Most payments a company makes to its shareholders, in respect of their shares, will be qualifying distributions and be subject to Income Tax.
However, if certain conditions are met, the payment can be treated as an exempt distribution. An exempt distribution is a payment that is treated as consideration for the disposal of shares and is subject to CGT.
When a company makes a purchase of its own shares, any excess paid over the amount of capital originally subscribed for the shares is usually treated as a distribution (a dividend). However, there are special provisions that enable an unquoted trading company or an unquoted holding company of a trading group to undertake a purchase of its own shares without making a distribution.
To check out the tax implications of an intended buy back, a clearance application may be made to HMRC. Under this procedure a company wishing to make a purchase of its own shares can obtain advance confirmation from HMRC that the distribution arising will be an exempt distribution.
Broadly there are two situations where a payment on the purchase by a company of its own shares is not treated as a distribution:
- the company must be an unquoted trading company; and
- either Condition A: purchase benefiting a company’s trade or Condition B: purchase in connection with Inheritance Tax liability must be met.
Guidance
Clearance applications and exempt distribution when a company purchases its own shares
Find out about clearance applications and how to apply to HMRC for advance confirmation of an exempt distribution when a company purchases its own shares.
From: HM Revenue & Customs
Published 3 December 2021
Contents
Who can make a clearance application
Condition A: purchase benefiting a company’s trade
Condition B: purchase in connection with Inheritance Tax liability
Check if you can make a clearance application
Substantial reduction calculation
How to make a clearance application
Clearance application checklists
Condition A checklist: purchase benefiting a company’s trade
Condition B checklist: purchase in connection with Inheritance Tax liability
Introduction
Most payments made by a company to its shareholders, in respect of their shares, will be qualifying distributions and may be subject to Income Tax.
This guidance explains:
- the conditions that must be met before the payment can be treated as an exempt distribution
- how a company can make a clearance application in connection with the purchase of own shares legislation
For the purposes of this guidance, an exempt distribution is a payment that is not treated as a distribution. It is treated as consideration for the disposal of shares and is subject to Capital Gains Tax.
Any reference to purchase of own shares includes cases where a payment is made by a company on the redemption or repayment of its own shares.
This guidance covers straightforward situations when a company purchases its own shares. More detailed guidance can be found in the:
- Company Taxation Manual (CTM17500 onwards)
- HMRC’s Statement of Practice SP2/82
- Corporation Tax Act 2010, ‘Purchase of own shares’
- Tax Bulletin 80, this explains the effect of the Tax and Civil Partnership Regulations 2005
About clearance applications
As a general principle, where a company makes a purchase of its own shares, any excess paid over the amount of capital originally subscribed for the shares is a distribution.
However special provisions in section 1033 of the Corporation Tax Act 2010 enables an unquoted trading company or an unquoted holding company of a trading group to undertake a purchase of its own shares without making a distribution.
The legislation also provides a clearance procedure. This means a company wishing to make a purchase of its own shares can get advance confirmation from HMRC that the resulting distribution will be an exempt distribution.
The payment is treated as consideration for the disposal of the shares in the hands of the seller and is subject to Capital Gains Tax.
Who can make a clearance application
A company may make an application before making a payment on the purchase of its own shares. Broadly there are two situations where a payment on the purchase by a company of its own shares is not treated as a distribution:
- the company must be an unquoted trading company
- either condition A or condition B must be met
Condition A: purchase benefiting a company’s trade
To be eligible to make a clearance application, the following must be satisfied:
- the company must be an unquoted trading company
- the purchase must be made wholly or mainly for the purpose of benefiting the trade carried on by the company or any of its 75% subsidiaries
- the seller must be a UK resident at the time in which the purchase is made
- the seller must have owned the shares for five years or more ending with the date of the purchase; this may be reduced to 3 years if the seller acquired the shares under the will or intestacy of a former shareholder
- the shareholding interests of the seller and their associates in the company (and group, if appropriate) must be substantially reduced
- the seller and their associates must not be connected to the company after the purchase takes place
- the purchase does not form part of a scheme or arrangement where one of the main purposes is to enable the seller to participate in the profits of the company without receiving a dividend and/or avoiding tax
Condition B: purchase in connection with Inheritance Tax liability
If the payment made by an unquoted trading company for the redemption, repayment or purchase of its own shares is used by the seller to pay Inheritance Tax charged on a death, the payment may not be treated as a distribution if the following conditions are satisfied:
- substantially the whole (meaning nearly all) of the purchase money is applied by the seller in paying the tax liability
- the tax was charged on a death
- the payment received from the company is applied in the discharge of the tax liability within two years of the death
- the tax paid could not have been paid without undue hardship
The payment by the company must be received by the person who is liable for the Inheritance Tax. Any Capital Gains Tax which is chargeable in respect of the disposal of the shares to the company may also be discharged out of the payment received from the company for the shares.
