Been reading this thread with interest, as a professional pest controller of many years I will first confirm that indeed it is an offence under the wildlife and countryside act 1981 to re-release a grey squirrel. Grey squirrels are also now known to carry a pox virus that affects the red squirrel.
Also reference to dumping the caged squirrel in a deep water butt is again another no no I am afraid. It is not an approved method of killing and constitutes an offence. The air rifle is a good means of despatching a caged squirrel however safety issues and indeed knowing where to best shoot the squirrel is another factor to avoid unecessary suffering.
If the squirrel problem needs to be addressed then how about using a trap that will deliver a fatal blow to the squirrel so as no further actions are needed once the squirrel has entered the trap ?
Have a look at this trap
http://www.kania.net/I use them all the time and can vouch they are extremely effective. The obvious safety factors would have to be considered to ensure children and non target species are denied access and whilst left outdoors overnight the trap should be covered or sprung to avoid the risk of catching hedgehogs. The trap is baited with bird table peanuts and once the squirrel puts it's head into the trap to remove them a swift blow is delivered to the back of the head/neck from a pre-set sprung loaded arm.
Very effective and saves the need to mess about with air rifles etc. The trap can also be tree mounted to keep it out of reach of children etc.
Hope this helps.