Selling shares back to the issuing company

Shareholders’ agreement

It’s quite common for the shareholders of owner-managed companies to agree that should one of them die their shares are transferred to those remaining. Any company shareholders that haven't already should consider making one. It prevents control of the company slipping away to persons not involved in the operation of the business. Naturally, the terms of such an agreement usually require the remaining shareholders to pay the going rate for the shares.

If one or more of the surviving shareholders can’t afford the shares and allows the others to buy them, it would shift control of the company and entitlement to dividends and put the non-buyers at a disadvantage. The shareholders can make a resolution that the company buy the shares instead of the other shareholders. That would mean control and entitlement to dividends each shareholder had prior to the shareholder’s death would be maintained. However, there’s a potential catch.

Capital gains tax v income tax

If the shareholders buy the shares from the deceased’s estate or beneficiaries there will only be capital gains tax (CGT) to pay if the amount they receive exceeds the probate value. Usually, in these situations the date of sale will be shortly after the deceased died and therefore the value of the shares won’t have changed much, if at all, since probate. The likelihood is that there will be no tax for the estate or beneficiaries to pay.

If the company buys the shares instead of the other shareholders and the amount paid is more than the deceased paid for them, the difference is liable to income tax and not CGT.

Example. In 1990 Jim set up Acom Ltd with three others. They each acquired 25 ordinary shares in Acom at a cost of £1 per share. Jim died in November 2021 when the shares were worth £7,500. If Acom bought Jim’s shares for that price, a total of £187,500, his beneficiaries will have to pay income tax on £187,475 (£187,500 - £25) instead of a zero CGT bill had the other shareholders bought them.

Purchase of own shares

There is a way for the company to prevent any part of the payment to the deceased’s estate or beneficiaries from being liable to income tax. The company can apply to HMRC for clearance for the purchase payment to be treated as capital and so subject to the CGT rules. That would put the estate/beneficiaries in the same position as if the shareholders had bought the shares, i.e. they would have little or no tax to pay.

Strict conditions must be met before HMRC agrees that a company’s purchase of its own shares qualifies for CGT treatment and they might not be met in the circumstances in our example. There’s a little known alternative set of less strict conditions for CGT clearance. They apply where the money from the shares is needed by the deceased’s estate to pay inheritance tax. These are more likely to be met in the circumstance given in our example.