UK: Treasury Shares: The New Regime

The Companies (Acquisition of Own Shares) (Treasury Shares) Regulations 2003 (the regulations), which are due to come into force on 1 December 2003, will liberalise the regulatory regime that applies to certain companies wishing to buy back their own shares. Pursuant to the regulations, public companies quoted on the London Stock Exchange's main market, its Alternative Investment Market (AIM) or their EEA equivalents will be able to hold up to 10 per cent of their own shares in treasury, whether for resale, for transfer pursuant to an employees' share scheme or for cancellation.

At present, companies are often reluctant to buy back their shares, because of the current requirement under English law that such shares must be cancelled. When circumstances change, those companies may find they have to incur the expense of issuing new shares.

The regulations will give certain companies greater flexibility to manage their capital structures effectively and to achieve optimum financial gearing without the cost of issuing new shares. The Department of Trade and Industry (DTI) anticipates that this might lead to a reduction in companies’ overall cost of capital and could stimulate investment. Companies would have the option of reselling treasury shares in small lots through the market at full market price, which would operate as an alternative to rights issues and placings which can involve significant underwriting costs.

Treasury shares can also be used to satisfy the exercise of options and other rights granted under employee share plans. One commercial benefit of using treasury shares for this purpose is that they can be cancelled or sold if the rights lapse and, as is not the case with shares held in employee benefit trusts (EBTs), the company will itself retain the benefit/sale proceeds. Buying shares at the time of grant of an option and holding them in treasury pending transfer at exercise will allow employers to hedge their liability on the option, while avoiding the anti-dilution limits imposed by institutional investor guidelines. Employers routinely operate EBTs for this purpose as well as to take advantage of favourable tax treatment. However, the tax benefits of EBTs have been significantly reduced by recent legislation which, among other things, restricts the availability of corporation tax deductions for contributions to EBTs. Employers will therefore, in many cases, find treasury shares a more cost-effective solution.

As at present, advance shareholder approval will be required for a purchase of its shares by a company and must specify the maximum number of shares which may be acquired, the minimum and maximum price which may be paid for the shares and the date on which such authority is to expire.

The name of the company (and not a nominee) must be entered in the register of members in respect of treasury shares held by it.

The purchase of shares for holding in treasury may only be financed out of distributable profits (unlike shares purchased for cancellation which, at present, can be financed out of the proceeds of a fresh issue of shares). Treasury shares may only be sold for cash.

If more than 10 per cent of the aggregate nominal value of the issued share capital of the company (or of the nominal value of the issued capital of the shares in any class) is held in treasury, the company must dispose of or cancel the excess shares within twelve months.

If the treasury shares are de-listed they must be cancelled forthwith (but not if they are suspended from listing or trading).

Pre-emption rights in Section 89 of the Companies Act 1985 (the Act) will apply to sales of treasury shares by a company (unless disapplied pursuant to Section 95 of the Act) but the treasury shares themselves do not attract pre-emption rights when the company is allotting new shares or when transferring them pursuant to an employee share scheme. However, in this respect, the voluntary Pre-Emption Group Guidelines should be borne in mind. These stipulate that an annual disapplication of pre-emption rights should be restricted to 5 per cent of the issued ordinary share capital and in any rolling three-year period (covering the three years immediately preceding the date of the issue in question) a company should issue no more than 7.5 per cent of its issued ordinary share capital by way of non pre-emptive issues for cash.

Companies holding shares in treasury may not exercise any rights (including voting rights and rights to dividends and other distributions) attaching to treasury shares, save that treasury shares will be eligible to participate in bonus issues.

Treasury shares should be excluded from the calculation when determining whether the compulsory acquisition procedure in Sections 428-430F of the Act can be invoked. Accordingly, there will be no need for treasury shares to be made subject to an offer.

Purchases, sales, transfers and cancellations of treasury shares must be notified to Companies House.

The market abuse regime under the Financial Services and Markets Act 2000 (FSMA) will apply to the sale of treasury shares.

Investors holding 3 per cent or more of a company's issued shares capital should exclude any treasury shares held by the company when calculating the percentage of the company's issued share capital that they hold, for the purposes of making disclosures under Section 198 of the Act.

Where the proceeds of sale of treasury shares are less than or equal to the price paid for them by the company, the proceeds are treated as realised profit. This is because the shares will have been purchased out of distributable profits as part of a buy back (unless the shares are allotted as bonus shares, in which case they are treated as having a purchase price of nil). Where the proceeds of sale exceed the purchase price the excess must be transferred to the share premium account (and the part equal to the purchase price is treated as realised profit).

