GST-free: Sale of a going concern

It sounds simple but the criteria to qualify for a going concern exemption can be complicated and a failure to strictly meet all criteria will result in GST (including potential penalties and interest) being payable. A detailed understanding of the GST exemption requirements is crucial to ensuring clients make informed decisions, minimise the risk of unexpected liabilities, and prevent commercial disputes. This article delves into some of the most common traps and highlights some tips to keep in mind to protect you and your clients.

Business or Enterprise

Whilst we will refer to business and enterprise interchangeably, it is important to note that the definition of ‘enterprise’ in section 9-20 of the A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act) for GST purposes is broader than ‘businesses’ and can include (amongst other things) ‘an activity, or series of activities’, done:

• in the form of a business
• in the form of an adventure or concern in the nature of trade
• on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property.

Why the going concern exemption is important

If the sale of a business is subject to GST, the purchaser should be entitled to claim the GST back as an ‘input tax credit’ (ITC) provided the purchaser is registered for GST, holds a valid tax invoice, and will use the business to make taxable supplies and/or GST-free supplies.

So, what benefit arises from purchasing an enterprise as a GST-free going concern? There are usually two potential benefits for the purchaser:

1. If GST is payable, the purchaser will need to pay the GST to the vendor (who remits it to the Australian Taxation Office (ATO)) and claim it back as an ITC. In short, there is a timing difference and a need to fund the GST payment.
2. Transfer duty (commonly known as stamp duty) is generally payable on the GST-inclusive purchase price (or GST-inclusive market value, if higher). So, if the sale is not a GST-free going concern and is subject to GST, duty is payable upon the GST and is a true out-of-pocket cost for the purchaser. This particularly applies if the business is the sale of a freehold with a lease, a business together with the freehold land on which it is operated, or a business that has customers in Queensland and/or Western Australia (which still charge duty on intangibles such as goodwill).

Does GST even apply to the transaction?

Always take a step back and ascertain whether GST is even relevant before diving into the detail of the GST-free provision. If the vendor/supplier is neither registered nor required to be registered for GST, or if they are not making the supply in the course or furtherance of an enterprise they carry on, the sale might simply be outside of the GST net and not subject to GST. If your client is a vendor that is not registered for GST but is required to be registered (broadly, because their annual turnover meets the 'registration turnover threshold' of $75,000), you should advise the vendor to register to comply with their obligations and minimise the risk of any penalties and interest.

After establishing that the vendor is registered (or required to be registered) for GST, and if the parties prefer the supply to be GST-free, it is important to step through each of the legislative requirements in the context of the relevant enterprise being supplied. First, identify:

• Who is the supplier/vendor?
• Who is the recipient/purchaser?
• What is being supplied?

The GST-free treatment applies to a supply of an enterprise from one supplier to one recipient. If there is more than one supplier and/or more than one recipient, you will need to consider each transaction separately to ascertain which, if any, can qualify as a GST-free going concern. There might be two or more supplies of separate going concerns, or there might be none that qualify.

The going concern requirements

Broadly, the GST-free going concern requirements in section 38-325 of the GST Act are as follows:

• The supply must be for consideration (this should be satisfied if the supply is a sale of a business/enterprise)
• The purchaser/recipient must be registered (or required to be registered — though it is best practice to actually be registered) for GST
• The vendor/supplier and recipient must have agreed in writing that the supply is of a going concern and
• The supply must be under an arrangement under which:
  • the supplier supplies to the recipient all of the things necessary for the continued operation of an enterprise and
  • the supplier must carry on the enterprise until the day of supply (whether or not as part of a larger enterprise).

Registered for GST

As the recipient must be registered or required to be registered for GST, it is best practice (for all parties) to ensure the recipient is actually registered for GST to avoid any doubt as to whether they are required to be registered. Search the Australian Business Register to check whether the purchaser is registered for GST and retain a copy of your search results on your file. Although the ATO can cancel GST registrations with retrospective effect in some circumstances, this is relatively uncommon. When acting for a vendor, it is prudent to require the purchaser to warrant that they are (and, at the time of the supply, will be) registered for GST.

Agreement must be in writing

The supplier and recipient must agree in writing that the supply is of a going concern. To satisfy this requirement, the parties must explicitly agree in writing that the sale is of a going concern for GST purposes or refer to section 38-325. It is not sufficient for a contract to simply provide for the transfer of all things necessary for the continued operation of the enterprise. It is also crucial that the correct supplier and recipient (rather than associated parties) execute the relevant written agreement. If not, this could jeopardise the GST-free treatment.

