Liquidating a company can be a tax effective strategy to extract capital amounts out of a company.
The operation of section 47 ITAA36 to members voluntary liquidations can be complex.
Tax advice should be sought by shareholders expecting to receive amounts under an members voluntary liquidation, or seeking to extract capital amounts from a company.
Companies may be voluntarily liquidated for a number of reasons, such as to reduce risk from previous activities of the company, to reduce annual compliance costs, or to resolve shareholder disputes, amongst other reasons. In certain circumstances, a voluntary liquidation can also be a tax effective means of extracting wealth out of a company.
The purpose of this article is to discuss the tax benefits which may be available in a Member’s Voluntary Liquidation (MVL).
An MVL, sometimes called a solvent winding-up, can be available if the members of the company vote in a special resolution to wind-up the company and that company has sufficient assets to pay out all creditors. Any assets above what is required to pay creditors is returned to the shareholders in proportion to their share rights.
An MVL should not be confused with ‘deregistering’ a company. Deregistration is a different and generally simpler process. In contrast, a company which is liquidated usually ceases to exist forevermore and cannot be reinstated unless a special application is made to ASIC or the Federal Court, such as in the case of phoenix activity, unfair dealings with creditors or similar dealings (see _Deputy Commissioner of Taxation v Australian Securities and Investments Commission _ FCA 594). The tax benefits which are available under an MVL are not available when a company is deregistered.
It is generally difficult to extract wealth out of a company without a tax impost. For example:
However, when a distribution is made as part of an MVL, the distribution amount retains the same character in the hands of the shareholder that it had in the hands of the company (if the company records can show the source of the specific funds). Accordingly, a distribution to a shareholder by a liquidator that represents income of the company is treated as a dividend for tax purposes and can be franked (subsection 47(1) ITAA36). The definition of income for the purposes of section 47 ITAA36 includes net capital gains, such as from selling business assets.
Any amount that is not assessed as a dividend under section 47 ITAA36 is assessed to the shareholder as a capital gain from CGT event C2 or G1 happening. If the capital proceeds from the CGT event relate to a pre-CGT capital gain, it should not be taxable to the shareholder. If the capital amount relates to a post-CGT capital gain, then the shareholder may be able to claim the 50% General CGT Discount on the capital amount distributed as part of an MVL. It is possible for the Small Business CGT Concessions to apply to the CGT event C2 or G1 itself, though it is uncommon.
Because of the ‘flow through’ tax treatment of amounts paid under an MVL, it can be particularly tax effective in the following scenarios:
Liquidating a company, especially older companies, can become extremely complex and fraught with tax pitfalls. Some important questions to consider are:
A liquidator can usually manage the liquidation process itself, though will often need tax advice if there is doubt about the tax treatment for the shareholders. Shareholders of companies that operated businesses or held pre-CGT property should be particularly aware of the potential tax benefits which they may be entitled to under an MVL.
Liquidating a company can be a tax effective strategy for both small business clients and larger groups to extract capital amounts out of a company, which is not usually possible while the company remains active. However, as can be seen above, the operation of section 47 ITAA36 to MVL’s can be complex.
Tax advice should be sought by shareholders expecting to receive amounts under an MVL, or seeking to extract capital amounts from a company tax effectively.
This article in no way constitutes legal advice. It is general in nature and is the opinion of the author only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.
Join Australian professionals who get monthly insights from Velocity Legal.