Tax considerations
Tax plays a crucial part in deciding how you structure and finance your UK acquisition. Below we highlight some of the key factors to consider, many of which will be familiar to you as a US buyer.
Share purchase vs asset purchase
Your acquisition of a UK business may be structured as the purchase of a target's shares or assets, and there are different tax implications for each.
Historic tax liabilities
On a share purchase of a UK company, historic and continuing tax liabilities remain with the target. As in the US, you would expect to seek an indemnity from the seller to protect against tax liabilities that haven't been factored into the price, alongside a full set of tax warranties to elicit disclosure of the target's tax affairs and provide you with a further remedy in the event of breach.
However, there are differences in approach with a UK market deal, including the following:
- In the UK, tax indemnities are typically used to cover specific identified risks or liabilities that may arise post-completion, whereas tax warranties are more general, serving as assurances from the seller about the target's tax affairs up to the completion date. In comparison, in the US, the use of tax indemnities is less common, with broader representations and warranties tending to cover a wide range of potential tax liabilities.
- The period for claims is generally the same for both UK and US deals (being the statute of limitations), although US agreements tend to include broader materiality thresholds or 'baskets' that must be exceeded before claims can be made. Separate thresholds will often apply to tax indemnity and warranty claims in the UK, and with lower caps on liability than the US.
- Various protections are commonly sought by sellers on a UK deal which would be unusual in a US context, such as counter-indemnities (for situations where the seller becomes secondarily liable for tax as a result of post-completion acts of the buyer), credit for overprovisions and third-party recovery obligations.
- The documentation will likely look different; in the UK an indemnity will often be contained in a separate tax deed or covenant, rather than being included as part of the main body of the purchase agreement.
In the case of an asset purchase, tax liabilities generally remain with the seller (except in relation to some employment-related taxes in certain circumstances). For this reason, a tax indemnity is not usually provided, and tax warranties are limited to sales tax (value added tax (VAT)), payroll tax, depreciation (capital allowances) and tax concessions.
Tax assets
On a share acquisition, you'll get the benefit of any valuable tax assets that the target may hold, such as trading losses, enabling you to mitigate future tax liabilities of your group. As in the US, the use of tax assets in post-acquisition periods may be limited in certain circumstances. On an asset purchase, tax assets will typically remain with the seller.
Transfer taxes
When shares in an English company are acquired, a transfer tax (stamp duty) at a rate of 0.5% of the consideration will be payable by you as buyer to register the change of ownership. As there are no similar transfer taxes under US law, you may be unfamiliar with this requirement and look to factor this cost into the price (although this would generally be resisted by the seller).
Earn-outs, deferred consideration and the assumption of debt or liabilities can form part of the consideration for stamp duty purposes. The treatment of earn-outs from a stamp duty perspective depends on whether the earn-out is subject to a floor or cap or is wholly unquantifiable (for example, where your payout is linked to future financial performance).
If there’s a cap, which is often commercially desirable for buyers, stamp duty is calculated by reference to the largest possible payout, even if the chances of actually achieving that level of payout are very low, which can be problematic given there's no right to reclaim overpaid stamp duty from HMRC.
No stamp duty arises on an asset purchase. However, where English real estate is being transferred, you will pay stamp duty land tax on the purchase price (at a rate of up to 5% for commercial property).
Sales tax
While the US doesn't impose a value added tax at federal, state or local level, the position is different in the UK. Although the transfer of shares is exempt from VAT, VAT may arise on an asset transfer (at the standard rate of 20%) unless it meets the conditions to qualify as the transfer of a business as a going concern, which is outside the scope of VAT.
Step-up in basis
Similar to the US, a share acquisition won't affect the target's base cost in its capital assets, whereas an acquisition of assets will usually result in an increase in the base cost of those assets for capital gains tax and capital allowances (depreciation) purposes. US buyers can often elect the treatment for US tax purposes, whereas the position for UK purposes depends on the nature of the transaction.
