The provisions of Section 179 – 186 Taxes Consolidation Act (TCA) 1997 examine the following scenarios:
- The departure of a disgruntled shareholder.
- The retirement of a controlling shareholder who wishes to stand aside and make way for new management/the next generation.
- Situations where one shareholder wants to continue carrying on the trade while the other shareholder would prefer to exit the business and the company has the necessary funds to buy back its own shares.
- Access to company surplus funds as part of succession planning
- An outside shareholder who initially provided equity finance but who now wants the return of that finance.
- A marriage break-up, etc.
What Happens in a Share Buy Situation?
Providing the shareholder meets the necessary statutory conditions, the company can buy back its shares from that shareholder allowing him/her to get the benefit of the Capital Gains Tax treatment as opposed to the more costly Schedule F Treatment. In other words, if the CGT Treatment doesn’t apply, any payment for the shares in excess of the amount the company originally received for the subscription of those shares will be treated as a distribution under Section 130 TCA 1997 and will be liable to Income Tax at the shareholder’s marginal rate plus PRSI plus Universal Social Charge.
Generally the only occasions where funds can be extracted from a limited company without the recipient being exposed to tax at his/her marginal rate of income tax are on:
- a repayment of capital at par
- the sale/disposal of the shares
- a liquidation.
What are the rules as outlined in the TCA 1997?
Where an Irish resident company repurchases/redeems/acquires/buys back its own shares, then any amount paid to the shareholder in excess of the original price paid at issue will be treated as a distribution under Section 130 TCA 1997.
A more beneficial Capital Gains Tax treatment (that is, at 33%) can be applied under Section 176 TCA 1997 providing certain conditions are met.
S176 – 186 TCA 1997 contain the legislative provisions relating to share buybacks as follows:
• The company must be an unquoted trading company or the unquoted holding company of a trading group.
• The shareholder participating in the share buyback must be both Irish resident and ordinarily resident in the tax year in which the share buyback takes place.
• The redemption, repayment, or repurchase of the shares must be made wholly or mainly for the benefit of a trade carried on by the company or any of its 51% subsidiaries. It cannot form part of any scheme or arrangement, the purpose of which is tax avoidance. It cannot be used to enable the shareholder to extract the profits of the company, or any of its 51% subsidiaries, and avoid being treated as having received a dividend.
• The shareholder must own the shares for a period of at least five years ending on the date of the disposal.
• There must be a substantial reduction in the shareholder’s interest following the buyback. Don’t forget, you must include the shares of (a) the shareholder whose shares have been brought back and (b) any associates of that shareholder. For completeness, the term “associate” includes husband, wife, civil partner, and minor child. The term “substantially reduced” means that there is a reduction in the nominal value of the participating shareholder’s shares of at least 25%. Another way of saying it is that the shareholder’s remaining shareholding, following the redemption of the shares, cannot exceed 75% of its value pre-buyback.
• The shareholder must no longer be connected with the company i.e. the shareholder and his/her associates, together, must own less than 30% of the company post buyback.
Under Section 186 TCA 1997, they cannot hold or be entitled to acquire more than 30% of [s186]:
- (a) the ordinary share capital of the company
- (b) the loan capital and issued share capital of the company
- (c) the voting power in the company, or
- (d) the assets on a winding up in the company.
The Trade Benefit Test
The repurchase of its shares by a limited company must be made “wholly or mainly for the purpose of benefiting a trade carried on by the company or any of its 51% subsidiaries”.
Tax Briefing 25 provides guidance on the “Trade Benefit Test”:
- (i) It must be shown that the sole or main purpose of the buyback is to benefit a trade carried on by the company or of one of its 51% subsidiaries.
- (ii) The Trade Benefit Test would be breached if the sole/main purpose was to benefit the shareholder by reducing his/her tax liability as a result of the more beneficial CGT treatment.
- (iii) From the company’s perspective, the test would not be met if the sole/main aim was to benefit any business purpose other than a trade.
Situations where the buyback will benefit the trade include:
Where there is a disagreement between the shareholders of the company over its management and that disagreement is or will negatively impact on the company’s trade if the situation were to continue. Enabling the shareholder to cease his/her association with the company without having to sell his/her shares to a third party would benefit the company’s trade.
Revenue has listed a number of examples which involves the shareholder selling his/her entire shareholding in the company and making a complete break from the company which would benefit the trade.
Revenue also recognises that the shareholder may wish to significantly reduce his/her shareholding and retain a limited connection which the company. For example, a shareholder with a majority shareholding wishes to pass control to his/her children but intends to remain on as director as an immediate departure from the business would have a negative impact on the trade. In such circumstances it may still be possible for the company to show that the main purpose is to benefit its trade.
In circumstances where a company isn’t certain as to whether the proposed “buyback” is deemed to be for the benefit of the trade and providing all the other legislative requirements have been meet, Revenue will issue an advance opinion on whether the buyback satisfies the “Trade Benefit Test” if requested.
Are there any situations where the above conditions don’t apply?
The conditions as outlined in Section 176 – 186 TCA 1997 will not apply where the shareholder uses the entire proceeds received from the redemption of the shares to:
(a) Settle his/her inheritance tax liability in respect of those shares. This must be done on or before 31st October in the year in which the CAT is payable in relation to the inheritance of those shares or
(b) Discharge a debt which arose in order to settle this CAT liability within one week of the buyback and where the shareholder could not otherwise have discharged the tax liability without incurring undue hardship.
In the event of a company buying back its own shares or those of its parent company it must file a Return within nine months of the accounting period in which the redemption occurred or within thirty days if requested in writing by the Inspector of Taxes.
The Return must include all payments liable to the Capital Gains Tax Treatment.
If any individual connected with the company is aware of any scheme to avoid the “Connected Person’s Rule” they must notify Revenue within sixty days of becoming aware of that information.
Are there any other issues to be considered?
A liquidation instead of a share buyback might be considered for succession planning purposes.
CGT Retirement Relief and CAT Business Property Relief can be used to minimize (a) the tax on the transfer of the business/company by the parent and (b) the gift tax for the child receiving it.