Lessons learned from the Inhouse M&A Tax Department

Case 1: Sale

Initial situation

NoSy AG is the operational parent company of an international group headquartered in Switzerland. NoSy AG acts as the headmaster company within the group, i.e. it assumes the relevant strategic functions in the areas of research and development, production, sales and all financial functions relevant to the group.

NoSy has subsidiaries in almost every country in the world. The IP is held centrally in Switzerland and the foreign group companies are either low-risk distribution companies (LRD), contract researchers or contract manufacturers for the Swiss parent company.

1. basic facts

The foreign ProdCo produces almost exclusively for the parent company NoSy AG. It works on behalf of NoSy AG and is compensated on the basis of its costs, including a margin in line with the market.

In recent years, ProdCo has made some investments in its production facilities, as a larger production volume was expected. The financing of the production plant was taken over by NoSy AG.

Due to changed market conditions, it has become apparent in 2021 that the increase in sales expected by NoSy AG will not materialise and that ProdCo's production capacity can never be filled, neither now nor in the future. NoSy AG has therefore informed ProdCo in writing that production volumes will drop significantly in the coming weeks and months and that it will not be able to use the free capacities for other purposes.

The management of NoSy AG and ProdCo have examined various alternatives and have come to the conclusion that the sale of the production facility is the only viable option. Accordingly, the M&A department was commissioned with the sale of the production site and a sales process was initiated. ProdCo's only asset is the production facility.

During discussions with potential buyers, it became apparent that the production facility is slightly oversized for all buyers. Accordingly, all purchase price offers are below the current book value of CHF 100m (statutory and IFRS identical). As a continuation of production is not an alternative for NoSy AG and ProdCo, the sale below book value was accepted and a purchase agreement was concluded with the buyer at a price of CHF 60m. The purchase agreement was signed at the end of 2021; closing is expected in mid-2022.

Questions

1. What questions will you receive from your colleagues in the Accounting Department?
2. What discussions do you need to have with the transfer pricing team?
3. What do you share with the deal team regarding transaction tax?

2. purchase price allocation

In addition to the production facility, the buyer also wants to acquire the entire product portfolio. The corresponding intangible assets belong to NoSy AG (self-developed).

The buyer is still not willing to pay more than CHF 60m for the production facility (book value CHF 100m). Instead, he sees the value driver in the intangible rights to the products. The buyer submits its offer to purchase a total of CHF 260m, stating in writing that it will pay CHF 200m for the intangible rights and CHF 60m for the production facility.

Questions

1. What discussions will you have with local management regarding purchase price allocation?
2. What will you tell the legal department that is drawing up the purchase contract?

3. pre-closing restructurings

ProdCo operates other production facilities which the buyer does not wish to acquire. The seller and the buyer agree that the production plant to be sold shall be transferred to a new company by way of a spin-off and that the buyer shall then acquire NewCo. The spin-off of the production plant to NewCo is included as a precondition in the purchase agreement. (Values analogous to basic facts, i.e. book value CHF 100m, sales price CHF 60m).

Questions

1. What discussions do you have with the accounting department?
2. What problems could arise with the auditors?

4. purchase price adjustment

NoSy AG has decided to fully divest the entire product division. Accordingly, the transaction perimeter includes the ProdCo (share deal), the SalesCo (share deal) and the intangible property rights (asset deal). The ProdCo and SalesCo are held by the local foreign holding company. NoSy AG owns the intangible rights (self-developed).

The contract negotiations are conducted by NoSy AG and it is included in the contract as the only contracting party. The buyer also appears in the contract only with its group parent company. However, the various assets are acquired by different buyer companies: ProdCo, SalesCo by the local buyer company. The intangible rights through the IPCo.

The two parties agree on an initial purchase price of CHF 500m. Due to the "Closing Accounts", there is a purchase price adjustment (increase) for the ProdCo and SalesCo of CHF 20m in total.

