Tax Receivable Agreements are legal contracts that outline the terms and conditions for the transfer of tax benefits from one party to another. These agreements are commonly used in mergers and acquisitions between companies, where the acquiring company gets the benefit of a tax asset of the company being acquired. To understand how Tax Receivable Agreements work, it is crucial to delve into the details of the tax benefits included in these agreements.
Tax benefits are entitlements granted to taxpayers by the government, allowing them to reduce the amount of taxes paid to the government. There are two types of tax benefits, namely net operating losses (NOLs) and tax credits. NOLs are tax benefits that arise when a taxpayer`s deductions exceed taxable income, leading to a tax refund or credit. Tax credits, on the other hand, are tax deductions that are directly subtracted from the taxes owed by a taxpayer, thus reducing their tax liability.
When a company is acquired, the acquiring company may be entitled to utilize the acquired company`s tax benefits as part of the deal. The acquiring company and the acquired company then enter into a Tax Receivable Agreement, which outlines the terms and conditions of the transfer of tax benefits. The agreement is usually negotiated between the two parties before the acquisition is finalized.
The Tax Receivable Agreement spells out how the acquired company`s tax benefits will be allocated between the two companies. The agreement also includes provisions for calculating the value of the acquired tax benefits and how they are to be used by the acquiring company. The agreement also spells out the timeline for how long the tax benefits will be available to the acquiring company, as well as any limitations or conditions on their use.
In some cases, Tax Receivable Agreements may also include clawback provisions. These provisions allow the acquired company to recapture some or all of the tax benefits if the acquiring company does not meet certain requirements or fails to use the tax benefits in the manner outlined in the agreement.
In conclusion, Tax Receivable Agreements are essential legal contracts that facilitate the transfer of tax benefits from the acquired company to the acquiring company. These agreements help to maximize the value of the acquisition by allowing the acquiring company to utilize the tax benefits of the acquired company. Companies looking to engage in mergers and acquisitions should be well-informed about the use of Tax Receivable Agreements and seek the advice of legal and financial experts to ensure that the agreements are structured appropriately.