Are you looking to sell your business? Here are some tax tips for Australian residents.
What is the process like for selling a company in Australia? You’ll need an accountant and lawyer but also need to get other things in order before listing it on the market. For example, if you’re going through a type of sale such as an asset sale or share buyback – both will require shareholders’ approval.
For starters: what is considered taxable income when selling a business? The Income Tax Assessment Act 1997 (ITAA) sets out how this applies. This blog post covers some basics about taxation and offers advice on preparing yourself financially before embarking on such a journey. Read more below!
The Australian Taxation Office is a government agency that provides tax information and advice for people living in Australia. This article contains a list of helpful tips on preparing your business so you can sell it quickly and efficiently.
Throughout the course of my entire life, I have always been passionate about entrepreneurship. Ever since I was young, I would watch my dad build up his company from scratch, which has really inspired me throughout the years. However, as time went on, he eventually decided to retire and sell off his business – something which brought us both great joy (and relief!).
How To Make The Sale Of Your Business As Tax Effective As Possible
What Tax Will I Pay When Selling My Business?
When it comes time to sell your business, you want to make sure you’re getting what it’s worth. After all, you’ve built the business to where it is today, so you want to see the fruits of your labour.
But selling your business comes with its own tax considerations, which you shouldn’t try to navigate without the help of an expert.
General Tax Rates When Selling Your Business
For tax purposes, selling your business is considered part of your business’ income, so the sale of your business is taxed under the appropriate tax rate for your business structure.
Sole Traders And Trust Structures
Given that you’re selling a business, you’re likely to be making a substantial sum on its sale. This means that depending on the sale price, you’ll generally be charged a tax rate from one of the highest individual tax brackets.
Taxable Income Tax rate on your income
$90,001 – $180,000 $20,797 plus 37% on each $1 over $90,000, + 2% Medicare levy
$180,001 and over $54,097 plus 45% for each $1 over $180,000 + 2% Medicare levy
Understanding Capital Gains Tax
Regardless of your structure, selling your business is considered to be selling an asset. This means you make a capital gain on this sale, which means you have to pay capital gains tax.
Put simply, a capital gain refers to the profit you make on the sale of an asset.
So if you sell your business for more than what it cost to start, this means you’re making a capital gain on the sale of your business. This triggers a capital gain event, which attracts capital gains tax (CGT).
The amount of CGT you pay on your business sale depends on five things:
- How much it cost you to start the business—your cost base. If you purchased your business, then the price you paid is your cost base. If you started the business yourself, essentially ‘from nothing’, your cost base may be a low as $0.
- The sale price of your business.
- The tax structure your business exists under. Some structures have the ability to minimise tax better than others.
- The tax concessions for which your business is eligible. There are a number of tax concessions that can dramatically reduce the tax you pay, which we discuss below.
- The amount of income you earned for the financial year in which you sold the business.
Let’s look at an example.
John started his accounting business himself and has grown his client base, so he now earns an annual salary of $200,000. However, he is taxed at the nominal 47% tax rate.
John decides it’s time to sell his business and sells it for $500,000 to an interested buyer. As he started his business for $0, he has now triggered a $500,000 capital gain on its sale.
Because the capital gain is added to his personal income, the capital gain is taxed at 47%, which adds a potential $235,000 to John’s taxable income.
This is why it’s important to undertake the right planning when selling your business.
Tax Minimisation Strategies When Selling Your Business
When done correctly, the available CGT tax concessions can enable you to minimise the tax you pay on the sale of your business. In some cases, you may even be able to reduce the tax down to $0.
There are a number of tax concessions available to qualifying small businesses to help reduce the burden of your CGT.
You qualify as a small business if:
- You have a turnover of less than $2 million, or
- You net assets are less than $6 million.
Then, you’re able to access the following CGT concessions.
For individuals, sole traders, and trusts that have owned their business for 12+ months, you receive a 50% reduction on the CGT amount of your sale.
If you’re 55 or older, you’re retiring, and you’ve owned your business continually for 15+ years, you’re eligible to disregard the entire CGT amount on the sale of your business.
An ‘active asset’ is one that’s been active and operational for at least half the time you’ve owned it. For example, a business is considered an active asset.
When selling an active asset, you’re entitled to a 50% reduction on the CGT on the sale.
This exemption allows you to disregard up to $500,000 of your capital gain. If you’re under 55, the capital gain amount must be deposited in your nominated super fund. If you’re over 55, you receive the capital gain completely tax-free.
If selling an active asset, you can choose to roll the capital gain over into a replacement asset. This reduces the cost base of the new asset by the rollover amount.
Tax Minimisation Strategies For Companies Selling The Business
There are a number of CGT concessions available to businesses operating under a company structure:
- If your company is sold as part of a share sale, then it qualifies for the first 50% CGT reduction. However, if sold as an asset sale, then it’s not eligible for the first 50% CGT reduction. More on this below.
