Tax Implications for the Sale of a Business

Sanjay Wavde, Partner and Elke Bremner, Senior Associate at Ashurst, share an outline of key tax implications involving the sale of a business. They will delve further into this topic at the Business Sales: Legal Issues & Risks conference on Friday 12 March 2021.

The sale and purchase of a business will raise a diverse range of tax considerations, depending on the nature and value of the assets of the business, when they were acquired and the circumstances of the particular seller and buyer. Different tax outcomes may arise depending on whether the sale is structured as the transfer of the assets used to operate the business, or a sale of the securities in the entity that operates the business. Often what yields the best tax outcomes for the seller will not be the best for the buyer, and it will be a matter for negotiation as to how the transaction is structured.

This article will provide a brief overview of the income tax, goods and services tax (GST) and stamp duty considerations relevant to a sale of a business, focusing predominantly on the key considerations when structuring a transaction as a share sale v an asset sale.

Unless otherwise specified, all legislative references are to the Income Tax Assessment Act 1936 (Cth) (ITAA 36), the Income Tax Assessment Act 1997 (Cth) (ITAA 97) and the A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act).

SHARE SALE v ASSETS SALE: KEY INCOME TAX ISSUES

The main income tax consequences of both a share sale and an asset sale and how differences in the outcomes in each case can influence taxpayer behaviour is discussed below.

The impact on a seller who has access to the “CGT discount”

Gains or losses made on the sale of shares will generally be on capital account, unless the seller is a share trader or acquired the shares in the ordinary course of a business or as part of a profit-making undertaking or scheme. If the owner of the shares is a taxpayer who is capable of benefiting from the CGT discount (which, for example, in the case of individuals reduces the taxable capital gain by 50%), this characterisation is potentially very significant in terms of income tax consequences due to the potential scale of tax savings. The access to the CGT discount is likely to be the most important taxation “influencer” in relation to the sale of a business. It means that where the CGT discount is potentially available, sellers of a business will almost always seek to sell shares rather than have their company sell the business assets.

The effect of other CGT concessions: small business CGT concessions

In some circumstances, the sale of the shares in a company or the sale of a business by a company may qualify for one or more CGT concessions aimed at small business owners, particularly (but not only) those approaching retirement.

For present purposes, it should be noted that the concessions may operate in the context of a share sale or an asset sale depending on the circumstances. So where these concessions are in play, there may sometimes be some flexibility for the seller as to how the business is sold.

There are four small business concessions that can operate in addition to the general 50% discount discussed above:

1. The small business 15-year exemption: a total exemption of a capital gain if the individual taxpayer (or company in which the individual is a significant individual) has continuously owned the CGT asset for at least 15 years, and the individual is 55 years old, or older, and retiring, or is permanently incapacitated.
2. The small business 50% active asset reduction: a further 50% reduction of a capital gain for an (active) business asset.
3. The small business retirement exemption: an exemption of capital gains up to a life-time limit of $500,000[1].
4. The small business rollover: a deferral of the capital gain for a minimum of two years. If the taxpayer acquires a replacement asset, the capital gain can be deferred until disposal of the replacement asset.

By way of example, a company may benefit from the concessions where it is a “small business entity” (ie it carries on a business and has an aggregated turnover[2] of less than $2 million) and disposes of a CGT asset or assets that satisfy the “active asset test”[3]. The benefit of the small business 15-year exemption or the small business retirement exemption can broadly be passed on to the company’s “CGT concession stakeholders”[4] by way of a distribution. Alternatively, an individual may benefit from the concessions where he or she disposes of shares in a company and satisfies the “maximum net asset value test”[5] and disposes of shares that satisfy the “active asset test”[6].

The effect of other CGT concessions: non-resident sellers

A preference for selling shares rather than assets may also be found where a business is ultimately owned by non-residents of Australia. This preference does not generally relate to accessing the CGT discount[7], but is more due to the fact that the scope of CGT is far more limited (generally to Australian real property interests and assets held through an Australian permanent establishment) in relation to assets that are disposed of by non-residents of Australia – so there is the possibility of no Australian CGT being payable in relation to some share sales, when CGT would be payable (by the Australian investment vehicle) on an asset sale.

