• Incorporating your business – tax implications

    Incorporating your business will have tax, reporting and compliance implications for both you and your business.

    Speak to a solicitor, accountant or registered tax agent to help you make an informed decision and the right one for your situation.

    This information may help you:

    • decide whether to incorporate your small business
    • understand the tax implications of that decision.

    This information is limited to tax and superannuation issues arising from restructuring a business through incorporation.

    Apart from the issues covered below, find out about what your super and fringe benefit tax (FBT) obligations are as the director of your company.

    While this document deals with the federal tax implications of a decision to incorporate, you should contact state and local government bodies for advice on other implications of incorporation.

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    Incorporating and capital gains tax

    There could be capital gains tax (CGT) implications if you incorporate and transfer existing business assets to the new structure.

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    Transferring assets

    When you incorporate your business, it is likely you will transfer business assets from your original business structure to your new company.

    Transferring an asset to your company is a CGT event. When a CGT event occurs, a capital gain or capital loss can arise. However, provided certain conditions are satisfied, you can choose to rollover the capital gain or loss under the CGT rollover provisions.

    Rollovers

    The rollover is optional and you do not have to provide us with a special notification of your choice. Your decision will be clear by the way you treat the capital gain or loss in your tax return.

    The small business restructure rollover allows eligible small businesses to defer any potential tax liability when transferring CGT assets, trading stock, revenue assets (work in progress) and depreciating assets.

    There are also separate rollover relief provisions available for businesses who don't meet the requirements for the small business restructure rollover.

    These are for transfers of a single CGT asset and transfers of all business assets, provided that certain conditions are met.

    This means that if you want the original business entity to retain ownership of some of the business assets (for example, you may not want to transfer to the company a motor vehicle you used in your business but also used for personal travel), you would apply rollover to each asset you transfer individually.

    You cannot rollover the capital loss or gain arising from transferring a collectable or personal use asset If the restructure rollover does not apply you can only apply rollover relief in relation to trading stock if you transfer all of the assets of your business.

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    The sale of goodwill

    Where recognised goodwill is transferred to a corporate structure, any capital gain will be subject to tax, unless relief is available under the small business active asset concessions.

    The circumstances that permitted the recognition of no-goodwill arrangements in applying CGT law to the admission and retirement of partners are not applicable on the transfer of the business to a company.

    This is influenced by the circumstance that the business is being transferred to the company and an ongoing interest in the company by way of shares is acquired.

    Trading stock considerations

    If a business has trading stock on hand ceases to exist – or is sold in its entirety to another entity – disposal of trading stock is considered outside the ordinary course of business.

    For income tax purposes and where the small business restructure rollover does not apply, the sale price assigned to the items of trading stock, disposed of other than in the ordinary course of business, is ignored. The disposal value to be included as assessable income is deemed for income tax purposes to be the market value of the trading stock disposed of.

    Where at incorporation, a business is sold to another entity – for example, a business conducted by a partnership decides to incorporate – there is a disposal of the trading stock on hand by the partnership old entity and a corresponding acquisition of this trading stock by the new company.

    This disposal of trading stock is outside the ordinary course of business.

    For income tax purposes, and where the small business restructure rollover does not apply, the value of the trading stock is deemed to be its market value rather than the sale price of the items.

    Example

    A newsagent business is run as a partnership by John and Mary Smith. They decide to incorporate. At the time of the change in business structure, the trading stock on hand is valued by the partnership at a market selling value (based on the retail sale prices) of $12,500, which does not correspond to the market value of the trading stock at the time of $13,000. In the sale agreement between the vendors John and Mary Smith and the purchaser, the amount of $15,000 was assigned to the value of the trading stock.

    However, for taxation purposes, there has been a disposal of trading stock outside the ordinary course of business. A deemed market value of $13,000 must be included in the business income in the partnership return.

