Don’t get run over by a runaway M&A train, get your tax issues under control from the start

By Tara Johnson, Emma Marr & Ian Fay

As the mergers and acquisitions (M&A) market starts to pick up a bit of momentum, this is a great time to think about the key tax issues for buying or selling a business, restructuring, or raising capital. Often, in the heat of a fast-moving transaction, important tax issues (and their consequences) can be overlooked, resulting in significant loss of value. Avoid these issues by bringing in a specialist M&A tax advisor as soon as the planning discussions start.

Getting the tax treatment of transaction costs right

It’s common for transaction costs to be pushed down to the company being sold, rather than being paid by the shareholders who are buying or selling the business. These costs, which typically include fees for advisors, lawyers, and accountants, can be substantial, and if their tax treatment is not correct, the cash tax impact can also be significant. Transaction costs borne by a company on behalf of the shareholders that are buying or selling the business may be treated as a dividend to that shareholder (the company is providing a benefit to the shareholder, who is receiving that benefit at no cost). The company will not only have a non-deductible cost, but should also treat the payment as a dividend, with associated withholding tax liabilities. If left unaddressed, accrued penalties and use of money interest could be significant by the time the tax treatment is corrected.

GST on transaction costs is also an issue that is easily overlooked, and is not as straight forward as simply assuming that the entity paying the expenditure gets an input credit. Managing the deemed dividend risk through a recharge of costs may not result in a correct GST position of these expenses. To get the GST treatment right, it’s necessary to understand a number of factors, including who is legally bearing the costs, the structure of the transaction (for example, whether it is the issue of new shares or the sale of existing shares or a sale of assets), the GST registration status of the relevant parties and which party is receiving the benefit of the work done.

Thinking about your exit strategy

While New Zealand doesn’t have a specific capital gains tax, there are various different tax rules that may still apply to the sale of a business. For example, buying shares or assets with the clear purpose of resale would result in a taxable transaction on sale, while buying with the purpose holding for the long-term may not. When examining what the purpose of a transaction might add, discussions had, and documents created at the time of acquisition will need to be considered. This could include investment committee papers, board papers, and other supporting documents (like internal memos and emails). It’s important to be clear about the impact of decisions made on acquisition, as they might determine the tax treatment of any profit made later.

Are you valuing tax losses in your transaction?

Following the introduction of the business continuity test (BCT) in April 2020, company tax losses are no longer automatically forfeited following a change in shareholding of more than 51%. Before the BCT, tax losses would immediately be forfeited in such a transaction, meaning any losses the company was carrying forward would not have been attributed any value. Now that losses may be able to be carried forward and used, consideration can be given to the potential value of losses.

We have not yet observed many transactions that do value losses. While Inland Revenue recently released further draft guidance on how they will interpret the BCT (see our October 2024 Tax Alert article) it remains to be seen whether greater certainty around its interpretation will lead to more transactions in which losses are valued.

If you are contemplating a transaction in which losses could continue to be available after sale, you should consider:

• What value can be attributed to the losses, and should any discount apply?
• Are you confident that the losses are available to be carried forward, and is any protection available under the warranties and indemnities given by the seller?
• Do your plans for the business after acquisition create the possibility that the BCT would not be satisfied, and the losses forfeited?
• Could any part of the purchase price attributable to the losses be paid over time, or repaid if the losses cannot be used?

Are you sure you know how much ASC you have?

Available subscribed capital (ASC) is capital, initially paid by shareholders, that a company can, in some instances, return to shareholders tax free. ASC can become a focus in transactions, including when companies are changing the share capital structure, are being restructured or wound up, or shareholders are exiting. Quantifying ASC when acquiring a company is also important.

While at a basic level the calculation of ASC can be simple, there is some complexity to the rules, and calculating ASC if it has not been tracked throughout the life of a company can be a difficult task. We recommend that companies keep records on all changes to ASC at the time those changes happen, and that if a transaction is planned, early attention is given to calculating ASC. Failure to demonstrate that a payment to a shareholder was ASC can mean that a payment the parties thought was tax free, is actually a taxable dividend, resulting in costs on both the company and the shareholder.

