Tax issues are major aspects of complex investment transactions involving the acquisition of an active business to expand one's own business, portfolio investments intended to grow shareholder value, granting/raising project finance or creating a joint business with partners who have unique technologies or specific competencies working on a certain market.
Tax Due Diligence
The objective of tax due diligence is to provide the potential buyer with detailed information about the Target’s current tax position, including:
Overview of the status of payments for taxes and levies, the status of the relationship with tax authorities and ongoing court disputes over tax matters
Assessment of existing historical tax risks that are not adequately reflected in the Target’s financial statements
Qualitative and quantitative assessment of the Target's tax assets, both those the seller declares in the transaction, and assets not declared by the seller
The main focus of our work when assessing the status of payments for taxes and levies is to identify the amount of overdue recognized tax liabilities for the Target for which the tax authorities will seek enforced recovery of arrears, including by initiating bankruptcy proceedings. For the status of the ongoing relationship with the tax authorities, tax due diligence procedures are aimed at qualitative assessment of tax liabilities that are the subject of ongoing disputes with tax authorities, and clarifying whether they are fully reflected in the financial statements presented for review to the potential buyer.
The key task of tax due diligence is to identify and also quantitatively and qualitatively assess the tax risks inherent to a Target. The crystallization of tax risks occurring as a consequence of either the Target directly violating provisions of applicable law or the approaches used by the Target to calculate tax liabilities failing to comply with the current practice of the tax authorities and courts may make it necessary for the buyer to pay them after the transaction. The results of tax due diligence to assess the Target’s tax risks will enable the buyer to support its negotiating stance to reduce the transaction price commensurately, or get an adequate form of contractual protection from the seller indemnifying losses if those risks materialize.
Tax assets (for example, tax overpayments, the amounts of tax losses available for carry forward, , or VAT amounts to be reimbursed from the state), on the contrary, are generally declared by the seller itself as a basis to increase the transaction price. The basis for such a price increase is that utilization of a declared tax asset by the Target after the transaction creates additional economic benefits for the buyer. Consequently, the purpose of tax due diligence is to verify the seller’s representations made with regard to existing Target’s tax assets and to determine whether the Target actually does have those tax assets and the likelihood of them being utilized in the declared amount and within the declared time period. Often it is found in a due diligence that the declared asset has serious defects (for example, a considerable portion of accumulated tax losses potentially available for carry forward consists of expenses which deduction is doubtful by some reasons), which means the transaction price increase by the tax asset amount requested by the seller should be adjusted accordingly.
Thus, the results of the tax due diligence of the Target are important tools in assessing the Target’s value and subsequently negotiating the price and seller’s warranties for the transaction.
Transaction structuring services
Each transaction and Target is unique and needs its own step-by-step plan to carry out. This plan needs to take both the seller’s and the buyer’s interests into account. The tax aspects of transaction structuring touch on both minimizing tax costs in the transaction itself and creating a tax-efficient asset holding structure, post-closing financing and operating structures.
At the same time, the Target, which is understood to be some type of business and provides an opportunity to evaluate its efficiency in the financial sense, may be represented on the legal level as a number of legal entities and/or actual assets which it is not in the interests of the buyer/seller to wholly acquire or alienate. For this reason, a proper carve-out of assets that are the subject of the transaction with the lowest associated tax costs takes on particular importance. Similarly, a transaction structure agreed upon by the parties may not meet the buyer’s long-range objectives taking into account its existing assets and the possibilities of achieving the anticipated synergistic effect, so further steps may be needed to integrate the acquired asset into the existing structure.
The scope of work for transaction/post-transaction structuring usually includes:
Comparable analysis of various alternatives of acquiring the Target, including with the use of leveraging, taking into account the current ownership structure and providing recommendations on the most tax efficient option within the given set of limitations
Comparable analysis of various alternatives of integrating the Target’s business into the buyer’s current operating structure and providing recommendations on the most tax efficient option
The following are taken into consideration when choosing the most tax efficient option: the specifics of taxation in different jurisdictions that may be considered for set up of an acquisition vehicle of the Target/ its certain specific assets on the buyer’s side; the tax implications for the transaction in all jurisdictions involved; the level of tax burden of dividend flows to a defined target level; the tax burden associated with financing the transaction and the functioning of the future operating structure; other tax implications that could substantially influence the choice of structuring option identified during the course of our assignment.
As the practice of successful M&A transactions shows, the complexity and ambiguity of how tax laws are interpreted, and the rapid development of tax regulation at the supranational level objectively require that not only lawyers specializing in civil-law relationships (including M&A transactions), but also tax practitioners should also be involved in the process of negotiating the provisions of the sale and purchase agreement for the Target. As they possess highly specialized knowledge, tax practitioners provide all-around assistance in ensuring the buyer’s or seller's interests having to do with tax matters receive proper contractual protections in the sale and purchase agreement (“SPA”).
Such involvement is not limited to some general review of standard tax terms and definitions of the SPA, but rather is intended primarily to assess the effectiveness and adequacy of contractual protection tools used in the SPA from the perspective of proper covering tax risks identified during the tax due diligence of a specific Target: tax warranties as well as general and specific tax indemnities. Tax lawyers can propose alternative methods of protection if the tax warranties and tax indemnities do not meet the interests of one or another party and cannot be expanded. And, of course, it is precisely tax lawyers (preferably ones who are directly involved in the tax due diligence process) who can evaluate the extent to which the information disclosed by the seller (the disclosures) to limit the effect of contractual protections in the SPA was actually and fully provided to the buyer.
Financial model tax assumption review
According to best business practices, before making a management decision about whether to complete a transaction, the financial model of the Target's business must be developed and the Target's key financial performance indicators for the forecast period must be evaluated depending on certain given scenarios. This is a way of verifying the market price for the Target offered by the seller and to subsequently reach final agreement on it during negotiations and after comprehensive due diligence of the Target. Tax burden has a direct and immediate effect on the Target's key financial performance indicators. For this reason it is particularly important to use correct tax assumptions in the financial model.
What time lag should be used to evaluate how long it will take to get VAT refunds from the budget based on the projected amount and schedule of investment in that specific Target? Does the financial model take into account, and to what extent, the possibility of applying depreciation premium for profits tax purposes depending on the composition of investments? Is it possible to fully deduct interest for leveraged finance based on its planned structure? Is it appropriate to use the Target's historically effective profit tax rate when projecting net cash flow? Does the model take into account future changes in tax law?