A company’s sale of a pre-CGT property may be tax-free to the company – but that does not automatically make the cash tax-free when it reaches the shareholder. How the proceeds are extracted can be the difference between no tax and tax at the top marginal rate potentially with penalties and interest.
This is a frequent and costly misunderstanding in private companies that have held property since before 20 September 1985.
The two-taxpayer problem
When a company sells an asset, there are two separate tax questions:
Is the company taxable on its profit from selling the property?
Is the shareholder taxable when value is extracted from the company?
A property acquired by a company before 20 September 1985 may be a pre-CGT asset. Subject to important qualifications – including any relevant changes in majority underlying ownership – the company’s gain on disposal can be disregarded for CGT purposes.
But the company and its shareholders are legally and fiscally separate. A tax-free gain inside the company is not a general licence for shareholders to withdraw the resulting cash tax-free.
The key question is not simply whether the property sale was exempt. It is: what is the legal and tax character of the payment made to the shareholder?
When the distribution may be tax-free
The classic pathway is a properly conducted winding-up, ordinarily a solvent members’ voluntary liquidation.
Where a liquidator distributes an amount attributable to a company’s profit on the disposal of a pre-CGT asset, the distribution may avoid treatment as a dividend under section 47 of the Income Tax Assessment Act 1936. The distribution is then treated as capital proceeds in relation to the ending of the shareholder’s shares: CGT event C2. If the shareholder’s shares themselves are pre-CGT shares, any resulting capital gain can generally be disregarded.
In simple terms, the potential 0% result usually depends on a chain of conditions:
Requirement | Why it matters |
The company’s property was genuinely pre-CGT | The company-level gain must retain its pre-CGT character; Division 149 and changes in majority underlying interests require careful review. |
The amount is distributed by a liquidator in the course of winding up | The timing and mechanism of extraction matter. The ATO expressly notes that a pre-CGT capital gain may retain exempt status when distributed by a liquidator but can lose that outcome if distributed before liquidation. |
The distribution is properly identified and documented | The company’s accounts, resolutions, capital profits reserve, liquidator’s records and distribution statements need to support the character claimed. |
The shareholder’s shares are pre-CGT | Even if a distribution is capital proceeds on liquidation, the shareholder-level CGT exemption depends on the shares being acquired before 20 September 1985, subject to the relevant rules. |
Other assets, profits and liabilities are dealt with properly | A liquidation distributes the whole company estate—not merely the attractive pre-CGT cash balance. |
This is not simply a matter of calling a payment “capital”, “return of capital” or “pre-CGT profits”. The substance, source, corporate steps and legal route of the payment matter.
The risky alternatives
If money is withdrawn before liquidation, or outside a genuine and correctly implemented liquidation process, the outcome can be very different.
An unfranked dividend
A payment may be an ordinary dividend, assessable to the shareholder. If the relevant amount is not backed by franking credits, the shareholder may face tax at their marginal rate without any offset for company tax.
For an Australian-resident individual already at the top marginal rate, the practical combined burden can be severe. The headline individual rate is often described as 47% when the 45% top marginal rate and 2% Medicare levy are taken into account, subject to the individual’s circumstances.
A Division 7A deemed dividend
Where a private company makes a payment, loan, advance, debt forgiveness or otherwise provides value to a shareholder or associate, Division 7A must be considered. Its purpose is to prevent private-company profits being accessed tax-free through informal drawings or loans. Division 7A deemed dividends are generally unfranked.
A “temporary loan”, shareholder current-account debit, payment of private expenses, or withdrawal labelled as an advance can therefore become a tax problem rather than a solution. The precise outcome will depend on the company’s distributable surplus, the nature and timing of the transaction, whether a complying loan agreement is in place, minimum yearly repayments and other Division 7A rules.
A poorly documented capital payment
Even a payment intended to be capital may not achieve its intended treatment if the steps, documentation or source analysis are deficient. Corporate law requirements, accounting treatment, solvency, tax characterisation and the application of anti-avoidance provisions need to be considered together – not in isolation.