Questions

1. What problems do you address with the legal department?
2. What questions do you receive from the Treasury Department?
3. What does the local holding organisation want to know from you regarding purchase price adjustment?

Case 2: Acquisition

Initial situation

NoSy AG is the operational parent company of an international group headquartered in Switzerland. NoSy AG acts as the headmaster company within the group, i.e. it assumes the relevant strategic functions in the areas of research and development, production, sales and all financial functions relevant to the group.

NoSy has subsidiaries in almost every country in the world. The IP is held centrally in Switzerland and the foreign group companies are either low-risk distribution companies (LRD), contract researchers or contract manufacturers for the Swiss parent company.

1. basic facts

The M&A department is currently looking at a target company (TargetCo) in Brazil. The company is held by the Brazilian sole shareholder Mr V, who is himself the founder, managing director and - indispensable - research director of TargetCo. TargetCo is operationally active in Brazil (R&D, production, sales) with about 250 employees and generates annual operating profits (operating margin of about 25%). The IP is registered in the name of a deeply taxed offshore company (OffshoreCo), which itself has no local staff and does not exert any strategic influence on research in Brazil. Nevertheless, a local law firm provides the defence and enforcement of the IP in the relevant markets. OffshoreCo is also 100% owned by Mr. V.

The tax due diligence revealed tax risks in the amount of approximately USD 20-30m, primarily in the area of indirect taxes at TargetCo. The purchase price to be offered in the first round (non-binding offer, "NBO") is around USD 150m. The sale will take place by means of an auction process, i.e. there are other bidders involved.

Questions

1. What does the M&A department want to know from you in order to complete the offer or the business case?
2. What does the legal department want to know from you in order to be able to draft the purchase contract or comment on the contract proposed by the seller?
3. What do you want to know from the consultant - apart from the final DD report?
4. What does the Head of Tax want to know from you?

2. purchase price allocation and acquisition structure

Not surprisingly, the seller informs us that he would like to sell the IP as part of an asset deal and that, in his view, at least 50% of the purchase price should be allocated to the IP. TargetCo, on the other hand, is to be sold as part of a share deal. The seller would also like to have only one party on the seller (OffshoreCo) and buyer side (NoSy AG) in order to simplify the transaction.

From the buyer's perspective, a direct purchase of the IP is generally preferred. Regarding participation, the local advisor confirms that a purchase through the local branch of the NoSy Group in Brazil, followed by an absorption of TargetCo, allows for the amortisation of goodwill.

Questions

1. What does the M&A department want to know from you?
2. What does the legal department want to know from you?
3. The treasury department contacts you and criticises the idea of acquiring a local shareholding; that is not good. What was overlooked?

3. risk management

The seller does not think that the risks mentioned in the Tax DD could materialise at some point and is therefore strictly against a partial purchase price reduction.

Questions

1. What risk management options are there and which are promising in practice?
2. What problems arise with regard to indemnification, representations and warranties?
3. What problems arise with the earn-out?
4. What needs to be considered if the seller would be a) an industrial seller (e.g. competitor), b) a PE firm or c) a large number of shareholders (in case of listing or heterogeneous shareholder structure)?

4. post-deal

We are in the eighth month since closing. The former owner continues to work in his company, which now belongs to the NoSy Group, and also contributes his knowledge in other areas for the benefit of the NoSy Group. Unfortunately, the risk of a set-off for the indirect taxes (in the period before closing) in Brazil is imminent, i.e. that the risk identified in the DD could materialise. The purchase agreements provide for full indemnification for tax liabilities that occurred before closing.

Questions

1. You want to create a provision for the possible tax liabilities. Is this possible within the framework of purchase accounting (against goodwill) or what do the auditors think?
2. Now that you have control over the books, consider starting a post-deal tax DD. Will that make a difference?
3. The colleagues from the Swiss Tax Compliance Team ask whether turnover tax is to be settled. What do you answer?