Company Purchase of Own Shares – Transactions Void (Russell Baker v HMRC TC02790)
The recent case of Russell Baker v HMRC TC02790 highlights the difficulties that arise where a company purchase of own shares does not meet the statutory requirements.
It also highlights the importance of considering general legal principles in conjunction with the relevant tax rules.
The directors of the company fell out in 2005 in consequence of which the company undertook a company purchase of own shares in January 2006 to buy back the shares of one of the directors. In return the director received total consideration of £120,000.
HMRC raised an enquiry into the taxpayers 2005/06 tax return and concluded that the consideration of £120,000 was a distribution subject to income tax because the distribution did not meet the conditions to be treated as capital as the shares had not been held for 5 years.
However, it then came to light that the company purchase of own shares did not meet the requirements of the Companies Act 1985 (the relevant provisions are now found in s.658 onwards of the Companies Act 2006) because the consideration was not paid in full on purchase and the company had insufficient distributable profits.
In consequence the following unintended consequences arose:
1. The company purchase of own shares was void for failing to comply with the Companies Act 1985.
2. The director remained a shareholder in the company
3. The company had a right of action to recover the funds paid to the director (subject to any relevant limitation period)
HMRC sought to argue that either the payment of funds should be treated as a distribution itself or alternatively the payment of funds amounted to a loan which had been written off, thus giving rise to a deemed distribution.
However, the tribunal found that the payment did not in itself did not amount to a distribution because it could be recovered by the company. In terms of the issue of a loan write off, the tribunal felt that no write off occurred in the 2005/06 tax year.
The tribunal was not concerned with any later tax years therefore it remains to be seen whether a loan write off will be treated as occurring if it is decided that the company is out of time to recover the funds.