Insight

Tax in M&A: M&A transactions and employer obligations – the perfect storm

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Over the recent couple of years, there have been pressure systems gathering momentum along two fronts. Whilst they have largely gone unnoticed by many in the industry, collisions between the two have occurred and left some casualties in the M&A space. These collisions are fast becoming more frequent and the damage becoming more palpable.
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In days gone by, it was generally regarded by many deal-makers that employer obligations were quite low down on the totem pole of risk. However, we are seeing an ever-increasing focus from multiple enforcement agencies on unpaid employee entitlements and the use of contract for hire labour. The significant uptick in compliance activity has coincided with exponential growth in the M&A space, leading many to believe there are huge levels of unquantified risk in the market – often not covered by warranty and indemnity insurance.

To provide clarity on these risks, we look at some of the key employment tax risk areas in more detail below:

1. PAYG

Due diligence is important to ensure PAYG has been appropriately withheld and paid across. Also noting, where appropriate filings are not made, penalties can apply – which can be particularly punitive ($111,000 to $555,000) where the group is a Significant Global Entity (Revenue > $1bn).

Recommendation: This is an area we have typically detected lesser risk. However, with evolving case law in this specific space (particularly in regard to contractors), we recommend this area is not overlooked as underpaid PAYG can be the subject of Director Penalty Notices.

2. Superannuation

Superannuation is an area we often detect shortfall. This can be expensive to remediate and leads to significant interest and penalty costs. Where superannuation is paid late or not at all, a Superannuation Guarantee Charge (SGC) is levied. This amount is calculated on salary and wages (broader definition that Ordinary Time Earnings) and is subject to a nominal interest charge at 10% and a quarterly administration fee. Noting as an employee entitlement there is no limitation on the period of consideration for this liability. However, when considering a review period, employers will often have regard for their record keeping requirements. The SGC can be subject to penalties of up to 200%.

Where a target has not met their obligations, the acquirer takes on this risk and can be subject to director penalty notices for the entire SGC amount (including penalties and interest).

Recommendation: Always ensure superannuation is included in the due diligence scope and meaningful testing of timings and application is included. Where a shortfall risk is identified, commission further work to quantify and remediate the exposure. This is not a straight-forward exercise, but may pose a significant financial and reputational risk if left unchecked.

3. Fringe Benefits Tax (FBT)

Whilst FBT is an area we usually find discrepancies and is a hugely expensive tax, it is an area clients regularly focus on less. Typically, the preparation of an FBT return involves a great deal of analysis and, whilst it is possible to garner an idea of what errors may lie beneath from a combination of interviewing management and review of work papers and filings, the greater risk of misstatement often lies beneath and sometimes unseen.

Recommendation: Always ensure FBT falls within your due diligence, ensure that the positions taken are considered reasonable and ensure that during the interview with management that the process seems comprehensive. Additionally, whilst we have seen little audit activity on the FBT front, we have seen significant compliance activity relating to lodgement and issuance of penalties in this regard, in particular SGE penalties noted above.

4. Employee Share Scheme (ESS) reporting

Incorrect operation and reporting of ESS is a common error found in the due diligence process and can be the subject of PAYG, FBT or Payroll Tax, dependent on structure of documentation. Additional triggers often arise as a result of the deal structure.

Recommendation: Always review documentation and filings made. This can be an area for penalties and also a common trigger for audit activity where the data matching between agencies does not align. Be aware the transaction may trigger ESS outcomes, including reporting which is often missed.

5. Payroll Tax

State revenue offices are recipients of significant data matching information and are leading the way in terms of proactive payroll compliance reviews (particularly NSW and more recently VIC and QLD). Whilst payroll tax is generally regarded as low risk in terms of materiality – at circa 5% of salary and wages – the risk of compliance activity is often regarded as high, with ESS, Contractors, FBT and Grouping being the main triggers. Additionally, interest and penalty regimes can be excessive.

Recommendation: Where potential shortfalls are detected, these amounts should quantified and remediated to ensure punitive interest does not continue to accrue.

6. Contractors

The definition of employee vs contractor is one that differs across legislations. This often gives rise to misstatement, particularly for superannuation and payroll tax.

Recommendation: Do not rely on common law definition of employee, superannuation and payroll tax have a much broader definition to bring in genuine contractors. This should form a key focus of any due diligence in the face of increased compliance activity in this area and data matching programs.

Employer obligations can cover a wide range of areas and all can have an impact on how taxes in an M&A transaction can play out: from being unaccounted for effectively, to leading to significant penalties. Get in touch with the team to discuss your employee obligations when planning – or undertaking – a transaction. 

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