How to Structure a Share Buyback to Minimise CGT for Remaining Directors

What Happens When a Director Wants Out

A director in your limited company wants to leave. They own 30% of the shares. You and the other director own 70% between you. You want to buy their shares back. The company will pay them cash, cancel their shares, and you two will own 100% between you.

That sounds straightforward. But the tax treatment depends entirely on how you structure the transaction. Get it wrong, and HMRC could treat the buyback as a dividend distribution to the remaining directors, hitting you with income tax at up to 39.35%. Get it right, and the departing director pays Capital Gains Tax at 14% or 24%, and you pay nothing.

This is a share buyback CGT directors planning point that comes up regularly when we advise growing businesses in Manchester, Birmingham and Bristol. The remaining directors often assume the tax falls only on the seller. That is not always true.

How a Share Buyback Works Legally

A company buys its own shares from a shareholder under sections 690 to 708 of the Companies Act 2006. The company pays the shareholder. The shares are cancelled. The remaining shareholders' percentage ownership increases automatically.

The company must have distributable profits (retained earnings) to fund the buyback, unless it uses a permissible capital payment. Most buybacks use distributable profits. The company must also pass an ordinary resolution and file a return at Companies House within 28 days.

There is no stamp duty on a share buyback because the shares are cancelled, not transferred. That is one advantage over a private sale between shareholders.

Why the Remaining Directors Can Get Taxed

Here is the trap. HMRC can treat a share buyback as a distribution (a dividend) to the remaining shareholders if the main purpose is to benefit them rather than the company. The logic is that the company has spent cash to increase the remaining shareholders' percentage stake. That looks like a return of value to them.

If HMRC reclassifies the buyback as a distribution, the remaining directors are treated as receiving a dividend equal to their proportionate share of the buyback cost. That dividend is taxed at dividend rates: 8.75% basic, 33.75% higher, 39.35% additional. No personal allowance on dividends above the £500 allowance.

Take a concrete example. A company with two directors, you and a departing director. You own 50% each. The company buys back the departing director's shares for £100,000. HMRC could argue that the buyback benefits you by giving you 100% ownership. They could treat £50,000 of the buyback as a dividend to you. At higher rate tax, that is £16,875 in extra tax you did not expect.

This is why share buyback CGT directors planning is not just about the seller's tax position. It is about protecting the buyers too.

When a Buyback Is Treated as Capital, Not Income

HMRC will treat the buyback as a capital transaction (taxed as CGT, not income) if certain conditions are met. These are set out in section 1033 of the Corporation Tax Act 2010 and HMRC's Statement of Practice SP2/82.

The key conditions are:

• The buyback is for the benefit of the company's trade. This means the company has a genuine commercial reason, not just a desire to rearrange ownership.
• The departing shareholder is unconnected with the remaining shareholders after the buyback. In practice, this means they sever all commercial ties. No consultancy agreement. No retained office. No ongoing director role.
• The departing shareholder must be a UK resident individual (or certain other qualifying persons).
• The buyback must not be part of a tax avoidance scheme.

If these conditions are met, the departing shareholder pays CGT on their gain. The remaining directors pay nothing. The company gets no tax relief for the buyback cost, but that is usually acceptable.

What Counts as a Benefit to the Company's Trade

This is the most important condition and the one HMRC scrutinises hardest. A genuine trade benefit might include:

• A director is retiring and the company needs to consolidate ownership to make strategic decisions faster.
• A director is leaving to compete and the company needs to remove them as a shareholder to protect trade secrets.
• A director is no longer contributing and the company needs to free up capital tied in their shares for reinvestment.
• A director has died and the company wants to buy back shares from their estate to avoid unwanted external ownership.

A buyback driven purely by the remaining directors' desire to increase their ownership percentage, without a genuine trade reason, is more likely to be challenged. HMRC looks at the commercial substance, not just the legal form.

The Full Capital Treatment Route

If the departing director meets the conditions, they pay CGT on their gain. For disposals in 2025/26, the rates are:

• 14% if Business Asset Disposal Relief (BADR) applies and the shares have been held for at least two years.
• 24% if BADR does not apply (the standard higher rate for shares).

The departing director's annual CGT allowance is £3,000 for 2025/26. Above that, the gain is taxed at the applicable rate.

For BADR to apply to a share buyback, the departing director must meet the conditions: they are an officer or employee of the company, they hold at least 5% of the ordinary share capital and voting rights, and they have done so for at least two years. Most departing directors in a partial buyout scenario will meet this.

So a departing director selling £100,000 of shares with a base cost of £1 could face a gain of £99,000. After the £3,000 allowance, £96,000 is taxed at 14% (BADR) = £13,440. That is much lower than the dividend treatment described earlier.

What Happens If the Conditions Are Not Met

If the buyback does not meet the trade benefit test, or if the departing director remains connected (e.g. they stay as a consultant), HMRC treats the buyback as a distribution. The departing director pays dividend tax on the full amount received, not CGT.

For a higher rate taxpayer receiving £100,000, dividend tax at 33.75% on £99,500 (after the £500 allowance) is £33,581. That is more than double the CGT bill under BADR.

