Mark McLaughlin looks at potential tax implications for shareholders if a company purchase of own shares does not satisfy legal requirements.
Company purchases of own shares can often be helpful. For example, a shareholder in a family trading company may wish to retire and exit the company to make way for the next generation.
It’s the law
However, the transaction must satisfy company law requirements (in Companies Act 2006) to be a valid company purchase of own shares. If the company fails to comply with them, the transaction is treated as void, and an offence is committed.
For example, the company is required to purchase its own shares out of distributable profits (or the proceeds of a fresh share issue to finance the purchase), and the company must pay for the shares on completion (subject in both cases to limited exceptions).
Void company purchases
What happens for tax purposes if a company purchase of own shares is found to be void under company law? The answer largely depends on whether the individual shareholder can keep the consideration paid by the company for their shares.
For example, In Baker v Revenue and Customs [2013] UKFTT 394 (TC), a manufacturing company decided that it would buy back the shares of a director shareholder (B) for £120,000 (paid in cash and assets). The company’s purchase of B’s shares took place during 2005/06. However, the transaction was found to breach company law (i.e. the company did not pay for the shares on completion, or have sufficient distributable profits).
HMRC sought to tax B on an income distribution of £120,000. However, the First-tier Tribunal decided that as the company purchase of own shares was void under company law, B was obliged to return the proceeds received for his shares to the company. Hence, there was no income distribution for tax purposes.
Proceeds not recoverable
By contrast, in Kinlan and Anor v Crimmin and Anor [2006] EWHC 779 (Ch), the company went into liquidation. The liquidators made a claim against a shareholder for monies paid by the company on a share buyback, on the basis that the transaction breached company law.
The High Court held that the share buyback was void (i.e. the company had insufficient distributable reserves, and part of the consideration was payable in instalments). However, the court also held that the liquidator could not recover the payments for the shares in the specific circumstances.
HMRC’s view
HMRC guidance on company purchases of own shares (in the Company Taxation manual at CTM17505) points out that if a purchase is invalid, the shares are not treated as cancelled and legal ownership remains with the shareholder.
HMRC also points out (at CTM15205) that a recipient who knows or has reasonable grounds to believe that a distribution is unlawful is liable to repay it to the company. As there is no distribution for tax purposes, if the company is a close company HMRC would treat the company as having made a loan to a participator, and a tax charge may arise (under CTA 2010, s 455). Furthermore, if the recipient is a director or employee of the company, there may also be a benefit-in-kind as a beneficial loan.
Conversely, there is no liability to repay the company if the shareholder is an innocent recipient of the funds. HMRC would therefore treat the individual as having received a distribution for tax purposes.
Practical tip
The company law requirements on a share buyback can be difficult. Professional advice is strongly recommended.
