Selling a business comes with a whirlwind of emotions, but it’s important to remember that, even though you’ve built a successful business, you still have more work to do.
And one of the biggest things to consider is the tax on a business sale.
Why is that the case? Depending on a range of factors, such as your business structure, you can pay as much as 49% tax on the sale of a business!
So, without sufficient planning, you could be losing out on a substantial amount of money that you could put towards retirement, a new business or simply enjoy as the reward for your labour.
For example, if you decided to run your business as a sole trader, partnership or trust, you’d be missing out on the ability to sell your company through a share sale rather than an asset sale. However, if you registered with an LTD or PTY LTD structure, you could opt for a share sale and enjoy lower tax implications when selling a limited company.
That’s the power of planning for taxes long before you sell your business.
Now, let’s dive into the most important tax implications to consider before selling your business.
The most important tax implications when selling a business
When it comes to taxes, there are five tax implications that you must be aware of when you sell your business as they will directly affect how much profit you keep. They are:
1. Your chosen business structure
In Australia, there are several business structures to choose from, but when it comes to taxes, there are two main groups – structures that function as separate entities from the owner and ones that do not.
Structures in the latter group, such as sole traders, partnerships and trusts, typically carry the highest tax burden. On the other hand, corporation and limited company capital gains tax rates tend to be more favourable.
However, it’s not as simple as that in the real world.
For example, there are certain instances where a corporation suffers from double taxation as the company initially pays its own tax then shareholders are taxed on their own dividends. So it’s vital to consult with a tax accountant to understand what’s best for your situation.
2. Income in the financial year you sell your business
In most cases, the income you generate in the year you sell your business will only have an impact on small businesses that opt for a sole trader, partnership or trust structure.
This is because these structures are taxed at individual income rates which are based on a tier system.
For example, if you earn $120,000 in a financial year, you’ll have a tax rate of roughly 27.5%. But if you were to earn $120,000 and sell your business for $60,000, you’d be taxed at just under 31% based on your total income of $180,000.
In comparison, corporate structures typically pay a nominal tax rate of 25% - 30% regardless of income.
3. Your business cost basis
Your cost basis refers to how much you initially invested in your business.
If you started your business from the ground up, this can be as low as $0. However, if you spend additional funds acquiring, holding and selling the business, these will increase your cost basis, reducing the amount of profit that qualifies for CGT.
For example, if you bought the business for $100,000 and sold it for $200,000, you’d have to pay CGT on $100,000 as this is your actual gain.
4. The price at which you sell your business
At a basic level, the more you sell your business for, the more taxes you’ll pay since you enjoy more profit. However, this isn’t always the case due to tax concessions.
For example, there are several concessions for small businesses that you can qualify for if the net value of your assets is less than $6 million. This means that, if you were to sell your business for less than $6 million, you could reduce your CGT by 50% and even get rid of them altogether in some circumstances.
Whereas, if you were to sell your business for $7 million, you may end up losing more to tax even though the price was significantly higher.
5. Any eligible tax concessions
In Australia, there are four CGT concessions you may be entitled to if you meet the overall small business criteria of having; aggregated turnover of less than $2 million per year or a net asset value under $6 million.
However, each concession has additional criteria that you must also meet which are:
This concession allows you to discount CGT on active assets that you’ve held for at least 12 months.
Active business assets are assets you use (or keep ready for use) for running your company. However, intangible assets can also count if they’re connected to your business.
For example, if you run your business out of an owned premises for five years, but decide to lease it out for a subsequent two years, it would count as an active asset because it was mostly used for your own business.
The retirement exemption excludes you from paying capital gains tax when selling a business up to a lifetime limit of $500,000 if you’re over the age of 55.
However, if you’re under that age, you can still qualify as long as you pay the exempt amount into a suitable superannuation fund or retirement savings account.
Upon selling an active asset, the Australian government allows you to defer your CGT for two years.
However, if you buy another active asset, you can defer your capital gains tax until you cause another CGT event to occur – ie. you sell your new active asset or fail to buy a new one within two years.
