When a shareholder in a company wishes to leave, and the remaining shareholders are happy for this to occur, basically there are two ways the separation can occur:
- The remaining shareholders can purchase the shares from the departing shareholder; or
- The company can buy back its shares.
The tax implications for the company, the departing shareholder and the remaining shareholders from these two approaches are very different.
Transfer of shares
With a transfer of shares, there is a CGT event for the departing shareholder, and the remaining shareholders must find funds for the purchase.
With the general CGT discount, the effective tax rate for the departing shareholder on the CGT event should not exceed 23.5%.
The major issue in this approach is how the remaining shareholders fund the acquisition. Ultimately the remaining shareholders will need to fund the acquisition from after-tax funds.
If the shareholders are on the top marginal rate of tax, they will need to generate income of $1.89 to pay each $1 of purchase price.
If the company has retained profits, the remaining shareholders may wish to use the company’s funds for the acquisition of the shares. After taking account of the imputation credits, a shareholder on the top marginal rate of tax will need $1.37 of dividends to pay each $1 of purchase price.
Where there is a transfer of shares, effectively there is double taxation – tax on a capital gain for the departing shareholder that reflects the departing shareholder’s proportionate share of the retained profits and tax on a dividend received by the remaining shareholders on the distribution of those retained profits.
If the company undertakes a buy-back of shares there will be a CGT event and a deemed dividend for the departing shareholder, and the company will use its funds to undertake the buy-back.
On a share buy-back, that part of the proceeds that does not represent a return of share capital of the company is deemed to be a dividend that can be franked.
If the departing shareholder receives funds by way of share buy-back, the effective tax rate for the departing shareholder should not exceed 26.9%.
The company should need just $1 of its retained profits to fund each $1 of share buy-back proceeds.
The rules relating to share buy-backs in the Corporations Act are very prescriptive. It is important that the share buy-back is carried out in accordance with those rules.
We have acted for a number of clients who have undertaken restructures of companies using share buy-backs. Please call Patrick Cussen or Rob Warnock to discuss the tax implications of such restructures and Patrick Cussen to discuss the procedures to implement share buy-backs.