Due diligence

Seven key areas should be at the forefront of your due diligence, as they will influence the shape of your acquisition holding structure.

Due diligence

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Issues that may affect structure

Some of the key tax due diligence issues that will influence the acquisition holding structure for a buyer are:

The Target is an Australian tax consolidated group
  • The buyer may look to acquire the tax consolidated group with its own tax consolidated group, usually through a Hold Co and Bid Co acquisition structure.
  • This prevents the Target tax consolidated group from deconsolidating as a result of the acquisition. The assets of the Target tax consolidated group will be reset by way of the entry ACA calculation, which can result in a step up in the existing tax cost of assets to market value.
  • Alternatively, a foreign resident could acquire the shares in an Australian tax consolidated group from an offshore Bid Co to retain the tax cost base of the Target’s assets if there would be a step down as a result of the acquisition.

The Target's tax written down value of its depreciating assets is significantly below market value
  • If the Target's tax written value of its depreciating assets is significantly below market value, the buyer could reset ("step up") the tax cost of those assets either through:
    • An acquisition of the entity by a tax consolidated group; or
    • Through an acquisition of the assets.

The Target has carried forward tax losses
  • If greater than 50% of the shareholdings are being acquired in a company, the continuity of ownership test is likely to be failed.
  • If the Target is acquired by a tax consolidated group, the Target's tax losses could be "refreshed" and carried forward by the buyer if the same business test can be satisfied to transfer the tax losses into the tax consolidated group. The utility of those "refreshed" losses will depend on a number of factors (including the relative value of the Target to the acquirer tax consolidated group).

The Target's assets do not comprise predominately of taxable Australian property assets
  • If the Target entity's assets are not predominantly taxable Australian real property, a foreign buyer will need to consider an exit scenario when establishing the acquisition structure.
  • For example, the foreign buyer could acquire the interest in the Target directly from an offshore entity, or it could set up an Australian Trust to acquire the Target.
  • Alternatively, a foreign resident could acquire the shares in an Australian tax consolidated group from an offshore Bid Co to retain the tax cost base of the Target’s assets if there would be a step down as a result of the acquisition.

The Target has significant franking credits
  • If the Target has franking credits, it is general practice that a pre-acquisition dividend is paid to the Vendor to flush out the franking credits which may not be available or as valuable to the buyer. In the case of a public company Target, it is customary for the Target to seek a tax ruling for its shareholders in order to provide tax certainty.

The Target has excess thin capitalisation capacity
  • A buyer may choose to inject additional debt into the structure by way of a shareholder loan up to the 60% safe harbour gearing limit.
  • For a non-resident shareholders, the interest payments would generally be subject to 10% interest withholding tax which reduces the effective tax rate paid in Australia.

Interaction with the regulator
  • The Australian Taxation Office runs a very active compliance program and tax audits/compliance reviews are very common. It is usual for due diligence to go into such interactions for the preceding four years. A tax indemnity and/or tax warranties are often given and received.