In undertaking an acquisition, a Buyer should consider how to best manage tax risk. This can include the following.
Tax due diligence and contractual protection
Tax due diligence of target entities can be conducted by the Buyer's tax advisers to seek to identify any tax exposure associated with the proposed acquisition (see Due diligence for further information).
Buyers should also seek contractual protection by negotiating appropriate tax warranties and seeking a tax indemnity to cover historic tax liabilities. In circumstances where a target is being acquired from a Tax Consolidated Group, the target may be able to be acquired with no historic income tax liabilities, subject to certain requirements (see Transaction documentation, particularly Clear exit from Consolidated Group).
One way in which an entity can manage taxation risk arising from an investment is by purchasing insurance to cover identified tax risks associated with particular aspects of an investment that may be of concern. This includes circumstances where tax laws or the position of the tax authority are unclear, or the complexity of the investment contemplated by the parties gives rise to unique considerations.
Tax insurance is a bespoke product which can cover not only primary tax exposures but also penalties and interest and can give gross up coverage if the insurance proceeds are themselves taxable. The policy may also be extended to cover legal and other tax dispute defence costs.
Examples of where an investor may wish to take tax insurance include:
- a purchaser is concerned about a disclosed historic tax position taken by the seller or target (which is not covered sufficiently by W&I insurance or a seller indemnity);
- the tax position of a group may have changed following an internal restructure; or
- a change in ownership gives rise to unclear tax consequences.
Tax insurance is a useful alternative to a tax ruling (discussed below) in managing tax risk, particularly where:
- the time constraints of a transaction do not allow enough time to obtain clearances from the Australian Taxation Office (ATO);
- the insured event is of a nature that the ATO would be unlikely or unwilling to give a ruling; or
- the parties in question do not wish to outline the entire transaction and the relevant background information of the parties involved to the ATO.
It is important to note that an insurer will generally require a tax opinion from your tax adviser and may also request an opinion on the tax implications of the insured event from Senior Counsel (an independent senior courtroom advocate). Care should also be exercised in negotiating the insurance policy to ensure that the insurer's exclusions do not inappropriately limit the insured from claiming under the policy.
Tax insurance offers flexibility between an investor and the insurer to negotiate a bespoke insurance policy that is tailored to a specific tax risk, which can provide certainty for investors in an M&A context. The market for tax insurance in Australia has developed in recent years so that bespoke tax insurance is provided by an increasing number of insurers.
To obtain a private binding ruling, the transaction or arrangement must be in serious contemplation.
A taxpayer can apply to the Australian Taxation Office (ATO) for a private ruling, which is written advice on how the ATO considers that a tax law applies to specific circumstances. Seeking a private ruling is a common way in which entities manage their tax risk. The advantage in applying for a private ruling is that the ruling legally binds the ATO even if the ruling is later proved to be incorrect. If the ruling is incorrect, the ATO can only apply the law correctly if it would be more favourable for the applicant. Accordingly, a private ruling provides certainty for a taxpayer in respect of a particular transaction.
Scope of a private ruling
A private ruling only applies to the particular scheme or circumstances that it describes. The ATO is not legally bound by a ruling where the scheme is not implemented in the way set out in the private ruling or material facts were omitted or misleadingly or inaccurately stated. Accordingly, it is important that the full and accurate facts of the transaction are outlined to the ATO when seeking a private ruling.
In order to obtain a private binding ruling, the transaction or arrangement must be in serious contemplation. It is not possible to obtain a ruling in respect of a hypothetical arrangement.
While the ATO aims to provide private rulings within 28 days of receiving all the necessary information, it is usually the case that rulings (particularly for transactions or arrangements that raise more complex matters) take longer than 28 days to be provided (approximately 2 to 3 months). [During the COVID-19 period in particular, rulings have generally taken longer to obtain (around 3 to 4 months) as the ATO has applied its resources to dealing with COVID-19 measures.]
In some circumstances, this timing can create problems for transactions that need to be completed quickly. If the tax risk is a material consideration in the transaction, a potential solution is to obtain the ruling after signing (but prior to completion) and make obtaining a favourable ruling as a condition precedent to completion or agree a value adjustment.
Where a particularly complex tax risk is identified and the proposed parties to a transaction are still in the negotiation phase, it can be prudent to request for an "early engagement" discussion with the ATO. During the early engagement process, the parties may discuss their timeframes with the ATO and have a more flexible discussion about the specific tax issues that arise. The early engagement process can also assist in streamlining the ruling process, as the ruling application can incorporate any comments or issues raised by the ATO prior to being formally submitted.