The sale of a family business is usually an exciting time for all involved. This is particularly true for those who started out with a business idea and after many years of toil, are now finally “exiting their business” – looking forward to retirement or their next adventure.
Despite the excitement, it can be a bitter pill to swallow when their accountant does the numbers and tells them how much tax they have to pay if they take all their hard-earned profit now! This is even more so the case when their accountant suggests they hold their “nest egg” and slowly pay annual dividends / wages over many years to ensure the most tax effective outcome.
A small to medium business owner can find it difficult at times to differentiate themselves from a corporate entity – in their mind, it is their money!
Not many of us enjoy paying tax, especially more than we have to pay. Accordingly, when the opportunity presents itself to minimise tax payable, we are all ears. That’s where a Members Voluntary Liquidation may be able to assist.
A Members Voluntary Liquidation (MVL) is the liquidation of a solvent company that results in a final distribution to shareholders (if funds / assets are held by the company) and ultimately, the deregistration of the company. The MVL process is initiated by the directors and shareholders of a company.
MVLs typically have three (3) major purposes:
- To bring finality to a company in a more formal sense than a voluntary deregistration of the company. Once a company has been deregistered, the company ceases to exist as a legal entity and can no longer do anything in its own right. A party cannot commence legal proceedings against the company without the permission of the Court. Reinstating a company after a liquidation is more difficult and requires an application to Court; hence, there is an extra layer of protection for former directors and officeholders.
- To assist in resolving disputes between shareholders by appointing an independent third party (the liquidator) to realise the assets of the company and pay a final distribution to shareholders.
Whilst there are other options available to deal with a shareholder dispute, placing a company into liquidation can be a cost-effective way to deal with the dispute without needing to make an application to Court (if you can get all parties to agree to the MVL – which is often the difficulty).
- Taxation benefits which are often centred around the return of share capital and / or Capital Gains Tax (CGT) concessions that can be accessed through the MVL process.
Ordinarily, whilst a company continues in existence, profits earned by a company are distributed to its shareholders as dividends.
Although a company can pay “franked dividends” (which benefits shareholders personally) often insufficient franking credits are available to pay all available funds as franked dividends (particularly following the sale of a business). Unfranked dividends received by an individual shareholder is assessable income and tax is payable on the income received at marginal tax rates.
Share capital is ordinarily returned to shareholders in a MVL without any taxation consequences for them personally. Accordingly, if a company has a large amount of share capital, it is usually beneficial for the company to be placed into MVL.
Final distributions by a liquidator in a MVL take on the nature of the equity accounts of the company, meaning if a capital reserve / profit is being distributed to shareholders, CGT concessions are likely to be available to shareholders to reduce the amount of tax payable by them personally (depending on their personal situation, more than one of the CGT concessions may be available).
Below is an example of the possible tax benefits of an MVL, when CGT concessions apply to individual shareholders (note: each individual shareholder’s circumstances need to be assessed separately).
Company Balance Sheet
Assets | Amount ($) |
|---|---|
Cash at Bank | 600,000 |
Total Assets | $600,000 |
Cell | Cell |
Equity | Amount ($) |
Share Capital | 100,000 |
Capital Profits Reserve | 500,000 |
Total Equity | $600,000 |
Possible Distributions
Final Distribution in MVL | Distribution as Dividend | ||
|---|---|---|---|
Distribution Category | Amount ($) | Dividend Category | Amount ($) |
Share Capital | 100,000 | Unfranked Dividend | 600,000 |
Distribution out of a Capital Profit Reserve | 500,000 | ||
Total Distribution | $600,000 | Total Dividend | $600,000 |
The Share Capital return is likely not to be subject to any income tax for an individual shareholder. CGT concessions are likely to be available for an individual shareholder for the Capital Profit Reserve portion of the final distribution. Depending on their individual circumstances, no income tax may be payable by the individual shareholder on the final distribution. | Income tax is payable on the unfranked dividend received by an individual shareholder at their marginal tax rates.
As the dividend is an unfranked dividend, no tax credits are available to the individual shareholder. | ||
MVLs are a powerful tool and when used in conjunction with the sale of a business, an MVL can often result in substantial tax benefits to shareholders (as can be seen from the above example).
Next time you or your clients are selling or exiting their business, consider whether the MVL process may be of some benefit. SV Partners can help you or your clients assess the options available and whether the benefits of a MVL are worth pursuing.
Article written by Daniel Luckman (Senior Manager) - SV Partners Sunshine Coast