Pros and cons
What can seduce you into buying a ready-made business: the procedure of state registration is completed, it already has accounts, certain history and reputation, employees, a base of clients is formed and tactics for conducting the business are in place. Purchase of an entity does not entail changing of the structure of the relationship with counterparts and governmental authorities: no need to conclude new contracts, receive new licenses, patents, and create new means of identification.
But there are some points that can make entering a ready-made business less attractive. The major point is no complete and accurate information about the past of the company: for instance, about the transactions that could have been made before purchase of the company and that could be invalidated for various reasons, as well as violation of the law when making the transactions, about the debts of the company, other problems that occurred or may occur. Besides, one can never forget about questions of the tax authorities concerning the transactions and payment of taxes and duties within the period before the purchase of this company or a share therein.
In this case, the key method to dispel doubts and fears is to try to obtain maximum information.
Searching for necessary information
Different Internet resources can provide you with such information: nalog.ru, Vestnik gosudarstvennoy registratsii (State Registration Bulletin), the website of Kommersant newspaper, http://bankrot.fedresurs.ru (information on bankruptcies), https://rosreestr.ru (a base of real estate objects and information on encumbrances thereon). It is better to check common courts at the location of the company or main assets accounting for the company’s business.
It is good to monitor disputes in the files of the arbitration cases at the website of arbitration courts of the Russian Federation.
Other sources of information may include requests sent to the governmental authorities, lawyer requests under Article 6.1 of the Federal Act "On Advocacy and the Bar in the Russian Federation" of May 31, 2002 No. 63-FZ, including the requests sent to the management of the company. If there is a dispute between negotiating parties during negotiation on selling of the business which can be settled only in court, the sources of the information may include materials of the case and requests that court is entitled to provide against the party’s motion during legal proceedings.
The requests may concern permits, consents, licenses to certain activities or notifications submitted by the company to appropriate bodies/facilities in due time; the company’s ownership of certain property; debts of the company, etc.
It should be noted that governmental authorities and facilities are not allowed to provide unauthorized persons with most of such information that is why analysis of the documents and data provided by the company itself is more informative. But its accuracy and credibility are debatable.
Even the most thorough verification of the business assets cannot give future owners a guarantee that the purchase will be smooth. Some circumstances may be missed during the collection of information and analysis thereof. Besides, the owner of the property or a part of it may be dishonest.
To protect himself from such situations the buyer of the assets can take some preventive measures.
Peculiarities of payment and risks when buying a business
One-time payment for the assets is not advisable. It is better to divide the amount of payment into several parts – it depends on the sequence of actions. The principal amount may be paid after the procedure of state registration is completed, the remaining amount may be paid after the documents concerning the company and its assets have been provided. The contract may better include the right to demand to recover damages caused to the buyer by the third party’s claims resulting from the purchase of the assets.
It is not too much to add the seller’s guarantees and representations into the sales contract: no third parties’ claims, restrictions and encumbrances against the assets; financial statements and tax reports of the company are accurate, no debts on the date of the transaction. The right of the buyer to withdraw from the contract unilaterally including reimbursement for the losses incurred or a penalty may be a punishment for dishonest representations.
Another option is to conclude a contract containing the terms on instalment payment and on the right of the buyer to integrate more thoroughly into the contents of the company’s activities, to run the company and to read the documents within a few months after the first payment. If the income derived from the activities of the company is smaller than the figures specified in the contract, the buyer is entitled to terminate the contract and to demand to return the first instalment.
The option mentioned above should not be confused with the situation when the buyer relies upon oral representations of the seller and when such agreements are not specified in the contract.
The buyer of the business shall bear in mind that not every case of provision of inaccurate information/non-provision of information by the seller may become a reason to file a claim against the seller.
Legal practice shows that judges refuse to invalidate sales contracts if a plaintiff refers to the fact he was misled by the information on the profitability of the assets purchased.
