What do Buyers of Businesses look for?

Nicolene Schoeman-Louw | SchoemanLaw Inc Category: Commercial Law | Contract Drafting When business buyers consider acquiring a business, they generally have two options available to them. The first is to acquire the shares in a company which holds the business. The second is to acquire the business itself from the person or entity conducting the business operations. Each transaction structure carries distinct legal, commercial, and tax consequences. In a share acquisition, the purchaser effectively steps into the shoes of the existing shareholder or shareholders and acquires ownership of the company together with all of its assets, obligations, liabilities, contractual relationships, and historical risks. By contrast, where the purchaser acquires the business itself, the purchaser is generally able to select which assets, contracts, and operational components are acquired as part of the transaction. This allows a purchaser to “cherry-pick” the assets required for the operation of the enterprise, whilst potentially excluding certain liabilities or undesirable assets from the transaction, which may significantly reduce commercial risk. Where a purchaser decides to acquire the business itself, an important consideration is whether the transaction may qualify as the sale of a going concern for VAT purposes in terms of section 11(1)(e) of the Value-Added Tax Act 89 of 1991 (“VAT Act”), through which the sale may qualify for VAT at the zero rate. This can provide substantial commercial and cash flow advantages to both the purchaser and the seller. VAT Considerations The VAT consequences associated with the acquisition may materially impact the overall cost of the transaction and, consequently, the parties’ respective bargaining positions and commercial incentives during negotiations. In larger transactions, this may significantly affect the purchaser’s immediate funding requirements or the portion of the purchase price to which the seller ultimately becomes entitled. For this reason, parties frequently attempt to structure business acquisitions in a manner which satisfies the requirements of section 11(1)(e) of the VAT Act, thereby allowing the sale to qualify as the disposal of a going concern at the zero rate. Requirements to Achieve the Zero Rate Section 11(1)(e) of the VAT Act sets out specific requirements which must be satisfied before the sale of a business as a going concern may qualify for VAT at the zero rate. The following requirements must generally be met: the seller and purchaser must both be registered VAT vendors at the time of the supply; the supply must consist of an enterprise, or part of an enterprise, capable of separate operation; the parties must agree in writing, at or before the time of concluding the agreement, that the supply is that of a going concern; the seller and purchaser must agree in writing, at the conclusion of the agreement, that the enterprise will be an income-earning activity on the date of transfer; the seller must dispose of the assets necessary for carrying on the enterprise to the purchaser, and the consideration may not include assets which are not necessary for carrying on that enterprise; and the parties must agree in writing that the consideration for the supply includes VAT at the zero rate. These requirements must be complied with strictly. A failure to satisfy any one of the requirements may result in SARS disallowing the application of the zero rate, which would render the transaction subject to VAT at the standard rate. What if a Business is not a registered VAT vendor? A question which may arise in practice is whether parties may rely on the going concern provisions where the business has not yet exceeded the compulsory VAT registration threshold of R1,000,000.00 in taxable supplies over a 12-month period in terms of section 23(1) of the VAT Act, and is accordingly not registered as a VAT vendor in terms of the VAT Act. It should be noted that section 23(1) contains a proviso in terms of which a person is not liable to register where the threshold is exceeded solely as a consequence of the cessation of, or a substantial and permanent reduction in the size or scale of, the enterprise, or the replacement of plant or other capital assets, which proviso may be directly relevant to a seller exiting a business. This does not, however, preclude the transaction from qualifying as the supply of a going concern at the zero rate, given that a person may register as a VAT vendor prior to exceeding the compulsory registration threshold and before transferring the business as a going concern. Section 23(3)(b) of the VAT Act permits voluntary registration where the total value of taxable supplies made in the course of carrying on an enterprise has exceeded R50,000.00 during the preceding 12 months, or where it can reasonably be expected that such taxable supplies will exceed R50,000.00 within 12 months from the date of registration. However, the latter ground is not automatic, the circumstances in which the Commissioner will accept that the R50,000.00 threshold can reasonably be expected to be exceeded are prescribed by regulation, and an applicant must satisfy those requirements before registration will be granted. Voluntary VAT registration may therefore constitute an important preliminary requirement on the part of the seller prior to concluding the transaction as the supply of a going concern. Conversely, where the purchaser is not a registered VAT vendor at the date on which the transaction is contemplated, voluntary registration may occur under section 23(3)(c) of the VAT Act. That provision permits voluntary registration where a person intends to carry on an enterprise from a specified date, the enterprise is to be supplied to that person as a going concern, and the total value of taxable supplies made by the going concern to be supplied exceeded R50,000.00 during the preceding 12-month period. Documentary Proof Required In addition to satisfying the substantive requirements of section 11(1)(e), section 11(3) of the VAT Act requires the seller to obtain and retain specific documentary proof acceptable to the Commissioner supporting the application of the zero rate, as elaborated upon in the South African Revenue Service's Interpretation Note 57 dealing with the disposal of an enterprise or part thereof as a going concern. The three most vital documents are the following: Agreement of Sale The drafting of the agreement is particularly important. In practice, poorly drafted sale agreements create serious risks of resulting in disputes regarding whether the requirements for zero-rating have been satisfied. Tax Invoice The seller must issue a valid tax invoice in accordance with section 20(4) of the VAT Act. Purchaser’s Notice of VAT Registration SARS additionally requires the purchaser’s Notice of VAT Registration confirming the purchaser’s status as a registered VAT vendor. If the required documentary proof is not properly retained, the parties run the risk of the acquisition not qualifying for VAT at the zero rate in terms of section 11(1)(e) of the VAT Act. The result being that VAT may become payable at the standard rate and, importantly, section 7(2) of the VAT Act expressly provides that the tax payable in terms of section 7(1)(a) must be paid by the vendor, being the seller of the enterprise. For this reason, the sale agreement should contain a VAT clause which allocates the risk of a failed zero-rating, entitling the seller to recover the standard-rated VAT from the purchaser together with an appropriate indemnity, failing which the seller carries that liability alone. Conclusion When purchasers evaluate a potential business acquisition, they are not only assessing the profitability and commercial sustainability of the enterprise itself, but also the legal consequences associated with the transfer itself. Where the requirements of section 11(1)(e) of the VAT Act are satisfied, the sale of a business as a going concern may qualify for VAT at the zero rate, and may serve as a convenient manner of transfer from the seller to the purchaser. However, purchasers and sellers should ensure that the transaction is structured carefully, that both parties satisfy the relevant requirements, and that the sale agreement is drafted properly to comply with the requirements imposed by the VAT Act. Parties should also bear in mind that the VAT treatment is only one element of a business sale. The transfer of a business as a going concern ordinarily results in the automatic transfer of employees in terms of section 197 of the Labour Relations Act 66 of 1995; a trader disposing of a business may need to publish notice in terms of section 34 of the Insolvency Act 24 of 1936 to avoid the disposal being voidable against creditors; the disposal of all or the greater part of the assets or undertaking of a company engages sections 112 and 115 of the Companies Act 71 of 2008; the transaction may require merger notification under the Competition Act 89 of 1998 where the relevant thresholds are met; and where fixed property forms part of the enterprise, the interaction between VAT and transfer duty must be considered. Contact an expert at SchoemanLaw for assistance with all your business sale needs. Nicolene Schoeman-Louw | SchoemanLaw Inc Specialist Technology, Commercial and Contract Law https://schoemanlaw.co.za/services/commercial-law/ https://schoemanlaw.co.za/services/contract-drafting/