Purchase of own shares in a private limited company

This helpsheet has been issued by ICAEW’s Technical Advisory Service to help ICAEW members understand key legal and accounting aspects of the purchase of own shares in a private limited company.

Members may also wish to refer to the following related helpsheet and guidance:

• Private company reduction of share capital
• TECH 02/17 BL Guidance on realised and distributable profits under the Companies Act 2006

This helpsheet covers ‘off market’ purchases under the share buy-back regime contained in Part 18 of the Companies Act 2006.

A private limited company may repurchase its own shares out of capital, distributable reserves, or the proceeds of a fresh issue of shares made for the purpose of financing the repurchase. Additionally, in 2015 the government amended the law around share buy-backs to permit private companies to make so-called ‘de minimis’ repurchases out of capital without having to identify available distributable reserves.

In summary a private company can buy back shares:

1. out of capital in accordance with Part 18 Chapter 5, Companies Act 2006; or
2. out of distributable profits (or the proceeds of a fresh issue of shares made for the purpose of financing the purchase) in accordance with Part 18 Chapter 4, Companies Act 2006; or
3. under section 692(1ZA), Part 18 Chapter 4, Companies Act 2006, out of capital, otherwise than in accordance with Chapter 5, up to an aggregate purchase price in a financial year of the lower of:
   (i) £15,000; or
   (ii) the nominal value of 5% of its fully paid share capital as at the beginning of the financial year.

Companies may purchase their own shares out of capital but this is a complex process requiring a special resolution, a directors’ declaration of solvency supported by an auditor’s report to be available for inspection and a public notice of the proposed payment (Companies Act 2006 sections 709-723).

Due to this complexity and the availability of other, simpler routes (such as performing a capital reduction – see our separate helpsheet Private company reduction of share capital), this procedure is not used frequently and is therefore not covered in detail in this helpsheet.

Where this route is being considered, companies would usually require legal advice with regard to the proposed transaction.

This is the most common route for repurchasing shares,but does require a company to have sufficient distributable reserves in order to make the purchase (unless it is funded from the proceeds of a fresh share issue). Members should refer to TECH 02/17 BL Guidance on realised and distributable profits under the Companies Act 2006 for further guidance on distributable profits.

Procedure

The basic procedure is set out in Chapter 4 of the Companies Act 2006 and is summarised as follows:

• The company’s articles must not prohibit the purchase.
• The purchase cannot be paid for over a period of time or by instalments (section 691(2)), except for the purposes of or pursuant to an employee share scheme (section 691(3) – see Share repurchase for the purpose of employee share schemes).
• The terms of the share purchase contract must be authorised by ordinary resolution before the contract is entered into (section 694). Members holding shares to be purchased are not eligible to vote.
• Either the contract or the memorandum setting out its terms must be available for 15 days prior to the ordinary resolution being passed at a meeting, or in the case of a written resolution the contract or memorandum must be sent out to every eligible member at or before the time the proposed resolution is sent to him.
• Where a company has more than one class of shares, class consent may be required from shareholders that have priority rights before the shares can be purchased.
• The shares must be fully paid.
• The shares must be cancelled immediately on acquisition unless holding the shares as treasury shares.
• Within 28 days of the shares being delivered to the company a return must be delivered to the Registrar of Companies (section 707) and, before it is filed, Form SH03 must be sent to HMRC for stamping (HMRC has published a helpsheet on Company purchase of own shares).
• The contract must be kept for ten years.
• If the correct procedure is not followed then the purchase is void and an offence is committed by the company and every officer in default. An officer in default is liable to a prison term of up to two years or an unlimited fine (section 658).

Accounting

The double entry for the purchase of shares out of distributable reserves with a cancellation of the shares is as follows:

Dr Distributable reserves (e.g. P&L Reserve) - with the amount paid
Cr Cash – with the amount paid

Dr Share capital – with the nominal value of the shares purchased
Cr Capital redemption reserve – with the nominal value of shares purchased

The double entry for the purchase of shares out of distributable reserves with shares held in treasury is as follows:

Dr Equity (Retained Earnings or Treasury shares) – with the amount paid
Cr Cash – with the amount paid

Note, the amount paid reduces the profits available for distribution, so it may be simplest to put the debit entry to retained earnings. However, if treasury shares are shown as a separate line item within equity, directors will need to include them as a deduction to retained earnings when considering the amount available to pay dividends.

This ‘de minimis’ option was introduced in 2015 to enable companies to make small share repurchases without the need to identify distributable reserves.

Procedure

The same basic procedure above applies for share repurchases made under the ‘de minimis’ rules but there are three key differences to note:

• The company’s articles must explicitly authorise the purchase.
• Under this method shares may only be bought back in any given financial year up to the lower of:
  (i) a maximum purchase price of £15,000; or
  (ii) the nominal value of 5% of the company’s fully paid share capital as at the beginning of the financial year.
• Shares purchased under section 692(1ZA) may not be held as treasury shares, i.e. they must be cancelled once repurchased.

Accounting

Where the purchase price is less than the nominal value (e.g. nominal value £100, purchase price £70), then the difference goes to a capital redemption reserve:

Dr Share capital 100
Cr Cash 70
Cr Capital redemption reserve 30

Where the purchase price is greater than the nominal value (e.g. nominal value £100, purchase price £120), then the difference, less any proceeds of a fresh issue, is charged to the capital redemption reserve, share premium, share capital or revaluation reserve:

Dr Share capital 100
Cr Cash 120
Dr Capital redemption reserve/share premium/share capital/revaluation reserve 20

Where the shares being repurchased were held as equity, the expenses of the repurchase should be charged directly to equity. These costs are a realised loss so reduce distributable reserves.

By contrast, if the shares being repurchased were held as a liability, the transactions costs would be shown in the profit or loss because these are costs associated with the settlement of a liability.

A private company may also reduce its share capital under the Companies Act 2006 by a special resolution supported by a solvency statement (sections 641-644). The helpsheet Private company reduction of share capital discusses this approach. Any company may also reduce its share capital by a special resolution confirmed by the court (sections 645-651).

Where a buyback is for the purpose of an employees’ share scheme, there are several minor differences under the Companies Act 2006 from the process discussed above, as follows:

• The purchase needs to be authorised under s693A which requires a general or limited authority to be granted in advance of the purchase;
• The shares are permitted to be paid for after purchase or in instalments (section 691(3)); and
• Where the purchase is made out of capital there is a simplified process set out in sections 720A-720B which requires a special resolution supported by a solvency statement.

ICAEW members, affiliates, ICAEW students and staff in eligible firms with member firm access can discuss their specific situation with the Technical Advisory Service on +44 (0)1908 248 250 or via webchat.