Tax Issues In Mergers And Acquisitions

Reasons to choose Wilson Browne

Negotiating a merger or acquisition deal is going to involve issues surrounding tax.

The tax treatment for the buyer and seller in acquisition deals usually becomes a key consideration in the negotiations for how the purchase will work.

Also, structuring M&A transactions in a tax-efficient manner can add significant value to the deal.

What Form Will the Transaction Take?

Typically, M&A transactions will involve one of the following:

Purchasing the target company’s assets
Purchasing equity interests such as stocks in the target company
Direct or indirect merger with the target company.

The tax consequences in each case will also depend on the tax classification of the owner of the target business, and which of the following types of ownership apply:

Disregarded entity
C-corporation
S-corporation
Partnership.
A disregarded entity is a company that is not considered separate from its owner for tax purposes. Therefore, acquiring all the interests in a limited liability company (LLC) that is treated as a disregarded entity is treated, for tax purposes, as the sale and purchase of all the LLC’s assets.

C-corporations are the most common form of corporation and generally have two levels of tax on their income. They’re taxed at entity level, on earnings, and at stockholder level when they distribute this income.

Eligible c-corporations can avoid this double taxation by becoming s-corporations. In this arrangement, all the profits and losses pass through to stockholders, who must include their taxable amounts on their individual income tax returns.

In M&A transactions involving both types of corporations, the selling shareholders tend to prefer to sell their stock. This provides the following tax benefits:

Under the law, the buyer then assumes all the liabilities of the target company
The selling shareholders in c-corporations can avoid double taxation
Selling shareholders in s-corporations are taxed at capital gains rates.

However, there is a potential for disagreement here, because while sellers may prefer to sell stock, buyers generally prefer to buy assets, because:

They can select only those assets they really want
They don’t assume liability under law for the target corporation
They can obtain a fair market value for the acquired assets.

There is then likely to be a need for negotiation between the seller and buyer, to reach a solution that both parties are happy with.

What are the Pros and Cons of Asset or Share Purchases?

For asset purchases, the pros are:

You can depreciate the asset price, or part of it, for tax purposes
You can gain a price deduction for the training stock you purchase
You inherit no previous liabilities from the company
It enables you to acquire part rather than the whole of a business, should you want to.

The cons are:

You may need to renegotiate certain things, such as employment and supplier terms and technology contracts
Usually, you need a higher capital outlay
The seller may find this a less attractive option
You may face higher transfer duties.

For share purchases, the pros are:

Usually, you have a lower capital outlay
The seller may find this type of transaction more attractive
As a buyer, you may benefit from the target company’s tax losses
You may benefit from existing employment and supply contracts
Typically, you’ll pay lower transfer duties.

The cons are:

You become liable for any previous liabilities of the target company, including tax
You acquire an unrealised tax liability for any depreciation recovery of the difference between the accounting and taxable values of assets
You won’t get a deduction on the purchase price
You might find it more difficult to make the transaction tax-efficient.

Corporate M&A Transactions and Tax

Tax issues in mergers and acquisitions can be different where both companies involved are corporations.

The parties may want to see if they structure these acquisitions as tax-free transactions.

However, if, for example, the shareholders face a loss or only a small gain from the target shares, or these shares are mainly tax-indifferent, then a tax-free acquisition may not be appropriate.

In fact, it’s frequently the case that private stock acquisitions are structured as taxable acquisitions.

Tax Structuring Considerations in M&A Transactions

Structuring a transaction for tax can add value to it, helping to ensure its success for all parties involved.

It makes sense to incorporate this tax structuring into the wider process of the deal and to therefore show it in all relevant deal documentation.

These tax structuring considerations normally include:

Tax implications of acquiring assets or shares, or a combination of both
Holding company jurisdictions and how to minimise tax leakage, such as withholding tax mitigation on interest and dividends when repatriating profits to the buyer
Integrating the target company into an existing group, including potential for tax credits such as R&D
Efficient financing of applicable acquisition tax, such as issuing stock to sellers, or taking on third-party acquisition debt
Controlling acquisition costs, such as VAT on transactions, tax-deductibility of transaction costs, transfer taxes and any capital duty that is due.

What are the Main Taxes on Corporate Transactions?

The main taxes on corporate transactions, including mergers and acquisitions, are:

Stamp duty – charged on instruments transferring stock and marketable securities, usually where an incorporated company transfers shares using a stock transfer form. If the transfer is done electronically, then stamp duty reserve tax (SDRT) applies instead. The buyer pays stamp duty.
Corporation tax – charged on worldwide profits, and both sellers and buyer can be liable for this
Capital gains and income tax – on gains for individuals arising from the disposal of assets.
VAT – applicable to some asset sales, unless the transfer qualifies as a transfer of a going concern (TOGC), in which case it’s exempt from VAT.