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The prospect of increased capital gains taxes has been a recurring topic of debate in recent years. While some argue that higher taxes on capital gains can discourage investment and economic growth, others contend that they can stimulate M&A activity. This blog post will explore how a capital gains tax hike could impact the M&A market.

The Tax Implications of M&A

When a company is acquired, the target company’s shareholders typically realize capital gains. These gains are subject to capital gains taxes, which can significantly reduce the after-tax proceeds received by sellers. A higher capital gains tax rate can make selling a company less attractive, potentially discouraging M&A activity.

The Potential Benefits of a Capital Gains Tax Hike

Despite the potential negative impact on M&A activity, a capital gains tax hike could also have some unintended positive consequences:

• Increased Deal Urgency: Anticipating a future increase in capital gains taxes, sellers may become more motivated to sell their businesses sooner rather than later. This could lead to a surge in M&A activity as sellers seek to avoid higher tax bills.
• Accelerated Dealmaking: Buyers and sellers may be more willing to negotiate and close deals quickly to take advantage of lower capital gains tax rates before they increase, resulting in a more active M&A market.
• Structural Changes: To mitigate the impact of increased capital gains taxes, companies may be more inclined to restructure their businesses or explore alternative transaction structures. This could lead to innovative dealmaking and increased M&A activity.
• Increased Demand for Tax-Efficient Structures: As companies seek to minimize their tax liabilities, there may be increased demand for tax-efficient M&A structures, such as Reverse Morris Trusts or Section 351 exchanges. This could drive innovation and complexity in the M&A market.

Balancing the Risks and Rewards

While a capital gains tax hike could stimulate M&A activity, it’s essential to consider the potential risks. A higher tax burden on sellers could reduce their willingness to sell, mainly if the market is challenging. Additionally, increased uncertainty about future tax policies could make it more difficult for buyers and sellers to reach agreements.

Conclusion

The impact of a capital gains tax hike on the M&A market is likely to be complex and multifaceted. While there are potential risks, there are opportunities for increased deal activity and innovation. By understanding the possible implications and carefully navigating the changing landscape, businesses can position themselves to capitalize on the opportunities presented by a higher tax environment.

Every person selling their business wants to maximize returns. For the buyer, risk mitigation is a top priority. However, neither of these states can be realized without proper consideration of the tax ramification during an M&A transaction.
To give us a professional outlook on this pivotal matter we interviewed Ed Castellani a tax attorney and certified public accountant at Fraser Trebilcock.

Here are Ed’s top five M&A tax consequence ramifications to be aware of.

Tax Ramification #1 Discuss the type of sale upfront

One of the key questions that needs to be addressed right off the bat prior to any documents being structured is what type of deal is this?

Is this an asset or stock deal? It’s important to clarify this because the type of deal in question presents unique tax consequences that will affect how the deal is subsequently structured.

For example the seller will want long term capital gains because this is the best tax consequence for them. And the way to achieve this is through a stock deal.

Buyers on the other hand won’t want a stock deal as much and will prefer the asset deal. In the end, negotiations will need to be had and a compromise reached.

Takeaway: “The best thing for a tax practitioner to do is to have the conversation up front. What kind of a transaction are we going to have? These types of questions should be some of the first fundamental decisions made…”

Tax Ramification #2 Incorporate tax issues into the LOI

Regardless of which Letter of Intent (LOI) you’ve entered into – binding or non-binding – the tax ramifications need to be spelled out in writing.

The LOI should disclose some information regarding the deal at hand. This makes it possible to evaluate the potential tax structures ahead of time.

Questions addressing whether this is an asset sale or stock sale must be answered. How the purchase price will be allocated, how the deal will be financed, how the money will be paid are further examples of what else needs to make its way into the LOI.

You don’t want to end up renegotiating the deal all over again once documents start being passed back and forth.

Takeaway: “The important provisions like the tax consequences and whether it’s an asset sale or a stock sale, and maybe even how the purchase price is going to be allocated to the assets, should be addressed in the letter of intent, because that establishes the tax consequences.”

Tax Ramification #3 Involve a certified public accountant

M&A deals should never proceed without qualified experts on board such as M&A attorneys, integration specialists, brokers, and certified public accountant (CPAs).

Where asset location is concerned, both the buyer and the seller must ensure they have a certified public accountant on their team reviewing appraisals. This is extremely important if there are major assets such as real estate involved.

You cannot afford to overlook this as the allocation of assets in these agreements determines the tax consequences.

The CPA is well-versed in matters pertaining to the business valuation of assets and issues such as depreciation recapture, and will be able to give their client the best tax advice to match their unique position and situation during the merger and acquisition transaction.

Takeaway: “The CPA has to be involved at this point on this asset allocation because the CPA will know what the basis in the assets is, how much the depreciation recapture, all of those tax issues.”

Tax Ramification #4 Plan your M&A with potential increases in tax in mind

The current Biden administration is keen to raise taxes. Capital gains tax may double from the current 20% to a high of 40%. That’s why we’re seeing so much activity in the market with people buying and selling actively. It’s a seller’s market if you want.  And buyers are having a field day.

The corporate rate is being considered for an increase too from 21% to 28%. That’s not all but for people with incomes above $400,000 per year, they also face potential increases in their capital gain rate and their income tax rate.

Don’t make decisions without consulting with a tax specialist.

Takeaway: “They also want to increase and expand the estate tax. It’s about every tax we have. They’re talking about raising it.”

Tax Ramification #5 Now is as good a time as any to buy

For buyers seeking favorable terms and conditions, now is probably as good a time as any to find a couple of good deals.

Money is readily available and cheap. And with tax rates set to go up, there has never been a better time than now to make your moves if you’re a buyer.

For sellers, the crystal ball is pretty clear – sell now.

Takeaway:  “It’s a good time to buy. Now’s a good time to act.”

Get the help you need

If you would like to discuss the tax implications you may face as a buyer or seller during mergers and acquisitions, our team of advisors is only one phone call away.

Sun Acquisitions boasts an experienced M&A team that can assist you to navigate mergers and acquisitions regardless of whether you’re a buyer or seller. Don’t hesitate to contact us.