In situations where multiple shareholders, who are not related, conduct business activities through a company, there may arise a point when they decide to go their separate ways, necessitating the departure of one of the shareholders from the company. In such cases, a tax accountant can assist in exploring two primary options for accomplishing this. Firstly, the departing shareholder can sell their shares to the remaining shareholder. Alternatively, the company can repurchase the shares held by the departing shareholder.
For example, assume Mike owns 80% of 4WD Pty Limited while Mal owns 20%. The company has operated a successful travel business for 25 years. Mal has decided to retire and wants to extract his interest in the company. The way the two alternatives might apply is described below:
- Share Transfer of shares owned by Mal to Mike
- Once a value is put on the business group (including all assets within the company group), Mike pays Mal for 20% of this value through a signed share transfer between them.
- There is no stamp duty on this transfer in NSW after the law change from 1 July 2016
- Mal would then have a Capital Gain on which he may pay CGT. The amount would depend on his circumstances. He would get a 50% general discount for holding the shares for over 12 months. Depending on eligibility, he may get the CGT Small Business Concessions (SBC) as well, possibly allowing him to get the CG down to Nil. Access to the SBC is quite strict and depends on what assets he has in his and connected entity’s hands. A proper review of this would need to be made to determine if he could access them.
- If he is not eligible for the CGT SBCs, and he was paying tax at the highest marginal tax bracket, Mal would then pay a maximum of 24.5% tax on the gain. If he were on lower marginal tax rates, then this tax figure would be lower (essentially, it is half his marginal tax rate)
- The benefit or otherwise for Mike in paying Mal for his shares depends on how he funds the payment. If he were to want to use funds within 4WD Pty Limited to pay him, then there would be tax ramifications in getting these funds out to allow this to happen (i.e. if by dividend, then there would be a tax on it as it came out). If so, the Buyback method below may be a better option.
- 4WD Pty Limited does a Buyback of Mal’s shares from him
- This is effected through paperwork with ASIC to buy back the shares from Mal. This is a more complex way of doing the transaction, and it will cost more professional time to affect the transaction.
- The amount paid to Mal would be treated mainly as a dividend from 4WD Pty Limited with franking credits attached.
- The main advantage of this method is that funds from the business group itself can be used to buy Mal out, meaning it is effectively done in partly pre-tax dollars.
- The tax effect in Mal’s hands depends on his circumstances. It would depend on what amount he received for the sale and his marginal tax rate. If he were in the highest tax bracket, the top-up tax payable on a dividend would be 27.14% at today’s tax rates. If he were on a lower marginal tax rate, this figure would decrease.
Summary
A share transfer is the more straightforward option and is often the obvious choice. Although a buyback adds complexity, it becomes attractive where it is necessary to use cash that belongs to the company itself to implement the transaction, as it avoids the need for the remaining shareholder to borrow from the company to purchase the shares.
Two situations are rarely identical, and taking specific advice that considers your circumstances is necessary.
Kreston Stanley Williamson Team
*Correct as of April 2017
Disclaimer – Kreston Stanley Williamson has produced this article to serve its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek advice about your circumstances. Liability is limited by a scheme approved under professional standards legislation.
