Enhancing equity value on a transaction

Establishing value from tax assets in a transaction can make a significant difference, increasing the proceeds received.?

By reviewing the completion mechanics of a transaction from a tax perspective early in the process, value can be maximised from both including tax assets inherent in the business and reducing net debt items to reflect the benefit of any tax savings arising from them.??

The completion mechanism (whether ‘locked box’ or ‘completion accounts’) should be reviewed from a tax perspective, and this should not be restricted to only the tax items in the debt schedule, but also the whole net debt schedule and the ‘equity ticker’ in locked box transactions.??

Value from tax assets?

The term ‘tax assets’ can take a wider meaning than what may initially be considered at face value – for example, beyond any corporation tax refunds known to be due or deferred tax assets recognised.??

A transaction provides the opportunity for tax assets to crystallise into cash tax savings. However, in order to ensure value is obtained for these tax savings in the transaction price, careful and early consideration is required so that a robust and seller-friendly position is articulated to bidders.?

Depending on the underlying nature of the business and its tax position, there could be several items which could generate value as tax assets.??

Examples of key areas where we have seen tax assets successfully priced into the deal are:?

• Corporation tax creditor – The corporation tax creditor should be reviewed to ensure that it factors in any tax payments made, capital allowances and refunds which can reduce the liability. Often, we come across corporation tax creditor positions which have not been carefully reviewed and are unnecessarily high.? ?

• R&D claims – whilst providing valuable financial support for the business, additional value could be obtained in the transaction by ensuring that the R&D relief under the new merged scheme is correctly accounted for in EBITDA and so included in the Enterprise Value of the business.?

• Corporation tax deduction on exercise of EMI (Enterprise Management Incentive) and other options – Typically, share options will be exercised in advance of a transaction. The corporation tax deduction is calculated on the difference between the exercise price and the market value of the shares received. Given options are typically offered at a low exercise price, significant corporation tax savings can be crystallised on the transaction. However, there will need to be modelling to demonstrate when the saving will convert into a cash saving to demonstrate that there is value to the potential purchaser.? ?

• Tax losses – The utilisation of tax losses has become more complex but more flexible over the last few years. Further, the increasing restrictions on the tax deductibility of interest has resulted in tax losses presenting more value on a transaction. If the tax losses can be modelled to show the future utilisation of these losses, a seller could obtain value for the tax losses carried forward.? ?

• Accrued interest payable – Typically, in private equity-backed structures, there will be accrued but unpaid interest which could become deductible on the repayment of the loan notes on closing of the transaction. The tax deductibility of the accrued interest will need to be modelled to take into account the increasingly complex interest restrictions such as thin capitalisation, corporate interest restriction etc. However, provided the analysis is undertaken, this can result in a reduction in the corporation tax liability in the net debt schedule, a cash-like item in the locked box or a reduction in the tax included in the equity ticker on a locked box deal.? ?

• Bonuses – Often bonuses are paid on a transaction to reward staff for past performance. Not all bonuses will be corporation tax deductible, especially if they relate solely to the transaction. Bonuses should be reviewed to ensure that these are considered to be net of any available corporation tax saving in the completion mechanism.? ?

• Transaction costs – Provided that careful consideration is given to the engaging entity for vendor due diligence costs, there may be arguments to claim that the VAT incurred on these costs can be recovered.?

Equity/profit ticker on locked box deals?

The tax calculations within the equity/profit ticker or other daily profit compensation payment can sometimes be overlooked, however, ensuring an appropriate calculation is made for the corporation tax adjustment (eg the effective tax rate) can help drive additional value.?

Typical issues can include:?

• Calculations are too simplistic and aren’t considered on a group basis?

• The effect of tax reliefs such as capital allowances/R&D are not considered.?

Summary?

Tax assets can help enhance the business’s value on the sale. However, value is often only obtained if supported by robust advice and tax modelling in order to ensure that purchasers consider these positions carefully rather than reject them outright.?

This article has focused on review of the tax assets to include in completion mechanisms. However, we can also provide support in defending and protecting value against bidder net debt adjustments following tax due diligence and therefore protect value as well as enhance value. For further details of common tax risk areas which bidders identify, please see the attached link Five Tax Issues for Due Diligence?

How BDO can support you?

Our team of experienced tax professionals can analyse and identify tax assets which can generate additional value on a transaction and provide the necessary technical input/modelling to support these.?

If you have any questions regarding how this works in practice, please do not hesitate to get in touch with Peter Adams or Will Searle ?