EIM03624 - Restrictive covenants: example 4: covenants given by directors in company take-over

Section 225 ITEPA 2003

Example 4

Two directors are also the only shareholders of a successful company that they have built up over a number of years. They receive an offer to purchase all of their shares from another company that is active in the same trade. Neither director has an employment contract. As part of the offer they are both offered seats on the Board of the purchasing company.

In the sale of shares agreements there is a clause restricting the vendors from working in the same business area for a period of 3 years. £100,000 is specified as consideration for agreeing to the clause.

The transaction went through and in addition to the value of the shares, both directors received £100,000 from the purchaser. The paying company did not deduct tax under PAYE. Both directors returned the sums as capital gains. The purchasing company treated the sums as capital in its accounts.

Comment

The directors entered into restrictive covenants with the purchasing company and received consideration for so doing. The undertakings were given in connection with the past employment (they were employees/directors for a number of years and built up knowledge and business awareness in the course of their employment) and with their future employment (they became board members of the purchasing company). The payments are within Section 225 ITEPA 2003.

The purchasing company should have deducted basic rate tax under PAYE, see EIM03603. The fact that the purchasing company treated the sums as capital is not relevant. There has been a PAYE failure. The responsible tax office should issue a determination to recover the basic rate tax.

The directors’ self assessment should be amended. The sums should have been returned on the employment pages. Credit may be claimed and given for basic rate tax deducted.