Under this method, first permitted in 1981, the company will take out plans on each of the shareholders taking part. The company will be the owner and the shareholders will be the people covered. The plans are life of another and no trusts are needed. The Companies Act 2006 legal requirements must then be satisfied before the buyback can take place.
The company will pay the premiums and get the proceeds of the life and/or critical illness plans on the shareholders’ lives. The company can then use these proceeds to buy the shares from a shareholder who has died or become critically ill.
An appropriate cross option/single option type agreement should be in force between the company and the outgoing shareholder or their legal personal representatives. Given that various Companies Act requirements have to be met before the buyback can proceed, the option agreement will have less certainty than an agreement between individual shareholders.
Five Engineering Ltd has an authorised share capital of 100 shares, issued as follows:
The company takes out five Life or Critical Illness plans on each of the shareholders. Scott dies and the company buys back his shares from his estate and in the process cancels them. The situation is now as follows:
The authorised share capital of Five Engineering Ltd remains 100. This now comprises:
Before the scheme buyback, each shareholder had a one-fifth interest (20/100). This has now increased to one quarter (20/80). The 20 cancelled shares may be re-issued in the future if needed. This also highlights a potential problem with the company buyback solution where there is a shareholder, for example a private equity investor, who has a stake but doesn’t want to increase that shareholding.
In that case, if the plans were instead set up as own life under business trusts, that investor could be removed as a potential beneficiary of the trusts so that their shareholding remains constant while the others are involved in purchase/sale of shares.
If the company is the plan owner, then although the premiums won’t be eligible for corporation tax relief, they won’t be taxable as a benefit in kind on the person covered. This is in contrast to the situation where shareholders take out own life plans and the company pays those premiums. In this case, the premiums paid will constitute benefits in kind for the individual.
The proceeds should not be subject to corporation tax because the plan is being taken out for a capital rather than trading purpose. For more on the taxation of Life or Critical Illness Cover proceeds received by companies, see the key person section at the start of this guide. We recommend companies seek advice from their own legal advisers.
The Companies Act 2006 sets out specific requirements to be met for a valid buyback of shares. The key points are summarised:
Extra safeguards are needed if the purchase is to be made out of capital. For example, where the purchase is funded from protection plan proceeds. The company’s accountant should be able to confirm the correct treatment at the time of any purchase. If a purchase using the plan proceeds is to be treated as a capital payment, the requirements can be summarised as follows:
The tax treatment of buybacks is unusual as the rules treat the buyback payment as a distribution (that is, a dividend) unless the payment falls within s1033 Corporation Tax Act 2010 in which case the buyback will represent a disposal for CGT purposes.
If the dividend treatment applies, any excess proceeds received over the original subscription price will be treated as investment income. This means higher rate income tax liabilities could therefore arise on the critically ill shareholder or their beneficiaries in the event of their death.
However, if the conditions are met for the CGT treatment to apply, then the excess over the original subscription price will give rise to a capital gain. There are advantages to this:
Conditions to be satisfied for capital treatment to apply.
Under s1044 Corporation Tax Act 2010, there’s a procedure for getting advance clearance to be obtained from HMRC that the capital treatment will apply.
Following share purchase, the company must make a return to its inspector (under s1046 Corporation Tax Act 2010) if it has bought its shares back under the capital procedures. This must be done within 60 days of purchase regardless of whether clearance was requested.
The plan proceeds and corresponding increase in the company’s assets could clearly increase the company’s share value.
However, it could be argued that losing a key person would have a downward effect. Whatever price may be specified by the option agreement, for inheritance tax purposes, the payment of a sum assured is a change occurring by reason of the death of the person covered.
The result is that the sum assured would be an asset of the company for the purposes of share valuation on the death of a shareholder (S171 IHTA 1984). Indeed, at any given time, the market value of the plans effected by the company would be included among its assets. Specimen option agreements should specify that the purchase price should be the value of the shares immediately before death. This means that only the market value of the plan would be included in the company’s assets.
This could be substantial if the person covered were in ill health at the time. Subject to any professional advice, the agreement should specify that the purchase takes place at market value as it’s possible that a sale at any other price could result in HMRC withholding clearance.
Any inheritance tax consequences would usually be minimised or completely avoided due to business property relief.
You could use some form of shareholder agreement (as with own life in trust and life of another plans).
Sample cross option agreements specifically drawn up for company share purchase are often offer by provider but they not intended for signature but instead should be used as a working document which the company solicitors can use to prepare an agreement specific to the clients’ particular circumstances.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.