Key points
- Balancing buyers’ and sellers’ priorities is crucial in Merger and Acquisition (M&A) transactions, with tax considerations often becoming a key focus.
- Buyers may consider acquiring business assets directly to avoid latent liabilities, but this can lead to administrative burdens and unintended tax consequences.
- Due diligence is essential to uncover potential issues, as relying solely on Share Purchase Agreement (SPA) protections can be risky.
Negotiating a transaction is always difficult, especially given the competing priorities of buyers and sellers. While the focus of many transactions begins with commercial and other considerations, tax inevitably becomes a key focus of most deals.
Simply put, vendors are motivated by achieving the best after-tax cash position and buyers want to inherit the least amount of risk possible while maintaining an efficient acquisition structure.
A vendor owning their interests in a company as an individual or through a trust structure will typically seek to dispose of their shares in a company to avail themselves of the general 50% Capital Gains Tax (CGT) discount and reduce their tax burden in addition to any other concessions (such as the small business CGT concessions).
On the other side of the table, a buyer might prefer to acquire business assets directly to reduce the risk of inheriting any latent liabilities that sit within the company being acquired.
That decision can come with an increased administrative burden, with the new owner needing to re-execute customer, supplier and other contracts under the acquiring entity’s name and Australian Business Number (ABN). The acquisition of assets could also trigger unintended tax consequences such as a duty impost, or Goods & Services Tax (GST) implications that may not arise from a share sale.
Because of this, buyers frequently settle for a share acquisition rather than an asset acquisition and rely on due diligence and various protections in the SPA to mitigate the risk they may be taking on buying shares versus assets.
But before they lock in that choice, there are a range of tax issues to consider first.
What tax due diligence should be undertaken?
A common misconception among buyers is that where they are acquiring shares, they can wholly rely on SPA protections in favour of performing adequate due diligence. In some instances, I have seen buyers suggest they wouldn’t need any tax due diligence — which is always risky.
While SPA protections provide some comfort, they are subject to qualifications and limitations that protect the vendor from certain liabilities arising from a claim. As an example, claims will generally be limited to the purchase price and may be qualified against disclosures made in the due diligence process.
A goal of due diligence is to uncover any skeletons in the closet and deal with these before or through transaction completion mechanisms and/or renegotiate pricing as a result.
This can require the vendor to amend historical returns to correct any inaccurate lodgements during due diligence phase (or deal with these post-completion with adequate adjustment provisions in the Completion Accounts), and is safer than relying on SPA protection and making a future claim against the vendor.
This is especially the case where the vendor key person may still be working in the business through an earnout period for instance as this could significantly impact the relationship and hence future earnings and value.
A typical due diligence scope would at a minimum include:
- Income tax
- GST
- Employment taxes (including PAYG withholding, superannuation guarantee, payroll tax and fringe benefits tax)
- COVID-19 benefits (such as JobKeeper and Cash Flow Boost, although this has become less relevant as time passes and the ATO’s lack of resources applied towards this); and
- Duty (generally depending on whether landholdings or significant leaseholds exist within the target).
The level of due diligence can differ based on the age and historical affairs of the target, such as whether it operates in a risky industry, has employees and/or whether it has made its own acquisitions or divestments, or whether the target was subject to a pre-deal restructure.
It can also be impacted from an income tax perspective by whether you are buying shares in a single entity, an entire consolidated group, or shares in a subsidiary of a consolidated group.
Where it is the latter, the existence of a valid Tax Sharing and Tax Funding Agreement (TSFA) is hugely relevant as in the absence of this, an entity is jointly and severally liable for the historic income tax liabilities of the entire group. A valid TSFA combined with the Target achieving a ‘clear exit’ can mitigate such joint and several liability and reduce the level of due diligence on income tax affairs.
Warranty and indemnity insurance has become increasingly popular in recent years, but is also no substitute for due diligence. Insurers will not provide coverage on matters where the buyer cannot show that adequate due diligence has been performed (they will even have their own advisors conduct top-up diligence to confirm sound due diligence has been performed by the buyer’s advisors). They will not provide coverage on known issues and tend not to provide coverage on high-risk areas such as transfer pricing and anti-avoidance.
