Buying or selling a business can be intimidating for both vendor and purchaser, as there are so many issues to consider.
The tax consequences of the transaction is one such issue. Failure to recognise the potential tax consequences can result in unexpected outcomes and unwanted issues surfacing down the track.
The types of tax issues that are encountered is first driven by whether the transaction is an asset sale or a share sale. An asset sale comprises the sale of the individual assets of a business, such as plant and equipment, inventory, debtors etc. Buyers may favour this approach because it provides certainty of what is being acquired. If the business is operated by a company, the business can be acquired by purchasing the shares in the company. Vendors often favour a share sale as it completely removes them from the business and all future obligations relating to it.
An asset sale allows the buyer to stipulate the assets it intends to acquire and the liabilities it intends to assume. As the buyer only acquires the assets of the business, it generally does not assume any of the historic risks of the vendor company e.g. outstanding tax liabilities. However, the cost of completing an asset sale is generally higher for both parties as each element of the business needs to be considered, for example, transferring employees, insurance, contracts, asset ownership, utilities and so on…
When completing an asset sale, the allocation of the purchase price to the various assets can have significant tax implications. Both buyers and sellers should review this to ensure the allocation of the price is reasonable and reflects the current market value of the assets being transferred.
Depreciation recovery income can arise on the sale of depreciable property. This must be determined on an asset by asset basis.
If an asset is sold for more than its original cost, the excess above cost should comprise a non-taxable capital gain.
This gives rise to a natural tension as vendors generally want to allocate as much of the price to items held on capital account where there is no depreciation clawback, e.g. goodwill. Conversely, purchasers usually want to maximise the cost price of depreciable items, to increase their future depreciation deduction.
If the tax book value of the assets broadly reflects their market value, it may be reasonable to use the tax book values as the transfer values. Taking this approach eliminates depreciation recovery income – and is arguably fairer to both sides.
Other examples include, the cost of trading stock which is generally deductible to the purchaser, while the cost of goodwill is generally non-deductible.
Share sales on the other hand essentially allows the buyer to step into the shoes of the seller. The company continues to own and operate the business, liabilities and obligations are unchanged, including potential tax issues unknown at the time of settlement. Given historic risks remain with the company thorough due diligence should be completed.
The purchaser should also consider requesting that the vendor provides appropriate tax related warranties and indemnities.
GST is another important matter to be aware of when buying or selling a business. When a business is sold as a “going concern”, the transaction should qualify as zero-rated for tax purposes. However, to be a “going concern”, the vendor must operate the business until settlement and must supply all of the goods and services necessary for the continued operation of the business. Additionally, both parties must be GST registered at the time of supply and record the fact that both parties intend for the sale to be a “going concern”.
If the assets of the business include either land or an interest in land, the sale should be zero rated for GST purposes. This applies even where the business is not sold as a “going concern”.
There are also specific tax rules relating to when leases are transferred, including where a lease is assigned, cancelled, or a sub-lease is executed, as part of a business sale. The rules can deem amounts derived on these transactions to be taxable in certain circumstances.
When preparing a business for sale it is important to consider the tax implications that will arise during the process and how best to deal with these. Seeking advice early in the process should allow the transaction to be completed efficiently and help to avoid an unexpected tax bill arising down the track.
The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.