Where a company redeems or purchases its own shares, tax will usually become payable by the shareholder.
In most cases, any payment to a shareholder exceeding the amount paid on allotment of the relevant shares is treated as a distribution (dividend) to that shareholder (see your Tax Workbook for tax treatment of distributions) unless repayment is on a winding up of the company. Therefore, as a general rule, the proceeds of a share buy-back will be treated as an income receipt in the hands of the shareholder.
However, ss.1033-1045 CTA 2010 allows the money received on the buyback to be treated as a capital receipt if the following conditions are satisfied:
- the shares must be in an unquoted trading company;
- the seller must be resident in the UK in the tax year in which the sale occurs;
- the shares must have been owned for at least 5 years;
- there must be a ‘substantial reduction’ in the seller’s shareholding (at least a 25% reduction in the percentage of the seller’s shareholding is required);
- for 12 months after the purchase, the seller must not hold more than 30% of the company’s:
- issued ordinary share capital; or
- share and loan capital; or
- voting power.
N.B. The shares bought back by a company are cancelled so the number of shares in issue are reduced; and
- the buy-back must benefit the trade and must not be part of a scheme to avoid tax or enable the shareholder to participate in the company’s profits without receiving a dividend.
These are quite stringent rules but where they can be met the shareholder will treat the receipt as capital in nature. This could mean that various CGT reliefs and exemptions can be utilised to reduce any gains made (e.g. the annual exemption), resulting in less tax being paid than would be the case if the money received was taxed as an income receipt. Importantly, the capital treatment is not optional: if the conditions are met, this treatment will apply.
Unless the purchase price for shares bought back is below £1,000, the company will usually have to pay stamp duty on the purchase unless one of a few limited exceptions applies.