MANAGEMENT BUY OUTS

1
MANAGEMENT BUY OUTS

• originally purchase by management/ senior
  employees of significant stake in their employer
• evolved to be led by institutions providing most
  of the finance
• in some cases management would not be retained
  (hence MBIs)

2
TYPICAL STRUCTURES

• buy existing company - simple - clearly
  capital in hands of vendor - no clawback of
  previous tax relief - no tax relief on purchase
  price - purchasers inherit companys history
• buy assets - potential clawback of tax
  reliefs - tax relief for some of the purchase
  price - clean cut-off

3
HIVE DOWN

• used to combine some of the benefits to
  purchasers of an asset purchase with some of the
  benefits to vendors of share sale
• popular with receivers
• usually relies on s343 (watch beneficial
  ownership)
• potential s179 issues

4
VENDOR TAX PLANNING

• typically will wish to sell shares but a
  hive-down may be acceptable compromise
• corporate seller will probably wish to strip out
  distributable profits by pre sale dividend
• may wish to use stock dividend

5
STOCK DIVIDENDS

• SDT B11.602
• usually arises from issue of shares taken in lieu
  of dividend at shareholders option
• treated as income equal to cash dividend grossed
  up at the dividend ordinary rate (ITTOIA 2005
  s411) and taxed at the dividend upper rate (if
  applicable)
• for CGT treated as if the cash dividend (ie
  before gross up) had been paid for the new shares
  (useful as pre sale device) (TCGA 1992 s142)
• not treated as a share reorganisation (s142)

6
142  Capital gains on stock dividends  (1)    
This section applies where any share capital to
which section 410(2), (3) or (4) of ITTOIA 2005
applies in respect of shares in the company held
by any person. (2)     The case shall not
constitute a reorganisation of the company's
share capital for the purposes of sections 126 to
128. (3)     The person who acquires the share
capital by means of its issue shall
(notwithstanding section 17(1)) be treated for
the purposes of section 38(1)(a) as having
acquired that asset for a consideration equal to
the cash equivalent of the share capital in
accordance with section 412 of ITTOIA 2005.
7
Income Tax (Trading and Other Income) Act
2005 Chapter 5 Stock Dividends From UK Resident
Companies 409 Charge to tax on stock dividend
income (1) Income tax is charged on stock
dividend income. (2) In this Chapter stock
dividend income means the income that is treated
as arising under section 410.
8
411 Income charged (1) Tax is charged under this
Chapter on the amount of stock dividend income
treated for income tax purposes as arising in the
tax year. (2) That amount is the cash equivalent
of the share capital on the issue of which the
stock dividend income arises (see section 412),
grossed up by reference to the dividend ordinary
rate for the tax year. 412 Cash equivalent of
share capital (1) The cash equivalent of share
capital within section 249(1)(a) of ICTA (an
issue in lieu of cash dividend) is the amount of
the cash dividend alternative. (2) But if the
difference between the cash dividend alternative
and the share capital's market value equals or
exceeds 15 of that market value   (a)    
subsection (1) does not apply, and   (b)     the
cash equivalent of the share capital is its
market value.
9
CONSEQUENCES OF STOCK DIVIDENDS

• before abolition of ACT stock dividends used to
  reduce ACT burden
• reduces cash outflow to company
• shareholder cannot reclaim the notional tax
  therefore not attractive to non taxpayers
• allows purchase of further shares without
  dealing costs

10
DIV STOCK/DIV BASE COST 100 100 20
0 SELLING PRICE A 250 150 250 GAIN 150
50 50 CGT(40) B (60) (20) (20) DIVIDEND
100 100 TAX CREDIT C 11
11 GROSS D 111 111 TAX(_at_32.5) E (36) (36)
NET 190 205 205 (A-B)
(AD-B-E) (A-B-(E-C)) notional
11
PURCHASERS TAX CONCERNS

• will wish to buy assets to maximise tax
  deductions and avoid inheriting companys history
• hive-down may be acceptable compromise
• preserve any tax losses (s343, beneficial
  ownership, s768)
• obtain personal tax relief for interest costs

12
INTEREST RELIEF

• must fall within s383 ITA 2007 (ie not overdraft)
• must fall within s392 and 393
• interest in general can be non qualifying,
  qualify at a restricted rate, be deductible from
  certain income or be fully deductible

13
Loans for interests in close companies 392 Loan
to buy interest in close company (1) This
section applies to a loan to an individual that
is used in one or more of the ways specified in
subsection (2). (2) The ways are (a)    
acquiring any part of the ordinary share capital
of a close company that is not a close
investment-holding company, (b)     lending to
such a company money which is used wholly and
exclusively (i)     for the purposes of the
business of the company, or (ii)     for the
purposes of the business of any associated
company of the company which is also a close
company that is not a close investment-holding
company, or (c)     repaying another loan to
which this section applies.
14
393 Eligibility requirements for interest on
loans within section 392 (1) Interest on a loan
within section 392(1) to an individual is
eligible for relief only if (a)     when the
interest is paid the company is not a close
investment-holding company, and (b)     the
capital recovery condition and either the
full-time working conditions or the material
interest conditions are met. (2) The capital
recovery condition is that in the period from the
use of the loan to the payment of the interest
the individual has not recovered any capital from
the company, apart from any amount taken into
account under section 406(2) (recovered capital
that is treated as a repayment of the loan). (3)
The full-time working conditions are
that (a)     when the interest is paid the
individual holds part of the ordinary share
capital of the company, and (b)     in the
period from the use of the loan to the payment of
the interest the greater part of the individual's
time has been spent in the actual management or
conduct of the company or of an associated
company of the company. (4) The material
interest conditions are that (a)     when the
interest is paid the individual has a material
interest in the company (see section 394),
and (b)     if the company exists wholly or
mainly for the purpose of holding investments or
other property, either (i)     the condition in
subsection (3)(b) is met, or (ii)     no
property held by the company is used as a
residence by the individual.
15
S393

• SDT E1.527
• loan to acquire ordinary share capital in a close
  non investment holding company
• or to lend money to such a company and either
• borrower has material interest (5) in the
  company, or
• owns some share capital and works for greater
  part of his time in management of the company