Nicola Williams: The importance of early M&A tax advice

Nicola Williams

As someone who has worked in an M&A specialist law firm, I have great respect for the important role these lawyers play in advising clients involved in a transaction. It is, however, surprising that tax considerations are often overlooked in the initial stages of the deal process only to have tax advisors called in at the eleventh hour to fix a situation that has often developed into a deal breaker or a significant sticking point between clients.

To ensure a smooth, surprise-free M&A transaction, it’s best to get expert advice on tax matters at the earliest possible opportunity. Failure to do so can impact on the value of a sale and purchase or potentially put it at risk altogether.

Entrepreneurs’ Relief (ER) provides one case in point. Many individual sellers hope to benefit from ER so that the rate of their Capital Gains Tax (CGT) is halved from 20 to 10 per cent. Securing this relief without tax advice is however not always straightforward. One recent case we are aware of involved a selling shareholder who had been told by his lawyer he qualified for ER; following that he resigned as company secretary prior to an anticipated sale completing. The conditions for ER were no longer met and he was taxed at the full 20 per cent rate on the sale of his shares.

Sellers who have signed a letter of intent with a purchaser prior to seeking tax input could also see an impact on ER. In a case where we were brought in at the later stages, the price mechanism in the letter of intent had been set such that no cash in the company would be paid for by the purchaser; this meant the sellers were required to take dividends of the cash at a much higher tax rate of 38.1 per cent. Earn-out rights can also impact on the availability of ER and well-advised sellers might wish to negotiate a ‘reverse earn-out’ right to secure this relief on the full price.

The tax covenant, a price adjustment mechanism under which the buyer can claim from the seller any tax owed by the target company prior to its sale, is another important consideration. It is not advisable to drop a ‘usual form’ of tax covenant into a sale and purchase agreement (SPA) as it may not tie up with the price mechanism set out in the heads of terms or the SPA. From the buyer’s point of view, there must be clear notice provisions in it as to how to make a claim against the seller or else such a claim could be subject to a legal challenge and fail, leaving the buyer out of pocket. From the sellers’ point of view, as they are the ones on the hook for the tax, it is key to ensure there are rights given to them in the tax covenant to control, or have significant input into, the defence against any HMRC claims brought against the target company. Where this has not been done, the sellers can be forced to pay claims with no right to challenge HMRC on the issues - underlining the value of getting expert advice on the tax covenant.

Clarity and agreement on what is being provided for and excluded from completion accounts is also an important consideration that should follow focused tax advice when the SPA is being drafted.

The typical period for claims to be brought under a tax deed is seven years; this significantly exceeds other warranty and indemnity claim periods (commonly 18 or 24 months). This can be further extended to 20 years if a tax authority brings an assessment under certain provisions. This is a significant period for the SPA and tax deed to be open to scrutiny from clients and other advisors should any tax-related claims arise.

Many of the above pitfalls can be avoided through engagement with tax advisors at the heads of terms, or at least at the SPA and tax covenant drafting, stage. Corporate lawyers have a key role to play in ensuring that either they or their clients take expert tax advice early in the process and at the drafting stage. This will reduce the risk of unwanted surprises (both as the negotiations between the parties progress and later, if any claims are made under the tax covenant), as well as helping to secure a positive outcome for their client - a result which any M&A lawyer is always keen to achieve.

Nicola Williams, member of the Entrepreneurial Tax team at accountants Chiene + Tait

Tags: tax

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