There are many ways that you can exit a business, for example through trade sale, IPO, private equity and family succession. Each option has its own nuances but one thing they have in common is the potential for complex tax implications. Without proper planning, the tax implications can turn a good deal into bad one.
Here are five tips for ensuring a tax effective exit from your business.
- Understand your tax profileYour tax profile is what informs tax planning and enables better tax outcomes to be achieved.
To understand your tax profile, you need a clear understanding of your business’s legal structure, assets and ownership.
Accessing CGT concessions is a major planning objective. For smaller businesses, the small business CGT concession can fundamentally change the tax outcomes from a sale. In the right circumstances, a business could be sold for $4 million with zero tax liability. For owners of larger businesses, the 50% general discount can have a major impact on tax exposure.
For older businesses, in particular family businesses, pre-CGT status can mean a tax-free capital gain. Changes in shareholdings or share structures, changes in the business and the acquisition of new assets can all adversely impact on your pre-CGT position.
Tax cost bases need to be determined for major assets and for ownership interests (shares, units, etc).
Franking credits are another important attribute. In many instances, limited value will be attributed to franking credits by the buyer, so looking to utilise these credits in pre-sale dividends or dealing with minority shareholders may be tax effective.
Losses, gearing and international assets are further examples of attributes that create tax implications during an exit transaction.
- Plan your preferred exit transaction
Once you have an understanding of your tax profile, you can identify your preferred exit transaction. Fundamentally, this will either be an asset sale or a share sale, but it tends to be more involved than that.The initial step is usually to model the different alternatives to identify the different tax outcomes, both for the business and the owners.
If the preference is to sell an entity, but it holds assets that are not going to be part of the sale, then restructuring is required. Depending on the intended purchaser and type of exit transaction, you may need to sell a ‘clean’ entity which will necessitate restructuring the ownership of the existing legal entities. Trust structures are common in private businesses but are often unattractive to purchasers and may need to be unwound prior to sale.
If the preference is to sell an asset, you need to consider the plan for the sale proceeds. Are these to be reinvested within the existing structure or distributed to the owners? What are the tax implications of these transactions? Are you planning to sell in one tranche or in multiple tranches over time? Each of these decisions triggers different tax implications.
The reality is that as businesses get larger the exit transaction involves a combination of these different features, all of which need to be managed in a coordinated way.
- Do your own tax due diligence
The general 50% discount has created a real bias towards the sale of shares in a company rather than the sale of the business assets of the company (the same applies for units in a unit trust, but this is a much less common structure).For the same commercial deal, this change in transaction structure can halve the tax payable by shareholders. However, purchasers still have a preference towards asset deals which ensure they receive a full tax cost base in the assets they acquire and protect them from exposure to historical liabilities of the target entity. Negotiation becomes key.
When negotiating a share sale, you place yourself at a significant advantage when you identify and address any major tax issue before you engage with a potential purchaser. This is where vendor due diligence becomes important.
Vendor due diligence processes can be undertaken across the business, but for tax, due diligence focuses on identifying risks that will deter potential purchasers. Private expenses, related party transactions, late payment of employee obligations, neglecting to identify tax obligations such as FBT and payroll tax are all tax issues that regularly arise in this context.
Be cognisant of the full package of information you will provide to the purchaser. Pro-forma balance sheets and normalised Profit and Losses (P&Ls) may help to justify a higher sale price, but the explanations for the adjustments may also point to tax issues that impede the deal.
- Restructure or reorganise your affairs in advance
Good tax planning is not crisis management. Pre-planning is key to achieving your targeted tax outcomes. If you need to separate assets into a new entity, unwind a trust, interpose a new clean entity or do any of a multitude of pre-sale planning transactions, doing it before a sale transaction is on the horizon is fundamental.Once you have started actively seeking an exit transaction, and especially if you have started negotiations with a potential purchaser, restructuring transactions may not be possible, at least not in a tax effective way.
On one hand, the ownership period requirements for some concessions (such as the 12-month holding period to access the 50% general discount) may be reset and therefore won’t be satisfied. However, even if the technical tax requirements are met, a transaction undertaken in anticipation of an exit that alters the tax outcomes of the exit transaction can, if undertaken in close proximity to the exit transaction, be struck down as tax avoidance. The same restructuring transaction undertaken well before any exit transaction is planned is much less likely to be subject to the tax anti-avoidance rules. As always, demonstrating the non-tax outcomes of all transactions is important.
- Stand in the buyer’s shoes
Like with many situations in life, understanding can be gained by spending time in the other person’s shoes. A purchaser will have a different perspective of your business and things that may be acceptable to you, may not be acceptable for a purchaser.Where an entity is being sold, it will usually be on a cash free/debt free basis with allowance to ensure adequate working capital. Related party loans are common in private businesses but will need to be addressed as part of any exit strategy. Preferably these loans would be cleared prior to engaging with a potential purchaser. If not, then have a clear plan as to how you will deal with these balances in parallel with any sale.
A purchaser does not have the benefit of your years in the business and the innate understanding that you bring. They will ask questions and being able to quickly answer those questions will instil confidence. For tax, documenting tax positions and having advice on any more complex matters is very beneficial as it demonstrates that you are on top of your tax affairs and less likely to have ‘skeletons in the closest’.
Legal documentation for any transactions is also very important, particularly for any pre-sale restructuring or reorganisation that you have done, or pre-sale transactions you intend to do, as the purchaser will want to know that tax issues aren’t going to be triggered for them.
Having an experienced tax advisor on your team will help you manage your tax issues and maximise your tax outcomes. William Buck has worked with many clients to help them achieve a tax effective exit from their business. For more information, contact your local William Buck Tax Advisor.