We all know selling or planning to sell a business brings with it many considerations, and that the likely tax outcomes are key among those factors.
Whether or not tax is payable (and how much tax) on the sale of a business can make a huge difference to the amount of cash that business owners walk away with.
Choices can, however, be made that reduce or eliminate the final tax bill, if the planning starts early enough.
Read on for MWM Advisory’s summary of the landscape and list of worthwhile tax-related considerations around the sale of a business.
Selling a business or the underlying ownership of a company
Because companies are not eligible for the 50 per cent capital gains tax (CGT) discount, it is better from a taxation perspective for individual owners to sell their shares in a company that is carrying on a business, than for the company to sell its business and then distribute the proceeds.
The flip side to this however is that the company continues to exist and as a result, the new owners may want specific amounts of protection against any of the company’s historical trading liabilities.
It is important to note this can differ dependant upon whether or not the trading business may instead be a sole trader or fixed/discretionary/family trust where the 50 per cent CGT discount can apply.
Small business CGT concessions
Small business CGT concessions are extremely valuable for businesses that meet the required conditions, and can allow the CGT on a business sale to be eliminated or at least substantially reduced.
The concessions can be used when a business has either ‘aggregated annual turnover’ or less than $2 million (the small business entity (SBE) test) or total net assets of less than $6 million (the net asset value (NAV) test), subject to certain grouping rules involving related entities and individuals.
The NAV test includes assets of controlling individuals, but specifically excludes the family home, superannuation balances and personal use assets, such as boats, cars and holiday homes.
Provided one of the above tests are satisfied (SBE turnover or the NAV test) the four concessions are generally dealt with in this order:
1. The 15-year exemption:
This is the holy grail of exemptions and ensures if your business has been continuously owned for 15 years and you are over 55 and retiring, then you will not have an assessable capital gain when the business is sold.
2. The 50 per cent active asset reduction:
If you have owned your business for greater then 12 months and you satisfy the SBE turnover test above or the NAV test above, the capital gain on sale will be reduced by a further 50 per cent.
3. The retirement exemption:
The retirement concession can be used by those aged under 55, but the difference is that the amount of the concession must be paid into a super fund, and many people are not prepared to do that as they need access to the entire sale proceeds. This amount currently has a lifetime cap of $500,000.
4. The small business rollover:
The small business rollover allows you to defer all or part of a capital gain for two years, or longer if you acquire a replacement asset (business) or incur expenditure making capital improvements to an existing asset (business).
Other tax considerations
Another key point is to look at the level of retained profits and associated franking credits in the operating company.
It is common where a share sale agreement exists to require any profits to be paid out as dividends to the existing shareholders prior to settlement.
So it is worthwhile planning to make dividend payments over a number of years rather than being stuck paying large dividends just before the sale, most of which may attract the top marginal tax rate. Even after franking credits, there could be a ‘top-up tax’ of up to 23 per cent.
A related issue that follows on from this is the ownership structure of the operating business and how any sale proceeds are to be distributed.
This is where it is important to have the correct underlying ownership structure of your business as and when it is established.
For example, if several entities own shares, then any dividends will be split among all the shareholders, and it could be more likely that at least some of the payments will be taxed at lower marginal rates.
In our experience, the cleanest and most effective approach is where all the shares are owned by a family discretionary trust or, if more than one family is involved, then multiple family trusts.
This provides maximum flexibility, allowing dividends to be paid up to the family trust(s) and distributed among various family members each year as appropriate, and makes satisfying the small business CGT concessions simpler.
For more information about tax considerations around the sale of a business, family trusts and structuring your enterprise for maximum benefit, call us on 07 5596 9070.