    As the purchaser, the company is treated as having bought the trading stock for the market value that is included in the vendor's assessable income. In this case, regardless of the contract price, the value of the purchase of the trading stock is $13,000.

    End of example

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    Debtors

    Unless the business you are selling is a money lending business, the company purchasing the business will be unable to obtain a deduction under the bad debt provisions for any debts transferred to it.

    This means that if, after the transfer, the debt is written off as bad, the new company will not be able to claim a deduction for the bad debt. This is because the bad debt rules allow a deduction only when the debt has previously been included as assessable income by the taxpayer claiming the deduction (in this case, the original business).

    If, however, you do not transfer the book debts of the business to the new company, the debts will be deductible if they are later written off by the original business structure.

    Prepayments

    Your business may have made prepayments for services or goods prior to incorporation. If, at the date of incorporation, not all the services or goods have been provided, the original business structure may remain entitled to a deduction for the portion of the prepayment that relates to the goods or services yet to be provided.

    For example, a partnership may have paid two months' rent in advance for the use of the business premises, but after a month the business is transferred to a company structure. Half of the prepayment relates to rent for the month occurring after the business is transferred to the company. The partnership is able to claim a deduction for the expenditure that relates to this period.

    A deduction will not be available, however, if the prepayment is capital expenditure (money spent on assets such as plant and equipment, goodwill, buildings, business names, patents and copyrights).

    Employee leave entitlements

    Accrued leave entitlements refers to leave payments that your employees are presently entitled to but which have not yet been taken. When incorporating your business the new company may assume liability for accrued leave.

    If the purchase price of the business is reduced because the new company assumes liability for accrued leave:

    • the company does not have to return the amount of the price reduction as income
    • the original business structure is not allowed a deduction for the price reduction.

    If the company assumes liability for accrued leave, and the original business structure pays the new company an 'accrued leave transfer payment':

    • the original business structure will be entitled to a deduction for the payment
    • the company must include the payment in its assessable income.

    An accrued leave transfer payment is a payment made:

    • in respect of an employee's leave (some or all of which accrued while the original business structure was required to make payments in respect of the employee's leave)
    • when the original business structure is no longer required (or are about to stop being required) to make payments in respect of such leave
    • to another entity when the other entity has begun (or is about to begin) to be required to make payments in respect of such leave, and
    • under (or for the purposes of facilitating the provisions of) an Australian law; or an award, order, determination or industrial agreement under an Australian law.

    Regardless of which of the above ways the transfer of the liability for accrued employee leave entitlements occurs, the company as employer will be entitled to a deduction in respect of accrued leave entitlements when they are actually paid to the employee.

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    Capital expenditure incurred in restructuring your business

    Capital expenditure related to business restructuring may be deductible in equal proportions over five years, subject to the non-commercial loss rules that apply to individuals (operating either alone or in partnership).

    For example, a sole trader or partnership that decides to incorporate may deduct, over five years, costs such as legal, search or lodgment fees incurred by them in relation to the incorporation.

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    Using service entities

    If you choose to incorporate an entity to employ staff who are on-hired to your business, you need to ensure that the amounts claimed for these services are correctly calculated.

    We can help you decide whether all the payments made under service arrangements are deductible under income tax law. Our service entity arrangements guide covers:

    • service arrangements and income tax
    • how a service arrangement can be conducted to minimise the risk of audit
    • other common services that can be provided through a service entity, such as recruitment, paying of expenses, hiring of equipment and renting of premises.

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    Stamp duty

    Stamp duty is usually payable on the transfer of a business by the purchaser of the business.

    Stamp duty is administered by the revenue authority of each state and territory. The relevant office in respect of your sale will depend on which state your business is conducted in and the location of your business assets. If your business operates in multiple states, stamp duty may be payable to multiple state authorities.

    To determine your obligations in relation to stamp duty, contact your relevant state or territory revenue authority.

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Last modified: 10 Nov 2016QC 19526