How a members' voluntary liquidation can be used to extract pre-CGT capital profits from a company
Problem: How to access pre-CGT capital profits?
The client’s company was established in 1978 and has a pre-CGT capital gain of $1.7M reflected as a capital profits reserve in the balance sheet.
The company has cash funds in the order of $1.4M and no liabilities.
The members no longer have a need for the company and want to access the pre-CGT capital profit in the most tax effective way.
Solution: A members' voluntary liquidation
Given the facts in this case, a members’ voluntary liquidation was the optimum solution.
The liquidator could distribute the pre-CGT capital gain to the shareholders as a tax free distribution.
In other circumstances, a share capital reduction might be the appropriate strategy – see Case Study: Tax Effective Capital Extraction Using Share Capital Reduction.
Strategy
We provided comprehensive legal advice that a members’ voluntary liquidation would be the most tax effective way for the members to access the pre-CGT capital profit.
The provisions in part 5.5 of the Corporations Act 2001 can be satisfied and a liquidator appointed.
Distributions to members by a liquidator attributable to a capital gain on a pre-CGT asset are not dividends as defined and can be distributed tax free to the members in the course of the winding up.
In the absence of written advice from the liquidator that the company will not cease to exist within 18 months of payment of an interim distribution, a shareholder may assume that the company will cease to exist within 18 months of the interim distribution (CGT event G1 would happen on payment of a distribution if the company did not cease to exist within 18 months of the payment).
But there are CGT consequences for the shareholders: CGT event C2 happens on deregistration of the company.
A capital gain is made if the capital proceeds from the ending of the shares is more than the cost base of the shares.
In this case, the members were deemed to have acquired their shares at market value on the date of death of the testator who bequeathed the shares to them.
A market valuation of the shares on the date of death was obtained in accordance with the ATO’s market valuation guidelines.
The capital proceeds from the ending of the shares is:
- The amount of any final liquidator’s distribution; and
- The non-assessable part of any liquidator’s interim distribution, where (or assuming) the company ceases to exist within 18 months of such distribution.
Where the shares have been held for more than 12 months, any gain will be a discount capital gain.
Outcome
The liquidator was able to make tax-free distributions to the members and the company was subsequently deregistered.
The timing of CGT Event C2 meant the members had access to significant tax-free funds for a considerable period before the tax payable on the discount capital gain from CGT event C2 was due for payment.
Having regard to the distributions and the deemed market value cost base of the shares, the tax ultimately payable on the discount gain was manageable.
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“I’ve had the pleasure of working with Mark on a few different client cases lately and have been constantly impressed by his knowledge and expertise. Mark has been able to achieve some awesome tax outcomes for my clients and I look forward to working with him again soon.” [Elle Sweeney CA, Client Advisor, Link Advisors Chartered Accountants]
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.
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