Structuring M&A transactions.
Optimism is said to be returning to the global mergers and acquisitions (M&A) markets, with deal volumes increasing and some economies reportedly returning to pre-crisis levels. The GCC region is seeing a significant level of activity in the power and utilities and infrastructure sectors which (while not strictly under the M&A heading) is seeing sizeable investment from large overseas groups.
Against this increase in market activity, though, tax authorities are continuing to focus on improving tax revenues and close the perceived "tax gap" (the gap between expected tax revenues and actual tax revenues), with cross- border structures and transactions being subject to increased scrutiny, through the tax assessment process.
In this two-part article, we look at the main tax issues affecting businesses, whether they are looking to expand through acquisitions or new investment, or which may be selling off surplus businesses. The first article will consider the issues affecting the structuring of transactions. The second article will consider some of the alternative holding structures that businesses may consider, and the issues to be aware of when undertaking transaction due diligence.
How are transactions being structured?
Many countries' tax systems provide specific tax reliefs or exemptions, to allow M&A transactions or group re-organisations to be carried out with minimal tax cost or, at the very least, to defer tax liabilities to some later date. The equivalent relief, under the Oman income tax law, only provides for exemption from gains arising on the disposal of shares in a joint stock company (and does not exempt gains on the disposal of a limited liability company).
Similarly, many tax regimes include "grouping" rules, under which assets can be transferred between companies in the same group without triggering a tax charge. As such, pre-sale re- structuring can be carried out, with a view to optimising the seller's position.
In the absence of specific exemptions or grouping rules, the structuring of transactions in Oman has to be based around the specific tax attributes of the target company, and of the shareholders, to determine which approach gives the optimal tax result for both parties.
What is the position of the seller? A buyer may acquire a business by purchasing the trade and assets of the business, or by acquiring the shares in the company through which the business is carried on.
A sale of the trade and assets would typically be taxable for the seller, given they would be holding the assets as a taxable company or some other taxable, trading entity. If the selling company had significant tax losses that would shelter any gains, a "taxable" sale of the trade and assets may be acceptable to the seller. Similarly, if the seller expected to realise a loss on the sale of assets, they may accept a trade and asset sale. On the other hand, if the seller was expecting to be taxable on the full gain, it would usually not be the preferred approach of the seller (from a purely tax point of view).
A sale of shares, on the other hand, may be exempt from tax if the shares are held by an individual (i.e. in a non-taxable capacity) or the shares are held in a joint stock company (for which the tax exemption is given).
How does this affect the buyer? The preference of the buyer may be driven (in part) by their tax position if they were to sell the shares in the future. An overseas buyer, for example, would not be taxable in Oman on any future share sale (provided they did not have any taxable presence in Oman) and they may benefit from capital gains exemption under the tax laws in their home country.
The buyer could also benefit from a tax exemption on dividend income received from the Omani company. This may be where the shares are held by an Omani company, where exemption is given under the income tax law for Omani dividends, or by an overseas company, where exemption may be given under a home country dividend exemption. There is no Omani withholding tax due on overseas dividend payments.
The buyer would acquire the company with existing tax liabilities, such as uncertain tax positions in unassessed tax years. The existing tax attributes would also transfer with the company, such as existing tax written down value of plant and machinery etc., carried forward tax losses etc.
The buyer would also acquire the company with existing debt levels.
It is not always easy to introduce additional debt into the company. A buyer may see this as a disadvantage if they would otherwise prefer to introduce additional debt, to optimise the performance of the business.
If, instead, the buyer were to acquire the trade and assets of the business, there would be greater flexibility to debt-fund the acquisition and optimise interest deductions in the buyer's tax calculation.
In addition, the buyer would claim tax depreciation on plant and machinery by reference to the asset purchase price, which one would generally expect to be higher than pre-existing tax written down value. Where a group of assets is acquired under a single sale agreement, the tax department would generally follow the allocation of sale proceeds set out in that agreement, provided they do not feel that the allocation is intended to achieve a tax advantage.
Of course, the buyer would acquire the trade and assets free of any historic tax liabilities or exposures of the selling company but without the benefit of tax losses that the company may have built up, and which would stay with the selling company.
Weighing up the advantages and disadvantages for both parties There is no clear choice, in any given transaction, as to the optimal structure for both the buyer and seller. Each will have to consider their tax position, and the tax position of the target business, and try to agree their optimal position with the other party. The final, negotiated structure will generally be a compromise between the wishes of each party and, ultimately, once the structure of the transaction has been agreed, the rest will come down to purchase price negotiations between the two parties. Negotiations will also take account of the results of any due diligence work carried out.
Deductibility of goodwill arising on trade and asset purchase
If the buyer recognises goodwill on the acquisition of the trade and assets (i.e. where the purchase price exceeds the fair value of the net assets acquired), a tax deduction can be claimed over the estimated productive life of the goodwill. The estimation of the productive life is subject to approval of the tax department.
Restrictions on related party finance charges
A trade and asset purchase typically gives the buyer greater flexibility to introduce debt into the business, as the purchase can be funded by debt. The tax deduction for interest on related party debt is restricted where the company's ratio of debt-to- equity is greater than 2-to-1 (i.e. two parts debt to one part equity). This analysis should take account of debt from all sources but the restriction will apply to interest on related party debt only; interest on, e.g. bank debt, would not be restricted.
The interest rate charged on related party debt should be comparable to rates that can be obtained from third party lenders. Where the interest rate and interest charge is considered excessive by the tax department, they may look to restrict the tax deduction to the amount that would have been charged by a third party.
The absence of specific M&A tax provi- sions in the Oman tax law means that it is less common to see a 'standard' approach to the structuring of trans- actions in Oman. Instead, buyers and sellers need to consider their individ- ual tax positions more carefully, to determine the structure that is optimal for them and which they feel they can successfully agree with the other party.
In Part Two of this article, we will consider some of the alternative holding structure that businesses may consider, to optimise their tax position. We will also consider the issues to be aware of when carrying out transaction due diligence.
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