We advise adding the following provisions into a contract
1. Provisions on a seller’s liability that can be represented as an opportunity of a buyer to demand to reduce a price in case of additional taxes, penalties, tax fines for the period preceding purchase of the business. One more reason for such demand may be inaccurate information specified in the financial statements, for instance, on the company’s receivables.
2. It is advisable to provide for a non-competition clause concerning competition with a former owner of the business – to divide fields, regions or the period within which a competing business cannot be started.
3. It is better to determine a procedure according to which the buyer receives the company’s documents including financial ones.
Tax risks when selling a business
If the business selling means selling of its fixed assets, for example, real estate, then the business can be sold by direct selling of these assets, reorganization of the company followed by separation of a new company from it and further selling of a share in the company separated.
When property is sold generally the VAT and the income tax should be paid if the selling price is higher than the purchase price.
Selling of a share in the authorized capital doesn’t result in an object to VAT regardless of the price. But it should be taken into account that the share in the company cannot be disposed of right after it occurred as a result of reorganization because a small period of time between establishment of the company and selling of the share therein can make it possible for a tax authority to change legal qualification of such transactions with the taxation purposes. It is also desirable that a new company with real estate put on its books conducts the actual business activity and receive an income.
A tax authority may consider such actions of a taxpayer as the establishment of another company and transfer of the property to its authorized capital in order to make up a scheme to evade taxes. In this case, the taxpayer risks to pay VAT based on the expert’s evaluation stating market value of the real estate and to face changing of legal qualification of the transaction.
With the taxation purposes, the transaction of disposal of a share in the authorized capital is considered as a transaction of a sale of property. The Tax Code of the Russian Federation directly states that a sale of a share in the authorized capital is not subject to VAT.
Legal practice shows that if a seller of a share is a legal entity and the share is sold at nominal value, there is a risk that a tax authority can claim the receipt of unjustified profit from the income tax.
These risks can be reduced arguing that based on the performance characteristics of the company the share should be sold at nominal value. It should not result in losses caused by operations associated with the selling of the share.
It should also be borne in mind that tax authorities may try to qualify the sale of the share as a sale of the company especially when a 100 % share in the authorized capital is transferred to one person at once. To rule out such a probability one can sell shares in parts dividing the share being sold into several blocks: a founder of the legal entity that is purchasing the company can register several new firms. Then they can purchase separate shares of the company. Therefore, following the transaction different entities will own the shares.
If there are a few businesses
This recommendation is topical for a seller of a share in business especially if 100% of the authorized capital of the company is transferred. As a rule, business is sold through several legal entities and these entities are usually members of one another. It makes sense that when one of the companies is sold by disposing of 100% of its shares this legal entity keeps being a member of other legal entities reserving all its right and obligations. These include but not limited to an opportunity to read the documents of the company, to take part in general meetings and in the process of decision making, to nominate candidates in management bodies and to exercise other rights stipulated by law.
To avoid such situations, the legal entity can be restructured with separation of a legal entity not possessing assets in the form of the shares in authorized capitals of other companies within the group of companies and then a share in this very company can be sold to a buyer. But in this case, it may make sense to sell property of this company but not a share in the business as the legal entity separated will be an independent legal entity not having history of the former company. As a rule, in this case this is about real estate
In this case of the business purchase, a buyer buys fixed assets without obligations of former owners (except for the case when the property is encumbered with mortgage or other restrictions). In this case risks associated with a probability of situations unexpected for a buyer are minimal.
Transactions of the sale and purchase of a business are complicated both for a seller and for a buyer. Each part has its advantages and disadvantages, difficulties and risks. Usually these issues are resolved at the stage of planning of the transaction and evaluation of the prospects of the business being purchased. Therefore, the importance of a preparatory stage when entering the procedure of purchase/sale of a business cannot be emphasized enough. Most of complicated issues are resolved at this stage and at the stage when the scheme is designed, and the documents are prepared. If they are resolved, the other part of the transaction of a sale of business assets is a mere formality.
February 05, 2019
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