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Share Buybacks

Oct 10, 2013

Share buybacks enable a company to purchase its own shares from one or more of its shareholders.

This can have several advantages including returning surplus money to shareholders, increasing liquidity and allowing for the removal of a dissident shareholder who wishes to sell but the other shareholders cannot afford to buy their shares.

Previously, shareholders had to approve every purchase by special resolution and the payment for the shares had to come out of distributable profits, the proceeds of a fresh issue of shares, or out of capital.  This was a time consuming and cumbersome process and the new statutory instrument, which came into force this in April this year, simplifies the previous regime. The changes could be of particular interest to companies who want to purchase an employee’s shares when they leave the company. However, question marks remain over how much of an impact they will have as some commentators have said the changes amount to little more than tinkering with the law.

The main change allows companies to buy back a small number of shares without having to calculate whether the purchase can be financed out of distributable profits. Although this exemption is limited, it should prove to be a useful mechanism for companies buying from so-called bad leavers. Related to this is the change which permits the purchase price to be paid in instalments rather than one lump sum where the buyback is for an employee share scheme. This marks a significant shift from the previous position. However, the provision is still not clear on how the company can finance the purchase after the event and further clarification is likely to be provided by the Department for Business, Innovation & Skills (BIS).

The need for a special resolution for every share buyback has also been moderated. Shareholders can now give standing authority for five years for a company to buy back shares within set parameters for the minimum and maximum amount payable for the shares. Furthermore, in the absence of a standing authority, purchases may now be approved by an ordinary rather than special resolution. Changes also allow private companies to hold purchased shares as treasury shares, an option previously only available to public companies. This means a company will be able to purchase its shares and then make the same shares available to other employees. Prior to the new regulations, the relevant shares had to be cancelled and could not be re-issued.

One area which has not been reformed is the tax treatment of buybacks. This is particularly relevant when shares are purchased by the company for more than their original subscription price, something which is common for good leavers.

The problem is that the amount paid for the shares less the subscription price for the shares paid when they were issued (not necessarily what the employee paid for them, eg if he bought them from an Employee Benefit Trust) will be treated as a distribution for tax purposes. The consequence of this is that the gain will be subject to income tax at the dividend rate (with no credit given for any income tax originally paid by the employee if they acquired the shares at a discount) unless a tax exemption can be relied upon. This flaw means that it is likely BIS will have to look at the tax aspect of buybacks in more detail to ensure they are more attractive to companies and shareholders alike.