The Corporation Tax Act 2010, ‘Purchase of own shares’ (sections 1034 to 1043) covers these conditions A and B.
Check if you can make a clearance application
The following guidance and examples will help you decide whether you meet the conditions to make a clearance application. The process has been divided into three qualifying stages:
Basics
Step 1: check if the company is quoted
A quoted company means a company whose shares (or any class of whose shares) are listed in the official list of a stock exchange. Shares include stock. An unquoted company means a company which is not a quoted company or a 51% subsidiary of a quoted company.
Summary
If the company is quoted payment will not qualify as an exempt distribution. If the company is not quoted, move on to step 2.
Step 2: check the company is a trading company or a holding company of a trading group
A trading company means a company whose business consists wholly or mainly of carrying on a trade. A trade does not include dealing in shares, securities, land or futures.
A trading group means a group, the business of whose members (taken together) consist wholly or mainly of carrying on a trade. Again a trade does not include dealing in shares, securities, land or futures.
Summary
If the company is not a trading company or a holding company of a trading group, payment will not qualify as an exempt distribution.
If the company is a trading company or a holding company of a trading group, move on to step 3.
Step 3: check the seller is resident in the UK in the tax year in which the purchase is made
The seller (and the seller’s nominee, if any) must be resident in the UK in the tax year in which the purchase is made. Personal representatives are treated as resident in the UK only if the deceased was resident in the UK immediately prior to death.
For the majority of people the question of residence for tax purposes is quite straightforward. HMRC’s Residence, Domicile and Remittance Basis Manual explains the rules in detail.
Summary
If the seller is not resident in the UK in the tax year in which the purchase is made, payment will not qualify as an exempt distribution.
If the seller is resident in the UK in the tax year in which the purchase is made, move on to step 4.
Step 4: check the shares meet conditions for minimum period of ownership
The shares which are purchased by the company must have been owned by the seller for a period of:
- 5 years ending with the date of the purchase
- 3 years if the seller acquired the shares under the will or intestacy of a former shareholder, the seller’s or personal representative’s holding period is aggregated with that of the previous owner
If the shares have not been owned for the relevant minimum period, payment will not qualify as an exempt distribution.
Acquisitions and disposals
Where the seller has made more than one acquisition of shares of the same class that are being redeemed, repaid or sold to the company, earlier acquisitions of shares are taken into account before later acquisitions.
However earlier disposals are treated as being made on a last in, first out basis. This gives the seller the longest possible period of ownership for this purpose.
Example
You are selling 800 shares in 2014. You acquired the same class of shares in the following years:
- 2007 — 500 shares
- 2008 — 500 shares
- 2010 — 500 shares
In 2011 you sold 600 to an unconnected third party. This earlier disposal is identified with the 500 shares acquired in 2010, and the balance of 100 with the 2008 acquisition. You will be left with the following shares:
- 2007 — 500 shares
- 2008 — 400 shares
- 2010 — 0 shares
The 800 shares sold in 2014 are identified with the 500 shares purchased in 2007, and the balance of 300 shares purchased in 2008.
Spouses and civil partners
If at any time during the 5-year period, the shares were transferred between spouses or civil partners living together at the date of transfer, then the periods of ownership of both spouses or civil partners are aggregated.
Example
Mr and Mrs S have been married and living together continuously since 2000. Mrs S acquired the shares in R Ltd on 1 January 2008. On 1 January 2012, after holding the shares for four years, she transferred the shares to her husband. Mr S sells all of his shares to R Ltd on 1 January 2015.
Without this provision Mr S alone would not satisfy the period of ownership condition as he has personally held the shares for less than 5 years.
However because Mr and Mrs S were married and living together at both the time of the transfer of the shares (1 January 2010) and the time of the purchase of the shares by R Ltd (1 January 2013), Mr S can treat the period when the shares were owned by Mrs S as part of his period of ownership.
Mr S is treated as having owned the shares for more than 5 years so the period of ownership condition is satisfied.
Summary
Move to the next stage, Substantial reduction calculation if the shares meet conditions for the minimum period of ownership explained in this section.
