Tax Bites: Extracting Funds from a Company

It is not uncommon for funds to be locked-up in a company.  These may have been generated over many years through the company’s trading activities or through trust distributions received.

In considering how to extract the funds out of the company, there are several alternative methods to consider.  The importance of the option chosen becomes even more important where the company has particular attributes like pre-CGT assets, pre-CGT profit reserves, Small Business Active Asset reserves and/or where the underlying shareholdings in the company are pre-CGT.

Loans

Any loan to a shareholder or associate of a shareholder is likely to be subject to Division 7A and will require the loan to be established under a compliant loan agreement that is required to be repaid over either 7 years or 25 years.

Dividends

The company could declare a frankable dividend to shareholders.  Depending on the marginal tax rate of the shareholder, the shareholder may be required to pay top-up tax on the dividend received.

Share buy-back

The company could undertake a selective share buy-back of some of the shares in the company.

In relation to a selective share buy-back, Division 16K of the ITAA36 relevantly states that apart from the amount of the share buy-back price that the company debits against its share capital account, the balance of the share buy-back price is treated as a frankable dividend.

For companies that have nominal share capital, almost all of the share buy-back price would represent a frankable dividend.

Liquidation

Section 47 of the ITAA36 states that on liquidation, distributions made by the liquidator that are funded from income derived by the company (but excluding non-assessable capital gains) shall be deemed to represent dividend payments unless they represent the return of the paid-up capital of the company.

In some instances, extracting the funds in the company in the most tax effective way may require a liquidation to occur.  For example, if the company wishes to extract funds sourced from profits from the sale of pre-CGT assets, the Small Business 50% active asset reduction or certain other capital reserves, the liquidation of the company would enable the funds to be returned to the shareholder as a return of capital rather than as a dividend.  If the shareholder holds their shares in the company as a pre-CGT asset or has a high tax cost base for their shares, this treatment may be extremely beneficial to the shareholder.

If you have any further questions relating to the above, please do not hesitate to contact Tim Olynyk on (03)9810-0700 or at t.olynyk@banksgroup.com.au

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