Mergers & Acquisitions: Share Acquisition Transactions - Back to Basics
Column inches in the press and business publications can be devoted to the area of “M&A activity”, and many professional services organisations refer to their M&A service offering, but what does it all mean? Typically, the term “M&A” encompasses a range of potential transactions, and refers to the aspect of corporate strategy, corporate finance and management which deal with the buying, selling and combining of different companies. In the current economic climate, with both debt and equity markets in turmoil, global M&A activity has fallen off dramatically in 2008; although this uncertainty in the market does present the possibility for distressed sales and opportunistic deals over the short to medium term. Companies which are well capitalized or which have access to credit lines, even in the midst of the credit crunch, should be in a position to take advantage of lower deal values to be had, or the potential to take over weaker/struggling competitors.
Taking certain aspects of M&A back to basics, this article focuses on the some of the key Irish tax considerations which can arise where a seller and purchaser are entering into a transaction on the basis of a sale and purchase of shares. Part I focuses on the seller tax considerations, while Part II will focus on the purchaser tax considerations. From a back to basics viewpoint, we have focused on the Irish tax considerations only, but as a significant number of M&A transactions involve a foreign counterparty to the deal, in such circumstances it would be important to consider the foreign tax implications, taking into account the group structure and global tax strategy, particularly when structuring acquisition debt.
Bearing in mind that a business sale can be structured as a sale of shares (often referred to as a stock deal) or a sale of some or all of the underlying assets, it is worthwhile recapping on the key factors which influence how the deal might be structured. The factors which motivate the manner in which an M&A deal is structured can often differ as between the seller and the purchaser. Some of the key considerations for each are summarised at Exhibits 1 and 2.
|Seller Tax Considerations :|
A Seller will generally seek to structure the transaction as a sale of shares as: -
|Purchaser Tax Considerations|
A Purchaser may prefer an asset based deal as: -
What is the best deal structure for a seller and purchaser respectively will always come down to the facts of each case. While it may generally be the case that a seller prefers a share deal, there will be situations where a seller will desire an asset based purchase, for example, where a seller has a high tax deductible base cost in the assets to be sold, and in contrast has little or no base cost in the shares of the company. Equally, although it may be the case that a purchaser may generally prefer an asset based acquisition, a share purchase may in fact become more desirable when, for example, stamp duty implications are taken into account. Assuming the assets of the target business would attract stamp duty at rates up to 9% rate, then, a purchase of shares, which attracts stamp duty at the 1% rate, may become more attractive.
SELLER TAX IMPLICATIONS
Where a sale of shares is involved, the seller will be subject to Irish Capital Gains Tax (“CGT”) on the disposal of the shares. The rate of CGT is currently 20%. The CGT liability is computed as 20% of the taxable gain arising on the sale, being the difference between the proceeds of sale and the deductible cost (known as the tax basis) which the seller has in the shares. A seller is also entitled to deduct qualifying incidental costs of acquisition and disposal in computing the taxable gain. However, it may be possible to avail of certain reliefs or exemptions to minimise or avoid the charge to Irish CGT. These include CGT retirement relief where an individual seller is concerned, or the CGT Participation Exemption for a corporate vendor. These are discussed further below.
Before considering the more detailed seller tax considerations in more detail, it is worth briefly considering some general matters which are generally relevant to every share deal.
Due Diligence and Tax Warranties and Indemnities
In the context of any share sale, the importance of an effective tax due diligence process and the subsequent negotiation of the tax warranties and indemnities cannot be over-emphasised. Most share based M&A deals will involve varying degrees of review work around the tax profile of the target company and will include certain purchaser protections with regard to potential historic tax exposures in the share purchase documentation. While an in-depth analysis of these issues is outside the scope of this article, there are a few key trends which we have noticed in recent M&A deals from the seller viewpoint. Perhaps attributable to the current economic climate, and a more difficult M&A market place, there is an increasing trend for sellers to prepare and make available a Vendor Due Diligence report to potential purchasers, as well as a greater willingness on the part of sellers to provide greater protection to the purchaser in respect of any tax liabilities arising prior to or on completion (of the share sale). Certainly, going back say two years ago, sellers were often in a stronger negotiating position and negotiated aggressively with regard to what items were to covered under the tax warranties and tax deed of indemnity, particularly where any pre-sale reorganisation or carve out structuring was involved.
