Technical factsheet:

Company purchase of own shares

Issued May2016

CONTENTS

1. Introduction

2. Legal aspects

3. Taxation

4. Accounting

5. Impact distributable profits have on purchase of own shares

6. Reporting

7. General business planning issues

8. Ethical considerations for the adviser

Appendix 1 Summary of the law relating to company buy back of own shares

Appendix 2 Extract from the Auditing Practices Board bulletin 2008/9

Appendix 3 Worked examples ofaccounting entries

Appendix 4 Example of an ordinary resolution and notice of ordinary resolution

Appendix 5 Extract from HMRC publication SP2/82: company’s purchase of ownshares

Appendix 6 Excerpt from Tax Bulletin 21

1. INTRODUCTION

Private companies often decide to purchase their own shares from shareholders. A common situation is when an existing shareholder wants to sell some or all of his/her shares and the other shareholders are unwilling or unable to purchase them. This factsheet also provides an overview of a reduction of capital which involves no payments being made by the company to shareholders.

The legal, tax, accounting, reporting and general business planning issues need to be carefully considered. Ethical matters will also need to be considered by both accountants working in the business and external advisers if the accountant is advising both the company buying the shares and the shareholder selling the shares.

2. LEGAL ASPECTS

Companies Act 2006 sections 641 to 653 deal with reduction of share capital and Part 18 sections 658 to 737 deal with the purchase by a company of its own shares. A summary of these sections can be found in Appendix 1.

The following legal requirements apply,if permitted by the articles of the company:

  • A private company may redeem or purchase its shares out of capital by passing an ordinary resolution together with a statement by each of the directors that the company is solvent, supported by an auditors’ report as to the reasonableness of such a statement. See Appendix 3 for an example of an ordinary resolution.
  • A private company may reduce its capital by issuing a solvency statement and passing an ordinary resolution. This procedure does not require a report by the auditors.
  • Public companies continue to require court approval for capital reduction.

A private company is able to provide financial assistance for the purchase of its own shares, or shares of its private holding company, provided that it does not result in an unlawful reduction of capital.

However, Companies Act 2006 prohibits a public company from giving financial assistance directly or indirectly for the purpose of the acquisition of its shares or those of its holding company, or for the purpose of reducing or discharging any liabilities incurred in the acquisition of such shares (CA2006 s678 and s679).

Treasury shares

Statutory instrument 2013 number 999 (SI 2013/999) simplified the rules for share buy backs and allows all companies limited by shares to hold their own shares in treasury.

In respect of the authorising of share buy backs the followingis available:

  1. Allow off-market share buy backs to be authorised by ordinary resolution (special resolution was required before 30 April 2013). An off-market share buy back is one where the purchase of a company’s own shares does not take place on a recognised investment exchange.
  2. Allow for the prior approval of multiple off-market share buy backs, for the purposes of an employee share scheme, to be authorised by a single ordinary resolution. The resolution will specify the conditions under which the shares may be bought back and will give the maximum number of shares that can be bought back, the price range and the time of expiry of the authorisation, that cannot exceed five years.

In respect of the financing of share buy backs the following amendments have been introduced:

  1. Allow private limited companies to pay for their own shares by instalments where the share buyback is in connection with an employee share scheme. (Previously under Companies Act section 691, when a company purchased its own shares it had to make full payment on the date it bought back those shares.)
  2. Allow private limited companies to buy back shares in connection with an employee share scheme to finance the purchase out of capital using a simplified procedure. This simplified procedure consists of the directors signing a solvency statement and the shareholders passing a special resolution. (Previously when shares were bought back out of capital, the directors needed to produce a solvency statement which the auditors reported on, shareholders passed a special resolution, a public notice of proposed payment was issued and the directors’ statement and auditor’s report was made available for inspection.)
  3. Allow private limited companies to buy back shares using ‘small’ amounts of cash if authorised to do so by its articles and without having to identify the cash as from distributable reserves. Small in this respect is the lower of £15,000 and the cash equivalent of 5% of its share capital in each financial year. Section 692 of the Companies Act 2006 allows a private companyto purchase a limited amount of its own shares without using the other three sources of finance allowed by the Companies Act 2006 (these being distributable profits, proceeds of a fresh issue of shares and capital [for private companies]).

In respect of a company being able to hold its own shares as treasury shares, the following has been introduced:

Allow all companies limited by shares to hold their shares as treasury shares. Section 724 was amended as previously only public companies with listed shares were able to hold their own shares as treasury shares. The shares allowed to be held in treasury are those acquired out of distributable profits or, for private companies, with small amounts of cash (as explained above).

3. TAXATION

The shareholder selling the shares will be taxed on the sale of his/her shares to the company either based on the ‘distribution treatment’ or ‘capital treatment’. Distribution treatment is broadly the same as a dividend and subject to income tax, whereas under the capital treatment the disposal is subject to capital gains tax.

