This article first appeared in Irish Tax Review, Vol. 31 No. 4 (2018) © Irish Tax Institute.
The purchase by a company of its own shares is one of the most common methods of exiting a business and has a number of benefits and a number of pitfalls that are discussed in this article. Two separate pieces of legislation are relevant: the Companies Act 2014 (CA 2014), which sets out the legal procedure to effect and authorise a purchase by a company of its own shares; and the Taxes Consolidation Act 1997 (TCA 1997), which sets out the parameters under which the monies received on the purchase or redemption can be treated as a capital receipt rather than an income distribution.
Share buybacks and redemptions are used for a variety of purposes, some of the most common of which are:
- To exit a shareholder or investor: the most common use for a buyback or redemption is to allow for the purchase of an exiting shareholder’s shares. The buyback mechanism allows the continuing shareholders to retain their shareholding proportions without a third party entering the fray or the continuing shareholders having to finance the exit.
- To raise finance: redeemable shares are a common form of investment in a company as they allow a capital injection by an investor who is looking for a return of his or her capital within a certain timeframe.
- To return cash to a shareholder: a company that holds a large amount of cash, whether retained profits or the sale proceeds of an asset disposal, may want to divest itself of same by returning capital to the shareholders.
- To facilitate exiting employees from a share scheme: a company that operates an employee share scheme may need to purchase the shares back from an employee who is leaving the employment of the company in the assortment of circumstances that led to a departure.
- To adjust shareholding proportions in a company: for a variety of reasons, certain shareholders may want to realise some of their investment or increase their investment, and a buyback or redemption can facilitate either of these objectives.
The terms redemption and buyback are used interchangeably, but they are not the same thing. There are two key differences between a redemption and a buyback of shares. The first is that a redemption applies to “redeemable shares” expressly issued with the purpose, or the expectation, that they be redeemed, whereas shares in a buyback do not need to be redeemable shares but can be any form of share. The second fundamental difference involves notification timing for the two procedures: a buyback has a prescribed notice period of 21 days during which the contract to buy back the relevant shares must be on display at the company’s registered office, but no such notice period attaches to a redemption. CA 2014 has introduced amendments to this rule, which are discussed later in this article.
Legal definition of the terms ‘Redemption’ and ‘Buyback’
It is a long-established legal principle that a company may not purchase its own shares. This rule has been maintained throughout the many iterations of the Companies Acts, including CA 2014. For instance, the Companies Act 1963 (CA 1963) permitted the issue only of preference redeemable shares and absolutely prohibited a company from acquiring its own shares.
The Companies Act 1990 (CA 1990) changed the landscape for a company acquiring its own shares, with companies being able to issue any form of redeemable share and being able to authorise the purchase of any share in limited circumstances. Under CA 1990, a redemption had to be authorised in the Articles of Association and the acquisition had to be funded out of profits available for distribution. Additionally, in the case of a share buyback:
- the shares to be repurchased need not have been redeemable and
- there was a prescribed notice period of 21 days during which the contract to buy back the relevant shares had to be exhibited at the company’s registered office.
Companies Act 2014
Under CA 2014 the central principles regulating the buyback and redemption of shares are unchanged, but there have been very subtle changes to the procedures, which have narrowed the gap between a redemption and a buyback.
As noted, the fundamental rule that a company having a share capital shall not purchase or redeem its own shares has been continued, at s102(2) CA 2014. It is a category 2 offence for a company (and any officer in default) to acquire its own shares otherwise than in a manner authorised by the Act. This sub-section also renders void any purported acquisition of the shares.
One of the most practical changes is that the provisions relating to a company acquiring its own shares, whether by redemption or purchase, are now consolidated and housed under the one section, s105 CA 2014. Section 105(1) CA 2014 provides that:
“A company may acquire its own shares by purchase, or in the case of redeemable shares, by redemption or purchase.”