Pricing the deal
The purchase price for the target company will always be a commercial negotiation for the seller and purchaser. The target company will have what is known as, in M&A speak, an enterprise value, and the aim of the parties involved will be to take certain matters into account in arriving at a mutually agreeable equity value for the target company, representing the price which should be paid for the equity/share capital of the target. Tax forms part of this negotiation process in moving from the enterprise to the equity value. The purchaser may refuse to pay for the value of tax losses or other tax attributes in the company, may seek an adjustment to deferred tax provisions, may argue that there are potential tax liabilities or deferred tax liabilities which have not been provided for in the accounts and in valuing the company, all of which the purchaser will want taken into account as price adjusting items to lower the purchase price.
Structuring the Sale
Where the target business which is to be sold consists of the only business activity of the seller, and where it is neatly packaged in a company or companies which can be acquired by the purchaser, then there may be no requirement to “tidy-up” the sellers house prior to entering into the sales process. However, in other situations, the seller may be carrying on a range of business activities, and may be interested only in selling off part of its business and associated assets. In this circumstance, it may often be the case that the seller will need to re-organise itself somewhat prior to the sale, so that the target business is “packaged” within the target company or companies in a way which is both attractive from both the seller’s and the purchaser’s perspective. This is commonly referred to as “carving out” or “spinning off” part of the seller’s business/assets and housing it in specific companies which are to be sold to the purchaser. It is outside the scope of this article to focus on the key tax issues involved in such pre-sale restructurings, but there are a range of tax issues involved, including the following: -
- Planning to ensure that the business is restructured in the most tax efficient manner; this generally involves structuring the transactions so that Capital Gains Tax reconstruction reliefs can apply (Sections 615 and 584/587 relief), stamp duty reconstruction relief can apply (Section 80 relief), and that there are no irrecoverable VAT costs involved in the restructuring;
- Careful consideration and planning for potential de-grouping issues on a sale of the target company/companies is required, in particular the Capital Gains Tax de-grouping provisions of Sections 623 and the rather nasty, and often overlooked, Section 625.
- Ensuring that the requirements of Revenue’s Tax Briefing 48 are satisfied, in particular, ensuring that when the pre-sale restructuring occurs, that it can stand-alone as a separate independent transaction, undertaken for bona fide commercial reasons, and which is not dependent or conditional on a subsequent sale of the relevant shares to the purchaser.
- A range of legal, accounting and company law issues require consideration, in particular, the level of distributable reserves required where a transfer of a business in return for the issue of shares to the transferor’s shareholders is involved. This is an issue for which there is no uniformity among the legal firms in Ireland, but it is hoped that the impending Consolidated Companies Acts, may provide definitive clarity on the matter.
Planning to utilise capital losses
Also along the vein of structuring the sale, the seller should always consider whether it has capital losses available which may be able to shelter any taxable gain arising on the sale of the shares. In the case of an individual seller, it is a question of identifying whether he/she has unutilised capital losses available from prior periods, or capital losses which have been realised in the same taxable period in which the sale of the shares at a gain occurs, and ensuring that he/she offsets these losses against his/her taxable gain. In addition, in certain circumstances, it may be appropriate for the seller to crystallise any unrealised capital losses which he/she may realise on a sale of certain assets/investments.
Where the seller is a corporate seller and can qualify for the CGT Participation Exemption, then the issue of capital losses is clearly not an issue. However, if the CGT Participation Exemption is not available, and if there are capital losses available for use elsewhere in the group structure, then consideration should be given to structuring the sale such that these losses can be utilised (as the capital losses cannot be transferred). For example, in an Irish group context, one could transfer the target company’s shares to the company which has the capital losses. This can generally be achieved tax free by relying on CGT group relief (s.617 relief) and stamp duty associated companies relief (s.79 relief), and it does not prevent the subsequent sale of the target company. The result of this structuring is that the company which sells the target company’s shares at a gain, is the same company with the capital losses, and hence, can use the losses to shelter all or part of the gain. Obviously there can be a range of other tax issues to consider before proceeding on this basis, but where there are capital losses within the group, consideration as to how they may potentially be utilised should be addressed.