The written agreement must be made at or before the time of supply (i.e. settlement/completion). This is usually included in the contract of sale but can be in a separate document provided it is clear and executed at or before the time of supply. Unlike an agreement to apply the margin scheme, the ATO does not have a discretion to provide an extension of time for this written agreement.

Another common mistake taxpayers make is thinking that an appropriate GST-free clause will ‘save’ them from paying GST. It is not a ‘get out of jail free’ card! The necessary written agreement is of no use if the other legislative requirements are not satisfied.

All things necessary to operate the business/enterprise

As noted, the supplier must supply to the recipient all of the necessary things for the continued operation of an enterprise. Accordingly, it is vital to identify the relevant parties and the enterprise being supplied. Strip everything else away and confirm whether one recipient/purchaser is acquiring everything they need to carry on an enterprise once settlement has occurred and, if so, whether all of those things are being provided by one supplier/vendor (and ensure that purchaser has entered into the written agreement with that vendor). If not, this requirement is not met and the going concern exemption will not apply.

In practice, careful analysis is required to establish whether all necessary things to carry on the business are transferring. For example, if the purchaser already owns a factory, its purchase of a manufacturing business will not be GST-free if the vendor does not sell or lease a suitable factory to the purchaser. The purchaser cannot use its existing factory, that does not transfer as part of this transaction, to make up the ‘all things necessary’ requirement. This is because a factory is necessary for the continued operation of the manufacturing business.

In contrast, unnecessary enterprise assets need not move across. For example, if the vendor has been using six trucks but only five are required to carry on the business, only five need to be supplied and the sixth can either also be supplied GST-free or can be retained by the vendor.

Assets used in the relevant enterprise that are not absolutely necessary for the continued operation of the enterprise can still be provided as part of the GST-free arrangement. However, assets that are not used in the relevant enterprise will not be GST-free. For example, if the purchaser is impressed by the vendor’s car when the parties meet to negotiate a deal, the vendor’s car cannot be supplied GST-free if it is not used as an enterprise asset.

The vendor can retain other business provided a whole business is supplied. For example, an in-house catering function cannot be sold as a separate enterprise if it has not been carried on as a separate business. However, if an entity carries on both a catering business and an events management business, it could sell the catering business whilst retaining the events management business.

Carry on business until the day of supply

For GST purposes, the day of the supply is the settlement/completion date. The final requirement, that the supplier/vendor must carry on the enterprise until the day of supply, will not be satisfied if the vendor ceases operating prior to the day of the supply.

As an example, if the relevant enterprise is a leasing enterprise and the tenant terminates their lease prior to settlement, the property would need to be re-let or the vendor must actively market it for lease until settlement to satisfy the requirement to ‘carry on’ the business until settlement. Only the vendor (not the purchaser) can market the property for lease to satisfy the vendor’s obligations.

Check the details or get a ruling

When advising on whether a transaction qualifies as a GST-free supply of a going concern, it can be useful to refer to GSTR 2002/5: Goods and services tax: when is a 'supply of a going concern' GST-free?

Although rulings only provide the views of the Commissioner of Taxation/ATO regarding the interpretation and application of the law, they provide guidance as to how a transaction is likely to be regarded by the ATO. In complex and/or high value matters, taxpayers might want to request a private ruling from the ATO.

Remember, the vendor is liable to remit the GST (if any) to the ATO and it may be appropriate to include an uplift clause in the contract (a clause that requires the purchaser to pay any GST in addition to the purchase price) in the event that the sale is ultimately held not to be a GST-free supply of a going concern — although this may also raise a problem with recovery.

As always, the benefits of a GST free going concern must be weighed up against the risk of GST (plus penalties and interest) being payable if the transaction is ultimately held to be a taxable supply rather than GST-free (after consideration of the matter by the ATO and, if applicable, review by the tribunal or an appeal through the courts).

Conclusion and take aways

Understanding and checking the specific requirements for a going concern exemption is important to avoid unexpected liabilities and commercial disputes.

Practitioners should:

• identify the supplier, recipient, enterprise, and ‘things’ being supplied
• search the ABR and keep records
• turn their minds to each of the relevant requirements of section 38-325
• refer to GSTR 2002/5 for further guidance
• seek further support or clarification, if required.

Guest author Rachel O'Donnell, of O'Donnell Tax Law, works in GST, as well as duties and land tax across all Australian States and Territories.