Of course, where foreign jurisdictions impose tax on gains at a rate that is higher than the 30% Australian corporate rate, a non-resident seller may prefer to have its Australian company sell the business assets in order to obtain the benefit of the deferral of home country tax that this can produce (ie by deferring the remittance of profits; subject to the application of any “anti-deferral” rules in the foreign jurisdiction).

Character of gains and losses

The character of gains or losses made in relation to the disposal of assets will generally be determined by reference to the role or function of the particular assets in relation to the operation of the business. Thus, for example, plant and equipment used in the business will generally be considered to be a capital asset of the business, as would goodwill. However, a capital characterisation can potentially be overridden (at least with respect to assets other than some depreciating assets which can never be expected to be sold for a profit) if the owner of the business had acquired the assets used in the business for the purpose of profit-making by sale (although this would not be the conventional situation).

In addition to the general law characterisation (as capital or revenue), specific tax rules can, in effect, impose capital or revenue treatment irrespective of the character of the particular item. In this regard:

• profits or losses in relation to the disposal of depreciable plant or equipment or in relation to the disposal of trading stock are deemed to be on revenue account (under Divisions 40 and 70 of the ITAA 97 respectively);
• profits on the disposal of “traditional securities” (in essence, non-discounted securities) are deemed to be on revenue account (per section 26BB of the ITAA 36), whereas losses on the disposal of traditional securities may be on capital or revenue account (per section 70B of the ITAA 36) (similar rules apply to taxpayers subject to the “taxation of financial arrangements” rules in Division 230 of the ITAA 97, ie gains and losses are generally deemed to be on revenue account, subject to certain limited exceptions); and
• the character of profits or losses on the sale of assets that qualify for depreciation under Division 43 of the ITAA (which includes buildings) will depend on their character at general law (so that, for example, a profit on a sale of a building that was held as a capital asset will be taxable under the CGT provisions, not as ordinary income and not as assessable income under Division 43).

Seller preferences where no access to CGT concessions or exemptions

 There will be many situations where a seller will not have access to the CGT discount, the small business CGT concessions or the non-resident CGT exemption. This may be because, for instance, there is no prospect of the transaction being undertaken by way of a sale of shares by an individual, trust or superannuation fund or the basic conditions for the small business CGT concessions are not met. The most common situation in this regard is where an Australian company seller is choosing to whether to sell shares in a subsidiary or have the subsidiary sell its assets. While CGT discount and non-resident CGT considerations are generally irrelevant in such situations, the differences in treatment between a share sale and an asset sale can still influence taxpayer behaviour. For instance, if a seller has capital losses (which it may not otherwise have any prospect of using) it would generally prefer the sale option that maximises taxable capital gains rather than revenue gains.

Tax consolidation aside, there will usually be a difference between the respective cost bases of the shares in the business operator company and the assets of the company: for instance, the company may have used its subscribed share capital to acquire an asset which has been subsequently tax depreciated. Some (very rough) general rules can be drawn from this concerning its influence on sale behaviour:

• where the difference is a “timing” difference (eg due to tax depreciation) it will normally not, of itself, have a decisive impact on the choice whether to sell assets or shares; and
• where the difference is a permanent difference (eg due to the shares being originally acquired by the seller from another party for a price well in excess of the underlying tax basis of the assets of the company), it will normally be strongly influential in relation to the choice.

Buyer preferences

This article has discussed a number of taxation matters that influence the choice by a seller of transacting by way of asset sale or share sale. The remaining section of this article now considers taxation matters that can influence the choice between an asset sale or share sale from the buyer’s perspective.

In this regard, a buyer of shares in a company will – with one exception – acquire (in effect) the historic tax assets, attributes and liabilities of the company along with the business carried on by the company. The exception is where the company being acquired was, prior to the acquisition, a subsidiary member (ie not the head company) of a tax consolidated group. In that situation, many tax attributes remain behind with the seller tax consolidated group and exposures to historic income tax liabilities can (where the tax consolidated group has in place a valid “tax sharing agreement”) be limited to a material extent through “clear exit” procedures.

