Purchase of own shares: What could possibly go wrong?

By | 30 November 2021

A company purchase of own shares (CPOS) is often a tax-efficient way for an individual shareholder to dispose of their shares (e.g., on retirement).

However, unexpected tax consequences can arise if a CPOS is not handled correctly.

Income treatment

As a general rule, when the company buys back its own shares from the shareholder, any ‘premium’ (i.e., payment in excess of the capital originally subscribed for the shares) constitutes a distribution of income (i.e., similar to a dividend).

If the proceeds are treated as an income distribution, it will probably be subject to tax at rates of 33.75% and/or 39.35% (for 2022/23).

Capital treatment

However, if certain conditions are satisfied (in CTA 2010, Pt 23, Ch 3) the vendor is normally treated as receiving a capital payment instead.

Capital treatment sometimes provides individual shareholders with a tax-efficient exit route from the company, particularly if capital gains tax (CGT) business asset disposal relief is available such that the CGT rate is only 10%; otherwise, the CGT rate is likely to be 20%.

Trading in shares?

By contrast, in some cases taxpayers may seek to argue that they are trading in shares. Trading receipts take precedence over income distributions for tax purposes (ITTOIA 2005, s 366).

Whilst any profits from trading in shares would be liable to income tax at possible rates of 20%, 40% and/or 45%, trading treatment may be attractive. For example, the taxpayer might have trading losses available to offset against a profit from the transaction.

Unexpected result

However, care is needed. In Khan v Revenue and Customs [2020] UKUT 168 (TC), the taxpayer bought all the shares (i.e., 99 shares) of a company (CAD) for £1.95 million (plus net asset value). The company then immediately bought back 98 of those shares from the taxpayer for £1.95 million. The two events were separately documented.

HM Revenue and Customs assessed the taxpayer on the basis that the proceeds received from CAD for the share buyback represented a distribution. The taxpayer argued that the disposal was of trading stock (which, as mentioned, takes precedence over a distribution for income tax purposes). However, the First-tier Tribunal held that the purchase and sale of shares in the company did not amount to a disposal of trading stock, and that the taxpayer’s acquisition of the company was, by nature, an investment.

The taxpayer subsequently argued before the Upper Tribunal that the true substance of the transaction was a composite one (i.e., he received the remaining share in the company devoid of £1.95 million of distributable reserves, in return for entering into the transactions). He contended that it was the selling shareholders who received the distribution, and any tax fell to be chargeable on them. However, in the Upper Tribunal’s view it was plain that the taxpayer received the distribution and he was entitled to receive it.

Practical point

A company purchase of own shares can be taxed in different ways. The tax and company law rules must be carefully considered in advance of the transaction, with a view to determining whether the desired tax treatment is available based on the circumstances.

The above article was first published by Business Tax Insider (January 2021) (www.taxinsider.co.uk).