Substantial reduction calculation
Step 1: check if the purchasing company is a member of a group
For this purpose a group is a company and its 51% subsidiaries.
Summary
If the purchasing company is not a member of a group, move on to step 2.
Step 2: check if the seller’s interest as shareholder immediately after purchase is not more than 75% of the seller’s interest immediately before
If the seller retains shares in the company after the purchase, their interest as a shareholder in the company must be substantially reduced after the purchase.
The substantial reduction in the seller’s interest as a shareholder in the company is considered in two ways, by reference to:
- the issued share capital
- entitlement to profits
Reduction in seller’s shareholding
To test whether there’s been a reduction in the seller’s shareholding, the relevant proportion immediately after the sale is compared with that immediately before the purchase.
The relevant proportion is the nominal value of the shares owned by the seller divided by the issued share capital of the company. If the seller’s interest immediately after the purchase is not more than 75% of their interest immediately before the purchase, it has been substantially reduced.
The calculation must take into account the fact that the number of shares in issue will have decreased after the purchase as these shares are normally cancelled by the company.
Example
A Ltd has an issued share capital of £1,000 comprising of 1,000 £1 shares. You hold 400 of those shares and sell 250 shares to the company.
This means that immediately before the sale you hold 40% of the issued share capital:
- the nominal value of your shares is 400
- the total issued share capital is 1,000
After the sale you hold 20% of the issued share capital:
- the nominal value of your shares is 150 (400 – 250)
- the total issued share capital is 750 (1000 – 250)
A 75% reduction in your shareholding would leave you with 30% of the issued share capital (75% of 40% is 30%).
After the sale you hold 20% of the issued share capital so your shareholding interest has reduced to not more than 75% of the original holding and the substantial reduction test has been met.
Reduction in seller’s entitlement to share in the profits
Broadly the seller’s interest as a shareholder is taken to be substantially reduced if the company were to distribute all its profits available for distribution and the seller’s entitlement to a share of those profits (expressed as a fraction of the total of those profits) immediately after the purchase would be not more than 75% of the corresponding fraction immediately before the purchase.
Summary
If the seller’s interest immediately after the purchase is more than 75% of their interest immediately before the purchase, then it has not been substantially reduced. Payment will not qualify as an exempt distribution.
Move on to step 3 if their interest immediately after the purchase is not more than 75% of their interest immediately before the purchase.
Step 3: check if any associates of the seller own shares in the company
When applying the calculation, the interests of any persons associated with the seller are also relevant. For this purpose, associates are:
- spouses or civil partners who live together
- children aged under 18 and their parents
- a person connected with a company is an associate of that company and any company it controls (example 1)
- a person accustomed to acting on the directions of another person in relation to the affairs of a company (both are associates of each other in relation to that company)
- companies are associated with one another if they are under the control of the same person (example 2)
Example 1
You are the sole shareholder of X Ltd. X Ltd has a 100% subsidiary, Y Ltd. You are an associate of both X Ltd and Y Ltd.
Example 2
You are the sole shareholder of C Ltd and D Ltd. This means C Ltd is an associate of D Ltd and vice versa.
When an associate of the seller owns shares
If, immediately after the purchase, an associate of the seller owns shares in the company their interests must be aggregated with the seller’s.
This combined interest must not be more than 75% of their combined interest immediately before purchase. Otherwise, payment will not qualify as an exempt distribution.
Example
- E Ltd has an issued share capital of £1,000 comprising of 1,000 £1 shares
- Mr and Mrs F are married and living together
- each owns 500 shares in the company
Because they are spouses, Mr F is associated with Mrs F and vice versa.
Mr F sells all 500 shares to E Ltd. Immediately before the sale, Mr F and his associate (Mrs F) hold 100% of the issued share capital:
- Mr F’s shareholding = 500 share (50%)
- Mrs F (his associate’s) shareholding = 500 shares (50%)
Because their interests are combined, Mr F’s notional shareholding is 1,000 shares (100% of the issued shared capital).
After the sale, the total issued share capital will be 500 shares and these will be held solely by Mrs F:
- Mr F’s shareholding = 0 shares (0%)
- Mrs F’s shareholding = 500 shares (100%)
Because their interests are combined, Mr F’s notional shareholding is 500 shares (100% of the issued shared capital). This means there’s no substantial reduction in his shareholding and payment would not qualify as an exempt distribution.
