The need to understand tax principles

Taxation is the most technically difficult part of buying or selling a business. The Australian taxation system is immensely complex and continually becoming more complex. Even for accountants, for whom tax work is a full time occupation, no one person could claim to be an expert on the whole of the Australian taxation system.

Accordingly, a solicitor cannot be required to be a tax expert in order to act on a sale or purchase of a business. However, some understanding of the basic principles is essential, at least to identify the issues. Otherwise, you risk putting your client into a tax trap, or allowing the solicitor for the other party to take advantage of your client.

This topic is an outline of practical taxation aspects of sales and purchases of business. However, it does not examine taxation issues in depth, and should not be relied upon as a substitute for a detailed consideration of the relevant taxation laws as applied to particular circumstances.

When a business is sold, a number of types of taxation are triggered, including the following:

Capital gains tax (CGT)

This is the most important tax triggered by the sale of a business. It is of vital concern to the vendor who will be liable to pay any CGT. It is also important to the purchaser, as the transaction will provide the purchaser’s cost base. When the purchaser later disposes of its interest of the business, this cost base will be the starting point for the calculation of any CGT payable on the disposition.

See Capital gains tax.

Small business relief

There are very generous concessions available on the sale of small businesses, which greatly reduce or eliminate Capital Gains Tax payable. These are covered by ss 152-1 to 152-430 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). To qualify for the concessions, a series of tests must be passed. Each is surrounded by complex rules.

The concessions are:

• • 15 year exemption. A business operating for more than 15 years can be sold free of CGT.
• • 50% reduction. CGT is paid on only 50% of the capital gain. This is in addition to the 50% discount on CGT for individuals selling assets they have owned for more than 12 months.
• • Retirement Exemption. There is an exemption for capital gains of up to $500,000 per person, if either the exempt amount is rolled into superannuation, or the person is already over 55 years of age.
• • Small Business Roll-Over. If, within 1 year before or 2 years after the sale of a business, the sale proceeds are used to buy another business, no CGT is payable on the sale of the first business.

See Small business relief.

GST

The sale of a business is a taxable supply under Div 9 of A New Tax System (Goods and Services Tax) Act 1999 (Cth). Accordingly, it exposes the vendor to a GST liability on virtually all the assets of the business. The GST may be avoided by using the going concern exemption under s 38-325 of that Act. However, there are many situations where the exemption is not available, or where the parties may not wish to apply it.

See GST.

Duty

Duty (referred to in some states as “stamp duty”) is covered by state legislation. Queensland, Western Australia, and the Northern Territory still impose duty on sales of businesses. In all other states, sales of businesses are exempt from duty, unless the sale includes a transfer of real property or other dutiable property.

As a business is a collection of different assets and rights, duty is imposed on defined business assets. These are different in different states. Duty on sales of shares has been abolished throughout Australia.

Some assets comprised in a sale of business attract duty anyway, such as goods that are dutiable under the general provisions, sales of real property or transfers of shares in land-rich companies or unit trusts. For example, in Victoria, duty may be imposed where the shares being transferred have a land use entitlement (or an entitlement to occupy land in Victoria): ss 10(1)(v) and 103A of the Duties Act 2000 (Vic).

See Duty.

Income tax

Selling a business may trigger ordinary income tax as follows:

Stock

A sale of stock included in a sale of business will attract income tax, just like the ordinary sale of stock in the course of the operation of a business.

Depreciable assets

Where plant and equipment are sold for more than their written down value, the difference is subject to income tax. Similarly, any sale for less than the written down value will create a deductible tax loss.

Conflict between vendor and purchaser

CGT is generally less than income tax. Accordingly, a vendor will try to structure the breakdown of the sale price to maximise the component for goodwill, and minimise the components for plant and equipment. A purchaser will try to do the opposite.

Taxation minimisation schemes

Taxation legislation imposes limits on the manipulation of value of assets included in a sale of business. This includes the following:

Market value

Assets will be deemed to be sold at market value, rather than at their stated prices, if the sale is not at arm’s length. This is covered by s 70-90 of the ITAA 1997 in respect of the sale of trading stock, and s 112-20 (market value substitution rule) of the ITAA 1997 for the cost base of a capital item.

Schemes to reduce income tax

Part IVA of the Income Tax Assessment Act 1936 (Cth) states, in effect, that any scheme to reduce tax will be void as against the ATO.

The role of the accountant

The client’s accountant is responsible for the client’s overall tax planning. Accordingly, it is important that the accountant should be consulted as to any tax strategies suggested by the solicitors acting on a sale or purchase of business.

See Income tax.