MBO deals may face big tax charges

Experts have warned that some MBO deals may need to be put on hold until after the publication of the finance bill because of measures announced in the recent Budget.

The measures, included in changes resulting from the introduction of international financial reporting standards, means that MBO teams acquiring the debt of related companies could be hit with big tax charges.

Uncertainty surrounding the issue has led experts to warn corporate finance teams and managers planning a buyout to seek tax advice or freeze their deals until the finance bill clarifies exactly what the rules will be.

‘There’s something in the Budget and it could be important. So, if you are looking at these kinds of situations you might consider putting deals on hold until you see the draft legislation,’ said David Mellor, tax partner at PKF.

The government has rejigged the rules announced in previous Budgets on the tax treatment of discounted debt acquired from related companies. The first came in the Finance Act 1996. Clarifications were then attempted in the Budget of 2002. The latest moves appear to return the rules to their original 1996 position.

The issue revolves around the arcane matter of acquiring the debt of related (subsidiary of sister) companies from a third party, such as a bank or, in the case of MBOs, from old parent companies.

The government said in the Budget that, if the debt is acquired at a discount, the difference between the original value and the new lower market value is a taxable benefit – but the precise details remain unclear.

Changes in the past have revolved around when to recognise for tax purposes the benefit gained from buying debt at a discount – critically, whether it is recognised over time, usually the term of the debt, or all in one hit. Buying debt at a discount is a frequent practice in MBO deals.

Other experts were highly critical of the government changes. Derek Jenkins, a tax partner at Pricewaterhouse-Coopers, said it was ‘extremely unfortunate’ that measures which fix many technical problems in tax treatments when moving to IFRS amounted to a ‘major retrograde step and a real problem for an important sector of UK industry’.

Last year saw the total value of larger MBOs grow to £19.3bn from £15.6bn in 2003, demonstrating the importance and strength of the market. Among the biggest deals by value were the MBO at The AA at £1.7bn, Saga at £1.3bn and DFS at £450m.

In all, 2004 saw 145 large buyouts completed totalling £19.35bn with the year seeing the highest value, and the highest number of deals, for four years. These amounted to increases of 24% and 17% on 2003.

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