Advivo Partner, Dale Edwards, explains the areas where tax can occur during the sale of your business
When people hear about the Small Business Capital Gains Tax Concessions, they often assume that when they sell their business that there will be no tax. Whilst in some instances that is the case, it is more usual that there is some aspect of tax that occurs due to the sale. This blog won’t be going into the mechanics of the Small Business Capital Gains Tax Concessions and will instead focus on the other areas where tax can occur.
The first relevant question to determine if there are any tax aspect is what is being sold. Only the business, or the “structure” or shell that contains the business (e.g., a company)?
When selling the structure
This pathway involves much more due diligence for the buyer and, because of this and the associated risks that they may take on, it is not a pathway that is used very often for smaller businesses.
The key tax considerations to this pathway are:
- Capital gains tax on the sale of the shares (if a company) or units (if a unit trust structure). This can sometimes be reduced to zero if the Small Business Capital Gains Tax Concessions are met, or at a minimum reduced by 50% assuming they have been owned by the seller for more than 12 months.
- Any dividends paid out prior to the transfer. Often long-established businesses that have been trading profitable will hold more assets that are required to cover their working capital needs. This surplus often gets paid out as a dividend to the selling owners just before ownership transfers. These dividends will be taxed to the shareholding entity at their respective tax rates.
- Removing “private” assets such as personal use cars of owners, or other non-business-related investments from the entity. This involves tax implications to that entity that a buyer will generally want to have covered by the seller.
Selling the business and keeping the structure
Businesses hold several different assets such as stock, plant & equipment, intellectual property (IP) such as patents and trademarks, debtors, and goodwill. Not all of these are taxed identically. When a business is being sold, there needs to be some sort of apportionment of sale proceeds made between these different assets.
If not all assets of the business are being sold, then the sale may not qualify for the Going Concern exemption from GST. This means that in the short term the purchaser may have to find additional funds to pay 10% GST to the seller on top of the agreed sale price, which the seller then needs to pay to the ATO.
The inventory component of the sale is generally clearly specified in the sale agreement as being at either cost or market value. This component is clearly determined and taxed the same as regular trading income would be taxed.
Debtors, if being sold with the other business assets, are treated as a collection of monies owed, so there would be no income tax on these as that has already been dealt with when the invoice was raised. There may be a GST taxing point though if the seller is on a cash basis for GST.
Plant & equipment such as cars, machinery, and other similar physical assets that decrease in value over their life are not subject to capital gains tax. On a sale, there is simply a taxable amount equal to the amount they are being sold for less the written down tax value. Given that in recent years it has been possible to write off quite expensive assets of this type immediately for tax purposes, that can mean that there may be a meaningful amount of tax to pay on the sale of these business assets.
It often surprises people to learn that IP assets such as trademarks and patents are treated in the same way as plant & equipment for tax purposes. They have a definable lifespan (unless they are an internationally recognised IP such as, for example, Coke or Nike). If the business being sold holds IP of meaningful value, then this should be taken into consideration on a sale as these are often internally generated products and so the tax would be due on the full sale price.
Lastly, we come to Goodwill. This is the element that is treated as a capital gain on sale, with all the potentially wonderful tax-saving concessions that may be available.
You may be wondering why the seller doesn’t specify low values for the taxed elements of the business in the sale contract so that the bulk of the proceeds are able to benefit from the lower tax impact. The thing is that the buyer would prefer for the other assets (such as plant & equipment) to have a higher sale price so that they benefit more from ongoing depreciation deductions.
This results in the usual process in sale contracts where the apportionment is not broken down (except for inventory), allowing both parties to make their own assessment of the values of each component. Provided that these assessments are reasonable and reflect market prices, that party would survive a review from the ATO relating to the transaction.
I’ve sold my business and I am left with a structure I don’t want anymore
Closing a structure that has existed and had a business running through it, is not as straightforward as lodging a form with ASIC. There are tax implications that happen and need dealing with. These can often end up meaning that the company needs to be liquidated to achieve the best tax outcome, especially if Small Business Capital Gains Tax concessions have been used in the sale, or if the business has received tax-free amounts in its lifespan such as Cashflow Boost. Otherwise, the closure may result in the taxation of these amounts at the shareholder level.
Any historic retained profits would need to also be paid out as dividends. As is always the case, these dividends are subject to tax. This can sometimes mean that it is more beneficial to delay the closure by several years to spread these dividends out and achieve a lower tax rate on them.
It’s always a good idea to work through this process with us at Advivo, as it does take some time to work through all the steps involved. Please contact us today to find out how we can assist in achieving the lowest tax outcome for you.