When a Director Sells Shares to Another Director: Ask a Solicitor

When a director or shareholder in a small company wants to leave, it is usually preferable for their shares to be sold to the company, or the remaining shareholders who will continue to run the business.  The shareholders will typically ask the company’s accountant to advise on the value of the shares.  Once a price has been agreed upon, there are two main courses of action. Either the company will perform a buyback by purchasing the shares, or the remaining shareholders may choose to buy the shares of the departing director.

In practical terms, selling private company shares to the remaining shareholders can be simpler to administer than a company share buyback . However, there may be tax benefits available if the deal is structured as a company buyback.

Shareholder to Shareholder Sales or Company Buyback?

With a share sale, the current shareholder will simply sell their shares to the purchasing shareholder for the agreed price.  This could be a lump sum payable on completion, or structured as payment over a period of time. It could also be linked to the future profits of the company, as an earnout.  Funding will come from the purchaser, and if the purchaser is an existing shareholder, their individual shareholding will increase.

A share buyback is where the company purchases the shares at an agreed price. In order to do this, Company Law rules must be followed, otherwise, the directors can be found liable for breach of their duties and HMRC can deny favourable tax concessions for the shareholder.

Funding for the transaction must come from the company, which must have sufficient distributable reserves to fund the share buyback.  If the funds are not paid from distributable reserves, liabilities can arise. Funds can come from retained profits or capital or borrowings.

Possible Tax Concerns of a Company Buyback

If a shareholder sells his shares to the company, then the shareholder may be charged income tax. The profit on the sale is treated as a dividend. However, in certain circumstances, the shareholder may be charged capital gains tax.

The requirements for HMRC to treat the share buyback as capital are that the seller must:

• Have owned the shares for over 5 years;
• Be selling all his shareholding; or
• Be substantially reducing the shareholding by over 25%; and
• Hold under 30% of the issued share capital.

Another condition is that the buyback must be for the benefit of the company’s trade (or to pay inheritance tax from a death). In order to check whether these conditions will be satisfied, it is usually advisable to apply to HMRC for advance clearance so that the buyback will qualify for capital gains tax treatment.

The seller can choose between income tax and capital gains tax treatment on the buyback.  If capital gain tax applies, then the seller could use the annual exemption and  Entrepreneurs’ Relief, in which case the seller would pay 10% capital gains tax.

Company Buyback Procedures

The main company law requirements to be dealt with for a buyback of shares include:

• A contract for the share buyback between the Seller and the Company.
• Board minutes to approve the share buyback and payment for the shares.
• Directors statement where payment is made out of capital.
• A resolution of the shareholders.

Stock transfer form transferring the shares.

Can a Director sell shares to another Director?

In most cases, a director may sell their shares to a fellow director without any issue. However, it is vital to check the clauses in the shareholders’ agreement, as there may be some restrictions put in place.

Directors are appointed to make decisions on behalf of, and in the best interest of, the shareholders. This typically means that they are authorised to approve the transfer of shares within the company. However, not all directors have this power. 

If the board of directors does not have the authority to make the transfer, then it will be up to the shareholders whether they grant the director permission to authorise the transfer of shares from one director to another. 

A director can sell shares to another director, but they may need wider approval to do so from the shareholders themselves.