Selling your business can be a volatile time. You've spent your life building your business, so you want to make sure you're getting the most value from the sale.
But selling your business triggers a capital gains tax event which, if handled incorrectly, can see you pay more a lot tax than you expected. This causes you to lose a high percentage of the value from your business' sale.
The good news is that there are a number of options available to minimise the tax you pay when selling your business.
Read more about our advisory work for businesses to see how you can make your future business sale tax effective, whenever that may be.
Understanding capital gains tax
Capital gains tax is the tax you pay when you sell an asset — in this case, your business.
You're required to pay tax on the difference between the amount you paid for the asset, and the value you sell it for.
For many business owners, they started their business at no cost—from scratch—so the capital gains they make will be significant. Which means the tax itself can be, too.
For example, say your business was started by its founder ("from nothing", he says) and sold for $1.5 million. This sale would trigger a capital gain event of $1.5 million, so you be assessed on the $1.5 million gain.
If your business was purchased for $500k and sold for $1.5 million, this is a gain of $1 million.
Once the gain is calculated, it's then added to the income of the entity that owns the business. So if your business operates under a company structure and your own company shares in your individual name, the capital gain amount is registered to you.
Whether you're an individual or a business, this can be significant. This is why it's crucial to get sound advice before selling a business.
Managing shares and assets
One of the most important considerations when selling your business under a company structure is whether you're selling the shares or the assets.
- A share sale involves just that: the buyer purchases shares in the company, effectively buying the company itself. The assets and liabilities are kept within the company, but the company's legal entity now belongs to the buyer. It's just the ownership of the shares that changes.
- An asset sale means some or all of the company's business assets are purchased. This can include things like property, land, stock, and intellectual property. The owner still retains the company's legal entity.
When you operate a business under a trust, sole trader, or partnership structure, it will always be considered an asset sale. If you operate the business under a company structure, you can choose either an asset sale or a share sale.
Companies typically find it more tax-effective to undertake a share sale. However, an asset sale is considered a more straightforward transaction, making it preferred by many buyers. Because when you undertake a share sale, you're buying the business. So you're accountable for the business' liabilities, too, which can include things like unpaid super or tax.
Capital gains tax concessions
There is hope in site for small business owners, however, in the form of capital gains tax concessions. These concessions can reduce, or in some cases even eliminate, the amount of capital gains tax you're required to pay on the sale.
The first 50% capital gains tax reduction
Sole traders, individuals, and trusts are eligible to access a 50% discount on the capital gains tax if they meet the ATO's criteria:
- Your business must have either less than $2 million of turnover, or net assets of less than $6 million.
- The entity claiming the concession must have net assets of less than $6 million.
- You hold the asset for over 12 months prior to the sale.
Companies are not entitled to this discount if the business is sold as an asset sale. If the company's shares are sold, then the company is entitled to this discount.
So, for example, a capital gain of $1.5 million is halved to $750k.
If you qualify for the first 50% concession, you then gain access to four subsequent concessions.
The 15-year exemption
If you've continuously owned your business asset for more than 15 years, you're 55 years or older, and you're retiring, you qualify for the 15-year exemption.
This allows you to disregard the entire capital gains tax on the sale of your business.
The 50% active asset reduction
This concession entitles you to receive a 50% reduction on the remaining capital gains tax on the sale of an active asset. An 'active asset' is one that's held in the course of undertaking your business. To qualify as an 'active asset', the asset must have been active for at least half the time you owned it, or if it's been in your possession for over 15 years, it must have been active for 7.5 years.
This includes tangible assets, like your shop front, or a warehouse, or intangible assets, like the business' goodwill.
Continuing with the previous example, your capital gain has already been halved to $750k. You receive a 50% discount on this remaining amount, meaning you only pay capital gains tax on the remaining $375k.
The retirement exemption
The retirement concession is a misnomer, as there's no age limit, nor any actual requirement for you to retire. This concession enables you to disregard up to $500k of your capital gain.
The reason it's called the 'retirement' exemption is that those aged under 55 years must contribute the capital gain amount into their nominated super fund. For those older than 55, you can receive the capital gain tax-free.
The interesting thing is that this exemption is a cumulative limit. So business owners can choose to use this exemption across the sale of several businesses, up to the maximum limit.
So, following the above example, you're now able to reduce the remaining $375k capital gains tax to $0.
The small business rollover concession
When you sell an active asset, you can choose to roll the capital gain over into a replacement asset, where the cost base of the replacement asset is reduced by the rollover amount.
This replacement asset must be purchased within a one-year period prior to the capital gains tax event, or two years following.
Plan ahead to minimise your capital gains tax
It's crucial to plan ahead when considering selling your business, in order to take advantage of every opportunity to minimise your capital gains tax.
You can begin this when you first set up your business, in the form of choosing the right structure that allows you to minimise your capital gains tax in the future.
But if you've already got an established business, you can still put the right plans in place.
For example, you may be able to negotiate a share sale with the buyer, rather than an asset sale, thereby qualifying you for the first 50% concession.
Alternatively, if it's likely your business sale will be over the threshold, you may consider lowering your sale price to qualify for capital gains tax concessions. While you're selling for less, the resulting concessions may see you keep more money in your pocket. However, this depends on multiple factors like your individual wealth outside of the business and its structure.
The final word
The biggest piece of advice for business owners is always to have the right support when selling your business. Many of these capital gains tax concessions are only available to you once, so it's imperative that you maximise them in order to gain the most benefit.
Your Liston Newton business advisor can help you plan for your business sale, and provide you with a roadmap to minimise the amount of capital gains tax you pay in the future.