ABC Incorporated, Inc Tax Issue (Case Study Sample)

Tax Issues Author name Institutional affiliation Course number and name Instructor name Assignment due date Tax Issues Part I There are several challenges that a firm faces when it comes to the retirement of one of the directors who has still invested in the company. In this case, the retirement of William and the intention to transfer the shares to ABC. The buyback of shares is a common problem that family-owned and managed companies face during succession planning or when one of the shareholders retires. In this case, ABC is purchasing back the shares and canceling the shares from the departing shareholder. The taxation laws are usually complex when the company intends to purchase back the shares from a retiring shareholder. Before the purchase is made, specific conditions must be followed. HM Revenue and Customs must provide clearance to ABC in advance to show that the seller of the shares, in this case, Mr. William, will be willing to pay the Capital Gains Tax (CGT) on the sales proceeds (Dalby, 2015). Usually, in the United Kingdom, this is taxed at the rate of 10%, and William will claim Business Asset Disposal Relief instead of payment of income tax (Elliot, 2021). This will allow him to pay a lower rate of 8.75% or a higher rate of 33.75%, depending on the amount gained from the disposal. The laws in the United States dictate that when a company initiates a share buyback at any given moment, the payments should be done in cash. Unfortunately, this is a major obstacle in many companies, adversely affecting the cash reserves needed to fund major transactions (Gannons Solicitors, 2018). However, an alternative approach that may be used is the signing of multiple completion contracts where the seller can sell smaller bits of the shares to the company to allow them adequately plan on the funds needed to make the payments for shares purchased. This means the company can finance the purchase from the profits generated in the future. The situation with ABC is more complex, considering the departing shareholder held more than 30% of the voting rights in the company. The guidelines by CGT dictate that the seller must not own more than 30% of ordinary or voting rights when undertaking the buyback if the departing shareholder exceeds 30%, as with ABC Incorporated Inc. This means the shares should be sold in trenches to allow beneficial capital treatment under HMRC. This will allow William to pay a CGT at the rate of 10%, which will be done by claiming BADR, thus avoiding paying a higher income tax as high as 39.35%. The biggest concern with the purchase is the price used to repurchase the shares. Where the associated price is greater than the market value, under the TCGA regulations of 1992, the difference between the share value and real value proceeds is taxable at the existing employment income. This means that PAYE and NICs must be paid at the current rate as taxes. Where the individual or company purchasing the shares from the retiring director falls under the scope of an employee with securities and the payout falls below the market value, then the individual will settle charges relating to income with the payment of taxes. Therefore, with the buyback of William's shares, ABC Inc. Ltd will be forced to settle the arising income tax charges because of the transactions. However, if ABC has sufficient financial resources and willing to purchase the shares in full, the rules of the purchase of shares may vary. In this case, William will get a cash payout and will not enjoy the benefits, such as capital treatment, as would be the case if another company did the purchase. If ABC goes ahead with the decision to purchase the shares through a buyback program, this will result in the company being taxed for the shares acquired. The tax will be applied similarly to the dividend distribution taxation unless their transaction meets the criteria as provided by CTA. William may qualify for relief since he has held the shares for a period exceeding 5 years which is the minimum period that will qualify a shareholder to get relief (Bloink & Byrnes, 2021). William will, therefore, be subjected to taxation, assuming this was a dividend distribution that will be calculated based on the gains. The gains, in this case, are the difference between the disposal proceeds and the actual market rates to determine the gains realized. According to CGT law, the taxes will be charged on the profits realized from the sales made in line with the costs incurred in purchasing the shares. From the rules of buyback of shares, the costs incurred on purchasing shares are used to determine the exact taxes to be paid. This is a disadvantage to ABC Inc. being forced to pay taxes for the buyback of the shares back to the company, which may not necessarily mean the company made a profit. Therefore, if the share values had increased, this would disadvantage them since they have not made capital gains in the form of profits (Bloink & Byrnes, 2021). The cash and property distribution to William will be subjected to taxation based on their associated value. The shares owned by the directors and shareholders are classified under the restricted securities category since a proportion of the value of the shares is taxed as income tax. In this case, both ABC Inc. Limited and William will be subjected to a tax payout from the transaction. Suppose William successfully opts out of the transfer of shares to another company. In that case, the managers will be charged income tax when the transaction is done, allowing William to sell his shares. In the first part of the transaction, it is clear that the decision to buy back the shares for William will attract income tax on the transaction made. In addition, the amount made in the sale of shares above the market rate will attract additional taxation since this will be treated as profits from the transaction. The piece issued as real property will also attract property tax during the transfer process, meaning William will be compelled to pay for it. As stated in the promissory note, the amount to be paid will also be subject to taxation based on the interest and prevailing taxation rates in the next four years. Part II In the second part, William intends to invest in a new company after obtaining the payment from ABC for the shares he held in the company. There will be a strict application of the HMRC policies, making it difficult for multiple completion contracts to get capital treatment. This will result in adverse consequences for William due to the high taxation from the government for the transaction. However, a formalized management buyout structure is vital. In this case, the investment in the new company Newco is great, allowing it to acquire the shares William held at ABC limited. Investment through the new company Newco is the best decision since Newco will purchase the shares and be taxed at the capital gain percentage. After the buyout, Newco can continue to pay the CGT attracting a tax of 10% after the application of BADR. However, this is not the ideal approach for William since it may involve the creation of an additional company which may result in additional charges such as stamp duty which may reflect the value attached to ABC limited. Alternatively, Newco may opt to use a different strategy where they will issue loan notes to ABC, and they will be secured on a floating charge on the existing company charge (Sebree, 2019). Another common tax issue is attributed to the tax deductibility costs arising from acquiring shares. Since no revenues are generated from the sales of the shares, the IRA deducts taxes in the form of tax deduction costs, which are calculated based on the amount of money spent in the purchase of the shares. This means that Newco must charge a certain percentage catering to the charges in response to the transaction. The MBO team tax position argues that tax issues tend to arise concerning the shares referred to as sweet equity acquired in the form of Newco. In this transaction, Newco should avoid triggering the income tax liabilities that may arise when they purchase the shares. Such a situation will arise when the amount used to purchase the shares is below the market rates. The low valuation of shares is meant to prevent the buyer from underestimating the value of the shares. However, the company has various platforms it can use to minimize the tax it will be required to pay. They can use the HMRC and BVCA, allowing the managers to use the provisions to manage the taxes they will pay and ensure the company is not subjected to other tax issues. In some instances, the MBO teams may prefer to incentivize the performances through well-structured income tax liabilities. If Newco borrows money to facilitate the purchase of shares at ABC, then the company should benefit through a tax relief that will be structured into the borrowed loan (Shields, 2021). In acquiring the shares from Newco Company, it will be paramount for the team to ensure that the transaction does not raise any issues with personal tax liabilities. The liability may arise due to the acquisition of the shares from ABC. The gains from the transaction with Newco will be assumed to be a gain, which means a capital gains tax. If William directly benefits from the transaction through cash payouts, this will result in personal liability tax, forcing him to make a payment to the Income Revenue Authority. The CGT treatment concerning this specific transaction is very beneficial as it will result in a 20 percent tax rate if the transaction falls to the high-rate taxation level. If they manage to secure relief for the transaction, then only 10 percent will be paid. If the shares sold are subjected to the income tax rate, this will be charged at 40 percent, which is relatively higher than the relative tax. The rate may rise to 45 percent if the taxable income exceeds the value of £150,000, in which ca...