- If you’re aged 55 or older, retiring, and you have continuously owned your company for 15 or more years, you’re completely exempt from CGT on the sale.
- If your company is considered an ‘active’ asset, you’re only required to pay 50% of the capital gain tax.
- When selling your company, if you’re under 55 and retiring, you can receive up to $500k of the capital gain tax-free if you pay this money directly into your super.
- When selling the company and founding/purchasing a new one, you can defer the current capital gain into the following financial year.
Asset Sale Vs Share Sale: What This Means
Companies have the option to sell the business as an asset or sell its shares.
- A share sale means the purchaser is buying shares in the company, essentially buying the company itself. Thus, the company’s legal entity belongs to the new owner, but the seller is able to keep the business’ assets.
- An asset sale means the company’s assets are purchased, which includes things like stock, property, or land. However, the seller still owns the company’s legal entity.
While an asset sale is more straightforward, it can be considered more tax-effective for a company to undertake a share sale. This means the new owner is now accountable for all the business’ liabilities.
The Importance Of Advanced Planning
When selling your business, the importance of advanced planning can’t be understated. The further ahead you plan, the better prepared you’ll be to take advantage of CGT minimisation strategies.
In some cases, this planning can begin when you first set up your business. This provides you with the opportunity — where practical, of course — to choose a structure that makes you eligible for CGT concessions.
If you know from the outset that your business will grow and a company structure is appropriate, look at holding your shares in a family trust. This may qualify your company for the first 50% CGT concession.
If you already have an established business, take the time to plan your sale strategy carefully. If the sale rate is likely to tip you over the $6 million net asset test, therefore disqualifying you from the first 50% concession, consider lowering your price to accommodate.
Tax Tips For Selling Your Business
There are many taxation issues that may arise when selling your business. While there is no magic bullet to maximise your tax position for every business sale, there are some key points that may prove to be money-savers if you factor them into your sale negotiations, writes Eddie Chung.
The following points will help clear up some common misunderstandings and oversights when it comes to selling a business and ensure you receive the best possible value for the asset you have worked hard to build up:
Do Not Apportion The Sale Price Across Various Assets On The Contract
It is likely that maximising or minimising the values associated with certain assets (e.g. trading stock, depreciating assets) to optimise your tax position may deteriorate the purchaser’s tax position.
Avoiding contractually attributing set values to the assets enables the parties to attribute independent values to those assets based on a reasonable allocation and apportionment of the total transaction value across all of the assets sold. This affords both parties some flexibility to independently optimising their respective tax positions.
Delay The Contract Date Where Possible If The Agreement To Sell Is Near The End Of The Financial Year
For capital gains tax (CGT) assets – which include assets such as goodwill and real property – the CGT event associated with their sale is generally crystallised on the date of the contract rather than the settlement date.
Therefore, delaying the contract from, say, 30 June 2016 to 1 July 2016 will have the effect of delaying any CGT payable on the sale for 12 months. -Thus, taxdeferred is tax saved.
Negotiate To Make A Separate ‘accrued Leave Transfer Payment’ To The Purchaser Where Possible
This is because the payment will be tax-deductible to you as the seller. This contrasts with the situation where the unpaid leave liabilities are adjusted against the overall sale price of the business, which may reduce your CGT instead.
Given the potential application of the 50 per cent CGT discount and/or other CGT concessions, the tax benefit associated with paying the unpaid leave employee entitlement and claiming a tax deduction for it is likely to be significantly greater than the tax benefit from reducing the sale price of the business by the liabilities assumed by the purchaser.
A word of caution, though: specific conditions must be satisfied before the payment is treated as an ‘accrued leave transfer payment’.
For instance, the payment must be made to another entity that has begun (or is about to begin) to be required to make payment in respect of the leave liability under an Australian law, award, order, determination or industrial agreement.
Therefore, if you are selling your trading entity to the purchaser and that entity will continue to be liable for the payment of the leave liability in future, the payment may no longer qualify as an accrued leave transfer payment.
Consider If There Are Ways To Pass On Any Carried Forward Tax Losses You Have Incurred During The Course Of Your Ownership Of The Business To The Purchaser
Doing so gives you negotiation leverage and potentially increases the sale price. However, be mindful that the ability of the purchaser to use those tax losses will depend on a number of factors.
For instance, as tax losses are attached to the particular entity that incurred the losses, the purchaser will need to purchase the trading entity to acquire those losses; certain conditions associated with the loss recoupment rules for the specific type of entity must also be satisfied for the losses to be available to the purchaser.
Further, being able to sell your interest in the entity (e.g. shares in a trading company), rather than selling your business out of the entity, may also enable you to access other concessions, such as the 50 per cent CGT discount, that would not otherwise be available.
Suppose the purchaser is reluctant to buy the entity and inherit the historical trading risks of the business. In that case, you may consider offering contractual warranties over a finite future period to provide indemnities to the purchaser if those risks materialise.
Sometimes reducing the purchase price works too, if the price reduction is more than compensated for by tax concessions that would not otherwise be available.
