background image Acquisition of a Target Company and Leverage

The acquisition of a target company may be financed by debt, or by the capitalization of the acquiring holding company.

In the case of debt financing, the holding company will pay interest charges which, subject to certain limitations (cf. Sec. 10.2. Thin capitalization rules), are deductible for tax purposes. In addition, if the target company is profitable, the holding company will receive dividends which would normally be tax exempt under the participation exemption regime.

Assuming that the holding company does not receive significant taxable income (other than exempt dividends), it will be in a loss-making position. It will then be possible, under certain conditions, to offset its losses against the profits of the target company through tax consolidation. The resulting tax savings will increase the yield of the holding company’s investment.

For example (ignoring the  thin-capitalization rules – cf. Sec. 10.2. Thin-Capitalization Rules), if a holding company acquires a 100% participation for EUR 20 million of which 50% is debt-financed against a 10% interest rate, it will pay interest charges of EUR 1 million during the first year. In case of tax consolidation, the tax savings would amount to EUR 344,333 (EUR 1 million x 34.43%, corresponding to the effective corporate income tax rate).

The financial feasibility of such a scheme should be verified insofar as it implies the realization by the target company of sufficient distributable profits following its acquisition to allow the holding company to reimburse its debts.