Business separation (split). Why is this necessary and how to reduce the risks of possible unpleasant consequences of such a decision?
- Business Separation: What is it?
- What is a business division?
- When you can and cannot split up a business
- Business fragmentation: legal optimization or tax crime?
- Tax risks of business separation
- Ways to Reduce Risks in Business Separation
The business is divided into several entities in order to apply special tax regimes, optimize processes and management. There is nothing illegal in the very concept of business separation, however, in some cases, government authorities may have claims against the company. Let’s take a closer look at how to correctly split a business, when necessary, what mistakes can be avoided.
Business Separation: What is it?
This is the splitting of the company into several interdependent entities and the subsequent division of profits between them. The purpose of the procedure is to optimize production, simplify management, and reduce the tax burden through special regimes or benefits. However, the latter circumstance should not be the main reason for the changes.
The tax authorities highlight the conditions for business fragmentation, which may cause inspections and increased supervision:
- Reducing the tax base due to the emergence of new partners.
- The transfer of specialists to a partner company while maintaining their tasks and areas of responsibility.
- The presence of working relationships and common goals among partner companies, as well as common suppliers, contacts and services.
The law does not prohibit the creation of interdependent enterprises, and the tax authorities will not have claims against you if the division of the business has a business purpose and is implemented not only on paper. However, if the procedure was formal, difficulties may arise.
What is a business division?
The tax service distinguishes between legal and illegal fragmentation. It will have no claims if each of the created companies operates independently, uses its own resources for its core activities and is under independent management.
Illegal business splitting is when formally independent firms conduct common processes, only people participate in the management of all companies, and each of the entities uses common resources to work.
The tax service can initiate an audit and if all the newly-minted companies are engaged in the same type of activity, there is a direct or indirect relationship between the owners and managers of enterprises. The basis for suspicions of dishonesty can also be artificial fragmentation, that is, immediately before companies begin to increase production capacity and the number of personnel.
Judicial practice in relation to cases of illegal business splitting has not yet been formed. However, the court will be inclined to take the side of the tax authority if the new companies do not have enough employees or specialists are transferred to another company purely formally. A sign of an illegal scheme is also the use by subjects of the same signs, sites, terminals and contacts.
When you can and cannot split up a business
Business separation is a common practice when it comes to streamlining management processes, taxation and production. Sometimes crushing business occurs as a result of natural internal processes, sometimes the cause is external circumstances: for example, a market crisis.
The creation of a group of companies makes sense when the company is large, engaged in several activities, and management has become very complicated. Then fragmentation allows you to create several interdependent companies, each of which will be headed by an experienced leader. At the same time, interdependent enterprises can adhere to the general principles of record keeping and decision-making.
When dividing a business, it is necessary to prepare for a dialogue with the tax inspectorate: make sure that all new structures independently purchase materials and pay expenses, calculate salaries, and keep accounts. That is, you need to be prepared for the fact that the Federal Tax Service will check: the fragmentation of the business actually happened or is it just a trick to reduce the tax base.
It is not allowed to proceed with business division only to reduce tax payments. If regulatory authorities suspect this, the company faces a large fine and other sanctions. A few years ago, it was the misuse of tax regimes that was considered illegal. Today, however, even the creation of two organizations on a common system may raise questions if they try to take advantage of contribution benefits.
Business fragmentation: legal optimization or tax crime?
As we noted earlier, the legislation of the Russian Federation does not prohibit the splitting of an enterprise in itself, and any businessman has the right to use such a procedure to legally optimize the structure of the company. However, if the Federal Tax Service of Russia sees signs of a targeted reduction in the tax base, then legitimate optimization may well turn into a tax crime. What mistakes do we advise to avoid so as not to arouse suspicion among regulatory authorities?
- Split the organization into several LLCs or individual entrepreneurs in order to continue to enjoy the privileges of the simplified taxation system (STS). Of course, one must always remember that the right to use such a special taxation regime arises subject to a certain restriction. It is expressed in terms of revenue, number of employees and the total cost of fixed assets. If the limits in these categories are exceeded, the founders often divide the business in order to maintain the simplified tax system, which is illegal.
- Keep track of the fact of the coincidence of the founders of the group of companies. If the enterprise is split up, these persons will be the beneficiaries of the separation scheme.
- The presence of individual entrepreneurs who will simultaneously be on the staff is illegal. Often unscrupulous businessmen register individual entrepreneurs for their subordinates in order to benefit from tax breaks, grants or patents.
To avoid a risk of “shadow of suspicion” from the scheme of division of your business, two main issues shall be followed.
First, the companies in the group must conduct different business activities from each other. Duplication will raise suspicion about the illegality of the division of the organization.
Secondly, the assets of each company should include its own property. An enterprise cannot conduct economic activities without certain funds on its balance sheet. Moreover, each firm in the group of companies must have sufficient funds for stand-alone activities.
If these rules are not observed, there is a high risk of falling under sanctions, which consist in recalculating the entire tax base of individual firms according to the rule of combined assets and revenue, that is, as if a single company.
Tax risks of business separation
The main risk that arises is the consolidation of a group of companies in order to optimize the tax base. In such a situation, the tax service will combine the income and expenses of the group and make additional tax assessments. If it is a group using the main system, you may face sanctions such as losing the right to reduced premium rates.
However, the tax service may not consolidate the group. However, even in this case, there are many risks. For example, recalculation of the amounts of transactions and, as a result, an increase in taxes, a change in the calculation of payments of prices on market indicators. Another possible risk is the refusal of the Federal Tax Service to recognize the general taxation system or expenses. This can happen if government agencies prove the nominality of certain works and services.
Another possible risk is evidence that the companies in the group received or provided services to other entities free of charge. In this case, the payments will be recalculated again and you will have to repay the additional amounts of taxes.
To avoid risks, splitting should be carried out for a business purpose. This means that by separating companies, you must create independent businesses that can operate independently of each other. At the same time, it is necessary to pursue rational goals, for example, the optimization of production and management. It is also critical that the documentation of the procedure is consistent with the actual state of affairs. If the division of enterprises exists only on paper, state bodies will resort to consolidation.
Ways to Reduce Risks in Business Separation
Crushing is one of the ways to optimize the enterprise. It is not a crime or a tax violation, but it can become one if its sole purpose is to reduce the tax base. This means that the division of a legal entity is purely nominal. To reduce risks, it is important to adhere to the following rules:
- Formulate a clear, economically justified goal of crushing. Ideally, if you can capture not only the business logic, but also the positive economic impact of the innovation. For example, increasing profits or reducing the risk of losses.
- Ensure the independence of businesses at the level of work schemes, bookkeeping and accounting, the receipt and distribution of resources. Therefore, do not use common workflow or frames.
Practice shows that state authorities will not have claims if the business separation is aimed for entering a new market, expanding the customer base or optimizing fixed assets. If the matter goes to trial, the arbitration court will be inclined to take the side of the taxpayer, provided that it can justify the purpose of the separation and prove the independence of each company.
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