The impact of Covid-19 tax regulations on M&A transactions

In this article, we will focus on the impact of Covid-19 tax regulations in relation to M&A transactions. In particular, we will address the impact of several incentives that need to be addressed when transferring a company.

Covid-19 Regulations 

Many countries have introduced Covid-19 related tax and other government incentives. These can – roughly – be broken into three categories: (i) extension of payment for taxes, (ii) a subsidy for wages (and sometimes other costs) and (iii) a reduced tax rate. When transferring a company, the benefits and setbacks of such regulations need to be discussed by the seller and the purchaser. This raises questions, such as: If a subsidy is successfully claimed, does this increase the equity value of a company? And if tax payments are being deferred who will pay for these debts? Or do you need to take into account that the cash position is also better as a result of not paying taxes? We will look into how to deal with these issues in case of a transaction.  

Attribution of tax risks in a transaction 

Before we detail handling specific Covid-19 related issues, we want to summarize the “normal” handling of tax issues in a transaction. Every outcome of a deal is off course a specific negotiation between the seller and the purchaser. For tax purposes, there is a common understanding on how to treat tax liabilities and tax risks. In general, these follow the date the business is transferred, also known as the effective date. Historic tax risks are allocated to the seller. Future tax risks are for the account of the purchaser.  

Locked box versus closing accounts 

In order to determine the historic and future tax risks, it is important to understand what kind of deal is being closed. Most deals fall within one of the two following categories: a locked box deal or a closing accounts deal. The key difference is when the economic risk and benefit in the target company passed from the buyer to the seller. 

Locked box 

A locked box deal is a deal with an effective date that predates the transfer of the shares. Usually the start date is set at the beginning of the book year of the entity that is transferred. Locked box is generally perceived as seller-friendly and is more popular in Europe than in North America.  

Closing accounts 

A closing accounts deal is a deal with an economic transfer at the moment of closing. Locked box is generally perceived as buyer-friendly. Closing accounts is far more popular in North America than in Europe.  

How to deal with Covid-19 regulations 

So how to deal with COVID-19 regulations in relation to an envisaged transaction?

In case of closing accounts, it is actually quite simple. The company is transferred per the date of signing. All tax liabilities incurred up to that date should be adequately incorporated in the purchase price. But there is no unclarity to whom any benefits should be assigned. Benefits incurred prior to closing are for the benefit of the seller. Risks in relation to those benefits are also for the account of the seller.  

Where it gets technical, is when parties opt to use a locked box mechanism. Many of the tax benefits incurred will fall in the period between the effective date and the closing date (the straddle period). Generally, tax risks incurred in the straddle period are for the account of the buyer, unless these are out of the ordinary course of business.  

Here it gets interesting: is a COVID-19 regulation considered ordinary course of business? This is unchartered terrain, where we cannot look to generally accepted principles to guide us. Parties need to understand the specific position in order to come to specific agreements in relation to these benefits and risk. And at Mazars we are more than happy to assist you navigate these unchartered terrains.