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Taxation Aspects on

Existing a Business

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Peter Adams

Overview of key considerations

1. SALE OF SHARES / UNITS OR BUSINESS ASSETS2. COSTS ASSOCIATED WITH SALE3. COMPONENTS OF THE PRICE4. LAND, STOCK AND EQUIPMENT5. WORK IN PROGRESS, CONTRACTS6. INTELLECTUAL PROPERTY, LICENCES7. EMPLOYEES8. GOODWILL9. CGT SMALL BUSINESS CONCESSIONS10. GST CONSIDERATIONS11. PAYMENT AND CONTRACTUAL ISSUES

Peter Adams

Sale of shares or business assets

Key influencing factors for purchasers and vendors

• Commercial risks

• Tax losses – requirements for entitlement – COT & SBT – Anti-avoidance

• Non-commercial business activities – deferred losses – seller & buyer Commissioner’s discretion – salary sacrifice planning

• Bad debts – capacity to deduct – requirements for companies

• Franking account surplus -

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Peter Adams

Sale of shares or business assets

Key influencing factors for purchasers and vendors (continued)

• Pre-CGT assets – Tainting assets as post – CGT if > 50% change of company ownership

• Small business CGT concessions – active asset test – shares / units

• Shares have higher cost base

• Shares pre-CGT and sale of business assets give rise to assessable income – Note CGT event K6 if > 75% post-CGT property

• Liquidation – sale of shares – may be more appropriate if company has tax-free reserves

Peter Adams

Costs associated with sale

• Tax treatment of legal, accounting and associated fees – generally capital costs

• No deduction under s8-1 as general immediate deduction but can claim 5-year write-off deduction under s40-880

• 5-year write-off deduction available even if business sale ultimate falls through

• 5-year write-off deduction also available to defend take-overs or to implement take-overs

• Tax treatment of tax related expenses – s25-5 deduction – only applicable relevant to income tax – registered tax agent –company deduction can be imputed to public officer

• Other incidental expenses – cost base for CGT purposes

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Peter Adams

Components of the price

• Expenses associated with the acquisition of a business are generally capital expenditure and not deductible

• Vendor will have an interest in maximising capital component of the transaction to:

– obtain the benefits of the concessional treatment of capital gains, egthe 50% discount

– obtain the benefit of the CGT exemption for pre-CGT assets (particularly goodwill)

– obtain the benefit of the CGT small business concessions.

• Purchaser may wish to maximise any possible revenue component of the transaction to obtain immediate deductions.

• Vendor will have interest in minimising the component of the consideration relating to trading stock and depreciating assets.

Peter Adams

Land, Stock and Equipment

• Treatment of trading stock:– market value at date of disposal– vendor wants value low value ascribed and buyer wants high, but not

always– If pre-CGT asset for vendor and trading stock for purchaser both may want

high value ascribed to asset– If stock prices are expected to rise vendor can defer tax liability by having

purchaser hold stock as bailee for sale on assignment– Commissioner’s approach – contracted value acceptable if armslength

parties

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Peter Adams

Land, Stock and Equipment

• Treatment of land and improvements – pre-CGT/post-CGT -separate land and buildings – note profit-making by sale exception

• Treatment of unused capital works – buyer inherits capital works deduction – vendor has to provide information within 6 months

Peter Adams

Land, Stock and Equipment

• Treatment of leased premises – assignment of post-CGT lease subject to CGT

• Lease premium paid – capital cost - part of cost base for vendor• Lease premium received capital gain under CGT event F1 but no

50% CGT discount• Strategy - include lease premium as part of goodwill – rent must

be at market rates• Lease incentives paid or lease surrender payments - capital costs• Lease preparation expenses deductible• Treatment of leased equipment – similar principles

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Peter Adams

Land, Stock and Equipment

• Depreciating assets – balancing adjustment for vendor (assessable income or allowable deduction) – no CGT unless CGT event K7

• Depreciating assets – purchaser’s entitlement to a (decline-in-value) deduction for cost – proportion ownership in disposal year

