Session Reporter

Cyrill Diefenbacher, Bär & Karrer AG, Zurich

cyrill.diefenbacher@baerkarrer.ch

Report on the virtual session of the 21^st annual U.S. and Europe Tax Practice Trends

23 March 2021

(Virtual meeting)

Session Chairs

Susanne Schreiber Bär & Karrer AG, Zurich

Michael Hirschfeld Andersen, New York

Speakers

Frank R Tschesche GvW, Frankfurt a.M.

Guillermo Canalejo Lasarte Uría Menéndez Abogados, SLP, Madrid

Ailish Finnerty Arthur Cox, Dublin

Avraham (Avi) Reshtick Mintz, New York​​​​​​​​​​​​​​

Opening of the session

Susanne Schreiber opened the session by introducing the panelists and presenting the agenda for the session.

The session’s brief: The pandemic has seen a change in the landscape of deals, which raises novel issues for advisers. The use of Special Purpose Acquisition Companies (SPACs) has dramatically increased. In an effort to deal with business uncertainty, contingent consideration and rollover equity are becoming a greater component of consideration paid by buyers. Distressed property sales have grown, which raises issues regarding how to deal with existing debt and limit adverse tax effects for borrowers and lenders alike. Broken deals have increased, raising even more complexity.​​​​​​​

Dealing with uncertainty: share-for-share exchange and variable prices

Frank Tschesche kicked off the topic with a general overview of the EU Merger Directive (Council Directive 90/434/EEC as codified by the Council Directive 2009/133/EC) in contrast to the German national law provisions relating to share-for-share exchanges in distressed and non-distressed situations. The overarching structural goal is to avoid dry income on the transaction, in particular where valuations are uncertain, or cash having to be paid out to meet taxes that would impede the transaction in distressed situations.

The EU Merger Directive foresees a deferral of capital gains tax by way of book value carry-over, based on certain conditions and subject to certain qualifying forms of reorganisations, a limitation on cash payments (ten per cent of nominal value of shares contributed) for the transaction and non-qualification as abuse. The comparison with German national law shows some differences: for example, the German law requires that at least a new share be issued (that is, it requires a minimal capital increase) and a potential consideration granted in addition to the new shares must not exceed either (1) 25 per cent of the nominal value of the shares contributed, or (2) €500,000, and in any case not exceed the nominal value of the shares contributed. Further, the German tax provisions foresee a clawback/retroactive taxation of hidden reserves transferred in the event of a sale of the contributed shares within seven years after the exchange of shares in case of contributions by individuals.

Michael Hirschfeld continued with a short overview of the complex US provisions relating to such share-for-share exchanges. As these rules are quite technical and different from the EU rules, he did not go into the details. 

Guillermo Canalejo Lasarte pointed out that even though all EU tax-neutral restructuring regimes were derived from the EU Merger Directive, local implementations may significantly vary. Spain, for example, does not have a similar clawback clause (except for cases where the rules were applied in an abusive way). Hirschfeld added that the US does not have any clawback rules either.

Schreiber confirmed the same (that is, no minimum holding period after the transaction) for Switzerland and added that Swiss rules further provide for more flexibility in terms of remuneration in a share-for-share exchange, where up to 50 per cent of the fair market value of the contributed shares may be paid in cash. Certain anti-abuse provisions apply (for example, in the case of a subsequent merger or liquidation).

Ailish Finnerty added that there is no blocking period in Ireland either, but Ireland is also more restrictive about remuneration that is allowed to be paid in addition to new shares issued in the context of a share-for-share deal.

Hirschfeld then raised the question of how to deal with uncertainties in terms of valuation. Tschesche pointed out in this context that only the hidden reserves at the time of the contribution would be relevant for retroactive taxation. It is thus advisable to have a valuation report at the time of the transaction available for this purpose.

Hirschfeld mentioned the increasing tension in the pandemic between sellers that want all cash on the one hand and buyers that don't want to give any cash at all on the other: possible scenarios include all cash upfront, cash over time, part equity upfront, part equity over time. He then spoke about rollover equity as an instrument of achieving a tax-free capital gain. In cases of corporate stock, tax-free reorganisation rules can limit the amount of cash that can be received which may block the deal. As an alternative, a new holding company may be formed between the owners of the buyer and the target; the holding company buys the assets of the target or its stock. Another structural alternative via partnership interest provides greater flexibility in getting tax-free treatment but can also present certain complexities.

Also, contingent considerations (cash considerations based on final valuation or future operating performance) are a topic increasingly found in recent deals. However, payment in later years triggers instalment rules: a tax liability may be deferred but it may distort the recovery of the tax basis and require payment of interest to the Internal Revenue Services (IRS) for the ability to defer taxes for large instalment sales (US$5m threshold). Schreiber mentioned potential inefficiencies that could arise out of these rules in cross-border situations in case of a European buyer and US seller. The seller may have a tax burden due to imputed interest, but the buyer may not have any deduction.

Avi Reshtick mentioned that the imputed interest concept may similarly apply in certain cases if compensation comes in the form of equity, and also reiterated the potential different treatment for buyers in other jurisdictions. Finnerty added in this context that an earn-out can also create a lot of issues from an Irish perspective and some restructuring may be required to mitigate exposures. Tschesche reiterated that contingent remuneration also falls into the limits mentioned previously regarding tax-neutral share-for-share exchanges.

SPACs: tax considerations for cross-border business combinations

Reshtick then introduced the hottest trend in the M&A market in 2020: Special Purpose Acquisition Companies (SPACs). A SPAC’s sole business plan is to raise funds to engage in a business combination with an unidentified target. A typical SPAC's equity consists of shares issued to public investors for cash, shares issued to sponsors (nominal price, 25 per cent of public shares) and warrants. If the SPAC is not engaged in a business combination transaction within two years, public shares are redeemed. SPACs may be organised under US law or non-US law (for example, British Virgin Islands (BVI) or the Cayman Islands).