Summary
Payment will not qualify as an exempt distribution unless the:
- seller’s associates do not own shares in the company
- seller’s associates do own shares but their combined interest in the company immediately after purchase is not more than 75% of the combined interest immediately before purchase
If you meet either of these criteria, move on to step 4.
Step 4: check if the seller is connected with the purchasing company immediately after the purchase
The seller must not be connected with the company, or any company in the same group, following the purchase of shares. A person will be treated as connected with the company if they:
- possess, or are entitled to acquire, more than 30% of the issued ordinary share capital, loan capital or voting power
- are entitled to receive more than 30% of the assets on a winding up of the company
In applying the connection test, the interests of the seller’s associates are aggregated with the seller’s.
If the loan capital of the company was acquired in the ordinary course of a business carried on by the shareholder which includes the lending of money and the shareholder takes no part in the management or conduct of the company, his interest in the loan capital is disregarded in applying the 30% test.
Example
G Ltd has an issued share capital of £1,000 comprising of 1,000 £1 shares. You hold 500 of those shares and sell 250 shares to the company.
Immediately before the sale you hold 50% of the issued share capital:
- nominal value of your shares = 500
- total issued share capital = 1,000
After the sale you hold 33.3% of the issued share capital:
- nominal value of your shares = 250
- total issued share capital = 750
Your shareholding interest is not more than 75% of that held previously. However, because you still own more than 30% of the remaining issued share capital, the purchase does not pass the connection test.
Summary
Payment will not qualify as an exempt distribution unless the seller is not connected with the purchasing company immediately after the purchase.
If you meet this criteria, move to the next stage, Purpose.
Purpose
Step 1: check if the purchase is being made wholly, or mainly, for the purpose of benefiting a trade carried on by the company or any of its 75% subsidiaries
The company’s sole or main purpose in making the payment must be to benefit a trade carried on by it, or by its 75% subsidiary.
The condition is not satisfied if the:
- transaction is designed to serve the personal or wider commercial interests of the seller (although usually the seller will benefit from it)
- intended benefit for the company is to some non-trading activity which it also carries on
The purchase will usually be regarded as benefiting the company’s trade if:
- shareholders disagree over the management of the company and that disagreement has (or is expected to have) an adverse effect on the company’s trade, this is providing the effect of the transaction will remove the dissenting shareholders entirely
- the purpose is to make sure that an unwilling shareholder, wishing to end their association with the company, does not sell their shares to someone unacceptable to the other shareholders
Examples of unwilling shareholders are:
- an outside shareholder who has provided equity finance (whether or not with the expectation of redemption or sale to the company) and who now wishes to withdraw that finance
- a controlling shareholder who is retiring as a director and wishes to make way for new management
- personal representatives of a deceased shareholder, where they wish to realise the value of the shares
- a legatee of a deceased shareholder, where he does not wish to hold shares in the company
It’s unlikely the transaction could benefit the company’s trade if the company:
- is not buying all the shares owned by the seller
- is buying all the shares but the seller retains some other connection with the company such as a directorship
This means the trade benefit test will probably not be satisfied.
However there are exceptions. For example, when a company does not have the resources to buy out its retiring controlling shareholder completely and it purchases as many shares as possible with the intention of buying the remainder in the future.
In these circumstances, it may be possible to show that the main purpose is to benefit the company’s trade.
HMRC does not object if a retiring director of a company retains a small shareholding for sentimental reasons. This should not exceed 5% of the issued share capital.
Summary
Move on to step 2 if the company’s sole or main purpose in making the payment is to benefit a trade carried on by it, or by its 75% subsidiary.
Step 2: check if the purchase is part of a scheme or arrangement enabling the owner of shares to participate in profits without receiving a dividend, or where tax avoidance is the main (or one of the main) purposes
Payment will not qualify as an exempt distribution if there is any such arrangement.
Summary
You can make a clearance application if the purchase does not form part of a scheme or arrangement:
- that enables the seller to participate in the profits of the company without receiving a dividend
- where the avoidance of tax is the main, or one of, the main purposes
How to make a clearance application
A company wishing to make a purchase of its own shares can get advance confirmation from HMRC that the distribution arising will be an exempt distribution. Clearance applications are the responsibility of the Clearance and Counteraction Team.
Email applications
The team can process your application more efficiently if you send your application by email to reconstructions@hmrc.gov.uk.
Do not include:
- attachments larger than 3MB
- self-extracting zip files (our software will block them)
HMRC cannot guarantee the security of emails received or sent and anything you send is at your own risk. This means it’s important to assess the risks of using email to send or receive information.
