The quirky interaction of the Corporations Act, an ASIC practice
note and the tax law can create a nasty sting in the tail for
ongoing shareholders following the redemption of preference shares
by a company.
Section 254K of the Corporations Act 2001 provides that a
company may only redeem redeemable preference shares out of profits
or the proceeds of a new issue of shares made for the purpose of
the redemption. A new issue of shares is often impractical.
Practice Note PN 68 issued by ASIC provides commentary on what
is required when preference shares are redeemed out of profits. PN
68 requires an accounting entry to record the transfer of retained
profits to the share capital account in order to preserve the
capital of the company and to protect creditors.
The accounting entry required to complete a redemption of the
preference shares will result in a "tainting" of the
company's share capital account for taxation purposes. Tainting
generally occurs when an amount is transferred to the share capital
account from some other account.
The effect of tainting is to generate a franking debit for the
company as though the transferred amount were a dividend. This loss
of franking credits may restrict the company's ability to frank
future dividends. Furthermore, the share capital account is no
longer treated as share capital. Any distribution out of share
capital could be treated as a dividend rather than a more tax
effective capital distribution. Whilst it is possible to untaint a
tainted share capital account, this can be an expensive
The ASIC stance on redemptions creates an anomaly because under
a share buy back or a capital return, capital can be returned to
shareholders without the need to transfer an amount from profits
into the share capital account. Thus the adverse tax consequences
associated with tainting a share capital account through a
redemption can be avoided.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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