Whether a buyer is prepared to take on the risks associated with the historic tax liabilities of a target company will depend on:

• the view the buyer takes as to the nature and scale of those risks (usually ascertained through tax due diligence procedures); and
• the buyer’s ability to secure valuable indemnities from the seller (or associates of the seller) or other insurance protection.

Assuming the buyer becomes sufficiently comfortable in relation to managing the historic tax risks of the target company, it may find certain tax attributes that come with the company to be attractive. The main potentially relevant attributes in this regard are franking credits and tax losses.

Franking credits come with less strings attached than tax losses do, the main restrictions on the buyer’s use of the credits being:

• the target company’s capacity to declare dividends; and
• whether the franking credits become “exempting credits” (which can occur under dividend imputation rules in the ITAA 97 when an Australian buyer acquires an Australian company that was previously foreign owned (ie when an “exempting entity” becomes a “former exempting entity”) and has franking credits).

In relation to tax losses, unless the buyer is a member of a tax consolidated group (as to which see our comments below), it will need to be satisfied that the target company will be reasonably certain of meeting the various elements of the “same business test” (SBT), or for losses incurred on or after 1 July 2015, the “similar business test” (SiBT), in Division 165 of the ITAA 97 in order for the losses to be available post-acquisition. The SBT in particular has a reputation for being very difficult to satisfy (particularly if material lengths of time have elapsed between the test time (ie just before the change of ownership occurs) and the year in which the loss is sought to be used). The newer SiBT is intended to be easier than the SBT to satisfy, but is similarly highly dependent on future facts with respect to the business. This means that buyers are generally often reluctant to ascribe any material value to the losses.

Apart from these potentially beneficial tax attributes, a buyer would generally not find it advantageous to acquire shares as opposed to assets. This is because, except in the case where the buyer is a member of a tax consolidated group, the amount paid for the shares is not used to recalculate (or “step up”) the tax basis of the underlying assets of the company. For instance, a buyer may pay $100 million for the shares in a company, but the tax basis of the assets of the company may retain their historic cost, which could be very low. The lack of a step up means that, if the buyer was to subsequently sell the business by way of an asset sale, a heavy tax burden would be imposed (that is, tax would be payable, in effect, on overall profits never earned).

Tax basis resetting (step up or down) does occur where a buyer of shares is a member of a tax consolidated group and the target company joins the group. In that situation, there can be two potential advantages:

• first, the purchase price for the shares is used to reset the tax basis in the target’s assets, so they may, in broad terms, be stepped up to their current market value (assuming that market value is higher than their historic tax basis); and
• second, if the target company has tax losses, the losses can be transferred to the head company of the acquiring group provided a loss transfer test is passed, allowing the losses to be used post-acquisition, albeit that the rate of the use of the losses may be restricted by reference to the applicable “available fraction”.

SHARE SALE v ASSET SALE: KEY GST AND STAMP DUTY ISSUES

GST

Different GST outcomes will arise for the seller and buyer depending on whether the sale of the business is structured as an asset sale or an entity sale. The key GST considerations are set out below.

GST treatment of sale: taxable, GST-free or input taxed?

Under the GST Act, the seller (as the supplier) is the entity which is responsible for determining whether a supply is subject to GST and, if so, remitting the correct amount of GST to the ATO. If the seller’s treatment is incorrect, the seller may be exposed to an assessment by the Commissioner, including interest and penalties.

Sale of securities

Where the sale of a business is structured as an entity sale, the GST treatment should not be controversial. The disposal of an interest in “securities” is a financial supply pursuant to item 10 of the table in sub-regulation 40-5.09(3). Securities for GST purposes include shares in a company and units in a trust. Where the buyer is a non-resident entity (ie an entity that is not a resident of Australia for income tax purposes), the supply of the securities should qualify for GST-free treatment as where a supply would be both input taxed and GST-free, GST-free treatment prevails.

Accordingly, the sale by a seller of the securities in the entity that carries on the business will be an input taxed financial supply or a GST-free supply. This means that no GST will be payable by the buyer to the seller, and the seller will have no obligation to account for GST to the ATO on its supply. The advantage for a buyer with an entity sale is that, similar to the supply of a going concern (see below), there will be no requirement to fund an additional 10% of the purchase price which may result in a cost savings for the buyer.

