What is a capital reduction?
A company may reduce its share capital in two ways:
- Share cancellation; or
- Share buy-back.
Generally, the purpose is to improve the capital structure of the business (debt and equity) in order to maximise value to its shareholders. Capital reduction may take the form of equal reduction or selective reduction.
Equal reduction applies to all shareholders leaving them with a proportionate holding. Whereas selective reduction applies to certain shareholders who receive cash in exchange for their shares, increasing the share proportion for the remaining shareholders.
A company will undertake capital reduction where:
- the company no longer requires as much capital as it did;
- the market value of the company’s shares do not reflect the enterprise value of the business plus cash balance less any debt; and
- there is a major shareholder or group or shareholders who wish to exit the company..
What are the tax considerations for shareholders?
The taxation treatment of capital reductions is summarised below:
| Resident shareholder | Foreign Resident Shareholders | |
| Unfranked Dividends | Are fully taxable at applicable shareholders marginal rate of tax | Are subject to withholding tax at the rate of 10-15%. But this may be as high as 30% for certain countries. |
| Franked Dividends | Are Taxable and the franking credit is to be added to the net dividend. Tax is calculated on the grossed up amount with a tax offset for the franking credit. | Not taxable in Australia. No credit for the underlying tax paid in the home jurisdiction. |
| Return on Capital | Reduces the cost base of the investment. However, in situations where the amount received exceeds the cost base then such amount would be regarded as taxable. | Generally treated the same as an Australian resident. |
The effectiveness of a capital reduction depends on the particular circumstances of the company. However, careful planning is required by the company and its advisers prior to undertaking such a process.
If you require any further information in relation to capital reduction, please contact the Accountants at The Quinn Group on (02) 9223 9166 or submit an online enquiry form today.
