Tax in M&A

Tax considerations play a pivotal role in mergers and acquisitions (M&A), influencing the structure, valuation, and ultimate success of the transaction. Proper tax planning and analysis can help avoid unexpected liabilities, optimize tax benefits, and ensure regulatory compliance. This article explores the key legal issues related to tax considerations in M&A transactions.

The structure of an M&A transaction can significantly impact the tax outcomes for both the buyer and the seller. Common transaction structures include:

• Asset Purchase: The buyer purchases specific assets and liabilities of the target company. This structure often allows for a step-up in the tax basis of the acquired assets, resulting in higher depreciation deductions. However, it may lead to double taxation at both the corporate and shareholder levels.
• Stock Purchase: The buyer acquires the stock of the target company, assuming its assets and liabilities. This structure generally avoids immediate tax consequences for the seller but does not provide a step-up in the basis of the target’s assets.
• Merger: The target company is absorbed into the acquiring company or a new entity. Mergers can be structured as tax-free reorganizations if certain requirements under the Internal Revenue Code (IRC) are met.

Conducting thorough tax due diligence is crucial to identify potential tax liabilities and ensure compliance. Key areas include:

• Historical Tax Compliance: Reviewing past tax returns, audits, and correspondence with tax authorities to identify any unresolved issues or potential liabilities.
• Tax Attributes: Assessing the target company’s net operating losses (NOLs), tax credits, and other tax attributes that could impact future tax liabilities.
• Sales and Use Tax: Ensuring compliance with sales and use tax obligations, especially in asset purchases where the transfer of tangible personal property may trigger these taxes.

Under IRC Section 338, a buyer can elect to treat a stock purchase as an asset purchase for tax purposes. This election allows the buyer to step-up the basis of the target company’s assets, resulting in higher depreciation deductions. There are two types of Section 338 elections:

• Section 338(g): The buyer makes the election without the seller’s consent, resulting in potential tax liabilities for the target company.
• Section 338(h)(10): The buyer and seller jointly make the election, typically in an S corporation or affiliated group context, allowing for favorable tax treatment.

Certain M&A transactions can qualify as tax-free reorganizations under IRC Section 368. To qualify, the transaction must meet specific requirements related to continuity of interest, continuity of business enterprise, and the use of stock as consideration. Types of tax-free reorganizations include:

• Type A Reorganization: Statutory mergers and consolidations.
• Type B Reorganization: Stock-for-stock exchanges.
• Type C Reorganization: Asset acquisitions primarily for voting stock.

These structures allow deferral of gain recognition for the shareholders of the target company.

Cross-border M&A transactions introduce additional complexities related to international tax laws. Key considerations include:

• Transfer Pricing: Ensuring that intercompany transactions are priced according to arm’s length principles to avoid tax adjustments and penalties.
• Foreign Tax Credits: Assessing the availability and utilization of foreign tax credits to mitigate double taxation.
• Withholding Taxes: Understanding the withholding tax obligations on payments such as dividends, interest, and royalties to foreign entities.

Tax considerations are integral to the success of M&A transactions, influencing their structure, valuation, and overall outcome. Proper tax planning and due diligence are essential to identify potential liabilities, optimize tax benefits, and ensure compliance with tax laws. Engaging experienced tax advisors and legal counsel is critical to navigate the complexities of tax issues in M&A.

1. Harvard Law School. (n.d.). Corporate Taxation in M&A
2. Internal Revenue Service. (n.d.). Tax Aspects of Mergers and Acquisitions
3. American Bar Association. (n.d.). Model Asset Purchase Agreement
4. University of Chicago Law School. (n.d.). Tax Due Diligence in M&A
5. Cornell Law School. (n.d.). Internal Revenue Code Section 338
6. Georgetown Law. (n.d.). Tax Planning for M&A
7. Stanford Law School. (n.d.). Tax-Free Reorganizations
8. Internal Revenue Service. (n.d.). IRC Section 368
9. World Bank Group. (n.d.). International Taxation in M&A
10. Harvard Law School. (n.d.). Cross-Border M&A Tax Issues

Disclosure

This is not legal advice and are my solely held, and individual opinions. If you want to speak with me regarding the content or are in search of a lawyer please reach out here.