Share buyback explained

A buyback of shares is where the company buys some of its own shares from existing shareholders.  There are three types of share buyback:

Share redemptions only apply to redeemable shares, and are when those shares are being bought back in accordance with the company’s articles of association. A share capital reduction is, where it can be used, a simpler way to reduce share capital than a purchase of own shares out of capital.

Under a purchase of own shares the shares bought by the company will either be immediately cancelled or, where the purchase has been fully financed out of distributable profits, held by the company in treasury.

Why carry out a buyback of shares?

There are various circumstances where a company may want to buy back its own shares including:

1. 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.

This type of situation is often covered by the terms included in a shareholders’ agreement.

2. To return excess cash not needed for the company’s ongoing operations to the shareholders.

3. To take advantage of what is seen as an undervaluation of the shares.

4. Especially for plcs; to increase the value of the remaining shares, increase the dividends per share or help maintain a market in the shares.

Before deciding on making a share buyback you should obtain suitable legal and taxation advice.

How to make a buyback of shares

The rules for share buybacks are set out in Part 18 of the Companies Act 2006 as amended by The Companies Act 2006 (Amendment of Part 18) Regulations 2013 (Statutory Instrument 2013/999) and The Companies Act 2006 (Amendment of Part 18) Regulations 2015 (Statutory Instrument 2015/532).

When considering a purchase of own shares the directors need to ensure that the following conditions are met:

• The articles of association do not prohibit share buybacks – these can be amended to allow a share buyback by passing a special resolution;
• a company cannot buy back all of its own non-redeemable shares as it must have at least one non-redeemable share in issue;
• the shares being bought must be fully paid; and
• the shares bought back must generally be paid for by the company on purchase unless being bought as part of an employee share scheme.

The directors will then need to consider the following:

• how the purchase is to be carried out – either market purchases or off-market purchases. Market purchases are where the company buys the shares through a share market and will generally be carried out by plcs (eg plcs buying shares through the London Stock Exchange);
• the terms of the contract of purchase, including the purchase price, to be entered into with the seller(s), although the contract does not have to be in writing;
• how the buyback is to be financed, as there are additional rules where the buyback is to be made out of capital;
• where the buyback is out of capital (permissible capital payment) the financial status of the company now and for the year following the buyback of shares; and
• obtaining the necessary shareholder approval.

Some of these are considered further below.

Financing a buyback

There are three ways that a company can fund a buyback of shares.

The easiest way is for the company to use its distributable profits and the proceeds of any new issue of shares.

A private limited company may also make a small purchase of its own shares out of capital, if it does not have sufficient distributable profits, up to an aggregate purchase price in one financial year of the lower of:

• £15,000; or
• 5% of the aggregate nominal value of its fully paid share capital as at the beginning of the financial year.

Finally, it is also possible for a private company to make a permissible capital payment to purchase its own shares if it does not have sufficient distributable profits and the payment out of capital is more than the lower of £15,000 and 5% of the aggregate nominal value of its fully paid share capital.  However, there are some further procedures that the directors need to follow. We will cover the requirements for permissible capital payments in a future article.

A company can use a combination of the above but must always use distributable profits and the proceeds of any new issue before making a payment out of capital.

Where the company is paying a premium above the nominal value of the shares and the buyback is being funded out of an issue of new shares then those shares being bought back must have originally been issued at a premium.  In this case the maximum proceeds that can be used is the lower of:

• the aggregate of the premiums received on the original issue of the shares being purchased; and
• the amount of the company’s share premium account (including that in respect of premiums on the new shares).

The share premium account is then reduced by the amount of any premium paid out of the new issue of shares.

Shareholder approval

The company’s shareholders also need to approve a buyback of shares. This will normally be by passing an ordinary resolution. We also provide a template resolution you can adapt and use to approve a share buyback for your own company. However, a special resolution will be required if the articles either do not allow purchases of own shares or specifically require one for a purchase of own shares.

Where the shareholder resolution is to be voted on at a shareholders’ meeting a copy of the proposed contract of purchase or written details of the terms (if the contract is not in writing) must be available for inspection for at least 15 days before the date of the meeting at which the resolution is to be passed.  Where it is to be a written resolution a copy of the contract or written details of the terms must be sent with the written resolution.

