Buying back its own shares is a very common way for a company to reduce capital. It helps situations where shareholders, who want to exit the company, struggle to find outside buyers for their shares. Carefully done, it could also result in some tax advantageous for the exiting shareholders whilst improving shareholder returns for the remaining shareholders. Buyback differs from capital reduction in that capital reduction results in increased reserves where as a buyback involves making payment to the shareholders, final outcome (of reduced capital) being the same for the company though!
Company law considerations
A limited company having a share capital may purchase its own shares (including any redeemable shares) provided there are no restrictions or prohibition in the company’s Articles. The companies Act 2006 (CA2006) lays down various conditions for buy back.
- The shares being bought back should be fully paid (to protect the interests of creditors).
- There must be at least one non-redeemable share in issue after the buyback. In other words the buyback should not leave the company with just treasury shares or redeemble shares after the buy back is over.
Authority for share buyback
A special resolution of the shareholders will be required for the buyback which could be obtained through a written resolution. Interested shareholders (i.e. those selling the shares) are not eligible to vote nor be a party to the written resolution.
Financing the buyback
The buyback should be made out of the distributable profits of the company, or out of the proceeds of a fresh issue of shares made for the purpose of financing the purchase. Shares could also be bought out of capital but that would mean having to comply with very complex procedures.
Agreement with the shareholders
Generally the terms of a buyback are agreed in advance with the shareholders before the special resolution is passed. This is because shareholder approval will be subject to unconditional agreement by the shareholders to the terms of buyback. The terms include the price to be paid, number of shares bought back etc. So it makes sense to have the terms agreed before moving a resolution.
After the buyback
- The bought back shares must be paid for in full in cash at the time of purchase; it cannot be paid in instalments or at a later date.
- Bought back shares are cancelled and the reduction in the share capital is transferred to a capital redemption reserve.
- Stamp duty is payable on the transfer @ 0.50% on the consideration where the consideration exceeds £1,000.
- There are also various Companies House filing requirements.
- Register of members will need to be updated and form SH03 will need to be filed with the companies house within 28 days
- The buyback agreement with the shareholders should be available for inspection by shareholders for a period of 10 years from the date of buyback.
- The relevant statutory accounts for that year should include appropriate disclosures with regard to the buy back.
Tax considerations
The proceeds of a share buyback are classified as a distribution for an individual shareholder, and a capital distribution (HMRC SP 4/89) for a corporate vendor. However, if some specific conditions are met the distribution could be treated as capital distributions for individuals too. The conditions are discussed below:
Company:
Unquoted company: The company (or if a 51% subsidiary then its holding company) should not be listed on a stock exchange (See HMRC Manual SVM09060 for more on listed companies)
The company should either be a ‘trading company’ or the ‘holding company of a trading group’. ‘Trade’ does not include dealing in shares, securities, land or futures.
The purpose: The buyback should wholly or mainly to benefit a ‘trade’ carried on by the company or any of its 75% subsidiaries. It should not form part of a tax avoidance scheme or arrangement (s1033, CTA2010). Benefiting a ‘trade’ for this purpose has been interpreted to include a disagreement by the vendors over the management of the company (HMRC SP/02) provided the disagreement would have an adverse effect on the running of the trade. If this condition is not met, then alternatively the purpose of buyback should be to meet the payee’s inheritance tax liability on a death which he could not have met otherwise.
Vendor:
The vendor must be UK resident and be ordinarily resident in the tax year in which the buyback takes place
The shares must have been owned by the vendor for at least five years ending with the date of buyback– reduced to three if acquired by will or intestacy. Where the shares were transferred to a spouse or civil partner their ownership counts provided that the transferor is still the spouse or partner living with him/her (s1035 CTA2010).
Post buyback the vendor’s shareholding and interests in profits of the company together with that of his associates must be reduced by at least 25% from the original level held before buyback.
Post buyback the vendor should not be ‘connected’ with the company or any company in the group. Vendor will be ‘connected’ where together with his associates if he holds or is entitled to hold, directly or indirectly, a) more than 30% of the company’s voting power, its issued ordinary share capital, or its issued share capital and loan capital, OR b) rights enabling him to more than 30% of its assets available for distribution to the company’s equity holders OR c) if he has ‘control’ of the company. Control will have the same meaning as provided under s1124 of CTA2010
Advance clearance
A company may apply in writing for clearance from HMRC (s1044, CTA2010) to ensure that the payment made upon buyback is a capital payment. The applications should be addressed to Clearance and Counteraction Team, Anti-Avoidance Group Intelligence, First Floor, 22 Kingsway, London WC2B 6NR. HMRC has to notify its decision within 30 days of receiving the application.
