Season 8 Episode 4
Martin: Welcome to The Business Owners Podcast where we throw aside taboos and share strategies for growing, protecting and exiting your business. My name is Martin Checketts and I represent Mills Oakley’s Private Advisory team.
Today I am joined by my Tax Partner and very special guest Ross Higgins, Welcome Ross.
Ross: Thank you Martin and it is a pleasure to be here.
Martin: Today Ross we are talking about a pet subject of mine which is business exits and in particular the tax consequences and the tax planning opportunities that can be associated with selling your business and I know that this subject is also very dear to your heart and that you have spent many decades advising business owners on exactly these aspects. Maybe to start things off could you tell me when things most often go wrong. You know, what is the absolute “no no” when selling your business from a tax perspective?
Ross: First thing you have to decide is “What am I going to sell?”. What happens sometimes is that people just use their own intuition and say well I am running a business and I am going to sell the business and then they might start talking to someone and even they might get contracts drafted up, draft offers all sorts of things received and then think I should probably get a lawyer involved. Then they come and see us and we say you need to think about what you are actually going to sell and in your circumstance you could sell either your business out of the entity or you could sell the units or the shares in that entity. In some cases in fact you have got layers of entities and there was one years ago where the client came and said oh look we are selling the shares and the entity and I said well all the shares and the entity are actually owned by a unit trust and the unit trust has got a better tax profile and cost base for its units and status then the shares in the company so you are better to sell the units and the trust and all the unit trust does is hold the shares in the Company so it is a clean entity you should sell that. Sometimes the reaction is oh well we are already down the path a little bit and blah blah blah and many times I have said it just needs to be put to the other side that look we have thought about it and we would like to actually sell you this entity, or we would like to sell you the shares or units in this entity rather than the business. And you know, so many times that has happened within a week the other party said yeah that is fine.
Now sometimes what can be a barrier can be the concern of the purchaser perhaps that they are buying an entity with a history and that can be a concern because if you just buy the business you are not buying the history of the entity, whereas if you buy the entity you are buying its history. Now there are a couple of issues with that if you are fairly confident in the way you have run things and you have been compliant with the law, forwarded your taxes, forwarded your super you know done the right thing then you might be confident to say well I am prepared to give you very very good warranties on this. And in many cases, the purchaser might do their due diligence and look at it and say yeah I am pretty happy to take the entity because I can see it has been run squeaky clean and so they are happy to take the entity. In some other cases where they are still a little uncomfortable there is the possibility that you may be able to restructure an existing business into a new entity without triggering tax ready to sell to a third party so the third party then can acquire their entity without the history problem but you still sell the interest in the entity which in many cases will give you a better flow through capital gains tax outcome then if you sell the business itself.
Martin Thank you Ross and boy we have traversed an awful lot of ground which is fascinating in that last couple of minutes. If I can take it back a couple of steps something that I am very passionate about is empowering the business owners to actually get in the driver’s seat on this issue. Because, as you have perfectly demonstrated, they are approached by a buyer often a sophisticated institutional buyer, a private equity fund whatever who drives the discussion around the sale structure and the buyer will set out the sale structure that works best for them. Normally a sale of the business and assets, but of course the discussion needs to be had and it may very well be that you had better off sell the shares. And you have to own that discussion early as a business owner.
Ross Yes you should own it early and the point is though not just to sort of lie down, I mean there was one that came to see me and they were already down the track a bit and had quite advanced documentation. I said to them within about five minutes of looking at it that you should be selling the entity not the business and so they said that might be a problem and I said well look just go back straight away and put the position to the buyer and the buyer was actually a US buyer and within 48 hours they had agreed and said that was fine. Now it saved our client $2 million.
Martin Yes and that kind of story really isn’t uncommon. From my personal perspective as a corporate lawyer transacting some of these deals I would also echo that. I would say that when it is properly explained when there is an appropriate approach taken to the mitigation of risks around buying the shares, buyers are actually often really comfortable with it, much more than conventional wisdom might dictate.
Ross Yes and if you don’t ask you don’t get.
