Selling a business you have spent so many years building up can be a difficult process, but getting the best price is not the only consideration. Tax has a big role to play in the financial result.
That means the ATO will be paying close attention. Selling a business is considered as disposing of an asset, so it triggers a capital gains tax (CGT) event.
If your sale isn’t handled correctly, you could find yourself on the receiving end of a hefty tax bill and a lot less profit than you expected.
In most cases, planning your exit should start when you establish your business. That way you can choose a business structure that makes the most of the various tax concessions available. These are complex, so contact us for advice about which concessions may be apply to your business.
For tax purposes, selling a business is considered part of your business income, so the proceeds are taxed at the normal rate for your business structure.
For sole traders and partnerships, this can be as high as 47 per cent. Whereas small businesses operating through a company structure are taxed at the significantly lower rate of 26 per cent.
Your CGT bill when selling depends on a range of factors, including how much it cost you to purchase the business, referred to as your cost base, sale price and the available tax concessions.
A decade ago, Ayumi set up a small dental practice. Over the years she has significantly grown her client base and now earns an annual salary of $190,000. Her current tax rate is 47 per cent (including the Medicare levy).
Ayumi agrees to sell the business to one of the dentists she employs in the practice for $500,000.
As she started the business from scratch, her cost base is nil, so when the sale goes through she will have triggered a $500,000 capital gain. (Her business set-up costs are not included in the cost base).
As this capital gain is added to her personal income, a potential $235,000 ($500,000 x 47 per cent) is added to Ayumi’s taxable income. If she takes advantage of some of the small business CGT concessions, Ayumi will be able to cut her tax bill substantially.
Your trading entity should be carefully considered when establishing your business, but it’s a good idea to review it periodically, particularly if you are thinking of selling.
With the government actively lowering tax rates for small business entities (SBE), the structure you originally selected may no longer be the most tax effective. The tax rate for SBEs operating as companies dropped from 27.5 per cent to 26 per cent from 1 July 2020 and a further cut to 25 per cent is coming in 2021-22.
Operating as a company also gives you the option to sell your business in different ways. You can either sell shares in the business or sell the business as an asset.
Exiting a business operating as a trust, sole trader or partnership is always an asset sale, but with a company structure either option can be used.
Carefully reviewing your tax structure and negotiating the right type of sales agreement also allows you to maximise the valuable small business CGT concessions.
For example, if you operate through a company structure and can negotiate a share sale, you can access several CGT concessions that significantly reduce your CGT bill.
The concessions are also important to keep in mind when setting and negotiating your sale price.
If your sale price is over the $6 million maximum threshold, it may be worth reducing it to qualify for the small business CGT concessions.
With so much at stake, professional planning and support are essential when the time comes to sell your business.
Many of the tax concessions are only available once, so it’s essential to organise your business and the sales process to maximise the available benefits.
Preparing your business for sale takes time and planning, if you would like assistance with your exit strategy please give us a call.