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Home > Mergers and Acquisitions Checklists > Structuring M&A Deals and Tax Planning

Mergers and Acquisitions Checklists

Structuring M&A Deals and Tax Planning


Checklist Description

This checklist outlines the significance of the way merger and acquisition (M&A) deals are structured in relation to potential tax liabilities.

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Definition

In planning for an acquisition, a decision needs to be made on whether the deal involves simply buying the target company’s shares or actually acquiring the business itself. Though the distinction may at first glance appear to be a technicality, in practice its significance can be considerable. This is because the acquisition of shares involves buying not only the underlying business of the target company, but also its assets, both tangible and intangible, and, crucially, its liabilities. In this respect, a share-based acquisition can carry higher risk for the acquirer, potentially exposing them to the risk of unforeseen skeletons in the closet. To help compensate for the higher practical risk of the share-based acquisition, buyers can demand warranties from the seller as part of the deal.

However, in spite of the prospect of having to agree to these terms to help protect the buyer from unknown potential risks, there can be some financial advantages for the seller in a share-based transaction. Chiefly, US tax law dictates that, provided they have held the stock for a minimum of one year, selling stockholders need to pay tax only once on the deal. This is levied at personal capital gains tax rates on the difference between their original share purchase price and the agreed acquisition sale price.

Although the stock transaction route can be highly advantageous from the seller’s perspective, the tax treatment of fixed assets can be disadvantageous for the buyer, who generally inherits the historically used depreciation structure. Under some specific circumstances other alternatives can apply, although the buyer nevertheless still assumes greater potential exposure to bombshells such as pension fund liabilities and product-related claims when making a share-based acquisition. However, this needs to be balanced against some of the pluses of a share-based deal from the buyer’s perspective.

Structuring a deal on the basis of the transfer of the assets of a business permits a buyer to sidestep most unforeseen liabilities and also to benefit from much greater flexibility in writing off asset depreciation. The chief downside is that the seller can effectively be hit twice by tax, substantially reducing the benefit the seller enjoys after the proceeds are taxed first at the corporate level. Should the corporation then be liquidated and the proceeds shared among stockholders, these beneficiaries are then liable for tax at the personal level. Given the complexity of the issues involves, sellers should seek professional advice at an early stage when considering entering into a transaction.

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Advantages

  • Well-structured deals can bring many pluses for both buyer and seller, allowing both parties to adjust their market exposure to reflect changes in their business objectives or personal circumstances.

  • Stock-based transactions are frequently preferred by sellers, offering attractive tax advantages to those who have held shares for longer than one year prior to the sale.

  • Stock-based deals can help buyers to benefit from existing contractual arrangements.

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Disadvantages

  • The structuring of deals and the associated negotiations are, by their very nature, complex and time-consuming, with no guarantee that a deal will ultimately result.

  • An asset-based deal will typically expose the seller to two levels of taxation, corporate and personal.

  • A stock-based transaction can be unattractive to a buyer given the tax treatment of fixed asset values.

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Action Checklist

  • Appreciate and understand the importance of the structure of the transactions.

  • Aim to find a consensus over the final structure of the deal.

  • Seek up-to-date professional advice on taxation matters, as specific circumstances may alter the taxation implications for one or both sides.

  • Bear in mind the importance of the after-tax numbers resulting from a proposed deal, rather than the pre-tax figure.

  • Recognize that only with a comprehensive understanding of the taxation implications of the deal can realistic discussions take place to strike a deal that is acceptable to both sides.

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Dos and Don’ts

Do

  • Aim to maintain cordial negotiations whenever possible.

  • Seek warranties wherever appropriate when buying to guard against potentially crippling unforeseen surprises.

  • Remember that sellers looking to realize the cash from the transaction at an early stage will generally be exposed to higher tax liabilities.

Don’t

  • Don’t skimp on the cost of professional tax advice, particularly given the substantial tax implications associated with particular deal structures.

  • Don’t leave involving your lawyers and accountants until the last minute, as only with informed professional advice can your options be considered objectively.

  • Don’t ignore the importance of effective communication with key stakeholders during the planning process.

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Further reading

Articles:

  • Ayers, Benjamin C., Craig E. Lefanowicz, and John R. Robinson. “The effect of shareholder-level capital gains taxes on acquisition structure.” Accounting Review 79:4 (October 2004): 859–887. Online at: www.jstor.org/stable/4093079
  • Erickson, Merle. “The effect of taxes on the structure of corporate acquisitions.” Journal of Accounting Research 36:2 (Autumn 1998): 279–298. Online at: www.jstor.org/stable/2491478

Website:

  • International Network of M&A Partners (IMAP): www.imap.com

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