How to ensure capital treatment on a company’s purchase of its own shares

23 November 2017

A company’s ability to buy back its own shares from an individual shareholder on terms which are beneficial for both itself, and more importantly the shareholder, is one of the most valuable areas of tax legislation.

With the difference between Income and Capital Gains Tax (CGT) rates being significant, it is crucial to meet the necessary requirements in order to ensure the full benefit of the capital treatment is achieved.

Initially, recourse must be to the Companies Act 2006 in order to consider legal requirements.

Buyback must be allowed by the company Articles of Association (as is invariably the case for companies incorporated in the last 30 years) and the company must have sufficient distributable reserves for the purchase price offered. This must be paid in cash at the time of purchase and not settled by deferred consideration or instalments. It is possible for the shareholder to loan back the sale proceeds to the company but the monies must pass between the two parties.

Turning to the requirements of the tax legislation, it is necessary for the buyback to be for the benefit of the company trade; for example, shareholders not agreeing as to the future course of the company or a generational change where an older shareholder wishes to exit the business. It should be noted that it is also possible to obtain favourable capital treatment where funds are needed to pay an Inheritance Tax liability.

For the share proceeds to be treated as capital rather than income distribution, other conditions need to be met:

  • the shareholder must be resident in the UK in the tax year of share purchase;
  • the shares must have been held for five years prior to the transaction (subject to relaxation of this rule in some cases);
  • the shareholding must be substantially reduced if some shares are still held; and
  • effective immediately after the transaction, the shareholder must not be connected with the company.

It should be noted also that the concept of connected persons needs to be considered when looking at some of the additional requirements referred to above.

Most helpfully, the tax legislation provides a well-used advance clearance procedure to ensure that capital treatment will apply to the transaction.

If you are considering a company share buyback and would like to ensure favourable tax treatment, please contact your local UHY tax expert for advice.