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?

On a day-to-day basis, the acquisition of stock is one of the most frequently used alternatives to gain control of a target company. From a tax perspective, the acquisition of stock has many virtues; among them, the fact that the sale of stock in a company is generally not subject to value added tax or that tax attributes of the target company are included in the acquisition thereof.

As mentioned above, the acquisition of stock includes tax attributes. However, it should be noted that tax liabilities prior to the transfer of the business are also included therein, thus outlining the paramount importance of conducting thorough accounting, legal and tax due diligence. (For further details, see question 9.)

Notwithstanding the foregoing, certain aspects must be taken into account when opting for this alternative. For instance, in some cases where certain tax requirements are not met, tax consequences for a non-resident purchaser could be triggered. Income tax could be triggered in operations in which non-residents acquire stock issued by a Mexican resident when tax authorities determine that the market value thereof exceeds the purchase price by more than 10 per cent.

A common alternative to the acquisition of a target company via stock purchase is the acquisition of the business assets thereof. In general terms, this option consists of the purchase of the assets that are essential for the operation of the target company. In a sense, this alternative enables the acquirer to handpick the assets that are considered valuable and discard other items deemed as a burden for the business in question.

Moreover, tax authorities may permit certain authorised deductions in connection with the calculation of income tax due for the acquisition of the business assets. Nevertheless, it is important to point out that pursuant to applicable Mexican tax laws, goodwill may not be deducted.

Unlike acquisition of stock, the general rule is for acquisitions of business assets to be subject to value added tax, and, whenever real estate is involved in the operation at hand, federal and local taxes thereupon could be triggered.

Furthermore, in an asset deal, in terms of article 26(iv) of the Federal Tax Code, the acquirer could be jointly liable for contributions generated prior to the acquisition of the ongoing business for up to the value of the business itself (the full price paid for all the assets).

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?

In connection with the acquisition of stock, no step-up in basis is considered regarding assets of the target company; in general terms, the step-up in basis only occurs concerning the price paid for the purchased stock. (The tax basis of the assets remains the same, thus, no step-up in basis could be deemed to exist.)

With reference to the acquisition of business assets, the basis for the acquisition will be the amount effectively paid therefor and allocated to each asset; hence, a step-up in the basis thereof could be considered.

Additionally, in the latter, both fixed assets and intangibles may be deducted through the straight-line method, bearing in mind that goodwill, among other items, may not be deducted for income tax purposes.

Other items, such as investments in fixed assets, cost and deferred charges, preoperative expenses, technical assistance and royalties may be deducted in the percentage set forth in the corresponding provisions for each item.

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 numerous aspects that must be carefully analysed in order to decide whether to acquire a target company directly (as a non-resident) or indirectly by means of a (Mexican) resident company.

In a stock deal, in cases where the purchase of the target company is made by the non-resident by means of a Mexican entity, the cost of the acquisition will be generated at the level of the first (ie, due to a capital increase in the resident company used for the purchase) and, indirectly, at the target company’s level. From a tax standpoint, tax consequences deriving therefrom could be either adverse or beneficial depending on several factors (such as the target company’s financial position in the relevant tax year).

Should the non-resident decide to perform the acquisition of the target company on its own, tax treaties executed by Mexico ought to be kept in mind given that certain benefits pertaining to the distribution of profits, capital gains, payments on interests, etc, from the target company to the purchaser could apply depending on the applicable tax treaty.

In an asset deal, if the acquiring entity resides abroad, a permanent establishment could be deemed to exist in cases where a non-resident acquires the essential assets directly and continues the operation thereof. Accordingly, the non-resident could be taxed over Mexican-sourced income and, in cases where a permanent establishment is deemed to exist, over income attributable thereto as well.

Regardless of the foregoing, other options such as special purpose vehicles could be considered in order to perform a tax-efficient acquisition, reducing exposure to liabilities.

Company mergers and share exchanges

Are company mergers or share exchanges common forms of acquisition?

From a tax perspective, mergers (provided that both of the parties involved are Mexican residents for tax purposes) tend to be more efficient than share exchanges. The foregoing is the case, given that mergers may be treated as tax-free transactions, provided that certain requirements are met. In that sense, it is common that mergers do not cause income tax or value added tax. (Exceptions may apply.)

Likewise, tax attributes of the merged company may be passed down to the surviving company. (Certain exceptions such as net operating losses may apply).

Pursuant to applicable Mexican tax laws, share exchanges are a tax-efficient alternative only to corporate restructures of entities of the same group, as any share exchanges could be considered as a double sale with the corresponding tax consequences (a taxable transaction for both parties).

Tax benefits in issuing stock

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

From a corporate standpoint, the issuance of stock by the acquirer as consideration could prove to be a convenient strategy. Likewise, the convenience thereof could lie in cases where the acquirer has a cash shortage or cash flow-related complications.

Nonetheless, in general terms no tax benefit is included in the applicable Mexican tax laws with regard to this alternative. Thus, even in cases where the purchaser issuing the stock might not trigger tax consequences, the recipient thereof could in fact have to face tax repercussions similar to a cash deal.

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?

Mexican tax laws do not contain documentary taxes such as stamp duties in connection with the acquisition of stock or business assets. However, value added tax is due in the performance, either by individuals or legal entities, of certain activities. In this regard, and as mentioned in question 1, value added tax could be payable concerning asset operations (ie, asset purchase agreements) in which business assets are acquired (certain exceptions, such as account receivables, may apply).

According to the Mexican value added tax law, the general tax rate is of 16 per cent. The sale of certain goods may be subject to a rate of zero per cent or even exempted from the tax at hand.

