We discussed in our last week’s article the key legal issues that arise in mergers and acquisitions. This week we continue the discussion on mergers and acquisitions, with a focus on the tax considerations thereof.
Experience shows that parties involved in mergers and acquisitions (M&As) at times fail to consider the tax implications of the merger or acquisition deal prior to and after the deal. But why are M&A tax considerations important?
Businesses with national, regional and international aspirations and ambitions cannot afford to overlook potential M&A opportunities. Yet if these opportunities are to yield synergies and value, it is vital that businesses proactively deal with the tax implications of each M&A.
When M&As involve multiple jurisdictions (i.e. cross-border deals), dealing with the tax implications is particularly vital as it helps parties to maximize tax planning opportunities and to identify/mitigate potential tax liabilities in M&As.
Thus, it is critical that parties understand the tax considerations of M&A deals. The following is a non-exhaustive list of the important tax considerations:
Level of tax compliance: What is the target/selling company’s level of compliance with regard to income tax and other tax filing obligations in the jurisdiction/s in which it is required to comply? It is useful to go beyond obvious concerns, and take a look at the activities of the target in other jurisdictions since, depending on the jurisdiction, activities that go beyond auxiliary or preparatory business activities may trigger income and other tax filing obligations.
Availability and utilization of tax assets: Are the tax assets (for example, tax overpayments, the amounts of tax losses available for carry forward, or reimbursable VAT amounts) declared by the target itself (as a basis to increase the deal price) actually available to the target? What is the likelihood of the assets being utilized in the declared amount and within the declared time period?
Tax deductible expenses: In general, expenses that are wholly and exclusively incurred in the production of income are deductible for income tax purposes. However, acquisition expenses such as stamp duties are typically non-deductible. In the tax position of the target, it is important to establish the sum of the non-deductible expenses.
Impact of tax treaties: What is the potential impact of the relevant double tax treaty (ies) on a cross-border M&A deal? There is a need to carefully and properly consider the issue of double tax treaties with the aim of preventing double taxation on profits from cross-border M&A activities.
Tanzania’s Income Tax Act 2004 provides the tax benefit of deducting costs of borrowed money used for a taxable purpose; therefore, the acquirer of a target company may deduct interest expenses on debt obligations so long as the thin capitalization rules are adhered to.
The rules provide for interest deductibility if the taxpayer is an “exempt-controlled resident entity”. Also, the amount of interest that an exempt-controlled resident entity may deduct for a year of income is limited to a debt/equity ratio of 7:3. An “exempt-controlled resident entity” is defined to include inter alia a resident entity in which 25 percent or more of the underlying ownership is held by non-residents or their associates.
It should be underscored here that the issues discussed above serve as just a sampling of the important tax considerations that will arise in a given M&A deal.
M&A deals require proper tax planning and effective due diligence and negotiation to ensure that the represented party maximizes tax planning opportunities and identifies/mitigates potential tax liabilities in such deals.
This certainly entails engaging experienced legal and tax advisors to provide guidance throughout the M&A process, while taking into account that the objective is to ensure the best M&A deal is achieved for both parties. M&As need not be a loser’s game.
In the end, however, the customer should be at every party’s M&A thinking. The customer, infrequently viewed as an actor affecting and being affected by an M&A deal, is a very critical element of the parties’ motives behind the deal.
Customers may react to the announcement of an M&A if it involves companies that they do not want to associate with, or if the customers view the M&A as shaky. The actions of customers may thus affect M&A integration strategies and governance.