A key consideration when selling a small or medium sized business operated through a company is whether to sell the business assets or for the shareholders to sell their shares in the company. Whilst commercial considerations are usually prevalent when structuring any business sale, the tax outcomes which result from these alternatives can differ significantly.
Typically a purchaser would prefer to acquire the business assets directly, rather than the shares in the operating company. This is due mainly to the uncertain history and risk associated with acquiring a company. What may be conveniently termed ‘baggage’.
In contrast, a vendor would usually prefer a share sale in order to access the 50% CGT discount (where the shares have been held longer than 12 months), the small business CGT concessions or to offset the cost base of their shares against the sale proceeds. These concessions may not be available to a company selling the business directly, or may be difficult to access.
In some states there can be a stamp duty advantage to the purchaser when acquiring shares in the company vs. acquiring the business assets.
To illustrate the contrasting tax outcomes between the two options, take the following simple example:
Adam is looking to sell his manufacturing business for $10 million. This business is owned and operated by ABC Pty Ltd, a private company Adam setup 10 years ago and of which he is the sole shareholder and director. The purchaser is indifferent to acquiring the shares in ABC Pty Ltd or the business assets.
The following is a snapshot of ABC Pty Ltd prior to the sale:
- Adam owns 100% of the shares in ABC Pty Ltd
- Adam purchased the shares in ABC Pty Ltd for $100.
- The cost base of the assets in ABC Pty Ltd is $4 million
- ABC Pty Ltd has retained earnings of $4 million
- Adam is on the top marginal rate of income tax for individuals 49% (including Medicare levy and the temporary budget repair levy)
Option one – sale of business assets
|Less: cost base of assets||($4,000,000)|
|Gain on sale of business assets (goodwill)||$6,000,000|
|Company tax payable (30%)||($1,800,000)|
|Net proceeds from asset sale:||$4,200,000|
To extract the sale proceeds from ABC Pty Ltd, a cash dividend of $8,200,000 will need to be paid to Adam. Assuming the company has sufficient franking credits to declare a fully franked divided, Adam will be taxed as follows:
|Fully franked dividend (including franking credits)||$11,714,286|
|Income tax at marginal rate (49%)||$5,740,000|
|Less franking credits||($3,514,286)|
|Net tax payable||$2,225,714|
The total tax payable under this option is summarised as follows:
|Total tax payable under option 1||$4,025,714|
Option two – share sale
|Share sale proceeds||$10,000,000|
|Less cost base of shares||($100)|
|Less CGT 50% discount||($4,999,950)|
|Total tax payable under option 2||$2,449,976|
Adam would be $1.5 million better off if he was to sell the shares in ABC Pty Ltd rather than undertake a business assets sale and extract the sale proceeds by dividend.
Besides illustrating the contrasting tax outcomes between the two alternatives, the example also demonstrates the need to undertake planning prior to signing a business sale contract. Other factors that may need to be considered when determining how to structure a business sale include various legal and commercial matters, assignment of contracts, suitable warranties and indemnities, apportionment of sale proceeds, application of GST, stamp duty, availability of tax losses, access to CGT cost bases, and access to small business concessions (refer to the following article for further details Tax relief available when selling a small business).
If you are considering a business purchase or sale, we can assist you in working through the various tax and commercial considerations that apply to your circumstances.
If you have any questions in relation to this matter, we invite you to contact Gurjeet Singh or your usual advisor at Baumgartners.