Seller tax residence
In terms of the territorial scope of Irish tax, an individual who is resident or ordinarily resident in Ireland for a year of assessment will be subject to Irish CGT on the disposal of his/her assets, irrespective of where such assets are located. Similarly an Irish resident company is subject to CGT on worldwide asstes. For non-residents and non-ordinary residents (including a non-resident company), a charge to Irish CGT can only arise in respect of certain specified assets, namely Irish land and buildings, certain mining/mineral rights, and shares which derive the greater part of their value from such assets. The remittance basis of taxation remains a planning possibility where an individual seller is non-Irish domiciled.
While this article is written in the context of an Irish tax resident seller, it is may be that the seller is planning to change tax residence (for example, if individuals are moving abroad) and consideration should be given to whether it is worthwhile making this move prior to effecting the sale. This is due to the fact that if the seller is non-Irish tax resident when the sale occurs, then it may not be subject to Irish CGT on the disposal.
From the corporate sellers perspective, this may not be advantageous, either due to the availability of the CGT Participation Exemption, or the fact that the shares being sold are CGT specified assets. In the former case, no CGT liability arises to the Irish tax resident corporate seller, as discussed further below, while in the latter case, the shares are specified assets and still within the charge to Irish CGT (unless the seller is resident in a country which affords full treaty protection and removes Ireland’s taxing rights on the sale).
Where an individual seller is concerned, being non-Irish resident when the sale occurs may result in the gain on disposal not being within the charge to Irish tax. There are a range of Irish and non-Irish tax considerations to consider here, and of key importance, will be the country where the individual has re-located. One will need to consider whether Ireland has a tax treaty with that country and what the provisions of that treaty provide for in the context of allocating taxing rights between the two countries in respect of capital gains. Careful consideration of the tax residency rules in that other country will also be required to determine whether the individual is resident there, where the individual is regarded as tax resident under the tax treaty, and what the tie-breaker provisions of the treaty are where the individual would be regarded as both resident in Ireland and the other country.
If the individual still remains within the charge to Irish tax (even though he/she is living abroad), then a sale could only be achieved on a tax free basis from an Irish viewpoint once the individual is both non-resident and non-ordinarily resident for Irish tax purposes (broadly meaning they have been non-Irish resident for over 3 complete tax years), and once the shares to be sold do not derive the greater part of their value from certain Irish specified assets.
However, there are certain anti- avoidance provisions (Section 29A TCA 1997) to consider which are designed to tax individuals who go temporarily non-resident for this specific purpose- i.e to avoid Irish CGT. This anti- avoidance provision imposes an exit charge where the individual becomes non-residnt on a temporary basis and disposes of relevant assets. The offending period for temporary non- residence is set at five years, so that if the individual leave Ireland and remains outside the State for at least six years of assessment, the provision does not apply.
This section operates by deeming the individual to have disposed of and reacquired his relevant asstes at market value on the last day of the last year of assessment in which he was tax-resident in Ireland. The relevant assets are share or rights to acquire shares, and thesection does not affect any other assets.
The charge only arises if there is an actual disposal during the temporary period of non-residence and where the individual in question does not remain non-resident foe long enough(at least six years at assessment) to avoid being caught under the s.29A charging provisions.
The disposal is calculated by reference to the market value of the shares at the date of the deemed disposal (i. e. 31 December of the year of departure) and is unaffected by any subsequent change in the value of the shares between that date and the date of the actual sale.
Finally, on the theme of tax residence and taxation rules, Irish residents (including corporates) need to remain cognisant of certain anti-avoidance provisions which can apply where gains are generated by a non-resident company which would be regarded as close if the company were tax resident in Ireland. These anti-avoidance provisions are discussed further below.