The taxation considerations in the factsheet do not consider the impact, if any, of the consultation Company Distributionsand Finance Bill 2016. This highlightsthe concern that the changes to taxation of dividend income would drive some people to try to get people to look at dividends, rather than salary, and would act as an incentive to arrange for returns from a company to be taxed as capital rather than as income, attracting tax at lower capital gains tax rates.

The government has stated that it ‘will continue with plans to amend the Transactions in Securities rules and introduce a new TAAR[Targeted Anti-Avoidance Rule]’.

The government commentsthat the legislation will be amended so that:

  • ‘it will not apply to minority shareholders
  • “arrangements” is clearly defined
  • distributions will not be treated as income to the extent that they represent thecapital gains “base cost” and
  • the exemption for distributions of irredeemable shares will be widened to ensure that the TAAR does not apply to standard “liquidation demergers”.’

The revised legislation will form part of the Finance Bill 2016 and remains due to come into effect from 6 April 2016. The main proposals are in the general anti-avoidance rule and within the transactions in securities and distribution clauses.

Where certain conditions exist, CTA 2010 s1033 provides that the distribution treatment does not apply to a payment made by an unquoted company on redeeming or purchasing its own shares. The effect is that the vendor is treated as receiving a capital receipt. However, if the vendor is a share dealer, the receipt will be trading income.

CTA 2010 s1033 provides that the purchase consideration is exempt from distribution treatment under CTA 2010 s1000 if either:

  • the purchase is made wholly or mainly for the purpose of benefiting a trade, and certain other conditions are met (CTA 2010 s1033(2)(a)) or
  • the purchase is made to enable the vendor to pay inheritance tax (specific exemption in CTA 2010 s1033(3)).

Where the conditions in CTA 2010 s1033 are satisfied capital treatment is automatic. It cannot be ‘disclaimed’. Nevertheless the vendor may be able to break one of the conditions to secure distribution treatment if this is beneficial.

HMRC will give clearance for capital treatment only if the purchase consideration is to be fully paid immediately on completion and paid in money. This means that payment by instalments is not possible. HMRC has indicated that is it possible to make a contract under which successive tranches of shares are to be purchased on specified dates.

Under CTA 2010 s1044, a company proposing to make such a payment may ask HMRC to confirm either that CTA 2010 s1033 will apply, or that it will not apply. Further guidance on this clearance procedure can be found in SP2/82, the link for which can be found below. SP2/82 also gives guidance on the ‘trade benefit’ test referred to above. (SP2/82 has been reproduced in Appendix 5.)

If a company makes a purchase of own shares that it believes falls within CTA 2010 s1033, it must make a return of the transaction to the Inspector (CTA 2010 s1046).

The return must:

  1. be made within 60 days of the payment
  2. give particulars of the payment
  3. explain why the company believes that CTA 2010 s1033 applies to the payment so as to exempt it from treatment as a distribution (see Statement of Practice SP2/82 (link below and Appendix 5)).

The company must make such a return even if the board has confirmed that CTA 2010 s1033 will apply to the payment.

If the company has agreed to pay the legal costs relating to a purchase of own shares, such costs are generally disallowable in computing the company’s trading income. This is on the grounds that they are:

  1. capital expenditure in respect of the company’s share capital, or
  2. within ICTA88 s74(1)(f).

The expenditure is also likely to fail the wholly and exclusively test under ICTA88 s74(1)(a). Company Taxation Manual CTM17320 contains information on the relevant law references concerning relief for costs of distributions and demergers; this can be found at

HMRC has produced the following document, which hasuseful taxation information relating to company purchase of own shares:

Statement of Practice SP2/82 is reproduced in Appendix 5 and can also be found at

It is for the company and vendor shareholder to agree a price for the shares. However, the directors have obligations to creditors and the shareholders. The following tax implications may arise if the company purchases its own shares for a value other than market value:

Purchase consideration exceeds market value

  1. If HMRC can show that the purchase is not ‘a bargain made at arm’s length’, then it may seek to apply TCGA 1992, s17, which provides for market value to be substituted for the actual consideration. HMRC explains what it considers is ‘a bargain made at arm’s length’ in Capital Gains Manual CG14542, which can be found at
  2. HMRC may argue that the excess of the consideration over market value is a distribution under ICTA 1988, s209(4).
  3. HMRC may argue that the excess could fall within the definition of remuneration due to the wide scope of ICTA 1988, s19.

Purchase consideration less than market value

  1. HMRC may argue that TCGA 1992, s17 should be applied (as explained above). This may result in a chargeable gain greater than the vendor expected. The excess is a gift to the company, although hold-over relief under TCGA 1992, s165 is not available.
  2. The gift will be a transfer of value for inheritance tax purposes, which will not be a potentially exempt transfer because it is a transfer to a company.
  3. Business property relief may be available on the transfer of shares, although this would not apply if death occurred within seven years as the shares are cancelled on acquisition by the company and therefore cannot remain within the estate of the recipient.
  4. A transfer at undervalue followed by some remaining connection with the company may result in the ‘reservation of benefit’ provisions being relevant and the estate on subsequent death could be treated as including the gifted element.

