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All you need to know for private companies
A purchase of own shares, also known as a share buyback, may have tax advantages for a shareholder who wants to reduce or end their shareholding in a company. A company’s decision on whether to undertake a reduction of share capital or a share buy-back is often driven in part by tax considerations.
The following discussion is only relevant for private companies as there are different processes to follow for public companies.
Buyback procedure
A private limited company may purchase its own shares in one of three ways:
- out of distributable reserves or the proceeds of a fresh share issue made for the purpose in accordance with section 690–708
- out of capital in accordance with section 709–723
- out of capital otherwise than in accordance with Part. 18, Ch. 5, up to certain de minimis levels – s692(1ZA).
All the legislation is defined within part 18 of Companies Act 2006 in detail.
Generally, the buyback out of distributable profits is a much simpler and easier route than a buyback out of capital due to the onerous nature of the requirements. But when a company does not have sufficient distributable profits out of which to finance the buyback, a purchase out of capital may appear to be the only option.
So, in these circumstances, a reduction of capital supported by a solvency statement (along with special resolution) can be used by private companies to create distributable profits out of non-distributable reserves and thereby be able to finance the buyback by the easier route – section 641 to 651.
There is no auditor’s report required when reserves are created under these provisions. Also, these distributable reserves provide flexibility to the remaining shareholders to draw dividend as well.
The procedure for repurchase of shares is pretty much the same whichever method is chosen; however, all buybacks must comply with these considerations:
- purchase must not be prohibited by the companyʼs articles
- a limited company may not purchase its own shares unless they are fully paid
- where a limited company purchases its own shares, the shares must be paid for on purchase unless purchase is pursuant to an employees’ share scheme or if the shares are redeemable, as agreed with the shareholder. HMRC CGT manual CTM17505 clearly states that ‘To effect a valid purchase the company must make full cash payment on purchase. The transfer of any other asset or the creation of a loan account because, say, the company does not have sufficient cash available does not represent payment. In such circumstances, the shares are not treated as cancelled and legal ownership remains with the vendor. The tax treatment following from an invalid purchase of own shares depends upon the actions taken (if any) to rectify matters.’
- where a company has more than one class of shares, consent may be required from shareholders with priority rights before the shares can be purchased
- the shares must be cancelled on acquisition unless they are to be held ‘in treasury’
- the company must keep the contract for ten years.
The table below highlights some of the key differences between both types of buyback routes:
| Requirements | Purchase out of distributable reserves/fresh issue | Purchase out of permissible capital payment |
| Applicable legislation | section 690-708 | sections 709-723 |
| Resolution | Ordinary resolution is passed for share purchase contract terms | Special resolution |
| Solvency statement | Not required | Required |
| Director’s statement | Not required | Required and must be made available to members (along with auditor’s report) before the resolution is considered. |
| Auditor’s report | Not required | Auditor’s statement is required that they have enquired into the company’s state of affairs. |
| Official gazette | No need to publish in official gazette | A notice must be published in the gazette at a general meeting, a copy of the solvency statement must be made available for inspection by members of the company throughout that meeting. |
Big decision: buyback or reduction of share capital?
Considering the above requirements and whether to go ahead with a reduction of share capital or buyback, it is much easier for a private limited company to reduce its share capital supported by a solvency statement than the purchase of own shares and therefore the purchase of own shares route will mainly be applicable to redeemable shares.
Nevertheless, a company may wish to repurchase shares:
- to be held as treasury shares
- for the purpose of an employee share scheme
- when company is in the run-up to being acquired
- where an existing shareholder wants to dispose of their investment and the other shareholders do not have sufficient funds to buy the shares of the leaving shareholder.
Taxation for the vendor
Where certain qualifying conditions are met, the proceeds from the buyback are taxed as a capital gain instead of being taxed as a dividend. Capital gains tax treatment applies automatically where the conditions are met so it is not necessary to claim CGT treatment.
It is possible to get business asset disposal relief (tax at the rate of 10%) if the conditions are met. HMRC CGT manual CG58600P includes all these conditions along with detailed guidance and clearance procedure.
Accounting treatment
ACCA’s technical factsheet, Company purchase of own shares, includes accounting treatment along with journal entries for all the methods discussed above. Additionally, it provides detailed guidance for legal and taxation aspects, template resolutions. Finally, Appendices 5 and 6 summarise the procedure for obtaining advance clearance from HMRC before any deliberations are concluded.