Seller of golf company battles buyer over right to $16.6 million VAT receivables as tax credit

In late 2010, Seller decided to sell Target (a wholly-owned subsidiary engaged in the manufacture and distribution of golf products, including Titleist-brand golf clubs, balls and tees and Footjoy-brand golf shoes) by way of auction. The eventual winning bidder was Buyer and after a period of negotiations, Buyer and Seller formalized the deal in a stock purchase agreement, dated May 19, 2011. A little over two months later, on July 29, 2011, the transaction closed, with Buyer purchasing all of the stock in Target for $1.225 billion, subject to certain postclosing adjustments.

To ensure the sale proceeded promptly and smoothly, Seller decided prior to soliciting bids to remove all issues regarding taxes by creating a bright-line allocation of Target’s preclosing tax liabilities to itself, as seller, and of postclosing tax liabilities to Target and its new owners. While no one from the Seller side explicitly conveyed that intent to Buyer, it was manifestly clear from the structure of the transaction as reflected in the stock purchase agreement.

That said, Buyer and Seller anticipated at least two types of tax situations where further arrangement was required. First, they foresaw that some of Target’s postclosing tax returns would include preclosing tax liabilities. To deal with this situation, Buyer and Seller agreed in the stock purchase agreement that Seller would reimburse Target for any preclosing tax liabilities included in Target’s postclosing tax returns.

Second, Buyer and Seller also anticipated the possibility that amounts related to preclosing tax liabilities might come into Target’s possession after the closing and need to be paid over to Seller. Buyer and Seller addressed this in the stock purchase agreement, which obligated Buyer to pay Seller any tax refunds or tax credits that relate to the period before the closing except to the extent Seller had an indemnification or payment obligation under the stock purchase agreement for taxes that had not been satisfied.

The wrinkle in this dispute concerned value added taxes (VAT), which were clearly taxes within the meaning of the stock purchase agreement, but never discussed during Buyer and Seller negotiations. Nonetheless, Buyer was aware from the outset that Target conducted business in countries that, unlike the United States, utilize a VAT system.

A VAT is a consumption tax, akin to a sales tax. For Target’s golf clubs, the VAT is imposed, in supposed recognition of the “value added,” at each stage of the golf club production or distribution chain. Each initial and intermediary vendor or retailer in the golf club chain, such as Target, pays VAT on Target’s own purchases of raw materials and other necessary products from Target’s suppliers (input VAT), and then bills and collects VAT from Target’s own customers (output VAT), with the final customer in the golf club chain, often a consumer, paying the entire amount of the VAT.

At the end of each VAT tax period Target reports and pays to the applicable taxing authority all of the output VAT that it has billed to its customers during that period, after taking a credit for all of the input VAT that Target has paid during the same tax period. Target’s output VAT is reported and paid to the taxing authority even if the tax has not yet been collected from Target’s customers. In theory, Target should be placed in a “net zero” position with respect to VAT by (1) taking a credit on a Target VAT tax return for the input VAT Target has paid and (2) collecting from its customers the output VAT that Target has paid to tax authorities.

Target reported the estimated amount of output VAT it is owed from customers as a separate line item figure or asset on its balance sheet, labeled “VAT receivable-trade.”  At the time of closing, the estimated amount reported in the “VAT receivable-trade” line item was $16.6 million.

While the words “VAT receivables” do not appear in the stock purchase agreement, those receivables were referenced in the accompanying disclosure schedules. By agreement of Buyer and Seller, a “working capital adjustment” was to be made for any difference between Target’s “base working capital” and the actual amount of its working capital at the time of closing, with a corresponding postclosing payment made by, as appropriate, the seller or buyer. However, the working capital purchase price adjustment mechanism did not include any changes in the amount of VAT receivables.

Three months after the closing, Buyer sent Seller a demand pursuant to the stock purchase agreement, for reimbursement of $19.3 million in taxes that Target had paid, postclosing, to various tax authorities for preclosing tax liabilities. Of the $19.3 million, approximately $3 million was for VAT. On November 1, 2011, Seller reimbursed Target for only $2.7 million, after taking a setoff of $16.6 million — the amount that was reflected in the “VAT receivable-trade” line item at the time of closing. According to Seller, it was entitled to the setoff under the stock purchase agreement because VAT receivables were amounts credited against or with respect to taxes for preclosing tax periods.

Buyer disagreed, and the dispute ended up in a Boston trial court.

The fuss all revolved around whether the of $16.6 million VAT receivable-trade (which represents Target’s estimate of the VAT Target paid by Target pre-closing to its vendors that Target would get back from its customers) was a tax credit or refund that relates to Target’s preclosing operations; which go to Seller under the stock purchase agreement. Buyer argued that the VAT receivables were not refunds or credits because they were owed by customers, (and not by a government) to Target.

The court did not buy Buyer’s argument and Buyer appealed; and lost.

The appellate court said that the transaction, was structured to allocate Target’s tax liabilities and benefits to Seller and Buyer on a pre- and postclosing basis, respectively. And, once again, while the $16.6 million in VAT receivables on Target’s balance sheet were not taxes per se as defined in the stock purchase agreement, they were related to preclosing taxes.

In addition, the appellate court noted, that because the VAT receivables were classified under “other current assets,” Buyer did not pay any additional amounts for those assets as part of the postclosing working capital adjustment. Instead, Target then proceeded, postclosing, to collect nearly all of the VAT receivables from customers. The net effect of Buyer’s interpretation, therefore, would be to hold Seller responsible for paying to the tax authorities the output VAT related to preclosing VAT receivables while barring it from recouping those amounts through the postclosing collection of the same VAT receivables. Such an interpretation the court concluded was at odds with the over-all tax allocation structure of the transaction.

This case is referred to Acushnet Co. v. Beam, Inc., Case No. No. 16-P-1611, Appeals Court of Massachusetts, Suffolk, (February 2, 2018).

Comment. This $16.6 million dispute (about 1% of the purchase price) involved two American based companies battling over what seems like a very esoteric argument over foreign value added taxes. It ended up going through trial and an appeal.

With 20/20 hindsight it would have been helpful had Buyer anticipated and got an express understanding with Seller about how to deal with the VAT receivables. But apparently neither party focused on this complicated issue. The result: It caught Target off guard and put Target in a cash crunch. As Target’s lawyer explained, because of the extremely seasonal nature of Target’s business, Target had to take on a number of loans to keep Target afloat until the next busy season for golf sales.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

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Posted in allocation of preclosing taxes refunds and credits, net working capital adjustment, stock purchase agreement, Taxation, value added tax or VAT

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