Income Tax on Share Buyback: Rules & Implications

(3 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

• Introduction

• Income Treatment for Share Buybacks

  • How Income Treatment Works

• Calculating Income Tax on Share Buybacks 

• Why Capital Gains Treatment is More Beneficial than Income Tax 

  • Conclusion

Introduction

Understanding Income Tax on Share Buyback is crucial for shareholders, as it determines whether the proceeds from a company’s repurchase of its own shares are taxed as income or capital gains. By default, the income treatment applies to UK-resident shareholders, unless specific conditions allow for capital gains treatment (discussed in Part 4).

For shareholders who are not UK residents, only income treatment applies, as capital treatment requires UK residency. Corporate shareholders, however, often qualify for capital treatment due to the substantial shareholding exemption (SSE).

🔗 Related Read:Key Considerations Before a Share Buyback(Internal link to Blog 2)

Income Treatment for Share Buybacks

How Income Treatment Works

Under the income treatment, the company classifies payments for a Company Share Buyback as income distributions (i.e., dividends). If the proceeds exceed the original subscription price of the shares, the excess incurs taxation at dividend tax rates, based on the shareholder’s marginal tax rate. CTA 2010, ss 1000(1)(B), 1024

🔗 External Resource:HMRC Dividend Taxation Rules (CTM15140)

Broadly, the value of the distribution subject to income tax will be equal to the proceeds arising on the purchase of own shares less the original subscription cost of the shares. The subscription price is normally the same as the nominal value of the shares. Any new consideration received by the company for the shares would also reduce the amount chargeable as a distribution.

CTA 2010, s 1115; CTM15140

In addition to being treated as an income distribution, as the shareholder is also disposing of a capital asset (ie their shares), a capital gains computation must also be prepared. Technically, the amount chargeable to capital gains is the cash received for the sale of the shares less the amount that has been charged to income tax under the distribution rules.

TCGA 1992, s 37

In practice, this usually means that the proceeds in the capital gains calculation is equal to the original subscription price of the shares.

Consequently, if the shareholder was the original subscriber of the shares, this computation will result in a capital gain of nil. If the individual was not the original subscriber, a capital loss will arise.

Calculating Income Tax on Share Buybacks

To determine the taxable amount under income treatment, use the following formula: 

🔗 External Resource: CTA 2010, s 1000(1)(B) - Income Tax Rules (UK Legal Resource)

If the shareholder was the original subscriber of the shares, the capital gain is typically nil. If the shares were acquired later, a capital loss may arise. 

Capital Gains and Income Tax on Share Buybacks

Since shareholders are also disposing of a capital asset (shares), a capital gains computation is necessary. However, the taxable capital gain is usually the original subscription price of the shares. 

There may be issues related to the ‘original subscription price’ where for example shares have been issues at a premium (see CTM17520), there have been bonus share issues (see CTM17530) or shares have been acquired as part of a share for share exchange (see CTM17510). Care must be taken.

🔗 External Resource: TCGA 1992, s 37 - Capital Gains Tax Rules (UK Legal Resource)

Why Capital Gains Treatment is More Beneficial than Income Tax

Due to favourable CGT rates (10% / 20%) and the annual exempt amount (£12,300 in 2021/22), the capital treatment is often more tax-efficient than income treatment. The dividend nil rate band is only £2,000, making dividend taxation less favourable. 

We shall look at that next time

Conclusion

The Income Tax on Share Buyback is a critical factor in determining the tax implications for shareholders. In most cases, income treatment applies unless capital treatment conditions are met. Seeking professional tax advice is essential to optimize tax efficiency.

🔗Related Read: Key Considerations Before a Company Share Buyback

🔗Next in Series:Capital Gains on Share Buyback: Tax Rules & Requirements

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.