A limited company will typically purchase its own shares when one or more shareholders wish to retrieve their initial investment and any capital gain made when no external buyer is available. Otherwise the company may be a family business where the family wishes to keep shares within family ownership but do not wish to buy them directly. Usually the purchased shares are cancelled after the buyback. Legally the company must have sufficient distributable reserves and the power within its Articles of Association to carry out a share buyback.

Tax Treatment

Payments made by a limited company can possibly be treated for tax purposes in one of two ways:

Income Treatment

If treated as income, the amount received by the individual is taxed in the same way as a dividend, with rates of 8.75%, 33.75%, or 39.35%, after the £500 tax-free dividend allowance (for the 2024/25 tax year) is applied. Additionally a capital gains tax (CGT) computation is required. The sale proceeds are equivalent to the original subscription price so if the individual were the original subscriber there would be no CGT. If they were not a capital gain or loss may arise.

Capital Treatment

Here, the sale triggers a CGT charge, taxed at 18% or 24% from 01-Nov-2024. Business Asset Disposal Relief may be available however. Generally the CGT rates are lower than the dividend rates making capital treatment preferable for most transactions. However both the individual and the company must meet specific conditions to qualify for capital treatment.

Conditions for the Company:

• Must be an unquoted trading company.
• Must not be a 51% subsidiary of a quoted company.

Conditions for the Individual:

• The share purchase must be for the benefit of the company’s trade.
• The individual must be a UK resident at the time of purchase.
• The vendor must have held the shares for at least five years, or three years if acquired upon death (the deceased’s ownership period and that of a spouse or civil partner can be counted).
• There must be a substantial reduction in the vendor’s shareholding, defined as a reduction of at least 25% in their total holdings.
• After the buyback, the vendor must not be connected with the company. Specifically, they must hold no more than 30% of shares (including those held by associates) after the buyback. Here, associates include spouses and children under 18.

An exception applies if the individual does not meet these conditions. This exception is valid if the payment primarily serves to pay off an inheritance tax liability incurred due to someone else’s death, provided this payment is made within two years of the person’s passing and financial hardship would occur without it.

Miscellaneous

In relation to the “benefit of the trade” condition, HMRC generally expects that a dissenting shareholder selling their shares back to the company should do so in full. However HMRC guidance indicates that retaining a minor shareholding, for sentimental reasons, is acceptable if it does not exceed 5% of the reduced share capital.

Advance clearance from HMRC can be requested to confirm whether capital treatment applies. HMRC has 30 days to respond to such applications. Additionally the transaction must be reported to HMRC within 60 days.

Speak to an Expert

A company’s purchase of its own shares is a complex area requiring careful consideration as the tax consequences can be significant. If you have any questions please get in touch with our tax team and we will be happy to help.