How does the acquisition structure impact tax?
The cost base of shares acquired in a company will generally be the purchase price (including adjustments), plus the value of any incidental costs incurred in making the acquisition.
This will be the case regardless of the acquisition structure.
Care needs to be taken in respect of purchase price adjustments and the impact this has on capital proceeds for the vendor, as if they are not defined appropriately, an adjustment could impact cash received but not capital proceeds.
While this is predominately a vendor issue, it can impact tax attributes (such as cost base) for the purchaser and may impact any ‘push down’ for tax consolidation purposes.
These considerations become even more complex where an earnout component is involved.
Depending on the terms of the earn-out, it will impact whether it satisfies ‘look-through’ treatment and whether any earn-out payments made are included in the capital proceeds / cost base of the shares, or only the market value of the earn-out right itself will be included in capital proceeds / cost base upfront (regardless of what earn-out payments end up being made).
Based on recent ATO guidance, including employee retention, clauses in earn-out conditions can muddy the waters in respect of whether an earn-out will satisfy look-through treatment.
What is the impact of tax consolidation on vendors and buyers?
A common acquisition structure will be one where a tax consolidated group acquires a Target or another consolidated group, or a consolidated group is formed post-acquisition by a corporate entity.
Tax consolidation is broadly available where an Australian company (which is not a wholly-owned subsidiary of another Australian company) acquires 100% of another Australian company or a trust whose units are wholly-owned by consolidated group members. In limited circumstances it can also include a discretionary where the beneficiaries are limited to the head entity or other consolidated group members (although less common).
A vendor may be interested in the acquisition structure of the buyer, as there are various concessions afforded to vendor groups when a consolidated group acquires another consolidated group. This therefore may form part of the negotiations and conditions precedent.
Consolidation provides administrative benefits, with the group only needing to prepare one consolidated income tax return, and allows for inter-group dealings to be ignored for income tax purposes (noting other taxes such as GST and Duty will continue to be relevant for consideration on inter-group dealings).
Tax consolidation is an income tax concept only, but grouping for GST purposes can be chosen if eligibility is satisfied. It could be required for payroll tax purposes if you satisfy the grouping definition.
More importantly though, in an arm’s length transaction at market value, the tax cost setting process (known as the Allocable Cost Amount (ACA) process) provides the potential for an uplift in the tax cost base of the assets of the target entity/group depending on the make-up of assets of the target.
This can be especially beneficial in a capital-intensive business with significant inventory and depreciable assets as it can provide immediate benefits (although this is limited in cases where accelerated depreciation measures have been accessed previously).
If the transaction involves a related party or related shareholders, however, careful consideration needs to be taken. The ACA process can produce inadvertent adverse income tax implications due to limitations in the cost base under the scrip-for-scrip rollover rules for example.
This can result in upfront capital gains where there is insufficient ACA to ‘push down’ into cash and cash equivalent assets, or a significant decline in the tax cost base of depreciable and CGT assets on a go-forward basis.
As such, indicative ACA calculations are always strongly recommended in cases where tax consolidation is contemplated.
What are the implications of offshore financing or debt funding on tax?
A common acquisition structure for foreign controlled entities is to establish an Australian entity (or consolidated group) which is funded by offshore debt and obtain debt deductions in Australia. These are generally valuable due to Australia’s comparatively higher tax rate.
The extent of debt deductions has always been limited by integrity measures such as the thin capitalisation rules (which have changed for income years beginning on or after 1 July 2023) and transfer pricing, but have become increasingly more challenging as a result of new integrity measures such as the Debt Deduction Creation Rules (DDCR).
Although the DDCR rules aren’t specifically targeted at third-party arm’s length transactions, they must be considered in respect of any debt structuring giving rise to Australian debt deductions going forward.