Unlike in the UK, it's possible for a US buyer to elect a specific entity classification to optimise their tax position. For example, choosing a disregarded entity or partnership could simplify their tax structuring and potentially reduce double taxation issues. US entity classification elections, or ‘check-the-box’ elections, are permitted for the most common form of English company (private limited companies), although public limited companies are per se corporations for US Treasury purposes. Complicated tax avoidance rules (anti-hybrid rules) should be considered where elections are intended to be made to treat an English company as a partnership or disregarded entity.
Sales tax
While the US doesn't impose a value added tax at federal, state or local level, the position is different in the UK. Although the transfer of shares is exempt from VAT, VAT may arise on an asset transfer (at the standard rate of 20%) unless it meets the conditions to qualify as the transfer of a business as a going concern, which is outside the scope of VAT.
Step-up in basis
Similar to the US, a share acquisition won't affect the target's base cost in its capital assets, whereas an acquisition of assets will usually result in an increase in the base cost of those assets for capital gains tax and capital allowances (depreciation) purposes. US buyers can often elect the treatment for US tax purposes, whereas the position for UK purposes depends on the nature of the transaction.
Unlike in the UK, it's possible for a US buyer to elect a specific entity classification to optimise their tax position. For example, choosing a disregarded entity or partnership could simplify their tax structuring and potentially reduce double taxation issues. US entity classification elections, or ‘check-the-box’ elections, are permitted for the most common form of English company (private limited companies), although public limited companies are per se corporations for US Treasury purposes. Complicated tax avoidance rules (anti-hybrid rules) should be considered where elections are intended to be made to treat an English company as a partnership or disregarded entity.
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UK acquisition vehicle
Whether you're acquiring a UK business via a share or asset purchase, there are various tax advantages that can be gained from establishing a UK holding company as the acquisition vehicle, and this is generally the preferred option for a US buyer:
- Financing a UK holding company with interest-bearing debt may generate tax deductions to set against taxable profits of the UK business (either directly or via group relief, depending on whether assets or shares are acquired). For further information on this, see our Acquisition debt finance section below.
- The use of a UK acquisition vehicle may, subject to various requirements, assist with the recovery of VAT on transaction costs.
- The UK has a full domestic exemption from withholding tax on dividends and a broad tax exemption for dividends received by corporate shareholders.
- Any future sale of the shares may benefit from the substantial shareholding exemption (the UK's capital gains tax participation exemption).
We've helped numerous US clients to establish UK acquisition vehicles to acquire businesses across a wide range of sectors. Should you wish to discuss the tax advantages of doing so, please get in touch with our International Corporate team.
Acquisition debt finance
The issues involved in considering the financing of the UK acquisition vehicle will often be tax driven. Of particular importance is the availability of interest relief and UK withholding tax on payments of interest.
Interest paid by the UK holding company to you, its US parent, would generally be allowable on an accruals basis as a deduction in calculating the UK company’s taxable profits. However, tax relief for interest can be restricted in certain circumstances:
- Where the UK Corporate Interest Restriction applies. Broadly, these rules restrict a group’s deductible net tax interest expense to 30% of its taxable earnings before interest, tax, depreciation and amortisation (EBITDA), subject to an optional group ratio rule which may permit greater deductions in some cases. All groups can deduct up to GBP2 million of net interest expense per annum before the restriction applies.
- Where the debt could effectively be treated as a form of equity (such that interest is treated as a distribution).
- Where transfer pricing and thin capitalisation rules apply to disallow interest on related party debt where the debt doesn't reflect arm’s length terms, based on the debt capacity of the UK company itself.
- Where certain anti-avoidance rules apply, for example where the loan has been entered into for an unallowable purpose or where either the interest is also eligible for tax relief in another territory or wouldn't be taxable for the lender (pursuant to certain anti-hybrid rules).
UK withholding tax would ordinarily apply to interest paid to you by the UK holding company, although this can often be reduced from 20% to 0% under the UK-US double tax treaty.
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