ATXP6 UK
Syllabus A4. Corporation Tax A4b. The scope of CT

A4bv. Purchase by a company of its own shares

Syllabus A4bv)

Advise on the tax implications of a purchase by a company of its own shares

Repurchase of shares by a company

Purchase by a company of its own shares

The Companies Act gives an unquoted company and companies quoted on the AIM the right to purchase their own shares.

In some circumstances the shareholder is treated as making a capital gains tax disposal rather than receiving a distribution attracting an income tax liability.

Conditions which must be met in order to be treated as a CGT disposal rather than as a distribution are:

  1. The company must be an unquoted trading company (companies quoted on the AIM are treated as unquoted).

  2. The shareholder must be resident in the UK.

  3. The shares must normally have been owned by the shareholder for at least five years.

  4. The shareholder must either dispose of his entire interest or reduce their interest in the share capital to 75% or less of the amount held before the repurchase of shares, and

  5. The shareholder must not immediately after the purchase be connected with the company (must not control more than 30% of the issued share capital or voting rights in the company.

If conditions are not met

If any one of the above provisions does not apply, then a payment for the purchase by a company of its own shares will be treated in the normal way as a distribution.

The amount of its distribution is the excess of the payment over the amount originally subscribed for the shares.

Note: Any legal costs and other expenditure incurred by the company in purchasing its own shares will not be allowable against the company’s profits.

Illustration

Gary owns 10,000 shares in A Ltd.

A Ltd. has 4 equal shareholders. 

Gary will sell either 2,700 shares or 3,200 shares back to A Ltd. 

Why will the capital treatment apply if he sells 3,200 shares but not apply if he sells 2,700 shares?

Solution

It will apply if he sells 3,200 shares because only a sale of this amount will reduce his holding to less than 75% of the original holding.

  • Selling 2,700 shares

    Original holding 10,000 shares/40,000 shares = 25%
    Holding after sale 7,300 shares/37,300 shares = 19.5%

    Reducing holding to less than 75% of original holding = 75%*25% = 18.75% 

    Therefore, selling 2,700 shares has not reduced his holding to less than 75% of the original holding and the deemed dividend treatment will apply in this situation.

  • Selling 3,200 shares

    Original holding 10,000 shares/40,000 shares = 25%
    Holding after sale 6,800 shares/36,800 shares = 18.5%

    Reducing holding to less than 75% of original holding = 75%*25% = 18.75% 

    Therefore, selling 3,200 shares has reduced his holding to less than 75% of the original holding and the capital treatment will apply in this situation.