When you head up a limited company, there will come a time where one of your current shareholders wants to retire from the company. A share buyback is one way to deal with this.
It's possible that your existing shareholders won’t have the funds to buy the shares back from the retiring shareholder. It's also possible that you won't be able to find a third party to buy the shares who's acceptable to your remaining shareholders. However, when a shareholder wants to sever or scale down their interest in the company, it's usually preferable that the company buys the shares back from the outgoing shareholder.
There will be other occasions where a share buyback may be appropriate, but the retirement of a shareholder is the most common scenario – and will be our focus in this overview.
The tax impacts of a share buyback
We’ll be looking at the resulting tax issues from a share buyback, not the administrative procedures to ensure compliance with the associated companies act regulations.
From the company perspective, you’ll need to pay stamp duty of 0.5% of the value of the shares that have been repurchased. It’s worth noting that any costs involved will not be deductible for corporation tax purposes.
For the individual, it’s a bit more complex. The proceeds from the buyback can be subject to either income tax treatment or capital tax treatment.
Income tax – the income tax treatment means that the proceeds are taxable as if they were dividend income. This means they’ll be taxed at between 7.5% and 38.1%, depending on the tax band it falls into. The higher-rate band starts when total income exceeds £50,250 and dividends in that band are taxed at 32.5%.
Capital gains tax – where capital treatment is applicable, the basic-rate band amount is 10%, and the higher-rate band is 20%. Where the shares are eligible for Business Asset Disposal Relief (formerly Entrepreneurs Relief) the first £1 million is taxed at 10%.
Qualifying for capital treatment
For many people, a capital tax treatment is the preferable route – with a far lower tax rate of tax to pay once the share buyback transaction has taken place.
To qualify for capital treatment, a number of conditions have to be met:
The purchase of shares by the company is wholly or mainly to benefit the trade of the company, rather than the wider or personal interests of the seller.
The transaction isn’t part of a scheme or arrangement where the main purpose is to intentionally avoid tax (tax avoidance always being a big no-no).
The transaction isn’t part of a scheme or arrangement that allows retained profits to be extracted as capital instead of dividends.
The seller must be tax-resident in the UK during the tax year of sale.
The seller must have owned the shares for more than five years.
There must be a substantial reduction in the seller’s shareholding after the buyback. This is satisfied if the post-transaction proportionate interest in the company does not exceed 75% of the preceding proportionate interest. For this substantial ownership test, the spouse’s shares are aggregated with the seller’s.
After the buyback, the seller is no longer ‘connected’ with the company. Connected means entitled to more than 30% of the share capital, loan capital or voting power of the company, or of the assets available for distribution on winding up.
For income treatment to apply, one or more of the tests for capital treatment have to fail.
Advance clearance can be obtained from HMRC that the capital treatment will apply to the repurchase of the company's own shares. The transaction should be at a market related value, so it’s advisable to get an independent professional valuation.
Talk to us about your share buyback plans
A share buyback avoids the need to either accept a third-party into your company, or to restrict your retiring shareholder from realizing the value of their holding. As such, buybacks can be a very useful mechanism for bringing shares (and therefore control) back into the company.
As your accountant, we’ll advise you on the correct procedures to follow to successfully implement a share buyback transaction. We’ll also help you to obtain the desired tax outcome for the departing shareholder – so they maximize the tax efficiency of the transaction.