This exemption allows people who are at least 55 years of age or who are permanently incapacitated to avoid any accessible capital gain on the sale of their business.
However, the main criterion is that the business owner must have held the asset for at least 15 continuous years.
What is the most tax-efficient way to sell a business?
The most tax-efficient ways to sell a business are those that completely negate the need to pay capital gains tax.
For both small businesses and corporations, this would be either opting for the active asset rollover exemption or the retirement exemption as these are much easier to qualify for than the 15-year ownership exemption.
Bear in mind that the overall criteria for corporate and small business exemptions (ie. annual turnover and net asset value) will be different.
Do you get taxed for selling a business?
In most instances, you will pay some form of tax when selling your business, but if you meet certain criteria, you can lower your capital gains tax by 50% - 100%.
For example, entrepreneurs who have held a business for at least 15 years and are at least 55 years old are eligible for a complete CGT write-off if they have had an annual aggregated turnover of less than $2 million or the sale of their business was worth less than $6 million.
How much tax will I pay on the sale of my business?
The amount of tax you’ll pay on the sale of your business depends on your company structure, the value of your business, the method of sale and whether you qualify for CGT concessions.
For example, a sole trader, partnership or trust with a sale and income value of $180,001 and over in a single financial year would pay $51,667 plus 45% for each $1 over $180,000 + 2% Medicare levy before concessions.
How do I avoid capital gains tax (CGT) when selling my business?
There are several ways you avoid capital gains tax upon the sale of your business, they are:
- Small business and corporate exemption where you’ve held ownership for 15 continuous years and are either aged 55 or over or are permanently incapacitated.
- CGT rollovers where you plan to use your gains to purchase another active asset within two years.
- Retirement CGT exemptions of up to $500,000 if you’re either over 55 years of age or you deposit your gains into a suitable superannuation fund or retirement savings account.
Is there an exemption from capital gains taxes on the sale of a small business?
Yes, there are capital gains tax exemptions for small businesses. They are:
- Retirement exemptions where you are at least 55 years old or you deposit your gains into a qualifying super fund or retirement account.
- The small business 15-year exemption where you’ve had continuous ownership over your business for at least 15 years and are either over 55 years old or are permanently incapacitated.
- Rollover exemptions where you plan to use your gains to purchase a new active asset within the next two years.
How are capital gains calculated when selling a business?
Capital gains tax is calculated based on whether you make money from the sale of your business – ie. you sell a business at a higher price than you initially paid.
For example, if you started a service-based business as a freelancer, your cost basis will likely be $0. So, if you sell your company for $500,000, your CGT will be based on the full amount. But if you spent money acquiring or improving your business in some way, it’s likely you’ll be able to lower the amount that qualifies for capital gains tax on a business sale.
These calculations are complex so you should consult a tax account to understand your true cost basis. Alternatively, you can use a capital gains tax calculator for a rough estimate.
Who pays sales tax when selling a business?
Sales tax when selling a business is another way to describe capital gains tax. This means that it’s the owner (the person selling the business) that will need to pay the business sales tax.
The bottom line: tax on selling a business in Australia
The most important factor to consider regarding tax when selling a business is preparation.
Without preparation, it’s easy to miss out on concessions and exemptions that can significantly reduce your capital gains tax. For example, if you weren’t aware of the net asset value cap of $6 million to qualify for concessions, you may try to maximise your return by selling your business for $7 - $8 million.
However, you’d likely end up with more money in your back pocket by selling the business for $5.9 million and securing CGT reductions between 50% to 100%.
This is why understanding the capital gains landscape is vital to maximise the return on your hard work.
But once you’ve done enough research and are ready to sell, make sure to read our guide on selling a business. This will prepare you for other aspects such as making your business attractive for sale and negotiating with buyers.
Finally, when you want to start the sales process, you can list your business on our site which gives you access to thousands of qualified buyers and support from our team.
Now the only thing left is to wish you good luck on your journey!