How can a share capital reduction be used to extract capital in a tax effective way?
Problem: How to extract excess capital?
Client company had $720K standing to the credit of a share premium account.
Cost base of the shares held by two trustee shareholders is $570K.
The company has capital surplus to requirements in the order of $700K.
Solution: A share capital reduction
A share capital reduction allowed excess capital to be returned to the shareholders as a non-taxable cash payment.
In other circumstances, a members’ voluntary liquidation might be the appropriate strategy – see Case Study: Tax effective capital extraction via members’ voluntary liquidation.
We provided comprehensive legal advice that a share capital reduction would be the most tax effective way for the company to return excess share capital to its members.
Section 256B of the Corporations Act 2001 authorises a company to reduce its share capital if the reduction:
- is fair and reasonable to the company’s shareholders as a whole; and
- does not materially prejudice the company’s ability to pay its creditors; and
- is approved by shareholders.
In this case, these requirements could be met.
The company was able to reduce its share capital by making a non-taxable cash payment to the members.
The payment was not a dividend as defined, because the amount of money paid was debited against an amount standing to the credit of the share capital account of the company.
The tax considerations were:
- Did s 45B ITAA36 apply? It was concluded that s 45B could not apply, having regard to the relevant circumstances of this case and those set out in PSLA 2008/10.
- What were the CGT consequences? The return of capital gave rise to CGT Event G1 (capital payment for shares) as the amount of the capital payment was more than the cost base of the shares. The cost base of the shares was consequently reduced to nil.
After applying the 50% CGT discount however, the shareholders net position was a substantial tax-free capital return and a modest but manageable capital gain.
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Want to know more?
If you have clients in a similar situation and are struggling with what to do and the tax consequences of capital extraction, our Legal Practitioner Director, Mark Mathews CTA, would be pleased to discuss the options and strategies that might be available to resolve your clients’ tax problem.
Call us now on 1800 MTL TAX (1800 685 829) or send us a message via our Contact page.