If a company contravenes the new rules, the company's officers are liable to be fined.

The Urgent Issues Task Force is currently consulting on the accounting treatment of treasury shares. Its draft abstract proposes that treasury shares should be presented as a deduction from shareholders' funds rather than recorded as an asset. It has also proposed that the purchase and resale of such shares should be accounted for as changes in shareholders' funds that do not give rise to gains or losses in the profit and loss account or statement of total recognised gains and losses. In effect, accounting for the purchase would be entered as a debit to distributable profits, which would be reversed upon the sale. Therefore (as any excess proceeds go to the share premium account), unless treasury shares are sold at a loss, the net effect on distributable reserves should be neutral.

In general, shares purchased into treasury will be treated as if they had been cancelled and shares sold out of treasury treated as if they had been newly issued. The sale of treasury shares will not normally give rise to a chargeable gain or allowable loss in the hands of the company. No income tax relief will be due to individual investors on shares sold out of treasury by a venture capital trust.

Under current legislation a company that purchases its own shares (and then cancels them) is subject to 0.5 per cent ad valorem stamp duty. The subsequent cancellation, resale or transfer of shares held in treasury will be subject to an additional fixed £5 stamp duty charge.

Apart from extensive consequential amendments to the Act, the regulations will impact upon FSMA, the Listing Rules, the AIM Rules and the Takeover Code, the proposed amendments to which are currently under consideration.

Companies who frequently buy or sell their own shares pursuant to the regulations may be engaging in the regulated activity of "dealing in investments as principal" under Article 14 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO). HM Treasury has proposed amending the RAO so that companies that do not use a broker will not need to seek authorisation from the Financial Services Authority (FSA) in order to buy back shares which they may hold in treasury, sell or transfer pursuant to an employees' share scheme. On 10 September 2003, HM Treasury issued a consultation paper in connection with this proposal. It also wants to ensure that companies wishing to buy back their shares for holding in treasury are not dissuaded from doing so by the cost of using a broker or other authorised person.

Companies that promote the buying-back of their shares for holding in treasury or the sale of such shares will fall within the restriction against financial promotion in section 21(1) of FSMA. However, there are no proposals to create a specific exemption in connection with this, as HM Treasury considers that most companies should be able to bring their conduct within existing exemptions under Articles 43 (members and creditors of certain bodies corporate) or 69 (promotions of securities already admitted to certain markets) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001.

The FSA's proposed amendments to the Listing Rules are designed to maintain investor protection and to reduce any perceived scope for market manipulation that the introduction of treasury shares may provide.

It is proposed that there will be a limit of 10 per cent on the discount to market price at which shares can be sold for cash non pre-emptively (unless the sale is either to a small number of shareholders specifically approved in general meeting and named in the relevant circular or the company is in severe financial difficulties or there are other exceptional circumstances).

In determining who is a "controlling shareholder" (those entitled to exercise or control the exercise of 30 per cent of the rights to vote at general meetings) treasury shares are not taken into account. Accordingly, the purchase of shares into treasury by a company could transform a shareholder currently near but under the threshold into a controlling shareholder.

Purchases of its own securities and sales and transfers of treasury shares by a company may generally not be made when the company is in a close period or in possession of unpublished price-sensitive information.

Sales and transfers of shares into and out of treasury must be disclosed (transfers into treasury could result from a buy-back or from an allotment of shares pursuant to a bonus issue).

As shares continue to be listed while held in treasury, no application for listing will be required when shares are sold or transferred out of treasury.

The FSA is expected to publish the final amended rules in October 2003. It anticipates that the possible reduction in companies' cost of capital may make the UK a more attractive place in which to list.

The London Stock Exchange is also considering minor amendments to the AIM Rules but it is not anticipated that they will be published for at least another month.

The Code Committee proposes the following two principal changes to the Code and the SARS.

In calculating percentage holdings and voting rights, share capital and relevant securities, shares held in treasury are to be ignored.

A transfer of shares out of treasury will normally be treated in the same way as an issue of new shares. Therefore, the board of a target will be prohibited under Rule 21.1 from transferring shares out of treasury during the course of an offer or if it has reason to believe a bona fide offer might be imminent, without shareholder approval. It will also normally be possible to obtain a Rule 9 whitewash of a transfer of shares from treasury if the acquisition of such shares would otherwise result in a mandatory bid obligation being triggered.