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published on 19 May 2022 | reading time approx. 3 minutes
Globalisation has long made its way into daily M&A practice. Over the time, certain terms from the English specialist jargon have also become established in the German transaction practice. The following article discusses tax aspects of the very frequently used structuring alternative – the so-called “debt push-down”.
In practice, company acquisitions are often financed through debt capital. The borrowing of capital involves future debt and interest repayment obligations. If, for the purpose of acquiring a target company, an acquisition vehicle is established (AcquiCo) and if this company does not engage in any further operating activities apart from holding the shares in the target company after the acquisition, interest expenses may only be claimed as tax-deductible expenses to a limited extent.
Debt push-down refers to a series of steps taken to enable the acquirer to “push down” the principal and interest debt arising from the debt financing to the target company as part of the transaction.
If an acquisition vehicle raises debt capital in order to finance the acquisition of the target company, this results in the obligation to repay the debt and interest at the level of the acquisition vehicle. The debt capital is usually settled by uses of profit distributions which will be paid out by the target company to the acquisition vehicle. If the acquisition vehicle does not generate any other income apart from the profit distributions, which are generally treated as tax-exempt income at the level of the acquisition vehicle, interest tax-deductible expenses will be considered very limited. The so-called debt push-down can help to avoid or mitigate this limitation deduction.
There are a variety of instruments that can be used for structuring a “push-down” of debt capital (debt push-down). When choosing the appropriate structure, the overall circumstances of the individual case must always be taken into account. The most relevant alternatives in practice are:
After the acquisition of shares in the target company by the acquisition vehicle, the acquisition vehicle may be merged into the target company by way of a down-stream merger. In this process, the target company acts as the acquiring vehicle. The same result is achieved through an upstream merger in which the target company, as the transferring company, is merged into an acquisition vehicle after the acquisition of its shares. The merger of the companies means that interest expenses incurred by the acquisition vehicle due to the borrowed capital can be offset against profits from the target company's operating business. The result of this consolidated approach (full integration) is that the taxable income as well as the effective tax burden (due to the deduction of the interest as a tax-deductible expense) is reduced.
The merger usually results in a transfer loss, which, depending on the amount, can have a negative impact on the balance sheet and even lead to disclosing negative equity. The loss incurred for HGB balance sheet purposes can be avoided by exercising the option to transfer the assets at fair market value (so-called step-up).
The direction of the merger should be carefully determined in advance. For example, the merger may lead to forfeiture of tax attributes (such as loss carry-forwards) or trigger real estate transfer tax or hidden profit distributions.
2. Tax consolidation / Tax Group
Another possible way of implementing a debt push-down structure is to establish a tax consolidation group for income tax purposes between the acquisition vehicle as the controlling company and the target company as the controlled company. In very simplified terms, the formation of a tax consolidation group leads to a situation where the tax consolidation group parent and the tax consolidation group company are seen as one taxable entity. On the other hand, the companies – unlike in the merger – continue to exist as individual legal entities. The establishment of the tax consolidation group has the advantage that profits and losses can be offset within the tax consolidation group. Thus, also in this case, the financing expenses at the level of the controlling company (acquisition vehicle) can be offset against the operating income of the controlled company (target company). This will reduce the total tax burden of the tax consolidation group.
In addition to the remarks outlined above, a debt push-down involves many other aspects to consider. It should be mentioned first of all that the calculation of the debt push-down should take into account the regulations and consequences of the interest cap as well as business tax additions. Furthermore, in the case of cross-border transactions, a reporting obligation according to DAC6 may be triggered or the regulations of Section 4k Geman Icome Tax may apply. In the case of shareholder loans, the arm's length principle should also be taken into account.
The term “debt push-down”, a loanword from the English specialist jargon became well-established in German. It is a structuring instrument that offers the possibility in daily M&A practice to use the frequently incurred debt financing costs in the most tax-optimised way in the acquisition of target companies. As is so often the case in tax law, special attention should be paid to the overall circumstances of the individual case when choosing the suitable structure.
Mimoun Houbbani
Associate Partner
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