During COVID-19, the ATO provided tax-free cash flow boosts to small businesses employing staff with an aggregate annual turnover of under $50 million. These were designed to help keep businesses operating, retain staff, and able to pay rent, electricity and other bills.
But if a business has decided to enter members’ voluntary liquidation (MVL), how are the cash flow boost reserves treated? What are the tax implications? And where should they sit on the balance sheet?
Members’ voluntary liquidation
A members’ voluntary liquidation is a tool used to formally dissolve and deregister a solvent company.
Members may decide to wind up their solvent company for several reasons. One is that it’s no longer operating and they have no use for it. Others include to save on ongoing compliance costs, to rationalise a group structure, to resolve a dispute or to access the company’s equity in a tax-effective manner.
During a members’ voluntary liquidation, the appointed liquidator realises the company assets, pays the company’s liabilities and ensures the company’s tax lodgements and payment obligations are discharged. They then make a distribution to the shareholders of any surplus funds.
Dividends versus capital distributions
Outside of liquidation, the distribution of company profits or capital gains will be taxable as dividends. In some cases, there may be insufficient franking credits, and as a result, dividends may be unfranked, leading to significant tax becoming payable by the shareholders on distributions received.
Under liquidation, certain equity classes are classed differently, with some providing more favourable tax outcomes for shareholders than others.
Here’s a summary of the tax treatment of distributions by a liquidator compared to those outside of liquidation:
|Liquidation||Liquidation||Outside of Liquidation|
|Retained Profits (to the extent it represents assessable income)||Dividend||Dividend|
|Capital Profits Reserve (pre-CGT assets)||Capital||Dividend|
|Exempt 50% Component of Capital Gain Attributable to Goodwill or Active Asset||Capital||Dividend|
|Capital Profits Reserve (post-CGT assets)||Dividend||Dividend|
Cash flow boost as NANE income
Cash flow boosts are non-assessable non-exempt income, meaning that the company does not pay tax on same. As these amounts are not assessable income to the company, in a liquidation scenario, cash flow boost reserves will be treated as capital in nature.
This means on payment of the cash flow boost out of the company during liquidation, it’s not treated as a dividend and should instead be included as consideration for the cancellation of shares under capital gains tax Event C2. Depending on the shareholder’s individual circumstances, this may mean that the distribution from the liquidator is effectively tax free in the hands of the shareholder.
Quarantine cash flow boost on the balance sheet
It’s important to quarantine the cash flow boost in separate reserve in the equity accounts on the balance sheet. This is to ensure the account is easy to identify when conducting tax planning and considering available options to access the company’s equity in a tax-effective manner, including via members’ voluntary liquidation.
If you’re unsure about the treatment of this, or if you have a client considering members’ voluntary liquidation, contact us today for advice.