Tax and tax law aspects relating to the exit

Case 1: Mixed contract: continued employment and non-competition clause

1. facts of the case

Disrupt AG, based in the canton of Zurich, is a start-up in the field of artificial intelligence development. It was founded jointly by Anna, Ben and Clara at the beginning of 2016 as an ETH spin-off. Anna, Ben and Clara all live in the canton of Zurich. They each held a one-third stake in the company when it was founded. Anna is the CEO of Disrupt AG, Ben is the head of the development department (CTO) and Clara is responsible for finances and attracting investors (CFO).

In order to cover ongoing capital requirements, private equity investors subscribed to further shares in Disrupt AG as part of capital increases in 2020 and 2022, meaning that the three founders now each hold 20% and the investors 40%.

Disrupt AG was loss-making until 2023 and was therefore constantly reliant on capital, which was provided in the form of equity and borrowed capital. A modest profit of CHF 50,000 is expected for 2024. Disrupt AG has 12 employees, including the founders.

Anna, Ben and Clara, all three of whom work at Disrupt AG, were paid a relatively low salary of CHF 60,000 p.a. up to and including 2022. In 2023, the gross salary was increased to CHF 120,000 per founder (all with a 100% workload).

The standard market salary is CHF 220,000 for Anna and CHF 200,000 for Ben and Clara.

A potential exit is on the horizon in 2024. A US technology company wants to acquire 100% of the shares in Disrupt AG. The US technology company wants to use the emerging breakthroughs in development for its own office software.

The share purchase agreement provides for a purchase price of CHF 20,000,000 for all shares in Disrupt AG. The purchase price is divided symmetrically between the shareholders, i.e. Anna, Ben and Clara each have a purchase price share of CHF 4,000,000 (a total of CHF 12,000,000 for the founders).

50% of the purchase price attributable to the founders (i.e. CHF 6,000,000) will be deposited in a blocked account (escrow) for two years ("holdback"). During this period, the salary for the three is to amount to CHF 150,000. In addition, a non-competition clause of two years is agreed and reinforced with a contractual penalty.

In the event of early termination, the escrow amount is forfeited (100% for termination in the first year and 50% for termination in the second year) and is transferred back to the buyer from the escrow. This holdback only applies individually, i.e. if Anna cancels early, for example, Ben and Clara do not lose their claim.

Questions

1. As an advisor, what would you recommend to founders when drafting the share purchase agreement?
2. Show the income tax consequences for Anna, Ben and Clara resulting from the sale of the shares?
3. Do you see a tax problem in connection with continued employment and escrow in the event of early termination?

Case 2: Reverse participation

1. facts of the case

Tech AG is held 50% each by its founders A and B (both founders resident in Switzerland). On July 1, 2024, A and B sell their shares to LuxCo, an acquisition vehicle for a private equity fund, for a price of CHF 50 million. A and B receive 70% of the purchase price in cash (i.e. CHF 35 million), the remainder is settled in 30% of the shares in LuxCo, i.e. the founders each invest 15% of their shares in Tech AG in LuxCo and receive LuxCo shares in return.

The founders remain employed by Tech AG, with salaries in line with the market. There is a shareholders' agreement between the shareholders of LuxCo, which contains the usual clauses such as purchase rights and purchase obligations (drag-along/tag-along), voting quotas, etc. However, there are no obligations to continue employment and no obligations to return the shares in LuxCo (i.e. no good leaver or bad leaver clauses). Furthermore, no non-competition clause is agreed.

LuxCo is financed with 30% equity and 70% debt (bank loan). There are no preference shares.

Variant: Good-leaver and bad-leaver clauses are agreed in the shareholders' agreement, according to which A and B must sell 5% of their shares (i.e. a total of 10%) to the fund at a fixed formula price. There are no such obligations to return the remaining shares.

On June 30, 2028 (exactly four years later), the shareholders will sell all shares in LuxCo to a third party for a price of CHF 100 million.

Questions

• What are the income tax consequences of the sale of Tech AG for A and B?
• How can the minority interests of A and B in LuxCo be qualified from a tax perspective? What needs to be considered?
• Explain the tax consequences for A and B of the sale of the minority interests in LuxCo.

