Case: Buyback of shares not on trading account
Judge Peter Kempster, Mr John Robinson
Decision released 19 March 2019
Income tax – company buyback of shares – whether a distribution – whether a trading transaction
Khan v R & C Commrs  TC 07052
The taxpayer (‘K’) was an accountant who had acted for the company in question (‘the Company’) for many years. The Company’s shareholders decided to wind up the business, as they believed there was no real prospect of finding a buyer and the employees of the Company were not interested in a management buyout. In June 2013, the shareholders approached K to see if he would be interested in buying the Company with a view to winding it up, as they did not want the burden and responsibilities of closing down the Company.
Under a share purchase agreement, K bought the entire issued share capital (99 shares) of the Company for cash consideration of £1.95 million plus net asset value (ignoring the reserves representing £1.95 million). The Company then immediately bought back from K 98 of the shares for cash consideration of £1.95 million; this was separately documented in an off-market purchase agreement. Both transactions completed on the same date, 28 June 2013.
Most of the cash for the buyback was provided by the Company drawing down an invoice discounting facility made available by NatWest. K provided a personal guarantee to NatWest in respect of this facility.
HMRC opened an enquiry into K’s tax return for the 2013/14 tax year, and closed the same in 2017 by adjusting the return on the basis that the buyback proceeds represented a distribution by the Company.
K’s evidence in relation to the transaction included that:
(1)He did not have the technical engineering knowledge required to continue trading long term, but as an accountant he could effect an efficient winding-up.
(2)The price sought by the shareholders could be funded from the Company’s own immediate resources; he had little to lose, and could benefit from any surplus on winding-up and the profits of a short period of continued trading.
(3)K would leave day-to-day management of the Company to the employees; as employees left, they were not replaced.
(4)The Company’s turnover in 2012 of £22 million fell to £17 million in 2013; the reasons the Company continued to be profitable included that the shareholders had ceased to draw salaries; the Company had since made losses.
(5)K had expected to wind up the Company within two or three years of acquisition but in August 2015 HMRC opened their tax enquiry and he was advised not to do anything with the Company until the enquiry was closed.
K’s primary argument before the Tribunal was that the purchase and sale of the shares was a trading transaction; accordingly, that the shares were trading stock and the trading profits rules took precedence over the provisions relating to savings and investment income (ITTOIA 2005, s. 366). The 99 shares were acquired for around £1.95 million. The disposal of the 98 shares by buyback for £1.95 million resulted, per K’s argument, in a small taxable trading profit. K still held one share and when the Company was liquidated as expected, there would be a further trading profit if a surplus over cost was achieved.
The Tribunal said the approach to the ‘trading’ issue entailed a multi-factorial evaluation of the evidence, the relevant importance of different factors would vary from case to case, and the matter should be viewed and evaluated in the round. The case of Marson v Morton  BTC 377 contained a particularly useful summary.
In the Tribunal’s view, the issue in this case fell ‘in the no-man's-land where different minds might reach different conclusions on the facts found’. On the one hand, and pointing against a trading transaction: the transaction was a one-off; it was unrelated to K’s profession of an accountancy practice; although K had purchased and sold shares on other occasions, there was no suggestion that he was a regular dealer in securities; he performed no work on the shares to enhance their value (indeed, he did not replace staff as they left and he adopted a hands-off approach to management); there was no intention to sell off or otherwise realise the shares piecemeal; the acquisition was self-funded in the sense that the resources came from within the Company and K did not borrow funds (although as the new owner of the Company he did provide personal guarantees to NatWest).
On the other hand, K’s evidence was that his plan from the outset was to run the Company for two years and then wind it up, hoping to realise some value at the end of the day – although in fact he did not wind up the Company; he owned the buyback shares (which represented 98 of his 99 purchased shares) for only a short time; and he obtained no enjoyment from the remaining one share (he took no salary or dividends from the Company during his ownership).
In the Tribunal’s view, K’s acquisition and disposal of the shares was not an adventure in the nature of a trade being carried on by him. He was not a securities trader; instead he saw an opportunity to acquire the Company, which he had owned outright since the acquisition, as an investment and fund that investment using the Company’s own reserves and borrowings. While he may not have viewed it as a long-term investment, it was still an investment, rather than a share trading transaction.
Accordingly, the disputed Closure Notice correctly stated the tax consequences of the buyback, as being the receipt of a company distribution.
The Tribunal suggested there were arguments both ways on the ‘trading or investment’ issue, before coming down on the ‘investment’ side of the line. It’s interesting that the Tribunal saw the plan to run the Company for two years and then wind up as counting in favour of the ‘trade’ argument.
For commentary on the ‘badges of trade’, see In-depth at ¶200-600.