Capital Gains on Share Buyback: Tax Rules & Requirements
- Omar Aswat
- Apr 9, 2024
- 5 min read
(4 out of 5: Share Buyback Series)
This article is part of our Share Buyback Series, covering key aspects of company buybacks, tax implications, and reporting obligations.
Table of Contents
Capital Gains Treatment for Share Buybacks
For unquoted trading companies, the proceeds from a Company Share Buyback can be taxed as capital gains rather than income distributions if the company is not a 51% subsidiary of a quoted company or if it is an unquoted holding company of a trading group.
CTA 2010, s 1033(1)(a); CTM17507
🔗 External Resource:HMRC Capital Treatment Rules (CTM17507)
Conditions for Capital Gains on Share Buyback
A ‘trading company’ is a company whose business consists wholly or mainly (ie greater than 50%) of carrying on a trade or trades, and a ‘trading group’ is a group of whose members, taken together, consists wholly or mainly of carrying on a trade or trades. The trading status is looked at 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 repurchase is made wholly or mainly in order to benefit the trade carried on by the company (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. For this purpose, personal representatives are taken to have the same residence as the deceased.
the vendor must have owned the shares for at least five years (three years if acquired as a result of a death). Holding periods of a spouse are aggregated for this purpose (see below)
there must be a substantial reduction in the vendor’s shareholding (see below)
following the buyback, the vendor must not be connected with the company (see below).
CTA 2010, ss 1033–1043
Condition B
The capital route also applies if the repurchase was to settle an IHT liability and virtually all of the proceeds are used to settle the bill and the bill could not have been settled otherwise without undue hardship. The IHT must be paid within 2 years of death.
CTA 2010, s 1033(3)
Trade Benefit Test for Capital Gains on Share Buyback
Whether or not a payment is made for the benefit of a company’s trade is a question of fact. However, guidance has previously been issued by HMRC in SP 2/82.
Situations listed where the trade benefit test would normally be regarded as satisfied include:
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 has stated that it expects exiting shareholders to sell all their shares, but will accept in some cases that a maximum holding of 5% could be retained for sentimental reasons.
External Resource:HMRC Guidance on Trade Benefit Test (SP 2/82)
Ownership & Reduction Tests for Capital Gains Eligibility
Period of Ownership Requirement
The selling shareholder must have owned the shares for five years before the buyback (three years if inherited). Certain transfers allow aggregation of ownership periods:
Inherited shares under a will can aggregate the previous owner’s holding period.
Spouses or civil partners (if still living together) can combine ownership periods.
External Resource: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.
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.
For the purpose of calculating the reduction in the vendor’s shareholding before and after the transaction, the interests of his associates must be aggregated with his 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
To fulfil Condition A, the vendor must not be connected with the company following the share buyback.
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.
As with the substantial reduction test, interests of the vendor’s associates are aggregated with his for the purpose of this test.
It is HMRC’s view that for there to be a valid purchase of own shares, the consideration for the buyback must be paid in cash at the time of the purchase. For companies with a shortage of cash reserves, this can represent a major obstacle to carrying out a share buyback.
Practical Considerations & Cash Flow Challenges
HMRC requires full cash payment at the time of purchase, making it difficult for companies with limited cash reserves to execute a buyback.
💡 Possible Solutions:
Loan back to the company – The vendor loans a portion of the buyback proceeds back to the company.
Multiple completion buybacks – The transaction is spread across multiple buybacks.
🔗 External Resource:CTM17505 - Funding Share Buybacks
Conclusion
Understanding Capital Gains on Share Buyback ensures tax efficiency for shareholders exiting a company. Meeting HMRC’s trade benefit test, ownership duration, and substantial reduction test is crucial for capital treatment eligibility. Seeking professional tax advice can optimise tax planning and compliance.
Stay tuned for Part 5: Advance Clearance and Reporting for Company Buyback of Shares.
🔗Related Read: Income Tax on Shares and Buyback: Rules and Implications
🔗Next in Series:Reporting for Company Share Buyback: HMRC & Compliance
Meet Omar Omar is a Chartered Tax Advisor (a.k.a an expert on tax issues) and founder of ASWATAX. He regularly shares his knowledge and best advice here in his blog and on other channels such as LinkedIn. Book a call today to learn more about what Omar and ASWATAX can do for you.
*Disclaimer: ASWATAX is a firm of Chartered Tax Advisors, and we strive to provide accurate, up-to-date tax insights. Tax laws may change, so this content is for general guidance only and not a substitute for professional advice. Seek independent tax and legal counsel before making decisions. ASWATAX is not liable for any loss from reliance on this information. Use at your own risk.
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