• No cost allocation in contract – reasonable cost / value attribution• Treatment of motor vehicles – depreciation car cost limit – no CGT

on sale of car but part of SBE CGT concessions assets base• Treatment of spare parts – capital costs / gain• Repairs – deduction entitlement – initial repairs – knowledge

irrelevant – cost base if not deductible

Peter Adams

Work in progress and Contracts

• WIP part of trading stock if tangible property• WIP – services business - amounts paid for WIP that are

assessable to the recipient are deductible to the payer. • Deduction available in year payment is made if a recoverable

debt has arisen for the work or reasonably expected to arise within 12 months after payment.

• Otherwise deduction will be available in the income year following the year of payment.

• Contracts – separate from goodwill - assigned business contracts generally have only nominal value at time of sale

• Debtors – bad debts – Vendor can retain debts and purchaser can act as collection agent – company retain bad debt deduction capacity if shares sold and SBT met

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Peter Adams

Intellectual Property and Licences• Patents, copyrights and designs – depreciating assets - balancing

adjustments• Partial assignment on instalment payment basis may be treated as

royalties not capital gain• Licence arrangements (IP) – part disposal of depreciating asset –

balancing adjustment• Tax treatment of trademarks – Not part of good will - CGT assets• Tax treatment of know-how – capital account - CGT event A1 if tied

to disposal of property or CGT event D1 on creation of right to provide know-how

• Can provide know-how on service agreement basis – deferred assessable income for vendor and allowable deduction for purchaser

• Statutory licences – not part of goodwill unless exclusive licence• Water rights – separate asset but will take CGT status from land

Peter Adams

Employees

• Annual and LSL entitlements – purchase price normally reduced on assumption of liabilities but actual accrued leave transfer payments deductible to vendor if paid

• CGT – capital proceeds take account of all liabilities assumed• Key person arrangements – capital account - CGT event D1

(restraint) – alternatively can provide service contract • Retirement allowances, gratuities – generally not deductible

unless in future interests of business – deductible under s25-50 if attributable to past services – purchaser deduction limitation

• Superannuation entitlements – transfer to new fund, member’s full actuarial reserve to be transferred

• Employee termination costs – capital costs

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Peter Adams

Goodwill

• CGT treatment of goodwill – pre-CGT status and acquisition• Trade names, logos and slogans –– as a result of Murry v FCT

no longer treated as part of goodwill• CGT goodwill concessions - small businesses• Restrictive covenants – tax treatment – CGT event D1 – no

50% discount

SBE CGT Concessions 1

Small business CGT Concessions:

CGT 15-year asset exemption

CGT 50% active asset reduction

CGT retirement exemption

CGT roll-over

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(3 of the 4 concessions have further conditions)

Then consider the 4 concessions

Start with basic conditions

Small business CGT concessions: methodology

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SBE CGT Concessions 1

Basic conditions for eligibility to small business concessions:

CGT event happens to an asset that the taxpayer owns event would otherwise have resulted in a capital gain taxpayer must either:

(1) be a "small business entity"; or (2) satisfy the maximum net asset value test ($6M), and

asset satisfies the active asset test If asset is a share in a company or interest in a trust, the

company / trust must have CGT concession stakeholder.

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Basic conditions: Step 1

A CGT event must have occurred in relation to a

CGT asset

Not relevant to:

• A gain/loss on a pre-CGT asset

• CGT event K7 occurs

• There has been a capital loss

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Step 2: CGT event

A capital gain must arise as

a result of the CGT

event

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Basic conditions Steps 3(a) & (b): who can access the concessions?

