Sale of business: the GST ‘going concern’ exemption
Despite the fact that the goods and services tax regime has been with us for nearly a decade, the going concern exemption still causes some confusion amongst parties to a sale of business transaction. In this article, we explain the criteria that need to be met to qualify for the exemption and the tax benefits that accompany the sale of a going concern, and we also identify some of the common misconceptions that still exist which can frustrate the best intentions of the transacting parties.
In our experience, the main reason most clients seek confirmation that a transaction qualifies for the going concern exemption is so that the purchaser does not have to provide additional funds to cover the GST. That is, so that the purchaser has to pay less up front for the business.
If a business is sold and GST applies, the purchaser is usually required to pay an additional 10% of the purchase price at completion to cover the GST. The purchaser will be entitled to get the GST back, through a 10% input tax credit, but the purchaser will not get this input tax credit until after completion. In addition, while a refund of the GST is available, if stamp duty is payable on the sale, the stamp duty is calculated on the basis of the purchase price including GST, and the GST component of the stamp duty is not refundable.
In contrast, if the business is sold as a ‘going concern’, the sale will be GST exempt by virtue of section 38-325 of the A New Tax System (Goods and Services Tax) Act 1999 (“the GST Act”) and no additional stamp duty will be payable.
We find that most clients have at least a general understanding of the going concern exemption, and that they understand that they will qualify if “all that is necessary” to operate the business is transferred to the purchaser. However, in some circumstances, parties fail to appreciate the interpretation that the ATO applies to this exemption and they are surprised to learn that GST must be paid on what they presumed was a “going concern”.
In a commercial context, a going concern refers to an entity’s ability to continue functioning as a business. The definition provided by the GST Act extends beyond this. Section 38-325 provides that the ‘supply of a going concern’ is GST-free where each of the following is satisfied:
- the sale is for consideration;
- the purchaser is registered or required to be registered for GST;
- the parties have agreed in writing that the supply is of a going concern;
- the vendor supplies all of the things that are necessary for the continued operation of an enterprise; and
- the vendor carries on the enterprise until the day of the supply (whether or not as part of a larger enterprise carried on by the vendor).
The written agreement between the vendor and purchaser that the supply of the business is the supply of a going concern must be entered into on or before the day of the supply. It cannot be entered into after the supply has occurred. Normally a written agreement would document that the supply is of a going concern before contracts are exchanged.
We have been approached by clients who have restructured their business and then ask us to formally document the transaction at a later date. Although it is possible to record the transfer at law, these clients are often disappointed to learn that although “all of the business” was transferred, it does not qualify for the GST exemption because there was no written acknowledgement by the parties before or at the time of the restructure that the sale would be of a going concern.
Given that there is no prescribed form that the agreement must take, nor that it must form part of the contract of sale, it is very simple for parties to ensure that they do not forfeit their entitlement to the exemption, so long as they are aware of this timing requirement.
Day of supply
The day of the supply is the date on which effective control and possession of the enterprise is transferred to the purchaser. While this date usually is the settlement date, it could occur before or after the settlement date. The key is when “effective control” passes. It is immaterial, for example, that the economic risk and benefits of the business have not yet passed.
What is the Enterprise?
An enterprise includes activities such as leasing, licensing, trading operations or charitable activities. An enterprise excludes any personal hobbies or activities conducted by employees.
Section 38-325 provides that the enterprise that is sold from the vendor to the purchaser may be part of a larger enterprise carried on by the vendor. In such a situation, it is critical that the enterprise being sold is capable of operating independently.
Supply must be of all things necessary for the continued operation of the enterprise
All things “necessary” for the continued operation of the enterprise must be supplied. This does not mean absolutely everything in the business, but refers to those things without which the business could not function. This generally comprises two major elements:
- the necessary assets for the enterprise to continue operation, such as premises, plant & equipment, goodwill, contracts etc.; and
- the operating structure and process of the enterprise, such as ongoing advertising and promotion.
The things that are necessary for the continued operation of an enterprise will vary depending on the nature of the enterprise and the thing supplied. For example, it may be difficult for the vendor to supply certain employment contracts or franchise agreements. The Australian Taxation Office does however accept that where this is the case, a transfer or surrender of a right (eg a statutory licence) may be sufficient.
Importantly, what the parties consider to be “necessary” may not always be enough to satisfy the ATO that the sale qualifies as a going concern. We recently acted for the purchaser of a mortgage broking business that was based in the outer suburbs. The business was almost entirely conducted by telephone and online and there was little or no locational goodwill attached to the leased premises from which it operated. The purchaser already operated a mortgage broking business from the city and considered it a simple proposition to conduct the new business from its existing premises. Given that the parties considered that the leased premises were not essential to the business enterprise, they were surprised to learn that the sale would not qualify as a going concern unless the purchaser took an assignment of the existing lease.
It should also be noted that a single purchasing entity and a single selling entity are required for the GST going concern exemption to apply. As a result, if important parts of the business are held by different entities and each of those entities sells their respective parts of the business to a purchaser, the sale of the business may not qualify for the going concern exemption even though the entities are related to each other.
The going concern exemption allows the purchaser to avoid timing delays that result when claiming input tax credits. This is particularly useful if financing needs to be obtained to purchase the business, as additional borrowings will not be required to cover the GST.
The GST going concern exemption also eliminates the need to separately value the assets which comprise the business being sold (although this may be required for CGT purposes).
Finally, in some circumstances the vendor, in treating the supply of a business as GST-free going concern, can claim input tax credits in respect of some expenses incurred in selling the business (eg, due diligence fees) whereas this would not be the case if the sale of the business was effected by way of a sale of shares (which is input taxed, meaning that input tax credits cannot be claimed on similar expenses).
As we have seen from the examples discussed in this article, it can be dangerous to assume that the exemption applies without having carefully considered the strict criteria applied by the ATO.
Even though a purchaser may be entitled to an input tax credit following the acquisition of a GST-inclusive business, most parties seek to construct the transaction in a way that enables the purchaser to avoid paying GST. As noted in this article, the advantages that accrue to the purchaser can extend beyond the cash flow advantages.
Not withstanding the advantages that accrue to the purchaser in terms of cash flow and stamp duty savings, the risk that a transaction may not be viewed as the supply of a going concern ultimately rests with the vendor. That is, although generally sale contracts provide that the purchaser is liable for any GST, as a matter of law, it is the vendor that is required to remit the GST to the ATO. For this reason, a vendor should require the purchaser to indemnify the vendor for any GST (and penalties) that may be payable in the event that the parties are mistaken as to whether the sale of business constitutes a GST free going concern.
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