Taxwise: Selling a business to family firm raises tax problems

The sale of an owner-operator business to a family company is often done to insulate the person from the risk of the business failing, while allowing the operator to continue to run it by controlling the family company.

However, problems frequently arise with tax issues when individuals sell a business to a company.

Here are some important tax issues to consider:

Many individuals attempt to continue operating the business as if it were still owned by them personally. When the business is sold to the company, the company should claim the operating expenses, such as wages, rent, vehicle expenses and so on, as tax deductions. These items should, therefore, be paid by the company and not the individual.

Usually the parties will want to ensure that the sale of the business is treated as a GST zero-rated going concern for cashflow management purposes. For the sale to be a "going concern," all components of the business must be sold to a GST-registered person as an ongoing functional operation, and both parties must agree in writing that the supply is of a going concern.

There are likely to be income tax liabilities associated with the transfer of such items as trading stock and "financial arrangements," which must be accounted for.

The ownership of shares in the company is important, as one of the benefits of selling the business to a company may be the opportunity for income from the business to be paid to relatives by way of dividends if they are shareholders or beneficiaries of a shareholding trust.

There may be gift duty consequences if the business is sold to the company for less than its market value.

Consideration should be given to the type of company that is used. If the company is trading profitably, then it could be registered as a "qualifying company," which will enable it to distribute capital gains, tax free, to the shareholders.

On the other hand, if the company is in a tax-loss situation, then the company could be set up as a "loss attributing qualifying company" so that any losses can be passed on to the shareholders, in proportion to their shareholding. The shareholders can then offset their share of the company's tax loss against their other income.

If these issues are not dealt with properly, they may have a negative impact on the individual or the company or both.

It is, therefore, crucial for people to take advice on the appropriate manner in which the business is sold and operated so they have a clear understanding of the legal and tax implications of the transactions.

* Denham Martin is the principal of Denham Martin & Associates, lawyers specialising in advice on taxation and related matters.