Q&A: Taxation of cross-border mergers and acquisitions
November 2021 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
November 2021 Issue
FW discusses the taxation of cross-border mergers and acquisitions with Brian K. Pinto, Siobhan L. Godley and Lindsay Wietfeld at Deloitte.
FW: How would you describe recent trends in cross-border M&A activity? What factors are driving these deals in today’s market?
Pinto: The COVID-19 pandemic certainly unleashed an unprecedented wave of M&A activity, taking advantage of global disruption. Whereas much of the M&A activity in 2020 was defensive in nature, such as gaining liquidity and safeguarding, the continued hot M&A market in 2021 is more representative of offensive strategies to accelerate digital transformation, address gaps in supply chains, reach new markets and access technologies and talent. The market simply continues to be white hot. In the last 12 months, we have had over $4.7 trillion of deals, which is the highest 12-month total in history, and many of these deals have a global footprint. In the last quarter alone, we have seen over $1 trillion of deals announced, including $164bn of special purpose acquisition company (SPAC) deals, which is also the highest ever on record. The activity is present across all industries and sectors, with the highest volumes present in technology, energy & resources and financial services. The most exciting fact is that the fuel is in place to continue powering a thriving M&A market, with private equity putting much of its $2.5 trillion of dry powder to work, global corporate cash reserves exceeding $3.5 trillion and SPAC initial public offering (IPO) proceeds of $202bn.
FW: In your experience, do acquirers adequately consider the tax implications of potential transactions? How important is tax planning to realising the full value of a deal?
Godley: When structuring a transaction, acquirers need to understand the tax profile, liabilities and attributes of their target group through a comprehensive due diligence process and then leverage off this highly fact-specific information to structure their transaction. Sophisticated acquirers do approach transactions with tax diligence and structuring as key workstreams, which can be a gating item in terms of valuing potential returns on a transaction. What can be more of a challenge is effective implementation and monitoring changes of law after the deal is done, and how the structure is being managed when the pressure of the deal has fallen away. This is where value can be lost when the intended structure is not effectively managed, such that a future purchaser identifies due diligence on a subsequent exit. So, the best approach is one which combines comprehensive due diligence and structuring with roles and responsibilities established for checking proper implementation and ongoing monitoring over the investment period. Tax is not just a day one priority but an end-to-end workstream acknowledging that value can be lost where focus is lost.
“Globally, we are seeing other countries increase their headline tax rates while also continuing to introduce legislation to activate BEPS and Anti-Tax Avoidance Directive (ATAD) provisions into local law.”
FW: Have there been any notable legal or regulatory developments affecting tax related to cross-border deals?
Godley: Notwithstanding the base erosion and profit shifting (BEPS) initiatives which have been with us for a number of years now, the carefully managed and staggered implementation across Organisation for Economic Co-operation and Development (OECD) and European Union (EU) member states has resulted in steady but inconsistent progression of tax change across international jurisdictions over a number of years. Combined with the nuances and differences in local implementation, this leads to increased complexity across the board when evaluating access to double taxation treaties, local interest deductibility and the impact of anti-hybrid legislation. This is before the additional complexity that may arise in implementing BEPS 2 – Pillar 1 and Pillar 2 – over the next few years. As countries recover from the pandemic and plan how to fill the hole of national deficits, it is potentially more likely that countries will seek to increase tax base and tax rates rather than reduce them, adding to the complexity of achieving tax-efficient structures.
FW: How should acquirers go about identifying the most tax-efficient structures for their transactions? What strategies should be considered?
Wietfeld: An acquirer should consider the tax implications of operational and economic structural matters early in the acquisition process to identify tax opportunities and synergies. Such considerations should include potential operational integration strategies and understanding future growth projections. For example, a buyer should evaluate whether there are any opportunities for local country tax consolidation if a target is being integrated with an existing business, and assess whether there is an opportunity to obtain any local credits and incentives. Future operational intentions and target projections should also be considered in determining the efficiency of the structure from a tax perspective. If an acquirer intends to repatriate cash generated by the target, consideration should be given to existing tax treaties and applicable withholding tax rates on the distributions. Additionally, if the transaction contemplates debt financing, a buyer may be able to arrange finance in the jurisdictions where the target has operations – both from a US state perspective and an international tax perspective – to benefit from interest deductions for tax purposes, taking into account applicable interest deduction limitation rules. Furthermore, an acquirer should determine early in a transaction process whether it is possible to structure the transaction in a manner that achieves a tax basis step-up in the acquired assets. Generally, a tax basis step-up generates significant income tax savings and synergies for an acquirer through post-transaction tax amortisation and depreciation deductions. There may be opportunities to achieve a tax basis step-up through the acquisition structure adopted or tax elections, and this often becomes a point of negotiation between the transaction parties.
