‘liquid gold’ – the valuable tax concessions for a Members Voluntary Liquidation (MVL)
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.
What are the tax benefits?
It is generally difficult to extract wealth out of a company without a tax impost. For example:
- the payment of a company’s retained profits to a shareholder is treated as a dividend and is assessable to the recipient under section 44 of the Income Tax Assessment Act 1936 (Cth) (ITAA36);
- other payments, loans or debts forgiven by a company can be deemed to be a divided for tax purposes under Division 7A of the ITAA36 and assessed accordingly;
- a capital gain made by a company which has been reduced by the Small Business CGT Concessions in Division 152 of the Income Tax Assessment Act 1997 (Cth) (ITAA97) or CGT indexation will still be taxed as an unfranked dividend when paid to shareholders, unless the capital amount is paid under the ’15 Year Exemption’ contained in subdivision 152-B of the ITAA97 or the ‘Retirement Exemption’ contained in subdivision 152-D of the ITAA97.
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:
- where the shares in the company are pre-CGT, or the company has a pre-CGT capital gain;
- where a company has disposed of assets used in a business, or a business itself, and claimed the Small Business 50% Reduction as part of the Small Business CGT Concessions (see subdivision 152-C ITAA97);
- where the company made a capital gain which was reduced under Subdivision 768-G of the ITAA97. Subdivision 768-G applies where a company disposes of shares in a foreign company in which it had at least a 10% interest and that foreign company carried on a business;
- where indexation has been used to reduce a capital gain (applies to assets purchased before 21 September 1999); and
- where there are shareholder loans under Division 7A of the ITAA36 that can be repaid through the liquidation process.
Tax Tips and Traps for an MVL
Liquidating a company, especially older companies, can become extremely complex and fraught with tax pitfalls. Some important questions to consider are:
- does the company have sufficient records to prove that amounts do not represent income, so they can be treated as capital?
- if there was pre-CGT property in the company, did the property become post-CGT because of the application of Division 149 of the ITAA97?
- is there a sufficient franking account balance to ensure there will not be any tax for the shareholders on the income portion of a liquidator’s dividend? Should a dividend be declared before liquidation commences to use up franking credits?
- can any excess cash be loaned to the shareholders or a related entity prior to the liquidation? Will Division 7A apply if such a loan is made?
- will the characteristics of the company affect a liquidation or will tax clearance from the ATO be difficult to obtain? e.g. prior tax consolidation, the controlled foreign company (CFC) regime, tax or reporting obligations outside Australia could affect the tax profile of the company.
- have all input tax credits been claimed on the relevant Business Activity Statements before liquidation?
- have all tax deductions been claimed? Remember some deductions are spread over a number of years (e.g. capital works expenditure, ‘black hole’ expenditure).
- does the company have any carried forward losses? Are these available to be utilised?
- do any assets need to be transferred or assigned prior to liquidation? e.g. Division 7A loans, trademark rights, employment entitlements for employees;
- is the company a guarantor for any bank loans or other financial arrangements?
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.