A limited liability company may acquire and hold control of its own shares. The provisions relating to own shares are set out in the chapter 15 of the Limited Liability Companies Act. Acquisition of own shares refers to a situation in which a company acquires its own shares from its shareholder for compensation by mutual agreement between the parties. The redemption of shares, on the other hand, is an obliging act by which the shareholder must dispose of their shares to the company, either for a compensation or for no compensation.
The number of shares to be acquired in a private limited company is limited only so that the company may not acquire or redeem all of its own shares. At least one share must therefore be owned by an external owner.
Decision-making in acquiring and redeeming shares
The acquisition and redemption of the own shares will be decided at the General Meeting. In a private LTD, a simple majority of votes is sufficient, i.e., more than half of the votes cast. The General Meeting may decide to acquire company’s own shares or may authorize the Board of Directors to decide on the acquisition of company’s own shares.
The premise for the acquisition of own shares is the equal treatment of shareholders by acquiring shares from each shareholder in relation to the old ownership. However, own shares may also be acquired in other ratios subject to certain conditions. In this case, we are talking about directed acquisition.
Directed acquisition of shares
A directed acquisition or similar authorization decision is subject to a weighty financial reason for the company, as well as a 2/3 majority of the votes cast at the General Meeting and of the shares represented at the meeting. Since the directed acquisition implies a disproportionate use of the company’s assets for shareholders, special attention must be paid to the ratio of the compensation offered to the fair price of the share when assessing the acceptability of a directed acquisition. The decision to acquire own shares shall indicate the compensation to be paid for the shares and the reasons for determining it and, if the compensation is assets other than money, a statement of the value of such assets. Paying a possible overprice may be illegal distribution of assets.
However, since the requirement for equal treatment of shareholders is a non-mandatory matter, shareholders may unanimously decide on a directed acquisition of shares, even where this does not involve any weighty financial reason for the company.
The shares must be paid out of the company’s distributable assets
Under the limited liability companies act, it is prohibited to acquire shares so that as a result of the acquisition, the company’s unrestricted equity would go negative. Company’s distributable assets must be able to cover the purchase. By following the creditor protection procedure, funds can also be allocated from the company by lowering the share capital, the premium fund or the reserve fund.
Own shares held by the company
There are three alternative ways that the company can do with respect to its own shares:
- the shares can be retained by the company,
- the shares can be transferred,
- or the shares can be cancelled.
A private LTD may retain its own shares indefinitely if they have been acquired in accordance with the Limited Liability Companies Act.
The company’s holding of its own shares does not produce share rights. For example, the shares have no voting power at the General Meeting. No dividend is paid for such shares either, nor do they entitle any rights when distributing company’s assets. The shares are not counted for if a unanimous or a majority decision by the shareholders is required. Shares also have no value on the company’s balance sheet; that is, the shares do not represent asset value to the company.
Cancelling of own shares
The board of directors may at any time cancel the own shares in possession of the company. Cancelling invalidates the rights connected to the share; it is removed from the share- and shareholder registers. The board of directors may issue this kind of a decision if, which is usually the case, the invalidation does not affect the share capital or the proportionate ownership of the shareholders. Invalidation is to be notified for registration to the trade register without delay. Once the notification has been registered the shares are cancelled.
Taxation of the acquisition of own shares
The taxation is discussed in general below and it cannot be applied to a unique acquisition of shares for a company. I recommend that in these situations the company and/or its owners consult an auditor or a lawyer who is expert in taxation before the acquisition of the own shares of the company.
The tax authorities have lately tightened their interpretation regarding the taxation of M&A, including acquisition of own shares. This means that the company and its owners should know that they might need to seek a preliminary ruling from the tax authorities before the acquisition of own shares. This usually takes up to two months.
Capital gains taxation
In accordance with Chapter 15 of the Companies Act, when a company acquires its own shares by trade for compensation from the shareholders, the transfer price received by the Shareholder shall be taxed under the general rule on the basis of the Capital Gain Tax Provisions. Gain on sale of businesses or investment assets is taxed as capital income. In 2023, the tax rate on capital income is 30% up to EUR 30.000. On capital income over EUR 30.000, the tax rate is 34%.
