Acquisition: shares or assets?

United Kingdom
In the Government's annual Budget (delivered on 17 April) a number of measures have been proposed (which will become law unless something major and unforeseen happens before the end of July) which may have an effect on whether an acquisition is structured as an acquisition of shares in a company (the target) or as an acquisition of the business of the target.

How an acquisition is structured has always depended upon an assessment of the tax and commercial issues for both seller and buyer and, through negotiation, striking a balance between their respective interests. Post-Budget this will continue to be the case but the friction between the wishes of the seller and those of the buyer may now be even more marked.

Historically sellers have preferred to sell shares in the target and the proposals in the Budget make this even more likely. With effect from 1 April 2002 where a UK company which has a "substantial shareholding" in the target (which is a trading company or group) the seller will be exempt from tax on the sale.

On the other hand, individuals are not eligible for the exemption but will be eligible for capital gains tax "taper relief". Where the shares in the target have been "business assets" throughout the seller's period of ownership the sale of the shares after 6 April 2002 will give rise to an effective rate of tax of only 10 per cent where the shares have been held for at least two years. These reliefs provide a strong incentive for the seller to sell shares rather than effect a sale of the underlying assets (which would attract tax at a higher rate).

A share sale will often trigger a capital gains exit charge in the target. This arises where an asset has been transferred intra-group to the target (for tax purposes at the transferor's base cost in the asset) and within six years of the transfer the target leaves the group. Most share sales are structured on the basis that the seller is responsible for meeting any such tax liability. In some cases this may result in the seller preferring to structure the transaction as a business sale because the seller may be able to shelter the gain arising on a direct sale of the asset that has been transferred intra-group whereas the seller would be unable to shelter it if the gain arises in the form of an exit charge. With effect from 1 April 2002 where an exit charge arises in the target the seller (or another company in the seller's group) and the target may elect that the tax liability is treated as having arisen in the seller or another company within the seller's group. This will give the seller the same flexibility to shelter the gain (for example, with capital losses) arising on the exit of the target from the group as a gain arising on a direct sale of the assets. It thus removes a possible disincentive for the seller to sell shares.

Buyers often prefer to acquire assets. Commercially, liabilities will only pass if expressly assumed and it is often easier in a business sale for the buyer to ensure that he only takes (and pays for) the assets that he wants. On a business acquisition the buyer will be entitled to claim capital allowances on eligible assets (e.g. plant and machinery) by reference to what he pays (correspondingly, the seller will suffer a claw back of allowances where the agreed price exceeds the tax written down value). In addition the buyer will obtain a step up in the base cost of the assets whereas on a share acquisition the capital gains base cost of the assets held by the target will remain at their historic values. Both of these considerations provide the buyer with an incentive to acquire assets. This preference is reinforced by two new measures announced in the Budget.

First, an exemption from stamp duty on the transfer of goodwill is introduced and it is intended that towards the end of next year stamp duty will be payable only on real estate (at the rate of 4 per cent for sales in excess of £500,000) and shares (0.5 per cent). The disincentive to buyers of acquiring assets at a rate of duty of 4 per cent as against shares at a rate of duty of only 0.5 per cent is therefore eliminated except where the value of real estate in the target is substantial.

Second, a new regime for the taxation of intangible assets is also introduced and is designed to align the tax treatment of intellectual property and goodwill with the accounting treatment. It will apply to intellectual property and goodwill acquired or created before 1 April 2002. Tax relief will normally be available for the amortisation of intellectual property and goodwill in line with the accounts treatment. For accounts purposes intellectual property and goodwill would normally be written off over its useful economic life; this would normally not exceed 20 years. Where it is likely to have an indefinite useful economic life no amortisation is chargeable for accounts purposes but an election may be made for a 4 per cent annual write off for tax purposes. On a purchase of shares a buyer would not obtain the benefit of the new regime whereas a direct acquisition of assets from a party not associated with the buyer will be taxed under the new regime. This will therefore provide an incentive for the buyer to acquire assets rather than shares.

It seems that as never before there will be scope for real differences of approach between sellers and buyers. The balance of negotiating power will never have been more important. In competitive tenders the value of bids for assets may be significantly higher than those for shares but the seller will have to consider his tax position carefully. There has been some call for the substantial shareholdings exemption to be extended to cover asset sales but whether the Government will listen remains to be seen.

For further information please contact:

Richard Croker

Phone: +44 (0)20 7367 2149

Email: richard.croker@cms-cmck.com

Simon Meredith

Phone: +44 (0)20 7367 2959

Email: simon.meredith@cms-cmck.com

Mike Boutell

Phone: +44 (0)20 7367 2218

Email: michael.boutell@cms-cmck.com