An SBE taxpayer

A partner in a partnership that is an SBE taxpayer

•They must be carrying on a business

A taxpayer that passes the $6m max net asset value

test

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SBE CGT Concessions – SBE requirement1

Small Business Entity (SBE) Requirement:

SBE must carry on a business and satisfy a $2m "aggregated turnover" test

Can be based on aggregated turnover for the previous year or the current year

Aggregated turnover is sum of SBE annual turnover and the annual turnovers of connected or affiliated entities

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Maximum NAV Test: NAV less than $6m

TaxpayerConnected

entitiesAffiliates

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SBE CGT Concessions - NAV Calculation

Sum of market

values of all CGT assets

Related liabilities & provisions

Net value of CGT assets

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Connected with

Control of the other entity

Controlled by the other entity, or both are under

common control

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Connected entity - Control (other than discretionary trust)

CGT Small Business Concessions (continued)

First entity

>40% of income

>40% of capital

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Control of a discretionary trust

CGT Small Business Concessions (continued)

First entity

Influence Test - Trustee acts

in accordance with

directions, control, etc.

Any of the 4 years before

>40% distribution

(can nominate up to 4

individuals as controllers))

Discretionary Trust: control

Distribution test

Influence test

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Affiliate

If they act, or could reasonably expected to act in accordance with

the taxpayer’s directions or wishes; or

In concert with the taxpayer

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Basic conditions step 4: CGT asset an active asset?

Test period begins when the asset was acquired & ends at:

The CGT event or When the business ceased, Whichever occurs earlier

The taxpayer has owned it > 15 years

And the asset was an active asset for a total of at least 7.5 years during the test period

The taxpayer has owned it for < 15 years

And the asset was an active asset for a total of at least half of the test period OR

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Basic conditions step 4: what is an active asset?

Assets used in a business of the taxpayer, an affiliate entity or connected entity of the taxpayer

Includes an intangible asset e.g. goodwill – inherently connected with the business

A share in a resident company or interest in a resident trust, where market value of the entity’s active assets, connected financial instruments & cash is greater than 80% of the total market value of the entity

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SBE CGT Concessions – SBE requirement1

Active asset requirement

Used in the course of carrying on a business by taxpayer,

connected entity or affiliate

The following are not active assets

Assets whose main use is to derive rent, royalties or FX

gains – recent case re holiday park

Shares in widely held companies or trusts

Financial instruments

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SBE CGT Concessions – SBE requirement1

Active asset requirement

The 80% rule is a “look through” test to ensure interests in

companies and trusts meet the active asset test

Market values of active assets and financial instruments

(cash) inherently connected with the business - must

exceed 80% or more of the market value of all assets

of the trust

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Basic conditions step 5: CGT asset is a share in a company or interest in a trust

CGT concession stakeholder

Small business participation

percentage of 90% or more

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CGT concession stakeholder

Significant individual in the

company or trust; OR

The spouse of a significant

individual in the company or trust

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Calculating small business participation percentage

Consider both the direct & indirect participation percentages: sec 152-

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CGT Small Business Concessions (continued)

• Significant individual’s are a subset of the concession stakeholders

CGT Concession Stakeholders

Significant

Individual

Spouse of

significant

IndividualParticipation %

must be > = 20%

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8 concession stakeholders

CGT Small Business Concessions (continued)

XYZ Unit Trust

Mr A– 20% Mrs A –5% Mrs B– 20% Mr B – 5% Mr C -20% Mrs C -5% MrsD -20% Mr D -5%

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SBE CGT Concessions1

Direct interest for discretionary trusts is smallest of any of

the following:

• % of income actually distributed during the current year

• % of actually capital distributed during the current year

Can be all capital or all income.

If both, the % is the smaller of the two

If no distributions made of income or capital – there will

generally be no significant individual, but trustee can

nominate up to 4 individuals as significant individuals

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Small business CGT concessions15 year asset

exemption

• Has priority over the other concessions

50% reduction

• Can choose not to apply

• Additional to the general CGT discount available to some taxpayers

Retirement exemption

• Capped to $500,000 lifetime limit

Rollover relief

• Can be applied before the retirement exemption

• Defers capital gains

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15 year asset exemption

Priority over all the other concessions.

Where the conditions satisfied, the whole capital gain is exempt from tax

Taxpayer does not have to apply capital losses against the capital gain before using this concession

There is no limit on how many times a taxpayer can access the 15 year exemption.

