Impact of Pillar Two on M&A transactions
March 2024 | TALKINGPOINT | MERGERS & ACQUISTIONS
Financier Worldwide Magazine
March 2024 Issue
FW discusses the impact of Pillar Two on M&A transactions with Amrish Shah, Chad Hungerford and Julie Garside at Deloitte.
FW: Could you provide an overview of the Organisation for Economic Co-operation and Development’s (OECD’s) global minimum tax Pillar Two rules? What are the key objectives under this initiative?
Hungerford: In July 2023, the 138 countries that make up the Organisation for Economic Co-operation and Development (OECD)/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS) agreed to a comprehensive action plan to support the swift and coordinated implementation of a global minimum tax aimed at ending the race to the bottom in corporate tax rates. Under Pillar Two, multinational groups with turnover of at least €750m and a presence in one of the implementing jurisdictions will be subject to a minimum tax regime that would force companies to pay taxes at a rate of at least 15 percent on a jurisdiction-by-jurisdiction basis. Pillar Two will be implemented in stages, with different portions of the regime coming into effect in different years in different countries. The earliest Pillar Two should take effect would be for financial reporting periods beginning on or after 31 December 2023.
FW: In the M&A arena, how is Pillar Two likely to impact transactions involving multinational enterprises – from target valuation, to tax due diligence, to structuring agreements?
Garside: Pillar Two will have a major impact on M&A transactions involving larger multinationals, although in the early years – until the end of 2026 – transitional rules may reduce its impact. In a simple sale and purchase context, both seller and purchaser need to evaluate its impact, including compliance obligations. A seller, if already within Pillar Two, will need to determine if selling a target asset will take it outside Pillar Two. It will also need to determine any ongoing Pillar Two liabilities and secondary liabilities which it may retain in respect of the target for the pre-sale period. These liabilities may be hard to quantify and insure, especially if a transaction occurs midway through a financial reporting period. A purchaser, if not already within Pillar Two, will want to know if acquiring the target will bring it within Pillar Two, and how. If the purchaser is already within Pillar Two, it will still want to know whether acquiring the target will change its Pillar Two profile. It will want protection from the Pillar Two liabilities and secondary liabilities. Both seller and purchaser will need to provide each other with relevant information to meet the extensive filing and reporting obligations which Pillar Two imposes. The purchaser may also want information on pre-sale tax minimisation transactions, such as tax-free basis step-ups, which can be overridden for Pillar Two purposes.
“Pillar Two will have a major impact on M&A transactions involving larger multinationals, although in the early years – until the end of 2026 – transitional rules may reduce its impact.”
FW: What are the competitive advantages and disadvantages for bidders with different Pillar Two profiles, such as those that remain outside the Pillar Two scope as a result of an acquisition?
Shah: Pillar Two requires ongoing compliance with and computation of the jurisdictional effective tax rate (ETR). Even in the case of a jurisdiction with a high headline tax rate, tax incentives and relief may result in top-up taxes. Buyers in an M&A deal will have to bear in mind the implications of getting ‘in scope’. There are other complexities like uniformity of accounting standard, and data identification and collation. A group that is out of scope will be spared the hassle of complying with Pillar Two rules and annual compliance and reporting, thereby providing it with an advantage. One of the important bidder groups that might benefit are private equity (PE) players. The €750m threshold is tested based on accounting consolidation, which potentially puts PE firm bidders at an advantage as, typically, the portfolio investments of such funds are not consolidated for calculating the €750m threshold. Even those multinational enterprises (MNEs) with higher ETRs will benefit, as the lower ETRs of the acquiring MNE will be sheltered in the jurisdictional blending process. Another important factor which is likely to be a consideration is the ultimate parent entity (UPE) jurisdiction once an M&A deal completes. In the case of a US-headquartered company to which US global intangible low-taxed income (GILTI) applies, calculation complexity would increase if a common approach is not adopted, and both US GILTI as well as the global anti-base erosion (GloBE) rules apply. In other cases where UK jurisdiction is relevant to an MNE, the joint and several liability for collecting top-up taxes may hold any constituent entities in the group liable. Differences in the treatment of qualified refundable tax credits which increase GloBE income and ‘non-refundable’ tax credits which reduce covered taxes may also impact the calculations.
FW: What challenges does Pillar Two pose for tax planning strategies in connection with M&A?
Shah: The mandate under Pillar Two is to ensure that MNEs pay at least 15 percent taxes in each jurisdiction in which they operate. With the inception of Pillar Two, restructuring a foreign entity prior to or after a merger or acquisition, taking into consideration the tax profile and group structure of the MNE and any foreign entities of the target, will become important. For example, the existence of entities in low or no tax jurisdictions will be inconsequential, as taxes will be collected by way of top-up taxes. Pillar Two does not displace any other anti-avoidance rules, including the controlled foreign corporation and anti-hybrid rule. Pillar Two rules determine ETRs differently from domestic tax and accounting rules, and hence care needs to be taken where there are mismatches between domestic tax regimes and the Pillar Two rules to ensure that top-up tax is not triggered as a result of typical deal structuring steps, including post-acquisition reorganisations and certain post-acquisition intragroup financings. Particular areas which could be sensitive include hybrid financing arrangements, high and accelerated levels of depreciation regarding intangibles, temporary tax holidays, techniques for managing tax on foreign exchange movements, and some, though not all, special reliefs for research and development expenditure. Pillar Two rules allow gains arising on a GloBE reorganisation to be deferred, in line with domestic tax treatment. However, where this does not meet the definition of ‘GloBE reorganisation’ under the rules, it may become taxable. There are separate tax treatments in the transition years, whereby the intragroup transfer of assets is treated as tax neutral, thereby preventing step-up asset values before GloBE rules kick in. Pillar Two rules may be implemented in different years by different countries, hence the UPE could be determined in different jurisdictions in the transition phase. Compliance requirements will have to be built in depending on Pillar Two implementation by different countries.
