Companies, like other entities, are able to access the small business CGT concessions, subject to meeting the relevant conditions.
Where the basic conditions are met, a company can apply the SBCGT active asset reduction (Active Asset Reduction), meaning:
- The first half of the capital gain is tax-free to the company (Tax-Sheltered Amount), and
- only the remaining half will be subject to tax at the company’s prevailing tax rate.
Unlike other SBCGT concessions (e.g., the SBCGT 15-year exemption), there are no special rules facilitating the tax-free payment out of the Tax-Sheltered Amount by the company to its shareholder(s).
This creates a problem as the benefit of the Active Asset Reduction at the company level is effectively reversed out at the shareholder level as:
- The payment out of the Tax-Sheltered Amount is a dividend; and
- unless there were sufficient franking credits available from other sources, the dividend would be unfranked (or largely unfranked).
Liquidating a company
Notwithstanding the above, if there is no need to retain the company following the relevant disposal, you may consider liquidating the company to achieve a better tax outcome.
On a liquidation:
- amounts that were income in the hands of the company are taxed as dividends on payment out by the liquidator (and these dividends may be franked); however,
- amounts that were not income in the hands of the company are:
- not taxed as dividends on payment out by a liquidator; and, instead
- treated as capital proceeds in relation to a CGT event relating to the shares (generally CGT event C2 on the cancellation of the shares).
The ability of a liquidation to deliver a better tax outcome for shareholders often arises in the context of a company with a ‘Pre-CGT Profits Reserve’, however, the same issues also apply in relation to a company with a Tax-Sheltered Amount.
A Tax-Sheltered Amount should be clearly identified in the company’s financials in an ‘Active Asset Reserve’ or the like so that a liquidator can easily identify both the amount and its nature.
The upstream capital gain on cancellation of the shares
As outlined above, the payment out of a Tax-Sheltered Amount by a liquidator will not be taxed as a dividend but as capital proceeds in relation to the cancellation of the shares.
Provided that the relevant conditions are met, the shareholder(s) may be able to access:
- the general 50% CGT discount (e.g., an individual shareholder or an individual beneficiary of a trustee shareholder); and/or
- one or more of the SBCGT concessions in relation to the cancellation of their shares.
We note that in determining whether or not to liquidate, you need to carefully consider the tax implications as a whole, for example, if the company has significant retained earnings and liquidation would result in very significant top-up tax on a large dividend, you may wish to hold off.
Further, if the disposal of the underlying business and/or asset giving rise to the Active Asset Reduction is subject to either:
- deferred consideration; and/or
- an earn-out arrangement,
The commercial reality is that you will not be able to liquidate until those payments or rights are finalized.
For more information on the SBCGT concessions, see our Explainer Video here.
If you would like to discuss this issue, or any other eligibility issues surrounding the SBCGT concessions and how you, or your clients, can benefit from them, contact Mosaic Tax Legal at firstname.lastname@example.org or 1300 115 841.