So we did an MBO, what next?
When companies are acquired via a Management Buy-Out (“MBO”) there will be a variety of tax issues which need to be considered post completion; completion is the beginning of the road rather than the end! Some issues may have been identified during the tax due diligence or structuring process, others may not.
This article focusses on some of the main company tax issues that the MBO team are likely to come across post-completion.
Deductibility of interest costs
It is likely that the MBO will involve the injection of new external or shareholder debt into the acquisition structure. Obtaining a tax deduction for the interest cost will be key to ensuring that corporate tax charges are minimised.
Tax legislation may restrict the amount or timing of interest deductions when there is a connection between the parties. The transfer pricing rules must be considered first and then the Corporate Interest Restriction Rules, these issues are discussed below.
Transfer Pricing considerations
As a general rule, the Transfer Pricing (“TP”) regulations apply to large companies i.e. companies with more than 250 employees and either more than €50m in annual turnover or a balance sheet value of more than €43m. There are circumstances where medium sized enterprises (50-250 employees and annual turnover of €10-50m or total balance sheet value €10-43m) are brought within the rules, but these situations are rare. However, it is anticipated that medium sized companies may soon be brought within the TP rules which would make the rules relevant to many more companies and groups.
The TP rules can apply when, parties ‘act together’ in relation to the financing of a business and are capable of controlling the company. If this is the case then the directors will be responsible for working out the amount of debt and the interest which is deductible on an arm’s length basis, and then making an adjustment to the corporation tax return if the arm’s length amount is less than the interest charged in the profit and loss account.
The determination of an arm’s length interest deduction will usually require a formal benchmarking exercise to confirm both the arm’s length quantum of debt and the appropriate interest rate. Transfer Pricing documentation will also need to be put in place. We can provide assistance with all of these workstreams.
Corporate Interest Restriction (CIR)
The Corporate Interest Restriction (“CIR”) can also limit the amount of deductible interest for businesses. The CIR rules are applied after and in addition to the Transfer Pricing rules. The CIR rules are complex, however if the group has a net interest expense in the UK less than £2m per annum the restrictions will not apply.
The rules restrict the amount of net interest expense that a group can set against taxable profits to 30% of its earnings before interest, tax, depreciation and amortisation (EBITDA) taxable in the UK (the fixed ratio method). An optional alternative restriction allows net interest expense up to an amount calculated by reference to the net interest to EBITDA ratio for the worldwide group (the group ratio method).
It will be necessary for the MBO team to identify whether the CIR rules apply, if they do, identify what the ‘CIR Group’ is and submit the CIR return. This is usually something that will require specialist tax advice.
Late paid interest rules
If the late interest rules apply, a tax deduction is only available when the interest is actually paid, not merely accrued.
Where a loan is made to a ‘close company’ by an individual who is a participator in the company, interest is only relievable on an accruals basis if the interest is actually paid within 12 months of the accounting year end. This will often include interest on deferred consideration or loan notes owed to vendors. Care must be taken not to claim a tax deduction too early.
Broadly, a close company is a company which is controlled by five or fewer participators (shareholders) or which is controlled by its directors. Consequently, most MBO companies are likely to be close companies for these purposes.
Deductibility of transaction costs
Transaction costs such as legal fees, tax advisory fees, cost of raising finance and corporate advisory fees are likely to have been incurred during the MBO. An analysis will be required to ascertain which of the fees are corporation tax deductible and which are not. Costs which are regarded capital in nature will not be deductible. Costs incurred up to the point that a decision is made to proceed with the transaction, such as due diligence costs, may be deductible.
This matter should be addressed early on in the deal process to ensure that invoices are addressed to the correct company, for example bank arrangement fees are not deductible in the hands of target if the loan is advanced to a different company in the acquisition structure.
Costs of raising finance are likely to be deducible as there are specific tax provisions in respect of these costs. Generally, these tax deductions follow the treatment applied in the financial accounts.
If some of the transaction costs paid by the company are actually advice to management rather than the company, then this will give rise to a Benefit in Kind which needs to be reported on the individuals’ annual P11D forms.
VAT Recoverability for transaction costs
VAT will be incurred on costs connected with the transaction e.g. legal and professional fees. A company will not be able to recover VAT on fees paid for services it has not been a beneficiary of e.g. legal fees incurred by a lender but recharged to a company.
Costs which a company has incurred, and for which it has received a benefit from the services provided, should be capable of being treated as an overhead cost of its business. However, if the business makes no taxable supplies, then the VAT on incurred on deal fees will be irrecoverable. The issue regarding taxable supplies is often addressed via the provision of management services to the target company. This is often the case when the acquisition vehicle (“Newco”) is responsible for paying deal fees, but would not be an issue when the target company pays the fees.
If Newco intends to provide management services to its subsidiaries post completion, it will need to register for VAT as an intending trader. This should be addressed as early as possible during the deal process to ensure timely recovery of input VAT.
Employment Related Securities (“ERS”) Other Annual Return (formerly known as Form 42) reporting
The acquisition of shares or securities by the management team must be reported using HMRC’s online portal by July 6 following the end of the tax year in which the MBO occurs.
Payment of corporation tax
Small companies must pay corporation tax within nine months and one day of the accounting period end.
It is possible that one or more of the MBO companies could fall within the instalment payment regime as a large company or even a very large company for corporation tax purposes. The use of new company to acquire the MBO target may result in there being two 51% related group companies for determining the profit thresholds.
Broadly, a large company is one whose profits in any accounting period exceed £1.5m but do not exceed £20m and a very large company is one whose profits in any accounting period exceed £20m, with these limits shared between all 51% related group companies.. Some thought should therefore be given to structuring the transaction to reduce the number of active group companies.
Conclusion
This article has sought to highlight a few of the main company tax issues that need to be addressed following an MBO. There will likely be others! As always, Claritas is here to help.