Share Buyback Transactions
It is important to remember that the ability to buyback or redeem shares in a company can be a useful planning technique where a shareholder wishes or is required to exit a company. For example, where the share deal in question is not an outright sale of the company to a third party, but rather, say a 25% shareholder has to exit, then a buyback of the shares held by the shareholders in the company may be an alternative solution. Where an individual shareholder is concerned, a share buyback transaction may not give rise to a favourable tax result (where unquoted shares are at issue), as the transaction is treated as a distribution to the extent of the difference between the share buyback proceeds received by the individual and the amount at which that share capital was originally issued by the company (which can be significantly different from the individual’s CGT base cost in the shares if the individual did not originally subscribe for the shares). The distribution amount is therefore subject to Dividend Withholding Tax and Irish income tax treatment. However, if the trade benefit test criteria can be satisfied, as outlined in the share buyback rules, then the transaction can be treated as being on CGT, and not income tax, account.
Where a share buyback transaction may also be useful, even where the trade benefit test cannot be satisfied, is where the shares are being bought back from a corporate shareholder. Provided the company in question is not a close company, the distribution received by the corporate shareholder will be treated as a tax exempt distribution for Irish tax purposes, and assuming that the CGT Participation Exemption can apply, a tax free “sale” (by reason of the buyback) has still been achieved.
From a commercial viewpoint, the buyback mechanism may achieve the same commercial results desired by the parties and the company concerned, result in lower transaction costs, and provided that the buyback is implemented correctly, there should be no stamp duty cost involved.
Other Practical Issues to Consider
CG50 Clearance certificate
This is often an area that is not dealt with until quite late in the deal process. It should of course be dealt with upfront in order to avoid any problems in the final stages of the deal completion, when time of the essence. In many cases, it will be clear to the seller and seller’s advisors, that the sale is not one which falls within the ambit of CGT withholding tax; however, the purchaser or its advisors may be of a view to the contrary, may require certain written opinions on the matter from the sellers auditors/accountants/tax advisors, or may insist on a CG50 clearance being provided in any event to ensure that they are fully protected (and have no withholding tax exposure under s.980). In addition, in view of the tight timelines involved in deal completion, it is worth noting that in the authors’ experience, Revenue practice in dealing with CG50 clearance applications is inconsistent. Some Revenue districts insist that signed contracts are provided with the application for CG50 clearance, whereas other districts will issue a clearance certificate based on a final draft contract. This inconsistency in approach can affect the timing and completion of the commercial transactions, and therefore, is better addressed earlier rather than later in the deal process.
The relevant section, Section 980 TCA 1997 provides that where the consideration (in money or money’s worth) exceeds €500,000 and the shares derive more than 50% of their value from specified assets (i.e. Irish land, minerals or exploration / exploitation rights within the Irish continental shelf), the purchaser is required to apply a 15% withholding tax to the consideration. The 15% withholding tax is due within 30 days of the consideration being paid. This 15% withholding tax can be avoided where the seller obtains a CG50 clearance certificate from the Revenue Commissioners and provides the purchaser with this certificate prior to the consideration being paid or delivered to the seller.
It can sometimes be difficult to determine, in the case of land owning companies, whether the company does derive more than 50% of its value from Irish land. In such cases, the purchaser is likely to require the seller to produce a CG50 clearance certificate, or else the purchaser will apply the 15% withholding tax. It should be noted that Revenue in determining whether a company derives more than 50% of its value from Irish land, treat all liabilities of the company as relating to non-specified assets, thereby increasing the value attributable to specified assets.
Where the target company being sold operates an employee share option scheme, long term incentive plans or other share incentive schemes, consideration needs to be given to how such schemes, and the individual participants in such schemes, are impacted by the sale. Careful review of the scheme documentation is required at the outset to determine what is provided for under the scheme rules. It may be that the rules provide for an accelerated vesting period and an ability for employees/management to exercise their share options, for example, in advance of a share sale/change of control situation. Early communication with the individuals involved is required, as well as addressing the timing of when their options will be exercised – it is important for the employees not to exercise too early, otherwise they will have a potential income tax liability due on the exercise of their share options, due within 30 days of exercise, and if for example, the share sale is delayed, or the deal is aborted, then they may not have the funds to pay the tax (as they have not realised a sale of their shares). There are three main scenarios which generally need to be considered, namely:
- Whether the employees exercise their options, and then sell their shares as part of the deal process;
- Whether there is a possibility of rolling over their options into options in the acquiring company;
- Whether a payment will be made to the employees such that they abandon their options and the options are cancelled;
There are different tax implications under each scenario outlined above, both from an individual employee and from the employer company’s perspective. A roll-over can generally be achieved on a tax free basis, although Revenue do place importance on the fact that the employees options must be rolled over into options in the acquiring company of equivalent value. Payments to abandon and cancel the options is generally the least attractive option, and there are full employer and employee taxes due in respect of the payment, including employers PRSI of 10.75%. Suffice to say that this is a particularly complex area, from a tax and employee relations viewpoint, and should be considered early in the day in the context of any transaction.
