As you may recall, we previously launched the first part in our commentary on Succession Planning and the importance of establishing the right strategies, which accurately reflect your wishes.

Our first article highlighted intergenerational transfer of wealth, focusing on forming the foundations to bequeath your legacy onto the next, and provided insights into how complacency in this regard can have effects on succession when ill-acted.

For Part-Two, we concentrate on succession in relation to owning a business, and the potential Exit Strategies business owners can undertake to fund their retirement and live life after work without worry.

In discussing Exit Strategies, we highlight the tax implications of transferring the business onto new ownership, specifically in relation to Capital Gains, and the sale of assets.  

Exiting a business for retirement

For some people, their retirement plans depend on their ability to maximise the sale of their business.

The process of selling a business is an emotional journey as well as a business decision and when done properly the process can take many years.

Well before the retirement date, the owners should be making sure that all the systems and processes for the business are in place for not only due diligence during the sale process but also for the changeover to the new owner. It is also important to make sure all employees who are vital to the management and operation of the business are committed to the sale process and to the new owners.

I recommend that during the business lifecycle, regular informal valuations of the business are undertaken to guide the retirement strategy and the timing of any exit. For business owners the value of their business may be overestimated in their own minds and having an external valuation undertaken can bring some reality to the conversation around an exit strategy.

There are many ways to exit a business, one option can be to pass on the business to the next generation of family coming through the ranks. This type of exit has usually been discussed and planned for over many years and in some instances even previous generations.

Another exit strategy is to sell to the existing management of the business. The management team have intimate knowledge of the business, its customers, suppliers, and employees. This sometimes can also achieve a higher price then going to the open market. This exit strategy is discussed and planned over many years.

Finally, a third Exit Strategy is selling the business on the open market to a third party. This strategy still requires intense planning to optimise the sale price achieved. This business sale may also come with additional terms and conditions around warranties, earning escrow calculations and a handover term with the new owners. Rarely does a WIWO option give the greatest exit value.

I will not discuss the IPO model as an exit strategy in this article.

Considerations for a Business Sale

For this article, I will assume that the business is housed inside an entity structure – either a Company or a Trust. Of course, other business structures include partnerships and sole traders.

If the business is housed inside a Unit Trust, then the owner has the decision to make about whether to sell the business assets or the actual Units in the Trust itself. Either way the business is transferred to new owners, but the tax outcomes between the two methods may be different.

If the business is housed inside a Discretionary Trust, then the owner can only sell the business assets to a third party.

If the business is housed inside a Company, then the owner has the decision to make about whether to sell the business assets or the actual shares in the Company. Either way the business is transferred to new owners, but the tax outcomes between the two methods may be different.

Discussions should be held early with your adviser around the best method for sale from a post-tax perspective. When selling the equity in an entity, the due diligence requirements from the potential acquirer are more stringent as they basically will inherit the entity structure’s history including employment issues and tax issues. It is very important to make sure that your business and the entity itself is “ready for sale” well before the marketing of the business sale takes place. Significant time and money can be wasted during the sale process if you decide to sell the equity in the entity, because it gives a better tax outcome, but the entity itself or the business itself does not suit that style of sale process.

Selling the business assets

If you end up selling the business assets inside a company structure, some assets that are sold will be revenue in nature and taxed at the company tax rate. Other assets, like goodwill, will be sold as a capital asset and capital gains tax will be paid by the company. Please note that a company does not receive the 50% general discount for capital gains.

For some small and medium sized businesses, the Small business CGT concessions may apply to reduce some of the capital gains realised on the sale of the business. These are discussed in more detail below.

For those businesses that fall outside of these concessions, the capital gain will be taxed at the company tax rate. For shareholders to then obtain access to the money from the sale of the business, a dividend strategy will need to be put in place to remove the retained profits over time or you could look to liquidate the company and get the money out and into the shareholders’ hands.

If your business entity is a Trust structure and the business assets are sold, then some assets will be revenue in nature and some assets will be capital in nature. The Trust structure does have access to the 50% general discount for capital gains and depending on certain rules, access to the Small business CGT concessions as well. The profits, whether revenue or capital are then distributed to unitholders (if a Unit Trust) or beneficiaries (if a Discretionary Trust).

Selling the equity in a structure

If you end up selling the shares in a company or Units in a Unit Trust, then the sale of these assets is capital in nature and capital gains will apply. Depending on the type of shareholder or unitholder, the 50% general discount will apply to any gross capital gains and potentially depending on certain rules being met, the shareholder or unitholder will have access to the Small business CGT concessions.

From the above differing tax outcomes, you can see why I spent some time in this article discussing the alternatives ways of structuring a sale of a business.

Small Business CGT Concessions

The small business capital gains tax (CGT) concessions allow you to reduce, disregard or defer some or all of a capital gain from an active asset used in a small business.

For these concessions to apply a small business entity is an entity with an aggregated turnover of less than $2m. If the turnover test cannot be satisfied then you must be able to satisfy the maximum net asset value test, which is currently set at $6m.

The asset being sold and generating the capital gain must satisfy the active asset test.

If the asset is a share in a company or an interest in a trust, it must meet additional conditions.

Please discuss the various terms and conditions involved in applying these concessions with your tax adviser.

There are 4 small business CGT concessions that can apply. You first apply the Small business 15-year exemption.

You will not pay CGT when you dispose of an active asset if you meet both of the following additional requirements:

• you are aged 55 years or older and retiring, or are permanently incapacitated
• you have continuously owned the asset for at least 15 years.

You may be able to contribute amounts to your super fund from the small business 15-year exemption without affecting your non-concessional contributions limits.

If the above exemption does not apply, then you can look at the Small business 50% active asset reduction.

You will only pay tax on 50% of the capital gain when you dispose of an active asset. The small business 50% active asset reduction applies if you meet the basic eligibility conditions. It applies in addition to the CGT discount. You may choose not to apply the concession if you prefer.

Next, you can look at the Small business retirement exemption.

Capital gains from the disposal of active assets are exempt from CGT up to a lifetime limit of $500,000.

If you are under 55, the exempt amount from the proceeds on disposal of the asset must be paid into a complying superannuation fund or a retirement savings account.

You may be able to use amounts from the small business retirement exemption as contributions to your super fund without affecting your non-concessional contributions limits.

Finally, you can look at using the Small Business rollover.

The small business rollover allows you to defer all or part of a capital gain made from a CGT event happening to an active asset. For example, you can defer your capital gain until a later year if you buy a replacement asset or improve an existing active asset. The replacement asset can be acquired one year before or up to 2 years after the last CGT event in the income year for which you choose the rollover.

Below is a hypothetical calculation showing the effectiveness of being able to use the Small business CGT concessions.

In effect the $2m capital gain has been reduced to nil.

Depending on your retirement strategy, the order you use the concessions can also be very effective in reducing the capital gain and the final amount that can be contributed to superannuation.

It is vital at the business exit point that both tax adviser and financial adviser are communicating to each other to maximise after tax cash-flow for the business owner. There are numerous valuations, calculations and elections with sensitive timing involved to achieve the result of the hypothetical example described above.

From this article, hopefully I have explained the importance of starting early on the succession plan or business exit strategy. It is important to ensure everything is in place to maximise the exit sale price and to be able to negotiate the best form of sale with the potential owners. In parallel with these mechanics of the sale process, the retirement strategy and after tax cash-flow calculations should be undertaken to ensure the final result from business sale process has been maximised.

For More Information

Should you require assistance in preparing your Succession Plan, please contact James Cavanough or Ian Walker at Lantern Advisory for a confidential discussion on (07) 3002 2690 | info@lanternadvisory.com.au