Share buybacks can be a powerful tool for small companies, offering a way to address retirements, ill health, or disputes among shareholders.
A share buyback occurs when your company repurchases its own shares from existing shareholders.
These shares are either cancelled or held in treasury, reducing the total number of shares outstanding.
In cases of retirement due to ill health, a buyback offers liquidity and a fair exit strategy for shareholders.
When significant disagreements arise among shareholders, a buyback can remove the dissenting shareholder, restoring harmony and stability within your company.
In short, buybacks provide several key benefits:
- Liquidity for shareholders: Offering an exit strategy for shareholders needing liquidity.
- Maintaining control: Helping you maintain control and prevent disruptions from shareholder conflicts.
- Financial flexibility: Allowing you to manage capital structures effectively and potentially enhance shareholder value.
However, there are some significant tax implications and considerations to bear in mind.
Tax implications of share buybacks
When your company buys back shares, by default the payment is taxed as a distribution (at Income Tax rates).
However, where specific conditions are met, the payment may be taxed as capital instead at Capital Gains Tax rates.
CGT rates are lower than Income Tax rates, so a departing shareholder can save a significant amount of tax where capital treatment applies.
The relevant conditions are set out in Part 3, Chapter 3 of the Corporation Tax Act 2010, but in summary, there are two scenarios where capital treatment may apply:
- Where the buyback is made ‘wholly or mainly for the purpose of benefiting a trade carried on by the company or any of its 75 per cent subsidiaries’ (the “Trade Benefit Test”); or
- Where the proceeds from the buyback (net of CGT) are applied to discharge an Inheritance Tax liability.
It is the Trade Benefit Test we are concerned with here.
A clearance can be obtained from HM Revenue & Customs prior to a buyback, to confirm whether the legislative conditions of the Trade Benefit Test would be met.
Whilst it is not mandatory to get this clearance, it is strongly advisable to do so.
There is also a post-transaction notification requirement that must be observed where capital treatment is sought.
Steps to execute a buyback
To execute a share buyback, you’ll need to take the following steps:
- Board approval: Your board of directors reviews and approves the buyback proposal, considering financial implications and alignment with strategic goals.
- Review shareholder agreements: Ensure compliance with pre-existing terms.
- Financial readiness: Ensure sufficient distributable profits or reserves to fund the buyback, as per the Companies Act 2006.
- Independent valuation: Conduct an independent valuation of the shares to determine a fair price, ensuring transparency and fairness for both the exiting and remaining shareholders.
- Shareholder approval: Obtain approval either at the AGM or through a special resolution at an EGM.
- Transaction documentation: Repurchase the shares directly from the exiting shareholder, thoroughly documenting the transaction.
- Stamp Duty and filings: Pay Stamp Duty at 0.5 per cent of the consideration paid and submit Form SH03 to HMRC.
- Update records: Cancel the shares or hold them in treasury, updating company registers and making appropriate filings to Companies House.
Clear expectations of your future tax treatment are also essential.
Accessing capital treatment requires a detailed understanding of legislative conditions, and pre-transaction clearance is strongly advised.
It is also important to ensure the buyback does not compromise your company's financial stability or liquidity – so get in touch with your accountant for help.
Plan the financing early to avoid prejudicing the company or remaining shareholders.
At Scholes CA, our business advisory and tax team can assist you with structuring buybacks and obtaining appropriate tax clearances.