As opposed to a company’s being authorised to issue redeemable shares, s66(4) CA 2014 now enables a company to issue redeemable shares unless expressly prohibited from doing so by its constitution. If there is no such exclusion in the constitution, the company has an unfettered power to issue redeemable shares. There is also no requirement that the terms of issue of the shares provide for payment on redemption, which means that shares that are not contractually issued as redeemable shares (and therefore do not specify payment on redemption) can be redeemed.
Section 83(3) CA 2014 further allows a company by special resolution to convert any of its shares into redeemable shares provided that it is not prohibited from doing so by its constitution.
The methods to authorise an acquisition by a company of its own shares have been expanded to include authorisation by:
- the constitution of the company,
- the rights attaching to the shares in question or
- a special resolution.
Historically, both redemptions and buybacks could not result in there being less than 10% non-redeemable ordinary shares in issue. This 10% restriction rule has been removed under CA 2014 with the exception of PLCs, with the result that all of the shares of a company can technically be made redeemable and can then be redeemed.
The final and most important change introduced in CA 2014 is the removal of the requirement to display the contract for 21 days, as previously required under s213 CA 1990. Under s105(8) CA 2014, the specific requirement to display the contract for 21 days has been replaced with a requirement to ensure that the contract or a written memorandum of its terms is furnished to all members of the company on request or that it is made available for inspection at the registered office of the company from the date of the notice of the meeting at which the resolution is proposed and at the meeting itself. This means, in effect, that the period of display is now only that of the notice period for the meeting itself and can be dispensed with if the contract is furnished to all members on request. It would appear that there is no requirement to display the contract at all so long as it is made clear to members that they are entitled to a copy on request.
Sections 105(6) and 105(9) CA 2014 are new provisions that refer to the mechanisms providing for the passing of written resolutions by LTDs under ss193 and 194 CA 2014. Under s105(6) CA 2014, there are a number of restrictions on the method of passing the special resolution to authorise the purchase of the shares. Unanimous written resolutions are disallowed under s105(6)(a), and if a majority written resolution is signed by a member of the company who holds shares to which the resolution relates, then in determining whether there is a majority of members (i.e. more than 50% of those entitled to vote at a general meeting at that time), no account is taken of that member’s shares. This means that any votes cast by the member who holds the shares to be purchased or redeemed are discounted in determining whether there is a majority.
Under s105(9) CA 2014, where the majority written resolution procedure under s194 CA 2014 is to be used to authorise the purchase, there is a modification to the period during which the purchase contract should be made available such that there is a requirement to display the contract at the registered office for a period of 21 days before the date of the signing of the resolution by the last member to sign. Again, this modification can be dispensed with if it is made clear that the contract is available to be furnished to all members on request.
Funding the Acquisition
The key underlying requirement is that any acquisition pursuant to s105(1) CA 2014 must be funded from either distributable profits or, where the shares are cancelled following the purchase or redemption, the proceeds of a fresh issue of shares made for the purpose of the acquisition.
Under s105(3) CA 2014, where the shares are being cancelled and funded out of a fresh issue and the shares acquired by the company are issued at a premium, i.e. at a rate higher than their nominal value, some or all of the premium payable on their redemption or purchase by the company may be paid out of the proceeds of a fresh issue of shares made for the purpose of the acquisition, up to an amount equal to:
- the aggregate of the premiums received by the company on the issue of the shares acquired or
- the current amount of the company’s undenominated capital (including any sum transferred to its share premium account in respect of premiums on the new shares),
whichever is less. In any such case the amount of the company’s share premium account or other undenominated capital shall be reduced by a sum corresponding (or by sums in the aggregate corresponding) to the amount of any payment made by virtue of the sub-section out of the proceeds of the issue of the new shares. Any other payments that are not in line with the above criteria will be unlawful, and any such release of shares will be void.
CRO Filing Requirements On redemption or a buyback of shares, a company has 30 days from the date of delivery to the company of those shares to deliver to the Companies Registration Office a return in the prescribed form stating, with respect to shares of each class acquired, the number and nominal value of those shares and the date on which they were delivered to the company.13 The prescribed form to be completed in this case is CRO Form H5.