Introduction

In a challenging economic environment, we commonly see businesses seek to re-evaluate strategic priorities. One common outcome of these considerations is where a business will look to divest non-core divisions.

Carving out units can often be seen as 'simple' from a tax perspective – why wouldn't it be if you are buying newly incorporated businesses with limited tax history in a structure set-up by the sellers specifically for the carve-out transaction? However, whilst the tax due diligence can, in certain instances, be simple; given the systems and people involved, the structuring and ongoing tax considerations are not always straightforward. In many circumstances, day one considerations can have longer term impacts from a tax perspective. As a result, it is always important to discuss your long-term post-transaction objectives with your tax advisers for these transactions.

We have prepared a series of articles outlining, in our experience, the key areas that require consideration from a tax perspective for a carve-out transaction. These range from areas that impact the pre-transaction planning through to the first periods of the new ownership. Specifically, we will cover (in no particular order):

  • Tax due diligence
  • Tax de-groupings and group claims and elections
  • Carve-out structuring
  • Structuring the consideration
  • Management equity
  • Defining the Day 1 Operating Model
  • Interim Operating Models
  • Facilitating the Value Creation Plan
  • Setting up the standalone tax function

The first article in the series will focus on the tax due diligence considerations for a carve-out transaction.

Part 1 - Tax due diligence (The 'Simple' Workstream)

The most common assumption we come across on a carve-out transaction is in respect of how to approach the tax due diligence workstream. The assumption is either:

  1. the tax due diligence should follow the standard buy-side due diligence approach; or
  2. there is a limited need for tax due diligence given that the business is being carved-out of a wider group, meaning there is limited tax history inherited by the purchaser.

In a number of instances one of these assumptions is true; however, in our experience, a number of carve-out transactions involve a combination of share and asset purchases depending on how the selling entity has historically operated the business being sold. As a result, you generally end up with a hybrid of the two approaches.

During this article, we outline the tax due diligence considerations for both options.

Share deals

Whilst most carve-out transactions will involve the acquisition of shares, it will be important to consider the history of these shares (or the shares of any of the underlying subsidiaries of the target). Specifically, are these:

  • shares of newly incorporated entities as part of the carve-out structuring; or
  • shares of entities that have historically held and operated the business being acquired when they were part of the seller group.

The references to a share deal refer to the latter scenario in this instance. Where you have any of these 'legacy' entities, you will generally inherit the tax history of that specific entity. Therefore, it will be important to undertake full tax due diligence on that entity (if deemed material).

We would expect the scope for the tax due diligence of these entities to resemble the 'classic' tax due diligence scope, which generally includes corporate taxes, indirect taxes and employment taxes, as well as any other specific taxes applicable to the business. It will also be important to consider the tax implications of any equity held by individuals transferring with the business. This will be considered in a later article covering the overall management equity position.

Asset deals

Although the term 'asset deal' is widely used, it is always important to confirm whether this is either:

  • a pure asset deal - acquiring the assets of each business via an asset purchase agreement with the Seller; or
  • a form of hybrid asset deal - usually structured as a hive down of the assets into a newly incorporated entity that will be acquired via share purchase agreement with the Seller.

There are certain differences between the two options from a carve-out structuring perspective which will be considered in a later article in detail. However, from a tax due diligence perspective, generally the new company does not inherit the tax history of the selling entity (unlike the share deals) and therefore the main diligence risks are similar – secondary liability taxation.

The UK tax legislation contains various provisions whereby one person may be made responsible for the tax liability of another. In the case of a carve-out transaction, the newly incorporated entity holding the business assets may be responsible for the tax liability of the relevant selling entity. These are known as secondary liabilities. It is important to note that these can affect both parties to the carve-out transaction.

For example, an entity within the transaction perimeter may bear secondary liabilities which arise as a result of a default in the seller's group. Commercially the position is generally that the buyer will be unwilling to bear this cost, but the seller is unwilling to provide information for entities outside of the transaction perimeter. For this reason, it is important that the buyer is appropriately protected via the tax covenant or warranties.

In our experience, areas to consider as a buyer from a UK tax perspective relate to:

  • corporation tax that has previously been deferred via a tax neutral transfer of tangible and/or intangible assets that may crystallise on (or after) the transaction;
  • unpaid VAT arising within a VAT group that the entities within the transaction perimeter were part of – this is because they are jointly and severally liable for VAT obligations;
  • stamp duty land tax to the extent the relief is required to be clawed back (e.g. as a result of the carve-out transaction);
  • potential liabilities arising where there was a previous group payment arrangement in place/a group payment that has ended as part of the carve-out transaction;
  • unpaid corporation tax on gains in respect of an asset where the buyer has acquired an entity that previously held (or now holds) the asset in question; or
  • unpaid corporation tax in respect of non-UK resident companies, controlled foreign companies and/or migrations of companies outside of the UK.

Similarly, an entity within the transaction perimeter may also incur primary liabilities which are triggered after it joins the buyer's group, but relate to a point when it was a member of the seller's group. In these circumstances, members of the seller's group may be subject to secondary tax liabilities.

In our experience, areas to consider as a seller from a UK tax perspective relate to:

  • the buyer changing the nature of the business post-transaction, which may trigger a secondary liability in the seller's group; or
  • an entity within the transaction perimeter may fail to pay a tax liability provided for in the relevant financial statements. HMRC may seek to recover this from the seller's group in certain instances.

As part of this article, we have outlined the common areas where there could be a secondary liability risk from a UK tax perspective. We would expect these to differ for each jurisdiction, so it would be important to consider the specific risks that may apply to each jurisdiction separately.

The pre-transaction carve-out structuring

The carve-out structuring is a complex workstream with a number of tax considerations which will be covered separately as part of a later article. However, it is important to ensure that the pre-transaction carve-out steps are reviewed from a tax perspective to identify any specific tax liabilities that would transfer with/crystallise in the target as part of the pre-transaction carve-out steps. Often we see this covered as part of the tax due diligence workstream and included in the tax due diligence findings.

Summary

Overall, a carve-out transaction requires a much more bespoke tax due diligence scope that has considered both the history of the entities being acquired and any pre-transaction carve-out steps. Specifically, we would expect two separate approaches, one for entities acquired via share deals and one for entities acquired via asset deals (whilst also covering the tax implications of the pre-transaction carve-out steps).

To maximise efficiencies, we generally recommend that buy-side advisers work with the sell-side advisers to understand the pre-transaction carve-out process prior to finalising the tax scope and approach. This will ensure appropriate tax due diligence coverage for the carve-out transaction.

January 15, 2024

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.