Tax implications of share buybacks

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Broadly, a company share buyback offers a mechanism whereby a shareholder can dispose of their shares in a company to the company itself for consideration, however, a company share buyback can generate unanticipated tax costs.

Where a company buys back its shares for a price above the subscription price for the share any amount in excess of the subscription price can be treated as a distribution by the company subject to income tax at marginal rates in the hands of the shareholder. Provided certain conditions are satisfied a shareholder may avail of capital gains tax treatment on the buyback rather than income tax, this is commonly referred to as share buyback relief. This relief can be useful where a shareholder would be otherwise unwilling to dispose of their shares in the company due to the prospect of a significant income tax charge on a share buyback.

Main conditions for share buyback relief

Broadly, the main conditions for share buyback relief to apply are as follows:

  1. The company buying back its shares must be wholly or mainly a trading company or the holding company of a trading company.
  2. The buyback cannot form part of a scheme to avoid income tax on distributions (dividends).
  3. The exiting shareholder must be both tax resident and ordinarily tax resident in Ireland in the tax year in which the share buyback takes place.
  4. The exiting shareholder must have owned the shares for a period of at least five years ending on the date of disposal (this ownership test can be modified in certain circumstances).
  5. The share buyback must be wholly or mainly be undertaken to benefit the company’s trade.
  6. The exiting shareholder’s remaining shareholding (if any) in the company post buyback must be substantially reduced. It is important to note that shareholdings held by certain associates aggregate for the purposes of this test.
  7. The exiting shareholder must no longer be connected with the company post buyback, again it is important to note that shareholdings held by certain associates aggregate for the purposes of this test.

Trade Benefit Test

As noted above, in order to qualify for capital gains tax treatment, the buyback must be wholly or mainly undertaken to benefit the company’s trade. Revenue outlined in Tax Briefing 25 that they will normally regard a buyback as benefiting the trade where:

  • The purpose is to ensure that an unwilling shareholder who wishes to end his/her association with the company does not sell the shares to someone who might not be acceptable to the other shareholders.
  • There is a disagreement between the shareholders over the management of the company and that disagreement is having or is expected to have an adverse effect on the company’s trade and where the effect of the transaction is to remove the dissenting shareholder.

Examples of this would include:

  • A controlling shareholder who is retiring as a director and wishes to make way for new management.
  • An outside shareholder who has provided equity finance and wishes to withdraw that finance.
  • A legatee of a deceased shareholder, where she/he does not wish to hold shares in the company.
  • Personal representatives of a deceased shareholder where they wish to realise the value of the shares.

Conclusion

Share buybacks are commonly used in practice as a means of facilitating a disgruntled shareholder to exit a company for consideration and also as a means of facilitating inter-generational succession planning. To discuss share buybacks with us please contact either Mark Doyle (mark@circulo.ie) or Amanda Comyn (Amanda@circulo.ie).

Business Asset Relief and Excess Cash

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In this article, Mark Doyle and Gearalt O’Neill discuss the impact of cash balances on a claim for CAT Business Asset Relief.

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Private company valuation for tax purposes in Ireland

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Introduction

The valuation of private companies for tax purposes holds significant importance within the Irish tax system. It plays a crucial role in accurately assessing the tax liability of shareholders in many different circumstances. Valuations undertaken for tax purposes must be guided by the relevant legislation for each tax head and often the valuation adopted for one tax head (e.g. CGT) may be different to the valuation adopted for second tax head (e.g. stamp duty). Where shares in a company are valued incorrectly, Revenue may impose penalties and interest on any under declared tax liabilities.

Capital Gains Tax (CGT)

The relevant legislation for determining the valuation of shares for Irish CGT purposes is section 548 TCA 1997. Shares are to be valued at “market value” which means the price those shares may reasonably be expected to fetch on a sale in the open market. In valuing those shares no reduction in value is to be made on the assumption that selling all of the shares at the one time would result in a lower price being fetched. Where the shares to be valued are not quoted on a stock exchange at the time at which their market value is to be determined it is to be assumed that there is available to any prospective purchaser of the shares all of the information which a prudent purchaser of those shares might reasonably require if such purchaser was proposing to purchase the shares from a willing vendor by private treaty at an arms length.

Capital Acquisitions Tax (CAT)

The relevant legislation for valuing shares for CAT purposes is section 26 CATCA 2003. Shares are to be valued at “market value” which is to be taken to be the price which such shares would fetch if sold in the open market on the date on which the share is to be valued in such manner and subject to such conditions as might reasonably be calculated to obtain for the vendor the best price for the shares. As with valuation for CGT purposes, no reduction in value is to be taken for any assumed decrease in value if all of the shares were sold at the same time, also any prospective purchaser is assumed to have all of the relevant information available to them pertaining to the shares and the company. However, section 27 CATCA 2003 contains specific provisions in relation to the valuation of shares in private companies for CAT purposes which will often create significant divergence between the valuation adopted for CAT and for other taxes. Broadly speaking, section 27 prevents the application of minority discounting to any group of shares that is under family control.

Stamp Duty

The relevant legislation for valuing shares for stamp duty purposes is contained in section 19 SDCA 1999. Shares for stamp duty purposes are valued in the same fashion that they are valued for CAT purposes, however the provisions of section 27 CATCA 2003 do not apply to determine the value of shares for the purposes of stamp duty (i.e. minority discounting does apply for stamp duty purposes).

Conclusion

By recognizing the significance of company valuation, shareholders of private companies in Ireland can effectively manage their tax obligations. Circulo have significant experience in valuing shares in private companies for all tax purposes. For further information please contact mark@circulo.ie or amanda@circulo.ie.