Don’t let go of your business without a tax liability plan

In a business succession plan, your clients are planning for the future financial well-being of both their businesses and their families.

For many a client, the interest in his or her own business will constitute the single greatest asset both in terms of net value and in terms of capacity to provide an income stream — by way of remuneration and return on capital — to support lifestyle needs.

Part of the business succession plan involves planning for the possibility of selling that asset.

A client’s planning needs to factor in the tax liability on the sale of business interests because this will impact the amount of money the client will have to support the lifestyle needs of his or her family.

That is, a client needs to plan for his or her family receiving $X net any tax liability arising as a result of the sale of business interests, not simply $X.

For many a client, however, determining the family’s ongoing financial needs will be dependant upon them receiving $X net of tax from the sale of their business interests, not $X pre-tax.

Life insurance may be an easy and inexpensive way of achieving this objective. That is, the sum insured can be increased to also cover the underlying tax liability.

Even if life insurance is not the answer (either because it is not possible, too expensive to also cover the tax liability or because the client has other financial reserves to meet his or her needs), a client should be made aware of what his or her financial position will actually be after the sale of his or her business interests (including any tax impact), so that he or she can plan for the future armed with all relevant information.

Given the complexity of our tax laws, determining the tax liabilities that arise as a result of a sale of shares in a company, units in a unit trust or interests in a partnership, it can be a troublesome exercise generally requiring the client to obtain separate advice from a tax adviser. This is not an area in which financial planners are ordinarily licensed to provide advice to clients.

Because the sale of business interests pursuant to a buy/sell agreement will take place, if it takes place at all, at some time in the future, the client’s tax adviser can really only provide the client with an estimate of the likely tax liability.

The estimate can only be done using current figures for the business (such as business value and CGT cost bases of business interests) and applying current tax laws.

If those figures change or the tax laws change then the client must be made aware of the impact that this may have on his or her financial position and the client should review the business succession plan. A business succession plan, like any other plan, requires regular review for it to be most effective.

As the circumstances of the business change, the documentation (most obviously the life insurance policy and buy/sell agreement) underpinning the business succession plan may also change.

Events that should trigger a review of the business succession documentation include: increases in the value of the business, causing the amount of insurance cover to be reviewed to cater for the increased value of business interests and the increase in the tax liability that will arise as a result of a sale of those business interests; new entities are introduced as part of the business structure; new owners and new principals come into an existing business structure; existing owners and principals leave a business structure; an existing buy/sell agreement is actually triggered; and changes in tax laws.

Businesses conducted as a partnership have particular tax issues to address with respect to the sale of their business interests. When a partner sells these business interests, the partner is actually selling his or her proportionate interest in each of the assets of the partnership. These assets could include things like debtors, work-in-progress, trading stock and depreciable assets — all of which have income tax implications on a sale — and goodwill, intellectual property and real property (possibly business premises), which have CGT implications.

Stamp duty implications of the transfer of business interests must also be kept in mind and identified, particularly where an interest in real property is being transferred either directly or by way of a transfer of shares or units in a ‘land-rich entity’. Put simply, the stamp duty costs to the purchaser of the business interests can be significant. Great care must be taken in succession planning, particularly where any of the entities in the business structure own real property.

Most readers will be familiar with the general operation of the CGT provisions to the sale of assets. Most readers will also be aware of the general operation of the CGT 50 per cent discount concession (for assets held for 12 months prior to sale) and also the CGT small business concessions.

But does the CGT 50 per cent discount concession apply in the buy/sell context where the sale of the business interests occur consequent upon the death of a business principal who is also the owner of equity interests in the business? Different issues arise where the owner of the business interests is not the principal but is, say, a family trust or a family company.

In order to determine the CGT liability, if any, it is necessary to know the acquisition date of the shares being sold; if those shares were acquired prior to September 20, 1985, whether any transitional provisions apply to nonetheless cause a CGT liability to be imposed in what would otherwise be a sale of pre-CGT shares; the CGT cost base to A of his shares in A Co Pty Limited; the time at which the shares were disposed of for CGT purposes; the capital proceeds received, or deemed to have been received, by the estate of A, or A’s estate beneficiaries, in respect of the sale; whether the Division 115 50 per cent discount capital gain concession applies; and whether any of the Division 152 small business CGT concessions apply.

In general terms and subject to certain specific conditions, Division 115 provides that a discount percentage of 50 per cent is applied to a capital gain if that gain is made by an individual or by a trust provided that the individual or trust has held the asset for at least 12 months prior to the CGT event happening.

Andrew Frankland is a partner, taxand financial services with the ArgylePartnership.