29 Jun 2020

M&A recovering from COVID


It is news to no-one that the impact of COVID-19 and Government and businesses’ response to it, combined with Brexit, make this a tricky time for corporate deal-making and yet… there are investors with funds to deploy and companies that would gladly sell a subsidiary or receive new equity investment. Deals will go ahead, but with questions to resolve and risks to allocate. This note discusses tax issues relevant to post-COVID period deals.

Buying a company with losses

In principle, a UK company can carry forward trading losses to a later period indefinitely. However:

  • Restrictions limit the use of carried forward losses: £5 million (per group) can be used each year but after that use is capped at 50% of profits. So a Target with available losses could still be tax-paying.
  • Additional restrictions apply where there is a change of control and a major change in the nature, conduct or scale of the business. These rules can be hard to navigate; the new owner of a loss-making business is likely to want to make changes.
  • Other anti-avoidance rules can apply where a business is bought for its tax-loss attributes. They are widely drawn and can create uncertainty and risk where the availability of losses affects deal pricing.

A UK company can also carry back losses for 12 months before the beginning of the loss period.

There is currently no indication that these rules will be relaxed for COVID-19 related losses. Similar rules elsewhere (e.g. in the U.S.) have been relaxed, so this may change. If so, the impact on corporate cash-flows and deal-pricing could be significant.
Even as things stand, Buyers and Sellers of loss-making companies should consider these points:

  • Closing an accounting period to ensure that a loss clearly arises in the Seller’s (or Buyer’s) period of ownership may be useful. Tax deeds often deem an accounting period to close – but HMRC do not sign up to that tax deed.
  • Selling assets rather than shares may be attractive if it gives the Buyer a higher tax
    base cost in the assets and the Seller has losses to absorb gains. Partnership sales are normally asset sales.
  • In certain cases where the Buyer is or becomes a lender in respect of impaired debt, the Target may recognise taxable income. Releasing some of the debt or converting it to equity pre-sale may be preferable.
  • If the Target’s debt is impaired, its shares may have negligible value. If so, payments received under warranty or tax deed claims may be taxable for the Buyer (and non-deductible for the Seller).
  • If the Target has third party debt to repay on completion, it could be put in funds to repay (rather than the Buyer undertaking to repay).

It is important to document tax considerations clearly, including the approach on positions to take in tax returns.

Deferred consideration

As businesses recover from lockdown and prepare for the end of the Brexit transition period, consideration structures reflecting valuation and pricing uncertainty are likely to be popular. Some Buyers may also want to lock into a price without paying upfront cash so deferred consideration may become more common. It is important to take deal-specific advice on structuring deferred consideration.

Deferral only

For consideration where the amount is known and payment is merely delayed, a Seller subject to capital gains tax is generally taxable on the aggregate amount of the day one and deferred consideration upfront (subject to any exemption or relief).

A corporation tax paying Seller may recognise a discount in its accounts which unwinds as the payment date approaches. That discount is likely to be taxed as if it were interest income.

If the deferral is for a relatively short period, the Seller may not object to the upfront tax cost. However, for longer deferrals, a “roll-over” transaction structure, where shares in the Target are exchanged for loan notes in the Buyer, may be preferred.

Contingent consideration

Where the consideration amount is known, but contingent, Sellers are again generally taxable on the full consideration upfront and without any allowance for contingency. A Seller taxed on this basis may be able to claim a refund if the contingent
consideration is not paid. Alternatively, the transaction could be structured as a “roll-over” into loan notes or shares.


Where the future consideration amount cannot be determined on day one, e.g. on an earn-out, the position is different. The amount that is taxed upfront is the aggregate of the day one consideration plus the value of the right to receive the future consideration. As and when future consideration is received, any excess received over the day one
market value of that right will be taxed.

Although this treatment can reduce the value that is taxed before the cash is received, there can be wrinkles. For instance, future receipts are treated as proceeds of disposal of the claim-right and not the shares. This displaces reliefs (e.g. the substantial shareholding exemption (for corporation tax payers) and business asset disposal relief (formerly entrepreneurs’ relief) (for qualifying individuals)) which exempt only gains on share disposals.

Such unascertainable consideration can be structured as a right to “roll-over” into shares or loan notes issued when the earn-out conditions are satisfied, provided the roll-over element cannot be satisfied in cash.

