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VAT considerations during a cross-border carve-out deal

There are many reasons to consider a carve-out transaction, from obtaining a cash infusion to introducing a new business line. But no matter what your motivation — or the size and age of your company — proper tax planning will allow you to better realize the full value of the business unit in question. Such transactions, which involve international elements and establishments in a number of jurisdictions, are particularly complex.

Indirect taxation is especially relevant in carve-out deliberations, both for its real-time transaction cost and its implications on the future operations of the carved-out business. Indeed, value-added taxes (VAT) may be significant (averaging approximately 20% from a global perspective) at the time of the transaction, depending on the value and nature of the assets being sold, the structure of the deal, and the jurisdiction or jurisdictions involved. To put matters into context, assets can be tangible (e.g., trading stock, land and property, machinery, etc.) or intangible (e.g., trademarks, goodwill, etc.), and VAT complexities will arise if assets are misclassified or the correct treatment is not applied to each element. Land and property assets are particularly complex and significant elements that carry a high degree of indirect tax risk due to the typically substantial asset values involved.

A key factor determining if a carve-out transaction itself may attract VAT is whether or not the transaction includes a purchase of business assets. If the deal does not involve assets, and instead only involves a sale of shares, there may not be a VAT charge to consider. That said, a deal involving shares may present opportunities to consider VAT in terms of overall budgeting and price negotiation. For example, the parties involved may not be able to recover VAT incurred on costs related to the transaction, such as consulting and legal fees.

If on the other hand assets are involved, VAT will definitely be a consideration. In an asset transaction, the applicability of VAT is largely determined by a set of complex and variable rules that determine if the transaction qualifies as a “transfer of a going concern.” If the transaction is classified as such, many jurisdictions require that it not be treated as a supply of goods or services for VAT purposes (and therefore VAT does not apply), usually subject to a series of conditions and tests. These typically seek to determine the status of the buyer from an indirect tax and commercial perspective, what use the assets will be put to after the purchase, and whether the assets are capable of separate operation.

No matter whether or not the sale of the carved-out business is deemed to be a transfer of a going concern, the purchaser must still pay attention to the indirect taxes which apply to its operations (i.e., in relation to the goods and services it supplies post carve-out). As such, it is important to consider which entities are operating and must collect and pay taxes, whether new entities must be established in order to sustain operations or make the newly formed company capable of supporting a local market or fulfilling an existing order book, and whether any new tax registrations are required. It is important to identify what indirect tax filings the business must make and how to make them properly (i.e., the “how, what, when and where” of paying VAT). To that end, current tax reporting and compliance capabilities should be assessed. These factors are the most important near-term considerations to make sure that your business remains in compliance with tax law during a time of significant change.

Once those urgent tax questions are answered, it is time to assess longer-term tax filing and internal infrastructure issues. In addition, access to technical expertise and resources will be required to ensure that the company is able to address indirect taxation questions as they arise. Remember, it is possible that the carve-out results in changes to back-office operations that degraded previously adequate tax capabilities and resources. It may be that you have to hire new staff or a third party expert to ensure you fulfill your indirect tax obligations.

If the carve-out deal includes transitional services agreements (TSAs) that provide for the provisioning of certain support services from the seller to the carved-out business there will also be VAT implications. It is important to consider VAT when structuring TSAs that accompany a carve-out.

If a transaction does not incorporate a TSA, the buyer will need to quickly assess whether it has the ability to manage its indirect tax compliance requirements, which will take effect immediately on closing the deal. This includes not only the ability to prepare and submit VAT returns (potentially in a number of different countries) but also the ability to make technical decisions around when and how VAT applies to various business transactions.

At last, when the new business is operating in compliance with indirect tax requirements and has in place sufficient access to technical resources (internally or externally), it is advisable to review the overall indirect tax profile of the company in order to identify inefficiencies and areas of risk. You should ensure that the business is operating in the most tax efficient way possible, eliminating any unnecessary VAT costs from the supply chain and addressing any needless or redundant VAT registrations.

With M&A activity on the rise again and with divestitures increasingly incorporating an international flavor, carve-out deals are a key tool in an executive’s arsenal. When considering the advisability, structure, and “life after” a carve-out, indirect tax considerations are an important element. Careful planning and considered action can save your business significantly both in transactional and ongoing indirect taxes.

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