Purchase Of Own Shares

A purchase of own shares is one way for a current shareholder to realise their investment in the company by selling their shares back to the company at an agreed upon price. For many small, unquoted companies it can be difficult to find a purchaser when a shareholder wishes to dispose of their shareholding. A common situation is when an existing shareholder wants to sell some or all of their shares (typically due to retirement or reduced involvement) and the other shareholders are unwilling or unable to purchase them.


A purchase of own shares is typically completed in situations where a company is owned by a limited number of individuals, often family members and there may be no wish for the shares to be sold to an external third party. It may also be difficult to find a purchaser willing to acquire the shares.

Purchase of own shares

What is it?

A purchase of own shares is when a company chooses to buy a number of its shares back from shareholders. As a company cannot hold shares in itself under company law, after the company has acquired its own shares, the company then completes a capital reduction and cancels the shares it has just acquired for one or multiple of its shareholders.


A company purchase of own shares is one method which enables a shareholder to realise their investment in the company, financed in effect out of the company’s own profits rather than from current shareholders or an external third party.


Why do it?

There are various circumstances where a company may want to buy back its own shares including, to buy out shareholders that no longer want to be involved with the company. This can happen in private companies where:

  • a shareholder wants to retire;
  • a shareholder wants to sell his/her interest in the company; or
  • a shareholder dies;


and

  • the remaining shareholder(s) are unable to buy the shares and do not want any other parties to own them; or
  • a third-party purchaser cannot be found.


Should the company have sufficient reserves, the company is a premade buyer, the purchase and subsequent cancellation will only increase other shareholders shareholding, there will be no new shareholders.


For example, if we had a company, Banana Limited which has 100 ordinary shares distributed amongst shareholders in the following proportions:

Shareholder
Number of Shares
Shareholding Percentage
Mr A

25

25%

Mr B

25

25%

Ms B

25

25%

Miss C

25

25%

Mr A would now like to retire and sell his shareholding. There is no external third-party interest in his shares and the remaining shareholders do not have the funds to buy the shares themselves. However, the company has sufficient reserves to buy the shares from Mr A so completes a purchase of own shares on all the shares owned by Mr A and cancels the shares immediately after the acquisition.


After the purchase of own shares and the subsequent cancellation of those shares the new shareholdings in Banana Limited are as follows:

Shareholder
Number of Shares
Shareholding Percentage
Mr A

0

0%

Mr B

25

33.33%

Ms B

25

33.33%

Miss C

25

33.33%

As outlined above, the number of shares owned by each Mr B, Ms B and Miss C has remained unaltered but their percentage holding of the ordinary share capital has increased from 25% to 33.33%.


A company purchase of own shares can be taxed in two ways on the departing shareholder, the departing shareholder will be taxed under either income tax or capital gains tax, depending on whether certain legislative conditions are met. If the necessary conditions that are outlined below are satisfied then the disposing shareholder will be subject to capital gains tax on the consideration received with the possibility of business asset disposal relief also being available reducing the tax rate to 10%.

Disadvantages

There are a number of legislative conditions that must be satisfied to qualify for capital treatment upon a purchase of own shares, otherwise the arising gain is subject to income tax which could lead to a large tax liability.


One of the specific requirements on the company, the legal requirements are imposed by Companies Act 2006. The purchase of own shares must be funded by the profit and loss reserve and so the company must have sufficient distributable reserves to cover the purchase price of the shares.


Stamp Duty Liability – If the purchase price exceeds £1,000, the company will pay stamp duty on the purchase price of shares.

Conditions

Without any special provisions, the payment for the shares will be treated as an income distribution and taxed as Income Tax on the vendor. However subject to meeting a number of conditions, the disposal of the shares will be treated as a capital transaction and will be subject to the normally lower Capital Gains Tax rates of 10% or 20%.


The conditions for the company share buyback to qualify as a capital transaction include:


  • The share buyback should be made for the purpose of benefiting the trade. HMRC view this as to include:
  • when there is disagreement between the shareholders over the management of the company which is having an adverse effect on the trade;
  • or removing an unwilling shareholder who wishes to end his association with the company, or
  • the retirement or winding down of responsibilities of a shareholder.
  • The seller must have owned the shares for 5 years.
  • The seller’s interest in the company must be substantially reduced. The seller’s interest must not be more than 75% of their interest immediately before the purchase.
  • The seller must not be connected to the company after the purchase takes place. A shareholder will be considered to be connected if they possess more than 30% of the issued ordinary share capital, loan capital or voting power or are entitled to receive more than 30% of the assets on a winding up.


Before completing a purchase of own shares, we would always suggest an advance clearance application to be made to HMRC. This will confirm the taxation treatment of the company share buy back and to provide certainty to the vendor on their taxation liabilities and ensure no future enquiry into the disposing shareholders tax liabilities.

Future Sale or IPO

The completion of a purchase of own shares does not hinder the company’s ability to be sold to a third party in the future, nor does it prevent an initial public offering or other float event.


It is also possible to complete a purchase of own shares alongside the implementation of an employee share scheme to incentivise key staff and allow current shareholders to realise value for their shareholding.

How can Hamilton Blake help?

We can help with structuring the terms of a purchase of own shares, preparing the documentation, agreeing clearance with HMRC, and taking you through the process of completing a purchase of own shares.


The process of a company purchase of own shares is outlined below:

  1. Initial Call – We would seek to arrange an initial call with you to further explain what a company purchase of own shares and answer any initial questions you have and also learn about you so we can advise on which route will be most beneficial for you and your company.
  2. Initial Report – After the initial call we would produce a detailed note on the potential routes that would be available to your company, whether that be a purchase of own shares or potentially an MBO and VIMBO. This note would outline the different options and the tax implications for each: the company and the departing shareholders.
  3. Follow up call – We would then seek to arrange a follow up call to go through any further queries you have once we have collectively decided on the optimal route for your company we would then liaise with the appropriate corporate lawyers to discuss the legal aspects of any share restructure.
  4. Final report – Hamilton Blake would then produce a final report outlining the steps we intend to take and the tax implications of each stage. Should a purchase of shares be the preferred route this note would outline each of the legislative conditions and how they are satisfied.
  5. Drafting of clearance application – Upon a final review of the final report, we would then draft a clearance application to HMRC which would out outline each of the legislative conditions and how they are satisfied, such that you receive capital treatment on the disposal.
  6. Liaising with HMRC and corporate lawyers – HMRC will then either agree or disagree with our tax analysis or request further information. Once we receive clearance from HMRC, we will liaise with the appropriate corporate lawyers to draft all the necessary documentation.
  7. Implementation – Once all the legal documentation has been drafted we would then be in position to implement the purchase of own shares and complete the buyback and subsequent cancellation of the shares.


Should you have any queries about the process or whether a purchase of own shares may the right route for you and your company then please do not hesitate to contact us.