In connection with operations and transactions carried out after the acquisition of a target company by means of an asset purchase agreement, distinguishing between activities subject to a zero per cent value added tax rate and those that are exempted thereof is vital given that, while the first may allow the crediting of paid value added tax, the latter do not give rise to such benefit.

In recent years, tax authorities have assumed an aggressive position towards value added tax refund claims, slowing down refund procedures, whereby legal action is often necessary in order to obtain a favourable resolution. The foregoing should be kept in mind due to the cashflow implications that could derive therefrom.

It is important to point out that even though the transfer of land (not including the transfer of other properties contained therein, that is, only the value of the soil) might be deemed as a value added tax-free operation, whenever real estate is involved in the acquisition of business assets, local taxes may be due (ie, transfer tax).

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?

Whenever the amount of authorised deductions exceeds the amount of taxable income, tax losses will be deemed to exist. Such losses may be used to reduce the taxable profit for the subsequent 10 tax years, until fully amortised. However, when in a given year a taxpayer fails to carry forward tax loss carry-forwards, even though such taxpayer could have done so, said taxpayer shall forfeit the right to do so in subsequent years, for up to the amount that could have been carried forward.

When there is a change in the partners or shareholders that control a company with pending tax loss carry-forwards and the sum of the company’s income in the preceding three years is less than the amount, updated for inflation, of those losses at the end of the last year before the change of partners or shareholders, such company may carry forward losses only to offset tax profits corresponding to the same type of business activities in which the losses were sustained.

Lastly, it should be noted that concerning mergers, the surviving companies are not entitled to use the losses generated by the merged companies and that losses of the surviving companies may only be used against gains generated as a result of the same type of business activities that gave rise to the losses prior to the merger.

According to Mexican tax laws, no special rules or preferential tax regimes apply for the acquisition of target companies subject to insolvency or bankruptcy procedures. However, taxpayers subject to such procedures may reduce debts remitted by their creditors (following the procedure set forth by the applicable laws) from pending losses in the relevant tax year in which the debt remittance took place. In cases where the amount corresponding to the remitted debts is greater than the pending losses, the differences therefrom should not be considered as accruable income unless the debts in question were originated by transactions between related parties.

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?

Mexican tax authorities and laws have assumed an aggressive position towards items related to or classified as interest payments. In that sense, in order for such payments to be deductible, certain requirements must be complied with. Therefore, thin capitalisation, transfer pricing and back-to-back rules, among other requisites, ought to be observed for such purposes. As outlined hereunder, the deductibility thereof is heavily conditioned.

Bearing the foregoing in mind, interest payments on borrowings obtained by a Mexican resident in order to acquire a target company could be deductible for income tax purposes provided that the lender’s corporate purpose includes acquiring, holding and transferring stock of other companies.

Concerning the deduction of interest payments between resident companies and foreign related parties, certain thin capitalisation rules ought to be abided by. Resident companies may only be entitled to deduct such payments as long as the total amount of debt contracted does not exceed three times the company’s net worth. In cases where such debt-to-net-equity ratio is not complied with, interest payments would not be deductible for income tax purposes.

In connection with the above-mentioned, it is important to point out that companies engaged in specific industries (ie, the financial system and certain activities related to the country’s strategic sectors) may be permitted to have higher debt-to-net-equity ratios, provided that the tax authorities grant them an authorisation therefore.

Moreover, with regard to the applicable transfer pricing rules, corporate entities entering into transactions with non-resident related parties must determine their accruable income and authorised deductions bearing in mind that the price and other compensation for such transactions are equal to the amount that would have been paid to independent parties on an arm’s-length basis.

Concerning back-to-back rules, yields on credits between related parties could receive the same treatment as if they were dividends.

Interest derived from foreign taxpayers is subject to income tax via withholding; nonetheless, non-resident parties should keep in mind that tax treaties entered into by Mexico could provide them with reduced withholding rates applicable thereto.

According to Mexican tax laws, debt pushdown is not an allowed practice. That being said, some operations between related parties could be deemed as debt pushdown operations. In this regard, tax authorities, considering that no business motives are involved in such transactions, have denied the deduction of interest.

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?

As outlined in question 1, any tax liability prior to the acquisition of stock in the target company remains therewith after the transaction takes place.

Consequently, adequate representations and warranties in the negotiation proceedings are of paramount importance in order to minimise or avoid any potential tax liabilities or contingencies, to enable the acquirer (and in some cases even the target company) to seek indemnity, as well as to ensure that the seller’s indemnities are backed up by collateral.

Likewise, regarding the acquisition of business assets, the purchaser could be jointly liable for taxes due by the seller of the ongoing business prior to the transaction, for up to the value of the business. In addition, other liabilities must be taken into account, for example, labour liabilities.

Based on the foregoing, it is essential to conduct exhaustive accounting, corporate and tax due diligence in order to verify the target’s tax compliance, identify potential liabilities and, consequently, establish strategic vantage points in the negotiation proceedings.

The purchaser (or the target company) could be entitled to seek indemnity from the seller in cases where tax authorities determine the existence of liabilities or that tax due was not duly paid prior to the acquisition. In this respect, it should be noted that pursuant to the Federal Tax Code, the statute of limitations regarding tax authorities’ auditing powers is five years, although certain exceptions may apply, in which the statute of limitations is 10 years.

In general terms, resident companies or permanent establishments that receive indemnity-related payments ought to accrue such items for income tax purposes. Concerning non-residents, income tax due should be determined over the total amount of indemnities or damages paid by resident companies or permanent establishments located in Mexican territory.

Regarding forms of protection generally sought for stock and business assets acquisitions, the most common mechanism used by the purchasing party is to deposit a percentage of the purchase price in an escrow account for a certain period of time in order to cover the seller’s indemnity obligations. Tax indemnity insurance is available in Mexico, but is not commonly used.