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Avoid costly surprises when buying a business

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Acquiring a business without knowing much about it is a significant business risk. Due diligence is essential when acquiring an existing business to alert the buyer to any historical liabilities.

1st Jun 2022
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The case of 50 Five (UK) Limited serves as an example of why due diligence is an essential component when acquiring an existing business. The consequences of not understanding the accounting position of the target business can have an impact on the acquired business and the shareholders. 

Ms Parkin and Mr Klumpenaar acquired an existing business whose trade was fitting and installation of heating and water systems. They sought to challenge VAT assessments raised by HMRC against the business they had purchased, but the case was struck out by the tribunal as there was no reasonable prospect of the appeal succeeding.  

The tribunal noted that: “It is bound by the judgment of the upper tribunal in AN Checker Heating and Service Engineers [2018]. In that case, it was determined that the legislative provisions which permit the sale of energy-saving materials at the reduced rate of VAT apply only where the supply of those materials is independent of an installation service. As such the installer will be charged the reduced rate but when making a supply on to the customer the full standard rate of VAT must be charged. Given that VAT is a consumption tax and the reduced rate is presumably intended to benefit the consumer, that judgment is counter intuitive.”

It is therefore inferred from this that the historical assessments issued by HMRC were in relation to charging a reduced rate on supplies instead of the standard rate. The transcript does not mention what the value of the assessment is or what periods it covered.

The case transcript does not explain how the business was acquired but presumably they either bought the shares of the existing company (unknowingly taking on its historical liabilities) or they transferred the business as a going concern to their own company but retained the VAT number of the seller. Either way, the new owners were liable for the historical VAT assessments, which they knew nothing about.

Historical errors

Acquiring a business without knowing much about it is a significant business risk. From a VAT perspective, historical errors can arise. Often even the seller isn’t aware they’ve made an error, whether it is an option to tax not being notified, cross charges between connected companies or zero-rating exports without holding proof of export.

The list of potential issues is long and away from VAT and into other taxes, other risks such as payroll/NI errors, employment law (minimum wage), SEISS grants and Bounce Back Loans are all possible tripwires for an unsuspecting buyer.

Due diligence doesn’t remove the historical liabilities, but it informs the buyer and this may lead to a reduced selling price or corrective action being taken before the purchase takes place. If the issues are significant then the sale may not go ahead.

A buyer may just want to get on and buy, thinking they don’t have time to grind through a due diligence process. Plus, of course, there are the additional fees from the accountants. However, as this case clearly demonstrates, a little patience and outlay would likely have paid for itself in terms of cash, and in avoiding having to deal with HRMC and going to tribunal. All that time expended post acquisition could have been spent focusing on growing the business.

Transfer of a going concern

The buyers in this case could have chosen to buy the business as a transfer of a going concern and obtained a new VAT registration for the new business. This would contain the VAT error to the old VAT number of the seller. 

Whether a sole trader incorporating or acquiring a target business, it makes sense to obtain a new VAT number to reduce exposure to historical risks. Acquiring shares in an existing business comes with the risk of historical errors, so if buying shares it makes sense to perform some sort of due diligence. If nothing else it then acts as a formal document that can form part of the purchase agreement.

In the case of 50 Five (UK) Ltd, their only recourse is to sue the previous owners. How successful that will be is uncertain – the sellers may have closed up shop and retired – but ultimately, the liability belongs with the company and to sue individual shareholders is not without difficulty. Proving the sellers knowingly sold with a VAT liability would be easier if a basic due diligence had asked some basic questions.

Sympathy for the taxpayer

The tribunal had sympathy but ultimately had no room to manoeuvre. The tribunal did suggest to HMRC that it may want to take a lenient position in terms of application of penalties, but the penalty regime is based on assisting and disclosing – there isn’t a rule for “feeling sorry for the taxpayer”. Perhaps a penalty suspended would be the fairest solution but there is no getting around the VAT liability owed to HMRC – a very expensive business purchase indeed.

Replies (5)

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paddle steamer
By DJKL
01st Jun 2022 14:22

Was the extant unknown vat arising re transactions pre purchase actually a diligence issue?

I suspect it could be poor or unenforceable tax warranties provided by the seller.

If I were the purchasers I might be looking to have words with my legal team.

Thanks (1)
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By Paul Crowley
01st Jun 2022 16:04

The assessments were raised before the sale
There is some incompatability of belief based on reading the case (only 2 pages)

"Summary findings of fact and reasons for the Decision
2. This is an appeal bought in the name of the Appellant in respect of assessments raised by
the Respondents against the company prior to the date on which it was purchased by the present
owners. The present owners were not made aware of the assessment at the time of purchase.
It had not been disclosed to them as part of the due diligence undertaken at that time."

Did due diligence take place?
Or did buyers accept a reduction in price and hope to get rid of the assessments?

Even a basic hand over from agent to agent asks about unresolved tax issues
At least one, or even more, of the parties involved is being disingenuous

Thanks (1)
VAT
By Jason Croke
01st Jun 2022 16:31

The case is frustrating in that some details aren't included, it doesn't even mention what the VAT liability is, but I agree with Paul that it could be that DD was thrown out on the basis of a lower purchase price with the aim to try and argue the liability with HMRC.

The transcript indicates DD was done, but I'm not convinced unless DD was limited to "everything okay mate?" and then they bought the business. Or maybe the transcript was wrong and no DD took place.

I get the feeling that there were no lawyers (or accountants) involved in this, as professionals we all know of business owners who go off and do stuff on their own, mate down the pub got this tidy little business selling it for a song, etc.

It is still a good case about "buyer beware" and buying a business without knowing what skeletons exist in the cupboards.

Thanks (0)
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By Brend201
01st Jun 2022 16:46

Yes, full disclosure appears to have been an issue at all stages. For example, the company appears to have lost £888k in 2017. The new owners also subscribed £1 million in the days after they took over. How did the company lose so much in 2017? It can't have been dividends. For a company purchase followed by a million quid investment within days of purchase, one would have expected that there would have been basic due diligence and watertight tax warranties. The new owners have subsequently invested a further £4.25 million since then too. I hope that it is because the business has great prospects.

Thanks (2)
Replying to Brend201:
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By Paul Crowley
01st Jun 2022 20:30

No way does that company not have an agenda
Cookiest set of accounts and huge losses I have seen in ages
Feels like candid camera of accounting, Dutch style

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