Explore a legal case that highlights the importance of addressing foreign tax liabilities in M&A deals. Learn from an $80 million acquisition where inadequate management of escrow arrangements led to a dispute over unpaid Mexican income taxes.
Wednesday, July 1, 2020
Introduction:
When one company acquires another’s assets, it’s crucial to address potential tax liabilities, especially when dealing with foreign jurisdictions. In this legal case, we explore how a buyer’s concerns over the seller’s nonpayment of foreign taxes were not adequately managed through an escrow arrangement.
The Scenario:
In a notable $80 million acquisition of a children’s publishing unit, the assets included subsidiaries based in Mexico. Of the purchase price, $2.2 million was allocated to these Mexican subsidiaries. The seller was responsible for Mexican income taxes on their gain from this sale, amounting to around $540,000.
To safeguard the deal, $5 million of the purchase price was set aside in an escrow account. This was meant to ensure that the seller fulfilled their obligations under the asset purchase agreement. The escrow funds would be gradually released over a two-year post-closing period.
The Legal Dispute:
The issue arose when the seller failed to pay the owed Mexican income tax. Post-closing, the seller even requested retroactive changes to the agreement to avoid allocating any purchase price to the Mexican subsidiaries – a request the buyer denied.
As a response, the buyer refused to release the escrow funds until the tax matter was resolved. While the Mexican tax authorities hadn’t taken action against the seller or the buyer for the unpaid tax, a legal dispute unfolded in a New York State court. The seller sought release of the escrow funds after the two-year period ended, but the buyer resisted, citing the outstanding tax issue.
The court ruled that the escrow funds couldn’t be held indefinitely due to the Mexican tax issue. The key point was that the funds couldn’t be withheld solely because Mexico hadn’t assessed the tax yet. It was suggested that Mexico might assess taxes even after the escrow funds were fully released to the seller.
Takeaway:
This case prompts us to consider the lessons learned. Could the buyer have predicted that the seller wouldn’t pay the Mexican income tax? Should the buyer have foreseen that Mexico might not take action against the seller during the escrow period?
In hindsight, it’s clear that a more comprehensive escrow agreement could have been beneficial. For example, specifying that a portion of the escrow funds wouldn’t be released until the applicable Mexican income tax statute of limitations had passed could have provided better protection for the buyer’s interests.
Reference:
This case is referred to as Publications Intl., LTD. v. Phoenix Intl. Publs., INC., 2017 NY Slip Op 30225(U) NYSCEF Doc. #10, Supreme Court, New York County, (February 1, 2017). https://schlamstone.com/wp-content/uploads/2017/02/2017_30225.pdf
By John McCauley: I help manage the tax risks associated with buying or selling a business.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
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