Fix the problems before you sell

Once you have an interested buyer, they are almost certainly going to perform some sort of due diligence on your company.  This will be to understand the business and to quantify any economic risks attached to it, ensuring where possible that these risks are borne by the vendor. Where something serious is found it can significantly affect the price paid or as an alternative alter the structure of the transaction. For example, it may lead to the purchaser insisting on buying the assets of the business rather than shares which will itself affect the net of tax proceeds you receive as a vendor. You can read about this here. It will also inevitably lead to a lengthening of the sale process if something is found of which the vendors were unaware and reduce the confidence of the buyer. Ultimately it may lead to the failure of the transaction.

Whilst significant corporation tax issues may emerge from purchaser due diligence this should usually be relatively unlikely since most companies will have been professionally advised on their corporate tax. Significant and unexpected problems are perhaps more likely to emerge in the area of employee tax. This is because employee tax issues usually relate to large aggregate sums, any mistake will usually have been compounded over the long term, and employment tax issues sometimes receive less scrutiny than the corporation tax filings. Finally, any liability to PAYE and NIC will rest firmly with the company and, if sizeable, could significantly reduce the value of the company and therefore the sale price.

Core employment tax areas

Let’s look at a couple of employment tax areas were significant and unexpected problems can in our experience arise which can jeopardise a transaction: the Employment Related Securities and the Disguised Remuneration tax codes. Where shares or share options have been acquired by employees the expectation may be that when employees sell these shares, they will have a personal capital gains tax liability with there being no tax liability on the company. However, the Employment Related Securities rules can operate to recharacterise a significant part of the proceeds of sale as employment income with the company having PAYE and NIC liabilities on this income. Where large employee shareholdings are held the total company liabilities arising on a sale can be very significant. Equally the Disguised Remuneration rules can, for example, treat certain loans to employees as earnings, with the company having PAYE and NIC liabilities on these loans. Both areas are some of the most complex parts of the UK tax code and it is very easy for some aspects of them to have been overlooked in the past giving rise to unexpected issues on purchaser due diligence. 

Conversely, in some other cases, the exercise by employees of share options on a company sale can give rise to large additional corporate tax deductions, and either reduction in, or repayments of, the tax which needs to be taken into account in valuing the net assets of the company for a typical transaction.

Broader risk considerations

Additionally, and from recent experiences, issues relating to the following have also given rise to blockers/delays on transactions, impacting on price and attractiveness of the deal, particularly as it can highlight how the organisation approaches tax as part of their behaviours/beliefs and risk compliance strategy:

• IR35 – payments to consultants that are off-payroll;
• The definition of vans for benefit-in-kind purposes – this is distinct from the definition used by insurers, the DVLA and HMRC’s VAT team;
• Whether dividends are actually “dividends” or just disguised earnings – have they come from distributable reserves and do they align with the correct share class, with documentation confirming this;
• Directors’ loan accounts – are they being reported on Form P11D and if not, is interest actually being paid at the appropriate rate?;
• National Minimum Wage – this can be a significant financial and reputational risk;
• CJRS – were the CJRS grants claimed to pay employees on furlough compliant? HMRC are anticipating an error rate of 8.7% on claims that were made.
• Payments that have been tax free on termination
• Payments to family members – are family members actually undertaking any work and is the pay commensurate to the duties being undertaken; and
• Payments to non-executive directors that have been made off the payroll.

What next?

Vendor or sell-side due diligence allows vendors generally to identify such areas in their business and address the issues before a sale process begins or to ensure that they are disclosed and presented in a balanced way to purchasers.  Either way, they can remove the possibility of disruptive and damaging surprises during the transaction. 

If you would like to discuss any aspect of Vendor Due Diligence please get in touch.

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