In the multi-stage process of merging companies, the valuation of entities is a challenge that can be considered as one of the most important steps of the entire undertaking. Why is the appropriate valuation of companies so important? Why is it worth using a method that allows determining the market value of companies?

We explain this, based on the Polish law, using the example of merging limited liability companies by way of acquisition.

 

Valuation of the company or companies?

One of the attachments to the merger plan of companies is a document establishing the values ​​of their assets. Such values ​​should be indicated on a specific day in the month preceding the submission of an application to announce the merger plan of companies or the announcement of the plan on the company's website.

Although the Commercial Companies Code[1] only draws attention to the need to value the acquired company, in practice the value of the acquiring company should also be valued. This is related to determining the exchange parity of shares of the acquired company for shares of the acquiring company.

 

Company valuation methods

There are various methods of company valuation, including, for example, the method of:

In practice, the so-called accounting method (book/balance sheet value method) is very popular.

The provisions of the Commercial Companies Code do not impose a specific method of valuing companies that plan to merge. The choice of the method of implementing this undertaking is left to the entities participating in the process and often depends, for example, on the circumstances of the given transaction and the economic situation of the companies.

 

Accounting method of company valuation and market value

Companies participating in a merger often choose valuation according to the accounting method, because the book value is easy to determine based on the company's balance sheet. To determine it, you need to subtract the values ​​of the company's liabilities from its assets.

With the accounting method, it is not necessary to conduct detailed analyses, comparisons of entities or financial forecasts. This is particularly distinguishing it from other, more specialized methods of company valuation.

However, it must be remembered that the result determined based on the accounting method very often does not reflect the actual market value of the entity. The accounting method only consider the information contained in the company's balance sheet and does not take into account other factors that may significantly affect the market value of the entity.

Although from the perspective of the provisions of the Commercial Companies Code, valuation using the accounting method is sufficient and does not constitute an obstacle to the effective merger of companies, other considerations speak in favor of using a more accurate valuation method.

 

Why is market value important?

Valuation of companies in accordance with market value is important because of the tax consequences of merger transactions. This particularly concerns issues related to CIT and transfer pricing regulations.

 

Valuation of companies and CIT

Corporate mergers are subject to a series of provisions in the Corporate Income Tax (CIT) Act, which refer to the concept of market value. According to one of them, in case of a merger with issuing new shares (i.e., one in which the shareholders of the acquired company receive shares in the acquiring company), the issuing value of the received shares cannot be higher than the market value of the assets of the acquired company.

Therefore, any excess of the market value of the assets of the acquired company over the issuing value of the shares received by the shareholders of the acquired company results in the acquiring company's taxable income.

Since balance sheet values ​​do not always reflect the actual market value of the entities being acquired, relying solely on them makes it impossible to:

 

Transfer prices in the context of company valuation

When the merger takes place between related entities (e.g. the parent company takes over the daughter company), the transaction is covered by the transfer pricing regulations. Their purpose is to ensure that the transaction complies with market conditions and, as a result, counteract tax avoidance.

In such a situation, conducting a market valuation of the acquired company is mandatory in order to determine the terms of the transaction in accordance with the arm's length principle[2]. Depending on the value of the transaction, additional documentation obligations may arise (e.g. preparation of local transfer pricing documentation and reporting the transaction on the TPR form).

How to determine the market value of a company?

Tax authorities allow determining the market value based on one of the commonly used company valuation methods. While choosing the method of implementing this undertaking, it is worth to remember that depending on the nature of the activities and assets of the merging companies, different methods will reflect the market value otherwise.

Selecting the appropriate method and justifying this decision are the taxpayer's obligations. However, in practice, it is worth entrusting the valuation of the company to entities that provide such services professionally.

If you need help in this area, please contact us! Our team has completed numerous company mergers and has extensive experience in this area.

 

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[1] Article 499 § 2 of the Commercial Companies Code

[2] Article 11c item 1 of the CIT Law