Martin Yeah. That is right so it is often about going to them with a suite of measures just as you say Ross it is like well we would like to sell the shares but we would like to indemnify you for any losses that you suffer as a result of that. Of course, it is subject to appropriate caps and limitations and the like and maybe we will give you some security for those claims in the form of a retention or whatever it may be, but it isn’t uncommon that you can with the help of a good lawyer package up something that is going to be acceptable to the buyer and give you the tax outcome that you want.
Ross Yes in some cases you can even give it to them for slightly lower consideration but still on a after tax basis you would be better off and so it might facilitate a bit of a win/win.
Martin Can you talk to me a bit about the small business tax concessions because this is often a very interesting overlay when you are looking at either selling or restructuring a business and it is an area that is not well understood. Could you give us a high level overview on how those concessions work.
Ross Oh, the high level thing is that these concessions are gold!
Ross They are fantastic. They only apply to active businesses so that if you just have a pure property investment which is for rental than that is not the case but it applies to an active business but it also applies to property used in that active business. Some people don’t realise that, and the rules were changed years ago to accommodate the fact that in most cases because of asset protection reasons that we often spout you have the property say in a discretionary trust in one entity, and then you have the business in another trust or company on the other hand. But, you can treat both as business assets so you can benefit from the small business concessions both in relation to the goodwill value that relates to the business in one entity and then in relation to the value of the business property that is used in the business in another entity on the other hand. And, it can also mean that in some cases if you you were still going to conduct the business but you wanted to sell the property you could benefit from the small business concessions in relation to the sale of the property even though you were still running the business. And so a lot of people don’t realise that. They think of the business, and don’t think that it can relate to the property used in the business. Now when it comes to these benefits you are a small business if you have a turnover of no more than $2 million a year and the interesting thing is that for a lot of businesses of course even small ones have turnovers way over that but for some service based businesses they could actually be quite profitable and yet still be under that $2 million a year turnover limit and that may facilitate in some cases businesses that could be worth you know $10 million if they qualify for the less than $2 million turnover they can still be treated as small businesses and that is a bit counter intuitive.
On the other hand, the alternative test (and you only have to satisfy one of them) to the turnover test is the “no more than $6 million net business asset test” in relation to the business and assets in connected entities. And that gets a bit complex as to what gets roped up in that $6 million test but it certainly excludes the family home and it includes superannuation. So in many cases small business owners are going to fall under one of those and therefore they have an active business so they will be able to use the small business concessions. Now you might like to ask me more questions about what these small business concessions are …
Martin Well thank you for feeding me that line Ross I appreciate it. Just before I do I think you are right people hear these words ‘small business’ and they think well surely I am not going to qualify because I have got a reasonably chunky business but it is amazing how many clients do fall within it. And so, Mr Higgins, talk to me about it! Tell me what are the features of the small business concessions.
Ross First of all the one that applies in first priority if applicable is called the 15 year exemption and this is where you have been running the business for 15 years and over all that period the particular parties who are now selling out or it could in fact be others have had a significant interest in that business. So you have to a significant individual test which includes people with 20% or more interest in the capital and income of the entity and their spouses. So what that means is it can be a bit tricky to go over the whole 15 years and potentially see that you have satisfied the test over those years.
In general concept it means that if you have run the business for 15 years and then critically you are selling it in conjunction or in connection with the retirement of one of the significant individuals. Doesn’t have to be every significant individual, it only has to be one then you can come under this 15 year exemption. Now it is important not to stuff it up by you know five years before the end of the 15 years you have felt it for 10 years and you do a little restructure sometimes they can start the 15 years going again. So you know if you are a small business and you are thinking of fiddling around with your business always have in mind the concessions that you might be eligible for in due course and get very careful advice before you shuffle things around.
Now if you get the 15 year exemption then that means that your capital gain is exempt. There is also a fantastic link between the small business concessions and some of the exemptions with contributions into superannuation under a separate CGT or you know capital gains tax contribution cap quite separate to the concessional contribution cap and the non-concessional cap. It is cap that just relates to in capital gains specifically to help people selling either pre CGT assets or small business assets.
Martin So to put it in simple terms you can kill two birds with one stone you can sell your business tax effectively and it is also a wonderful opportunity to get a lot of money into your Super Fund.