“At heads of terms and memorandum of understanding stage, acquirers need to be clear in terms of the tax assumptions that underpin their bid for a target group.”
FW: In terms of tax due diligence and assessing the target company, what key issues – such as existing tax liabilities or related disputes, for example – need to be considered?
Wietfeld: Generally, tax due diligence seeks to identify potential tax risks inheritable by a buyer, as well as to assess the value of any tax attributes, such as net operating losses, as both matters impact overall deal value and negotiations. Depending on a target’s tax classification – be it C corporation, S corporation or partnership – inheritable tax risks could include both income and non-income tax exposures, such as sales, use, payroll and property, among others. For example, due diligence on a target subject to entity level taxation, such as a C corporation, would focus on historical income tax risks and potential implications for any net operating loss balances that would carry over to the buyer. Non-income tax exposures, such as payroll, property, sales use, gross receipts and franchise, generally transfer to a buyer in an acquisition of target shares or assets. It is also important to understand whether the target has any past or pending tax audits that could give rise to assessments, any tax reserves for uncertain tax positions, any tax attributes that are expected to carry over to a buyer such as credits and incentives, and any recent acquisitions or divestitures that may impact the overall tax risk for the target. Furthermore, a key component of tax due diligence is to assess historical tax compliance processes to determine if any changes to the tax function are recommended to mitigate post-transaction tax risks.
FW: What advice would you offer to acquirers on mitigating transactional tax risks? What benefits can tax liability insurance provide?
Godley: At heads of terms and memorandum of understanding stage, acquirers need to be clear in terms of the tax assumptions that underpin their bid for a target group. This may include, among others, accounting policies adopted relevant to tax, latent gains embedded in the structure, availability of tax losses and any tax depreciable assets. Requirements as to the availability of due diligence information, proposed completion mechanism – locked box or completion accounts – should also be agreed between parties, as well as the approach to warranties and indemnities. It is also critical that the parties agree whether the vendor will stand behind the contractual protection or an insurer will fill the gap, and if so, who bears the cost? Papering these assumptions early between the parties helps both the acquirer and vendor manage any pricing discussions should material tax issues arise as part of due diligence. Tax liability insurance has been evolving over recent years and is now a tried and tested and pragmatic route in managing tax risks – it is important to ascertain quickly any excluded items, such as identified high risk items or very typically transfer pricing risks.
“An acquirer should consider the tax implications of operational and economic structural matters early in the acquisition process to identify tax opportunities and synergies.”
FW: As tax policies and imperatives continue to evolve around the world, what impact do you expect prevailing trends to have on cross-border M&A in the months and years ahead? How are buyers and sellers likely to respond?
Pinto: We are anticipating tax legislation in the US in the near term. Although there have been proposals coming out of Congress and the White House, a few areas that seem to have common momentum in corporate tax include an increase in the headline tax rate, changes to the international tax provisions that would increase the rate of US tax paid on earnings from non-US operations and various programmes to encourage ‘green’ investments. Globally, we are seeing other countries increase their headline tax rates while also continuing to introduce legislation to activate BEPS and Anti-Tax Avoidance Directive (ATAD) provisions into local law. Dealmakers are keeping a close eye on this dynamic legislative environment as well as the continued momentum around environmental, social and governance (ESG) issues, as these will play important roles in M&A strategy, tax due diligence and in driving tax synergies in integration, or disposition and separation in the case of sellers.
Brian K. Pinto is a partner in the international tax & transfer pricing services practice at Deloitte US, where he serves as the global lead tax partner on some of Deloitte’s largest clients. He also serves as the Deloitte global tax & legal leader for M&A. He received his MS in tax and his BBA in accounting at Texas A&M University. He can be contacted on +1 (214) 840 7802 or by email: bpinto@deloitte.com.
Siobhan L. Godley is a transactions partner in Deloitte’s real estate tax team. She also leads Deloitte’s UK real estate practice including all audit, financial advisory, valuation, planning and development and real estate consulting services. In this capacity she is a member of the Financial Services Executive Group and Financial Services Global Diversity and Inclusion Board. As a chartered accountant and a chartered tax adviser, she has over 22 years of experience. She can be contacted on +44 (0)20 7007 2745 or by email: sgodley@deloitte.co.uk.
Lindsay Wietfeld is a tax partner in Deloitte’s M&A services practice based in Chicago. She has over 15 years of experience and has spent the last 11 years exclusively serving Deloitte’s M&A practice. She also serves as the M&A tax corporate growth leader within Deloitte. She has assisted clients with significant corporate transactions, acquisitions of closely held companies, multijurisdictional due diligence projects, and corporate restructuring. She can be contacted on +1 (312) 486 9388 or by email: lwietfeld@deloitte.com.
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