Share Buy Backs & Redemptions
Companies (Accounting) Act 2017 – Commencement
A company can only acquire its own shares by purchase or where the shares are redeemable in nature by redemption or purchase. In addition a share buyback/redemption can only be carried out where:
(1) There are profits available for distribution i.e. there are sufficient distributable reserves. It is imperative that an entity carefully assess the reserves figure to ensure that the profit and loss reserves included the trial balance only relate to realised profits. Before any buyback is attempted the distributable reserves must be ascertained. The profit and loss reserves themselves may not always be fully distributable as it will depend on what has been recognised in profit in the past. An example would be investment property fair values (other than where marketing and negotiation has occurred and the legal documentation happens shortly afterwards) being recognised in the profit and loss account which ultimately may be shown in profit and loss reserves in the balance sheet unless the entity in the past has had the presence of mind to strip out such movements separately.
(2) The share buyback/redemption is made out of the proceeds from a fresh issue of shares made for the purposes of the acquisition. Where it is funded from the fresh issue of shares the amount that can be bought back is limited to the total amount of proceeds received from the shares issued.
Where the shares being acquired were previously issued at a premium and credited to a share premium account, the max amount that can be set against the share premium account/ (debited) is the lesser of the amount originally credited to the share premium account on issue of the shares being redeemed or the current amount of the un-denominated capital (which is effectively all types of capital the company holds which is in excess of the nominal value of the company’s shares issued). Any balance imposed by this restriction is debited with the balance of the proceeds taken out to redeem the shares.
Section 106(4) requires a capital redemption reserve to be created where a buyback has been financed from profits available for distribution so as to maintain the capital of the company. Where the buyback is financed from the fresh issue of shares in whole or in part and the proceeds on the issue of the new shares is less than the total nominal value of the shares acquired then the balance is recognised in a capital redemption reserve fund. Where share capital is redeemed this has no impact on the authorised share capital of the company.
Any incidental costs incurred on the acquisition of own shares must be paid out of profits available for distribution or from the proceeds from the fresh issue of shares (Section 110(1))
The company can only have the authority to acquire its own shares if:
- It is permitted by the constitution of the company; or
- It is permitted by the rights attached to the shares concerned; or
- A special resolution has been passed (Section 105(4)).
If the special resolution as detailed in the third point above is passed as a result of the member exercising his voting rights to which the resolution for the buyback for those shares relate, then the buyback of the shares is not deemed to be approved if this resolution had not been passed if that member had not voted (Section 105 (5)). For the other points, when determining whether the requisite majority has been passed and the member to which the shares relate has signed the special resolution in writing then his interest is ignored in determining whether the majority resolution has been passed.
The best course of action to ensure a valid special resolution is passed is to ensure that the member to which the buyback relates does not vote on the resolution itself.
Where redemption is to be utilised to effect the acquisition of own shares and the shares are currently non-redeemable the company will need to pass a special resolution to provide the company with the power to redesignate/convert those shares to redeemable shares and the power to redeem those shares.
Application and Opportunities
This section is a very beneficial section within the Act especially when combined with the tax legislation assuming there are distributable profits available or there is proceeds available from the fresh issuance of shares so that the buyback/redemption can be carried out lawfully. It gives a great opportunity to companies in the following situations:
(1) Provides a greater ability to get access to funds on retirement especially where the remaining management team/shareholders do not have the financial capacity to buy the shares from the exiting shareholder so instead the company purchases the shares from the retiring shareholder.
(2) Where 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; or
(3) 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. Examples of where this could be useful are:
- An outside shareholder who has provided equity finance and wishes to withdraw that finance;
- A controlling shareholder who is retiring as a director and wishes to make way for new management;
- Personal representatives of a deceased shareholder where they wish to realise the value of the shares
- A legatee of a deceased shareholder, where she/he does not wish to hold shares in the company.
Note the commentary below assumes that the amount being paid by the company for the shares is in excess of the amount the shareholder subscribed for the shares originally. Where this is not the case it is more than likely no tax consequences arise.
