By Tim Kilham, Head of Franchising, Lanyon Partners
Buying a business or opening a new business is a risky step to take. However, as the saying goes, nothing ventured, nothing gained. There are times in your life when you have to take a bold step forward; now is that time for you.
If you choose to buy a franchised business in Australia, then you are increasing your chances of having a successful business. Various studies have been done, and they show that a franchised business is twice as likely to succeed as a non-franchised business. Of course, that does not mean that all franchised businesses in Australia succeed – that is far from the case. So you need to do your homework, buy the right business at the right price and in the right location, structure it properly and then work hard to make it a success.
We have advised many franchisees across a wide range of businesses on the purchase of their franchised business. Based on this experience, we set out some of the key financial considerations involved in buying a franchise.
GST and the Initial Purchase
It is important that when you negotiate the price for the purchase of the franchise business that it is clear whether or not the price includes GST. For example, when you buy an existing franchise business from another franchisee, there will be no GST included in the price provided that both you and the seller are registered for GST, the contract provides that the sale is of a going concern (and therefore that no GST is to be charged), and the seller supplies you, the purchaser, with all the things necessary to be able to carry on the business.
In practical terms, what this means is that if you agree to buy an existing business for $200,000, and the sale of a business is a going concern, you will not be able to claim any GST on the purchase price of the business, and the seller will not pay any GST on the amount it receives. The net cost to you is therefore $200,000. Conversely, if the sale is not regarding as being a sale of a going concern for GST purposes, you will be able to claim input tax credits of 1/11th of the purchase price, and the seller will have to pay GST on 1/11th of the amount it receives. In this case, therefore the effective purchase price to you is $181,818 (because you will get back GST of $18,182 – 1/11th of the purchase price of $200,000).
Dissection of the Initial Purchase Price
When you are buying a franchise business, it will generally be to your advantage if in the purchase agreement you maximise the amount that relates to fixed assets (plant, equipment, furniture, etc, on which you can claim depreciation) and you minimise the goodwill amount. This will generally help to maximise your current depreciation claim and minimise future capital gains tax payable.
Having said that, from the seller’s perspective, the best result is achieved if the price for depreciable assets is reduced and the goodwill is increased. The purchaser’s and seller’s interest do not coincide!
There is no requirement to specify the components of the price of the business in the sale agreement. The agreement might simply specify that the total price for the assets, goodwill, etc is $200,000, without specifying the break up of those amounts. In that case, you as the purchaser are required by tax law to make a reasonable apportionment between the assets that are acquired. The seller is also required to make this reasonable apportionment. The apportionment that is made by the purchaser and the seller may not agree, and indeed you will probably never know what apportionment the seller makes. The seller’s apportionment, however, is irrelevant to you – you are simply required by tax law to make a reasonable apportionment from your perspective.
No article on the purchase of a franchise business can ignore the business structure you choose. It is said that structuring is better than restructuring and you ignore this statement at your peril! Choosing the correct structure for you is of considerable importance for both commercial and tax reasons. Each situation is different and no one structure will suit all franchisees.
The choice of business structures available in Australia includes sole trader (sole proprietor), partnership, company and trust, or some combination of these. There is no one structure that is right for everybody – the right choice of structure depends on a huge range of factors including the risk you are taking, your age, your marital status, whether you have children and how old they are, the level of borrowings, etc, etc. What you should do is seek advice from an accountant experienced in franchising before entering into any franchise purchase. Creating the right structure in the first place will protect your assets and may produce significant tax savings. Once the franchise agreement has been signed, it may not be possible to change the structure or if it is charged may result in significant stamp duty, capital gains tax and other costs.
A key factor in choosing the right structure is to make sure you protect your assets. Asset protection refers to projecting personal assets such as your house and other investments held personally against business risks, especially the risk of being sued.
Another important consideration in choosing a structure is to minimise ongoing income tax liabilities. Simple structures – such as a sole trader or sole proprietor – costs very little to set up, but also provide little ability to minimise tax (because as a sole trader you will personally pay tax on all the profits of the business). A discretionary trust on the other hand is more complicated and costly to set up, but by using a discretionary trust you are able to legitimately split the income between yourself and other family members who can receive that income at a tax effective rate.
Although you are thinking of buying a business, and therefore the last thing on your mind at this stage is selling the business, your planning at this stage should also take into account how you are going to minimise capital gains tax on the sale of the business. If you are successful in business, you will one day sell the business and you will sell it for more than it costs you. It is possible on the sale of a business to pay capital gains tax at a rate of anywhere between 0% and 46.5%. Which would you prefer?
With the right advice – and particular proper structuring – it is often fairly easy to reduce the taxable portion of every $1 of capital gain to 25 cents. Then, instead of paying tax on the remaining profit, tax can be avoided by buying replacement assets or by rolling over some of the profit into a superannuation fund. The capital gains tax concessions are very generous and you should structure your affairs – now, when you are buying the business – to be able to take advantage of them when you sell the business.
About the author
Tim Kilham is a director of Lanyon Partners Chartered Accountants and heads up the franchising area of that division. He can be contacted on:
phone: 03 9861 6100
email: [email protected]