Capital Gains Tax (CGT): Timing is everything for a seller

Timing is everything when it comes to Capital Gains Tax (CGT). A decision in a case before the Administrative Appeals Tribunal (AAT) earlier this year highlights how costly it can be if you get the timing wrong… and how easy it is to get it wrong!

In this case the business owner (Vendor) decided to sell his business. The prospective purchaser was interested in buying the business but wanted the opportunity to undertake a “due diligence” before committing to the purchase. What was required to facilitate this was an agreement to protect the parties’ interests during and after the due diligence process. The prospective purchaser wanted the exclusive right to agree to the purchase price within a set period after completing the due diligence, and the Vendor wanted confidentiality in relation to the information disclosed during the due diligence process… so what was needed was an agreement restricted to exclusivity and confidentiality.

Unfortunately for the Vendor, he signed an agreement prepared by his Business Sales Broker … it was a pro-forma Heads of Agreement. This agreement provided for much more than just exclusivity and confidentiality. It also set out the purchase price, stated that a deposit was payable on the signing of the Heads of Agreement, set out what the apportionment of the purchase price was … apportioned between goodwill, fixtures, fittings and equipment… and stated that the parties agreed to be bound by the terms of the Agreement notwithstanding it was “subject to and conditional upon” the execution of a Contract for Sale of Business.

After the “due diligence” was completed, the Contract for Sale was signed and the Vendor made a capital gain of $704,129.

Just prior to the signing of the Contract for Sale, the Vendor qualified for the CGT small business active asset exemption, and the small business retirement exemption, the consequence of which was to reduce the capital gain to $0… as long as the CGT event (the sale) was effected when the Contract for Sale was signed.

Unfortunately for the Vendor, the ATO took the view (and the AAT agreed) that, because the details stated in the Heads of Agreement were so extensive, the CGT event occurred on the day the Heads of Agreement was signed. The problem for the Vendor was that just prior to signing the Heads of Agreement, the Vendor did not satisfy the maximum net asset value test … and, therefore, he did not qualify for the exemptions at all.

I don’t know how much tax the Vendor had to pay, but I suspect it was considerably more than the $2,000 (approximately) it would have cost him to have a lawyer draft the appropriately worded Exclusivity and Confidentiality Agreement. That $2,000 would have been a very worthwhile investment indeed!