Foreword by Andrew Chilvers
For ambitious companies eager to expand into overseas markets, often the conventional route of organic business development is simply not fast enough. The other option to invest in or buy a business outright is far quicker but often fraught with unforeseen dangers. And even the biggest, most experienced players can get it badly wrong if they go into an M&A with their eyes wide shut.
If you search for good and bad M&As online the Daimler-Benz merger/acquisition with Chrysler back in 1998 is generally at the top of most search engines on how NOT to undertake a big international merger. Despite carrying out all the necessary financial and legal measures to ensure a relatively smooth deal, the merger quickly unravelled because of cultural and organisational differences. Something that neither side had foreseen when both parties had first sat down at the negotiating table.
These days the failed merger of the two car manufacturers is held up as a classic example of the failure of two distinctly different corporate cultures. Daimler-Benz was typically German; reliably conservative, efficient, and safe, while Chrysler was typically American; known to be daring, diverse and creative. Daimler-Benz was hierarchical and authoritarian with a distinct chain of command, while Chrysler was egalitarian and advocated a dynamic team approach. One company put its value in tradition and quality, while the other with innovative designs and competitive pricing.
Jude Odinkonigbo and Uche Val Obi, SAN discussed The Art of Deal Making: Using External Expertise Effectively as part of the Tax chapter.
Describe a typically tax-efficient deal structure in your jurisdiction? Any examples.
A typical tax-efficient deal structure in Nigeria could be described as an investment plan or scheme that least exposes an investment to different aspects of the country’s tax regime. In summary, such a deal structure or scheme should drastically minimize the business’ tax exposures more than other available investment options. One example of the available tax-efficient deal structures in Nigeria – especially after the incentives intro- duced by the Finance Act, 2019 – is “Real Estate Investment Company” (“REIC”). A REIC is a company duly licensed by the Securities and Exchange Commission (“SEC”) for the sole purpose of acquiring intermediate or long-term interests in real estate and/or property development.
Some of the tax incentives enjoyed by a REIC are:
1. Exemption from Income Tax: Rental or dividend income earned by a REIC is exempted from the company income tax (“CIT”) provided that a minimum of 75% of the income is distributed within 12 months of the end of the financial year in which the income was earned.
2. Exemption from Excess Dividend Tax (“EDT”): Ordinarily, EDT applies to dividend paid in excess of profits declared by a company in an accounting year. However, a REIC is exempted from EDT: provided that the REIC distributes a minimum of 75% of its rental and dividend incomes within 12 months of the end of the financial year in which the income was earned.
3. Exemption from Withholding Tax (“WHT”): WHT does not apply to dividends and distributions payable to a REIC. However, dividends and distributions payable by REIC to its shareholders attract WHT.
The purpose of the tax incentive is to attract investment in the real estate sector of the Nigerian economy. However, the most used forms of deal (re)structuring in Nigeria are mergers and acquisitions. Indeed, how a business enterprise is structured may be the most important factor that determines how tax-efficient such a business may be. A tax-efficient structure saves taxes and improves output. To realise a tax-efficient structure, Passive Invest- ment Holding Companies are often used. In this case, a holding company accumulates dividend and interest incomes, which it may lend back or reinvest in the originating company. Income taxes payable by an originating company are reduced because dividends are not taxable, since they are considered franked investment income; and interests paid are deductible.
What elements of a structure or deal could prevent a client from implementing your recommendations? For example, holding companies, trusts, exemptions, withholding tax.
Traditionally, a deal structure in an M&A may be realised through asset purchase, stock purchase or merger. The major processes of deal structuring in Nigeria include: the acquisition vehicle; post-closing organisation; form of payment; form of acquisition; legal form of selling entity; accounting; and tax considerations. Generally, clients contest the location of holding companies and the characterisation of entities. Thus, deal structuring can be a contentious issue arising from the failure to agree on allocation of debts and tax liabilities. Clients who buy often generally prefer assets while those who sell often prefer stock. Usually, clients want an informed understanding or appreciation of the implica- tions of a preferred structure – especially for the mitigation of tax exposures and other commercial purposes.
How would you minimise the tax risks on a deal, including historic tax liabilities and ongoing tax optimisation?
Typically, tax risks in a deal are reduced by planning. In an ideal situation, it is expected that to minimise compliance risks, the con- text of such deals should be established. This will involve setting boundaries within which mitigation or monitoring strategies can occur. Thereafter, the possible risks should be identified. This may be achieved through client segmentation, which is fundamentally essential for thorough identification of risks. The next stage is to ideally assess and prioritize the risks by establishing a sound framework for assessment and data analysis. This is important because not all risks will necessarily be addressed. What is needed is a balanced approach to the treatment of a wide range of risks.
The next step will be to determine the appropriate treatment strategies. Ideally, avoiding taxes and saving revenue are usually the utmost goals of most companies. Indeed, tax optimization usually leads to additional cash for companies. With the amend- ments made by the Finance Act, 2019, there is tax rate reduction opportunities for companies based on income aggregation.
Though these strategies may be complex, they often help to save money, which can be reinvested.
Some of the strategies are:
1. Taking advantage of tax credits and incentives: for example, structuring a business to take advantage of “Pioneer Status” under the Industrial Development (Income Tax Relief) Act. This confers massive tax Incentive (tax holiday) for a maxi- mum of five years.
2. The implementation of effective compensation strategies, most of which are deductible expenses.
3. Consider a global tax planning: Entities can adopt this strategy by restructuring the way capital is financed through an interme- diary company that may hold its assets.
However, it must be noted that an effective tax optimization plan may be complex, time consuming, time bound due to changes in tax laws in jurisdictions that a prospective business intends to operate.
Top Tips – Tax Traps To Be Avoided In Your Jurisdiction
• Buy-Sell Arrangements (“BSA”): If BSA is not properly arranged, it may trigger capital gains tax. In particular, this occurs when the owners unwind the buy-sell transfer policies back to the insureds. It is advised that a trusted cross-purchase is done using partnerships.
• Exposing Life Insurance Proceeds to Potential Income Taxation: Life insurance proceeds may be subject to income taxation by virtue of section 33(4)(d) of the Personal Income Tax Act 2011 as amended (PITA). To avoid this trap, it is better to comply with section 33(4) before the policy is issued.
• Triggering Transfer-for-Value Rule: Death ben- efits may be subject to income taxation due to the transfer-for-value-rule. It is advised that it qualifies for transfer to a partner exception; stock redemption arrangement; and purchase of new insurance.
• Tax Traps in the commercialization of Intellectual Property (“IP”): Many complex and costly tax prob- lems may arise following the development and commercialization of a Nigerian company’s IP.
• Loss Carry-forward in an M&A: Losses may only be carried forward by the new entity if it continues with the same line of business the old or extinct company was involved in.