Acquisitions (from the buyer’s perspective)

Tax treatment of different acquisitions

What are the differences in tax treatment between an acquisition of stock in a company and the acquisition of business assets and liabilities?

An acquisition of business assets allows a purchaser to choose the assets and liabilities that it acquires and ensures that it does not inherit the tax liabilities of the target company. As a result, a purchaser usually prefers to acquire business assets rather than stock. However, a purchaser based outside the United Kingdom may prefer to isolate its UK tax and legal liability in the target by acquiring its stock. A UK corporate seller will often prefer a stock sale because of the availability of the substantial shareholding exemption to exempt any chargeable gain from UK tax.

Historic and continuing tax liabilities

On an acquisition of stock, historic and continuing tax liabilities (including potential secondary tax liabilities) remain with the company (becoming the purchaser’s responsibility on acquisition). For this reason, a seller usually gives a tax covenant to the purchaser, allowing the purchaser to recover historic tax liabilities from the seller on an indemnity basis.

Generally, tax liabilities remain with the seller on an asset acquisition. However, where a transfer constitutes a ‘succession’ for tax purposes, the buyer will take over responsibility for end-of-year payroll and national insurance contributions (NICs) returns for the entire tax year in which the transfer takes place (although complications can potentially arise for certain NICs liabilities). For these reasons, it is not normal for a seller to give a tax covenant on an asset acquisition and tax warranties are generally limited to value added tax (VAT) and capital allowances, share schemes, payroll records, tax concessions and cooperation.

Transaction taxes

On an acquisition of stock, stamp duty or stamp duty reserve tax (SDRT) is payable by the purchaser at 0.5 per cent of the consideration paid for the stock (stamp duty rounded up to the nearest £5). Stamp duty land tax in England, land and buildings transaction tax in Scotland and land transaction tax in Wales (together, SDLT) is not payable. In addition, there is no VAT on the consideration.

On an asset acquisition, there is no stamp duty or SDRT charge (assuming no stock or marketable securities are transferred). However, SDLT will be payable by the purchaser (at various rates) on the purchase price allocated to the property. VAT is also payable on the purchase price, unless the acquisition involves the transfer of a business (or part of a business) to be used by the purchaser in carrying on the same kind of business as that carried on by the seller. This is known as a ‘transfer of a going concern’, and the VAT treatment is mandatory where the conditions are met.

Step-up in base cost

An acquisition of stock will not affect the target company’s base cost in its capital assets.

On an asset acquisition, there will be a step-up in the base cost of the assets acquired. Although the purchase price must be allocated to the individual assets acquired, the allocation set out in the contract is not always determinative. For example, His Majesty’s Revenue and Customs (HMRC) may challenge that apportionment as not being ‘just and reasonable’, any values allocated for generally accepted accounting practice purposes must be used instead for intangibles and special rules apply where a transfer is intra-group or between associated companies.

Tax assets

If a company holds valuable tax assets such as trading losses, acquiring stock enables the purchaser to acquire those assets and to use them to mitigate future tax liabilities of the company, subject to anti-avoidance rules. In contrast, on an asset acquisition, the tax assets of the company will typically remain with the seller. 

Step-up in basis

In what circumstances does a purchaser get a step-up in basis in the business assets of the target company? Can goodwill and other intangibles be depreciated for tax purposes in the event of the purchase of those assets, and the purchase of stock in a company owning those assets?

A purchaser will normally get a step-up in basis in the business assets of the target company on acquiring business assets. Where the seller is a third party, the purchase price should be allocated to the individual assets on a ‘just and reasonable’ basis and the purchaser’s base cost will be the amount allocated to each asset plus the incidental costs of acquisition. However, where a purchaser and seller are connected parties, market value rules apply.

Whether any assets are entitled to tax depreciation (and how much) depends on the nature of the asset, the amount paid for that asset and its market value (or, in some cases, the arm’s-length price).

Domicile of acquisition company

Is it preferable for an acquisition to be executed by an acquisition company established in or out of your jurisdiction?

There are many reasons why it is often preferable for an acquisition to be executed by a UK acquisition company, including:

  • the UK's corporation tax rate is as at the date of publication 25 per cent on profits over £250,000 (with a rate of 19 per cent applying to profits of £50,000 or less and marginal relief available for businesses with profits between £50,000 and £250,000) and effective tax rates can be reduced as the United Kingdom has attractive tax reliefs for research and development, intellectual property and capital allowances; 
  • the UK’s extensive double tax treaty network is available to UK companies to prevent double taxation and reduce withholding tax (WHT) on cross-border interest, royalty payments and other payments;
  • the United Kingdom has full domestic exemption from WHT on dividends and a broad exemption from tax on receipt of dividends by corporate shareholders;
  • the substantial shareholding exemption will often apply on a subsequent disposal of stock to exempt any gains from the charge to tax if the conditions are met;
  • tax relief for interest may be available to offset the target’s taxable profits or taxable profits from other UK companies (or UK permanent establishments of non-UK companies already owned by the purchaser) subject to interest deductibility restrictions, transfer pricing and anti-hybrid rules; and
  • tax losses can be transferred between group companies (subject to certain conditions).
Company mergers and share exchanges

Are company mergers or share exchanges common forms of acquisition?

