Facts
A company sold a pre-CGT asset for $100,000.
The shareholder wishes to access the sale proceeds from the sale of that pre-CGT asset.
It is proposed to undertake a selective share buyback.
There is only one (1) shareholder in the company.
The shareholder initially paid $500 for its 50 shares (which had $50 paid up capital) and are post-CGT 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
In Tax Tip #27, we discussed the tax consequences of a selective share buyback and the same tax consequences apply in this tax tip regardless that the proceeds are sourced from the sale of a pre-CGT asset.
The tax consequences are:
The $50 is a debiting against the $50 share capital account. The $50 is not a dividend. It is a capital payment that triggers 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 $500 (a capital loss).
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.
Importantly, but unfortunately, even though the proceeds are sourced from the sale of a pre-CGT asset, no tax was paid on those proceeds and thus the company could not frank those proceeds. If the company does decide to frank the dividend, it will be using franking credits from its retained profits account which will mean the future distribution of those retained profits will be short of franking credits.
Liquidation
The better strategy would be to liquidate the company. Note, if the company continues to trade, a liquidation may not be feasible at this time but may need to be delayed to the future.
The special rule in section 47 ITAA 1936 (about distributions by liquidator) provides that only 'income derived by the company' is treated as a dividend. ‘Income derived by the company’ includes an amount included in the company’s assessable income and a net capital gain. However, the proceeds from the sale of the pre-CGT asset is not ‘income derived by the company’ because it was neither of these.
Therefore, the remainder $99,950 distribution is not a dividend, but only in liquidation, and is a capital payment.
However, and importantly, the remainder $99,950 triggers CGT Event C2 and is subject to the capital gains tax provisions.
Assuming the CGT 50% general discount applies, tax is nonetheless applicable to the proceeds from the sale of the company’s pre-CGT asset.
Pre-CGT Shares
If the shares were also pre-CGT then the tax on CGT Event C2 would be $nil.
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