Introduction

Most practitioners will deal with a company purchase of own shares from time to time. As a general rule, when a company buys back its own shares from a shareholder, any payment in excess of the capital originally subscribed for the shares constitutes a distribution, which generally falls to be treated as income (ICTA 1988, s 209(2)(b)). However, in the case of unquoted trading companies, if certain conditions are satisfied the transaction is automatically excepted from income distribution treatment (s 219), and the vendor is treated as receiving a capital distribution instead (unless the vendor is a share dealer, in which case the receipt will be treated as trading income). This treatment provides a potentially tax-efficient exit route, particularly if full business asset taper relief is available to the shareholder in respect of the shares

Company law requirements

However, it is important to remember that a purchase of own shares must comply with various company law requirements to be valid. HMRC can only consider a request for clearance (under ICTA 1988, s 225) on a purchase which appears to be a valid transaction (Tax Bulletin, Issue 21 (February 1996)). Companies Act 1985 specifies a procedure for share buy-backs. Companies Act 2006 was given Royal Assent on 8 November 2006, and is being introduced in stages by October 2008. Part 18 of that Act (‘Acquisition by limited company if its own shares’) is scheduled for introduction on 1 October 2008. Companies Act 2006 restates some provisions of its predecessor, and changes others. Some key company law considerations for an unquoted (or ‘off market’) purchase of own shares are briefly outlined below.

Power to purchase own shares

Companies Act 1985 gives a company the power to purchase its own shares, if authorised to do so by the Articles of Association (CA 1985, s 162(1)). By contrast, Companies Act 2006 does not include a requirement in the company’s Articles to purchase its own shares, although the members may restrict or prohibit a purchase of own shares through the company’s Articles, if they wish. This is helpful, as the Articles of some older companies do not contain the necessary authority. The share purchase must not leave the company with only redeemable and/or treasury shares (CA 1985, s 162(3); CA 2006, s 690).

Authority for purchase

Companies Act 1985 requires the share purchase contract to be agreed by the company’s members through a special resolution beforehand (CA 1985, s 164(5)). The contract (or a detailed memorandum of its terms) must be available for inspection for at least 15 days before the meeting, and also at the meeting. Companies Act 2006 also requires a contract for an ‘off-market’ company purchase of own shares to be approved in advance (CA 2006, s 693). However, that Act allows a company to enter into a contract to purchase its own shares, on condition that the shareholders approve the contract terms by a special resolution (CA 2006, s 694(2)). If the contract is not approved, the company may not purchase the relevant shares and the contract lapses. A copy of any written contract (or a memorandum of its terms) must be made available to the members. For resolutions at meetings, it must be available for inspection at the company’s registered office for at least 15 days prior to the meeting, and also at the meeting itself (CA 2006, s 696(2)).

Payment for the shares

The shares purchased must be fully-paid, and the company must pay for the shares on completion (CA 1985, s 159(3); CA 2006, s 691).

Distributable profits

A company must purchase its own shares out of distributable profits, or out of the proceeds of a fresh share issue to finance the purchase (CA 1985, s 162(2); CA 2006, s 692(2)). An amount equal to the par value of the shares bought back must be transferred to a capital redemption reserve account. However, a private company may purchase its own shares out of capital, if certain conditions are satisfied (CA 1985, ss 160(1), 171-177; CA 2006, ss 692(1), 709-723).

Cancellation of shares

Following the company share repurchase, the relevant shares are treated as cancelled. The company’s share capital is reduced by the nominal value of the cancelled shares (CA 1985, s 160(4); CA 2006, s 706).

Return to Companies House

The company can enter into the contract when the resolution is passed. A return must be made to the Registrar of Companies within 28 days, stating the number of shares purchased, their nominal value and the date of purchase (CA 1985, s 169(1); CA 2006, s 707). Except in the case of treasury shares which are not cancelled, the company must also notify the Registrar of Companies of the cancellation of the shares within 28 days, together with a statement of the company’s share capital (CA 2006, s 708). Companies Act 1985 imposes this notification requirement only in relation to treasury shares which are cancelled (CA 1985, s 169(1A)).

Inspection of contract

Companies Act 1985 requires that the share purchase contract (or a memorandum of its terms) must be retained at the company’s registered office for at least ten years from completion of the contract (CA 1985, s 169(4)). Companies Act 2006 also stipulates a ten year retention period. However, it also provides that a copy of the contract (or any variation) may alternatively be kept for inspection at a specified place. The company must notify the registrar of the place where the contract is available for inspection. Contracts (or memorandums of terms) relating to private companies must be made available for inspection by any of its members (CA 2006, s 702).

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