Facts
A shareholder wishes to exit a company. It is proposed that the company buys back those shares for $100,000 so that the other shareholder is not required to procure any funds to exit the leaving shareholder. The leaving shareholder initially paid $50 for its 50 shares.
Question
What are the tax consequences for the selective share buyback?
Answer
$50 will be a CGT event. The remainder $99,950 will be a dividend. Whether such dividend is franked or not, that is a decision for the company
Tax Tip
Section 44 ITAA 1936 provides that dividends paid to a shareholder by a company out of profits derived by it from any source is assessable income of the shareholder. Section 6 ITAA 1936 defines ‘dividend’ to include any distribution made by a company to any of its shareholders but excludes any distributions debited against a share capital account. The $50 is a debiting against the $50 share capital account. It is not a dividend. It is in fact a CGT Event C2 (about cancellation, surrender and similar endings). However, the capital gain is $nil because the proceeds of $50 are reduced by the cost base of $50. The remainder $99,950 is a distribution that is not debited against a share capital account and is a dividend as the distribution is from company profits. Depending on the marginal tax rate applicable to the leaving shareholder, a dividend that is fully franked may not be an unfavourable outcome. For example, if the leaving shareholder’s only income was the $99,950 distribution, and with full franking credits, the leaving shareholder will have $nil further tax to pay. The alternative would be a transfer of the leaving shareholder’s shares to the remaining shareholder/s. Assuming the CGT 50% general discount applies, the tax on $100,000 would be about 25%, being similar to the franking credit. The net cash to the leaving shareholder, in both cases, is about $75,000. However, if the consideration for the share buyback was materially in excess of $100,000, which would lead to ‘top-up’ tax on the fully franked dividend, a share buyback may not achieve the best tax outcome for the leaving shareholder.
If you would like to receive up to date tax tips directly to your email, subscribe below.
Comments