Looking forward to 2016, mergers and acquisitions (M&A) will be back in vogue. The ground work has already been laid. 2015 has witnessed an increasing volume of transactions, with household names such as Topaz and Avoca being bought and sold. M&A is not confined to multi million euro transactions. We are currently witnessing transactions at all price levels. As we close out on 2015, we expect a busy 2016. Improving financial markets (albeit slowly), underpinned by a desire to emerge from a hiatus of growth, is stimulating buyers and sellers to enter the market. This pattern is not confined to any one sector. We are seeing equal expressions of interest in the retail, manufacturing, technology and consultancy sectors.

In the Celtic Tiger days, many of us would have regularly advised on M&A transactions. These transactions require a different skill set. When working for the potential purchaser, they require a combination of an ability to dispassionately review and question the targets tax history, mitigate the potential exposure with appropriate warranties, with the ability to advise on an appropriate acquisition structure. Written from the perspective of being the purchaser’s advisor, this article summarises the key steps involved in the tax due diligence process.

Step 1 – Review the financial statements

Do you know what the target does? What countries does it operate in, what product does it make, is it profit making? While these may appear to be relatively obvious questions, it is imperative the fundamentals are understood. In the absence of same, it will become more challenging to scope and agree the objectives of the due diligence. These fundamental questions can readily be addressed by reviewing the financial statements filed with the Companies Registration Office. Armed with this knowledge, a more tailored and focused approach can be adopted. Subject to purchaser preference, this information can also influence the scope and review period of the due diligence.

Step 2 – Information requests

While information request lists may be perceived as burdensome, from the purchasers perspective they are a useful tool for extracting and documenting information. With a carefully crafted questionnaire, they can produce unexpected replies and result in renewed focus being placed on an alternate direction (e.g. potential payroll exposure). The information requests should be broad in scope and encompass all relevant tax heads. Separate questionnaires should be prepared for:

• Corporation tax;
• PAYE / PRSI;
• VAT & RCT

Depending on the nature of the target company, queries in relation to taxes such as stamp duty may be captured under the corporation tax questionnaire. This questionnaire could include queries in relation to whether there were any group reorganisations or asset transfers.

From a practical perspective, individual questionnaires should be completed for each of the tax heads. More often than not, the vendor’s tax agent will not be involved in the day to day VAT and PAYE compliance. They will however have the corporate tax information. Separate questionnaires should, in theory, aid higher quality information to be gathered in a more timely manner.

Step 3 – Site visit

Ideally the information requests will have been completed prior to undertaking a field visit. However, this may not always be feasible due to time constraints. At a fundamental level, the field visit should serve as an opportunity to review and sample source documents. However, where the true value lies in is the ability to meet with management. This one to one interaction can be used to determine:

• what internal procedures it operates (e.g. how expense claims are made and processed);
• how the organisation operates on a day to day basis (e.g. are there employees working in say Newry and Drogheda and is there a potential PAYE exposure);
• how sales are negotiated and concluded (i.e. is there a potential permanent establishment issue to address).

The underlying motive for the site visit is to identify and quantify positions where tax may be underprovided, or where a particular interpretation of the legislation has been taken. This will ultimately influence the potential purchaser on the price to be paid, or indeed, if they should walk away from the transaction.

Step 4 – The report

The tax due diligence report is the product of the above steps. It should enable the potential purchaser, often an individual with no tax knowledge, to understand the magnitude of any potential issues identified. Sometimes, it can also serve as an opportunity to identify post acquisition synergies which could be achieved. However, at a fundamental level the report needs to:

• identify the years and tax heads reviewed;
• summaries the tax exposures identified;
• quantify potential interest and penalties;
• rank the potential exposures in order of severity; and
• identify the impact of any recent tax changes which could have an impact in terms of structuring the acquisition (e.g. availability of knowledge development box).

Depending on the relationship to date and the remit of the purchaser, in certain cases it may be possible for the findings of the report to be discussed with the vendor’s tax agent.

Step 5 – Legal documentation

Assuming that the due diligence report has not identified any deal breaker, the report’s findings need to be considered in terms of the Share Purchase Agreement, the Tax Deed and the Tax Warranties. The purchasers advisors (legal and tax) should seek to tailor and incorporate specific indemnities and warranties to address the potential exposures. It is not suggested that a warranty be included in respect of all matters identified. Reflection on the risk of the potential exposure and the likelihood enforcement should guide on what should be provided for. Where matters are considered to be of particular risk, consideration should be given to a proportion of the consideration being held in escrow until the risk is considered to have abated.

Structuring the acquisition

Typically when a client is looking to purchase a company, the initial engagement will be to undertake a due diligence. While this work offers value to the client, the true value is in identifying opportunities to facilitate the acquisition and integration of the target into the purchasers existing structure. The ability to offer this value will only come if the advisor truly understands the client, their business and their long term objectives. In structuring the acquisition consideration needs to be given to:

• Who will purchase the company?
  Depending on the complexity of the purchasers existing group structure, this may be a relatively straight forward question. However, if the purchaser is a sophisticated group with international operations, additional consideration will need to be given to how the integration of the target will impact on the group tax charge, financial reporting requirements, legal obligations etc. An effective acquisition structure will also factor in the availability of a participation exemption in the event of a disposal.
• How will the transaction be financed?
  Most likely the transaction will be funded by debt. This could be third party or intra group. Either way, consideration will need to be given to which company should borrow and the tax deductibility of the interest. Tax deductibility needs to be considered in the context of the overall group tax charge. This will influence whether the loan should be structured so as to facilitate a deduction being given as a trading expense or non-trade charge.
• How will the target company interact with the rest of the group post acquisition?
  Consideration needs to be given to what the target company will do post acquisition. Will it be trading with the group? Will it be granting licences to international sister companies? Post-acquisition, cashflow should not be impaired by withholding taxes being levied on intra-group royalty payments or funds being held up due to VAT refunds not being processed. Correctly integrating the target in the value chain can maximise free cash reserves. The targets role in the value chain should also be considered in the context of transfer pricing and how it will be rewarded for its contribution.

Conclusion

As we close out on 2015, the year ahead holds the prospect of being one of growth. M&A advisory can be interesting but challenging work. The right skill set and methodology needs to be applied. Focus should not be limited to the target company. A more holistic and rounded approach should be adopted whereby consideration is given to the acquisition structure and post-integration. The return of M&A activity brings with it an opportunity to work closer with clients and to transition from their tax advisor to a trusted business advisor.

Cormac Kelleher is an International Tax Director with Mazars.

Email: ckelleher@mazars.ie

Website: www.mazars.ie