The United Kingdom does not have a mechanism to effect legal mergers of entities; and since Brexit, the EU Mergers Directive is no longer available. However, it is common for acquisitions to involve share exchanges so that the purchaser issues shares in itself to the target shareholders as consideration for the shares in the target company. The main reason for doing this is so that, commercially, the seller has a continued vested interest in the success of the target company.

For tax purposes, where a target shareholder exchanges its shares for new shares as part of an acquisition, the shareholder is not treated as having made a disposal of the old holding for the purposes of capital gains tax provided certain conditions are met (share-for-share exchange relief). Instead, the shareholder is treated as having acquired the new holding at the same time, and for the same consideration, as the old holding. In addition, any new consideration given for the new holding is treated as having been given for the old holding (thereby increasing the amount of consideration for the old holding). When the new holding is eventually sold, tax will be payable on any gain arising, subject to the availability of any tax relief.

For shareholders holding more than 5 per cent of the share capital (or of any class of shares), share-for-share exchange relief only applies if the exchange is for bona fide commercial reasons and is not part of a tax avoidance scheme.

Tax benefits in issuing stock

Is there a tax benefit to the acquirer in issuing stock as consideration rather than cash?

Where the purchaser issues shares in itself to the target shareholder as consideration rather than cash (a share-for-share exchange) provided the conditions are met (including, for shareholders holding more than 5 per cent of the share capital (or of any class of shares), that the exchange is for bona fide commercial reasons and it is not part of a tax avoidance scheme), any chargeable gain arising on the disposal of the old holding of the target shares may effectively be rolled over into the new holding of shares in the purchaser entity so that the seller can defer its tax liability until an eventual disposal of the new holding. There is generally no particular tax benefit to the acquirer in issuing stock as consideration rather than cash.

Transaction taxes

Are documentary taxes payable on the acquisition of stock or business assets and, if so, what are the rates and who is accountable? Are any other transaction taxes payable?

Stock acquisition

Stamp duty or SDRT is payable on the consideration paid (or stock issued or debt assumed by the purchaser) for the transfer of that stock at a rate of 0.5 per cent of the value of that consideration. The stamp duty payable is rounded up to the nearest £5 for each instrument of transfer. SDRT is chargeable when an unconditional agreement to transfer shares is made. The payment of stamp duty usually discharges any SDRT charge that arises on the same transaction. In practice, SDRT generally only needs to be paid in the context of electronic share transfers on the Certificateless Registry for Electronic Share Transfer securities depositary platform where there is no physical instrument of transfer.

Stamp duty must be paid to HMRC within 30 days of the date of the instrument of transfer and confirmation of stamping by HMRC should be provided for the instrument of transfer to be admissible as evidence in civil proceedings and for the company’s statutory books to be written up.

Various stamp duty reliefs are available (if the relevant conditions are met), for example, intra-group relief, share-for-share exchange relief and reconstruction relief.

The UK government is considering modernising and consolidating the existing stamp duty and SDRT legislation, with a new single tax to replace them that is self-assessed and administered in line with the rest of the UK tax system. It has been proposed that it will be subject to clearer rules on geographical scope, tax base and calculation of liability. If reform goes ahead, we can expect draft legislation to follow and it is possible (although we expect unlikely) that change may occur during 2025.

The acquisition of stock is not subject to VAT.

Asset acquisition

Asset acquisitions are not subject to stamp duty or SDRT, assuming none of the assets are stock or marketable securities. However, SDLT in England, land and buildings transaction tax in Scotland and land transaction tax in Wales will generally be payable by the purchaser at various rates depending on whether the property is residential or non-residential and on the price allocated to the property on a just and reasonable basis.

VAT is also payable on the purchase price unless the acquisition is a transfer of a going concern.

Net operating losses, other tax attributes and insolvency proceedings

Are net operating losses, tax credits or other types of deferred tax asset subject to any limitations after a change of control of the target or in any other circumstances? If not, are there techniques for preserving them? Are acquisitions or reorganisations of bankrupt or insolvent companies subject to any special rules or tax regimes?

Corporate income loss restrictions

Carried forward trading losses are denied where there has been a change of ownership within three years before, or up to five years after, the losses were incurred and (among other conditions) there is a major change in the nature or conduct of the company’s trade. In addition, losses can only be set against up to 50 per cent of profits and gains exceeding the annual deductions allowance of £5 million (that amount is increased in certain situations).

