Company Purchase of Own Shares

A Hidden Tool in Divorce Settlements

Tax is a key issue in determining how assets can be split and distributed in divorce. The impact of tax can be as important in determining the financial outcome for the parties as the nuances of valuation methodology - such as the multiple or minority discount. Yet often the tax implications do not receive sufficient consideration in the process.

For example, if we assume in a hypothetical case that Mrs Mouse is seeking a payment of £3 million for her 50% shareholding in Mice Enterprise Limited. The company has cash reserves to allow such a payment to be made.

Cash extraction as a dividend

The starting point is typically for Mr Mouse to purchase the shares of Mrs Mouse and to finance this by drawing a dividend from the company. If Mr Mouse simply draws £3 million from the company, his income tax liability (payable the following 31 January) will be approximately £1,180,500 (assuming a dividend tax rate of 39.35%). Therefore, although he has drawn the £3 million needed by Mrs Mouse, after paying the tax he is left with only £1,819,500 to pay her.

The dividend needed to arrive at a net-of-tax figure of £3 million is much higher: a dividend of £4,946,414 would have a tax liability is £1,946,414 but the net available to pay Mrs Mouse is now the original £3 million target.

It is important to look at the tax cost to achieve the required net value of £3 million and not the tax on a £3 million dividend. The tax differential is £765,914 (£1,946,414 less £1,180,500).

Cash extraction via Company Purchase of Own Shares (“CPOS”)

However, if Mrs Mouse owns the shares, then a CPOS may be possible. If the payment is structured as a CPOS and liable to capital gains tax (“CGT”) the tax due to achieve a net-of-tax payment of £3 million (assuming a 24% CGT rate) is £947,368. The gross consideration is £3,947,368.

The tax cost saving to make a net payment of £3 million as capital rather than as a dividend is £999,046 (£1,946,414 less £947,368).

In my indicative calculations I have ignored Business Asset Disposal Relief which may reduce the tax costs further.

There are several hurdles to overcome to make the CPOS treatment viable, including:

1. HMRC clearance – I would allow two months to obtain clearance
2. The criteria for CPOS are:

    • Not for the avoidance of tax
    • Shareholder is UK resident in the tax year
    • Shares have been owned by the shareholder for five years (or three years if the company was formed less than five years ago)
    • Shares must be fully paid up (there are possible solutions for tranches or loan notes, but these are more complex)
    • Funded from distributable profits
    • Payment for the shares at purchase
    • The selling shareholder’s interest is substantially reduced and there is no material ongoing connection to 

    NewCo structure

    If CPOS is not viable there can be other alternatives including a NewCo structure or demerger. These alternatives may also avoid or mitigate tax. Specialist tax input is required. 

    In summary

    The tax costs of different approaches to extraction of liquidity can be substantial. We recommend that in all cases the Single Joint Expert (“SJE”) should be instructed to consider the tax alternatives. In more complex or larger cases consider instructing a Shadow Adviser to give input on the tax costs of how cash payments are to be made or assets extracted from companies. Start the discussion on tax early and facilitate engagement between the SJE and the company’s own tax advisers. 

     

     

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    Email: fiona@fhmforensic.co.uk
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