Tax in a M&A transaction can also take various forms and is dependent on the asset types, market conditions, economic pressures, speed and timing of the deal, who the acquirer or vendor is – and so on. In our Tax in M&A series, we will look at a full range of tax aspects, considerations and implications that can have a significant impact on the tax optimisation and financial sustainability of a deal.
Acquiring a business with tax losses
There are a number of reasons a business may be experiencing tax losses. For instance, there is a current trend of acquiring technology companies. Most companies in this sector have for many years sustained tax losses while investing in and developing their core offerings and intellectual property. If not managed properly, acquiring a company with tax losses can be fraught with challenges. If the target entity has significant carried forward tax losses, the vendor can sometimes have an expectation that the purchaser should be able to obtain the tax benefit attributable to the losses in the future. Therefore, there can be an assertion that the purchase price should be adjusted so that the vendor is paid for the future tax benefit that will accrue to the purchaser when the losses are recouped.
However, whether or not the purchaser is actually able to utilise the brought forward tax losses will depend on a number of factors.
Here is a look at some of these considerations:
- Ensuring or obtaining sufficient comfort that the relevant loss recoupment tests were not compromised in the vendor group in a historical period and the losses are in fact ‘available’ at the time of the acquisition. The target will need to be able to able to satisfy the "Same Business Test" (or similar business) for loss recoupment as the Continuity of Ownership Test is failed upon acquisition by the purchaser. These tests are onerous and require detailed review and documentation.
- If the target joins a purchaser tax consolidated group, the "Available Fraction" (AF) attached to the losses needs to be determined. The AF determines the rate at which the losses can be recouped. In order to calculate AF, very detailed information about the target group going back four years will be required.
- Once the losses are in the purchaser’s group, the losses will be subject to the Continuity of Ownership Test going forward (with reference to the new ultimate owners) which would also need to be monitored post acquisition.
- In most instances, there could be a number of events that occur post-acquisition that would compromise the losses or the AF in the future. For example, future changes in shareholding of the purchaser group could breach the COT. Injections of equity or other acquisitions in the future would adversely impact the AF attached to losses. There is no guarantee that the purchaser will be able to satisfy the loss recoupment tests in the future and over what time period any benefits would accrue.
- Under the Tax Consolidation rules, the purchaser will have to choose between retaining the losses and obtaining a cost base uplift on assets. Further, in certain situations, choosing to retain the losses can result in a capital gain to the vendor. The impact of these outcomes need to be factored into the value of any tax benefit attaching to the tax losses.
As you can see, there are a number of issues that come into play when tax losses are involved and there is a lot to consider in a transaction. Accordingly, most transactions would not allocate any value to the potential use of tax losses by the acquirer. In many cases, acquirers may choose to ‘cancel’ the tax losses. To inherit tax losses can trigger a reduction in tax cost bases of other acquired assets which is often not desirable.
If not considered at the outset of a deal, there is potentially further ‘transaction stress’ at the end of a deal and delays. If you have tax losses and are considering a sale or looking to acquire a business with tax losses, resolving these matters upfront is highly recommended.