As the saying goes, if you fail to plan, then you plan to fail.
A business desirous of embarking on a successful Merger & Acquisition (M & A) transaction, must amongst other things, take into account tax concerns that may affect the structure of the deal and its eventual success. By doing this, such business is able to minimize tax liabilities, avoid tax pitfalls, and comply with relevant tax regulatory authorities and laws, whilst milking to the fullest the financial benefits of a well-planned M&A transaction
On the flip side, where this is not done, such a company runs the risk of incurring unforeseen tax liabilities, missing out on tax benefits that accompanies mergers, selecting a tax-inefficient M&A structure that lowers net profitability, and failing to comply with relevant tax laws, which can result in fines, interest, and more scrutiny from tax authorities. In this article, we unravel tax implications you should consider when entering a Merger and Acquisition Transaction.
TAXATION IMPLICATIONS IN MERGERS AND ACQUISITION
According to the provisions of section 29 (12) of the Companies and Income Tax Act (CITA), prior to embarking on an M & A transaction, the merging businesses must first seek the consent of the FIRS and its direction. The section provides that:
"No merger, take-over, transfer or restructuring of the trade or business carried on by a company shall take place without having obtained the Service's direction under subsection 9 of this section and clearance with respect to any tax that may be due and payable under the Capital Gains Tax Act".
To apply for the FIRS directions, the merging businesses are required to send copies of all pertinent transaction documents and when the M & A transaction meets the FIRS's satisfaction, the FIRS will issue a letter of "approval-in-principle."
APPLICATION OF THE COMMENCEMENT AND CESSATION RULE1
UNRELATED PARTIES
When parties involved in M&A transactions are not related, the old (absorbed) and new (emerging/surviving) enterprises are considered distinct2. In such instances, the commencement and cessation regulations as provided in section 293 of the CITA (as amended by the Finance Act 2023) will apply to the surviving and ceasing company, respectively.
This means that the new and old company will be expected to file their returns in line with the commencement and cessation rules.
ALLOWANCES AND ABSORPTION OF LOSSES
Being a distinct new entity from the ceasing company, the emerging business is entitled to enjoy all the capital, investment, and initial allowances available to new businesses. However, the new company is not permitted to absorb any unutilized capital allowances or tax losses of the ceasing company.
RELATED PARTIES
Section 29 (9) of the CITA provides that:
Where a trade or business carried on by a company is sold or transferred to a Nigerian company for the purposes of better organisation of that trade or business or the transfer of its management to Nigeria and any asset employed in such trade or business is sold or transferred, if the Board is satisfied that one company has control over the other or that both are controlled by some other person or are members of a recognized group of companies, the Board may in its discretion direct that the the provisions of subsections (3) and (4) of this section (section 29) shall not apply to such trade or business(Commencement and Cessation Rules).
This means that, where parties involved in M&A transactions are related, the old and new enterprises are not considered distinct and, the emerging and surviving company will not be subject to the commencement and cessation rules.
Rather the emerging business will continue to file its return as an ongoing concern and its annual returns will be determined on a preceding year basis.
This is the case even where a new company is incorporated to carry on any trade or business previously carried on in Nigeria by a foreign company4. If the FIRS is satisfied that the trade or business carried on by the re‐constituted company immediately after the incorporation of that company under the Act is not substantially different in nature from the trade or business previously carried on in Nigeria by the foreign company, then the commencement and cessation rule will not apply5.
ALLOWANCES AND ABSORPTION OF TAX LOSSES
For related entities, as the emerging company is not deemed to be distinct from the ceasing company, it shall not be entitled to any initial allowance with respect to acquired assets and other allowances deemed to have been received by the ceasing company6. However, it will still be entitled to other tax allowances available to businesses within its sector7.
The re-constituted company, as provided for in Section 29 (10) of the CITA, will also not be entitled to any initial allowances in respect of assets vested in it by the foreign company. Also, it shall be deemed to have received all allowances given to the foreign company with respect to those assets and any allowances deemed to have been received by the foreign company8.
By the provisions of Section 29 (10) (d) of the CITA, the amount of any loss incurred by the foreign company (who is the ceasing company) in the trade or business it previously conducted in Nigeria during any assessment year, as long as it has not been deducted from any of the company's assessable profits or income for that year under the applicable provisions of the Companies Income Tax Act 1961 or the Income Tax Act, will be considered a loss incurred by the reconstituted company in its trade or business during the assessment year in which its trade or business began.
OTHER TAX CONSIDERATIONS
In relation to M & A arrangements, section 32 of the Capital Gains Tax Act (CGTA) states that if the reorganization agreement is between related parties, Capital Gains Tax (CGT) will not be applicable to the sale or transfer of assets. However, for this to apply, the related parties must have been connected for at least 365 days prior to the date of reorganization9.
As it relates to VAT, when products and services are supplied that are not excluded from VAT under the VAT Act, section 42 of the Value Added Tax Act levies a 7.5% VAT.
CONCLUSION
On the 28th of March 2024, the Central Bank of Nigeria released a circular to all commercial, merchant, and non-interest banks in Nigeria announcing an upward review of the Minimum Capital Requirement10. In a bid to meet this new minimum capital requirement and avoid the big hammer of the apex bank come March 2026, several financial institutions have started entering M&A transactions with one another11. For these financial institutions, one primary thing that must be considered in all proposed M & A contracts is the tax implication of such transaction on the merging businesses because combining entities that fail to consider this factor before entering an M & A contract, may soon find themselves in avoidable pitfalls that greatly undermine the success of their M & A deal.
Footnotes
1. Section 29 (3) and (4) of the CITA provides for the Commencement and Cessation taxation rules respectively
2. In this instance, the surviving company is seen as a totally new business formed by the merged businesses
3. Section 29 (3) and (4) of the CITA provides for the Commencement and Cessation taxation rules respectively
4. Section 29 (10) CITA
5. Section 29 (10) (a)CITA
6. Section 29 (9) (C) CITA
8. Section 29 (10) (c)CITA
9. Where the acquiring company decides to dispose of the assets acquired within the 365 days after the transaction date. This exemption will be revoked, and the companies will be treated as though they did not qualify for the exemption.
10. CBN's Review of Minimum Capital Requirements for Commercial, Merchant, and Non-interest Banks in Nigeria
11. A good example of this is the Providus & Unity Bank merger
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.