Case 3: Asymmetrical purchase price allocation

1. facts of the case

A and B are founders of Prodo AG, a start-up based in the canton of Zurich, which programs CAD software for the manufacture of hearing aids and dental implants. A and B are also domiciled in the canton of Zurich. They each hold 50% of the capital shares, but A has a voting majority of 80% through his voting shares (share capital of CHF 100,000, 400 voting shares with a nominal value of CHF 125 and 100 ordinary shares with a nominal value of CHF 500, A holds all 400 voting shares and B holds all 100 ordinary shares):

Both founders are employed by Prodo AG and receive a normal market salary. Dent AG, a listed dental implant manufacturer, is one of Prodo AG's most important customers and would like to strengthen its ties with Prodo AG. It therefore acquires half of the voting and capital shares of A and B respectively. Following this transaction, the shareholding rights are as follows:

Dent AG pays the two founders a total purchase price of CHF 10 million, with A receiving a share of CHF 6,000,000 and B a share of CHF 4,000,000. As part of the share purchase agreement, A and B undertake to work for Prodo AG for a further two years and also enter into a non-competition clause.

Variant: Prodo AG has no preference shares and A and B hold exactly 50% of the capital and voting shares, but the same asymmetrical purchase price allocation occurs as in the previous case. Prodo AG is an eye clinic and A and B are ophthalmologists at Prodo AG. A and B receive a relatively low fixed salary of CHF 80,000 per year. The remaining salary depends on the respective turnover generated, with both doctors keeping a divisional account. Immediately before the sale, the turnover figures were as follows:

After the sale, A and B receive a normal market salary and enter into a temporary non-competition clause.

Question

What are the income tax consequences of the sale of the shares in Prodo AG for A and B?

Case 4: Indirect partial liquidation / "warm-up" / authoritative conclusion

1. facts of the case

Albert sells 100% of the shares in his start-up "Transform AG" to the investment company "Investotron AG" for CHF 5,000,000 on May 15, 2024 (binding transaction). Albert held the shares as private assets prior to the sale and was their founder. The annual financial statements as at December 31, 2023 had not yet been prepared at the time of the sale; the profit as at 2023 is expected to amount to CHF 800,000. As at May 15, 2024, the non-operating funds amounted to CHF 1,400,000.

The balance sheet of Transform AG as at December 31, 2022 prior to the sale can be presented as follows

Following the sale, Transform Ltd. will distribute a dividend of CHF 1,300,000 to Investotron Ltd. on July 15, 2024 based on the 2023 annual financial statements now available.

Questions

1. Assess the tax consequences of the dividend distribution on June 15, 2024.
2. Variant: The sale will take place on July 1, 2024. The annual financial statements for 2023 have not yet been approved by the Annual General Meeting.

Case 5: Indirect partial liquidation / holding company

1. facts of the case

Albert holds 100% of the shares in X Holding AG. X Holding AG is a holding company and in turn holds 100% of the shares in X AG. Albert founded X AG as a start-up in 2016 and has been its CEO since its foundation. In 2018, he contributed X AG to X Holding AG as part of a non-cash contribution (variant: in March 2024). In order to avoid income tax consequences under the title of transposition, the contribution was made solely against the existing share capital of X AG of CHF 100,000 at the time of the contribution.

On July 15, 2024 (commitment transaction), Albert sells 100% of the shares in X Holding AG to Y AG at a price of CHF 5,000,000.

The approved annual financial statements 2023 of X Holding AG are available for sale. The balance sheet of X Holding AG as at December 31, 2023 can be presented as follows

The approved annual financial statements 2023 of X AG are available for sale. The balance sheet of X AG as at December 31, 2023 can be presented as follows

On July 20, 2024 (i.e. after the sale), X AG will distribute a dividend of CHF 900 to X Holding AG. The balance sheet of X Holding AG as at December 31, 2024 can be presented as follows

Based on the balance sheet as at December 31, 2024, X Holding AG distributes a dividend of CHF 900,000 to Y AG on July 15, 2025.

Question

Assess the income tax consequences of the dividend of CHF 900,000 from X Holding AG to Y AG for Albert.

Case 6: Integration of the target (ITL)

1. facts of the case

The Eye Group, combined under EyeHold AG, operates various eye clinics in Switzerland. In the past, it has acquired various eye clinics that were managed in the form of corporations, including A AG and B AG. The sellers were always natural persons domiciled in Switzerland. At the time of sale, A AG and B AG each had non-operating and distributable assets of CHF 500,000 and hidden reserves of CHF 300,000.

