A purchase of own shares, is a purchase, by a company of its own shares from a dissenting or retiring shareholder, a company buys back its shares where a shareholder wants to reduce or end their involvement with the company and it could be that the other shareholders may not want to, or may not have the funds to buy the shares from the departing shareholder.
The advantages from a tax viewpoint is that such a Purchase of own shares is given capital gains tax treatment for the shareholder selling the shares provided that qualifying conditions required by the Companies Act 2006 and Corporation Tax Act 2010 are met fully.
The way in which the buy-back is structured can have a significant impact on the departing shareholder’s tax bill, Where the conditions are satisfied, the proceeds from the buy-back are taxed as a Capital Gain; otherwise, the proceeds are taxed as a dividend and therefore at Income tax rates which are considerably higher.
So, What are the company law requirements?
A buy-back which does not comply with company law is invalid, and therefore it is important that careful attention is paid to the company law requirements.
The main requirements are summarised below (Note: the rules are relaxed where the purchase takes place for the purposes of an employees’ share scheme):
- Shares must be fully paid up;
- Shares must be paid for on purchase, HMRC interpret this as meaning that the payment must be made wholly in cash; ie not by way of the creation of a loan account;
- the purchase must be made out of:
- the purchaser’s distributable reserves which ’ means ‘profits out of which the company could lawfully make a distribution ….. equal in value to the payment’, this is to be determined by reference to the company’s latest annual accounts as circulated to its members or, where those accounts show insufficient profits, interim accounts.
- the proceeds of a fresh issue of shares;
- capital (subject to the company meeting a number of stringent conditions); or
- cash (if the company is authorised to do so by its articles) up to an amount in a financial year not exceeding the lower of £15,000 and the value of 5% of the company’s share capital; and
- the purchase must be authorised by an ordinary resolution of the company. An ordinary resolution is a resolution that is passed by a simple majority.
The bought back shares must be cancelled (unless they are to be held in treasury).
The company must make a return to Companies House within 28 days of the buy-back and where stamp duty is payable, the form must be stamped by HMRC before it is sent to Companies House.
In order to get around the paid-in-full requirement above, it is common for a multiple completion contract to be used, under this arrangement, the vendor agrees to sell their shares to the company with legal completion of the sale taking place in tranches In this way, payment for the shares is deferred in a manner that is compliant with the requirements of company law.
So What happens if a buy-back is invalid?
The seller retains beneficial ownership of the shares and holds the sale proceeds as constructive trustee for the company, this could have benefit in kind and s. 455 tax implications (S455 tax is essentially a holding tax payable by the company)
Key points to look out
The following are clear indications that CGT treatment is not available:
- The company’s shares are listed on a stock exchange.
Neither of the following applies:
- the company carries on a trade; and the company is the holding company of a trading group.
Neither of the following applies:
- the shares are being bought back for the benefit of the purchaser’s trade; and
- the shares are being bought back to enable the shareholder to pay an IHT bill.
- The company was incorporated within the last 5 years (note: 3 years where the seller inherited the shares).
It is worth noting that the Company (the purchaser) is unable to deduct legal costs associated with the buy-back in calculating its trading income for tax purposes as the expenses are capital in nature.
Stamp duty is payable where consideration for the buy-back exceeds £1,000 the amount due is 0.5% of the consideration rounded-up to the nearest £5. As regards the Stamp duty Transfers of shares between companies in a group are exempt from stamp duty.
Where stamp duty is payable, form SH03 must be sent to HMRC for stamping, Interest and penalties will be payable where the form is presented late for stamping; eg more than 30 days after the date of the transaction.
As mentioned above, In the hands of the seller, the amount received on the buy-back of the shares is either:
a distribution, in which case the amount received is subject to income tax; or
it is not a distribution, in which case it is subject to CGT.
Depending on the circumstances, the seller may prefer CGT treatment to income tax treatment, or vice versa, it is therefore imperative that appropriate professional advice is obtained as to which route is best for a given situation.
Special rules apply where the shares are ‘Employee shareholder shares’.
The information contained in this article is for general information purposes only and does not constitute advice, Whilst we endeavour to keep the information up-to-date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability for a particular purpose. We recommend that professional advise should be taken from a suitably qualified expert before undertaking any action.