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15 year asset exemption: conditions

The individual is 55 years old or over & the CGT event happened in connection with retirement or permanent incapacity

The CGT asset is owned by the individual, or a company or trust that has a significant individual for at least 15 years; and

The CGT asset is owned continually for at least 15 years42

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Special terms• Significant reduction in hours

or change in present activities

• Not a permanent & everlasting retirement from workforce

Retirement:

• Ill healthPermanently incapacitated:

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Distribution of the 15-year CGT asset exemption amount

Must make the payment within 2 years of the CGT event

Made to a CGT concession stakeholder

Must not exceed a certain amount

Not classified as a dividend

Does not erode the cost base

Not included in the assessable income

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50% reduction

No additional basic

requirements

Optional

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Impact of this concession

Company may have insufficient franking credits

CGT event E4

Assessable to the shareholder as an unfranked dividend

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Small business retirement concession

Capital proceeds form the CGT asset must be used for retirement (actual retirement not required)

Can further reduce or eliminate a capital gain

Capped to a $500,000 lifetime limit47

Used with the other CGT concessions

Does not apply where the 15 year asset exemption applies

Applies only to the balance of any gain remaining after applying the general CGT discount

50% reduction applies before the retirement exemption, although the taxpayer can choose to not apply the 50% reduction (esp for companies & trusts)

The retirement exemption can apply to all or part of the gain

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Retirement exemption eligibility conditions

CGT events J2, J5 & J6

Contribution requirement for individuals less

than 55 years of age

Individuals aged 55 and over are not required to

make this payment

Payment requirements for CGT concession stakeholders of

companies & trusts

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Consequences of choosing small business retirement exemption

Entity Element Consequence

Individual Capital gain Capital gain equal to CGT-exempt amount is disregarded (i.e. not included in assessable income)

Company or trust Capital gain Capital gain equal to CGT-exempt amount is disregarded (i.e. not included in assessable income)

On-payment by company or trust to the CGT concession stakeholder

Is non-assessable non-exempt income in the hands of the stakeholder

On payment cannot be deducted by the company or trust from its assessable income

On payment is not a frankable dividend by a company & is excluded from the deemed dividend provisions in Div 7A

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Small business CGT rollover reliefAllows a taxpayer to roll over the capital gain

Does not apply where the 15 year asset exemption applies

50% reduction applies before rollover relief, although the taxpayer can choose not to apply the 50% reduction

May be applied in conjunction with the small business retirement exemption

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Eligibility conditions

Replacement asset

Must be an active asset

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Consequences of rollover relief

Capital gain is disregarded:

to the extent that it does not exceed the

cost base of the replacement asset

Crystallisationof the gain:

Where no replacement asset

acquired (J5)

Where replacement asset changes status

(J2)

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Where no replacement asset acquired CGT event J5

Deemed capital gain arises

The capital gain may be eligible for the

small business retirement exemption

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Where the replacement asset changes its status: CGT event J2

The replacement asset stops being an active asset: e.g. the taxpayer disposes of the asset or stops using it in their business

The replacement asset becomes trading stock

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Sales of GST-free going concerns - requirements

• the sale must be for consideration

• buyer must be registered or required to be registered for GST

• seller and buyer must have agreed in writing that sale is of a going concern

• under the agreement, the seller carries on the business until the date of sale, and

• the seller supplies the buyer with all of the things necessary for a business's continued operation.

GST Considerations

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• Separate land and business – transfer as part of business GST-free

• Sale of buildings – GST free if tenanted

• GST increasing adjustment if subsequent to GST-free going concern supply ongoing input taxed supplies are made – MBI Properties case

• Sale of partnership business – GST free but not partnership interest

• Sale of franchise – GST-free but not new franchise

• Sale of shares - financial supply – input taxed

• Sale of farmland – GST free if farming business carried on

• Forfeited deposits – GST treatment

• Assumption of liabilities – GST treatment – statutory liabilities

GST Considerations (continued)

GST & Real Property

Specific real property transactions

GST-free Going Concern

Supply of an enterprise as a going concern is a taxable supply under the general GST rules.

