A share buyback is often a thing for the big guys. But not necessarily.
Any company can do a share buyback. The question is just whether it should.
In this episode Emily Pritchard of ACIS will walk you through the pros and cons of a share buyback. Here is what we learned but please listen in as Emily explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Share buybacks are an option to reduce the cost of capital, vary control in a company or create a tax-effective shareholder exit.
But whether a share buy-back actually makes sense depends on various factors.
Share buy-backs are not the only option you have.
If shares are redeemable, companies can redeem them – provided the relevant company has enough profits to fund the redemption. A redemption must be paid for out of profit.
If shares are not fully paid yet, you can forfeit them.
And another option is to just sell shares from one shareholder to another shareholder – be it an existing or new shareholder.
So all up there are 4 options:
1 – Redemption
2 – Forfeiture
3 – Sale
4 – Share Buy-Back
Whichever way you go, always consider the Corporations Act and the company’s constitution.
Sale v Buy Back
If you contemplate a share sale v a buy back, ask the following 6 questions:
1 – What is the exiting shareholder’s marginal tax rate? The higher the marginal tax rate, the better a transaction on capital account with CGT discounts. So the higher the marginal tax rate, the more a share sale makes sense.
2 – Has the exiting shareholder available capital losses? The more available capital losses, the better a share sale would be so that the existing capital losses can offset any capital gain.
3 – How many franking credits has the company available? The more franking credits to share, the better a share buy-back looks.
4 – Would small business CGT concessions apply? If they do, a share sale is probably more tax-effective.
5 – Are the shares held by the exiting shareholders pre-CGT? If yes, a share sale is probably more tax-effective since the entire amount is probably CGT free.
6 – Would the remaining shareholders or new shareholders be able to fund a purchase of the shares? If there is nobody to pay for the shares, then a share sale is off the table anyway and a share buy-back is all you got.
If you are after CGT discounts, go for a share sale and not a buy-back. A share sale is on capital account. So any capital gain might attract the 50% CGT discount and small business CGT concessions.
With a share buy-back on the other hand, most of the payment will hit your assessable income as a dividend, so no CGT discounts.
If you are after using franking credits, go for a share buy-back and not a share sale.
Most companies have little paid up capital. Any excess of the share buy-back above the amount of the paid up capital is deemed to be a dividend. The good news is that this dividend is frankable. So the company can distribute its franking credits as part of the share buy-back, reducing the shareholders tax on the dividend.
But remember that any amount of the dividend component that exceeds market value is not frankable. And watch out for the benchmark franking percentage.
With a share sale, you can’t pass franking credits since it is on capital account.
Ways of Buy-Backs
The Corporations Act allows different ways of a share buy-back, each with its own set of timing and administrative requirements. Some require a special or unanimous resolution by shareholders. The most common ones are the “equal access” and “selective” share buy-backs.
Notice to ASIC
Whenever you do a share buy-back, make sure that ASIC receives sufficient notice of any share buy-back before you pay the cash.
With share issues or transfers you can wait informing ASIC until after the event. With a share buyback you can’t. ASIC wants to know in advance. And the reason for this is that share buybacks put creditors and other shareholders at risk.
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 15 March 2021