The SPAC is often set up in the Cayman Islands or BVI and, pre-combination, it migrates to the US or an EU country (for example, Ireland). Reshtick briefly discussed the key tax considerations connected with SPAC transactions: for example, non-recognition treatment for shareholders of a private target (except for cash), non-recognition treatment for shareholders of the SPAC and the goal of achieving a tax-efficient structure going forward, the facts and circumstances of the case to be considered for an optimised structure (eg, the residency of the private target, the target's shareholders and the SPAC's shareholders) as well as other typical factors to be considered (for example, contingent consideration, bridge financing (convertible debt)).

Reshtick and Finnerty then explored a few typical structuring options with SPACs and respective key US and Irish tax considerations. A SPAC (in the example, assumed to sit in Ireland) acquisition of a private target may be structured as a reverse triangular merger or share-for-share-exchange potentially with contingent consideration and the post-combination merger of the target. The share-for-share exchange requires careful structuring in Ireland (to avoid stamp duty and adverse consequences for a private investment in public equity (PIPE) investor, and to achieve rollover relief for EU shareholders).

As an alternative, a structure was discussed where, instead of the SPAC acquiring the target, a new holdco (for example, in Ireland) is interposed and there are two different transactions happening at the same time: (1) the merger between the SPAC and the transitory subsidiary of the new holdco (the SPAC shareholders in this context become owners of a similar instrument at the level of the new holdco in a tax-efficient manner); (2) a share-for-share exchange between shareholders of the new holdco and target shareholders. Finnerty again elaborated on the key tax considerations from an Irish perspective in such structures and Reshtick discussed certain US tax implications.

Distressed deals: loans

Schreiber presented an example of a case with a distressed target, which has been heavily financed with intercompany debt, where a buyer purchases the shares and the shareholder loan (SHL) with the SHL at a discount. She posed the issue of whether unfavourable taxation may be avoided in such an example if the SHL is repaid at full value, waived or converted into equity. In the example, a Spanish company acquires the shares in a German company for one and a shareholder loan with face value of 100 at 70.

Canalejo Lasarte mentioned that under the Spanish Generally Accepted Accounting Principles (GAAP) rules, the difference between the face value and fair (acquisition) value of the shareholder loan (in the above example a difference of 30) would be, in the case of an acquisition below the face value and a subsequent conversion of the debt into equity, fully taxable in the hands of the acquirer. Corporate income tax treatment follows the accounting rules. In case of a waiver (instead of a conversion into equity), this would be considered a deemed equity contribution, which would increase the tax basis of the Spanish company’s investment in the German company and would not be taxable. Depending on how the transaction is undertaken and which GAAP is applicable, a tax liability may be incurred or not.

Tschesche added that the situation may be even worse if the German tax position is looked at. Corporate income tax in Germany could be incurred (in the amount of 30) if, at the time of the waiver, a loan with a nominal value of 100 is only worth 70. A set-off against net operating loss may help mitigate the exposure.

Schreiber summarised that, as a lesson learnt, it is important to plan ahead and review the situation in case a distressed SHL should be acquired, and whether a contribution of the SHL prior to the transaction may be possible and is more beneficial (which is, for example, the case for a US target to avoid a taxable waiver of debt).

Distressed deals: negative purchase price

Schreiber discussed the instance of an acquisition of a company with bad will / risks / overindebtedness and situations where the seller accordingly transfers shares and also makes a payment to the buyer. Generally, there is a high likelihood that such a payment constitutes taxable income for the buyer. There may be structuring options to mitigate this risk, for example, with a contribution by the seller into the target company before the sale (instead of a payment to the buyer), but other corporate / legal considerations need to be taken into account.

Indemnity Payments and broken deals

Canalejo Lasarte discussed some aspects of pre-closing items with regard to representations and warranties (R&W) insurance. In many cases, the insurance does not cover all of the items highlighted (for example, difficulty regarding EU illegal state aid or transfer pricing matters). In three-party deals (buyer-seller-insurer), clear agreement on who takes the lead when a claim is made is recommended.

Then Canalejo Lasarte discussed how a broken deal or indemnity payment may be treated from an income tax perspective. The tax treatment differs depending on whether a payment is considered a regular income / expense or purchase price adjustment. It is recommended that this is clarified in the sale and purchase agreement (SPA) that a payment is made as an adjustment to the purchase price, which may also be helpful for the seller in that it may benefit from the participation exemption. In Spain, there is a Spanish GAAP-imposed time limit of only one year from closing for purchase price adjustments. After this time period, an additional payment by the buyer will not be considered a purchase price adjustment anymore and will thus generate taxable income (instead of a capital gain from the sale for the seller). Also, a payment under an indemnity previously not taken into account under the SPA would be fully taxable income for the buyer. Thus, often a gross-up provision is included by the buyer. VAT is also an important aspect to be reviewed (ideally, a payment under the SPA should not be subject to VAT).

Transaction costs

Canalejo Lasarte mentioned that transaction costs are a hot topic in Spanish M&A, and tax deductibility was not allowed in various past cases by the Spanish tax authorities where the costs were borne by the Spanish bidder. The question then arises whether the bidder is the acquisition company or the private equity fund behind it. Also, one needs to assess how the services rendered can be evidenced, how tax deductibility can be efficiently used in the context of an income tax grouping and the VAT treatment needs to be analysed (including the possibility to reclaim VAT on services received).