Tax Talk: Share buybacks – getting the best deal

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If your company needs to buy back shares for whatever reason, it’s worth checking whether you qualify for capital treatment.

It’s not uncommon for a shareholder to exit a company by way of a share buyback where they sell their shares back to the company. This could be because there is no suitable external buyer or as part of the company’s process to remove a dissenting shareholder.

The default tax position is that this repurchase is treated as an income distribution, subject to Income Tax. However in some cases, it may be possible to treat the disposal as a capital transaction for tax purposes, which would be subject to Capital Gains Tax (CGT).

How do I obtain capital treatment?

To qualify for capital treatment on a purchase of own shares, the company must be an unquoted trading company. The repurchase must fulfil either all of Condition A or Condition B:

Condition A

  • The buyback is made wholly or mainly in order to benefit the trade carried on by the company, or a 75% subsidiary. For example, by removing a dissenting shareholder, or to ensure that an unwilling shareholder does not sell their shares to an unacceptable new shareholder. But the condition is not met where the transaction is designed to serve the personal or wider commercial interests of the seller
  • It does not form part of a scheme or arrangement which aims to enable the seller either to participate in the profits of the company without receiving a dividend, or to avoid tax
  • the seller must be resident in the UK in the tax year of the purchase
  • the seller must have owned the shares for at least five years. Holding periods of a spouse are added for this purpose
  • there must be a substantial reduction in the seller’s shareholding. This means that their interest in the company must be 75% or less of what it was before the buyback. This includes the interests of any associates
  • following the buyback, the seller must not be connected with the company. This means they must not own, or be entitled to own, more than 30% of the issued ordinary share capital, loan capital and issued share capital, voting power, or the assets on a winding-up. Interests of associates are included.

 Condition B

  • the whole, or substantially the whole, of the payment is applied by the seller to discharge their liability for IHT arising on a death, within two years of that death

HMRC offers an advance clearance procedure to clarify its position on the tax treatment of a buyback.

Two scenarios

Let’s look at an example where the conditions of capital treatment are met:

An individual owns 1,000 £1 ordinary shares in a company, that are fully paid. They will be bought back at £15 per share. The Capital Gain is 1,000 x £15 = £15,000 minus £1,000 = £14,000. This would be liable to tax at either 10% or 20%.

But what if the conditions for capital treatment are not met?

The dividend received will be £14 per share, being the £15 received on the buyback less the £1 subscription price. The total dividend is therefore £14,000. This would be liable to tax potentially at the highest rate of 38.1%, which is due to increase to 39.35% from 6 April 2022.

What about non-tax issues?

Tax is not the only important issue. There are several other key points to be aware of:

  • the company must have sufficient distributable reserves to carry out the buyback
  • the company must make a full cash payment for the shares. (Note that a workaround via a multiple completion contract is less attractive now that HMRC is restricting the availability of Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) with this route)
  • Any shareholders’ agreements or articles of association should be reviewed to check there are no restrictions or prohibitions on buybacks
  • there are also company law requirements to appropriately effect the buyback.

Don’t forget

If capital treatment is available, you must report the buyback to HMRC within 60 days. Stamp Duty will be payable at 0.5% of the consideration unless the purchase price is £1,000 or less.