The shareholders whose shares are the subject of the share buyback cannot exercise the votes attached to those shares. Such shareholders may at a general meeting, however, exercise any votes on any other shares they hold.

In addition, if the purchase is being made by a private limited company partly out of capital (a permissible capital payment) then the company is required to carry out additional procedures.  These additional procedures are explained in our Using capital for a redemption or purchase of own shares article.

Holding shares in treasury

When a company buys back its own shares, those shares will normally be immediately cancelled.  Companies, however, are not required to do this and can, where the purchase has been fully financed out of distributable profits, instead decide to hold them in treasury.

Public limited companies are more likely than private companies to hold shares in treasury as this allows them to sell these shares easily to new investors in the future. This removes any need for shareholder approval for a new share allotment.  In addition, holding shares in treasury and then selling them may not reduce distributable profits in the same way as cancelling the shares.

Whilst shares are held in treasury the company has no voting or dividend rights on the shares. However, if the company carries out any capital reorganisation, other than a rights issue, the treasury shares will be subject to the change.

Shares held by the company in treasury can still be cancelled by the company at any time.

Taxation issues on purchase of own shares

Tax on seller

The amount paid for the shares by the company can have taxation implications on the seller of the shares. Any amount over the initial issue price will normally be treated as a distribution.  This will then be treated as taxable income and not as a capital gain and so taxed at the seller’s marginal tax rate.

The amount over the initial issue price can in limited circumstances be treated as a capital gain if certain conditions are met.

Tax on company

Stamp duty is payable by the company on the purchase of shares. For off-market purchases, this is calculated at 0.5%, rounded up to the nearest £5, of the purchase price paid by the company.  However, if the total consideration is £1,000 or less and does not form part of a series of transactions of more than £1,000 then no stamp duty is payable.

Stamp duty is also not payable where the company buying back its own shares is  a qualifying asset holding company and all the conditions for exemption to stamp duty are met.

Reporting the buyback

Once the buyback of shares has been made the Companies House form SH03 should be completed.  Where stamp duty is payable by the company on the purchase this should, once the form has been signed, be paid to HMRC.  Stamp duty should be paid by electronic transfer by one of the following means:

• online
• CHAPS
• BACS transfer

A copy of the signed form must then be sent to HM Revenue & Customs (HMRC) preferably by email to [email protected].  The copy can alternatively be sent by post.  Once the stamp duty has been paid an email (or letter) will be sent back confirming that stamp duty has been paid together with an HMRC authentication code. See the Government’s guidance on paying stamp duty on shares for more information.

The HMRC authentication code should then be entered onto the form SH03 in section 2.

In addition, if the shares are being immediately cancelled, then, in most cases, form SH06 should also be filed at Companies House within 28 days.  Where the company is a public limited company and section 663 of the Companies Act 2006 applies form SH07 should instead be filed at Companies House.

Once the above forms have been completed, either as electronic documents or on paper, they need to be sent to Companies House within 28 days of the buyback.  Where stamp duty is payable a copy of the email or letter from HMRC confirming that stamp duty has been paid should also be sent.  The documents can be sent in the post, or for forms SH06 and SH07, using Companies House document upload process.  If you use Inform Direct to process a buyback then these forms are automatically generated for you to use.

Also, where the purchase of own shares is being treated as a capital return, a return under section 1046 of the Corporation Tax Act 2010 should be completed and sent to HMRC within 60 days.

Record requirements

In addition to completing the above forms the company should:

• Update the register of shareholders/members and other similar records for shares bought and cancelled by the company from each shareholder;
• Update the accounting records for the shares bought and cancelled;
• Cancel the share certificates for the shares bought back;
• Issue new share certificates where the shareholders still have a holding after the buyback.

In addition, the company must keep a copy of the contract to purchase its own shares or a memorandum of its terms (if it was not in writing) for ten years. This must be available for inspection at its registered office by shareholders and, if a public company, by any other person.

Other types of share reorganisation

For more information on other types of share reorganisations read our following articles:

• share capital reduction;
• share redemption;
• redemption or purchase of shares out of capital;
• share split;
• share consolidation.

An earlier version of this article was published in February 2018, which has been updated for changes to how to pay stamp duty on share buybacks and reporting such transactions to Companies House.