Where internal restructures are being considered, the DDCR rules need to be front of mind.
What GST considerations should be kept in mind?
Another issue to consider is that of GST.
Where a transaction is undertaken by way of a share transfer, the supply of shares to the acquirer will be an input-taxed supply.
This means that the purchaser might be restricted in its entitlement to claim the input tax credits on any costs associated with the acquisition. There might be an entitlement to claim a reduced input tax credit (RITC) for certain costs.
Claims may not be restricted where the entity does not breach the financial acquisitions threshold, which requires a separate complex analysis.
The entitlement to any input tax credits can be material especially on larger transactions and to the extent they are not able to be claimed, they represent a sunk cost — which is a real cash leakage.
Importantly, where they are not claimable, the non-claimable portion can generally be added to the cost base of the shares acquired.
Under an asset sale, GST will generally need to be charged unless it is a supply of a ‘GST-free going concern’.
To be a ‘going concern’, the following general conditions must be satisfied:
- The sale is for consideration.
- The purchaser is registered or required to be registered for GST.
- The purchaser and seller have agreed in writing that the sale is of a going concern.
- Under the arrangement between the parties, the seller carries on the enterprise until the date of sale
- Under the arrangement, the seller supplies the buyer with all the things necessary for the enterprise’s continued operation.
Although on the face of it all the above conditions may seem to be easily satisfied, issues can arise around the satisfaction of point 5.
This is generally a risk for the vendor, but the risk to either party in respect of the Commissioner later deeming the transaction not to be the disposal of a ‘going concern’ can be somewhat mitigated by an appropriate gross-up clause in the Business Sale Agreement. Placing reliance on indemnities comes with risk though.
Is duty still an issue?
Duty on the acquisition of shares in a company/unit trust has generally been abolished throughout Australian states and territories. However, landholder duty can still arise for purchasers in situations where a person acquires a significant interest in an entity which is a landholder.
The meaning of ’significant interest’ differs by state, but in NSW it includes an interest of 50% or greater in a private company context, 20% or more of a private unit trust scheme, or 90% or more of a public entity. The interests acquired are aggregated with interests already held by that acquirer and their associates.
The definition of ‘landholder’ and threshold again differs by state and in NSW, a ‘landholder’ is an entity with interests in land with a value of $2 million or more.
Landholder duty rates generally range from 4.5% – 6.5%, depending on the state the land is situated (in NSW it is 5.5%). The rate may be significantly higher if the purchaser is a foreign person and the acquisition involves an acquisition of a landholder with an interest in residential land.
In calculating ‘Landholdings’, it isn’t simply the land itself that is included, but also anything fixed to the land.
Once the relevant threshold is breached and the acquirer is subject to landholder duty, it can be payable on the value of the landholdings plus goods and chattels of the landholder, depending on the state (subject to certain exceptions).
When determining whether any entity owns land and its value, it isn’t only the direct legal ownership of any interest in land that needs to be included but also its indirect landholdings.
This could arise if an entity (whether it owns land or not) has an interest such as a shareholding in another company which the latter company itself owns land.
The rules are slightly different for direct asset acquisitions.
Most states, apart from Queensland and Western Australia, have also abolished duty on the transfer of business assets (excluding land) which aren’t transferred in conjunction with other dutiable property such as land or interests in land.
This means buyers must be careful about where the business they plan to acquire operates, as in either of those states it could give rise to unintended duty implications.
Given the complexity of the rules in each state it is generally safer to obtain duty sign off before entering into the transaction to ensure no inadvertent liability is triggered.
How can Pitcher Partners help?
Pitcher Partners provides buy-side and sell-side M&A tax support to private companies, listed companies and multinational groups. We provide buy-side due diligence, tax structuring and overall transaction support as well as sell-side readiness such as vendor due diligence and pre-sale restructuring.
Our corporate finance team also provides sell-side advisory, financial due diligence and valuation services.
Should you wish to discuss the above article or a specific transaction in further detail, please contact Paul Marino on +61 410 637 862.