However Subdivision 38-J of the GST Act entitles the vendor and purchaser to treat the arrangement as GST-free if certain conditions are met.

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GST & Real Property

Specific real property transactions

GST-free Going Concern

For GST-free treatment, following conditions must be met:

1. supply of the going concern is for consideration

2. recipient is registered, or required to be registered, for GST

3. parties have agreed in writing that the supply is of a going concern

4. supplier supplies to a single recipient everything necessary for the continued operation of the enterprise

GST & Real Property

Specific real property transactionsGST-free Going Concern• Where particular premises are necessary for the

continued operation of an enterprise, these premises must be sold or leased to recipient for the supply to qualify as a GST-free going concern

• Where enterprises are run from leased premises, then it may be necessary to supply the lease either by assignment or by surrendering the lease and facilitating the grant of a new lease - this must be done by the day of the supply if the premises are necessary for the operation of the enterprise

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GST & Real PropertySpecific real property transactions - GST-free Going Concern• Sale of a leasing enterprise to a third party will normally be a supply of a going

concern eligible for GST-free status if all the things necessary for the continued operation of the enterprise are supplied

• ATO view is that a building that was tenanted and is temporarily vacant will still be supply of a going concern if new tenants are being sought at time of supply

• Supply will still be eligible even if parts are not being actively marketed if they are being repaired or refurbished.

• However, where building has never been occupied it cannot be regarded as a going concern

• ATO considers that going concern principle cannot be used on sale of a property to a “sitting” tenant

GST & Real Property

Specific real property transactions - GST-free Going Concern

• Sale of a part interest in leased commercial premises can qualify as a sale of a going concern.

• GSTR 2004/6 states that where a property is used in carrying on a joint activity from which income is received jointly (such as leasing), it will be a tax law partnership that carries on the enterprise – regardless of how the property is held

• ATO considers that where a co-owner in a tax law partnership sells its interest in a leased commercial property, the sale results in a supply by the tax law partnership.

• ATO states that this supply can be the supply of a going concern as ATO accepts that a leasing enterprise can be carried on in relation to each co-owner's interest in a leased commercial property.

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GST & Real Property

Specific real property transactions

GST-free Farmland – supply of farmland

• Certain supplies relating to farm land and Crown land are GST-free.

• If farm land is sold as a going concern, the transaction will be GST-free as a going concern

• However, the supply of farm land is also GST-free if the recipient intends to carry on a farming business on land on which a farming business has been carried on for at least 5 years

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• Timing issues – CGT event A1, CGT event B1, CGT event E1

• Warranties and indemnities – clawback clauses – “recoupments” reduce cost base and capital proceeds

• Prepayments and apportionments – reimbursement assessable (generally or under s20-35) and deductible to purchaser

• Price adjustment clauses – not acting at arms length

• If sale price renegotiated before settlement then sale price is renegotiated price

• Forfeited deposits – CGT event H1 – no 50% discount

• Payment by instalments – full taxable capital gain upfront

• Earnout clauses – CGT event A1 – capital proceeds is cash + market value of right – existing treatment – New Legislation

Payment and contractual issues

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Tax Update - LegislationTax and super LAM No 6 Bill - CGT and earnout rights

• Capital gains and losses in respect of look-through earnout rights (LTERs) will be disregarded.

• Payments received or paid under LTERs will affect the capital proceeds and cost base of the underlying assets to which LTERs relates.

• Assessments can be amended up to four income years after income year in which last potential financial benefit under LTER was due to be paid.

• Capital losses arising from relevant CGT event cannot be used until they cannot be reduced by future financial benefits received under LTER

• Amendments will apply to earnout arrangements on or after 24 April 2015

• ATO released details of administrative treatment of these measures https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-on-capital-gains/CGT--Look-through-treatment-for-earnout-rights/?page=2

Conclusion

Wrap up

Questions

Thank you

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