Company purchase of own shares: A tax-efficient exit strategy

Most shareholders will, at some point, find themselves asking, “How do I plan an exit route?” A common reason for wanting to exit a company is retirement but other reasons for wanting to leave may include a breakdown in relationships, wanting to invest in alternative activities or taking a step back to spend more time with the family, for example. Whatever the reason is, it’s important to get appropriate professional advice and consider all of the options available, such as a company purchase of own shares.

What is a company purchase of own shares?

It’s exactly what it says on the tin! A company will buy back its own shares from the exiting shareholder, normally for a cash sum equal to the market value of the shares. Those shares are then cancelled by the company.

Why buy back shares?

A share buyback allows a shareholder to dispose of, or reduce, their holding without forcing the remaining shareholders to buy the shares or risk the shares falling into unwanted hands by selling them to a third party. If the funds are to come from the company, it will be more tax-efficient for the company to buy back shares than for dividends to be paid to the other shareholders to allow them to buy the shares.

Tax implications

By default, any amounts received by the outgoing shareholder in excess of their initial investment will be treated as a distribution. However, if certain conditions are met, this excess could be treated as a capital repayment. This means the shareholder would be taxed on any gain at capital gains tax rates, currently a maximum of 20%, rather than the dividend tax rate applicable to distributions (up to 39.35%).

There may also be tax implications under the employment related securities legislation and stamp duty payable on the buyback.

Conditions for capital treatment

For the buyback to attract capital treatment, both the company and the shareholder must meet certain conditions:

• The company must be an unquoted trading company or the unquoted holding company of a trading group.
• The buyback must be for the benefit of the trade and not for the avoidance of tax.
• The shareholder conditions must be met (see below).

These tax requirements are additional to any legal requirements, which may include the following:

• The company must comply with the Companies Act 2006, including the need to have distributable reserves and articles of association which permit the buyback.
• The purchase must be for cash consideration on completion (other than in very limited circumstances).

Shareholder conditions

The shareholder must be a UK resident in the year the share purchase occurs. The shares must have been owned by the seller throughout the five years to the date of the disposal. The seller’s interest as a shareholder must be ‘substantially reduced’ and they must not be ‘connected’ to the company following the purchase.

In practice, when the benefit of trade, substantial reduction and connection tests are taken together, this normally means exiting from the business entirely, although this does not strictly need to be the case.

HMRC clearance

It’s usually advisable to get clearance from HMRC that the distribution will be treated as a capital repayment before conducting a company purchase of own shares.

Need help?

A company’s purchase of its own shares can be a tax-efficient exit route for shareholders. However, you should take into account individual circumstances, company law matters and professional advice. There may also be alternative transactions to consider, particularly if some of the conditions mentioned above cannot be met.

If you’d like to discuss this further, please get in touch with one of our experts who can help you. Call 0330 024 0888 or email enquiry@larking-gowen.co.uk.

Sarah Caley