Revenue Note for Guidance
178 Conditions as to reduction of vendor’s interest as shareholder
Summary
Where the vendor’s shareholding in a company is not fully purchased, redeemed or repaid, then, except for the special circumstances catered for in section 181, his/her interest must be substantially reduced. The reduction in the vendor’s interest in the company is calculated by reference to both the vendor’s shareholding and the vendor’s entitlement to share profits. Both shareholding and profit entitlement must, after the sale of the shares, be reduced by at least 25 per cent. In addition, the vendor and the vendor’s associates must not, after the sale of the shares, be entitled to more than 30 per cent of the capital, voting rights or assets on a winding up of the company. In calculating a vendor’s interest in a company, the interests of the associates of the vendor are also taken into account. Where a company is a member of a group, separate rules apply which are set out in section 179.
Details
Vendor’s interest
(1) Where a company does not buy back all of a shareholder’s shares, the vendor’s interest in the company must be substantially reduced.
Associates’ interest
(2) In calculating the interest of a vendor in a company, the interests of the vendor’s associates have to be taken into account. An associate’s interest in the company acquiring its own shares is only brought into the reckoning if, immediately after the acquisition by the company of its own shares, the associate owns shares in the company.
Example
O Ltd has an issued share capital of 2,000 €1 shares of which 400 are owned by P and 100 by P’s wife.
- If O Ltd purchases 100 shares from each of them, Mrs P will own no shares after the purchase and the comparison to determine the reduction in P’s interest will ignore Mrs P’s former holding. Before the purchase, P’s interest is 20% (400/2000) and after the purchase is 16.67% (300/1800), so that is less than the requisite 25%.
The comparison to determine the reduction in Mrs P’s interest will need to include P’s holding, because he still owns shares after the transaction. Mrs P’s interest (including that of her associate) is reduced from 25% (500/2000) to 16.67% (300/1800) that is, by more than 25%. - If, instead, O Ltd purchased 200 shares from P and none from Mrs P, the comparison to determine the reduction in P’s interest will include Mrs P’s holding because she still owns shares after the transaction. His interest is reduced from 25% (500/2000) to 16.67% (300/1800), that is, by more than 25%.
(3) For the purpose of determining whether a vendor’s interest has been substantially reduced, the interest of the vendor’s associates are treated as that of the vendor.
Reduction of vendor’s interest
(4) To ascertain whether the required 25 per cent reduction in the vendor’s interest in the company has been made it is necessary to compare, the total nominal value (that is, excluding premia paid) of all the shares (ordinary or preference) in the company held by the vendor immediately before the buy back of shares, expressed as a fraction of the company’s issued share capital at that time, to the corresponding fraction immediately after the buy back.
It should be noted that shares purchased by the company are deemed by section 184 to be cancelled for all tax purposes. Therefore, the vendor’s percentage holding after the purchase is based on a reduced issued share capital. This means that to qualify for capital gains tax treatment the vendor must sell more than 25 per cent of his/her original holding.
Example
D Ltd has an issued share capital of 100,000 €1 ordinary shares, of which E holds 20,000 (that is, 2/10ths or 20 per cent). If E sells 5,000 to D Ltd, D Ltd’s issued share capital is reduced for tax purposes to 95,000 shares of which E holds 15,000, a fraction of 15/95ths or 15.79 per cent.
Thus, although E has sold 25 per cent of the original holding, E’s percentage holding has been reduced by only 21 per cent, and the buy back will not qualify for capital gains tax treatment (that is, it will be treated as a distribution). To achieve a reduction of 25 per cent, E would need to sell 5,890 shares.
(5) In addition to the above requirement concerning the reduction in the vendor’s shareholding after the buy back of shares by the company, a substantial reduction is also required in the vendor’s interest in the distributable profits of the company. The proportion of the company’s profits available for distribution to which the vendor is entitled immediately before the company buys back its own shares is compared with the corresponding proportion immediately after the buy back. Both proportions are calculated on the basis that the company distributes all its available profits. The vendor’s profit entitlement after the company’s buy back of its shares must not exceed 75 per cent of the vendor’s profit entitlement before the purchase.
(6) In dividing the profits of a company among those entitled to them, the maximum fixed dividends for a full year or other fixed rate distribution entitlements are attributed to shareholders entitled to them. This prevents the vendor from reducing his/her interest in distributable profits by waiving his/her right to a preference dividend or other entitlement to a fixed amount.
(7) A vendor’s entitlement to a share in profits is based on the “profits of the company available for distribution”. Such profits are the company’s distributable profits within the meaning of Part IV of the Companies (Amendment) Act, 1983, (that is, accumulated realised profits less accumulated realised losses) increased by —
- a notional addition of €100,
- an amount equal to the sum of the maximum fixed rate distributions payable, and
- the amount by which the sum paid by the company on the purchase (in respect of which capital gains tax treatment is claimed) and the sum paid on any other purchase or redemption by the company at the same time exceeds the company’s distributable profits immediately before the purchase.
Example
The issued share capital of X Ltd and the shares owned by Y are as follows —
Issued |
Owned by Y |
|
€1 Ordinary |
20,000 |
3,000 |
€1 8% redeemable preference |
12,000 |
5,000 |
32,000 |
8,000 |
X Ltd purchases 1,000 of Y’s ordinary shares for €2,000 and redeems 3,000 of Y’s preference shares at par. The issued share capital of X Ltd is then —
Issued |
Owned by Y |
|
€1 ordinary |
19,000 |
2,000 |
€18% redeemable preference |
9,000 |
2,000 |
28,000 |
4,000 |
The nominal value of Y’s shareholding as a percentage of the total shares in issue has been reduced from 25% (8,000/32,000) to 14.3% (4,000/28,000), so that the test prescribed in subsection (4) is satisfied.
The accumulated undistributed profits of X Ltd are €3,600.
The profits available for distribution, and the amounts to which Y is entitled, are as follows —
Before the reduction |
Profits |
Share of Y |
||
* Part IV (C(A)A 1983) |
€3,600 |
€540 |
(3,600 × 3/20ths) |
|
* €100 |
€100 |
€15 |
(100 × 3/20ths) |
|
*Preference dividend |
€960 |
€400 |
(€5,000 × 8%) |
|
*Excess of costs of buy-back over profits available for distribution (€5,000–€3,600) |
€1,400 |
€210 |
||
€6,060 |
(19.2%) |
€1,165 |
After the reduction
*Part IV C(A)A 1983 |
NIL |
NIL |
|
*€100 |
€100 |
€11 |
|
*Preference dividend |
€720 |
€160 |
|
€820 |
(20.9%) |
€171 |
The exhaustion of the distributable reserves results in an increase in Y’s entitlement to share in profits, so that the consideration will not qualify for relief from the distribution charge.
(8) Except in the case of trustees or personal representatives, references to entitlement means beneficial entitlement.
Relevant Date: Finance Act 2019