The 2006 Companies Act has made it much simpler for a private company to reduce its share capital. This has a number of uses in the context of company reconstructions, so I thought I would share some recent experiences with you in this newsletter.
Returning capital to shareholders
I was approached by a company that had some £5 million of share capital, which they had subscribed to support bank lending of about £8 million. The bank loan is long repaid and the shareholders wanted to take out the money that they had originally subscribed into the company as they did not need such a large capital base.
Technically, this would also be more tax efficient than a dividend. The company could have paid dividends of over £3 million, which would have been taxed in the hands of the shareholders at 30.55%. Conversely, a reduction of capital, whereby all but £100,000 of the share capital is returned to the shareholders would, at worst, have generated a capital gain chargeable at 10% (as this was a trading company). And the capital gain might well have been virtually nothing (in effect, returning £4.9 million of capital that had been subscribed at an initial cost of £4.9 million, so no gain).
HMRC doesn’t like reductions of capital, which they consider to be income tax avoidance. But we believe that HMRC is wrong in most cases, and have advised clients accordingly. This is, of course, a difficult area and each case should be dealt with on its own merits.
Saving stamp duty
In another, less contentious, scenario, our client family owned a number of companies that had grown up over the 35 or so years that the family business had been carried on. Each of these companies was held by different combinations of the family members (mother, son, daughter and family trust) and the decision had been made to put all of the companies under a single holding company, for ease of management, among other reasons. This was a fairly straightforward transaction of share-for-share exchange for which clearance can be obtained from HMRC that there should be no tax charge arising.
However, a share exchange of this nature would also carry a substantial stamp duty charge on transferring the shares of the various companies under the new holding company. Instead, we were able to structure the transaction as a reduction of capital by each company, followed by the issue of new shares to the holding company, which in turn issued shares to the shareholders. Neither the reduction of capital nor the issue of new shares carries a stamp duty charge, and HMRC clearance for the transactions was also obtained. We have now carried out a number of similar transactions, saving clients many thousands of pounds of stamp duty.
We are often asked to advise on the best way to split a company or group between different shareholder groups. In many cases, particularly where investment companies are involved, rather than trading companies, it was necessary to carry out the separation of activities by way of a “liquidation reconstruction”. This was often not a commercially desirable approach, because no one likes to liquidate a company if it can be avoided, and the liquidation process itself can be quite pricey.
Many of these transactions can now be efficiently structured by using a reduction of capital, instead, which avoids the need for a liquidation and the additional fees. A number of cases we have dealt with involved the splitting of property portfolio companies, where the reduction of capital approach also ensures that no charge arises to stamp duty land tax.
Once again, with all of these transactions we have obtained HMRC clearance in advance that they are commercial transactions and no tax avoidance is involved.
The simplified Companies Act rule for reducing capital of private companies has proved surprisingly flexible in company reorganisations and reconstructions. Why not give us a call or drop us a line to see how we could help your clients.