And as we covered earlier, the remaining directors can also face a deemed dividend. That double-hit makes an unplanned buyback extremely expensive.

Structuring the Buyback to Protect the Remaining Directors

If you are a remaining director planning a buyout, here is the practical sequence we recommend to our clients at Holloway Davies:

1. Document the trade reason. Write a board minute explaining why the buyback benefits the company's trade. Be specific. "The departing director's retirement has created a gap in operational management. Consolidating ownership with the remaining directors will allow faster decision-making on a new product line." Generic statements like "it is in the company's interests" will not satisfy HMRC.

2. Sever all connections. The departing director should resign as director, employee and consultant. No retained office. No ongoing fees. No continued involvement. If they must provide transitional support, keep it short and at arm's length.

3. Use distributable profits. The company must have sufficient retained earnings. If not, you may need a permissible capital payment, which requires a special resolution and a solvency statement.

4. Get an independent valuation. HMRC will challenge an undervalue. Use a qualified accountant or corporate finance advisor to value the shares at market value. The departing director's gain is based on market value anyway, so an undervalue only hurts them.

5. File the correct paperwork. The company must file a return of purchase of own shares (form SH03) at Companies House within 28 days. The departing director reports the gain on their self assessment return (SA100) and the capital gains pages (SA108). The company reports the buyback in its corporation tax return (CT600) and its annual accounts.

6. Consider a pre-clearance application. You can apply to HMRC for clearance under section 1044 of the Corporation Tax Act 2010. This confirms that HMRC accepts the buyback is not a distribution. The application is not mandatory, but it removes uncertainty. We recommend it for buybacks over £50,000.

Alternative: The Remaining Directors Buy the Shares Personally

Instead of the company buying back the shares, the remaining directors could buy the shares personally from the departing director. This is a straightforward share transfer, not a buyback. The departing director pays CGT. The remaining directors acquire shares at their cost and pay no tax at the point of purchase.

The catch is that the remaining directors need personal cash. If they do not have it, they may need to take a dividend from the company first. That dividend is taxable at their marginal dividend rate. So the total tax cost is the departing director's CGT plus the remaining directors' dividend tax on the cash they extract.

Compare that to a company buyback where the company pays directly from retained profits. The company gets no deduction, but the remaining directors pay no personal tax. The departing director pays CGT. For many clients, the company buyback is cheaper overall, especially if the remaining directors are higher rate taxpayers.

We run the numbers both ways for every client. The right answer depends on the company's retained profits, the directors' personal tax positions, and the size of the buyback.

What About the Company's Corporation Tax Position

The company gets no corporation tax deduction for the buyback cost. The shares are cancelled, reducing the company's share capital and retained earnings. The buyback does not affect the company's trading profit.

However, the buyback does reduce distributable reserves. That may affect the company's ability to pay dividends in future. If the company needs to maintain a certain level of retained earnings for working capital or lender covenants, plan accordingly.

The buyback also reduces the number of shares in issue. If the company pays dividends, the remaining directors' dividend income will increase proportionately because they now own a larger percentage. That is a natural consequence, not a tax problem.

When BADR Might Not Apply

Business Asset Disposal Relief is valuable, but it has limits. The £1 million lifetime limit applies across all qualifying disposals. If a departing director has already used some of their BADR allowance on a previous business sale, the remaining allowance may be small.

BADR also requires the departing director to be an officer or employee of the company. If they have already resigned as a director before the buyback completes, they may lose the relief. The timing matters. Complete the buyback while they are still a director, then they resign afterwards.

BADR requires a minimum two-year holding period. If the departing director acquired their shares less than two years ago, they will not qualify. They will pay CGT at 24% instead of 14%.

Practical Example: A Manchester Consultancy Buyout

We advised a software consultancy in Manchester's Northern Quarter. Three directors owned 40%, 35% and 25% respectively. The 35% director wanted to retire. The remaining two directors wanted to buy out their shares.

The company had £180,000 in retained profits. The departing director's shares were valued at £95,000. The company bought them back using distributable profits. The departing director had held the shares for six years and had used £200,000 of their £1 million BADR allowance on a previous business sale.

The departing director's gain was £94,500 (after £500 base cost). BADR applied to the full gain because it was within the remaining £800,000 allowance. Tax at 14% was £13,230. The remaining directors paid nothing personally. The company's retained profits reduced to £85,000, but that was sufficient for working capital.

If we had structured it as a personal purchase by the remaining directors, they would have needed to extract £95,000 as dividends first. At 33.75% higher rate, that would have cost them £32,062 in dividend tax. The company buyback saved them that cost.

When to Speak to an Accountant

A share buyback is not a DIY job. The tax treatment depends on the specific facts: the company's trade, the departing director's circumstances, the valuation, and the documentation. One wrong step can turn a 14% CGT bill into a 33.75% dividend tax bill for the seller and a deemed dividend for the buyers.

If you are considering a buyout, speak to an accountant before you do anything. Do not let the departing director resign first. Do not agree a price informally. Do not assume the company can just write a cheque.

We handle exit and capital gains planning for clients across the UK. If you are in a similar position, contact us to discuss the specifics of your situation.

For more background on how company ownership works, see our fundamentals guide to limited company structures.