Sharing the Buy-Back Love

In recent months we’ve seen an increase in the number of clients enlisting our legal services team to prepare and lodge documentation facilitating share buy-backs. These are where a company buys back shares from a shareholder and immediately cancels them. 

There are a number of reasons our clients are contemplating share buy-backs, namely reducing the cost of capital, varying control in a company or creating a tax effective shareholder exit. Regardless of the motivation, it’s always essential to comply with the requirements of the Corporations Act, and to understand the tax implications of a buy-back.

Exiting stage left

Most often we encounter share buy-backs as a means of facilitating a shareholder exit. This can be achieved either by a share sale or a buy-back.

An exiting shareholder’s shares may be sold to remaining shareholders, with the ownership percentage of some, or all, of the remaining shareholders increasing. Where those shares are on capital account, the selling shareholder makes a capital gain to the extent that the capital proceeds exceed their cost base. Where the proceeds are less than the reduced cost base, a capital loss is incurred.

There are clear tax benefits in exiting a shareholder via a buy-back, as opposed to a share sale, not to mention that a buy-back utilises the financial resources of the company, rather than that of new or existing shareholders. Additionally, in most jurisdictions stamp duty will not be applicable with a buy-back. 

Once it has been determined that a share buy-back is the correct next step for a shareholder and/or company, it is essential to comply with the technical and administrative requirements of relevant legislation and regulatory bodies. Whilst the share buy-backs we most commonly deal with are “equal access” and “selective”, there are numerous derivations, each with its own set of timing and administrative requirements which must be adhered to under the Corporations Act. Similarly, whether a buy-back is approved by a special or unanimous resolution of shareholders must be determined in accordance with these requirements.

In all cases, ASIC requires sufficient notice of any share buy-back in the interests of safeguarding both potential creditors and other company shareholders. As a result, and, unlike most other dealings with company shares (such as share issues or transfers), ASIC cannot be informed of a share buy-back after the fact. 

Benefits of share buy-backs

In addition to a potential tax saving for an exiting shareholder, a share buy-back delivers a number of advantages, including:

The proceeds of a share buy-back are divided into a capital component and a dividend component. Any amount received in relation to the buy-back of shares, above the amount of paid up capital attributable to those shares, is deemed to be a dividend. 

The practical effect of this is that the shareholder is receiving a frankable distribution, the tax payable on which can be offset by any franking credits that may be available (although it is worth noting that any amount of the dividend component that exceeds market value is not frankable). For most companies with limited paid up capital, the capital component of a share buy-back will be minimal, meaning most of the sale price will be deemed to be a dividend (which may be franked). For companies with significant paid up capital, there is a particular process that needs to be followed to determine the split of the capital and dividend components for the share buy-back.

Food for thought

Some final considerations if you are considering a share buy-back:

 Our legal services team is available any time to assist with share buy-backs. You can reach us at 1800 773 477 or contact us.