We discussed in Part I the key legal issues that arise in mergers and acquisitions. In this Part II 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.
There are ‘change in control provisions’ triggered at the moment the underlying ownership of an entity changes by more than 50% as compared to any time during the previous three years.
Where there is such a change, the consequences are that the accounting period of the entity is split at the point of such a change, so that the parts of the year of income before and after the change are treated as separate years of income, and there is deemed realisation of assets and liabilities at market values.
In certain cases, such a change can also result in the forfeiture of unutilised tax losses and tax credits. The Commissioner General of the Tanzania Revenue Authority has to be notified immediately before and after the change in control has occurred.
There is a thin capitalization restriction on the amount of deductible interest for what are termed 'exempt-controlled resident entities', where the debt-to-equity ratio exceeds 7:3. The Income Tax Act, 2004 contains specific definitions of 'debt' and 'equity' for the purposes of thin capitalization.
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.