Even though the Goods and Services Tax ('GST') was introduced over 10 years ago, the 'going concern' exemption still causes some confusion amongst parties in a sale of a business transaction.
In this article, we will briefly explain the going concern exemption and the criteria that need to be met to qualify for the exemption, as well as the tax benefits that accompany the sale of a going concern.
What is the going concern exemption?
A 'going concern' refers to an entity's ability to continue functioning as a business. If a business is deemed to be a going concern, then the sale of the business is GST exempt.
The purpose to seeking the going concern exemption is so that the purchaser of a going concern business does not have to provide the additional funds to cover the GST and therefore pay less up front for the business.
If GST applies, the purchaser will generally be required to pay an additional 10% of the purchase price at completion of the transaction to cover the GST. Although the purchaser will be entitled to get the GST back through the input tax credit system, the purchaser will not get the 10% back until well after completion. Additionally, while the ATO will eventually refund the GST to the purchaser, if stamp duty is payable on the sale of the business, it will be calculated on the total purchase price which includes the amount for GST.
However, if the business is sold as a "going concern", the sale transaction will be exempt from GST and cost less at the time, plus no additional stamp duty will be payable.
What are the requirements for a going concern exemption?
From our point of view, clients are generally aware of going concern exemption and that the transaction will qualify if "all that is necessary" to operate the business is transferred to the purchaser. However, in some circumstances, there is a lack of appreciation of the ATO's interpretation of the going concern exemption. This can lead to a surprise for clients when they learn that GST must be paid on what they had presumed was a "going concern".
Apart from the general definition of a "going concern" as mentioned above, the GST Act provides that the "supply of a going concern" is GST-free where each of the following is satisfied:
1. The sale is for consideration.
2. The purchaser is registered or required to be registered for GST.
3. The parties have agreed in writing that the supply is of a going concern.
A written agreement, commonly known as a "sale of business contract", must be entered into on or before the transfer of the going concern business. This means that a written agreement cannot be entered into after the business has been transferred to the purchaser.
Normally, the written agreement would specify that the supply (i.e. the business) is a going concern before the contracts are exchanged. This is an important aspect because it shows that all concerned parties expressly acknowledge that the business is indeed a going concern.
4.The vendor supplies all of the things that are necessary for the continued operation of an enterprise. This requirement does not mean absolutely everything in the business, but refers to those things without which the business could not function. Generally, this includes the necessary assets such as premises, plant and equipment and customer contracts, as well as the operating structure and processes such as ongoing advertising.
However, it should be noted that what the parties consider to be necessary does not necessarily mean that the ATO will have the same view.
5. The vendor carries on the business until the day of the supply. The supply is transferred on the date on which effective control and possession of the business is transferred to the purchaser. This date generally refers to the settlement date, however on occasion it may occur before or after the settlement date.
Regardless of whether you are a purchaser or vendor in a sale of business transaction, it pays to have a clear understanding of your legal rights and responsibilities from the outset.
Notwithstanding the advantages a purchaser gains in terms of cash flow and stamp duty savings from the going concern exemption, the risk that the ATO may not view the transaction as a supply of a going concern ultimately lies with the vendor because even if the sale of business contract provides that the purchaser is liable for any GST it is the vendor that is required to remit the GST to the ATO.
For the above reason, a vendor should include a carefully constructed indemnity clause in the sale of business contract requiring the purchaser to indemnify the vendor for any GST that may be payable in the event that the ATO does not view the sale transaction as a GST free going concern.
If you are considering selling, or purchasing a business, speak to one of our experienced commercial lawyers for advice.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.