The disadvantage for sales of businesses by way of entity sale is the potential restriction on claiming input tax credits on costs which relate to the disposal and acquisition of the securities where the supply is an input taxed financial supply. An entity will make a “creditable acquisition” and will therefore be entitled to claim an input tax credit, where:

1. it acquires the thing solely or partly for a “creditable purpose”; and
2. the supply of the thing is a taxable supply; and
3. it provides, or is liable to provide, consideration for the supply; and
4. it is registered or required to be registered for GST[8].

An acquisition will be for a “creditable purpose” if the entity acquires the thing in carrying on its enterprise. However, pursuant to section 11-15(2) of the GST Act, an acquisition will not be for a creditable purpose where:

1. the acquisition relates to the making of supplies that would be input taxed; or
2. the acquisition is of a private or domestic nature.

Accordingly, any costs incurred by the seller or the buyer which relate to the sale and acquisition of the securities will not, prima facie, be for a creditable purpose. This will have the effect of increasing transaction costs (eg legal fees, accounting fees, investment bank fees etc), subject to the availability of any reduced input tax credits, by 10%.

Where an entity only makes input taxed supplies on an ad hoc basis (ie it does not make input taxed supplies as part of carrying on its normal enterprise), the entity may be entitled to claim full input tax credits on associated transaction costs if the entity does not exceed the “Financial Acquisitions Threshold” (commonly referred to as the “FAT”). Section 11-15(4) of the GST Act states that an acquisition is not treated as relating to supplies that would be input taxed if the acquisition relates to financial supplies and the FAT is not exceeded.

The FAT requires an entity to look at a rolling 12 month period to determine whether either or both of the below thresholds are exceeded:

1. the amount of all input tax credits to which the entity would be entitled for financial acquisitions exceeds $150,000 (ie $1,500,000 in costs); or
2. the amount of input tax credits in (a) would be more than 10% of total input tax credits on all acquisitions (including financial acquisitions) in the 12 month period.

Accordingly, where it is possible to structure the sale as the transfer of the securities in the relevant entity that carries on the business, there may be some advantageous GST outcomes depending on the GST profile of the seller and the buyer. From a buyer’s perspective, this will need to be weighed against whether it is commercially sensible to acquire the entity that carries on the business (eg whether it is able to obtain sufficient indemnities and warranties from the seller).

Sale of assets

Where the sale of a business proceeds by way of an asset sale, the key question from a GST perspective is whether the sale will qualify for GST-free treatment as the supply of a going concern.

The key advantage from a GST perspective is that the buyer will have no obligation to fund an additional 10% of the purchase price. Where the purchase price for the business being acquired is material, this can result in a substantial cost savings for the buyer, especially if the buyer is required to use external debt to fund the purchase price. Had the buyer been required to pay an additional 10% GST, it may have been necessary to obtain a separate GST debt facility which can lead to increased borrowing costs. Furthermore, as stamp duty is payable based on the GST inclusive consideration, by treating the sale as the supply of a going concern this will also have the effect of potentially reducing the stamp duty payable (by approximately 5.5% of 10%), depending on the nature and location of the assets acquired.

The main disadvantage for treating the sale of a business as the supply of a going concern is the uncertainty in respect of whether the treatment will be challenged by the ATO. As noted above, it is the seller’s responsibility to determine the correct GST treatment and if the requirements of the supply of a going concern are not satisfied, the seller may be liable for interest and penalties.

In the author’s experience, there is a reluctance on the part of sellers to treat sales of businesses as the supply of a going concern due to the uncertainty of a contingent liability. To mitigate against this risk, there are a few options that the seller and buyer can agree to such as:

1. the buyer agreeing to indemnify the seller for any additional amount of GST payable on the sale of the business, coupled with any liability for interest and penalties – there is likely to be some resistance from the buyer in agreeing to provide this indemnity; or
2. the seller making an application to the ATO for a private binding ruling on whether the sale qualifies as the supply of a going concern – the ruling can sometimes be a condition precedent to completion of the sale and accordingly, this may lead to delays in completing the sale, as well as increased costs for both parties.

