When it comes to mergers and acquisitions (M&A), the details in the contract can significantly impact the tax outcomes for both parties involved.
After determining the structure of the deal and completing due diligence, it's essential to formalise the transaction with a sales contract that accurately reflects the intentions of the parties and incorporates the agreed-upon actions. As part of this process, it’s critical that the sales contract mirrors the intent of the parties, incorporates the agreed-upon actions stemming from the due diligence, and does not impose any unexpected obligations, liabilities, or risks on either party.
This article highlights key areas within a sales contract, or Share Purchase Agreement (SPA), that require careful tax consideration to avoid unexpected obligations, liabilities, or risks.
Purchase price
Although the word ‘tax’ is not always included in a Purchase Price clause, it’s nevertheless important to review it from a tax perspective.
Examples of tax issues included in a Purchase Price clause include:
- Deferred consideration: There can be materially different tax outcomes where deferred consideration is contingent vs non-contingent. Further, where the deferred consideration is contingent, there are further tax differences where the relevant contingency is based on the economic performance of the target, vs another contingent metric. It’s imperative to understand these differences and review the deferred consideration wording appropriately.
- Purchase price adjustments: Most deals include a purchase price adjustment that operates as a mechanism to ensure the final purchase price reflects the value of the target at closing. This mechanism operates through the inclusion of specific financial metrics agreed upon by the applicable parties and can include tax accounts such as Provision for Income Tax, and Deferred Tax Assets / Liabilities. These accounts can be material, thus where they are included in the purchase price adjustment, they need to be calculated accurately to determine the impact on the purchase price.
Tax relief related clauses
As part of the structuring process, the intent of the parties is to execute the deal in a tax efficient manner, which – among other things – can include tax rollover relief where the vendors are receiving shares as compensation. The conditions for tax relief for a share-for-share transfer are very prescriptive and the specific inclusion, or exclusion of terms within the SPA can result in rollover relief ineligibility.
Given rollover relief is generally only available where non-cash compensation is received, it’s of upmost importance that the SPA be worded to facilitate such relief. Where rollover relief is not available, tax may be required to be paid on the receipt of illiquid non-cash assets.
Tax warranty & indemnity clause
Tax warranty and indemnity (W&I) clauses are principally used to protect the buyer from tax risks inherited from the target that existed prior to the deal, although also exist to ensure that the vendor is not unreasonably exposed to future claims.
Tax W&I clauses are often drafted from a template and should be reviewed, understood and agreed to. Too often, we deal with disgruntled parties disputing that the W&I were not reflective of what was agreed in negotiations, outlined in the due diligence process, or not fully appreciated/understood at the time of signing.
Importantly, tax W&I are only as good as the vendors’ ability and willingness to pay on the claim. Thus, consideration should be applied to whether the withholding of a portion of the purchase price in escrow is an appropriate strategy. This amount could be held on trust by the lawyers and released upon resolution of a particular tax risk.
Tax consolidated groups
Where purchasing a subsidiary out of a tax consolidated group, it is important that the SPA includes a ‘clear exit mechanism’. This ensures that the subsidiary does not remain joint and severally liable for the pre-transaction tax liabilities of other members of the exited tax consolidated group.
A ‘clean exit’ is generally achieved through the target paying an ‘exit amount’ (i.e. its share of tax for the period up to exit) as prescribed under the Tax Sharing Agreement.
Each party's role
Finally, it’s important to understand and agree upon 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, including who will take carriage of a tax dispute, and who will bear the costs.
Final thoughts
Significant time and energy is spent in structuring and negotiating a deal, along with the due diligence exercise. It’s crucial that what has been agreed upon is accurately reflected in the SPA and that each party is clear of their respective obligations, liabilities and responsibilities in signing the SPA.
We highly recommend that the SPA be reviewed by a tax specialist to mitigate any oversights regarding the above.
At Grant Thornton, our tax team has extensive experience in reviewing every aspect of an SPA, and in providing practical recommendations that help protect your interests.
Tax planning essentials for successful M&A transactions
