Corporate capital repayment
For owners of unincorporated businesses, i.e. sole traders and partnerships, withdrawing the equity from businesses is relatively straightforward. There are no additional tax consequences because income tax will have already been paid on the accumulated profits. The same isn’t true for owner managers of companies. Both company and tax law will have an impact.
Can you take the cash?
There are three main potential areas to consider when taking equity capital from the company other than by paying a dividend. The first is that its balance sheet must remain positive following the transaction. Second, the company must either have enough cash or be able to raise it through borrowing. Third, there will be tax consequences for the shareholders.
Realising share capital
Any accumulated capital is reflected in the value of the company’s shares. Unless you intend to sell any of your shares, there are two main options for accessing it: the company can buy some of its shares from you, or it can repay some of the share capital.
Example – company share purchase – Steve set up Acom Ltd in 2010 with £100 in exchange for 100 ordinary £1 shares. It is now worth £1 million. Acom can repurchase, say, ten shares from Steve for £100,000 leaving him with 90.
Example – share capital reduction – The circumstances are the same as in the first example but instead of buying shares from Steve, Acom reduces its share capital by reducing the value of each share. It pays Steve £100,000. He still owns 100 shares but they are now 90p ordinary shares.
Trap – Where a reduction of share capital is made it must be for all shares of the same class and so isn’t suitable if your intention is to repay capital to only one or some of the shareholders. However, it can be more tax advantageous.
Company share purchase
Because Steve intends to continue as an owner manager of Acom after it buys some of his shares, unless tough conditions are met, he will be liable to income tax (at up to 38.1%) on the part of the money that isn’t a return of his original capital.
If instead Acom makes a reduction in share capital and immediately pays it to each of the shareholders, i.e it doesn’t retain any of the value for itself, it is a capital distribution on which Steve will be liable to capital gains tax at up to 20%.
Comparison – Share purchases are more flexible than reductions in share capital but can result in higher tax bills.
Tip – Consult your accountant about the company law and tax consequences before any type of share transaction as most require special clearance from HMRC. Plus, they can help you work out which is more tax efficient.