Claiming input tax credits
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Claiming input tax credits for an acquisition that is remote from a potential M&A transaction
Acquisitions made at an early stage with respect to a possible M&A activity may be too remote from any intended input taxed financial supply for input tax credits to be denied by reference to the possible final supply.
Because the acquisition is so remote from any possible M&A activity, it may be appropriate to claim input tax credits on a basis which is consistent with how input tax credits are claimed on overheads or enterprise costs – that is, to treat the acquisitions as relating to all of the enterprise activities, rather than any particular supplies, and to apportion input tax credits accordingly.
If the expenses are incurred as part of a unit or business area that has the specific function of engaging in M&A, it may be more appropriate to assess creditable purpose by reference to the activities of that unit or business area and treat the expenses as overheads of that unit. For example, if the work is done by a unit which solely engages in the input taxed acquisition and supply of shares, input tax credits would be denied.
If M&A activity is not part of the usual business, creditable purpose might be assessed by reference to the supplies made by the business as a whole. The expenses would be treated as enterprise costs. In this context, by 'usual business' we mean that such M&A activity is not, in itself, a focus of the entity's core business activity.
Claiming input tax credits for an acquisition that is no longer remote from a potential M&A transaction
If an acquisition has a sufficient connection with potential supplies made under the M&A, its creditable purpose depends on both the nature of the acquisition and the intention of the business at the time of the acquisition.
Acquisitions that are related solely to the pursuit of a particular option need to have creditable purpose assessed by reference to that option. For example, advice on the availability of the GST-free going concern concession obtained by a purchaser of business assets would relate to the supplies that are intended to be made by the purchaser using those business assets and not to an input taxed acquisition-supply of shares. Therefore, if those assets are not intended to be used to make input taxed supplies, input tax credits would be allowed.
Acquisitions of services such as the provision of advice on taxation, regulatory, contractual or other matters in the context of an M&A activity need to be examined to determine whether or not they relate to a specific form of M&A transaction or a number of different forms indifferently. There are services such as taxation advice that in some contexts may be described as general overheads. As a general proposition, however, we do not consider that taxation advice relating to the M&A activity constitutes a general overhead cost of the business. Rather, that advice may be specifically related to the M&A. The creditable purpose of such advice will need to be determined on the basis of the nature of that advice and the particular purpose or purposes to which it is directed.
Where acquisitions relate indifferently to the alternative forms an M&A transaction may take, in determining creditable purpose you will need to assess the degree of relatedness to any potential input taxed supply. This should be assessed by reference to the current preferences or decision of the enterprise (for example, senior management or the board) in conducting the M&A, as at the time of acquisition.
If this is not possible because no sufficiently defined approach to the proposed transaction has been developed, there might be other objective factors that could be used to establish creditable purpose. For example, for a business that engages in M&As regularly, this might be done by reference to the business's track record of successful M&A transactions.
On the other hand, there may be no particular objective factors that indicate the form in which the M&A is likely to occur. If it is reasonable to consider that it is about as likely as not that the M&A will be conducted in a manner that gives rise to an input taxed supply as a non-input taxed supply, a fair and reasonable approach may be to claim 50% of the input tax credits.
Where success fees are consideration for a supply that is properly construed as the provision of the ongoing services of an advisor in connection with a particular M&A, creditable purpose for those services should be determined by reference to the intended use of the acquirer over the period in which those services were being acquired.
The potential that the M&A activity may not culminate in a completed deal (for example, the parties may walk away) is not relevant in assessing the extent of creditable purpose. That is, where the probability of being successful in any M&A activity is 10% (because of the number of bidders etc), it does not mean that you are entitled to claim 90% input tax credits for the acquisition as an overhead and are only required to assess creditable purpose in respect of 10% of the relevant acquisitions relating to that potential M&A.
When an M&A is in phase three, the GST character of the intended transaction will generally be known and creditable purpose can be determined based upon the GST character of the intended transaction. That is, acquisitions made in this phase will typically be related to the intended supply that will conclude the M&A transaction.
Example one – company decides to sell part of its business by either selling shares or assets depending on which is more commercially attractive
Vendor Ltd is in financial difficulty and, after having a strategic review undertaken (phase one), is seeking to divest some of its operations. It is open to all offers for all the group's assets or selling shares in its operating subsidiaries. Vendor Ltd establishes a project team and engages external expertise (an investment bank, an accounting firm and a legal firm). Vendor Ltd issues an information memorandum to Australian entities and also establishes a data room that allows prospective buyers to access the group's confidential business data and records so that they can perform due diligence before making a final bid under the offer process (phase two).
When objectively viewed, Vendor Ltd does not have a preference about whether the bidders offer to buy business units, assets or shares in operating subsidiaries. This is evidenced by the information memorandum provided to potential bidders and the advice provided to the accounting provider by Vendor Ltd that information on all aspects of the corporate group be included. It will consider each bid individually. Objectively viewed, Vendor Ltd intends to sell assets or shares (subject to bidders providing an attractive offer), but there is no basis on which to assess the relative likelihood of the form the transaction will take before bidders put in their bids. For acquisitions that relate to this period of time, it is reasonable for Vendor Ltd to determine that creditable purpose is 50%, as it is considered about as likely as not that a transaction will proceed by way of an input taxed share sale or a taxable (or GST-free) asset sale.