“The nature of the Pillar Two top-up tax requires detailed financial accounting and tax computations on an entity by entity and jurisdiction by jurisdiction basis.”
FW: When integrating the tax systems of acquired or emerging entities, what additional complications might Pillar Two obligations place on a companies’ tax processes and underlying calculations?
Hungerford: Pillar Two is incredibly data intensive. The nature of the Pillar Two top-up tax requires detailed financial accounting and tax computations on an entity by entity and jurisdiction by jurisdiction basis. Depending on the industry and the breadth of the acquired entities’ operations, an acquirer may need 150-plus distinct data elements for each entity to complete its Pillar Two computations. Moreover, these data elements will be needed for at least three use cases: forecast and interim financial reporting, year-end financial reporting and actual Pillar Two tax returns. If the target was not previously subject to Pillar Two, as is likely to be the case in many tuck-in acquisitions, this could be a huge lift for finance and tax teams at both the acquirer and the acquired enterprise.
FW: With the OECD recommending that the Pillar Two rules become effective in January 2024, what advice would you offer to companies that are considering deals over the coming year? How should they go about assessing the various risks or opportunities presented by Pillar Two?
Garside: Over the next year, the Pillar Two position will be uncertain as taxpayers grapple with the new rules, not least in terms of calculating ETRs and locating the information to do so. This uncertainty may be mitigated by transitional reliefs until the end of 2026. Whether these reliefs are available will need to be evaluated per jurisdiction. Therefore, unless an acquiring company is certain that it will be outside Pillar Two pre and post-transaction, and that the same applies to any target asset, it needs to be cautious when evaluating Pillar Two risk during due diligence and seeking suitable contractual protections. It will also need to work out where the Pillar Two rules are actually in force, as many jurisdictions are still in the process of implementing them. Equally, groups looking to dispose of a division or group company need to be aware that buyers will be asking questions about Pillar Two and will need to prepare adequate responses.
“Though M&A deals are largely business driven, any significant tax impact may necessitate considering its effect on deal dynamics.”
FW: Do you believe Pillar Two will have a material influence on the way deals are approached and undertaken, both from a tax-specific perspective and more generally? How might this shape M&A trends over the long term?
Shah: Though M&A deals are largely business driven, any significant tax impact may necessitate considering its effect on deal dynamics. Pillar Two rules will also significantly affect financial and IT due diligence because the quality, generation and processing of relevant data will have to be reviewed. Furthermore, the ETRs of the target group would certainly be material to commercial considerations. A deal may result in the MNE group falling in scope or out of scope for Pillar Two. In scope MNEs will have to undertake complex calculations for ETR annual filings and compliance. The way deal terms are negotiated will also change, with post-deal considerations such as recapturing the deferred tax liability rule, access to historical carrying values for assets, the impact of withdrawn elections, and whether it is a full deal or certain jurisdictions are kept outside deal parameters. From a commercial perspective, tax, as a key deal element, will now have to be dovetailed as a fulcrum in the overall deal strategy.
Amrish Shah is part of the tax practice of Deloitte in India. He has more than 30 years’ experience having previously worked with Indian boutique tax firms and Big Four firms. He has advised large multinational companies and private equity firms on domestic and cross-border transactions covering acquisition and divestment, tax and regulatory structuring to optimise tax planning as well as direct tax due diligence assignments. He can be contacted on +91 22 6185 4310 or by email: amrishshah@deloitte.com.
Chad Hungerford is a partner in Deloitte Tax LLP’s international tax practice and is based out of San Jose. He has more than 19 years of experience advising US based multinational companies on the tax planning, tax accounting and tax reporting obligations associated with their global footprint. He is Deloitte’s global Pillar Two leader, US international tax ASC 740 leader and Silicon Valley international tax practice leader. He can be contacted on +1 (408) 704 2574 or by email: chungerford@deloitte.com.
Julie Garside is a partner in Deloitte’s M&A tax group based in London, UK. She has over 20 years’ experience in advising both private equity (PE) and corporate clients on acquisitions, disposals and multinational restructuring projects, including capital markets transactions. She leads Deloitte UK’s M&A tax practice and has particular responsibility for PE. She can be contacted on +44 (0)20 7303 6166 or by email: jugarside@deloitte.co.uk.
© Financier Worldwide
THE PANELLISTS
Deloitte Touch Tohmatsu India LLP
Deloitte Tax LLP
Deloitte LLP