EyeHold AG would like to simplify its structure. To this end, the target companies are to be absorbed into the main operating company, Eye AG. Eye AG is also a subsidiary of EyeHold AG.

Variant: Eyes AG is the parent company of the absorbed A AG and B AG (subsidiary absorption).

Option 2: Eyes AG (sister company) has a (qualified) capital loss in accordance with Art. 725a CO (reorganization merger).

Option 3: A AG was founded in 2022 (two years before the sale) via a tax-neutral conversion with retroactive effect from 1.1.2022. On May 14, 2024, A AG is sold by its founder to Eyes AG for a price of CHF 1,000,000.

The sale triggers income tax consequences at the level of the founder on the hidden reserves existing at the time of the conversion (Art. 19 para. 2 DBG). The amount of hidden reserves at the time of the conversion is decisive. The sale triggers income tax consequences at the level of the founder on the basis of CHF 500,000.

This relates to the goodwill existing and deposited at the time of sale (no hidden reserves on assets/debt capital), which must now be taxed due to the breach of the blocking period. A AG generates a profit of CHF 150,000 in 2022 and 2023, but "only" pays tax on CHF 50,000 in the tax balance sheet due to the amortization of goodwill of CHF 500,000 (straight-line amortization of 20% over 5 years):

The assets available at the time of sale and distributable under commercial law (as at the balance sheet date of 31.12.2023) amount to CHF 250,000 (total annual profits of CHF 300,000 minus the legal reserve of 50% of the share capital of CHF 100,000). The residual amount of goodwill capitalized for tax purposes at the time of sale is CHF300,000. In June 2024, A AG distributes a dividend of CHF 250,000 to EyeHold AG (option 4: A AG is liquidated).

Questions

1. Do the sister mergers have tax consequences for the sellers? If so, to what extent?
2. Variant: Does the subsidiary merger have tax consequences for the seller? If so, to what extent?
3. Option 2: Are there any tax consequences from the sister merger (reorganization merger)? If so, to what extent?
4. Variants 3 and 4: Will the distribution or liquidation of A AG have tax consequences for the sellers? If so, to what extent?

Case 7: Integration of the target

(Based on VGer ZH SB.2022.00060 of October 4, 2023).

1. facts of the case

Therap AG, based in Zurich, is a biotech company specializing in the development of innovative remedies. The company was founded in 2013.

On June 16, 2024, it was acquired by the listed US pharmaceutical group Peters & Peters via a specially established acquisition company based in the UK for a price of CHF 50,000,000.

On the same day, Therap AG concluded an agreement with the newly founded P&P Austria AG, a Peters & Peters Group company based in Austria, under which it has agreed to provide

• general and administrative services relating to the distribution of P&P Austria AG products, and
• P&P Austria AG is committed to research and development, whereby the research results belong to P&P Austria AG.

Therap AG is remunerated for these services on a cost-plus-10% basis. An annual profit after tax of CHF 100,000 is expected. The newly founded P&P Austria AG is expected to generate a profit of CHF 800,000 p.a. based on the contracts entered into.

Also on 16 June 2024, Therap AG sold all intellectual property rights (IPR) and non-viral contracts to P&P Jersey Ltd, a Group company based in Jersey, for a price of CHF 25 million. The carrying amount of the intellectual property is CHF 10,000,000 and corresponds to the capitalized research costs.

Finally, Therap AG also sold all of its remaining operating assets to P&P Austria AG. As the remaining operating assets showed a surplus of liabilities at book value, Therap AG compensated P&P Schweiz AG an additional CHF 1 million for this transfer.

In the consolidated annual report, Peters & Peters allocated the purchase price for the investment in Therap AG as part of the purchase price allocation (PPA) as follows:

• CHF 40 million for intellectual property and non-viral contracts
• CHF 500,000 for operating fixed assets
• CHF 9.5 million cannot be allocated to specific assets (i.e. goodwill)

Questions

Identify the potential profit tax consequences for Therap AG of the following transactions:

• a. Intellectual property for sale
• b. Sale of operating fixed assets
• c. Conclusion of an agreement regarding general/administrative services and contract research (R&D).