Tax matters in solvent liquidation dividends

Is it income or capital?

A solvent members' voluntary liquidation is the formal way of resolving a company’s affairs. As part of the winding up process, the liquidator must distribute any remaining company assets to its shareholders according to their rights and interests in the company. 

But how does a recipient shareholder treat the distribution in terms of tax and why might a solvent members’ voluntary liquidation be beneficial? 

While the Australian Taxation Office (ATO) considers the entire distribution to be capital proceeds, where there are retained profits in a company, the portion of the distribution relating to retained profits is deemed to be an ordinary dividend. Accordingly, the distribution of a company’s assets will first be taken from the retained profits balance until it is exhausted. In the hands of the shareholder recipient, this is ordinary income pursuant to section 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and will be taxed at the shareholder’s marginal tax rates. 

Therefore, when developing a strategy, the company could choose to distribute and exhaust the remaining retained profits balance prior to placing the company into a solvent liquidation as ordinarily there is no real difference to the recipient, other than the timing of the distribution. 

The cancellation of the shares of the company as part of the liquidation process is considered to be CGT event C2. Therefore, the remaining distribution is considered to be the capital proceeds from the shares’ cancellation (section 104.25 and section 104.135(6) of the Income Tax Assessment Act 1997 (ITAA 1997)). Consideration can then be made as to whether any tax implication may be reduced in respect to the capital proceeds such as:

• If any portion of the distribution attributable to capital proceeds from a pre-CGT asset may potentially retain its tax-free status pursuant to the Archer Brothers principle (see TD 95/10).

• The availability of the 50 percent CGT discount for individuals (section 115.10 of the ITAA 1997).

• Eligibility for the small business CGT discount (section 152.205 of the ITAA 1997 and ATO ID 2010/90).

• Whether the small business 15-year exemption or retirement exemptions are available.

The above is provided for general information purposes only. A members’ voluntary liquidation can result in a better tax outcome for shareholders, but it will depend on the shareholders’ personal circumstances and therefore we are unable to provide individual tax advice. Any tax advice should specifically address and be tailored to the individual unique circumstances. We recommend that formal taxation advice be obtained first, setting out the proposed strategy and actions prior to placing a company into a solvent members’ voluntary liquidation.

As liquidators, we can wind up the companies, distribute any assets, ensure all of its affairs are properly wound up and finalised, and deregister[1] the company in accordance with the tax strategy set out in the advice.

Related article: How a members’ voluntary liquidation can benefit all stakeholders

[1] through the Australian Securities and Investments Commission (ASIC).