Employment taxes

Where contingent or earn-out consideration is linked to an individual continuing to work in the business, the consideration risks being treated as employment income. Similarly, shares or loan notes received by an individual (or their associate) in connection with a
past, present or future employment or directorship may be “employment-related securities”. If so, income tax and national insurance contributions could be payable by the Target or Buyer.

UK actions in response to COVID-19

The Government has taken a number of tax-related actions in response to COVID-19. Many have necessarily been implemented on the basis of broad-brush policy rather than technical legislation and inevitably will not fit every situation perfectly.

Deferring tax payments

Companies may defer some VAT payments (although not import VAT payments) and HMRC have offered time-to-pay VAT and corporation tax arrangements for businesses affected by COVID-19. Care is needed where a Target has deferred tax payments as
changes in circumstances (including a take-over by a Buyer with more favourable circumstances) can affect the position.Interrupted business operations HMRC have also provided some guidance on trading operations affected by COVID-19. Generally, a
temporary pause in trading activity should not be treated as a permanent cessation and carrying on similar activities to those previously carried on should not be treated as the start of a new trade.

HMRC have not yet commented on transfer of going concern VAT treatment where the business has temporarily paused, however. Buyers should use the due diligence and warranty negotiation process to flush out the background to business changes and
the transaction documents should allocate risk clearly.

Employment taxes

Many companies have furloughed employees – and some will have made errors in calculating furlough amounts and paid too much or too little tax. Errors resulting in underpayments must be notified to HMRC and repaid as soon as they become known.
Buyers and Sellers may need to agree appropriate deal risk allocation where there is uncertainty. Please click here for our briefing on HMRC’s new furlough scheme enforcement powers.

Salary waivers have also been popular but they are not always implemented in a tax-efficient way so there may be unexpected tax liabilities. Please click here for our briefing on salary waivers.

There is continuing uncertainty around ‘tax-advantaged’ EMI option schemes, for example where valuations are difficult. HMRC have now proposed in amendments to Finance Bill 2020 that furloughing, or reducing the hours of, an EMI option holder as a result of COVID-19 should not be a “disqualifying” (potentially taxable) event in respect of options granted before 19 March 2020, but not how furloughed employees are to be treated in calculating the maximum 250 employee limit. This affects sales of companies where options have been granted and could be a headache for companies wishing to grant new options.

For companies wishing to grant new EMI options, better news is that HMRC have agreed an automatic 30 day extension for EMI valuation agreement letters already issued, where the usual 90 day valuation period expires on or after 1 March 2020. Also, any new valuation agreements issued on or after 1 March 2020 will be valid for 120 days.

More good news is that changes to the employment tax rules on workers providing services via intermediaries (e.g. personal service companies) have been deferred until April 2021. This should reduce uncertainty for many Buyers and Sellers. Please click here for our briefing on this deferral of the IR35 extension.

Impact on R&D tax relief

Small or medium sized companies claiming R&D reliefs may cease to qualify if they have also received a loan under the Coronavirus Business Interruption Loan Scheme (CBILS) or the Bounce Back loan scheme as they are classed as state aid. A business claiming payable credits under the SME scheme or the R&D Expenditure Credit (RDEC) regime will have to show it had not ceased to be a going concern at the times of claim and payment. HMRC have not yet provided guidance on how this interacts with the relaxation in accounting reports on going concern status during the COVID period.

Please click here for our briefing on COVID-19 and company reporting.

Similar state aid issues arise for companies where shareholders have claimed tax relief under the Enterprise Incentive Scheme (EIS).

Directors of insolvent companies

There is also a risk for directors of companies which fail with significant tax debts.

Finance Act 2020 will introduce new rules: where an individual (i) is a director of two or more companies wound up on an insolvent basis and HMRC’s creditor claims are for more than 50% of the unsecured creditor pool, and (ii) continues to be involved in a
similar business, HMRC can make that person jointly and severally liable for tax debts with the insolvent company if they consider it necessary to protect the Exchequer.

HMRC say the new powers are intended to address “phoenix” situations where insolvency is used to side-step tax liabilities or where tax affairs are not properly managed. However, as is common with anti-avoidance legislation, HMRC’s powers are widely drawn and HMRC are expected to use operational discretion in their use.

The new powers are significant - many companies may be insolvent (or near to it) as a result of current events. It will be important to ensure rescue operations do not prompt HMRC to use these powers.