for a company selling or purchasing shares from an unconnected company (see 'Related links' on this page).

Here, we explore some of the options relating to the disposal of shares by a shareholder.

If the shareholder is also the director of the company it is vital to plan the exit at an early stage in order to obtain the maximum benefit. Guidance on this area can be found in the Planning your exit from your business and Guide to…annual investment allowances documents.

If the shareholder wants to dispose of their shareholdings in a company they have the following options:

  • sell the shareholdings to an unconnected party;
  • sell the shares back to the company;
  • gift the shares to a family member or an unconnected party.

Unconnected party

If the shares are sold to an unconnected party, the shareholder will realise a capital gain which is the difference between proceeds received and original cost.

Provided that the shares are in a trading company and the seller is an employee or an officer of the company which holds at least 5 per cent of the share capital, entrepreneur relief (ER) will be available, up to an accumulated total lifetime limit of £10,000,000.

This effectively means that the gain will be taxed at the rate of 10 per cent. Technical Factsheet 164: Entrepreneurs' relief contains additional guidance. 

It is possible for shares acquired under the Enterprise Management Incentive Scheme to qualify for Entrepreneurs' Relief where the 'personal company' requirement is not met (see HMRC Guidance CG64052, available via the 'Related links' section on this page).

Back to the company

The purchase of shares by the company is often called a ‘share buy back’.

Where a significant shareholder seeks an exit but the existing shareholders can’t afford to purchase the shares and the changes would have a detrimental impact on the business, then the only route to realise the capital originally invested might be for the company to purchase its own shares.

There are strict legal requirements regarding the purchase by a company of its own shares; however, the process has been simplified by the changes introduced in the Companies Act 2006.

Assuming that the requirements of the act have been observed, there are two possible tax treatments of the share disposal by the shareholder: the income treatment or the capital treatment.

Capital treatment may provide a better tax option for the exiting shareholder; however, the following conditions have to be met in order for this treatment to apply:

  • The company should be an unquoted trading company.
  • The purchase should be mainly for the benefit of the trade and not be part of a tax-avoidance scheme.
  • The seller must be resident and ordinarily resident in the UK at the time of the buy back.
  • The seller must have owned the shares for at least five years (or three years if acquired as a result of a death and the ownership period of the deceased is included).
  • The seller should have a 25 per cent reduction in the company shareholdings when comparing pre- and post-buy-back shareholdings.
  • Following the buy back, the seller must not be connected with the company - which effectively means that the seller will not be entitled to more than 30 per cent of share capital loan, voting power or net assets on a winding up of the company.

If the capital treatment applies entrepreneurial relief might be available, provided that it meets the criteria set out above.

 

 

Gift of share

If the donor gifts the share, the donor will be treated as making a disposal for capital gains tax purposes.

The proceeds are deemed equal to the market value of the assets at the date of the gift.

This applies even if the donor and the donee are not connected persons, so the donor might have a gain on which capital gains tax is due but no money to pay the tax.

In this instance, the donor and donee can  elect jointly to defer the gain under the ‘gift relief’ provision. Essentially, the relief transfers the capital gain from the donor to the donee.

Gift relief is available on gifts of any number of shares in an unquoted trading company in which the seller owns at least 5 per cent of the voting rights.

If gift relief is available, the way the relief works is by taking the capital gain and deducting it from the base cost for the donee.

This means that the donor does not have a chargeable gain while the donee is treated as acquiring the share at a base cost equal to the donor’s base cost.

 

 

Reinvestment relief

 

If a taxpayer realises a gain on any asset and subscribes for shares in a new Enterprise Investment Scheme (EIS) share, they can make an EIS reinvestment relief claim to defer all or part of the gain.

The amount of the gain that can be deferred is the lower of:

  • the capital gain realised on the disposal;
  • the amount reinvested;
  • the specific amount claimed.

The reinvestment must be made within 12 months before or 36 months after the disposal of the original asset.

The frozen gain becomes chargeable when the EIS shares are sold, the investor becomes a non-UK resident within three years of the issue of the shares or the EIS shares cease to be eligible shares.

 

 

Changes introduced in Finance Act 2012

Gains realised on the disposal of any asset in 2012/13 that are invested through the Seed Enterprise Investment Scheme in the same year will be exempt from CGT.

The measure was introduced to support the government’s growth policy by helping smaller, riskier, early-stage UK companies, which may face barriers in raising external finance, to attract investment, making it easier for these companies to be established and to grow.