Author: Stephen Zaaiman (Renmere)
It is difficult to define the term ‘Mergers and Acquisitions’ or ‘M&A’ as an abstract concept. Whereas most commercially-minded practitioners ‘know it when they see it’, it often seems that no single definition quite succeeds in capturing the concept within four corners. This is particularly true in the field of tax where it is not uncommon for the resident M&A practitioner to declare jurisdictional authority over anything ranging from a residential lease agreement to a capital allowance review.
However, as broadly inclusive as the field may be, the core of M&A work comprises those commercially negotiated acquisitions and disposals which fall within the broader ‘purchaser/seller’ paradigm. Typical examples include competitive and negotiated purchases and sales of businesses, shareholder interests, business combinations and mergers in their various shapes and forms. Inseparable from these transactions are transactions which facilitate or closely relate to these arrangements such as acquisition funding, investment holding structures and management incentive arrangements.
With the above in mind, it is imperative that an M&A tax advisor develops a comprehensive set of skills in relation to the ‘inner core’ of M&A transactions referred to above. In this regard, two distinct (but related) disciplines form the foundation of every M&A tax advisory practice:
- the tax due diligence; and
- transaction structure advisory services.
The tax due diligence
In the South African context, tax due diligence assignments will usually pertain to the acquisition of shares.
The prudent third party purchaser will, at the very least, require a detailed investigation of the legal, financial and tax affairs of a target entity before entering into a purchase and sale agreement for the acquisition of the shares. Failure to identify potential tax exposures may result in the purchaser suffering an unanticipated diminution in the value of its newly acquired investment.
The two major challenges which confront a tax advisor in any due diligence assignment pertain to the identification of and response to risk exposures of the target entity.
Whereas the identification of tax exposures in the target entity can appear to be a reasonably straight-forward task, the seller may often insist on strict limitations pertaining to the review procedures. The seller will typically insist on a limitation of the available time to complete the review as well as the procedures which may be followed by the purchaser’s advisors. Various factors may impact the extent of these limitations. For example, the seller may be reluctant to expose the target’s management team to a protracted review process for fear of disrupting the day-to-day operations of the business. As a consequence, the tax advisor is often left with the challenging task of formulating a review scope and process which balances the need for a thorough review on the one hand, with the need for swift execution on the other.
Once the relevant exposures have been identified, the tax advisor has to determine the appropriate course of action in response to the relevant risks. In this regard, it will be incumbent upon the purchaser to assess each item to determine whether it constitutes a potential ‘deal-breaker’, whether it impacts the purchase price, whether the general warranties in the sale and purchase agreement will provide effective protection, whether it should obtain an indemnity from the seller or whether some other protective measure may be appropriate. The tax advisor’s role in assisting with the formulation of the correct strategy in this regard is essential.
It is imperative that the review procedure remains dynamic to ensure that significant peripheral issues do not go undetected as a result of a slavish reliance on scope limitations.
Once the due diligence phase is concluded, the relevant terms of the Sale and Purchase Agreement (‘the SPA’) should be reviewed by the tax advisor to ensure that the contractual protection mechanisms are appropriate with reference to the tax risks identified during the review. It is not unusual for the tax advisor to be summoned to the negotiating table in order to debate the relevance and impact of a particular tax concern in relation to the SPA.
Transaction structure advisory
Transaction structure advisory work usually requires the tax advisor to abandon the relative safety of post mortem-type compliance reviews and to venture into the dangerous realm of advising clients on their future actions.
Whereas there are certainly instances where it is best to assume a passive role as part of the transaction structuring team, sophisticated M&A transactions often rely heavily on the M&A tax advisor’s guidance for the development of the appropriate transaction mechanism. In these instances, the tax advisor will perform an important role, both in respect of the design of the transaction structure as well as in respect of the facilitation of input by the commercial, legal and other work streams.
In efficient transaction structuring teams, there will typically be a high level of lateral competency across the various disciplines and it will be incumbent upon the tax advisor to develop a good understanding of the commercial, legal, financial, regulatory and other parameters which may impact the transaction structure.
As is the case with the due diligence review, transaction structuring work is usually performed under significant time pressure and it pays to have a pragmatic approach during the initial phases of the process. Given the fact that skilled resources tend to become a scarce commodity within a busy transaction team, time is often better spent developing solutions during the initial stages rather than issuing wordy opinions on hypothetical issues. However, overemphasising this approach runs the risk of progressing into the later stages of the transaction with a technically flawed transaction structure.
Tax advisory work in the context of M&A transactions requires a strong tax technical basis, a good understanding of M&A related legal and accounting principles as well as a commercially minded approach.
Apart from the inherently dynamic nature of transaction work, it should be born in mind that the annual tax legislative amendments may introduce unanticipated challenges under a prospective transaction. Significant amendments were introduced over recent years to curb perceived abuses in the context of M&A transactions and this remains an area of focus on the part of SARS and National Treasury. To this end it is important to remain mindful of underlying tax policies and trends.