A share buyback is when a company buys back its own shares, reducing the total number available. This can boost share value, change the company’s financial structure, and offer an alternative to dividends. In this guide, we’ll walk you through how buybacks work, their tax impact, and the pros and cons.
What is a share buy back?
A share buyback is when a company buys back its own shares from shareholders, reducing the total number of shares in circulation. Fewer shares mean each remaining share represents a bigger slice of the company, which can increase share value. Companies do this for different reasons, from rewarding shareholders to reshaping their business strategy.
Why do companies buy back shares?
Companies buy back shares for a few smart reasons:
Giving value to shareholders – Instead of paying dividends, a buyback lets shareholders sell their shares for an instant return.
Boosting earnings per share (EPS) – With fewer shares in circulation, profits are spread across a smaller pool, making the company’s financials look stronger.
Snapping up undervalued stock – If a company believes its shares are trading too low, buying them back can be a way to invest in itself.
Reshaping finances – A buyback can help balance debt and equity, giving the company more control over its financial strategy.
What are the risks?
Poor use of funds – Instead of reinvesting in growth, companies might spend money on buybacks without a clear long-term strategy.
Debt concerns – If a company borrows money to buy back shares, it can put pressure on its finances.
Bad timing – If shares are repurchased at a high price, the financial benefit may be lost.
Short-term gains, long-term losses – Buybacks can boost earnings per share (EPS) in the short term, but they don’t always lead to sustainable growth.
How can a private limited company buy back its own shares?
A private limited company can repurchase its own shares in three main ways, depending on where the funding comes from. Each method has specific legal requirements under Part 18 of the Companies Act 2006.
1. Using distributable reserves
Most companies fund share buybacks using distributable reserves (profits available for distribution) or by issuing new shares specifically to fund the buyback. This method follows the rules set out in Sections 690–708 of the Companies Act 2006.
2. Using company capital
If a company doesn’t have enough distributable reserves, it may be able to fund a share buyback using capital. This approach has stricter legal requirements and follows Sections 709–723 of the Companies Act 2006.
3. Using a small amount of capital (‘De Minimis’ rule)
Companies can also buy back shares using a limited amount of capital without following the stricter capital reduction rules. This applies when the buyback amount is within a small (‘de minimis’) threshold, set out in Section 692(1ZA).
💡 Why it matters: The method chosen affects the legal process, approval requirements, and tax implications of the buyback. If you’re unsure which approach is best for your company, getting expert advice can help ensure compliance and tax efficiency.
How a share buy back works
A share buyback isn’t a simple transaction - there are a few legal steps companies need to follow. Here’s a quick rundown of how it works:
1. Board approval
The process starts with a decision by the company’s board of directors. They must decide whether a buyback is in the best interest of the company and its shareholders. The board will outline:
The number of shares to buy
The greatest price per share the company is willing to pay
The reasons for the buyback
The board of directors makes this decision formally in written statements. This process is known as board resolutions.
2. Shareholder approval
A company must get shareholder approval before going ahead with a share buyback. You need approval through an ordinary resolution (more than 50% of shareholder votes) or a special resolution (over 75% of shareholder votes) The approval depends on the type of company structure and the buyback method. The Companies Act 2006 provides detailed rules on when and how you need shareholder consent.
3. Funding the buyback
A company must have profits (known as distributable reserves) or use specific types of capital (such as share premiums) to fund the buyback. If you plan to use debt, you must consider the impact on its financial stability.
4. Choosing the method of buyback
There are several ways a company can put in place a buyback. A solicitor for buying a business will be able to advise you on the best method for you:
Market purchase: Shares are bought back from the open market, often over a set period.
Tender offer: The company makes a public offer to shareholders to buy several shares at a set price. This tends to be higher than the market value.
Private agreement: Buy backs can be arranged privately with a shareholder. This will depend on certain rules and approval by shareholders.
5. Executing the buyback
Once the legal and financial preparations are complete, the company begins purchasing shares. This must be on the agreed terms. Documents can be drawn up such as a share purchase agreement for larger transactions or private agreements.
6. Cancelling or retaining the shares
In most cases, shares repurchased by the company are cancelled, reducing the total number of shares in circulation. Alternatively, the company may hold them as treasury shares, which can be resold or used later for employee share schemes.
7. Notifying Companies House
Companies in the UK must file appropriate documents with Companies House after completing a buy back. You need forms such as SH03 (Return of purchase of own shares) and SH06 (Notice of cancellation).
8. Compliance with regulatory guidelines
Companies must comply with additional regulations if they are publicly listed. These include disclosure obligations, restrictions on the timing of buybacks, and compliance with the UK’s Market Abuse Regulation (MAR) to prevent insider trading.
How is a share buyback taxed?
When a company buys back shares from a shareholder, the money received is usually taxed as dividend income. However, in some cases, it may be possible to have it taxed under Capital Gains tax rules, which could result in a lower tax bill.
When can a share buyback be raxed as Capital Gains?
HMRC will only treat a share buyback as a capital gain instead of a dividend if certain conditions are met:
You’ve owned the shares for at least five years before selling them back to the company.
Your stake in the company significantly reduces - for example, if you owned 30% of the company before the buyback and only 5% afterward.
There’s a valid business reason for the buyback, such as company restructuring or succession planning (not just a way to reduce tax).
It’s not part of a tax avoidance scheme - the transaction must have a genuine commercial purpose.
If you haven’t held the shares for five years, there may still be legal ways to structure the buyback to qualify for capital gains tax treatment.
Getting HMRC approval for Capital Gains tax treatment
If your buyback meets HMRC’s criteria, you can ask them to confirm that the payment will be taxed as capital gains rather than as income (dividends). This is called HMRC clearance and requires submitting detailed paperwork in the correct format.
FAQs
Is a share buyback a good thing?
A share buyback can be positive if it reflects a company’s financial position and prospects. However, if a company prioritises buy backs over investments, it may harm long-term growth.
What is a buyback of shares with an example?
If a company has 1 million shares outstanding, and its earnings are £1 million, this will result in earnings per share (EPS) of £1. If the company buys back 200,000 shares, reducing the total to 800,000 shares, the EPS increases to £1.25 - boosting the profitability.
Why would a company buy back its own shares?
Common reasons include returning excess cash to shareholders. This can boost the EPS, helping to maintain the percentage of existing shareholders and give confidence in the company’s future.
What is the five-year rule for share buy back?
HMRC request shareholders who sell shares back to the company to not resume a significant connection within five years. This could be as a director of the company. This rule helps determine whether the proceeds are taxed as capital gains or income.
Final thoughts
A share buyback can be a smart financial move for companies, offering benefits like increased share value and improved financial flexibility. However, it comes with risks, including potential debt burdens and regulatory considerations. Seeking expert advice from a corporate lawyer can help ensure a buyback aligns with your financial goals and complies with UK regulations.
References
Tax and Employee Share Schemes by Gov.UK
Market abuse regulation by the Financial Conduct Authority
Disclaimer: This article only provides general information and does not constitute professional advice. For any specific questions, consult a qualified accountant or business advisor. Bear in mind that tax rules can change and will differ based on your circumstances.