Ross That is absolutely right. Now the next alternative if you don’t qualify for the 15 year concession and you might not because you don’t quite tick over the 15 years or you do tick over the 15 years but know you are not going to retire you are going to work for another 5, 10, 15 years so you can’t use that. So the other concessions there are a general 50% discount. Now everyone has probably heard of the general 50% CGT discount if you have held something for over 12 months and the way it works with the small business discount is that there is a sort of layer on that. So let’s just look at say a couple of spouses who sell their business and they realise a $4 million capital gains on the sale of their small business you know capital gain on goodwill. Now if they hold it say in a discretionary trust then they are entitled to the general 50% discount so that will bring that capital gain from $4 million down to $2 million. Then they can apply a small business active asset reduction of another 50% so that will bring their capital gain from $2 million down to $1 million. It is looking pretty good so far. So then you have $1 million but still a taxable capital gain. And with that you can use the next concession which is known as the retirement exemption and the retirement exemption gives a significant interest holder and I said that was you know 20% or more and their spouse and together they are called CGT concession stakeholders and they have up to a lifetime concession limit of $500,000. Consequently here we have reduced our gain so far down to $1 million they can each have half a million dollars used under the retirement exemption to bring the capital gain down to zero and pay no tax at all.
Martin There it is.
Ross That is just sensational and if one or other is under 55 years of age and that time then to get that retirement exemption they must put it into Super. If they are over 55 they don’t have to put it into Super but in many cases of course we would say yes this is a golden opportunity to put it into Super under that separate CGT cap so it is a golden opportunity to get money tax effectively into Super.
Martin That is great Ross and a detailed analysis but one that I think really demonstrates the power of these concessions so thank you.
Just as a final question in relation to the small business concessions. You might think about using them upon selling the business but of course another really good way to use the concessions might be upon a restructure for example if you are looking to transition to the next generation. And presumably, the principles apply in exactly the same way?
Ross Yes they apply in the same way. With the restructure done for a legitimate commercial purpose like that in particular you are doing it primarily for the purposes of you know putting it into another structure which you think is going to facilitate that succession. So for example it might be going out of just a discretionary trust into some other vehicle like a company or a unit trust which has equity interests in it which might be passed onto different people and you know that facilitates the succession and incidentally to that restructure you can take advantage of the small business concessions.
Martin That is a really important point that you just made about the bona fides of the restructure because you can’t just shuffle things around to get a tax benefit. It must be driven by a commercial purpose primarily.
Ross That is certainly the better way to go about things. We do have some general anti avoidance provisions which attack arrangements which are made for the sole or dominant purpose of tax avoidance. You know this is always subject of debate but if you have got you know good commercial reasons for doing something and you get incidental tax benefits which are a natural part and parcel of that, then I think you are in a pretty good position to say that those general tax avoidance provisions are not applicable and particularly whilst it is not specifically written in the law there is always been this understanding and it was mentioned in the original explanatory memorandum in Part 4A that if it is more of the natural of Part 4A is in the Income Tax Assessment Act and that is the general anti avoidance provisions that I was talking about for the sole or dominant purpose of tax avoidance.
Martin Yes, the provision that says “Don’t do anything just for tax benefit”…
Ross: Yes, or for the dominant purpose even. If you are doing it for the dominant purpose of something commercial and you are actually moving assets around in a real sense into a different structure and entity for a commercial purpose, then the chance of it being attacked is extremely low. Martin: That’s great Ross, thank you. So we have covered an awful lot today, it’s been very interesting, so thank you.
To summarise I would say to anybody listening to this, please be tax aware on the sale of your business, please don’t negotiate anything, don’t sign anything without getting some tax advice. It’s number one cab off the rank. And once you have locked that in by all means, bring in other advisers for the due diligence or contracts, whatever you like, but set this up right from a tax perspective to start with. Also be aware of the general small business concessions, try and get a level of understanding around them, and a level of understanding around whether you might qualify now and in the future. Because this is going to help direct your succession planning, and also remember of course that you can get these general concessions not only on selling your business but also potentially on transitioning to your management team or to the next generation.
So Ross Higgins, thank you very much!
Ross: My pleasure, Martin!