Whether buying or selling a technology company, there are a number of tax traps that may arise. Below, we discuss some of the tax traps that we have come across in recent transactions.
Where companies leave a UK corporate tax group, such a ‘de-grouping’ may give rise to a UK corporation tax charge.
In a number of recent cases, the sellers were unaware that a potential de-grouping tax charge may arise until it was identified by the purchaser. Some recent examples include:
- n an intra-group transfer of intellectual property, which, although purportedly made a number of years ago, was not properly documented at the time and which, as a result, was not an effective transfer;
- n a poorly drafted cost sharing arrangement, which transferred title in intellectual property (rather than each of the companies acquiring the relevant rights from inception); and
- n an inadvertent de-grouping that occurred a few years before the proposed sale, where shares were issued to a number of individuals associated with the founders, which took the corporate group ownership below the minimum 75%.
In each case substantial legal fees were incurred investigating the potential tax liabilities, and in two cases the original share deals became asset deals (which are much less favourable for the sellers) as a consequence of the tax risks.
In each case the potential concerns could have been avoided. This demonstrates the importance of obtaining proper advice before intra-group transfers are made, and of ensuring the company’s house is in order prior to starting on a sale process.
Cash purchase of EMI options
As part of an acquisition, a seller proposed that rather than allow certain employees to exercise their Enterprise Management Incentives (EMI) options and participate in the sale, the EMI options would be cancelled in exchange for a cash payment.
The EMI legislation provides relief only on the acquisition of shares pursuant to an EMI option – there is no relief for income tax arising on a release of an EMI option for a cash payment.
This is a less tax-efficient alternative for the employee and the PAYE and national insurance cost was reflected in a purchase price reduction.
Ensuring the company is ready to be sold
As a general house-keeping matter, it is always a good idea to review the company structure and to make sure that the company is ready to be sold.
As mentioned above, it is particularly important for a technology company to ensure that it owns all of the intellectual property that a prospective buyer believes it is acquiring – as this is often the most valuable asset of a technology company. Finding out halfway through a sale process that the company does not own the intellectual property will delay the sale and may be expensive to remedy.
In addition, if there is any reorganisation of shares required, for example to remove minority shareholders from subsidiaries, this should be done well in advance of commencing any sale transaction.
Payment of target debt
Where a target company has an outstanding debt, the purchaser can make a stamp duty saving by agreeing to procure the repayment of the debt, and reducing the consideration paid for the shares.
To make this stamp duty saving, there must be an obligation on the buyer to procure repayment of the loan, there must be a clear distinction in the share purchase agreement between the amount paid as consideration for the sale of the shares and the amount to be used to procure repayment of the debt – in particular, the consideration and procurement obligations should be in separate clauses and the money trail should follow the analysis.
Is a consultant really an independent contractor?
In one recent transaction, the seller mentioned that he had engaged a consultant to do a little work in Australia, and that post acquisition, the business would like to change his status and take him on as an employee.
Upon further investigation, the consultant was found to act solely for the target company, there was no written contract with the target company, he occupied premises rented by the target company and negotiated and entered into contracts on behalf of the target company!
This gave rise to a concern that the target company, which was a UK company, was carrying on business in Australia through a permanent establishment – and gave rise to one large mess to sort out.