The whole area of pensions and termination payments can also arise in the context of share sale transactions, and as to what those issues are, will depend on the facts of each particular case.
Pre-disposal abnormal dividends
Another area to be aware of in the context of structuring a share deal, and to ensure that a seller does not unwittingly fall into the realms of this anti-avoidance legislation, relates to the area of pre-sale dividends. Finance Act 2008 introduced a new S.591A TCA 1997 which treats a dividend or distribution made by company in connection with a disposal of the company shares, as abnormal, where the value of the dividend exceeds the amount that could reasonably have been expected to be paid, if there were no disposal of the company shares. The result is that the abnormal dividend is treated as part of the consideration for CGT purposes and disregarded for all other purposes. The dividend is treated as being made in connection with the disposal of the company shares, where there exists any scheme, arrangement or understanding by virtue of which the dividend is paid. The aim is to prevent a corporate vendor converting a taxable capital gain into a tax-free dividend receipt. The section does not apply where the scheme, arrangement or understanding is undertaken for bona fide commercial reasons and does not form part of any scheme, arrangement or understanding of which the main purpose or one of the main purposes is the avoidance of liability to tax.
CGT: Reliefs, Exemptions & Other Rules
In the case of a cash sale (including consideration comprising debt), as mentioned the gain on disposal is liable to 20% CGT, unless a specific relief is available.
Where the consideration is contingent, in cash form and capped at a maximum figure (e.g. earn-outs or post completion working capital adjustments) Section 563 TCA 1997 provides that the valuation of such consideration for inclusion in the calculation of the chargeable gain is not to be discounted for the deferred or uncertain nature of the consideration. Where the contingency does not occur such that the consideration is never realised (or is lower than the amount originally brought into the charge to CGT), Section 563 TCA 1997 provides for the recalculation of the CGT payable with a refund of any taxes overpaid. However, Revenue is under no statutory obligation to pay interest on such tax refund.
Where the contingent consideration is not capped and is “wholly unascertainable” Irish Revenue follow the decision in the UK case of Marren v Ingles (1980) STC 500. In this case it was determined that the UK equivalent of Section 563 TCA 1997 did not apply and the value of the contingent consideration must be determined by a qualified independent valuer at the time of disposal. Further a separate asset, being a chose in action, will be deemed to exist having a base cost equal to the value determined for the earn-out at the time of the share disposal. Each subsequent receipt under the earn-out will be treated as a part disposal of this chose in action. Therefore, if the actual earn out proceeds turn out to be lower than amount originally taken into account for CGT purposes, a capital loss will be realised.
From a seller’s viewpoint, an earn-out can present practical and cashflow difficulties, particularly where they have to pay the CGT upfront based on an earn-out which they may potentially never realise (if there are for example, performance criteria to be satisfied in the company and these are not met), or which they may realise to a lower extent (compared to the value on which the CGT was paid). There is the possibility of achieving a tax deferral where the earn out takes the form of shares in the purchaser company, and where there is no possibility of taking the earn out in cash form. The reader is referred to the published Revenue precedent in this regard to Section 586.
Another common issue to consider, where individuals are concerned, is whether the earn out represents part of the proceeds for the sale of the shares by the seller (therefore subject to CGT), or whether it might represent a form of taxable remuneration (subject to payroll taxes), if those individuals are required to remain working in the target company for certain periods of time and to perform specified duties/responsibilities and achieve certain milestones. A careful review of the facts of the case is required, as well as the share sale documentation – If it is clear that the earn out is consideration for the sale of the shares, then CGT treatment should apply. Individual sellers should always ensure that this issue is taken into account as part of the share deal process, and in separately agreeing the remuneration package for the additional services which that individual will perform for the target company going forward. In particular, Inland Revenue in the UK will look to whether the individuals in question continue to receive market value remuneration during the earn-out period, thereby supporting the fact that the earn-out amounts are properly within the remit of CGT.
