Chapter 6 Terminating Share Interest Notes

MCL - Corporate Taxation Chapter 6 Terminating Share interests Abbreviation Co- Company Div - dividend Indiv - individual MV- market value SH - shareholder Solv- Solvent Insolv - Insolvent A. INTRODUCTION 1. Gains on disposal of shares and on the distribution of corporate profits have thus far been considered as separate taxing events. The termination of shares often collapses these gains into a single event. 2. This happens where a solvent corporation with retained profits is liquidated. Liquidation distributions are both consideration for the disposal of shares in the corporation and a distribution of profits (or return of capital). 3. A partial liquidation: The collapsing of gains into a single event also can happen where the corporation buys its own shares. 4. Terminations of shares end the reflection of real assets caused when shares are created. So this chapter is also linked to Chapter 4 in that it involves the reversal of the duplication of corporate assets. 5. A share is simply an amalgam of individual rights. As a result, it seems possible to terminate a part of share (terminating/ restricting certain rights attached to the share). 6. Terminations of shares: a. Termination of shares where termination of the corporation itself is not anticipated - involves termination of some of the corporation's shares but not all of them: consider tax treatment of redemptions of shares (e.g where the corporation has issued shares on terms as to their redemption and cancellation) A corporation buying its own shares (share buy-back), because the corporate law of many countries anticipates that a corporation must cancel shares that it buys in itself. b. A process involving the termination of the corporation itself - liquidation/winding B. PARTIAL SHARE TERMINATION MCL - Corporate Taxation 1. The particular rights attach to shares - right to share in a division of profits, right to a subordinated return of capital, right to vote in a general meeting of members of the corporation. 2. It is unlikely that a corporation can unilaterally terminate a SH's rights to dividends or to vote at a GM. 3. Types of terminations are unlikely to occur without SH compensation. If the SH receives further rights in the corporation as consideration for the termination of dividend or voting rights, this is a corporate reorganisation. If the SH receives cash, ay still be a reorganisation. Unless the amount is debited to the corporation's share capital account, the cash payment is likely to be a distribution of profits and so be classified as a dividend for tax purposes. 4. If the SH consents to the termination with no consideration, there is likely to be a shift of value from the shares in question to other shares in corporation. 5. Most common type of partial termination of share rights - a termination of a right to receive a return of share capital. The form and consequences of such a termination may be different depending on whether the corporate law in question still recognises shares as having a par value not. Par value allocates a particular amount of share capital to each share, and (subject to rights to share premiums) this allocation defines the capital rights attaching to such shares. By contrast, capital rights attaching to non-par value shares are generally a right to share (on a defined basis; eg proportionally) in the corporate pool of share capital. 6. Other share rights, a corporation does not need permission of a particular SH to cancel rights to a return of capital. There is a special procedure that a corporation follows to cancel it. - i.e. Special resolution (e.g resolution of 75% of members entitled to vote). Sometimes the directors - need to clarify the solvency of the corporation./ approval of a court may be required. UK- special resolution + solvency statement by directors; public co - special resolution + court approval Germany - special resolution, creditors must be given 6 months to demand security and payments to SHs cannot be made until this time expires. US- directors of a corporation can make a distribution to SH (whether of profits or capital) provided they are satisfied as to co's solvency 7. Financial circumstances in co: ? if net value of the co's assets > its outstanding share capital - SH will receive a payment for the cancellation (i.e SH will receive a return of capital). ? if the shares have a par value, return of capital will directly reduce that par value and so the amount that the SH may receive as a return of capital in the future. ? if the share have no par value, then the return of capital will reduce the capital pool from which the SH may claim a return of capital in the future. Tax treatment of returns of capital -discuss MCL - Corporate Taxationif net value of co's assets < the amount standing in the co's share capital account, there may be no payment to the SH as compensation for the cancellation of capital. Amounts standing to the credit of the share capital account may simple be cancelled. This is a way by which co that have permanently lost part of their share capital may formally recognise that fact. If a corporation may only make distributions out of profits, cancelling lost capital may be the only mechanism by which it can put itself into a position to pay any dividends in the future. Return of Capital 1. Share capital - an investment made in a co in order to secure a return in the form of dividends. A simple return of the funds invested (presume no more than amount invested) is not typically a taxing event under an income tax because it does not involve a gain. 2. If the return involves a termination of the investment, the investor must go through a reconciliation process. 