The capital gain from the acquisition of own shares is calculated in the same way as in sale of shares i.e., the acquisition price paid by the company is deducted from the original acquisition price of the shares. Instead of acquisition price the presumption of cost can be used if it results in a more favorable outcome for the taxpayer. The presumption of cost for shares owned for more than 10 years is 40 % and for the shares owned less than 10 years the presumption is 20 %. The effective tax rate for the acquisition price of the company is 19-25 % when using the presumption of cost.
In both acquisition of own shares and in redeeming them a transfer tax is to be paid. Also when transferring forward the shares acquired, the transfer tax has to be paid. The liable taxpayer is the acquiring party, in this case the company. Acquisition of own shares is regarded as a trade and a 1,6 % transfer tax is to be paid.
When is acquisition of own shares considered as tax evasion?
As a general rule, in accordance with Chapter 15 of the Companies Act, when a company acquires its own shares by trade from shareholders, the transfer price received by the shareholder shall be taxed on the basis of the capital gains tax provisions. Where the acquisition of own shares involves the distribution of company assets to shareholders, the so-called tax avoidance section 29 of the Act on Tax Assessment Procedure on hidden dividend distribution may become applicable.
If an LTD pays a price higher than fair value for its shares, the amount that exceeds the fair value shall be taxed as a hidden dividend under Section 29.1 of Act on Tax Assessment Procedure. Regardless of the amount paid for the shares, the distribution of the company’s assets to shareholders by redeeming or acquiring shares may be considered a hidden dividend pursuant to Section 29.2 Act on Tax Assessment Procedure if it is obvious that the distribution of assets is done to avoid the taxation of dividends. However, the application of this section does not require pricing that is different from the fair price.
Case law and taxation practice play a major role when interpreting the Section 29.2 of the Act on Tax Assessment Procedure. In case law, based on the established interpretation, some of the elements relating to redemption situations are considered aggravating, some as mitigating. For example, the rule has not generally applied to share acquisitions related to generational changes in family-owned companies or situations where a minority shareholder is bought out of the company. The new provisions of the Companies Act on the acquisition of own shares are aimed at safeguarding equal treatment of shareholders.
In tax law, the premise is that a hidden dividend is at hand if shares are acquired or redeemed from all shareholders in equal quantities, or shareholdings or control have not otherwise changed.
Points in favor of applying the tax avoidance section (aggravating circumstances)
When the shares are redeemed from all shareholders at the same proportion, the taxation of covered dividend is considered to be unapplicable only in the cases where the company has distributed extra assets left from downsizing the business or the sale of unnecessary property. The capital needs of the company are in these cases seen to have decreased.
Instead, in circumstances deemed aggravating by the Tax Authorities;
- Only a part of the main shareholder’s shares has been acquired,
- The funds used in the acquisition have lately been “gathered” with a sale of company assets,
- Regular payment of dividends has been cancelled and
- The transaction price is set off by forgiving the shareholder’s liabilities for the company.
Points against applying the tax avoidance section (mitigating circumstances)
Thus, the Company’s reduction in operations and the reduction in capital needs may be considered mitigating circumstances for the application of Section 29.2 of the Act on Tax Assessment Procedure, mainly only in situations where the acquired shares are cancelled. In situations where the acquired shares are further disposed of, there will be no definitive reduction in the company’s capital that would normally justify the distribution of funds to shareholders.
If a financial reason is given for acquiring own shares, it shall not be considered to be avoidance of tax on dividends. The reasons considered acceptable in tax practice have been at hand when:
- All shares of a minority shareholder are acquired by the company,
- All shares or enough shares to remove the control over the company are acquired from a majority shareholder,
- The shares are acquired to implement a generational change in a family-owned company,
- The Company’s operations are substantially reduced and/or changed in other ways, resulting in lower capital requirements and the shares are cancelled,
- The price of acquisition is not higher than the fair price of the shares,
- The shares are acquired to continue the business and the company has paid dividend regularly.
However, the application of tax avoidance provisions is always based on an overall assessment. Therefore, the conclusion should not be drawn from the above that if three arguments are in favor and two against, then the tax avoidance acts do not apply. In itself, even in an acceptable arrangement, a hidden dividend may also arise if the price paid to the shareholder exceeds the fair value of the share. I recommend that, even in a slightly unclear situation, this assessment be carried out by a lawyer or auditor who is expert in taxation.