When one director/shareholder in a small company wants to leave, it is usually preferable for their shares to be sold to the company or the remaining shareholder/s who will continue to run the business. The shareholders will usually ask the company’s accountant to advise on the value of the shares. Once a price has been agreed, it should be considered whether the company will buy back or purchase the shares, or should the remaining shareholder/s buy them?

In practical terms, private company share sales to the remaining shareholder/s are simpler to administer than a company share buyback, but there may be tax benefits in structuring the deal as a company buyback.

Share sale or share buyback?

With a share sale, the selling shareholder will simply sell to the purchasing shareholder for the agreed price. This could be a lump sum payable on completion or structured as a payment over a period of time, or could be linked to future profits of the company, as an earn out. Funding will come from the purchaser and if the purchaser is an existing shareholder, their individual shareholding will increase.

A share buyback is where the company purchases the shares at an agreed price. In order to do this, Company Law rules must be followed otherwise the directors can be found liable for breach of their duties and HMRC can deny favourable tax concessions for the shareholder.

Funding for the transaction must come from the company which must have sufficient distributable reserves to fund the share buyback. If the funds are not paid from distributable reserves, liabilities can arise. Funds can come from retained profits or capital or borrowings.

Tax issues

If a shareholder sells his shares to the company, then the shareholder may be charged income tax. The profit on the sale is treated like a dividend. However, in certain circumstances, the shareholder may be charged capital gains tax.

The requirements for HMRC to treat the share buyback as capital are that the seller must:

  • Have owned the shares for over 5 years;
  • Be selling all his shareholding; or
  • Be substantially reducing the shareholding by over 25%; and
  • Hold under 30% of the issued share capital.

Another condition is that the buyback must be for the benefit of the company’s trade (or to pay inheritance tax from a death). In order to check whether these conditions will be satisfied, it is usually advisable to apply to HMRC for advance clearance that the buyback will qualify for capital gains tax treatment.

The seller can choose between income tax and capital gains tax treatment on the buyback. If capital gain tax applies, then the seller could use the annual exemption and Entrepreneurs’ Relief, in which case the seller would pay 10% capital gains tax.

Company procedures

The main company law requirements to be dealt with for a buyback of shares include:

  • A contract for the share buyback between the Seller and the Company.
  • Board minutes to approve the share buyback and payment for the shares.
  • Directors statement where payment is made out of capital.
  • A resolution of the shareholders.
  • Stock transfer form transferring the shares.