April 9, 2024



For unquoted trading companies only, the amount received by a shareholder on selling his shares back to the company may be treated as capital, rather than as an income distribution (explained in the previous email), provided certain conditions are met.

This treatment only applies to purchases of own shares by unquoted trading companies that are not 51% subsidiaries of a quoted company, or to purchases of own shares by unquoted holding companies of a trading group.

CTA 2010, s 1033(1)(a); CTM17507

A ‘trading company’ is a company whose business consists wholly or mainly (ie greater than 50%) of carrying on a trade or trades, and a ‘trading group’ is a group of whose members, taken together, consists wholly or mainly of carrying on a trade or trades. The trading status is looked at the date the share buyback takes place.

To qualify for capital treatment on a purchase of own shares, the repurchase must fulfil either Condition A or Condition B:

Condition A (all must be fulfilled)

  • the repurchase is made wholly or mainly in order to benefit the trade carried on by the company (see below)
  • the repurchase does not form part of a scheme or arrangement which aims for the avoidance of tax
  • the vendor must be resident in the UK in the tax year of the purchase. For this purpose, personal representatives are taken to have the same residence as the deceased.
  • the vendor must have owned the shares for at least five years (three years if acquired as a result of a death). Holding periods of a spouse are aggregated for this purpose (see below)
  • there must be a substantial reduction in the vendor’s shareholding (see below)
  • following the buyback, the vendor must not be connected with the company (see below).

CTA 2010, ss 1033–1043

Condition B

The capital route also applies if the repurchase was to settle an IHT liability and virtually all of the proceeds are used to settle the bill and the bill could not have been settled otherwise without undue hardship. The IHT must be paid within 2 years of death.

CTA 2010, s 1033(3)

‘Trade benefit’ test

Whether or not a payment is made for the benefit of a company’s trade is a question of fact. However, guidance has previously been issued by HMRC in SP 2/82.

Situations listed where the trade benefit test would normally be regarded as satisfied include:

  • removing a dissenting shareholder, where disagreements between the shareholders over the company’s management is causing an adverse effect on the company’s trade, or
  • ensure that an unwilling shareholder (such as a retiring director, representatives of a deceased’s estate or a withdrawing equity financier) does not sell their shares to an unacceptable new shareholder.

HMRC has stated that it expects exiting shareholders to sell all their shares, but will accept in some cases that a maximum holding of 5% could be retained for sentimental reasons.

Period of ownership

The selling shareholder is required to have held the shares for the whole of the five-year period ending with the date of the buyback. However, there are a number of deeming rules that can increase the likelihood of a shareholder meeting this test.

If shares have been transferred on a ‘no-gain / no-loss’ basis between spouses or civil partners, the holding periods of the two spouses or civil partners are aggregated for this purpose. Note that this does not apply if the couple are no longer living together.

For shares inherited under the terms of a will or on intestacy, the vendor’s or personal representative’s holding period is aggregated with that of the previous owner. In addition to this circumstance, the total holding period which is required is three years rather than five.

CTA 2010, s 1036(3)

Substantial reduction test

To fulfil Condition A, the vendor’s shareholding must be ‘substantially reduced’ following the share buyback, which means that their interest in the company must be 75% or less of what it was before the buyback. The combined interests of the seller and any ‘associates’ (see below) are taken into account for the purpose of the substantial reduction test.

CTA 2010, ss 1037–1038, 1059–1061

If a shareholder sells his entire shareholding back to the company, it should be easy to demonstrate that this test has been met. If the vendor retains an interest in the company then a calculation of the before and after position must be carried out to determine whether there has been a substantial reduction.

For the purpose of calculating the reduction in the vendor’s shareholding before and after the transaction, the interests of his associates must be aggregated with his interests. ‘Associated’ for this purpose includes:

  • spouses or civil partners who live together
  • children aged under 18 and their parents
  • persons connected with a company are associated with that company and any company controlled by it and vice versa
  • companies are associated with one another if they are under the control of the same person
  • a person acting on the directions of someone else in relation to the affairs of a company is associated with that other person and vice versa.

CTA 2010, ss 1059–1061

The connection test

To fulfil Condition A, the vendor must not be connected with the company following the share buyback.

CTA 2010, ss 1042(1), 1062

A person will be treated as connected with the company if they possess, or are entitled to possess, more than 30% of the:

  • issued ordinary share capital
  • loan capital and issued share capital
  • voting power in the company, or
  • the assets on a winding up of the company.

As with the substantial reduction test, interests of the vendor’s associates are aggregated with his for the purpose of this test.

It is HMRC’s view that for there to be a valid purchase of own shares, the consideration for the buyback must be paid in cash at the time of the purchase. For companies with a shortage of cash reserves, this can represent a major obstacle to carrying out a share buyback.

There are two possible solutions which are a loan back to the company or by way of a multiple completion buyback that can be used to alleviate problems with funding the purchase.


There is a clearance procedure for capital treatment of buybacks. Regardless of whether or not clearance is sought, there are also reporting requirements. This will be discussed in the final part along with issues to consider following the buy back.

As always, get in touch if you require a specialist tax consultant!

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