The Role of Tax in Mergers & Acquisitions

While not usually a deal breaker, almost every business transaction has tax implications, whether it’s an acquisition, joint venture, restructuring, refinancing or disposition. Understanding and planning for these implications can mitigate transaction risk, enhance the business opportunity and provide crucial negotiation insights. Details that are minor from a business point of view, such as which legal entity survives in a merger, can have significant consequences from a tax standpoint. The particular structure of a transaction can mean that one party might achieve a significant tax benefit at the expense of the other party, or even worse, both parties could end up significantly worse off than if a different structure had been used.

In addition, whether on the buy-side or sell-side of a transaction, understanding the historical tax exposures of a target company is critical to understanding the value of that company and the representations, warranties and indemnifications necessary to close the deal. In order to optimize value to both parties in a transaction, the tax implications should be considered throughout the entire deal-making process, from pre-transaction structuring to due diligence through post-deal integration.

Pre-transaction Structuring

The tax structure of a transaction has a direct bearing on the purchase price and other essential economic variables of the deal. Without a clear understanding of the tax issues and consequences of different alternative structures, the parties cannot intelligently negotiate key terms of the deal.If the parties to a deal attempt tax planning after reaching an agreement on the structure, it is often too late to repair any damage. By considering tax implications in advance of a deal, issues and opportunities can be identified and effectively handled pre or post deal. Because there often is more than one way to structure a transaction to achieve business goals and objectives, tax advice early in the process can maximize economic value. If private equity is involved, it may also be useful to plan an exit strategy to reduce tax exposures post-divestiture.

Tax structuring advice should be sought to:

  • Determine the acquisition vehicle and type of acquisition
  • Determine the potential for a step-up in tax basis for the buyer
  • Determine non-income tax implications, including transfer taxes, sales and use, property taxes, employment taxes, and unclaimed property
  • Determine the tax treatment to the target and/or selling shareholders
  • Determine future tax planning opportunities and exit strategies that can minimize cash taxes and reduce the effective tax rate of the combined enterprise
  • Determine the availability of the target’s carryover tax attributes, such as tax credits and net operating losses, after the transaction is completed
  • Determine debt financing and exit strategies

Due diligence and the Purchase Agreement

After considering the structure of a transaction, buyer and seller should focus their attention on due diligence and the purchase agreement. Both parties need to understand the historic tax liabilities of the target in order to more effectively negotiate key terms in the purchase agreement, including acquisition price, escrow, representations, warranties and indemnities.

On the buy side, tax due diligence is needed to determine the true economic value of the target. Consideration should be given not only to unquantified tax liabilities of the target, but also to tax assets or planning opportunities of which the target and other competitive bidders may not be aware. Due diligence should include income taxes as well as indirect, property, and employment taxes and unclaimed property. This approach will allow the buyer to understand the target’s tax-related exposures, to identify valuable tax assets, and to negotiate key terms of the purchase agreement accordingly.

On the sell side, tax due diligence provides insights on matters relevant to the seller’s decision-making process. An effective tax due diligence review before going to market can increase a target’s selling price, reduce buy-side due diligence times and concerns, and increase credibility with buyer(s). Specifically, conducting sell-side tax due diligence allows time for the seller to remedy any previously undiscovered tax issues prior to a sale.

In addition, sell-side tax due diligence and modeling is often used by sellers to negotiate a higher purchase price in cases when the buyer wants to achieve a step-up in the basis of assets, or where the seller has substantial tax attributes, such as net operating losses, general business credits, or capital loss carryovers that may be usable by the combined enterprises after the transaction.

In conducting tax due diligence, tax advice should be sought to:

  • Assess the tax risks, opportunities and consequences to the parties involved
  • Determine strategic methods of reducing tax risks (e.g., escrows, holdbacks, indemnities)
  • Assess the post-transaction integration efforts needed to align the tax postures of the two parties
  • Review contract provisions to protect parties from tax risks and ensure retention of opportunities
  • Conduct financial modeling and determine the impact of taxes on the target and the parties

Post-transaction Implementation

Even after the tax issues have been resolved and the deal has been negotiated, taxes continue to matter. Post-deal implementation is necessary. The transaction needs to be implemented correctly to achieve and sustain the intended results. The transaction needs to be documented and reported to the taxing authorities properly to prevent costly post-closing surprises. In larger transactions, post-deal integration involves integrating companies and tax departments, including systems, people and processes. Post-deal tax advice should be sought to:

  • Determine post-closing adjustments and the opening balance sheet
  • Prepare tax filing documenting the transaction to achieve tax results – statements, disclosures, tax return filings
  • Identify and implement tax planning opportunities
  • Integrate tax department operations, including strategy, people, process, technology and internal controls

If you have any question about the role of tax in mergers and acquisitions, please contact the author of this article, Sara Neff.


About FGMK
FGMK is a leading professional services firm providing assurance, tax and advisory services to privately held businesses, global public companies, entrepreneurs, high-net-worth individuals and not-for-profit organizations. FGMK is among the largest accounting firms in Chicago and one of the top ranked accounting firms in the United States. For more than 40 years, FGMK has recommended strategies that give our clients a competitive edge. Our value proposition is to offer clients a hands-on operating model, with our most senior professionals actively involved in client service delivery.

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