Share Buyback Agreements
Director | Attorney
A share repurchase agreement is used when a company buys back shares from one or more of its shareholders or investors. The buyback is also a tax-efficient way to return money to shareholders. Once shares are repurchased they are considered cancelled, but they can be kept for redistribution in the future. The agreement will have to detail the purchase amount, the purchase method and schedule, as well as any representations or warranties of the buyer and seller to each other. There are a number of tax and legal implications that must be considered when you draft a Share Buyback Agreement, so it is important to ask your legal representative to review the agreement to avoid any possible issues.
In 2008, section 48 of the Companies Act (the “Act”) provided new guidelines for the Share Buyback process, bringing it in line with the reporting and responsibility principles of the King IV Report on Corporate Governance.
If shares are being repurchased from a director or officer of a company, then Section 48 (8) (a) of the Act says that a special resolution of the shareholders of the company will be needed. This is the case for large enterprises as well as SMMEs. A buyback falls within the definition of ‘distribution’ as stated in Section 1 of the Act. This means that in addition to passing a resolution approving the buyback the board must apply the solvency and liquidity test by satisfying itself that the assets of the company equal or exceed the liabilities of the company, and that the company will be able to pay its debts as they become due in the ordinary course of business for a period of 12 months following the repurchase.
Depending on the percentage of shares being repurchased, there are additional provisions in Section 48 of the Act which state that the company can only buy shares back if other shares of the company will remain in issue after the transaction. If the transaction involves the acquisition by the company of more than 5% of the issued shares of any particular class of the company’s shares then the agreement must meet the requirements of Sections 114 and 115 of the Act. Section 114 provides that the company must appoint an independent expert to compile a report that evaluates the consequence of the share buy-back as well as the effect of the transaction on the value and interests of the remaining shareholders. Section 115 of the Companies Act defines the special resolution required by the shareholders.
Share buyback transactions, depending on the structure, will be subject to capital gains tax (CGT) or paid as a dividend. Dividends are generally exempt from income tax in terms of the Income Tax Act and dividends paid to South African resident companies are exempt from dividends tax as well. This is a great advantage for the seller, but it is important to check the conditions so that CGT is not triggered.
Prior to drawing up a share buyback agreement, no matter how simple or how complex the transaction, it is important to carefully consider the proposed arrangement against the provisions of both the Companies Act as well as the Income Tax Act, especially if the buyback involves more than 5% of any particular class of the issued shares of the company or if the shares are being acquired from a director or a prescribed officer of the company.