The impact of indirect taxes and the Income Tax Act on corporate valuation in mergers and aquisitions

Abstract

When mergers and acquisitions are conducted, valuation plays an important role in establishing a fair market value (FMV) of a target company. A number of variables including direct taxes are considered during the valuation process. This study looks at the impact of indirect taxes on the valuation result of target companies involved in mergers and acquisitions. Target companies considered for this study were those from different industries that were involved in mergers and acquisition transactions in 2004/2005 period, had at least three years of financial information available and had paid capital gains tax (CGT), an indirect tax, following a successful conclusion of the transaction. Research showed that there is likelihood that valuation result of target companies involved in mergers and acquisitions is significantly different when valuation included CGT compared to when valuation excluded CGT. Furthermore, considerable savings, implying higher ROI, could be realized should corporate acquirers and private equity factored in the effect of indirect taxes on FMV of target companies especially in industries where there are considerable under-valued operating assets. Effective tax rates can be determined for different industry groups and they can be mathematically be modelled with fair accuracy.