Executive Summary:

In cross-border acquisitions, more than one country’s tax rules will apply.  English law is frequently chosen to govern such transactions.  This article highlights a number of the main tax issues arising in cross-border share and asset purchases, and discusses how some of these issues can be eliminated or mitigated through efficient structuring or specifically addressed in the sale and purchase agreement.

Main Article:

INTRODUCTION

A cross-border private acquisition is an acquisition of one or more private businesses comprising companies and/ or assets, where the purchaser, the seller and the target companies/assets are not all in the same jurisdiction. The cross-border element of these transactions inevitably means that more than one country’s tax rules will be in play in the same transaction. English law is frequently chosen to govern these transactions and it is usually commercially desirable to have one set of contractual provisions applying across the board.

In this article, we highlight a number of the main issues that do not arise on solely UK acquisitions. Some of these can be eliminated or mitigated through efficient structuring and some may need to be dealt with specifically in the sale and purchase agreement.

ISSUES COMMON TO SHARE AND ASSET PURCHASES

Withholdings required from the purchase price
If a withholding for or on account of tax is required from the purchase price, it would go directly to value by affecting the amount receivable by the seller or, if a gross up is included in the agreement, payable by the purchaser.

Who should bear the cost or risk of a withholding? Where it is clear that a withholding is required, the question is made easier as the cost is known, so it can easily be factored into price.

The more difficult question is who should bear the risk where it is not certain that a withholding is required as it is harder to factor that risk into price. On one hand, withholding is a requirement on the purchaser and the purchaser will at the time of payment need to decide whether to withhold. And, if there is no gross up, there is not much commercial pressure on a purchaser to be robust in taking a view that a withholding is not required. On the other hand, in most circumstances withholdings relate to the location of the assets being sold and the tax position of the seller.

Should the parties seek confirmation from the appropriate tax authorities that no withholding is required or would that raise an unnecessary red flag? If the seller takes the risk, should there be conduct rights and/or an indemnity against the purchaser’s costs of being pursued by a tax authority after completion in respect of a withholding that the tax authority asserts should have been, but was not, made?

Allocation of consideration
In a cross-border transaction, more than one tax authority is likely to have a vested interest in how the purchase price is allocated between the target assets and/or shares. Not only might such authority disagree with the parties’ allocation, it might also disagree with the opinion of other tax authorities. This makes the issue of allocation more complicated than on a purely UK transaction and so the parties will need to ensure that they have robust defensible positions so that they obtain the tax value they expect from the transaction.

Indemnity and warranty payments
In a UK transaction, ESC D33 provides comfort that where payment is made by a seller of an asset to a purchaser under a warranty or indemnity included under the terms of sale, the consideration for the sale will be adjusted and that payment will not be treated as a capital sum derived from the asset. Most jurisdictions take an equivalent approach, but not all may.

Other jurisdictions may take different approaches on related matters. On a recent Brazilian transaction the target company would have obtained tax relief for the settlement of certain tax liabilities covered by the tax covenant (whilst this may be the case in the UK for employer’s NICs, it is not generally so) and the purchaser was expecting tax depreciation in respect of a significant part of the purchase price. As payments under the tax covenant would have constituted reductions in consideration, the purchaser would have suffered a significant loss of tax depreciation on those payments being made. Here, the combination of a payment under the tax covenant (which would ordinarily have been calculated taking into account the tax relief available on settlement of the tax liability) and a gross up for tax on receipt would not, due to the reduced tax depreciation, have put the purchaser back in the position it would have been in had the relevant tax liability not arisen. That would have been unacceptable from the purchaser’s perspective. The parties could have used a gross up that, as well as covering tax on receipt, covered the loss of tax depreciation. In the circumstances, however, the parties decided it was preferable for both sides to ignore the tax relief available on settlement of the tax liability in calculating the amount due under the tax covenant, the benefit of which would roughly equate to the lost tax depreciation, and to use a gross up for tax on receipt only.

Stamp duty
Any stamp duties or other transfer taxes arising on the transaction should be identified at an early stage. It might be that on a global purchase some of those could be mitigated by, for example, having a local transfer agreement for a particular jurisdiction.

Could anything done by the seller affect the transfer taxes payable? In Italy there is currently a concern that a pre-sale business hive-out to another group company followed by a sale of the transferee to a third party might be recharacterised as a direct sale of the business to the third party, resulting in significant transfer taxes for which the parties involved could be jointly liable.

Transitional services
Transitional services may be required by the purchaser. In a cross-border deal, care should be taken to ensure that there is no unnecessary tax leakage in providing or paying for those services, particularly due to withholding tax on cross-border payments and different VAT requirements in the relevant jurisdictions.

ISSUES ON SHARE PURCHASES

Consolidation
On acquiring companies, a purchaser may request a tax covenant to protect it against unexpected tax liabilities of those target companies. A UK-style tax covenant can generally be tweaked to cover non-UK jurisdictions in which the target companies are liable for their own tax liabilities; however, special attention must be given to jurisdictions in which target companies are taxed on a consolidated group basis and part of the consolidated group is purchased.

As a matter of local law, are those target companies responsible for tax relating to their own actions or income, profits and gains? If not, subject to the next point, is a tax covenant actually required?

Are there any “re-charges” in respect of that tax for which the target companies could be liable and are those target companies in any way liable for the consolidated group’s tax? If so, a tax covenant would need to be tailored accordingly.

Do exit charges arise on leaving the consolidated group? Who benefits from pre-completion reliefs and is there a requirement for payments to be made in respect of them? Care must be taken to ensure that local tax law does not cut across the intention behind the contractual tax protection.

Change of control
When companies are acquired, there is likely to be a change of control both at the level of acquisition and for subsidiaries below. This can lead to tax being triggered in the acquired group (such as, in some circumstances, German real estate tax) as well as deferred tax assets being put at (increased) risk. It might be possible to mitigate some of those effects through careful structuring.

Compliance
We note above that it is usually commercially desirable to have one set of contractual provisions applying across the board. That is true in relation to ongoing compliance matters, although there may be certain bespoke provisions needed in relation to particular jurisdictions. Further, if the seller is exiting a particular jurisdiction, it might make sense for the purchaser (or target company) to prepare pre-sale tax returns with the seller having a right of review, as opposed to the other way around.

ISSUES ON ASSET PURCHASES

In a UK share purchase it is common for a purchaser to seek protection in respect of certain of the target company’s tax liabilities, but, on an asset sale, protection is not generally sought for any tax relating to the business’s pre-completion profits. That is because, as a matter of English law, such tax liabilities do not transfer to a purchaser. That might not be the case in other jurisdictions and, in such cases, bespoke protection for succession taxes may be advisable.

Do the parties expect the asset transfer to constitute a transfer of a going concern and so be outside the scope of VAT? Whilst VAT law in all EC countries should derive from the same starting point (Articles 19 and 29 of the Principal VAT Directive (Directive 2006/112/EC)), each such country may require the fulfilment of different conditions in order for relief to be available — the sale contract would need to cover those conditions.

FINALLY

Whilst the above is by no means an exhaustive list of the issues on cross-border acquisitions, it gives a flavour of some that can arise. Each transaction tends to involve bespoke issues which will need to be addressed.