Selling or exiting your small business: What it means for your tax

You’ve spent years building up your successful small business but now you’re looking to take a step back. Maybe you’ve received an offer from a competitor that you can’t refuse, perhaps a staff member wants to buy out the business or perhaps even your children are interested in taking over. Before you sell up, you need to understand how each option will affect your tax.

As you approach later life, you need to have a personal, financial and business plan in place.

When it comes to your business succession plan, minimizing tax exposure is certainly important but there are three other factors which make a succession plan valuable:

  • It helps to minimize family discord, making it clear what your intentions are
  • It gives you time to “groom” a potential successor, whether from within the family or from an external source
  • It will protect and enhance your wealth – building up your super, protecting your assets from creditors as well as itinerant family members

How Might You Exit Your Business?

The four main ways in which you might look to exit your business are:

  • Selling the business
  • Passing the business to family members or others already within the business
  • Closing it down, by ceasing trading and selling the assets
  • Liquidating the business

Here’s a breakdown of each option, and what it means for your tax.

1. Selling the Business

In practice, the most common way to exit a business is to sell it. Before you can do that, there are some essential steps that you’ll need to take:

Get A Valuation

You’ll need a fair, impartial understanding of what your business is worth. That will help dictate the price and may also concentrate your mind on whether you want to progress with the sale or not.

Later on, if you decide to sell and need to calculate your tax liability, a valuation done at the pre-sale stage can help in any discussions with the Australian Taxation Office (ATO) about the values used in your Capital Gains Tax (CGT) calculations.

A valuation isn’t just about assessing the past performance of your business and the value of your business assets; a purchaser will also factor in the future prospects of the business after you’ve gone.

Get Your Records Up To Date

Potential purchasers will want to do due diligence on your business and that means they will expect to see clean, clear, complete business records.

Understand What You’re Selling

Are you selling the whole business or just part of it? Are you selling shares in a company or assets owned by the company? You’ll need to be on the same page as your potential purchasers.

Decide How You Will Sell

You might need to engage a business broker to market your business or you might already be aware of a potential purchaser in your circle of contacts.

Get Professional Advice

Take tax, accounting and legal advice throughout the process, from the initial succession plan through to the closing of the deal.

Assess Your Future Involvement

Some buyers like the previous owners to stay on to provide stability for staff and customers, either as an employee or a consultant. Are you prepared to do that or would you like a clean break

2. Passing On The Business

Many small business owners decide to pass on their business to their children, grandchildren or other relative.

The tricky part of this is ensuring that the “old” generation takes away a decent return for all their hard work over the years, whilst the “new” generation isn’t crippled by debt.

To ensure that all parties feel happy with the deal, often the best way to do that is for the “old” generation to simply sell the business to the “new” generation at market value, based on an independent valuation.

Selling for less than market value can have CGT consequences since tax law often substitutes market value where a transaction occurs between connected parties, such as family.

Where more than one child or other relative is taking over ownership, it can be worthwhile forming a family trust structure to own and operate the business.

3. Closing Down The Business

This is an option that is rarely attractive and generally only becomes a worthwhile option if the business’s future prospects are bleak, such as no buyer or no suitable offer.

If you choose to close down, you simply sell off your business assets, pay off your creditors and take out whatever is left.

4. Liquidating The Business

Only a company can be liquidated.

A liquidation generally occurs when one of the creditors of the company petitions the court to have the company liquidated, at which point a liquidator is appointed to collect and sell the assets of the business and then distribute the funds to the creditors.

Anything left over (minus liquidator fees) then goes to the company’s owners.

Realistically, a liquidation only happens when the company cannot pay its debts. It would not normally be an option as part of a planned exit strategy.

Tax Consequences Of Exiting A Business

Small business owners who decide to sell up or exit their business have access to a variety of concessions to help defer, reduce or even eliminate any CGT.

The 50 Per Cent CGT Discount

The 50 per cent discount is available against most capital gains arising on the sale of assets, including shares, property and business assets.

The main features of the discount are as follows:

The discount is available to individuals, trusts, partnerships and complying superannuation funds but not to companies

The rate of the discount is 50 per cent for individuals, trusts and partnerships and 33 1/3rd per cent for superannuation funds

To qualify, the asset must have been owned for 12 months.

Clearly, qualifying for the 50 per cent discount is easy and it provides a very valuable relief. But if you also qualify for one or more of the small business CGT concessions, you can potentially go one step further, even reducing your tax bill down to zero.

Relief For Small Businesses

The special small business CGT concessions are available in addition to the 50 per cent general CGT discount.

The policy is designed to encourage participation in the small business sector by giving a variety of tax efficient mechanisms which reward long-term investment in a small business.

They do this by reducing or in some cases totally eliminating capital gains arising where small business people exit or reduce their involvement in trading businesses or – in the case of the rollover relief – they dispose of one small business asset and replace it with another.

There are four CGT concessions that may apply on the disposal of a small business:

  • The 15-year exemption
  • The 50 per cent reduction
  • The retirement exemption
  • Roll-over

Broadly speaking the concessions are available provided you run a small business (which for these purposes is one with a turnover of less than $2 million) and the assets being sold are active assets, which basically refers to assets which are used in a business.

Shares in a company can also be active assets if the underlying business of the company is trading in nature, rather than investment driven.

The Tax Concessions, And How They Can Work For You

If you pass the basic tests, above, you’re then into the small business CGT concessions regime and can consider which concessions to take advantage of.

The 15 Year Exemption

If you meet the basic conditions, a small business asset disposed of is totally exempt from CGT if you have owned the asset for at least 15 years up to the disposal, you are at least 55 years of age and are retiring. The exemption can also be claimed if you become permanently incapacitated, in which case you don’t need to be 55 and nor do you need to retire.

Small Business Retirement Exemption

A taxpayer can choose this exemption to completely eliminate a gain up to a lifetime limit of $500,000.

Although commonly used in a retirement situation, it isn’t actually necessary to retire to benefit from it. If you are under 55, money from the disposal of the asset must be paid into a complying superannuation fund or a retirement savings account. If you are over 55, there is no obligation to place the proceeds into super (though you can do so if you want).

A common planning strategy for those aged 53 to 54 who don’t want to pay proceeds into super is to roll their capital gain over using the small business roll-over relief (see below) and then take advantage of the retirement exemption when you hit 55.

50 Per Cent Active Asset Reduction

Where a capital gain is derived from the sale of an active asset (see the description above), a 50 per cent reduction is available. That’s in addition to the general 50 per cent discount, so taking the two together, the gain is reduced by 75 per cent for entities other than companies (which can’t claim the general 50 per cent discount, but can claim the 50 per cent active asset reduction).

Roll-Over Relief

The fourth small business concession doesn’t exempt a qualifying capital gain from tax at all; it merely defers it.

This relief allows a business owner to “rollover” the capital gain derived from the sale of their business (or an asset in the business) for two years to one or more new businesses or business assets.

Although the CGT concessions can produce a surprisingly healthy tax outcome when exiting a business, the rules are very complex and it pays to take advice with a tax accountant such as H&R Block to check what you’re entitled to and to ensure that your exit is structured in such a way as to meet both your tax and broader financial and lifestyle goals.