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Markel Tax

04 May 2020

Plan before you buy that business

Before you buy that business

It is inevitable that the current Covid-19 pandemic will have a major economic effect postponing many large commercial business sales. On the flip side, some small business owners struggling in the current climate may decide now is the time to sell their business. For those who are interested in acquiring businesses, some of which may be showing signs of distress, there are a number of important tax-related matters that should be considered before acquisition. This article considers some of the issues to consider when acquiring a corporate business.

Share acquisition vs trade and asset acquisition

There are two ways to acquire a business carried on by a company. Firstly, the company itself can be acquired by way of a share purchase from the shareholders. Secondly, the business can be acquired by purchasing the trade and assets from the company.

A trade and assets sale is often favoured by a purchaser as they are able to negotiate exactly which assets they want to acquire and which liabilities they want to leave behind. The purchaser is also not faced with acquiring a company with potential issues such as inherent tax liabilities, all of which would have to be quantified and disclosed with suitable warranties and indemnities in a costly due diligence process (see below). Conversely, a seller is likely to want to sell the shares in a company so they are not left holding a bundle of liabilities. More importantly, valuable reliefs—such as business asset disposal relief (albeit now reduced to gains of £1m) and the substantial shareholding exemption—may apply to share sales, which may result in a lower tax liability on exit for the seller.

Some of the other key differences for a purchaser between a share sale and a trade and asset sale are:

  • In a trade and asset sale, trade losses will be lost and capital losses will remain behind in the target company. In a share sale, by contrast, the purchaser will be able to utilise the losses of the target company subject to certain restrictions including;

    • Where there is a change in ownership (broadly where more than 50% of its ordinary share capital changes hands) trade losses carried forward that arose after April 2017 but before acquisition of the company cannot be surrendered (assuming the purchaser is another company which is part of a group) into the new group for a period of five years following the change in ownership.

    • Additionally, where within a specified period there is a change in ownership and either a major change in the nature or conduct of a trade carried on by the company, or the scale of its trading activities has become small or negligible, losses arising before the change in ownership may not be offset against any profits after the change in ownership.

  • In a trade and asset sale, stamp duty land tax will be suffered on the acquisition on land and buildings In a share sale, the purchaser will be subject to stamp duty at the lower rate of 0.5%.

  • In a trade and asset sale, the tax value of the assets is the amount paid by the purchaser, so the base cost for tax purposes going forward is uplifted with the potential to claim higher capital allowances. This will not be the case with a share sale. In purchasing the assets of a business, the VAT rules relating to TOGCs (transfer of a going concern) should be considered. A TOGC will remove VAT from the purchase, which can be a significant advantage particularly when the assets include a property. However, care must be taken as TOGCs can be delicate, and an invalid TOGC can have adverse VAT and SDLT implications.  There may also be a transferred liability under a TOGC which needs to be carefully considered as to its future effect on the business’ VAT position.

  • In acquiring shares, other VAT risks arise, such as losing the recovery of VAT on costs where there has been insufficient forethought at the outset.

Structuring the acquisition

The tax structuring of an acquisition is an important step in the process of acquiring a business, ensuring that the shares or trade and assets of the target company are acquired in the most tax efficient way. This may be more important for purchasers who operate within a group. A review of the available tax structures is often conducted at the due diligence stage and the following are some of the issues that will be considered, depending on the complexity of the transaction:

  • The ability to move profits within a  group to repay debts of other group entities or pay future dividends to shareholders,

  • Hiving up trades from acquired companies to streamline group structures,

  • Whether any clearance or advance assurance applications need to be submitted to HMRC prior to the transaction,

  • Whether new entities need to be incorporated to facilitate the acquisition,

  • Maximise use of losses and deductions within the acquired company or within a group of companies,

  • How the business could be used to incentivise key employees through the use of a share scheme for instance,

  • The future plans for the acquired trade and what exit plans the purchasers have in mind,

  • Minimising VAT implications when planning how to hold acquired assets.

Ideally, any thoughts on structuring should be considered well in advance of the acquisition particularly where clearances or advance assurances are being sought from HMRC, as this can take several months.

Funding considerations

There are some additional considerations around the funding of a newly acquired company that should be made when acquiring the shares of a distressed company. These considerations may be particularly relevant given the current economic situation.

One key issue is where debt is acquired from third party lenders that is owed by the target company. The acquisition at undervalue could result in a taxable deemed release in the target company of the difference between the acquisition value of the debt and the carrying value in the target company, resulting in a taxable credit. There are exemptions that may apply to negate the deemed release, such as the corporate rescue exemption, however there is a short deadline to ensure the conditions for the exemption are met.

Again, VAT considerations should not be overlooked. For example, the VAT advantages of a TOGC can only be invoked if the assets of a distressed business form a going concern.

Due Diligence

The due diligence process is an investigation into the legal, commercial, financial and tax history of the target company to establish a clear understanding of the business and to avoid any unforeseen issues or liabilities from arising. From a tax perspective, the key reasons for undergoing a due diligence review is to determine:

  • Whether the company’s employment tax, VAT and corporation tax, compliance are up to date with HMRC. Also, whether there are any open enquiries, and their status;

  • Whether there are any errors, or more significantly omissions, in the company’s compliance returns, particularly employment tax and VAT omissions. If so, the potential exposure to future tax liabilities, interest and penalties;

  • Whether the corporation tax and deferred tax figures in the financial statements are accurate and, if not, the impact of any discrepancies; and

  • What risk there is of a hidden VAT liability such as over-claimed input tax, incorrect VAT liability applied to sales or an intended change of use (e.g. property under the Capital Goods Scheme).

Once potential risks have been identified, the purchaser may consider whether or not to proceed with the purchase depending on the severity of the issues raised. Alternatively the proposed price for the company or business may be renegotiated, or additional warranties and indemnities incorporated into the sale and purchase agreement to account for the risks identified. The risks can also influence whether to purchase the shares in a company or simply the assets (see above). 

VAT

VAT implications require careful consideration when acquiring a business, including the level of VAT risk acquired with the business and how this should be handled during negotiations.  Attention should also be paid to the VAT risk inherent in the different ways the purchase might be structured and what steps can be taken to mitigate such risks.

For example, recent cases have seen acquirers incur large professional fees in performing due diligence and structuring advice, only to find they cannot recover the VAT paid on these fees. 

Steps taken at an early stage to manage VAT risk can result in significant savings.

Summary

The above considerations are a few of many that a prudent purchaser and their advisers should factor in before proceeding with an acquisition. As a reminder of some of the key issues to consider:

  • Have all risks or liabilities within the target company been identified?

  • Should the trade and asset or shares of the target company be acquired?

  • Does the target company have any losses carried forward and how could these be used effectively?

  • Will any debts owed by the target company be acquired from the lenders?

  • Where should the target company sit within the existing group?

  • What are the VAT implications of the acquisition?

Purchasing a business will be a major transaction for many clients and they will want comfort that all aspects of the sale are covered to avoid unexpected tax and VAT liabilities, particularly in more complex and larger transactions. The team at Markel Tax have many years of experience advising on the sale and purchase of businesses so feel free to contact us.

For further information or assistance with the tax considerations of purchasing or selling a business please contact Markel Tax on 0845 490 0509 and ask to speak with Martin Mann or Mark Baycroft, or for VAT support please ask for Kevin Hall.

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Tagged Tax for entrepreneurs and corporates Value added tax (VAT) services Tax for entrepreneurs and corporates Value added tax (VAT) services Tax for entrepreneurs and corporates Value Added Tax (VAT) services COVID-19
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