TAXING AWAY M&A: The effect of corporate capital gains taxes on firms” acquisition activity

High capital gains taxation prevents mergers and acquisitions (M&A) activity that would benefit the shareholders of the companies involved. That is the central finding of research by Maximilian Todtenhaupt and colleagues, to be presented at the Royal Economic Society”s annual conference in Brighton in March 2016.

Taxing capital gains is an important obstacle to the efficient allocation of resources, their study suggests. It imposes a transaction cost on the vendor that locks in appreciated assets by raising the vendor”s reservation price in prospective transactions. This is called the lock-in effect and is of crucial importance for the M&A market since capital gains taxation may effectively prevent corporate acquisition deals.

In this empirical study, a group of German researchers analyses the impact of corporate capital gains taxes on M&A activity in a large number of countries. They find that high capital gains taxation does indeed prevent M&A deals and are able to quantify the associated efficiency loss for shareholders, which ranges up to $3.06bn (£2.14bn) per year for the United States.

The study makes use of the fact that over the last decade, a large number of countries have abolished or substantially reduced the taxation of capital gains realised by corporations when they sell their subsidiary shares. These include the UK, Germany, France, Italy as well as most Scandinavian countries.

The study evaluates the effect of these reforms on acquisition activity in the respective countries and thus provides a reliable empirical estimate of the lock-in effect in the case of corporate M&As. Estimation results suggest that a one percentage point decrease in the corporate capital gains tax rate would raise both the number and the total deal value of acquisitions by about 1.1% per year.

This estimate can be used to compute the potential efficiency gain from fully exempting corporate capital gains realised in M&As in those countries that tax corporate capital gains at high rates such as the United States and Japan.

A widely used proxy for the efficiency gain of an M&A deal is the premium that the acquirer is willing to pay for the target on top of its market price. This should capture the market value of potential synergy gains.

In the study, country- and industry-specific gains are computed and related to the potential increase in acquisition activity resulting from a full exemption of M&A capital gains from taxation to obtain the overall efficiency gain for shareholders.

The largest potential efficiency gain would be realised in the United States where it amounts to $3.06bn (£2.14bn) per year. In comparison, if one were to reintroduce the corporate capital gains tax for acquisitions in the UK, the efficiency loss would amount to $0.76bn (£0.53bn) per year.

Taxing Away M&A: The Effect of Corporate Capital Gains Taxes on Acquisition Activity, ZEW Discussion Paper No. 16-007, Mannheim Lars Feld, Martin Ruf, Ulrich Schreiber, Maximilian Todtenhaupt und Johannes Voget (2016)

Maximilian Todtenhaupt