Understanding Company Buyback of Own Shares

A company buyback of own shares occurs when a trading company repurchases its shares from shareholders. A ‘trading company’ is a company whose business consists wholly or mainly (i.e., greater than 50%) of carrying on a trade or trades, and a ‘trading group’ is a group whose members, taken together, consist wholly or mainly of carrying on a trade or trades. Assess the trading status on the date the share buyback takes place.

To qualify for capital treatment on a purchase of own shares, the repurchase must fulfil either Condition A or Condition B:

Condition A (All Must Be Fulfilled)

• the company repurchases shares wholly or mainly to benefit its trade. (see below)
• the repurchase does not form part of a scheme or arrangement which aims for the avoidance of tax
• the vendor must be resident in the UK in the tax year of the purchase. Personal representatives assume the same residence as the deceased for this purpose.
• the vendor must have owned the shares for at least five years (three years if acquired as a result of a death). Aggregate the holding periods of a spouse for this purpose. (see below)
• there must be a substantial reduction in the vendor’s shareholding (see below)
• the vendor must avoid any connection with the company following the buyback (see below).

CTA 2010, ss 1033–1043

Condition B

The capital route applies when the company repurchases shares to settle an IHT liability, using virtually all proceeds to pay the bill, where the liability could not otherwise be paid without undue hardship. The vendor must pay the IHT within two years of the death to qualify.

CTA 2010, s 1033(3)

‘Trade Benefit' Test

Determining whether a payment benefits a company’s trade depends on the facts. However, HMRC issued guidance on this in SP 2/82. The trade benefit test normally satisfies situations such as:

• removing a dissenting shareholder, where disagreements between the shareholders over the company’s management is causing an adverse effect on the company’s trade, or
• ensure that an unwilling shareholder (such as a retiring director, representatives of a deceased’s estate or a withdrawing equity financier) does not sell their shares to an unacceptable new shareholder.

HMRC expects exiting shareholders to sell all their shares but, in some cases, allows them to retain a maximum holding of 5% for sentimental reasons.

Period Of Ownership

The selling shareholder must hold the shares for the entire five-year period leading up to the buyback date. However, there are a number of deeming rules that can increase the likelihood of a shareholder meeting this test. When spouses or civil partners transfer shares on a ‘no-gain / no-loss’ basis, they aggregate their holding periods for this purpose. Note that this does not apply if the couple are no longer living together. When a vendor or personal representative inherits shares under a will or on intestacy, they aggregate their holding period with that of the previous owner. In this case, the required total holding period is three years instead of five.

CTA 2010, s 1036(3)

Substantial Reduction Test

To fulfil Condition A, the vendor’s shareholding must be ‘substantially reduced’ following the share buyback, which means that their interest in the company must be 75% or less of what it was before the buyback. The combined interests of the seller and any ‘associates’ (see below) are taken into account for the purpose of the substantial reduction test.

CTA 2010, ss 1037–1038, 1059–1061

If a shareholder sells his entire shareholding back to the company, it should be easy to demonstrate that this test has been met. If the vendor retains an interest in the company then a calculation of the before and after position must be carried out to determine whether there has been a substantial reduction. When calculating the reduction in the vendor’s shareholding before and after the transaction, aggregate the interests of the vendor's associates with their interests. ‘Associated’ for this purpose includes:

• spouses or civil partners who live together
• children aged under 18 and their parents
• persons connected with a company are associated with that company and any company controlled by it and vice versa
• companies are associated with one another if they are under the control of the same person
• a person acting on the directions of someone else in relation to the affairs of a company is associated with that other person and vice versa.

CTA 2010, ss 1059–1061

The Connection Test

The vendor must avoid any connection with the company following the share buyback to fulfill Condition A.

CTA 2010, ss 1042(1), 1062

A person will be treated as connected with the company if they possess, or are entitled to possess, more than 30% of the:

• issued ordinary share capital
• loan capital and issued share capital
• voting power in the company, or
• the assets on a winding up of the company.

Just like in the substantial reduction test, aggregate the interests of the vendor’s associates with their own for this test.

HMRC views a share buyback as valid only when the company pays the consideration in cash at the time of purchase. For companies with a shortage of cash reserves, this can represent a major obstacle to carrying out a share buyback.

There are two possible solutions which are a loan back to the company or by way of a multiple completion buyback that can be used to alleviate problems with funding the purchase.

CTM17505

There is a clearance procedure for capital treatment of buybacks. You must meet reporting requirements regardless of whether you seek clearance.

As always, get in touch if you require a specialist tax consultant!