4. ACCOUNTING

CA 2006 s686 allows only redeemable shares to be redeemed if they are fully paid. Similarly, s 691 allows only a limited company to purchase its own shares if they are fully paid,unless purchasing the shares in relation to an employees’ share scheme.

Treasury shares

Companies Act 2006 sections 724 to 732 deals with treasury shares. The Companies (Acquisition of Own Shares) (Treasury Shares) Regulations 2003 (SI 2003 No. 116) amended the Companies Act 1985 so that in certain circumstances qualifying shares may be held ‘in treasury’ for future sale by the company.

Statutory Instrument 2013 No. 999 made further amendments with effect from 30 April 2013 in relation to treasury shares. From that date private companies were able to hold treasury shares.

Capital redemption reserve

Where shares are redeemed or purchased wholly out of profits available for distribution, a sum equal to the amount by which the company’s share capital is diminished on cancellation of the shares (the nominal value of the shares) should be transferred to the capital redemption reserve (CRR). (CA 2006 s733)

Where the redemption or purchase is financed wholly or partly by a new issue of shares, the transfer to the CRR is reduced by the proceeds of the new issue. In the case of a private company, the transfer to the CRR should be further reduced to the extent that the company can make a permissible capital payment.

The capital redemption reserve may only be used subsequently to make a bonus issue of shares.

Appendix 3 examples 1, 2 and 3 demonstrate the accounting treatment.

Share premium account

Where the shares to be redeemed or purchased were issued at a premium and a fresh issue of shares is made for the purposes of the redemption or purchase, any premium payable on redemption or purchase may be charged against the share premium account.

The premium so charged cannot exceed the lower of:

  1. the premium received on the issue of the shares now being redeemed or purchased
  2. the current balance of the share premium account, including any premium on the new share issue
  3. the proceeds of the fresh issue.

Therefore, where there is no fresh issue of shares, no amount may be charged to the share premium.

Appendix 3 example 5 demonstrates the accounting treatment.

Permissible capital payments (only applicable to private companies)

The permissible capital payment (PCP) is the amount by which the purchase or redemption cost exceeds the amount of distributable profits plus the proceeds of any new share issue.

If the PCP is less than the nominal value of the shares redeemed or purchased, the difference is transferred to capital redemption reserve (CA2006 s 734(2)). This means that a private company should use its available profits and any share proceeds before making a payment out of capital.

If the PCP is more than the nominal value of the shares redeemed or purchased, the excess may be used to reduce any of the following:

  1. capital redemption reserve
  2. share premium account
  3. revaluation reserve
  4. fully paid share capital (CA2006 s 734(3)).

Appendix 3 examples 4, 6 and 7 demonstrate the accounting treatment.

The following procedures must be followed before a payment out of capital can be lawfully made:

  1. The payment must be approved by a special resolution (CA 2006 s716(1).
  2. The directors must make a statement (CA 2006 s714(1-3).
  3. A report by the company’s auditors must be annexed to the directors’ statement (CA 2006 s714(6).
  4. Within a week of the date of the special resolution, a notice of the proposed capital payment, giving the information specified in CA 2006 s719, must be published in the Gazette.
  5. Within a week of the date of the special resolution, a notice of the proposed capital payment, giving the information specified in CA 2006 s719, must be published in a national newspaper or given by written notice to each creditor.

The directors’ S714 statement is explained in greater detail:

Under CA2006 s714(1-3), the directors are required to issue a statement thatmust specify the amount of the permissible capital payment for the shares in question and that, in their opinion as regards its initial situation following the date on which the payment out of capital is proposed, there will be no grounds on which the company could then be found unable to pay its debts, and for the following year the company will be able to continue to carry on business as a going concern (and will accordingly be able to pay its debts as they fall due). In forming their opinion, the directors must take into account all of the company’s liabilities (including any contingent or prospective liabilities).

The directors’ statement must be in the prescribed form and must have annexed to it a report by the auditor stating that they haveenquired into the company’s state of affairs, that the permissible capital payment for the shares in question has been properly determined and that they are not aware of anything to indicate that the opinion expressed by the directors as to the ability of the company to pay its debts and continue as a going concern is unreasonable.

Reduction of capital (by special resolution and solvency statement): available to private companies

This reduction generally applies:

  • where the company wishes to reduce the liability on any of its shares in respect of share capital not paid up
  • where the company is over-capitalised
  • where the company has suffered a loss of capital (ie cancelling share capitalwhich is unrepresented by available assets).

Appendix 3 example 8 demonstrates the accounting treatment.

CA 2006 s641 and statutory instrument,‘The Companies (Reduction of Share Capital) Order 2008’ (SI 2008/1915), sets out the means by which a company can reduce its share capital. This procedure also applies to a reduction in those reserves that have similar characteristics to share capital (ie the share premium account and the capital redemption reserve), although it does not apply to any merger reserves. For private companies, court approval and an auditors’ report are not required.

CA 2006 s641(2) states that this method of capital reduction cannot be used if, after the reduction, there would no longer be any member of the company holding shares other than redeemable shares or if the articles do not permit it.

This procedure is that directors make a solvency statement confirming that each director: