Tax in M&A: Share purchase agreements and what to consider when in negotiations

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M&A activity has had a significant uptick during the pandemic, with cashed-up buyers capitalising on opportunities for strategic investments. With any investment, it is important to properly assess the level of tax risk that a target investment entity presents.

A comprehensive tax due diligence will allow a purchaser to assess the level of tax risk. Post the tax due diligence, tax warranties and indemnities in a share purchase agreement (SPA) provide protection against tax claims that may arise as a result of the target’s past activities.

Most experienced legal practitioners will insert a standard set of tax warranties and indemnities in a SPA. However, it is crucial that these warranties are reviewed by your tax due diligence team to provide any recommendations regarding the context of the particular transaction.

We look at how tax risk is managed through a properly drafted and negotiated SPA.

Negotiating a SPA

There are a number of considerations to navigate when negotiating – or planning to negotiate – a SPA.

  • Withholding cash: Any tax warranty and indemnity is only as good as the sellers’ ability and willingness to pay on the claim. Based on the profile of the seller and nature of risks identified, consider if withholding of a portion of the purchase price in escrow is an appropriate strategy. This amount would be held on trust by the lawyers and only released to the seller upon say, for example, resolution of a particular tax risk.
  • Time limits: Consider the time limits that are appropriate for any claims. Time limits for any claims and any maximum and minimum claim amounts are important negotiating points which require input based on the tax due diligence. Time limits can vary greatly and range from four to seven years. Generally, tax returns are open for amendment for four years from date of assessment. Consequently, tax return for a pre-completion period that is lodged after completion may still be open for amendment four years after completion. Further, transfer pricing issues can have a seven year amendment period.
  • Disclosure exclusions: Often the standard clauses in a SPA will exclude any ‘disclosed matters’ from being the subject of a claim. It is important to understand how any disclosed matter exclusion relates to tax warranties. Normally, it would be appropriate for any amount of tax included in the completion accounts to reduce the amount payable under the tax warranty. However, a disclosure exclusion should not extend to matter identified in diligence. This is appropriate because while a due diligence may identify a risk, it is not always possible to be fully conclusive or quantify the risk.
  • Following legally agreed processes: Pay attention to the procedural elements of any tax claim. For example, SPAs will specify how soon after an issue is known that the buyer must inform the seller. What rights does the seller have to take carriage of any tax issue that is disputed in the future by a Revenue Authority? If the legally agreed processes are not followed, the buyer may find themselves in breach and not be able to make a claim.
  • Understanding terms of the SPA: The definition of terms fundamental to the ability to make claims are critical eg ‘tax’, ‘credits’, ‘event’ and so on.
  • Interest and penalties inclusion: Whether or not interest and penalties are included within the definition of what can be claimed (generally they should be).
  • All jurisdictions included?: Whether claims can be made for tax exposures in any jurisdiction including outside Australia.
  • Tax liabilities: Care should be taken to ensure that the tax indemnity covers not just actual tax but also liabilities that are not strictly tax themselves but which are clearly tax related e.g legal costs of a dispute.
  • Tax consolidated groups: If purchasing a subsidiary out of a tax consolidated group it is crucial that the SPA has a ‘clear exit mechanism’ under the SPA.
  • Each parties’ roles: The other important area of review is to do with agreeing the respective responsibilities of each party post completion. The SPA should specify who is lodging any straddle tax returns and review rights of each party- who will take carriage of a tax dispute, and who will bear costs.

Working with clients

Negotiating and agreeing all of the above requires a good grasp of the risk profile of the target and also the commercial imperatives of the buyer. If you are negotiating a Share Purchase Agreement, get in touch to arrange a tax review of the SPA so you can ensure you are fully protected in the event that historical tax liabilities are identified post acquisition.

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