Transaction costs tax deduction
Section 552 provides a CGT deduction for qualifying disposal transaction costs, including associated irrecoverable VAT, in calculating the chargeable gain on disposal.
Irish VAT legislation provides that the issue, other than the issue of new stocks, new shares, new debentures or new securities made to raise capital, the transfer or receipt of, or any dealing in shares is VAT exempt (First Schedule VATA 1972). Also, the seller will not be entitled to a VAT deduction in respect of VAT incurred on disposal costs of the shares. However, as an exception the seller can recover VAT on costs incurred relating to the sale of shares to parties outside of the EU.
CGT Reliefs & Exemptions
The main reliefs available are:
- CGT Participation Exemption under Section 626B TCA 1997 for companies
- Retirement relief under Section 598 TCA 1997 for individuals, and
- Share for Share relief under Section 586 TCA 1997 applicable to both corporate and individual sellers
It is worth noting that Sections 598 and 626B TCA 1997 provide a CGT exemption while Section 586 TCA 1997 is a deferral mechanism (and on subsequent disposal of the consideration shares, the tax implications of that disposal need to be determined).
Corporate Seller - CGT Participation Exemption
In order to improve Ireland’s competitiveness as a holding company location, Finance Act 2006 introduced a CGT exemption on the disposal of qualifying shares by a company. The exemption also applies on the disposal of certain assets related to shares (i.e. options and convertible debt). The exemption does not apply to the disposal of either shares or related assets that derive more than 50% of their value from Irish land or buildings, minerals or mining rights.
At a very general level, the key criteria to be satisfied in order to avail of the CGT Participation Exemption are:
- The shares sold must be in a company resident in an EU Member State (including Ireland) or a country with which Ireland has a tax treaty in force.
- A qualifying 5% plus ordinary shareholding (there are tests by reference to profits and assets on a winding up) must have been held for a continuous period of 12 months ending no earlier than 24 months prior to the disposal date.
- The shares sold must be those of a trading company, or the business of the seller and each of its effective 5% subsidiaries, taken together, must consist wholly or mainly of the carrying on of a trade of trades.
- The shares in the company sold must not derive the greater part of their value from Irish land/mineral rights.
There are more detailed rules governing the above mentioned criteria, and how they are to apply and operate in conjunction with certain other tax reliefs, particularly in group situations. Therefore, where a corporate seller is involved, a key focus in structuring a share sale will be availability of the CGT Participation Exemption.
Individual Seller - Retirement Relief
An individual seller may be able to realise a tax efficient sale of the shares of his/her “family company” (as defined in s.598), where certain conditions are satisfied. At a high level, these criteria include the fact that: -
- The seller must be at least 55 years of age at the date of disposal, although there is no obligation to actually retire;
- The seller must hold shares in the “family company” for at least 10 years ending with the disposal date;
- The seller must have been a working director of the company for a period of not less than 10 years ending with the disposal, and must have been a full time working director for 5 of them;
A family company is one where the seller holds at least 25% of the voting rights or the seller holds at least 10% of the voting rights and his family (comprising spouse and certain qualifying relatives) hold at least 75% of the voting rights. For the purpose of the ownership test, the period during which the seller operated the business prior to incorporation, can be included, provided the seller was entitled to CGT transfer of a business to a company relief under Section 600 TCA 1997 on the incorporation. This pre-incorporation period is deemed a period during which the seller was a full-time working director.
It is important that the shares are shares in a company whose business consists wholly or mainly of carrying on one or more trades or professions. Alternatively, the shares can be shares in a holding company of a trading group.
Where the disposal qualifies for retirement relief, and where the consideration, as calculated for this purpose, does not exceed €750,000, the gain is exempt. At a high level, the consideration as calculate for this purpose is based on the proportion of the chargeable business assets to tota assets. The specific calculation differs depending on whther the shares are shares in a famiy holding company or not. Chargeable business assets means assets( including goodwill but excluding shares or securities held as investments) which are assets use fo the purposes of farming, a trade, profession, office or employment, carried on be the individual, the individuals family company, or a company which is a member of a trading group of which the holding company is the individual’s family company.