3. If amount received > the cost base of the investment, the investor realises a gain; if <, realise a loss. 4. Returns where only part of an investment is realised - headache. Country UK Return of Capital Returns of capital are excluded from the definition of distribution. There may be capital gains consequences. TCGA s. 122(1) Where a person receives... in respect of shares in a company any capital distribution from the company... he shall be treated as if he had in consideration of that capital distribution disposed of an interest in the shares. S42-The cost base of the shares is apportioned based on MV of what is received and on the MV of what remains of the shares. The result may be chargeable capital gain. A chargeable gain may be avoided if the capital payment is small when compared to the value of the shares, normally accepted to be about 5%. In this case, only this cost base of the shares is written down. ->S122(2) If the amount distributed is small, as compared with the value of the shares in respect of which it is distributed(a) the occasion of the capital distribution shall not be treated... as a disposal... (b) the amount distributed shall be deducted from any expenditure allowable under this Act as a deduction in computing a gain or loss... Germany S122(4)- if the capital payment exceeds the cost base of the shares there is an immediate chargeable gain. EStG Art. 20(1) 'Repayment of nominal capital' is specifically excluded from income form investment (divid). No realisation event in the case of a return of capital. The return of capital reduces the SH's cost base in the shares. MCL - Corporate Taxation Investment income includes the following... 2. payments derived from the dissolution of a company subject to unlimited tax liability... as far they do not involve a repayment of nominal capital... The same shall apply to payments occurring by virtue of a capital reduction... which are deemed to be profit distributions [from the capital contributions account] Under KStG s. 28 capitalisations of profits are treated as made first from shareholder contributions and then from profits. If profits are capitalised they are recorded separately from other capital. Capitalisations of profits are treated as distributed before nominal capital and such distributions are treated in the same manner as other distributions because of EStG s. 20(1)No.2. Return by cash payments (co-> SH) 1. As a substitute for dividends, particularly if the return does not involve the termination of the whole investment (ie cancellation of the shares). If substitution is a straightforward matter, then corporations may manipulate the payment of dividends and returns of share capital so minimize SH taxation. 2. Whether the form of a return of capital, as a partial termination of an investment in shares, is recognised for tax purposes or whether the tax law recharacterises that payment as a dividend. 3. Corporate law may make it difficult for corporations to return capital to their SHs, -> follow the maintenance of capital approach. (Germany, UK) C. LIQUIDATION / BUY-BACK: Full termination of shares, in which the ongoing existence of the corporation is anticipated. -> Shares are issued on terms of their redemption (redeemable shares) / agree with SHs to buy back their own shares. 3 factors to consider: 2 pertain to source of the funds used by co for acquisition: 1) retained profits -( tax system)must make a decision as to whether to treat any part of the price paid by the corporation for the shares as a dividend or not. 2) share capital/ mixtures - how to treat the cost base of the shares disposed of. Country UK Liquidation/buy-back CTA 2010 s. 1030 A distributions made in respect of share capital in a winding up is not a distribution of a company... CTA 2010 s. 1000(1)(B) In the Corporation Tax Acts "distribution", in relation to any company, means any other distribution out of MCL - Corporate Taxation assets of the company in respect of shares in the company, except however much (if any) of the distribution... represents repayment of capital on the shares... CTA 2010 s. 1033 (1) A payment made by a company on the redemption, repayment or purchase of its own shares is not a distribution... if... the company is an unquoted trading company, or the unquoted holding company of a trading group, and... either [A] the redemption, repayment or purchase is made wholly or mainly for the purpose of benefiting a trade carried on by the company or any of its 75% subsidiaries... and the redemption, repayment or purchase does not form part of a scheme [to distribute profits or avoid tax]... US IRC s. 331 (a) Amounts received by a shareholder in a distribution in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock. (b) Section 301 (relating to effects on shareholder of distributions of property) shall not apply to any distribution of property... in complete liquidation. IRC s. 302(d) Except as otherwise provided in this subchapter, if a corporation redeems its stock... and if subsection (a) does not apply, such redemption shall be treated as a distribution of property to which section 301 applies. IRC s. 302(a) If a corporation redeems its stock... such redemption shall be treated as a distribution in part or full payment in exchange for the stock. Subsection (a) shall apply if: ? the redemption is not essentially equivalent to a dividend. ? the distribution is substantially disproportionate with respect to the shareholder. ? the redemption is in complete redemption of all of the stock of the corporation owned by the shareholder. (4) [the redemption is of stock held by a non-corporate shareholder and is made in partial liquidation of the redeeming corporation] Share redemptions 1. Those that are issued on the terms that they will be redeemed in certain events. i.e. Effluxion of time (5 years redeemable shares). 2. Procedure: capital that is contributed when the redeemable shares are issued is repaid when the shares are redeemed. Unless the shares are issued at a discount or redeemed at a premium, the redemption of shares should not give rise to the issue whether the co has distributed a divd. Country UK Share redemptions Messy: CTA 2010 (UK) S1000(1)B 

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