Share Transfer vs Share Buy Back – what’s the difference?

Where two or more unrelated shareholders trade through a company, there often comes a time where they part ways, presenting a need for one of the shareholders to exit the company. Broadly, this can be achieved either by the departing shareholder selling his shares to the remaining shareholder, or alternatively by the company itself buying back the shares held by the departing shareholder.

For example, assume Mike owns 80% of 4WD Pty Limited, while Mal owns 20%. The company has operated a successful travel business for 25 years. Mal has decided to retire and wants to extract his interest in the company.  The way the two alternatives might apply are described below:

  1. Share Transfer of shares owned by Mal to Mike
  • Once a value is put on the business group (including all assets within the company group), Mike pays Mal for 20% of this value by way of a signed share transfer between them.
  • There is no stamp duty on this transfer in NSW after the law change from 1 July 2016
  • Mal would then have a Capital Gain in his hands on which he may pay CGT. The amount would depend on his circumstances. He would get the 50% general discount for holding the shares for more than 12 months. Depending on eligibility, he may then get the CGT Small Business Concessions (SBC) as well which could allow him to possibly get the CG down to Nil. Access to the SBC is quite strict and depends on what assets he has in his, and connected entity’s hands. A proper review of this would need to be made to determine if he was able to access them.
  • If he is not eligible for the CGT SBC’s, and he was paying tax at the highest marginal tax bracket, Mal would then pay a maximum of 24.5% tax on the gain. If he was on lower marginal tax rates then this tax figure would be lower (essentially it is half his marginal tax rate)
  • The benefit or otherwise for Mike in paying Mal for his shares depends on how he funds the payment. If he were to want to use funds within 4WD Pty Limited to pay him then there will be tax ramifications in getting these funds out to allow this to happen (ie if by dividend then there would be tax on it as it came out). If this was the case then the Buyback method below may be a better option.
  1. 4WD Pty Limited does a Buyback of Mal’s shares from him
  • This is effected by way of paperwork being done with ASIC to buyback the shares from Mal. This is a more complex way of doing the transaction and it will cost more in professional time to effect the transaction.
  • The amount paid to Mal would then be treated mainly as a dividend from 4WD Pty Limited with franking credits attached.
  • The main advantage of this method is that funds from the business group itself can be used to buy Mal out meaning it is effectively done in partly pre tax dollars.
  • The tax effect in Mal’s hands really depends on his circumstances. It would depend on what amount he received for the sale, and what his marginal tax rate is. If he was in the highest tax bracket then the top up tax payable on a dividend would be 27.14% at today’s tax rates. If he was on a lower marginal tax rate then this figure would decrease.

Summary

A share transfer is the simpler option and would often be the obvious choice.   Although a buyback adds complexity, it becomes attractive where it is necessary to use cash that belongs to the company itself to implement the transaction as it avoids the need for the remaining shareholder to borrow from the company to purchase the shares.

Two situations are rarely identical, and it is always necessary to take specific advice that considers your own circumstances.