Share Buybacks – Beware the Pitfalls!
Sometimes, a company might want to buy back its own shares, but there are a number of rules to be aware of and steps to follow to ensure that it is done correctly. This note considers some of key points for share buybacks by private companies under the Companies Act 2006.
Why might a company want to buy back its own shares?
Methods of finance
The most common ways in which a company will fund the purchase of its own shares are:
Each method of funding above has its own set of procedural steps to follow, but it is not our intention to run through those steps in this update.
There’s no running away from Tax
A buyback is generally divided into a capital element and a distribution element for tax purposes. Generally speaking the capital element represents the amount subscribed for the share (broadly the nominal value and any premium paid) and anything received in excess of that is treated as a distribution unless (for unquoted companies) it can be given capital treatment for tax purposes. Generally, capital treatment is preferred for most shareholders although individual circumstances will no doubt vary.
There are specific conditions which must be satisfied for capital treatment to apply to the buyback and so it is always advisable for a shareholder to seek appropriate tax advice first. It may also be advisable to obtain prior clearance from HMRC.
Things you need to consider first
Payment for shares – don’t mess it up!
An important issue to consider is how the shares are to be purchased. Statute requires any shares bought by a company as part of a share buyback to be paid for at the time they are purchased.
This principle of “cash on completion” means that it is not possible for the payment to be deferred or paid in instalments. You must also be careful about what constitutes “cash” for payment purposes. It may not be what you think it is.
If you can’t pay for the shares in one go on completion then it is possible for a buyback contract to provide for a number of buybacks in stages or tranches.
If the buyback is funded out of distributable profits, then the company must have sufficient distributable profits to pay for each individual tranche of shares at the time of each buyback.
Cancel shares or hold in Treasury?
Shares the subject of a buy-back can be cancelled or held in treasury. Treasury is a “share storage” where the shares are held by the company itself (the company needs to be registered as the holder of the treasury shares). Those shares can be transferred or sold by the company at a later date rather than being cancelled. Holding shares in treasury is only possible if the buyback has been done out of distributable profits.
The company holds the treasury shares but cannot exercise voting rights and is not entitled to any dividends or capital distributions, if any are made by the company. Shares held in treasury can be cancelled at any time.
The company may transfer the treasury shares at any time for cash consideration unless the transfer is pursuant to an employee share scheme, in which case consideration is not required. Any treasury shares sold this way are treated, for tax purposes, as if they were freshly issued shares and generally therefore don’t attract stamp duty on the initial resale.
Stamp duty treatment on the buyback is the same for shares held in treasury as it is with shares which are subsequently cancelled.
Consequences of non-compliance
A company purchasing its own shares must comply with Part 18 of the Companies Act 2006. Failure to do so will result in the acquisition being void and will also lead to an offence being committed by the company and every officer in default.
If the buyback is void then the shares remain in issue as being owned by the “selling shareholder”. This could lead to bigger issues for the company in terms of future actions taken without considering this shareholder, who remains a member. Dividends and company decision making could be tainted as well as a future company sale process.
Getting it wrong could be disastrous!
Don’t forget the filings, statutory books and of course any stamp duty!
Following the buyback you should attend to the payment of any relevant stamp duty, the relevant filings at Companies House and the updating of the company’s statutory books, including any required changes to the PSC register (Persons with significant control).
Ensuring you comply with the statutory requirements of a buyback will allow you to move forward in the full knowledge that there is no comeback on the company or its directors and will enable you to draw a line under the process. The last thing the company will want is to have to incur the time and expense of unravelling a void transaction!
For further advice on any of the issues raised in this article please contact Mark Tromans on 01543 431920 or email email@example.com