Chapter 35 Purchase of own shares Flashcards
35.1 Introduction
A company can purchase its own shares, called a share buy-back. The company purchases its own shares and the shares are normally then cancelled. Where shares are bought back from a corporate shareholder, the capital treatment always applies. There are two possible tax treatments of the share disposal by the individual, the income treatment or the capital treatment.
Under the income treatment the receipt by the individual is treated as a dividend and taxed at the income tax rates, after the tax-free dividend allowance of £2,000.
Under the capital treatment, the disposal gives rise to a chargeable gain which is taxable on individuals at 10% or 20% and may qualify for business asset disposal relief.
35.2 Corporate shareholders
Where shares are bought back from a corporate shareholder, the capital treatment always applies.
35.3 Individuals as shareholders – income treatment
Payments by companies in respect of share buy-backs from individuals are usually treated as income distributions. The dividend will be the amount received on the share buy-back less the original subscription price (normally the same as the nominal value of the shares). In addition, there is a capital gains computation on the disposal. The sales proceeds for CGT purposes are the original subscription price of the shares, which is the price at which the company issued the shares to the original shareholders. Consequently, if the shareholder was the original subscriber of the shares, this computation will result in a capital gain of nil. If the individual was not the original subscriber, a capital gain or loss will arise.
35.4 Individuals as shareholders – capital treatment
If conditions are met, the buy-back will not be treated as a distribution, instead the shareholder will be treated as receiving a capital gain sum on disposal of the shares equal to the amount paid by the company. This give rise to just one capital gains computation.
This treatment only applies to purchases of own shares by unquoted trading companies that are not 51% subsidiaries of a quoted company. The repurchase must satisfy either of the following two conditions:
• Must wholly or mainly benefit the trade carried on by the company and not be part of a scheme to avoid tax. The vendor must be UK resident at the time of purchase, vendor must have owned the shares for at least five years (three years if acquired as a result of death and the ownership period of the deceased is included), holding periods of a spouse is included. There must be a substantial reduction in the vendors shareholding (must not hold more than 75% of their prior interest after the buy back) and following the buy back the vendor must not be connected with the company (connected here means owning more than 30% of the shares)
• The whole, or substantially the whole, of the payment is applied by the person to whom it is made in discharging a liability of his for-inheritance tax arising on death of another person, within the period of two years after the death.
35.5 The substantial reduction test
The substantial reduction test requires a 25% reduction in the vendor’s interest in the company when we compare his holdings before and after the buy back. We compare the total value nominal value of the shares owned by the vendor immediately before the buy back, expressed as a fraction of the issued share capital of the company at that time, with the corresponding fraction immediately after the share buyback. The fraction must not exceed 75% of the fraction before the buy back.