Repayment of Research & Development loss tax credit

The R&D Loss Tax Credit (RDLTC) regime is a scheme designed to support innovative companies engaging in R&D activities before they become profitable (see our August 2023 Tax Alert article for more on RDTLCs). This scheme allows companies which are R&D intensive to receive the tax effect of their losses as cash instead of carrying forward the losses. The aim is to boost cash flow for companies heavily investing in R&D that may not yet be making a profit.

The RDLTC works, in effect, as a loan that is repaid when the company starts to make a profit. If there is a sale event before the ‘loan’ is fully repaid, the full outstanding balance will need to be repaid on that loss recovery event. A number of events can trigger this early repayment obligation:

• Disposal of intellectual property
• Appointment of a liquidator
• Company migration, or no longer a company
• Shareholding change of greater than 90%

If a significant transaction is contemplated, the obligation to repay the RDLTC should be factored into the transaction process and value.

What will the transaction mean for any employee share scheme?

If a business is being sold or is introducing new shareholders, and has an employee share scheme (ESS) or an employee share option plan (ESOP) in place, the sale is likely to impact on the ESS/ESOP. An existing ESS/ESOP may be wound up, with payments made to participants, the ESS/ESOP may continue, or a new ESS/ESOP may be set up. While New Zealand’s tax rules around ESS and ESOPs are intended to create neutrality between a payment in cash or a payment in shares, the rules can create complex tax issues. Where payments are made to existing employee shareholders who have a key role in the transaction, the deductibility of any payment made to wind up an ESS or cancel options, as well as any potential payroll withholdings, filings and reporting obligations, will need to be considered. The specific terms of the plans will need to be reviewed, and any payments should also be factored into the overall transaction value.

Purchase price allocation

Asset sales need to have a specified “purchase price allocation” (PPA), under rules introduced in 2021. The aim of the rules is to stop buyers and sellers allocating asset values in a different way that gives more favourable tax outcomes to each party. If the buyer and seller don’t agree on the allocation, there are mechanisms to allow first the seller, then the buyer to set the values. If neither do so, the Commissioner of Inland Revenue can set the values, and can, in any case, reconsider values that have been allocated by the parties to the sale. Generally, the best outcome is for the parties to agree the asset values between them, and to maintain documentation supporting those values. While the sale documentation might not necessarily include the full PPA, it should include a mechanism for settling the PPA within a reasonable period after sale. The PPA rules don’t apply to every asset sale, with exceptions for more simple or low value sales.

Are you complying with the Approved Issuer Levy rules?

The Approved Issuer Levy (AIL) regime is available when interest is paid by a New Zealand resident to a foreign lender. An AIL registration allows a borrower to pay a levy of 2% on the interest payments to the foreign lender, rather than paying the Non-Resident Withholding Tax (NRWT) rate (often 10% or 15%). To pay AIL, the borrower and the loan or security must be registered with Inland Revenue before AIL can be applied. Currently there is no flexibility around this rule. If the AIL registrations are not done, there is no way to register retrospectively and un-do the error and NRWT has to be paid instead. While the rules will be changing, with draft legislation before Parliament to allow retrospective registration, its not currently proposed that this change will itself be retrospective.

In the fast-moving transaction, it can be easy to assume AIL can be taken care of later. However, you should consider the detail of any financing arrangements, and be aware that in some cases interest can be paid sooner than expected. The definition of ‘interest’ can include some financing fees, and the terms of the financing may mean that the fees (i.e., interest) are paid on settlement. This means AIL registrations need to be in place before settlement to ensure any payments of interest can have AIL applied.

We recommend checking early and often to make sure that the AIL rules are being complied with, as mistakes can cause significant costs. Our September 2023 Tax Alert article provides more detail on the AIL regime.

While these are some of the tax issues we commonly observe in our M&A work, there are many areas where tax plays an important role in planning and executing a transaction. Please contact your usual Deloitte advisor for support in your M&A activity.