Selling a business can be a complex process, with various tax implications to consider. One important concept for business owners to understand is the sale of a business as a “going concern.” When a business is sold as a going concern, it may be eligible for a Goods and Services Tax (GST) exemption, potentially saving the seller and buyer a significant amount of money.
In this comprehensive guide, we’ll explore what constitutes a sale of a business as a going concern, the requirements for qualifying for the GST exemption, and the benefits for both buyers and sellers. We’ll also delve into the legal and tax implications, common pitfalls to avoid, and frequently asked questions to help you navigate this complex process with confidence.
What is a Sale of a Business as a Going Concern?
Definition of a Going Concern Sale
A sale of a business as a going concern involves the seller transferring everything necessary for the buyer to continue operating the business in its current state. This includes all assets, operating processes, and commercial activities relevant to the enterprise. For a sale to qualify as a going concern, the business must be operating and making a profit at the time of the transaction.
Benefits of Selling as a Going Concern
Selling a business as a going concern offers significant advantages, particularly in terms of GST exemption. If the sale meets certain criteria, it can be treated as a GST-free supply under the A New Tax System (Goods and Services Tax) Act 1999. This means that no GST is payable on the sale price, providing financial benefits for both the buyer and seller.
For the buyer, a GST-free sale means they don’t have to pay an additional 10% on top of the purchase price. This can make the acquisition more affordable and allows the buyer to allocate those funds towards other aspects of the business. Additionally, the buyer may be able to claim input tax credits for GST paid on expenses relating to the purchase, such as legal fees.
From the seller’s perspective, a GST-free sale can result in a higher net return, as they don’t have to remit GST to the Australian Taxation Office (ATO). This can be particularly advantageous for sellers looking to maximise their proceeds from the sale. Furthermore, selling the business as a going concern can be a more attractive proposition for potential buyers, as it provides them with a turnkey operation that can generate revenue from day one.
It’s important to note that while the going concern exemption can provide significant tax benefits, it’s not automatically applied to every business sale. The transaction must meet specific requirements set out by the ATO, which will be discussed in detail in the following sections. Failing to meet these requirements can result in the sale being treated as a taxable supply, with GST implications for both parties.
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Essential Requirements for GST-Free Going Concern Sales
For a business sale to qualify as a GST-free going concern, several key requirements must be met. These criteria ensure that the transaction genuinely involves the transfer of a fully operational enterprise, rather than just a collection of assets. Understanding and adhering to these requirements is crucial for both buyers and sellers to avoid potential GST liabilities.
Payment and GST Registration Requirements
One of the fundamental conditions for a GST-free going concern sale is that the transaction must involve payment or consideration. This means that the buyer must provide some form of compensation to the seller in exchange for the business. Additionally, the purchaser must be registered for GST or required to be registered at the time of sale. This requirement ensures that the buyer is a legitimate business entity capable of continuing the enterprise.
Written Agreement Requirements
Another essential aspect of a GST-free going concern sale is the existence of a written agreement between the buyer and seller. This agreement must explicitly state that the sale is of a going concern. While there is no prescribed format for this agreement, it is typically included as a special clause within the sale contract. The written acknowledgement provides clarity and certainty for both parties regarding the nature of the transaction.
Supply of Necessary Business Elements
For a business to be considered a going concern, the seller must supply the buyer with all the necessary elements for the continued operation of the enterprise. This includes tangible assets such as premises, equipment, and inventory, as well as intangible assets like goodwill, contracts, licenses, and intellectual property. The specific elements will vary depending on the nature of the business, but the guiding principle is that the buyer should receive everything essential to carry on the enterprise without significant interruption.
Continued Operation Until Sale
The final requirement for a GST-free going concern sale relates to the continuity of the business operations. The seller must carry on the enterprise until the day of sale, ensuring a smooth transition to the buyer. This means that the business should be fully operational and trading as usual up until the point of transfer. Any significant interruptions or closures leading up to the sale could jeopardise the going concern status and potentially trigger GST liability.
Legal and Tax Implications
GST Consequences
When a business is sold as a going concern, the sale is generally GST-free. This means that the seller does not have to charge GST on the sale price, and the buyer can claim input tax credits for any GST included in the purchase price of the business assets.
