One of the main reasons for this has to do with the way that the sale of the business was structured and the tax effects of the particular structure. Chris Norris, partner at Cameron & Prentice Chartered Accountants, examines the finer financial realities of selling a business or company.
When selling a business which is operated as a company or close corporation, the sale can either be structured as the sale of the business out of the company or CC, or the sale of the shares/member’s interest in the company or CC. Very different tax effects arise from each of these options depending on the specific circumstances of each case. Invariably it costs significantly more in taxes (recoupments of wear and tear on assets, CGT on sale of the business and secondary tax on companies (STC) to get the cash into the owner’s pocket) when selling the business out of the company or CC, than when selling the shares themselves.
Take the simple example of a business worth R5 million, where the net tangible assets, fairly valued, are worth R3 million and the goodwill factor is worth R2 million. Assume that R500 000 of wear and tear will be recouped on fixed assets and also that no CGT valuations (as at 1 October 2001) were done on either the value of the business or the value of the shares. The CGT base cost for the business assets is thus assumed to be 20 per cent of proceeds.
If the owner sells the business out of the company or CC, the entity will be liable for CGT on sale of the goodwill, income tax on the recoupment and STC on the dividend declared to get the cash into the owner’s pocket. In this scenario, income tax on the recouped wear and tear would amount to R140 000, CGT would amount to R224 000 and STC R421 455, giving total taxes of R785 455. Cash in the owner’s pocket will amount to R4 214 545.
However, if the owner sells his shares for R5 million, he will be liable for CGT of only R400 000 (assuming a CGT base cost of 20 per cent of proceeds) and will receive cash in pocket of R4.6 million, a better result by almost half a million.
From a purchaser’s perspective, it is preferable to purchase the business out of the company or CC. This allows the purchaser to pick the assets that he is interested in and ensures that he will not be liable for any undisclosed liabilities that may surface in the future.Also, acquiring the company or CC means that the purchaser in effect assumes the seller’s latent CGT and STC bills on the net asset value and value of the goodwill. The seller is therefore usually under pressure to sell the business out of the entity and should ensure that the sale is structured as efficiently as possible to minimise transaction taxes and, in turn, maximise net cash received. Where significant transaction taxes will be incurred, the seller needs to be aware of this fact to assist him in negotiating the selling price and applicable transaction terms.
Source: By David Warneke (TaxTALK)