When inheritance tax can be helpful in a company purchase of own shares

The issue

On a purchase of own shares by a company the default position is that any profit over and above the amount subscribed for the shares will be treated as a distribution. There are various special rules whereby this default position is overturned and any profit can be treated as a capital gain. Unsurprisingly, most shareholders are keen to benefit from lower capital gains tax rates.  However, the benefits have been eroded by increases in capital gains tax rates and the scaling back of Business Asset Disposal Relief (‘BADR’), formerly Entrepreneurs’ Relief.
 
Often this special capital treatment can apply in a retirement scenario.  The main conditions are that:
 
1. The company must be unquoted;
2. The purchase must be wholly or mainly for the benefit of the company’s trade;
3. The transaction must not form part of a scheme to allow the owner to participate in profits of the company without receiving a dividend or to avoid tax;
4. The seller must be UK resident;
5. The shares must have been held for five years;
6. Almost all of the shares must be disposed of; and
7. The seller must not be connected with the company after the sale (generally defined as 30% or more of the issued share capital, loan capital and issued share capital or voting power).
 
There is an extra scenario whereby capital treatment can apply without meeting conditions two to seven above. This may be applicable whereby the whole, or substantially the whole, of the payment, apart from any sum applied in paying capital gains tax charged on the redemption, repayment or purchase, is applied by the person to whom it is made in discharging a liability of that person for Inheritance Tax (IHT) charged on a death.  It must also be applied in that way within two years after death. The sting in the tail here is that this special rule will not apply if the IHT liability could have been met without “undue hardship” by a different payment.
 
This relief can be of great value because there will have been an uplift of the capital gains tax base cost of the shares on death.  This means that any company purchase of own shares will usually not give rise to a tax charge where capital treatment applies.
 
When is there undue hardship?
 
The problem with this route for gaining capital treatment is that it is quite difficult to properly demonstrate the ‘undue hardship’ that would be caused without the funds from the share purchase. Fortunately, the full circumstances can be set out in a clearance letter.  This provides the forum for sensible discussion with HMRC before the transaction is enacted.
 
WSM’s view
 
After 5 April 2026 we can see that this point will have more widespread importance. This is because, from that date, Business Property Relief (BPR) and Agricultural Property Relief (APR) will only be fully available up to a cap of £1m.  After that, the relief will then only apply to 50% of the value. This means that estates will be left with significant IHT bills without necessarily having the liquid assets to meet the liabilities.

Imagine the case of a £20m trading company which triggers £3.8m of IHT. It is highly likely that such a sum would need to be met from the assets of the company.  Hopefully, HMRC could be convinced that undue hardship would be caused. On this point, more clarity from HMRC on ‘undue hardship’ would be welcome as their guidance is somewhat sketchy at the moment. Perhaps they could even go a step further and introduce a ‘deemed hardship’ provision in cases where IHT is payable due to the BPR restrictions.

As an additional point, an important legal requirement is that a purchase of own shares must be met out of distributable reserves.  This means that the practicality of paying IHT in this way should always be established at an early stage.