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Tax treatment of different acquisitions

What are the differences in tax treatment between an acquisition of stock in a company and the acquisition of business assets and liabilities?

 

The main difference from the acquirer’s perspective is that there is only a step-up in the tax basis on an asset purchase, while a stock acquisition as a general rule does not allow for a step-up on the basis of the target’s assets.

 

Another important difference is that an asset acquisition would generally be taxable for the seller as ordinary income. In a stock acquisition, the seller may benefit from a 17 per cent capital gains tax and even benefit from a capital gains tax exemption in the case of dispositions of regularly traded, publicly listed stock, and provided some specific conditions are met. Tax-free acquisitions through corporate reorganizations are also generally available only for stock acquisitions and not for asset acquisitions.

 

Finally, VAT, registration duties and transfer taxes may apply on asset transfers but not to a stock acquisition.

 

2.      Step-up in basis

 

In what circumstances does a purchaser get a step-up in basis in the business assets of the target company? Can goodwill and other intangibles be depreciated for tax purposes in the event of the purchase of those assets, and the purchase of stock in a company owning those assets?

 

If a Chilean acquisition company acquires all of the issued shares of the target, which as a consequence is wound up into the acquisition company, the difference between the acquisition price and the tax equity of the target has to be assigned pro rata to the tax basis of the non-cash assets of the target. If the target does not have non-cash assets, this difference may be amortised in a six-year period.

 

As a general rule, goodwill and other intangibles may not be depreciated for tax purposes. However, tax goodwill, which is defined as the difference between the acquisition price and the tax equity of the target, may be indirectly deducted through depreciation and inventory costing of the increased tax basis of non-cash assets that occurs as explained above.

 

The purchase of stock in the target may not be depreciated or amortised. The stock acquisition, cost-adjusted for inflation, may be recovered as basis upon disposition or liquidation of the investment.

 

3.      Domicile of acquisition company

 

Is it preferable for an acquisition to be executed by an acquisition company established in or out of your jurisdiction?

 

A Chilean acquisition company is generally preferred, except in the specific cases described below.

 

Having a local acquisition company will allow deferral of the 35 per cent dividend withholding tax, applicable to dividends paid to non-resident shareholders until dividends are effectively paid by the acquisition company to its non-resident shareholders, since intercompany dividends between local entities are not taxed. It should be noted that, under the corporate tax integration system, the effective rate of withholding on net dividend payments to a non-resident is approximately 21.6 per cent, assuming that the underlying profits were subject to a 17 per cent corporate tax. See question 13 for how corporate taxation and the dividend taxation integration system works.

 

Another reason for having a local acquisition vehicle is that this structure allows for interest relief in the case of borrowings to finance the acquisition. Although group tax filings are not allowed, interest expenses deducted by the acquisition company may be offset against dividends received from the target and a refund for the 17 per cent corporate tax paid by the target on the underlying profits may be requested by the acquisition company. In addition to the interest deduction benefit, in the case of interest payments to a non-Chilean bank or financial institution, the interest withholding tax is reduced from 35 per cent to 4 per cent. This could generate an efficient repatriation mechanism, as cash distributed as dividends would be subject to a 35 per cent dividend withholding tax.

 

A local acquisition company would also be preferable for an asset acquisition, since it may be able to use the VAT normally applicable in this case as an input credit against the VAT charged on its sales or provision of services.

 

If the stock of the target has appreciated in value and the seller is a non-resident that holds the target through an offshore intermediate holding, it may prefer to sell the intermediate holding to an acquisition company located outside Chile. In such cases, the gain derived from the sale would not be subject to income taxes in Chile.

 

If the purchase company is located in Chile, the gain from the sale of an offshore intermediate holding would be subject to Chilean taxation.

 

4.      Company Mergers and Share Exchanges

 

Are company mergers or share exchanges common forms of acquisition?

 

Mergers or share exchanges are common where parties are seeking to conduct the transaction without incurring income taxes for the target or the sellers, given that the tax code normally allows reorganizations such as mergers, spin-offs and other forms of corporate reorganizations at cost basis without having to book any gain for income tax purposes that would otherwise result if the transaction were conducted as a taxable transfer.

 

5.      Tax Benefits in Issuing Stock

 

Is there a tax benefit to the acquirer in issuing stock as consideration rather than cash?

 

Generally there is no tax benefit to the acquirer in issuing stock as consideration rather than cash. In addition, using appreciated stock of a Chilean company as consideration might result in taxation for the acquirer.

 

6.      Transaction Taxes

 

Are documentary taxes payable on the acquisition of stock or business assets and, if so, what are the rates and who is accountable? Are any other transaction taxes payable?

 

There are no documentary taxes or other transaction taxes payable on the acquisition of stock.

