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Extracting profits through a company reorganisation - introduction

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Where a company has accumulated cash reserves and a shareholder wants to leave the company and receive cash for their shares, it may be possible to achieve this through a company reorganisation by way of a share exchange. In this way the remaining shareholders can buy out the departing shareholder without incurring any charge to capital gains tax and without using their own resources.

The transaction must be carried out for bona fide commercial reasons and not to avoid capital gains tax or a corporation tax charge on capital gains.

For example, assume that the shares in Oldco Ltd were held as follows:

  • 25% Mr Archer
  • 25% Mr Brown
  • 25% Mrs Clarke
  • 25% Mr Davies

Mr Archer is unhappy as he wants to develop an export market while the other shareholders want to remain UK orientated. A great deal of time is spent in meetings trying to agree the best way forward for the company and there is some friction. They all decide that it would be in the company's and Mr Archer's best interests if he were to leave and sell his shares in Oldco Ltd. The other shareholders want to buy his shares and continue running the business. They form another company, Newco Ltd which acquires all the shares in Oldco Ltd. Newco Ltd pays Mr Archer cash for his shares and issues shares to Mr Brown, Mrs Clarke and Mr Davies in exchange for theirs. The cash for the purchase of Mr Archer's shares can come either:

  • from the cash reserves of Oldco Ltd after Newco Ltd has taken it over; or
  • from a bank loan, for example, made to Newco Ltd and secured against the assets of its new subsidiary.

An alternative to a company reorganisation is for the company to purchase its own shares. If the conditions for a company purchase of own shares are met, consideration should be given to this method of extracting profits from the company as a potentially cheaper and easier solution than a company reorganisation.

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