Key tax and legal issues to consider in a merger deal

The year 2019 is witnessing an increasing number of industry-shaking announcements of mergers and acquisitions. Most announcements have happened as various parties knock on the doors of the Competition Authority of Kenya and other statutory offices that pose the legal hurdles on the way to ultimate amalgamation.

The reasons for some entities yielding to the pressure to be taken over seems to vary in various sectors. Is the Kenyan economy and regulations presenting a harsh operating environment forcing the application of the rule of natural selection? Are Kenyan markets competitively growing and yearning for strategic alliances from supplying industries?

For example, in the Kenyan banking sector, Commercial Bank of Africa (CBA) and its rival NIC Group are set to create the third largest lender by assets estimated at Sh 444.3 billion. This announcement came shortly after CBA made a cash buy-out offer of Sh1.4 billion to Jamii Bora Bank — a shot in the arm for Jamii Bora that is currently drowning in negative liquidity. The last decade recorded seven acquisition approvals by the Central Bank of Kenya.

The telcoms and E-commerce sectors also experienced their fair share of amalgamations. Telkom and Airtel Kenya recently announced plans for a merger that will see shareholders of the two companies enter into an agreement to merge their respective mobile, enterprise and carrier service business lines. A joint venture named Airtel-Telkom will spearhead the partners’ objectives of enhancing scale, efficiency and strategic brand presence.

In the online retail business, Goodwell Investments (a Dutch firm) acquired a share in Copia, a promising E-commerce business that specialises in supplying products and services to currently undeserved consumers in rural Kenya, for Sh 200 million.

Due diligence

Another deal in the manufacturing sector involved French firm, Soc’iete’ BIC, which completed transfer of manufacturing facilities of Haco Industries in Kenya and businesses of distribution of stationery, lighters and shavers in East Africa. The acquisition is part of BIC’s continued growth strategy in Africa.

The winners and losers in any amalgamation deal are usually identified not long after close of the first or second financial year after the deal. The determinants are largely a combination of the legal, financial and tax implications of an amalgamation. Most parties to an intended merger will prefer undertaking expensive, but necessary, due diligence reviews to hedge their risks.

A due diligence report will advice on the calculated and bearable risks that a party should expect after a deal. An attractive deal poses little or no legal, financial and tax risks to all parties after a merger.

It is imperative that the financial and tax impact of any merger deal is projected before a legal form of transfer is chosen. The tax impact of an acquistion deal totally differs from that of a merger. To be clear, a merger entails combining operations under mutually agreed terms. On the other hand, an acquisition entails taking over of another institution’s operations. The parties to a deal may be a combination of loss making or profit making entities alone, or a mix of the two.

Tax losses

From a tax perspective, when a loss making entity merges with a profit making entity, it stands to lose since tax losses from previous years are not transferable to the new entity. The same treatment applies where a profitable entity acquires a loss making one. However, when a loss making entity acquires a profit making entity it stands to utilise all its previous tax losses against profits generated after the deal. Such factors should dictate the choice of an amalgamation deal since synergy optimisation is key to all parties.

Furthermore, the VAT Act 2013 also provides additional incentives by eliminating tax on transfer of any properties on a going concern basis between two registered persons. Similarly, the Income Tax Act shields parties to an amalgamation from accounting for tax on any capital gains arising. However, the enabling law requires clarification and guidelines on the tax exemption procedure.

In conclusion, all parties intent on amalgamating should be aware of the legal, financial and tax eventualities before sealing a deal. They should seek for proper and sound advice based on thorough reviews by relevant professionals and experts.