 

In an acquisition of business assets, VAT would normally be applied at 19 per cent on the transfer of inventory, personal property, real estate developed by a construction company and fixed assets, if sold before fully depreciated or within four years of their acquisition. The seller would be liable for charging VAT on the transfer. The purchaser, if it is a local acquisition company registered as a VAT taxpayer, would be entitled to offset such VAT as an input credit against its VAT output debits on its own sales or services.

 

7.      Net operating losses, other tax attributes and insolvency proceedings

 

Are net operating losses, tax credits or other types of deferred tax asset subject to any limitations after a change of control of the target or in any other circumstances? If not, are there techniques for preserving them? Are acquisitions or reorganizations of bankrupt or insolvent companies subject to any special rules or tax regimes?

 

As a general rule, net operating losses, tax credits and other tax attributes, such as accelerated depreciation of the target, may not be used by the acquirer if the target is liquidated or merged into the acquirer. Consequently, in a post-acquisition reorganisation, it is important to preserve the legal existence of the target. Losses and other tax attributes are not affected, however, if the name of the target or other corporate attributes are changed as a consequence or after the acquisition, that do not affect its existence as a legal entity.

 

In addition, the net operating losses of the target may not be deducted from earnings obtained after a change in control occurring during a calendar year if, in addition, any of the following conditions is met:

 

• as a consequence of the change in control or in the 12-month period immediately preceding it, the company changed or expanded its main line of business, unless it keeps its original line of business;

 

• upon the ownership change, the company does not own capital assets or other assets related to its trade or business that allow the continuation of the same trade or business or the value of which is not related to the acquisition value of the company; or

 

• following the ownership change, the company solely obtains passive income from investments in other companies or as a recipient of profit reinvestments.

 

For these purposes a change in control is deemed to occur in the calendar year when the new shareholders or owners acquire or end up acquiring directly or indirectly at least 50 per cent of the capital or participation in the company.

 

An exception to this limitation on the use of losses exists when the change of ownership occurs between companies belonging to the same corporate group.

 

Acquisitions or reorganizations of bankrupt or insolvent companies are subject to general rules.

 

8.      Interest Relief

 

Does an acquisition company get interest relief for borrowings to acquire the target? Are there restrictions on deductibility where the lender is foreign, a related party, or both? Can withholding taxes on interest payments be easily avoided? Is debt pushdown easily achieved? In particular, are there capitalization rules that prevent the pushdown of excessive debt?

 

As explained in question 3, interest relief is only available if a Chilean acquisition company is used. In addition, interest expenses may not be deducted if the target company is organized as a corporation and not merged into the acquirer, since potential income from the target (ie, dividends and capital gains) may not be subject to ordinary income taxation. Additional acquisition structuring, such as interposing an intermediate Chilean limited liability company between the local acquisition company and the target, could be used to ensure interest relief at the level of the acquisition company.

 

Deductibility restrictions do not depend on whether the lender is foreign, a related party or both, although under transfer-pricing rules the Chilean Revenue Service has the authority to challenge excessive interest charges made to a local borrower by a foreign related party.

 

Generally interest payments to a foreign lender are subject to a 35 per cent withholding tax. This tax may be reduced where the lender is resident in a tax-treaty country. Most tax treaties signed by Chile provide for a maximum interest withholding tax of 15 per cent.

 

In addition, interest payments made to a foreign bank or financial institution may be subject only to a 4 per cent interest withholding tax. If the funds are already available within the acquirer’s group or borrowings are made outside of Chile, it is common to use back-to-back transactions, where the local acquisition company borrows from a foreign bank, using as security cash deposited by a member of the acquirer’s group in the same bank. A non-Chilean resident financial entity registered with the Chilean IRS under a procedure established in 2008 can also be used instead of a back-to-back transaction with a bank. Interest paid on the back-to-back loan to the foreign bank or to a foreign registered financial entity would qualify for the reduced 4 per cent interest withholding tax. However, the back-to-back loan as well as a loan from a related party financial entity would be subject to thin capitalization rules, under which, if the borrower’s debt with related parties benefiting from the 4 per cent withholding tax exceeds three times its equity, interest payments deemed to be in excess of such ratio would be subject to a 31 per cent surtax. It is important to note, however, that related party borrowings are only subject to these thin capitalization rules if interest payments on those loans may benefit from the reduced 4 per cent withholding tax.

 

It may be possible to achieve debt pushdown without much structuring if the acquisition has taken place as a taxable transaction. It could be more complicated to achieve debt pushdown in cases where the acquisition is not taxable in Chile, when both the seller and acquirer are foreign companies. Debt pushdown would be subject to the same thin capitalization rules mentioned above, also only on its related party debt.

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