A shareholders agreement decides who gets paid what on exit. It does not decide how that payment is taxed. Discounted leaver prices, share buy-backs and company-funded share purchases can each produce a tax bill larger than the cash received. Review the exit clauses with your accountant before you sign, not after someone leaves.
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.
A shareholders agreement is a private contract between the shareholders of a company, covering voting, share transfers, exits and dispute resolution. A constitution is a public governance document that binds the company and its members by statute. The agreement is confidential and can be amended by the parties; the constitution is lodged and generally requires a special resolution to change.
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.
Because the price in the agreement is not necessarily the price used for tax. Section 116-30(2) of the ITAA 1997 replaces capital proceeds with market value where the proceeds differ from market value and the parties did not deal at arm's length. A shareholder forced to sell at a discount can be taxed on the full undiscounted value.
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.
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.
| Step | Deed price accepted | Market value substituted |
|---|---|---|
| Capital proceeds | $400,000 | $500,000 |
| Less cost base | $50,000 | $50,000 |
| Gross capital gain | $350,000 | $450,000 |
| After 50% CGT discount | $175,000 | $225,000 |
| Additional tax at 47% | Nil | $23,500 |
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.
In a private company, an off-market buy-back is split into a capital component and a dividend component. Only the amount debited to the share capital account is treated as capital proceeds. The balance is a dividend, which may be franked and is assessable to the exiting shareholder as income rather than a discounted capital gain.
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.
One that can be applied without further negotiation. A workable clause names the earnings measure, the period averaged, the normalisation adjustments, the multiple or the method for setting it, the treatment of surplus assets and debt, and who values the company if the parties disagree. A clause that says only "maintainable earnings times a multiple" will be argued about.
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.
Only if the funding is structured correctly. Where a private company lends money to a continuing shareholder so they can buy out a departing one, Division 7A of the ITAA 1936 can treat the loan as an unfranked deemed dividend unless a complying loan agreement is in place. The benchmark interest rate is 8.77 per cent for the year ending 30 June 2027.
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.
We review the exit, valuation and funding clauses for tax consequences before you sign, and work alongside your lawyer on the drafting.
Contact our Chadstone officeSection 254T of the Corporations Act 2001 sets three tests, all of which must be met. The company's assets must exceed its liabilities immediately before the dividend is declared, with the excess sufficient to pay it; the payment must be fair and reasonable to shareholders as a whole; and it must not materially prejudice the company's ability to pay its creditors.
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.
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.
| Clause | The tax question it raises |
|---|---|
| Leaver pricing | Does the discount expose the seller to market value substitution? |
| Valuation method | Is the earnings base defined tightly enough to apply without dispute? |
| Buy-back mechanism | How is the capital and dividend split determined, and who decides? |
| Funding of transfers | Will company funding create a Division 7A loan? |
| Drag-along rights | Do dragged shareholders lose access to small business CGT concessions? |
| Dividend policy | Can the company satisfy all three limbs of section 254T? |
| Employee equity | Are option and share scheme holders caught by the transfer clauses? |
| Reporting obligations | Who lodges the ASIC notification within 28 days of a transfer? |
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.
Book an initial meeting with our CPA team to review the tax and valuation consequences of your agreement.
Book an initial meetingDisclaimer: The information provided in this article is general in nature and does not constitute specific tax, legal, or financial advice. Drafting a shareholders agreement is legal work and should be undertaken by a qualified lawyer. We recommend seeking professional advice tailored to your individual circumstances. 42 Advisory is a CPA firm and Registered Tax Agent.
No. A proprietary company can operate with only a constitution or the replaceable rules. A shareholders agreement is optional, but without one there is no agreed process for share transfers, exits or deadlocks.
No. It is a private contract and is not lodged. A company constitution is a different matter, and changes to share structure or member details must be notified to ASIC using Form 484, generally within 28 days.
These are commercial terms, not legal categories. A good leaver typically exits for reasons such as retirement or illness and is paid full value. A bad leaver exits in circumstances the agreement penalises and is paid a discounted price. The definitions vary between agreements.
Not directly. The constitution binds the company and its members under section 140 of the Corporations Act 2001. A shareholders agreement binds only the parties to it. Where the two conflict, the company cannot act contrary to its constitution, so the documents should be aligned.
It depends on the purpose. Costs of a capital nature, such as establishing the equity structure, are generally not deductible under section 8-1 of the ITAA 1997 but may form part of a cost base or be deductible over five years under section 40-880. Advice on the specific expenditure is recommended.