Insolvent companies

Where a seller business is in administration or liquidation (or some other procedure such as a voluntary arrangement or a mortgagee in possession over certain assets), special tax rules apply. If the business is still trading, its VAT registration will continue, but the appointment of administrators and liquidators is notified to HMRC. When a company goes into liquidation it will have ceased trading (which triggers certain tax implications) and have lost beneficial ownership of its assets, which can cause issues such as loss of tax grouping (which could affect the availability of group reliefs for a business on an asset sale to a subsidiary). By contrast, going into administration does not itself result in cessation of trade or loss of beneficial ownership. HMRC has preferred status as an unsecured creditor, ranking ahead of holders of floating charges and unsecured creditors for the purposes of VAT, income tax under pay-as-you-earn, employee national insurance contributions, student loan deductions and construction industry scheme withholdings (and related interest and penalties for any of these), but not corporation tax.

Interest relief

Does an acquisition company get interest relief for borrowings to acquire the target? Are there restrictions on deductibility generally or where the lender is foreign, a related party, or both? In particular, are there capitalisation rules that prevent the pushdown of excessive debt?

Corporation tax relief is available in respect of interest payments by a borrower to a lender. However, this is subject to various restrictions set out in the following that limit tax relief for net interest and other financing costs.

Corporate Interest Restriction

The Corporate Interest Restriction only applies to individual companies or groups of companies that had net interest and financing costs of over £2 million in a 12-month period. Broadly, if it applies, the company’s or group’s net tax-interest expense for a period of account is limited to 30 per cent of the lower of:

  • its UK taxable profits before interest, taxes, capital allowances and some other tax reliefs; and
  • the company’s or group’s worldwide net interest expense (fixed ratio rule).

In addition, the company’s or group’s net UK interest deductions cannot exceed the global net third-party interest expense of the group (modified debt cap).

Anti-hybrid rules

Anti-hybrid rules deny deductions for arrangements that give rise to hybrid mismatch outcomes and generate a tax mismatch. For example, mismatches can involve either double deductions for the same interest expense or deductions for an interest expense without any corresponding receipt being taxable. The rules are complex, but broadly attempt to neutralise the tax mismatch created by arrangements by changing the tax treatment of either the payment or the receipt, depending on the circumstances.

Transfer pricing and thin capitalisation

Transfer pricing rules apply to limit tax deductions, where funds are borrowed or guaranteed from a connected party, to the amount that would have arisen if the lending arrangement had been entered into between unconnected parties. The United Kingdom does not have a separate thin capitalisation regime nor a formal thin capitalisation safe harbour and thin capitalisation concepts form part of the transfer pricing regime, with HMRC considering the level of debt, interest rate and other terms that would have been agreed between unrelated parties in determining the appropriate level of interest deductions.

Protections for acquisitions

What forms of protection are generally sought for stock and business asset acquisitions? How are they documented? How are any payments made following a claim under a warranty or indemnity treated from a tax perspective? Are they subject to withholding taxes or taxable in the hands of the recipient? Is tax indemnity insurance common in your jurisdiction?

Stock acquisition

A purchaser will normally seek to obtain a tax covenant or indemnity from the seller that enables it to recover the amount of any historic tax liabilities of the target company from the seller on a pound-for-pound basis. In other words, this should mean the purchaser is not out of pocket for any historic tax liabilities that the seller should have paid or accounted for during their period of ownership of the target company, and that have not been factored into the price of the acquisition by the purchaser.

A purchaser will also normally obtain a set of tax warranties from the seller. These serve a dual purpose as for:

  • information gathering (primarily to ascertain if there are any potential tax issues in the target that should be reflected in the purchase price, need specific indemnity cover, and (or) action post-completion); and
  • a further possible remedy if the purchaser suffers a loss as a result of a breach of warranty.

Payments by the seller following a claim under a warranty or indemnity should be treated as an adjustment to the purchase price and should not be subject to tax in the hands of the purchaser (unless the amount of the claim exceeds the purchase price) or any withholding obligations.

Warranty and indemnity insurance is frequently used to provide cover for the target company’s historic tax liabilities, particularly for situations where the seller intends to distribute the proceeds of sale to investors and limited recourse is available or in distressed sale scenarios where the purchaser has no real recourse available to it. If obtained, the insurer effectively stands in the position of the seller with regard to the tax covenant and tax warranties, although the use of the insurer’s standard form tax documents (synthetic tax deeds) is becoming increasingly common. It is also common for insurance policies to include strict limitations and they do not usually provide cover for known issues, secondary tax liabilities, transfer pricing issues and anti-avoidance issues unless special cover (which is increasingly available) is obtained.

Asset acquisition

A purchaser will not need a tax covenant or extensive tax warranties on the basis that, generally, the purchaser does not inherit the sellers’ tax liabilities and (or) assets. Tax protections under asset purchase agreements are generally limited to a small number of warranties and VAT provisions.