G The classic tax covenant sticks closely to the underlying tax cash flows and therefore ignores the impact of deferred taxation provisions, but does not do the same with deferred taxation assets. This apparent inconsistency is partly reconciled by various protections to the Sellers in respect of Corresponding Savings and Sellers’ Reliefs. However there is no protection provided to the Buyer from the tax covenant in the event that deferred tax liabilities are underprovided. The Buyer may therefore find that the tax charge in the accounts after Completion is greater than he had anticipated due to this factor.
1Introduction
1.1 The most common error in the first draft of the tax covenant is the simplest: the tax covenant has not been correctly modified so that it reflects the nature of the transaction.
1.2 There are a number of ways that transactions can be struck: two of the most common bases are:
1.2.1 the consideration is agreed, based on the innate value of the business, and there are to be no Completion Accounts. The Sellers warrant to deliver at least the level of net assets as shown by the Last Accounts. There are provisions that no distributions or “leakage” will be taken from the Company in the stub period from the Last Accounts to Completion. Implicit in this structure is that the Company has a value which does not vary month by month: by way of example if the company is generating profits before tax of £1 million a year, on a rising trend, the value agreed between the Buyer and the Sellers may be £7 million. If this value includes a significant goodwill component, it will be considered that this value does not vary week by week and month by month: the value of the company has been agreed and it is not expected to alter within a time- span of say 6 months. The fact that the net assets will be gradually increased in that period as profits are made and retained is not sufficiently material to vary the perception of the £7 million value. The price is agreed in say February and it remains the price in May; 1.2.2 the positive or negative goodwill component of the deal is agreed, but the actual consideration is to be determined by Completion Accounts. The Sellers can withdraw profits from the Company within certain limits but such withdrawals automatically lead to a price adjustment through the mechanism of the Completion Accounts. This approach is therefore linking the price payable for the shares very closely to the increases or decreases in the net assets as the transaction proceeds: if the managing director, in an act of low cunning, buys his wife’s car from the company for a price markedly below the book amount just prior to Completion, this act leads to an adjustment to the Consideration. This approach of Completion Accounts is very appropriate for smaller transactions, notably those where the Sellers are less sophisticated. 1.3 The pricing structures in 1.2.1 and 1.2.2 are mutually exclusive. The standard tax covenant precedent used by the Buyer’s solicitors has to be modified to be consistent with these alternative structures.
75
Made with FlippingBook Learn more on our blog