Marginal relief applies to limit the CGT to 50% of the excess of the consideration, as calculated above, over €750,000.
Where the disposal is to a child of the seller, the same rules as detailed above for calculation the consideration which qualifies for relief, namely by reference to chargeable business assets, except that the €750,000 cap does not apply. Therefore the chargeable business asstes can be transferred to a child CGT free, irrespective of monetary value.
Finance Act 2008 introduced a requirement that the relief only applies to the sale of qualifying assets where the sale is made for bona fide commercial reasons and does not form part of any arrangement or scheme of which the main purpose or one of the main purposes is the avoidance of liability to tax.
Share for Share Exchange Relief
In the case of a bona fide share for share exchange involving the issue of shares in the acquiring company, Section 586 provides that the shares disposed of, by either a corporate or individual seller, are treated as exchanged for the new shares issued by the acquiring company and Section 584 applies such that the new shares are treated as acquired at the same date and CGT base cost as the old shares disposed of. Effectively, the gain on disposal is rolled-over into the new shares.
In order for Sections 584 and 586 TCA 1997 to apply the following conditions must be met:
- the acquiring company must issue shares to the target shareholders in proportion to or as nearly in proportion to, their holding of shares in the target,
- the acquiring company has, or will have control of the target company, as a result of the shares issue; alternatively, the share issue must be the result of a general offer to the members of the target company or class of them, provided the offer was made in the first instance on the basis that if accepted by the parties concerned, the issuing company would have control of the target company.
- the exchange is affected for bona fide commercial reasons and not for tax avoidance purposes.
The above relief is an effective relief where the seller(s) wish to retain an equity interest in the enlarged business following the share for share exchange.
Anti-Avoidance CGT Aspects
While this article is written in the context of an Irish tax resident seller, it is worth noting that capital gains arising to non-resident companies on the sale of non-specified shares (i.e. shares other than shares which derive the greater part of their value from Irish land and buildings, certain mining/mineral rights), which would normally not fall within the charge to Irish capital gain tax, can still give rise to a capital gains tax liability due to the anti-avoidance provisions contained in Section 590 TCA 1997.
This section deals with the attribution of capital gains of a non- resident company, which would be regarded as a close company if Irish resident, to any shareholder who, at the time the chargeable gains accrue, is resident or ordinarily resident and if an individual, is Irish domiciled. The section treats the relevant portion of the chargeable gain as accruing to that person.
A company is regarded as a close company if it is controlled by five or fewer participators or participators who are directors, irrespective of their number, or on a full distribution of its income, more than 50% goes to five or fewer participators or participators who are directors. The term participator is very widely defined and in determining the shareholding percentage of each participator, interests of associates (i.e. spouse, ancestor, lineal descendant, brother or sister) of the participator are included.
The amount of the gain attributable to the participator corresponds to the participators interest in the company. The section does not apply where the aggregate amount apportioned to the participator and connected persons does not exceed one-twentieth of the gain. Where within 2 years of the date that the chargeable gain arises to the non-resident company, the company makes a distribution in respect of that chargeable gain, any amount of tax already paid by the participator under Section 590 TCA 1997, which has not been reimbursed by the company or deducting in computing the gain arising on a sale of the participator’s interest in the non-resident company, can be offset against the income tax or capital gains tax liability arising on the distribution.
The provisions of the relevant tax treaty, being the treaty between Ireland and the country of tax residence of the non-resident company, must also be consulted as they can afford protection from a charge under Section 590 TCA 1997.
In summary there are a number of tax issues to be considered by the seller. These tax issues will differ from those of the purchaser which we will discuss in Part II, and this may result in conflicting objectives. The objective of the professional advisors for both parties is to ensure that they achieve the best deal for their respective clients, while bearing in mind that the overall aim is to ensure a deal is reached. Proper planning at the outset coupled with an effective due diligence and negotiation process will help to ensure that the best deal is achieved for both parties.
This article was written by Lorraine Griffin, Tax Partner and Rose Cox, Senior Manager, Tax Services, Deloitte and featured in the November 2008 edition of the Irish Tax Review publication.
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