The amount paid by the company for shares that it buys back, either as a purchase of own shares, a share redemption or share capital reduction can have tax implications on the seller of the shares and to a lesser extent on the company.
For the seller of the shares the main concern is where the amount received is above the price at which the shares were initially issued by the company (ie bought back or redeemed at a premium). Any amount received above the original issue price will normally be treated as a distribution by the company and taxed as income on the recipient. This is the case even if the shares were bought by the seller from another person for more than the original issue price.
The payment can in certain circumstances be treated as a capital receipt by the seller if a number of conditions are met.
When is the premium treated as a distribution?
Any payment by a company out of accumulated profits is generally treated as a distribution of the returns made by that company. This includes dividends, similar payments, payments on winding up of the company and amounts above the nominal value of the shares paid on redemptions, cancellations and purchases of own shares.
The tax treatment of the payment is set out in sections 1000, 1003, 1024, 1025 and 1033 to 1048 of the Corporation Tax Act 2010.
Sections 1000, 1003, 1024 and 1025 state that any amount over the initial issue price will normally be treated as a distribution unless section 1033 applies. Therefore, where section 1033 does not apply this amount is treated as taxable income in the hands of the seller.
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As such it is taxed as if it was a dividend and so taxed at the seller’s marginal tax rate. This is likely to be a higher tax rate than if the premium was treated as a capital payment and hence subject to tax as a capital gain.
When are the proceeds treated as a capital payment?
As mentioned above the requirements of section 1033 need to be met for the payment to be treated as a capital payment. This means that the premium over the initial issue price can be treated as a capital payment where:
- the consideration was paid immediately the shares were purchased; and
- the company is an unquoted trading company or the unquoted holding company of a trading group (however the trade must not be dealing in shares, securities or land); and
- substantially the whole of the payment (apart from any sum used to pay capital gains tax charged on the shares sold) is used within two years after death by the seller to settle an inheritance tax liability arising on death that could not have been paid without undue hardship using other assets;
- the purchase is made wholly or mainly for the purpose of benefiting a trade carried on by the company or any of its 75% subsidiaries; and
- the purchase does not form part of a scheme or arrangement where one of the main purposes is to enable the seller to participate in the profits of the company without receiving a dividend; and
- the purchase does not form part of a scheme or arrangement where one of the main purposes is the avoidance of tax; and
- the requirements set out in sections 1034 to 1043 of the Corporation Tax Act 2010 (so far as applicable) are met which include amongst other requirements:
- that the seller is resident and ordinarily resident in the United Kingdom in the tax year in which the purchase is made or the deceased person must have been resident and ordinarily resident in the United Kingdom immediately before death; and
- that, if the shares are held through a nominee, the nominee is also resident and ordinarily resident in the United Kingdom in the tax year in which the purchase is made; and
- that the shares have been owned by the seller (or seller’s cohabiting spouse or civil partner at the time of the transfer) for five years ending with the date of the purchase, unless the ownership has arisen from a will or intestacy when the shares must have been owned by the deceased and then seller for three years; and
- that the seller’s interest and the combined interests of the seller and the seller’s associates (spouse, civil partner, minor children or connected companies) in the company or group of companies must be substantially reduced. By substantial reduction the final interest is required to be not more than 75% of the before purchase interest – eg sell at least 25% of the seller’s interest. A person’s interest is the percentage of total nominal value of shares issued that are owned by that person; and
Example of what is a substantial reduction
- Jean owns 1,000 ordinary shares with nominal value of £1 and 10 preference shares with nominal value of £10 in Juniper Limited (the Company) which has 10,000 ordinary shares and 100 preference shares. Jean’s interest before the purchase is 10% (calculated as (1,000 x 1 + 10 x 10)/(10,000 x 1 + 100 x 10)).
- If all the Company’s preference shares are redeemed the seller and Company then have just 1,000 and 10,000 ordinary shares respectively. Jane’s interest is still 10%. This means that Jane has not met the requirement for there to be a substantial reduction in her interest.
- If instead of redeeming the preference shares the Company only redeems the 1,000 ordinary shares owned by Jane her post purchase interest is now 1% (calculated as (10 x 10)/(9,000 x 1 + 100 x 10)). This means that her interest has met the requirement for the holding to be substantially reduced so that the proceeds could be treated as a capital receipt provided all the other conditions are met.
- the seller’s right, together with those of the seller’s associates, to distribution of profits must be substantially reduced, such that after purchase this is not more than 75% of the right before the purchase; and
- the seller must not, immediately after the purchase, be connected with the company making the purchase or any other company that is a member of the same group as that company. A company is connected if the seller, together with associates, owns 30% or more of the company’s ordinary shares, issued share capital or voting rights; or if the seller is entitled to more than 30% of the company’s assets on a winding up; and
- any transactions occurring within one year of the purchase are deemed to be part of the same scheme.
This is a complex area and specific tax and legal advice should be obtain before such payments are made.
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