However, if the ATO determines that the sale does not meet the going concern exemption requirements, the seller will be liable to pay GST on the transaction. In such cases, it is common for sale contracts to include a clause that passes the GST liability and any related penalties to the buyer.
If a property is bought as part of a GST-free going concern sale but the buyer uses it for a purpose other than making taxable or GST-free sales, they may have to make an increasing adjustment. The amount is usually calculated as 10% of the sale price multiplied by the proportion of non-creditable use.
Capital Gains Tax Considerations
In addition to GST implications, selling a business as a going concern can also trigger capital gains tax (CGT) obligations. CGT applies to the sale of assets acquired on or after 20 September 1985, with the tax levied on the difference between the asset’s cost base and its sale price.
However, small business owners may be eligible for various CGT concessions that can substantially reduce their tax liability. These include:
- 15-year exemption for assets owned for at least 15 years
- 50% active asset reduction on capital gains from the sale of business assets
- Retirement exemption for gains made from the sale of active business assets
- Rollover provisions allowing the deferral of capital gains for up to two years
To qualify for these concessions, the business must meet certain criteria, such as having an aggregated annual turnover of less than $2 million or net assets not exceeding $6 million.
It’s crucial for sellers to seek professional tax advice to determine their eligibility for these concessions and to ensure compliance with all CGT obligations when selling a business as a going concern. Proper structuring of the sale and thorough documentation can help maximise tax benefits and minimise potential liabilities.
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Common Pitfalls and Risk Management
Selling a business as a going concern can be complex, and there are potential pitfalls that sellers should be aware of to manage risks effectively. Two key areas to focus on are the risks of ATO rejection and the importance of including appropriate contract protection clauses.
ATO Rejection Risks
Even if the parties to a sale believe they have satisfied all the requirements for a GST-free going concern sale, there is always a possibility that the ATO will reject the exemption. Some potential reasons for ATO rejection include:
- Failure to provide all necessary business elements to the buyer for continued operation
- The seller not carrying on the business until the day of supply
- Insufficient documentation to prove the transaction meets going concern criteria
- The buyer not being registered or required to be registered for GST
To minimise the risk of ATO rejection, it’s crucial for sellers to:
- Ensure all essential business assets and operating structures are transferred to the buyer
- Continue operating the business as usual up until the settlement date
- Maintain detailed records and documentation of the sale process and agreements
- Confirm the buyer’s GST registration status before proceeding with the sale
Seeking professional tax advice can also help navigate the complexities of going concern sales and ensure compliance with ATO requirements.
Contract Protection Clauses
Given the potential financial consequences if the ATO rejects a claimed GST exemption, it’s essential for sale contracts to include clauses that protect the parties’ interests. Some important clauses to consider are:
- GST recovery clauses that pass on the liability for any GST and penalties to the buyer if the ATO denies the exemption
- Warranties and indemnities where the seller warrants that the sale meets going concern requirements and indemnifies the buyer for any losses if this is not the case
- Conditions precedent making the sale contingent on the parties obtaining professional tax advice confirming the transaction qualifies as a GST-free going concern
- Clearly defined terms and conditions setting out each party’s obligations and responsibilities in relation to the going concern sale
Engaging experienced legal professionals to draft and review the sale contract can ensure these protective measures are included and enforceable.
Conclusion
In summary, selling a business as a going concern can provide significant benefits for both buyers and sellers, particularly in terms of GST exemption. However, meeting the strict criteria for a GST-free sale requires careful planning and attention to detail. The seller must provide everything necessary for the continued operation of the business and carry on the enterprise until the day of supply.
Failure to meet these requirements can result in the ATO rejecting the GST-free status, leaving the seller liable for the tax. To mitigate this risk, it’s crucial to seek professional advice from experienced commercial lawyers and accountants who can guide you through the process and ensure compliance with all legal and tax obligations. By understanding the complexities of selling a business as a going concern and taking proactive steps to meet the requirements, you can maximise the financial benefits and minimise the potential risks of the transaction.
Frequently Asked Questions
