Potential tax traps of the Fonterra capital share return

Shareholders have approved the sale of Fonterra’s Mainland Group to Lactalis which will return $3.2 billion to its shareholders on 14^th April. The amount returned is $2/share with Fonterra shareholders receiving an average payout of around $400,000. The payout has been confirmed to be tax free, so why are we making you aware of potential tax traps with the payment?

Although the money is tax free when received by the share owning entity, depending on the type of entity involved, the money could be taxed if withdrawing it to be used for personal purposes. For example, this could be for paying off debt on a beach house, or investing in your personal name, or helping the kids into their first home.

Most farming entities operate a company structure, therefore any withdrawal of company funds by the shareholders is either treated as a loan or must be offset with a shareholder salary or dividend. In this case, because it is a capital receipt for the company, it must be offset by a dividend (shareholder salaries are distributed from taxable profit). This is unless the shareholders have a large credit shareholder current account.

If treated as a loan from the company to the shareholder, it is subject to FBT interest rates. The current FBT interest rate is 5.77% which is usually higher than the bank interest rate. Its also a really tax inefficient way to withdraw funds as it creates taxable income for the company (interest received) but the interest expense is not tax deductible for the shareholders as the funds are used for personal reasons.

The alternative is to treat the withdrawal of funds as a dividend however this attracts quite a bit of extra tax. You could easily be paying an extra 11% tax without knowing (company 28% compared to 39% shareholder tax). When a dividend is declared there is 5% dividend withholding tax (DWT) that must be paid at the time, plus if the dividend causes the shareholders to go into the 39% tax bracket there is an extra 6% tax due at year end. This also affects provisional tax for the following year.

For example, if receiving a $400,000 payout there would be $112,000 of imputation credits attached to the dividend plus $20,000 of DWT paid at the time which attaches 33% of tax to the shareholder. However, if the shareholder is in the 39% tax bracket they must pay $24,000 terminal tax. This results in a net payment received for the shareholder of $356,000.  

An alternative and much more tax efficient position is to leave the funds in the company and use them to reinvest (eg. new machinery, farm development) or pay off debt. Then the entire $400,000 can be utilized and you aren’t losing $44,000 to tax.  

If the share owning entity is a trust (not very common) the funds can be distributed to beneficiaries as a tax free capital distribution however there needs to be the right documentation in place.

If the share owning entity is a sole trader or partnership there is no tax for withdrawing the funds for personal use as they aren’t considered separate legal entities like a company. These structures are less common though due to less flexibility with tax planning, asset protection and succession planning.

One final thing to note is that the 14^th April payment also includes a dividend of 14-18c per share from Mainland earnings prior to the sale which WILL be a taxable payout. It will have imputation credits attached to it to reduce the tax the share owning entity must pay.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.