Do Not Forget To Apply Available Tax Concessions That Allow You To Legally Reduce Your Tax Bill On The Sale Of Your Business
The most common concession is perhaps the 50 per cent CGT discount, which allows you to reduce the capital gain on the sale of a CGT asset by half, provided that the business asset has been held by an individual or a trust for at least 12 months before sale.
In addition, the ‘small business CGT concessions is a suite of extremely potent CGT concessions that have the potential to substantially reduce or even eliminate your CGT liability altogether if your aggregated group net asset value is less than $6 million (excluding your main residence and superannuation benefits) or your aggregated group turnover is less than $2 million.
Special rules apply to how you calculate these amounts and which entities within your group are to be included.
Proceed with caution if you are applying these concessions – these rules can be complex and prescriptive, so you need to ensure that you ‘tick every box’ to qualify for the concessions. Getting them wrong may lead to the Tax Office coming back to you later on to deny your claim.
For completeness, under the ‘look-through approach’, if you structure the business sale so that you get paid by the purchaser in instalments that are dependent on the future performance of the business (commonly known as an ‘earn-out arrangement’), those future instalments may also qualify for any CGT discount or small business CGT concessions that may have been claimed when the business was sold.
For instance, under the ‘supply of a going concern’ GST-free treatment, if you sell everything that is necessary for the purchaser to continue the operation of your enterprise (or part of an enterprise), it is likely that the business sale will not attract GST, despite the fact that you are the ‘supplier’ in the transaction.
Again, the devil is in the detail, so you need to ensure that the way you structure the sale will enable you to access the exemption (for example, if you sell the business and business premises to separate entities that belong to the purchaser).
As a precautionary measure, it is always advisable to incorporate a ‘GST recovery clause’ on the sale contract to enable you to recover any GST from the purchaser if the Tax Office subsequently decides for whatever reason that you were not eligible to apply the GST exemption.
The sale of a business may seem reasonably straightforward, but this is often not the case when you get down to the detail. Therefore, it is always advisable to involve your lawyer and accountant to guide you through the sale and ensure that they work together to achieve the best result.
In particular, all draft contracts and agreements should be reviewed by your accountant from a tax perspective to ensure that you legally minimise your tax liability and maximise the return on all your blood, sweat and tears in building the business up for sale.
Tax Considerations When Selling A Business
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 end up with. However, there are often choices that can be made to reduce or eliminate the final tax bill if the planning starts early enough.
Selling Business Or Company?
This is often the first question that comes up and can be a critical one. In general, individual owners should sell their shares in a company carrying on a business than for the company to sell its business and then distribute the proceeds because companies are not eligible for the 50 percent capital gains tax (CGT) discount.
Of course, not every buyer is prepared to acquire the company, and that is a matter for negotiation, but if sellers understand just how much tax is at stake, they might not give up the argument quite so easily, and it may be possible to find a way to do the deal on the basis of a share sale that satisfies both parties.
The small business CGT concessions are extremely valuable for businesses that meet the required conditions and allow the CGT on a business sale to be eliminated or substantially reduced.
The concessions are applied after the CGT discount and, while there can be tax savings when the concessions are used by a company selling its business assets, they usually provide greater benefits under a share sale, and its easier for the shareholders to access the funds.
The concessions can be used when a business has either “aggregated annual turnover” of less than $2m (the SBE test) or total net assets of less than $6m (the NAV test), subject to certain grouping rules involving related entities and individuals. For example, 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).
Two additional criteria apply to share sales:
Firstly the shares must be sold by an individual with a direct or indirect interest of at least 20 percent in the company carrying on the business (a “significant individual”), or if the shares are sold by a company or trust, then certain other specific rules must be satisfied.
Secondly, the relevant company must satisfy the “active asset” test under which at least 80 percent of the company’s gross asset values have been represented by business assets for at least half the period of ownership (except if the business has been carried on for more than 15 years, the test need only be satisfied for 7.5 years in total).
For this test, non-business assets will include passive investments, loans to shareholders and (in some cases) large cash balances that are not needed for carrying on the business.
The retirement concession can also be used by those aged under 55, but the difference is that the amount of the concession (in this case $500,000) 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.
An alternative is to reinvest the $500,000 into another active asset, including shares in a company carrying on a business, as long as they qualify as a significant individual with an interest of at least 20 percent, but again that does not suit every situation.
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 for a share sale agreement 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 is a “top-up tax” of around 23 percent.
A related issue is the ownership structure of the operating company.
If one individual owns all of the company’s shares, they must receive all of the dividends.
If several entities own shares, then any dividends will be split amongst all the shareholders, and it is more likely that at least some of the payments will be taxed at lower marginal rates.
However, be wary of having separate classes of shares with special dividend rights, as this can make applying the small business CGT concessions on a sale much more difficult.
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 then distributed amongst various family members each year as appropriate, and makes satisfying the small business CGT concessions quite simple.