Shareholders Agreement Australia: Tax Traps Founders Miss

The most expensive clause in a shareholders agreement is rarely the one founders argue about. It is the leaver clause, and the argument is usually about the discount percentage rather than the tax outcome.

Here is the problem. A departing shareholder can be assessed for capital gains tax on the market value of their shares even when the agreement forces them to sell for less. The Australian Taxation Office is not bound by the price two parties wrote into a contract. Under the market value substitution rule, it can replace that price with what the shares were actually worth.

Most guides to shareholders agreements are written from a drafting perspective. This one is written from the other side, which is what happens when the clauses are triggered and someone has to lodge a tax return. We are CPA accountants, not lawyers, so this covers the tax and valuation mechanics rather than how to draft the document itself.

What Is a Shareholders Agreement, and How Does It Differ From a Company Constitution?

Under section 140 of the Corporations Act 2001, a company's constitution has effect as a contract between the company, each member, and each director and secretary. A shareholders agreement sits alongside it as an ordinary commercial contract.

The practical difference matters when the two documents conflict. A shareholders agreement cannot override the Corporations Act, and it cannot force the company to do something its constitution prohibits. We regularly see agreements that promise a buy-back the constitution does not permit. If you are still deciding how to hold the business, our guide to choosing a company structure in Australia is the better starting point.

Why Does a Bad Leaver Discount Create a Capital Gains Tax Problem?

Selling shares triggers CGT event A1 under section 104-10 of the ITAA 1997. Ordinarily the capital proceeds are simply what you were paid. The market value substitution rule in section 116-30 is the exception.

Whether the rule bites depends on whether the parties dealt at arm's length. This is not settled by the fact that the price came from a contract. In Kilgour v Commissioner of Taxation [2024] FCA 687, the Federal Court found that genuine bargaining between the parties pointed to an arm's length dealing. Where a leaver price is imposed by a formula the departing shareholder has no ability to negotiate at the time of sale, that reasoning is harder to rely on.

Worked example: the $23,500 surprise

A Melbourne professional services company is worth $2,000,000. A founder holds 25 per cent, a parcel worth $500,000. She subscribed at incorporation and her cost base is $50,000. She resigns in circumstances the agreement classifies as a bad leaver, triggering a 20 per cent discount, so she is paid $400,000.

She receives $400,000 and is taxed as though she received $500,000. The 50 per cent CGT discount applies because she held the shares for more than 12 months. The 47 per cent rate assumes the top marginal rate plus Medicare levy.

She may qualify for the small business CGT concessions if the company passes the $6 million maximum net asset value test and she meets the significant individual requirement. That is a substantial if, and it is exactly the kind of question worth answering before the clause is drafted rather than after it fires.

How Is a Share Buy-Back Taxed When a Shareholder Exits?

Many agreements say the company will buy back the leaver's shares without addressing how the price is split. That split drives the tax outcome, and it is the ATO's principal concern with buy-backs, as set out in Practice Statement PS LA 2007/9.

Where the amounts are significant, the company can seek certainty from the ATO. Its guidance on class ruling applications for share buy-backs sets out the information required.

One point is often misunderstood. The 2022 change that removed the dividend component from off-market buy-backs applies to listed public companies only. Private companies are unaffected and still apply the capital and dividend split.

Market value matters here too. The ATO states plainly in its guidance on share buy-backs that capital proceeds cannot be less than the market value the shares would have had if the buy-back had not been proposed. A buy-back at a discounted leaver price does not escape the issue described above.

What Valuation Method Should a Shareholders Agreement Specify?

In our experience the disputes are almost never about the multiple. They are about the earnings base. Should the departing founder's above-market salary be added back? What about the one-off legal costs, the related party rent, or the research and development offset received in a single year?

Minority discounts deserve the same care. Applying a discount for lack of control is orthodox valuation practice, but a discount written into the agreement as a fixed percentage is a commercial term, not a valuation conclusion. That distinction is what attracts the market value substitution rule. Our startup accounting and advisory team sees this most often at the first external raise. Our business valuation services and our guide to valuing a business before retirement both cover the methodology in more detail.

We recommend naming an independent valuer in the agreement and specifying that the valuation is made on a stated basis at a stated date. Naming the valuer in advance removes one of the most common deadlocks.

Can a Company Fund a Share Purchase Without Triggering Division 7A?

This is the trap in agreements that leave the funding mechanism open. The remaining shareholders often have no cash, so the company pays. If the company buys the shares itself, that is a buy-back and follows the rules above. If the company lends money to the remaining shareholders, Division 7A applies.

A complying loan needs a written agreement, interest at or above the benchmark rate, a maximum term of seven years unsecured, and minimum yearly repayments. Miss a repayment and the shortfall is assessable to the shareholder without franking credits. Modelling this properly is part of what our three-way forecasting service is for, because a seven year repayment obligation changes the company's cash position materially.

When Can a Company Actually Pay a Dividend?

This is commonly described as a solvency test, which understates it. The three-limb test in section 254T replaced the former profits test in 2010, and assets and liabilities must be calculated in accordance with accounting standards.

Dividend policy clauses matter for shareholders agreements because a minority holder relying on distributions has little protection if the agreement says only that dividends are declared at the board's discretion. Where shareholders want different distribution outcomes, the structure itself may need attention. The ATO sets out how dividends paid in compliance with section 254T are taxed in Taxation Ruling TR 2012/5. Our comparison of share classes and discretionary trusts for distributing company profits sets out the options, and ongoing tax planning should test the policy each year.

Which Clauses Need a Tax Review Before You Sign?

These are the eight clauses we look at first when a client sends an agreement across. Each raises a question the drafting alone will not answer.

The last one is administrative but frequently missed. Changes to a company's share structure or member details must be notified to ASIC using Form 484, generally within 28 days, and late lodgement attracts fees. Keeping that current is part of the tax and corporate compliance work we handle for company clients.

Key Takeaways

• A contractual sale price does not determine the taxable amount. Section 116-30(2) can substitute market value.
• Private company buy-backs still split into capital and dividend components. The 2022 change applies to listed companies only.
• Define the earnings base in the valuation clause, not just the multiple.
• Company funding of a share purchase needs a complying Division 7A loan at 8.77 per cent for the year ending 30 June 2027.
• Notify ASIC of share transfers within 28 days using Form 484.

Frequently Asked Questions