Every merger and acquisition (M&A) deal is unique. There are a number of factors to consider during an acquisition which can each result in excessive tax charges.
It is important to remember that the tax implications of an M&A transaction will vary depending on a number of factors, including the nature of the assets being acquired or sold, the timing of the transaction, the identity of the acquiring or selling party, and the tax laws of the countries involved.
When looking at M&A tax in acquiring a loss-pregnant entity, below are some of the most common tax factors that can have a major bearing on the tax efficiency and long-term viability of a transaction.
Purchasing a company with tax losses
There could be several causes for a company's taxable losses. For instance, it has become common practice to buy up tech firms, or exploration companies with a more niche foccus like Lithium, uranium or rare earths. Some companies will be at the forefront of R&D on the verge of a breakout technology, whereby millions were sunk by investors into the hopes of a potential future return that has not eventuated as yet.
Most businesses in such industries have operated at a loss for many years while they spent money on investing in and growing their core goods and intellectual property. Inadequate planning can lead to a number of complications when acquiring a firm with tax losses.
The Seller's Common Negotiation Angle
The seller may believe that the buyer is entitled to the tax advantage due to the carried forwards tax losses if the target firm has substantial carried forwards tax losses. Therefore, it may be argued that the purchase price should be revised upwards to account for the tax benefit to the buyer once the seller's losses are recovered. However, there are a variety of considerations that will determine whether or not the buyer can use the tax losses that were carried forward.
It is important to obtain enough assurance, that the vendor group's previous loss recoupment tests were not compromised and that the losses are, in fact, "accessible" at the time of the acquisition.
Common Tests for Tax Losses
Due to the purchaser's failure to meet the Continuity of Ownership Test (COT), the target must be able to pass the "Same Business Test" (or an equivalent test) in order to recover losses. These assessments are laborious and call for careful analysis and record-keeping.
If the target becomes part of a purchaser tax consolidated group, the "Available Fraction" (AF) of the losses must be calculated. The recoupment of losses is governed by the AF. Very specific data about the population of interest dating back four years will be needed to compute AF.
After an acquisition, the losses are now part of the buyer's group and must be tracked using the Continuity of Ownership Test (with reference to the new ultimate owners).
There are often a lot of things that could happen after an acquisition that would endanger future losses or AF. The COT may be broken if, for instance, the buyer group's shareholding composition were to alter in the future. The AF associated with losses would be lowered if equity injections or other acquisitions were to take place in the future. There is no assurance that the buyer will pass the loss recoupment criteria in the future or that any benefits will accrue over a specific time frame.
The guidelines for Tax Consolidation require the buyer to decide between keeping the losses and getting an asset cost base increase. In addition, the seller may realise a monetary gain if they want to keep the losses. Any tax gain associated with the tax losses must account for the impact of these outcomes.
Should You Attribute Value to Tax Losses in a Deal?
It is clear that there are many factors to think about and negotiate when tax losses are at stake in a business deal. Therefore, the prospective utilisation of tax losses by the purchaser would not be valued in the majority of deals. There are several scenarios in which acquirers may want to "cancel" the tax losses. It is not ideal to inherit tax losses because doing so can cause the tax cost bases of other purchased assets to be lowered.
Deal delays and additional "transaction stress" can be avoided if these factors are anticipated from the start. When selling a firm or buying one with tax losses, it's a good idea to take care of the tax issues involved as soon as possible.
To ensure that your mergers and acquisitions (M&A) agreement is designed to provide you with the most favourable tax consequences, we assist clients in keeping abreast of the myriad tax issues that can arise throughout the course of an M&A transaction.
If you are considering buying an Australian company with tax losses, contact us to know more.
