Succession and divestment
Selling your business is likely to be the largest and most important financial transaction any business owner will ever make. So why is it then that this very important succession process is often overlooked or undermanaged?
Start planning early
Not starting early enough with the process of preparing a business for sale, whether as part of a succession plan or divestment process, is common. Good planning and preparation is essential to ensure you extract maximum value when you decide it is time to exit.
While the value of a business is based on the business’s cash flows, the other part of the value equation which relates to the certainty of those cash flows is often overlooked. Ensuring that key contractual arrangements and in particular the ownership of intellectual property of the business is documented is fundamental to meeting your price expectations as a vendor. It may also be the difference between the sale proceeding or not and in some cases the smallest detail can completely derail the process.
For example, overlooking the need for a clause in contracts with key staff or contractors that confirms that ownership of intellectual property created while they are providing services resides with your business could cause real problems for a purchaser, if they are concerned about being subject to a claim by those employees or contractors later down the track.
Engagement with a third party to undertake pre-sale due diligence is the most effective way of ensuring the business is in the best position to maximise value.
Plan the approach
When you are selling your business as part of a divestment or succession plan is it important to consider the way in which the sale is to occur and to ensure that you have considered the income tax and GST implications of the options available to you.
Where the shares in the business have not been acquired as part of a business of dealing in shares or with the purpose of resale then the gain on sale of the shares should generally not be subject to income tax. As the sale of shares should be an exempt supply for GST purposes, generally the parties should not need to account for GST on the sale.
While it is usually relatively easy to document a share transaction, there are usually higher due diligence costs for the purchaser and vendor given that the trading history and therefore historical liabilities remain with the business. Planning for this process in advance and ensuring that you are ready to respond to the purchasers enquiries will assist them in gaining confidence in the business and its processes.
Because historical liabilities transfer with the business, this can mean that comprehensive warranties and indemnities are required to be provided by the vendor and can result in the vendor being tied to the transaction for a number of years following settlement or having an amount of the purchase price being held in escrow.
Where there is a progressive transfer of the business through a succession plan, it may be possible to dispense with some of the complexity relating to warranties and indemnities given the vendor remains involved in the ownership of the business.
The income tax treatment of earn-out payments and also any restraints of trade, particularly where the owner continues to provide services following the sale, also need to be carefully considered and documented in the agreement for sale and purchase.
Sale of assets
In some situations it may be appropriate to divest a business by selling the underlying assets rather than by sale of the shares.
These situations might include circumstances where:
- The parties do not want the purchaser to take on the historical trading risk of the business and rely on the strength of warranties or indemnities provided; or
- The purchaser wishes to obtain a step up in the cost base of the assets it is acquiring, where the market value of the assets are greater than the current accounting / tax book value.
In an asset transaction, the tax consequences on the sale of the assets will fall on the vendor. As such, it is important that you take income tax advice prior to the sale, particularly regarding how the various assets will be treated on disposal and how the proceeds from the sale will be treated when returned to you.
Whilst manageable, the GST consequences of the sale of assets needs to be considered and relevant clauses included in the agreement for sale and purchase depending on whether the parties intend for the sale to be zero-rated or subject to GST at 15%.
In an asset transaction, due diligence typically focuses less on the business and more on the assets being acquired. Consideration should be given to how the purchase price will be apportioned across the various assets, as this apportionment will impact on the tax treatment for both parties.
Where settlement may be deferred, the financial arrangement rules may operate to treat part of the purchase price as being interest. It is important that consideration is given to what the lowest price would be for the shares or assets under the agreement and the inclusion of a clause in the agreement for sale and purchase to this effect.
There are a number of income tax and GST rules that can give rise to adverse consequences where the sale of assets or shares occurs between related parties as part of a succession plan.
These can include:
- Limitations on the ability to get a cost base uplift on the transfer of assets and limitations on the tax depreciation rates that are available;
- Taxation on the return of proceeds from the sale to owners where the gain is from a transaction with a related party; and
- GST timing rules resulting in the obligation to account for GST earlier than would normally apply.
Whether you are looking to sell your business as part of a succession plan or divestment it is important that you start early with the process of preparing a business for sale and take tax advice on the options available if you want to maximise value.
Tax Alert August 2013 contents:
- Tax Alert - August 2013
- Clarity, controversy, or both: Inland Revenue’s finalised guidance on tax avoidance
- Succession and divestment
- Clarifying the tax consequences for deregistered charities
- Research and development expenditure: Deja vu?
- Bloodstock investors finish down the track
- A necessary review of allowances
- Deloitte announces new tax partner