How to get the best tax outcomes on the sale of a business

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Owen Hodge Lawyers help energetic business owners in the sale and purchase of their businesses and in the sale of shares they own in their trading company.

Taxes which are relevant to the selling and buying of a business or shares in a company include capital gains tax, income tax, stamp duty and GST. If your advisor gets the structure wrong then thousands of dollars will end up in the hands of the ATO. In conjunction with your accountant, we can get the structure right for you. This generally means more money for your superfund and your retirement.

Have a look at these recent case histories for recent examples of how we have helped our clients.

The seller has access to the CGT discount

Our client John Smith owned all the shares in Smith Pty Ltd. John set up Smith Pty Ltd 20 years ago and bought the shares he owns for $1.00. They are now worth $10 million. When Smith Pty Ltd was set up, its assets including the goodwill of the business, were also worth just $1.00.

John wanted to sell the business and he had instructed his broker to list Smith Pty Ltd as the vendor on the sales advice form. We informed him that Smith Pty Ltd would realise a taxable capital gain of $10 million and after paying tax at the current corporate rate of 30%, it would leave Smith Pty Ltd with after-tax cash of $7 million. That would be distributed to John as a fully franked dividend of $7 million (with the remaining $1 a return of capital). John would then be subject to top-up tax on the unfranked dividend of approximately $2 million leaving John with $5 million in cash.

However, we explained that if John were to sell his shares in Smith Pty Ltd, then after taking into account the 50% CGT discount (under Division 152 of the Income Tax Assessment Act 1997), he would realise a taxable capital gain of only $5 million (assuming a top marginal rate of 50% for simplicity’s sake). The tax payable by John would only be about $2.5 million leaving him with $7.5 million in cash.

The savings that we could achieve by John selling his shares, rather than Smith Pty Ltd selling the business, was $2.5 million. John’s wife, who had been an accountant in her early years but had not practised as such for over 20 years, argued that Smith Pty Ltd could sell the business and lend the proceeds of sale to John (forever). Of course, we explained that the proposed arrangement would attract the operation of Division 7A of the Income Tax Assessment Act 1936 and in order to avoid the loan being re-characterised by the ATO as a taxable dividend to John, a benchmark interest rate would have to be charged and loan repayments would have to be made.

Non-resident sellers

What if the shares of Smith Pty Ltd were held by UKCo, a company which is a tax resident of the UK?

One of our clients was in this very situation last month:

Smith Pty Ltd did not own Australian real property and UKCo held the shares on capital account (i.e. UKCo is not a share trader and did not acquire the shares in the ordinary course of a business or as part of a profit making undertaking or scheme). In this situation, no Australian tax would be payable on the sale by UKCo of the shares in Smith Pty Ltd – although UK tax (currently 20%) may be payable by UKCo on that profit.

But if Smith Pty Ltd sold its business assets it would pay $3 million in tax (as in the first example). Whilst it could remit the after-tax proceeds from the sale as a fully franked dividend to UKCo with no further Australian tax payable, selling its business assets would still leave the total Australian tax cost at $3 million.

If UK tax of more than $3 million was payable in relation to either transaction, and a full tax credit was available for the Australian tax, then UKCo may be indifferent as between an asset sale and a share sale because of the tax set-off arrangements between the two countries (i.e. because of the foreign tax credits which are allowed between the two countries).

But we explained that generally non-resident companies prefer to pay less Australian tax because of difficulties in claiming full foreign tax credits and difficulties in claiming their own domestic tax concessions to bring their overall UK tax bill below the Australian corporate rate of tax.

So in this circumstance, the shares were again sold.

No access to CGT concessions

This often occurs. Take the example of an Australian company with a wholly owned Australian subsidiary. Should it sell its shares in the subsidiary or have the subsidiary sell its own assets?

Our client was recently in this situation. The CGT discount and non-resident CGT considerations were irrelevant (and normally are) in these circumstances. Nevertheless the seller, Smith Pty Ltd, had carry-forward capital losses of $3 million. The directors wanted to sell its wholly owned subsidiary, Subsmith Pty Ltd (Subsmith – our client), both being members of the same tax consolidated group.

Subsmith’s assets consisted of plant and equipment and Subsmith had been advised by its former advisors that its sale would realise an accounting and tax loss of $1.5 million if Subsmith sold them. Subsmith also had goodwill and the advisors had said that Subsmith would realise a profit on the sale of the goodwill of $2.5 million. So if Subsmith sold its own business, Subsmith had been told that it would realise a profit of $1 million (being $2.5 million – $1.5 million).

We agreed with Subsmith that by contrast, if Smith Pty Ltd sold its shares in Subsmith, then Smith Pty Ltd would realise the same profit – $1 million – which would be a capital gain for Smith. A share sale has the effect of netting all underlying gains or losses into one gain or loss of a capital or revenue nature (depending on the nature of the shareholding). In this instance, the $1 million capital gain incurred by Smith would be set off against its carried forward capital losses of $3 million leaving a balance of losses to be carried forward of $2 million.

Nevertheless, we convinced Subsmith to sell its own assets. Subsmith’s former advisors had not taken into account the effect of the sale on the consolidated group. Subsmith’s sale of its own assets would result in an improvement of the tax position of the consolidated group. The consolidated group would derive a capital gain on the sale of the goodwill of $2.5 million. That gain would be sheltered from tax by its capital losses of $3 million. This would leave a carry-forward capital loss balance of $0.5 million. In addition, there would be a deductible revenue loss of $1.5 million on the sale of the plant and equipment which it could use against other taxable income.

Other matters to be taken into account when considering buying and selling businesses and shares are buyer preferences and the capacity of the seller to declare dividends, the status of franking credits, proposed earn-out arrangements, the application of GST, stamp duty, purchase price allocation and other matters.

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