When you are trying to get a start-up off the ground, its fair to say that keeping on top of tax is generally not top of the to do list. Deduct PAYE, pay your GST, job done right? If you haven’t made a profit, does it really matter?
It can matter when it’s time to sell. Historic exposures remain with a company, and tax due diligence covering the last 5 financial years is a common part of a sale process, often conducted alongside commercial, financial and legal due diligence by a prospective purchaser.
We regularly undertake tax due diligence for buyers, with a particular focus on the tech/software space and these are some common issues that we see. Some of these can be resolved with some upfront planning and only a small cost. Others may be trickier to resolve but knowledge of the issue can help with mitigation. When it comes time to sell, you want top dollar for your business, and the fewer red flags the better.
- Tax status of developed software: capital or revenue: There is a lack of clear guidance on whether software developed in-house is taxable on sale. Generally, where it is developed for use in your business or to license to customers (including SaaS) we wouldn’t expect this to be the case. However where you have sold or assigned all or part of the underlying copyright rights more than once, there is a risk IRD could view the software as trading stock and taxable on sale. This could be relevant for example where you have sold the rights to license a product in a specific jurisdiction. Where this is this case, it could impact a future buyer’s ability to restructure, or to bifurcate/strip out the software asset, which could ultimately go to value.
- Internal restructures: Similarly, IRD can view the sale of internally developed software as taxable. If you are restructuring or moving IP between entities, it is important to speak to your tax advisor upfront to ensure no adverse consequences arise.
- Development expenditure: The tax treatment of development expenditure will commonly follow the treatment under IAS 38 accounting standards. Where an entity has not been audited however there is a risk that IAS 38 has been incorrectly applied, resulting in the incorrect tax treatment. Where IAS 38 is not applied, there is further complexity (and commonly less favourable outcomes).
- Repayment of R&D loss cash out: Have you cashed out losses under the R&D Tax Loss Cash-Out scheme? If so, a change of shareholding can result in this amount being repayable to IRD by the purchaser post acquisition.
- R&D Tax Incentive: Many businesses in this sector are coming to the end of their eligibility for the Callaghan Growth Grant, and that means moving to the R&D Tax Incentive regime. There is significant complexity in how to apply the 15% credit for software developers and in determining qualifying development expenditure. It is important to explore the R&D tax incentive with your advisor to ensure you maximise your entitlement. For many businesses the scope can be wider than you think.
- Cross border license of software: Have you licensed software to an entity overseas or are you paying for licensed software? NZ or foreign withholding tax could be payable on any royalties (including deemed royalties if nothing is paid). Transfer pricing rules will also apply if the foreign entity is related which can re-price transactions for tax purposes.
- Look through companies (LTCs): If you operate through an LTC, the LTC will generally revert to being an ordinary company on the date of sale of your shares in the LTC which can have complex transitional consequences including a deemed sale and reacquisition of the underlying assets. This can trigger adverse consequences for the vendor or purchaser which are important to understand.
- Employee share schemes: When shares or options are issued as part of an employment package, there are complex rules and Inland Revenue guidance in relation to the timing and quantification of income for employees. While tax risk generally remains with the employee, employers should provide guidance or advice to employees on these issues to avoid an unexpected tax bill and ultimately ensure value is preserved in what you are offering.
- Fringe benefit tax and private expenditure: If material FBT exposures are likely to arise, it is generally in relation into the treatment of vehicles provided to shareholders and employees. Signwriting a Ford Ranger does not make it exempt from FBT! While other benefits might not give rise to a material tax exposure; not paying FBT can appear to be symptomatic of a poorly managed tax/finance function. Similarly if there is significant private expenditure going through the company accounts, this will generally be identified in due diligence.
- Employee / contractor distinction: Although primarily a legal issue, there are many contractors engaged in these industries that are at risk of being categorised, legally, as employees. This can give rise to leave entitlement exposures and associated PAYE, Kiwisaver and FBT issues for the employer.
- Structure: Certain structures make it easier to sell, list or raise capital and it can be worth thinking about this earlier rather than later and have a ‘sale ready’ structure so you can move quickly when needed.
These are just some of the common industry issues that should be considered before you go down a sale process and ultimately will go to value. Manage these issues well, maximise your proceeds. Please reach out to us, or your usual Deloitte advisor if it would be helpful to discuss this further.