Tax issues for natural persons as sellers
Workshop on the occasion of the ISIS) seminar on 27 October 2020 entitled "Tax pitfalls in Mergers & Acquisitions transactions".
Case 1 - Indirect partial liquidation
Zurich-based Snapp AG develops and produces electronic selection systems.
As a result of various financing rounds during the difficult start-up phase of Snapp AG, A (domiciled in ZH) only holds a minority interest of 30% at the time of the sale and the private equity partner (AJK Finance AG) holds a 70% interest.
A sells its 30% stake to AJK Finance AG for CHF 6 million. At the time of the sale, Snapp AG has reserves of CHF 4 million (as at 31 December 2019 until and including the sale) that are not required for operations and that can be distributed.
Six months later, AJK Finance AG sells its 100% shareholding to Kauf AG.
What are the tax consequences for A, if
- Kauf AG and Snapp AG merge with each other two years after the acquisition to exploit synergy potential.
- A grants AJK Finance AG a loan of CHF 3 million at the time of sale (the shares in Snapp AG serve as collateral) and AJK Finance AG decides to pay a dividend of CHF 2 million before the sale to Kauf AG.
A sells its 100% stake in Snapp AG held as private assets to AJK Finance AG, which was newly founded for the purpose of purchasing the stake, for a price of CHF 20 million.
AJK Finance AG has equity of CHF 4 million. The remainder of the purchase price is financed by a bank loan of CHF 6 million and a subordinated vendor loan of CHF 10 million. Both the bank loan and the subordinated vendor loan bear interest at 3%. The bank loan is to be repaid within 7 years. The subordinated vendor loan has a term of 12 years (excluding annual amortization).
At the time of the sale, Snapp AG has reserves of CHF 4 million (as of 31 December 2019 until and including the sale) that are not required for operations and that can be distributed. The profit for 2019 amounts to CHF 1 million.
Case 2 - Sales agreements
Run AG is based in Zurich and develops and produces running shoes. Run AG was founded in 2005 by A and B (both resident in the Canton of Zurich). They each hold 50% of the shares (nominal value CHF 100,000) as private assets. A is the creative mind behind the successful running shoes, head of production and CEO of Run AG. B is the chief financial officer.
On 1 June 2019, B sold 30% of its shares to A. He was prepared to give the shares to A at a price of only 80% of the property tax value according to KS SSK No. 28 as per 31 December 2018 (CHF 8 million) (purchase price CHF 1.92 million): He is of the opinion that A should continue to hold the majority of the shares in Run AG (80%) independently and in the spirit of the founders.
On 1 April 2020, Run AG was sold for CHF 10 million to Kauf AG, which is independent of Run AG and also based in Zurich. Before the sale, Run AG has no reserves that are not operationally necessary and distributable.
What are the tax consequences for A and B?
Facts variant 1
Run AG was founded on 1 April 2014. It is still developing its business activities. The partly already achieved turnover is not yet sufficient to cover the high development costs.
As part of a financing round in April 2019, an enterprise value of CHF 5 million was determined. Two months before the financing round, A had transferred 10% of Run AG to long-time employee C (resident in the Canton of Zurich). The purchase price corresponded to the pro rata equity according to the balance sheet of Run AG as of 31 December 2018 (net asset value for 10% = CHF 10,000). As part of the sale of the company on 1 April 2020 to Kauf AG for a total of CHF 10 million, C received CHF 1 million for the sale of his 10% interest.
What are the control consequences for C?
What are the tax consequences for A, if
- the latter waived a salary prior to the sale and subsequently receives a salary in line with industry standards.
- After the sale, the latter will receive a salary that is lower than the usual salary in the industry.
Situation variant 2
A and B each sold their 50% shares to Kauf AG on 1 April 2020 for a total of CHF 20 million. B received CHF 8 million for his 50% stake and terminated his employment with Run AG. A received a total of CHF 12 million for his 50% stake, of which CHF 5 million was deposited in an escrow account:
According to the purchase agreement, the amount of CHF 5 million will be released on April 1, 2022, provided the following conditions are met:
- The "RUN 'N' CLOUD" development project will be ready for the market by April 1, 2022;
- The revenue and return targets set out in section 6.1 will be achieved;
- The seller was employed by Run AG until 1 April 2022. If the employment relationship is terminated by 1 April 2022 at the latest, the entitlement of the buyer is reduced by CHF 200,000. Accordingly, if the conditions set out in points 1 and 2 are met, an amount of CHF 4.8 million is still released for payment.
How are any future payments to be assessed from a tax perspective?
Facts variant 3
With the sale, A also ends his further employment for Run AG. In the purchase contract a non-competition and non-competition clause is agreed for 3 years. A total amount of CHF 5 million is deposited in an escrow account for the various guarantees given in the purchase agreement.
What are the control consequences for A in the following variants?
- If the non-competition clause is complied with, an amount of CHF 300,000 is released from the "escrow account" for payment.
- The contractual penalty for breach of contract is CHF 1 million.
Situation variant 4
A and B set up a bonus pool of CHF 1 million for various employees.
What are the tax consequences for the bonus recipients and Run AG in the following variants?
- The buyer (Kauf AG) does not agree to the bonus pool and leaves the alignment to the sellers. A and B pay the bonus payments directly from the purchase price received.
- The buyer (KaufAG) agrees to the bonus pool, which reduces the purchase price by CHF 1 million. Run AG will pay the bonus payments to the employees of Run AG after the transaction.