Selling Shares in a Start-Up: Key Tax Considerations

When structuring a start-up, one of the most common challenges founders face is how to value and sell shares to incoming investors.

The Scenario

A client plans to establish an IT company with 1,000,000 shares split between classes A and B. The company would begin with issued capital of just $100, meaning each share has a nominal value of $0.0001. The founders intend to raise funds by selling 5% of the shares for $500,000. Understandably, this raises concerns about how such pricing aligns with corporate law and tax implications.

Key Considerations

1. Issuing shares at a premium

   • Selling shares to an unrelated party in an arm’s length transaction is generally not problematic, even if the price is significantly above the nominal share value.

   • The direct value shifting rules may apply when shares are issued at a discount, but issuing shares at a premium does not normally trigger these rules. The ATO has addressed a similar scenario in ATO ID 2003/890.

   • The main risk lies in whether the cost base for capital gains tax (CGT) purposes is reduced to market value if the transaction is not conducted at arm’s length (s112-20 ITAA 1997). In genuine commercial negotiations, this is less likely to be an issue.

2. Current shareholders selling existing shares

   • If instead of issuing new shares, the founders sell part of their existing holdings, this would trigger a taxing event for them.

   • Any gain would need to be assessed for CGT, and depending on the circumstances, concessions such as the 50% general discount or small business CGT concessions might apply.

3. Different share classes

   • Having multiple share classes (e.g., A and B) introduces additional complexity.

   • This structure can make it more difficult to access small business CGT concessions and may complicate distributions or control tests. Each case needs to be reviewed carefully.

     
     

Professional opinion:

Raising capital by selling shares at a premium can be legitimate if conducted at arm’s length. However, the tax consequences differ depending on whether new shares are issued or existing shares are sold. Founders must also be cautious about the use of multiple share classes, as this can impact future access to tax concessions. It is strongly advisable to obtain an independent valuation to support the share price and to engage tax and legal advisers early. This ensures compliance, strengthens investor confidence, and mitigates the risk of future disputes with the ATO.