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. 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 it is better for individual owners to 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 can allow the CGT on a business sale to be eliminated or at least 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. 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).
There are two additional criteria that 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 “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 shares in the company, then they must receive all of the dividends.
If, however, 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.
Be wary of having separate classes of shares with special dividend rights, however, 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.
Peter Bembrick, HLB Mann Judd