Non-assumption of Trade Liabilities in the Books of Purchasing company

25/12/2020 1 By indiafreenotes

Except for the Assumed Liabilities, the Buyer shall not be responsible for, assume, pay, perform, discharge, or accept any liabilities, debts or obligations of the Seller of any kind whatsoever, whether actual, contingent, accrued, known or unknown, including, without limitation, any relating to accounts payable, interest-bearing debt, notes to Affiliates or other related Persons, interest and termination penalties on indebtedness, taxes, employee compensation, severance, pension, profit-sharing, vacation, health insurance, disability insurance or other employee benefit plans and programs, worker’s compensation, breach or negligent performance of any contract, or breach of warranty relating thereto, liabilities resulting from breach of contract, torts (including, without limitation, product liability claims), illegal activity, unlawful employment or business practice, infringement of intellectual property rights, claim for environmental liability or remediation or any other liability or obligation whatsoever. All such non-assumed liabilities, debts and obligations shall remain the responsibility of the Seller which shall pay and discharge the same when and as due.

Assumption of a liability

In a sale of business transaction, it is common for the purchaser to assume certain existing or future obligations of the vendor to make payments to third parties.  As explained in the Draft Ruling:

The following types of liabilities are commonly assumed by a purchaser:

  • Trade creditors/accounts payable;
  • Product warranties;
  • Long service leave obligations of employees;
  • Environmental rehabilitation;
  • Rates;
  • Land tax;
  • Plant and equipment or property leases; and
  • Hire purchase obligations.

As the ATO identifies in the Draft Ruling, to determine the GST consequences, it is necessary to focus on the contractual arrangements entered into between the vendor and purchaser.  The focus is on what is agreed by the parties and the GST consequences that flow from this agreement.

Supply and consideration

It is a fundamental requirement of making a taxable supply that an entity makes a “supply” for “consideration”.  The essence of a sale of business transaction is that the vendor supplies certain assets of a business to a purchaser for consideration.  In circumstances where the purchaser assumes certain liabilities of the vendor as part of this transaction, a key issue is whether the purchaser’s assumption of a liability is simply part and parcel of the main transaction, or whether it has any separate GST implications.

It has been a concern of some tax advisers that, in agreeing to assume the vendor’s liability to third parties, the purchaser makes a supply to the vendor for consideration.  The basis for this concern is in the extremely wide definitions of “supply” and “consideration”.  Relevantly:

The definition of supply includes “an entry into, or release from, an obligation” to do anything and

The definition of consideration includes “any payment, or any act or forbearance, in connection with a supply of anything”.

Taken together, on one view, the line of analysis would be as follows:

  • In assuming, for example, the liability to pay trade creditors, the purchaser makes a supply constituted by the entry into an obligation the vendor; and
  • the vendor provides consideration for that supply equal to the amount required to be paid by the vendor in respect of the entitlements or, more typically, allowed by the vendor as an adjustment to the purchase price.

There are four general case law exceptions to the rule of buyer non-liability in asset transactions:

  • The buyer assumes the seller’s liabilities expressly or impliedly.
  • The transaction in substance constitutes a merger or consolidation of the buyer and seller (de facto merger).
  • The buyer is “a mere continuation” of the seller.
  • The intent of the transaction is to defraud the seller’s creditors.

The de facto merger theories are the most commonly cited by courts. Facts which support those theories include:

  • Continuity of management.
  • Same physical location.
  • Same general business operations.
  • Common equity ownership.
  • Assumption seller’s ordinary course business trade debt.
  • Seller’s dissolution following the sale.