Sarah Bradford looks at some tax implications for an individual shareholder where an unquoted trading company buys back its own shares, and highlights some of the traps to avoid.
In certain circumstances, it may be useful for an unquoted company to buy back its own shares from an individual shareholder, for example to enable the shareholder to exit the company, or on the death of a shareholder, or to acquire shares for a share scheme.
From a company law perspective, the purchase by a company of its own shares is governed by Companies Act 2006, Part 18 (as amended). Care should be taken that the company law requirements are met.
Capital or distribution?
The general rule is that where an unquoted company buys back its own shares from a shareholder, the shareholder is treated as having received a distribution. That distribution is charged to income tax in the same way as a dividend.
However, where certain conditions are met, special rules apply under which the shareholder in the unquoted company is treated as having received a capital payment in respect of the shares. Where the capital treatment applies, any resulting gain is subject to capital gains tax (CGT).
Distribution treatment
The distribution treatment is the default position, and applies when the conditions for capital treatment are not met. The shareholder is treated as having received a distribution equal to the amount received for the shares less the amount (if any) paid for them. The distribution is taxed as for a dividend at the dividend rates of tax.
Capital treatment
The capital treatment is only available to an unquoted trading company, in two situations.
The first is that the purchase of own shares is made wholly or mainly to benefit a trade that is carried on by the company or a 75% subsidiary of it, and is not made as part of a tax avoidance scheme or a scheme designed to enable the shareholder to participate in the profits of the company without receiving a dividend. In addition, further conditions as to residence, period of ownership must be met.
The second situation in which the capital treatment may apply is where the payment is used wholly or substantially to discharge a liability to inheritance and is applied in discharging the liability within two years of death.
Under capital treatment, a gain will arise equal to the proceeds less the amount paid. A liability to CGT will arise to the extent that the gain is not sheltered by losses or covered by the annual exemption. Where entrepreneurs’ relief is available, any gain will be taxed at 10%. Otherwise the liability is at 18% for a basic rate taxpayer and 28% for a higher or additional rate taxpayer.
Advance clearance can be sought from HMRC that the conditions for the capital treatment are met.
Be careful!
- The capital treatment will not always be beneficial – if the shareholder is a basic rate taxpayer, distribution treatment will be better.
- Entrepreneurs’ relief is valuable. If entrepreneurs’ relief is available, make sure that the conditions for relief are not compromised. For example, the shareholder should resign as an officer or employee of the company after the repurchase, not before.
- Beware triggering an employment income tax charge unintentionally – although the purchase of own shares itself does not trigger an employment income charge, one may arise if, for example, restrictions are lifted to enable the company to buy back the shares.
Practical Tip :
A purchase by a company of its own shares can be complicated. Professional advice should be taken in advance.