Example two – planned takeover where decision to make acquisition by way of share purchase is made at an early stage
Cat Ltd is a listed entity and has identified Mouse Ltd (another listed entity) as a potential takeover target that could be restructured and integrated into Cat Ltd's operations (phase one and two are already completed at this point).
Cat Ltd determines that the only realistic means to proceed with a takeover is by purchasing the shares in Mouse Ltd and engages Investment Bank (IB) to advise on a takeover strategy. On IB's advice, Cat Ltd proceeds to acquire Mouse Ltd shares on market and then later announces an off-market takeover bid for the remaining shares (phase three).
In this scenario, it was apparent that at the time Cat Ltd engaged IB it had determined that the only means realistically available to effect the takeover was by a share purchase.
In this case, there is an objective basis to determine that there was only ever one option available, being the acquisition of shares. IB's services only relate to the purchase of shares and therefore Cat Ltd cannot claim input tax credits.
Example three – planned M&A: assessing creditable purpose of services remunerated by way of a success fee
MinCo has been assessing its capacity to expand and evaluating market conditions (phase one).
MinCo decides that it wishes to expand its mining interests by making a significant acquisition and engages IBank (an investment bank) to assist in identifying a suitable target and in all aspects of effecting the acquisition. IBank is to be paid a retainer and is to receive a significant payment upon successful completion of any deal. At the time IBank is initially engaged, MinCo has no particular preference for how best to proceed with any deal, as IBank's mandate is to canvass all possible options. Over a period of three months, IBank undertakes research into suitable targets and, having formed a view about a particular target entity, recommends that MinCo acquire Digger Co by way of share acquisition (phase two).
MinCo accepts the recommendation, subject to the necessary checks. Over the next four months, IBank, with the assistance of several other service providers, undertakes due diligence into Digger Co. All due diligence proves satisfactory and MinCo approaches Digger Co with a proposal that they merge by way of MinCo acquiring all of Digger Co's shares using a scheme of arrangement (phase three).
The scheme of arrangement to execute the takeover is accepted four months later, and MinCo acquires all shares in Digger Co. MinCo pays IBank a success fee of 3% of the capital value of Digger Co (phase three).
In working out the input tax credits to claim on IBank's services, MinCo applies the following analysis:
- Phase two: No preference is established but there is an intention to proceed – the options IBank is looking at could involve asset or share acquisitions, and there are no other objective measures that can be ascertained to determine the likelihood of one option or another. For acquisitions that are not specific to a particular option, input tax credits are claimed based on 50% creditable purpose.
- Phase three: During this period the company is pursuing the acquisition of shares. As such, it is considered that no input tax credits can be claimed for acquisitions related to the potential share acquisition.
- For the payment that is made at the conclusion of the transaction relating to services performed by IBank during the different phases, a reasonable assessment needs to be made as to what extent the services related to work in the different phases.
Example four – company decides to sell part of its business - several different options
Indigo Co has decided to refocus on its core activity of manufacturing electrical appliances and has decided to sell off a part of its non-core business, which is operated by way of a wholly owned subsidiary. Due to the nature of the non-core business, it is considered that there is a real likelihood of interest from a particular non-resident entity in acquiring the business by way of share acquisition. There are also two resident entities interested in acquiring the business – one has indicated that it is interested in purchasing the key business assets, and the other has indicated it is only interested in a share acquisition. Indigo Co is keen to sell the business for the right price and has no preference as to how the transaction will proceed.
From the point at which Indigo Co determines it will sell off part of its business, Indigo Co moves out of phase one and into phase two. During phase two, some denial of input tax credits on acquisitions related to supplies that would be input taxed is required.
Indigo Co undertakes various planning, financial modelling and preparation of information to provide to potential bidders and engages investment banking, valuation, and specialist accounting and legal services to assist in the sale.
Indigo Co is aware that there needs to be some level of denial of input tax credits in regard to acquisitions made that relate to the sale. There are three potential bidders, each having a different preference for the form of the transaction. It can't be predicted which bidder is likely to be successful. Therefore, Indigo Co decides, in the absence of other factors, to apportion input tax credits taking into account the respective preferences of each bidder.
Possible GST character of supply
Entity A (non-resident)
GST-free sale of shares
Entity B (resident)
Taxable sale of assets
Entity C (resident)
Input taxed sale of shares
There are three equally likely forms that the transaction could take, one of which is input taxed. Indigo Co concludes that it is fair and reasonable to claim input tax credits on the basis of two-thirds (66%).
When the M&A activity progresses to phase three (for example, when negotiation with a preferred bidder commences), Indigo Co will be able to determine a revised input tax credit percentage for services acquired from that point onwards.
End of example