If you’d like HMRC to respond by email, please let us know and confirm that you understand and accept the risks involved. If you are an agent responding on behalf of a client, please confirm that they understand and accept the risks involved.
Postal applications
HMRC accepts no responsibility for applications lost in transit prior to receipt. You should use a secure delivery method such as Royal Mail (or similar) recorded delivery. Send your application to:
BAI Clearance
HMRC
BX9 1JLClearance application checklists
The following checklists for condition A and B identify the information HMRC needs to reach a decision. Please provide the information in the order given below and specify whether you are applying using condition A or condition B. This will help us process your application as quickly as possible.
Condition A checklist: purchase benefiting a company’s trade
Information about the company
- the company name
- the trade of the company
- the company’s unique tax reference
- confirmation the company is unquoted
- confirmation the company is a trading company or the holding company of a trading group
- the names of the group companies together with their unique tax references (if the company is a member of a group)
Information about the payment
- details of the shares to be purchased
- the name of the present owner
- the purchase price and the number of shares to be bought
- details of any other transactions taking place between the company and the seller at or about the same time
- confirmation that the company is acting in accordance with Part 18 of the Companies Act 2006
- details of how the payment will be made (for example, cash, cheque, bank transfer) and whether in full or in instalments
Information about the shareholders
- a list of the current shareholders in the purchasing company, showing each person’s current holdings including amount, class and dividend rights, where appropriate include details for each company in the group
- details of any relationships between the shareholders
- where the shareholder is the son or daughter of another shareholder, confirmation that he or she is over 18 or details of their age
- if the shareholder is a trust, provide details of the names of the trustees, the settlors, and the beneficiaries of the trust
Information about the purpose
- a statement of the reasons for the purchase, including the trading (and any other) benefits expected to accrue from it, whether or not to the purchasing company
- confirmation that the purchase does not form part of a scheme or arrangement where the main purpose (or one of the main purposes) is to enable the owner of the shares to participate in the profits of the company without receiving a dividend, or for the avoidance of tax
- confirmation that the seller will receive no other payment from the company, or details of any such payment to be made
- particulars of any prior transactions or arrangements to be carried out in preparation for the purchase
Information about the seller
- the present residence status of the seller and any intended change
- the unique tax reference or National Insurance number of the seller, or if not known, their private address
- the period of beneficial ownership by the seller of the shares to be purchased and any other relevant holdings
- confirmation that the combined interests of the seller and any associates in the company will be substantially reduced, or if the company is a member of a group, confirmation that the combined interests of the seller and any associates in the group will be substantially reduced
- confirmation that the seller (after including any interests held by his associates) will not, immediately after the purchase, be connected with the company making the purchase or with any company which is a member of the same group as that company
Accounts and other financial information
The application should be accompanied by:
- copies of the latest available financial statements for the purchasing company
- if appropriate, copies of the latest financial statements for the group and for any group companies
- a note of any material relevant changes since the balance sheet date or confirmation that there are no changes
- details of any loan or current account which the seller maintains with the company or with any group company
Condition B checklist: purchase in connection with Inheritance Tax liability
Information about the company
- the name of the company making the purchase
- the trade of the company
- the company’s unique tax reference
- confirmation that the company is unquoted
- confirmation that the company is a trading company or the holding company of a trading group
Information about the payment
- details of the shares to be purchased, the name of the present owner, the purchase price and the number of shares to be bought
- details of any other transactions between the company and the seller at or about the same time
- confirmation that the company is acting in accordance with Part 18 of the Companies Act 2006
- details of how the payment will be made (for example, cash, cheque, bank transfer) and whether in full or in instalments
Information about the Inheritance Tax
- the name and date of death of the deceased
- the Inheritance Tax reference number of the deceased
- the amount of the outstanding tax and whether or not the liability has been agreed
- the extent to which the purchase price is to be applied in satisfaction of the tax liability
- a full explanation of the circumstances in which there would be ‘undue hardship’ if the tax liability were to be discharged otherwise than through the purchase of own shares from this or another such company
- the unique tax reference or National Insurance number of the person to whom undue hardship would be caused, or if not known, the address of that person
Accounts and other financial information
The application should be accompanied by:
- copies of the latest available financial statements for the purchasing company
- if appropriate, copies of the latest financial statements for the group and for any group companies
- a note of any material relevant changes since the balance sheet date or confirmation that there are no changes
- full details of all assets and liabilities held within the estate of the deceased at the date of death