In close companies, any distribution made by a close company to its shareholders is normally treated as an income distribution and is liable to income tax/ PRSI/USC in the hands of the shareholders. This includes a situation where the company uses its existing funds to buyback/redeem shares from the shareholders.
The excess of the payment to the shareholders over and above the amount originally subscribed for the shares is treated in the same way as an ordinary dividend and is therefore within the remit of income tax. An exception to this rule is provided for in Section 176 TCA, 1997. That Section provides that, subject to meeting certain conditions, the payment may be treated as a capital payment. That is, the payment received from the company is treated in the same way as if the shares had been sold. Any gain arising over and above the amount originally subscribed for the shares is treated for tax purposes as a capital gain and benefits from CGT treatment. One of the advantages of CGT treatment is that a relief known as ‘retirement relief’ may be available (see below).
The conditions which must be met for CGT treatment to apply to a share buyback as stated in Section 177-186 of TCA 1997 are as follows:-
(1) The shareholder whose shares are being bought back/redeemed must be resident and ordinarily resident in Ireland for the tax year in which the purchase is made.
(2) The shares must have been owned by the shareholder for a period of at least 5 years.
(3) The shareholders interest in the company immediately after the purchase/redemption must be substantially reduced (generally this means that the shareholders interest in the company in all respects must be reduced by at least 25% – i.e. entitlement to dividends and assets on a winding up are reduced by at least 25%).
(4) The company must be an unquoted trading company.
(5) The redemption/buyback of shares is made wholly or mainly for the purpose of benefiting the trade carried on by the company. Tax briefing 25 provides further instructions on what is deemed to benefit the trade and is discussed further in the step action plan below.
(6) The redemption does not form part of a scheme or arrangement, the main purpose or one of the main purposes of which is to enable the owner of the shares to share in the profits of the company without receiving a dividend.
(7) The shareholder must no longer be connected with the company (after the buyback the shareholder and his/her associates must own less than 30% of the capital (both shares capital and loan capital) of the company. An associate includes a spouse and minor children).
If the above conditions are met any amount provided in excess of the par value will be liable to capital gains tax. As it is within the remit of CGT, there are two further reliefs that can be claimed which will reduce the amount of CGT payable where certain conditions are met, those being:
(8) Retirement relief
(9) Entrepreneurial relief
The above reliefs are outside the scope of this help sheet but can be very worthwhile if they apply.
Implementing a share buyback/redemption of shares where the company neither has profits available for distribution nor has issued new shares to cover the cost of the share buyback thus making the buyback illegal and exposing the directors to a penalty under company law.
Incorrectly assuming where the shares are redeemed at an amount equal to their original subscription price, that the requirements to have profits available for distribution is not applicable when in fact it is.
Not performing a formal valuation on the company prior to the buyback and therefore incorrectly placing too high a value on the shares being redeemed, therefore exposing the company and the shareholders whose shares were redeemed to income tax issues and exposure the company to dividend withholding tax liabilities.
Assuming the buyback qualified for capital gains tax treatment (i.e. all of the conditions stated in Section 176-186 of Tax Consolidated Act 1997) when in fact the requirements/conditions for the capital gains tax treatment had not been met so therefore any excess paid above original subscription price should have been subject to income tax as a distribution.
Incorrectly assuming that by issuing shares to a new shareholder or shareholders other than the shareholder who is disposing of his/her shares at less than market value that this creates no capital tax issues. In reality by taking this course of action this triggers a capital gains tax event for the existing shareholder whose shares are to be redeemed and creates gift tax issues for the receivers of those new shares as effectively it has resulted in a deemed disposal and receipt of a gift respectively.
Where there is only a small numbers of shares in issue and further shares are needed in order to allow the share buyback to proceed, the directors incorrectly issue new shares to the shareholder whose shares are to be bought back or they offer a rights issue which results in the required ownership of 5 years as mentioned in condition 2 above not being met.
Incorrectly allowing the amount payable on the buyback to be deferred and paid in instalments, resulting in the 30% test mentioned in point 7 above not being met.