Selling Your Shares Back

Implications of company buy backs

There are circumstances where it can be useful for an unquoted company to buy back its own shares from an individual shareholder, e.g. to facilitate the exit of a shareholder from the company or on the death of a shareholder.

Company law

The purchase of a company’s own shares is addressed by the Companies Act 2006, Part 18 (as amended) and these provisions should be carefully observed.

Tax treatment

In general, where a company buys back its own shares, the shareholder is treated as having received a distribution, a dividend if you will. The distribution is taxed in an identical manner to that of a dividend. The amount received by the shareholder less any amount paid for the shares is taxed at the dividend rates of tax.

Under certain conditions however it is possible to have the sale of the shares treated as a capital payment thereby subjecting the shareholder to Capital Gains Tax rather than Income Tax.

Capital treatment

There are only two situations when capital treatment can apply to the buy back of shares.

Firstly, where the purchase of own shares is made wholly or mainly to benefit a trade that is carried on by the company (or its 75% subsidiary), and is not made as part of a tax avoidance scheme or a scheme designed to enable the shareholder to enjoy profits of the company without receiving a dividend. There are also criteria relating to residence and period of ownership that have to be met.

Secondly, where payment is used wholly or substantially to discharge a liability to inheritance and is applied within 2 years of death.

Where capital treatment applies and there are insufficient losses to reduce the gain or the annual exemption does not cover the gain, then Capital Gains Tax will be payable at a rate of 18% for a basic rate taxpayer or 28% for a higher/additional rate payer. However, entrepreneurs’ relief is available to tax the gain at a more favourable rate of 10%.

Considerations

• Capital treatment will not always be the most preferable option, particularly if the shareholder is only a basic rate taxpayer.
• Where entrepreneurs’ relief is available it is important to ensure that the conditions for the relief are not compromised.
• Don’t unwittingly cause an employment income charge to arise. This is not automatic with a buy back of own shares but could unintentionally be sparked by something like the lifting of restrictions to facilitate the company’s purchase of the shares.
• If necessary, seek advance clearance from HMRC that the conditions for capital treatment are met.

The process can be complex so always consult a professional adviser.