HMRC have changed their view on the Purchase of Own Shares ‘connection test’: this affects multiple completion contracts.
We have seen HMRC deny tax clearance applications in respect of the Purchase of Own Shares in a couple of cases and now it has provided the Chartered Institute of Taxation (CIOT) with a note explaining their current thinking on the legislation.
The qualifying conditions for capital treatment on a Purchase of own shares are found at s.1042 CTA 2010. Amongst these is the condition that after the purchase the seller must not immediately be connected with the company or a company in the same group.
S.1062 defines ‘connected with’ as follows:
“A person is connected with a company if the person directly or indirectly possesses, or is entitled to acquire, more than 30% of
(a) the issued ordinary share capital of the company,
(b) the loan capital and the issued share capital of the company, or
(c) the voting power in the company.”
Where multiple completion contracts are used, the purchase is made by using a single contract with multiple completion dates.
- They are generally used where the company does not have sufficient cash to pay for the shares in full upfront because it is often not possible to simply leave consideration outstanding without breaching the 30% test as this will make the seller a loan creditor of the company.
In order for multiple completion contracts to work:
- For Capital Gains Tax, there must be an outright disposal of the beneficial interest in the disposal shares at the date of the contract.
- Payment to the seller and transfer back of the shares to the company can then be made in tranches.
- The seller retains legal title, as nominee for the company.
The potential issue has always been that if the seller holds shares, even as a nominee, those shares will still have voting rights.
In the past, HMRC has been known to accept that this might be avoided by converting the remaining tranches of shares that were not acquired and paid for at contract date into a separate class of non-voting shares.
- This new note makes it clear that HMRC consider that the word ‘possesses’ at s.1062 refers to legal ownership only. Since the seller will only transfer beneficial ownership at the date of the contract with the legal title being retained on the ‘non-completed’ shares, in most cases those shares will mean that the 30% limit under the connection test will be failed.
- HMRC say that this is the case even if those remaining shares are converted to ‘deferred shares’ with no voting or economic rights in the company at the contract date.
HMRC have confirmed that whilst they will not void any previously issued clearances where the connection test may not have been met due to retained legal ownership of the shares, they will not grant clearance in such circumstances in the future.
It may be that this method of implementing a purchase of own shares transaction is no longer viable in many cases and alternative solutions such as a Purchase by a holding company, will have to be found.
Update January 2023
Note that in January 2023 the CIOT have made budget representations flagging that there is no policy reason for HMRC to enterpret the legislation in this way. CIOT have requested that Government change the legislation to provide clarity as to whether "possess" is referring to legal or beneficial ownership.
Useful guides on this topic
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