The other advantage for treating the sale as a GST-free supply of a going concern is that the seller should be entitled to claim back the GST incurred on all costs relating to the sale, on the basis that the costs will not relate to the making of a supply that would be input taxed.

If the sale of the assets does not qualify as the supply of a going concern (eg because the seller is not supplying something “necessary” to the buyer), the GST treatment of the sale will be determined by having regard to the nature of the particular assets. In most cases, this should result in the sale of the assets being treated as taxable but there may be certain assets which are input taxed (eg trade debts) or GST-free (eg farm land).

Stamp duty

Where the sale of a business is structured as an asset sale, it will be necessary for the buyer to determine where the relevant assets are located, whether the assets are “dutiable property” and what portion of the purchase price is referable to the dutiable assets to enable the calculation of the buyer’s duty liability.

Where a sale of a business can be structured as the sale of securities in the entity which carries on the business, this will generally have a more favourable stamp duty outcome.[9] The reason for this is that no State or Territory imposes duty on the transfer of unquoted marketable securities, with New South Wales being the last State to abolish this duty in July 2016.

Accordingly, where the seller is indifferent to an asset sale or an entity sale, the buyer may prefer an entity sale if this will result in a material stamp duty savings, which is likely to be the case in circumstances where the target entity does not hold significant land holdings or “fixtures”.

[1] If the taxpayer is under 55 years old, the amount must be paid into a complying superannuation fund or a retirement savings account.

[2] “Aggregated turnover” is broadly the company’s annual turnover plus the annual turnovers of any business entities that are affiliates of, or connected with, the company.

[3] Broadly, a CGT asset is an active asset if the taxpayer owns it and uses it or holds it ready for use in the course of carrying on a business. An intangible asset, such as goodwill, will also be an active asset where it is inherently connected with the business.

[4] Broadly, this is an individual with a “small business participation percentage” in the company of at least 20%.

[5] Broadly, a taxpayer satisfies the “maximum net asset value test” where the total net value of CGT assets owned by the taxpayer (other than the family home, superannuation and certain other assets), any entities connected with the taxpayer and the taxpayer’s affiliates and entities connected with those affiliates (subject to certain exceptions) does not exceed $6 million just before the relevant CGT event.

[6] Broadly, a share in a company will be an “active asset” if the company itself holds active assets (and inherently connected financial instruments and cash) with a market value of at least 80% of the market value of all of the company’s assets.

[7] The general 50% CGT discount was removed for non-residents and temporary residents of Australia from 8 May 2012, but there is still potential for a portion of the gain derived on the sale of land rich companies by a non-resident individual, for example, to benefit from the discount because of transitional measures. This may provide an incentive for such individuals to prefer a share sale rather than an asset sale.

[8] See section 11-5 of the GST Act.

[9] Provided that the relevant entity is not a “landholder” in any Australian State or Territory.

Sanjay Wavde is a Partner in the Sydney Tax practice at Ashurst, advising on income tax matters, with a particular focus on funds management, mergers and acquisitions, and infrastructure transactions. He provides practical and strategic advice on a wide range of complex tax issues. His expertise includes advising on tax disputes, tax due diligence and structuring, and advising on tax-related transaction documentation issues. Sanjay has significant international experience. He has a Master of Laws in Taxation from New York University School of Law, is also admitted as an attorney in New York, and has practised taxation law in both Australia and the United States.  He is a Chartered Tax Adviser of the Tax Institute and the Sydney Chair of the Taxation Committee of the Law Council of Australia. Connect with Sanjay via email or LinkedIn

Elke Bremner is a Senior Associate in the Sydney Tax practice at Ashurst and has over 10 years’ experience in advising on indirect tax matters, with a special focus on GST and stamp duty as well as land tax and other State based taxes.  She has extensive experience advising on a broad range of GST and State tax issues in respect of real estate and infrastructure projects, mergers and acquisitions, takeovers, foreign investment, restructuring and insolvency arrangements and litigation settlements.  Elke is a Fellow of the Tax Institute of Australia and a member of the Property Council of Australia’s Indirect Tax Committee. Connect with Elke via email or LinkedIn