What are the tax implications when buying or selling a business?
The application of Value Added Tax (VAT) to sales of businesses is an important task, as it involves complex tax regulations and can have significant financial implications for both buyers and sellers.
In this article we expand on the VAT implications of buying a business, specifically a Going Concern.
Key Terms
Generally, when one buys a business, one doesn’t buy the assets comprising the business, but rather the business in what is commonly referred to as a ‘Going Concern’.
Per section 11(1)(e) of the Value Added Tax Act, No 89 of 1991 (the “VAT Act”), in order to zero-rate the transaction, a number of conditions must be satisfied including:
The seller and the purchaser must both be registered as VAT vendors as defined in the VAT Act;
The supply (subject of the sale) must consist of an enterprise or part of an enterprise which is capable of separate operation;
The parties must state specifically in their agreement of sale that the supply is a going concern;
The parties must agree in their written agreement of sale that the enterprise will be an income earning activity on the effective date, being the date of transfer or take-over of the business;
All the assets necessary for carrying on the enterprise, must be disposed of to the purchaser; and
The parties must state in the agreement of sale that the consideration for the supply (the purchase price) includes VAT at a zero rate.
Vat on sale of an asset is different to sale of a 'going concern'
There is a difference between selling assets individually and selling a going concern, specifically with respect to the potential VAT implications. Buying assets (from a Vat Vendor) attracts VAT at the applicable rate, generally 15%. However, the sale of a ‘Going Concern’ is Vatable at 0%.
The way the transaction is structured is vitally important to ensure that Vat applies at 0%.
VAT registration
To qualify for zero rating, both the seller and the buyer must be VAT registered. In cases where the prospective buyer is not currently registered as a VAT vendor, it is advisable for them to have initiated the registration process before finalizing the agreement.
The agreement should include provisions addressing scenarios where zero rating is not applicable due to non-compliance with these requirements.
VAT on sale of 'going concern'
Both the seller and the purchaser are required to formally acknowledge in writing that the sale of the business constitutes a "going concern." This acknowledgment hinges on the presence of a revenue-generating operation at the time when ownership of the business is handed over to the purchaser. For instance, if a landlord sells a rental property to the tenant, it wouldn't qualify as a going concern because the income-generating activity (i.e., the rental enterprise) is terminated and not transferred to the purchaser.
The change in ownership of an enterprise through the sale of shares in a company or membership in a close corporation does not fall under the classification of a supply of a going concern. Instead, this type of transaction is considered a "financial service," as outlined in section 2(1)(d) of the VAT Act.
Financial services are exempt from VAT as per section 12(a) of the VAT Act. Therefore, they do not qualify for the treatment and benefits associated with the supply of a going concern under VAT regulations.
Transfer of a Going Concern
For a transaction to qualify as a supply of a going concern, it must adhere to the definition provided in paragraph (i) of the proviso to section 11(1)(e) and meet the criteria specified in paragraphs 4 through 6. If a sale pertains solely to a property, such as a farm, it will be classified as a supply of a capital asset and not necessarily as a sale of the entire farming enterprise. However, when the transaction includes all the necessary agricultural equipment, crops, and assets required for conducting the farming activities, and the parties explicitly agree to include and sell the income-earning activities, it will meet the qualifications for being considered a going concern under VAT regulations.
Finally
There are various VAT planning strategies to minimize VAT liability for both the seller and the buyer.
It is vitally important to keep proper documentation, invoices, and compliance with VAT regulations to avoid penalties.
It is a prerequisite that the seller transfers the assets necessary for the continuation of the business to the purchaser. Assets that are surplus to the operational requirements of the business, such as outdated inventory or outstanding debts, do not need to be included in the sale of the business. An asset that has the potential to be operated as a business, but is not currently involved in any income-generating activity, does not meet the criteria for being considered an income-earning activity.
The presence of an ongoing, active business operation is essential. Consequently, the sale of a dormant business or a business that has yet to commence its operations does not qualify as a going concern.
Additional Resources
This article if for informational purposes and not as a substitute for professional tax advice.
It's crucial to stay up to date with the latest VAT regulations and consult with a transaction expert for specific cases, as VAT rules can vary by jurisdiction and may change over time.
AC Corporate Transaction Services is a professional services firm guiding clients successfully through corporate finance, legal, governance and tax issues. Our services include capital structuring, business valuation and transaction advisory work.
If you require further information please contact AC Corporate Transaction Services on: info@accts.co.za.
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