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M&A Tax

M&A Tax

With macroeconomic indicators pointing in the right direction following sustained global economic uncertainty, and initial fears over Brexit subsiding, there’s optimism that global M&A activity will continue trending upward in 2017.


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With macroeconomic indicators pointing in the right direction following sustained global economic uncertainty, and initial fears over Brexit subsiding, there’s optimism that global M&A activity will continue trending upward in 2017. 

At the same time, however, a cloud of uncertainty looms amid intensifying scrutiny of M&A transactions from tax authorities, the potential for major tax reforms globally, particularly in the US, and uncertain political agendas on the global front. To what extent such factors will have an impact on the M&A market – and when – is the big question for 2017.

Perhaps the biggest tax development affecting cross-border M&A globally involves the OECD’s action plan to combat tax Base Erosion and Profit Shifting (BEPS). Companies with cross-border transactions and structures are facing a period of uncertainty as governments must first determine how the guidance affects current rules, then work to enact domestic tax changes — a process that could take years. While these developments unfold, some potential buyers may avoid transactions involving sophisticated international tax planning structures.

In addition, the EU drafted the 2016 Anti-Tax Avoidance Directive (ATAD) for adoption and future implementation by EU member states. The ATAD package of measures, which aims to ensure consistent and appropriate implementation of the OECD’s BEPS recommendations by EU member states, will result in more-stringent legislation along with greater harmonization. 

It’s already evident that the international campaign to combat tax base erosion and profit shifting (BEPS) — both as part of the OECD project and through countries’ unilateral moves — is altering the tax environment for cross-border M&A in significant ways regarding country-by-country reporting, focus on substance and interest deductibility:

Country-by-country reporting will make things more transparent for tax authorities in terms of how multinationals are operating and where revenue, profits and tax payments are coming from. And while the OECD has not proposed that the reports be made available for public scrutiny, the EU is consulting on this possibility as part of its tax transparency package. As a result, buyers could gain access to more-detailed information about potential targets for due diligence purposes, and sellers should be mindful of the reputational implications of this increased transparency.

Focus on substance: One major point of concern around BEPS is how tax authorities are increasingly looking for sufficient business substance in offshore business structures, especially those involving low- or no-tax jurisdictions, and they are denying preferential rates for dividend and interest withholdings where insufficient substance exists. When structuring an acquisition, substance in holding companies will require much more attention and, where an acquirer or acquired entity lacks sufficient substance in certain jurisdictions, it may affect their ability to access treaty benefits. 

Interest deductibility: ATAD’s “interest deduction limitation” dictates that, regardless of domestic interest limitation in place among individual countries, minimum uniform measures for EU states will be applied to interest deduction and the limiting of excessive interest deduction. This will have an impact on M&A markets, in particular the net cost of funding for acquirers. The denial of deductions for interest has emerged as a common legislative means of eliminating the tax benefits of cross-border debt financing structures. Germany and Denmark were among the first countries to challenge tax deductions for interest paid on loans taken up by companies to finance their own acquisition. Countries such as Sweden are tightening rules for interest on related-party debt. The UK and US are considering a proposed fixed-ratio rule (FRR) to limit tax relief of net (including third-party) interest of 10-30 percent of net earnings before interest, dividends, taxes and amortization (most countries expect 20–30 percent), which will affect international investors and especially highly leveraged groups.

Business as usual in Europe – for now

Meanwhile, BEPS-related concerns are considered critical for tax due diligence reviews. While companies will remain focused on discovering the historical risk profile of any company they are acquiring, changes regarding implementation of BEPS and increased transparency will make companies far more concerned about the future sustainability of a target company’s tax profile. For example, if a target group has a relatively low effective tax rate, acquirers today will be particularly concerned about how sustainable that lower tax rate will be and many will conduct modelling around various sustainability factors. Tax due diligence in this regard will need to be much more forward-looking.

Overall, however, even as the world around them is poised for change, it is still “business as usual” for the moment among companies and private equity funds in Europe. For as long as legislation remains unchanged to reflect BEPS, or the anti-tax avoidance directive in the EU, companies will try to benefit from existing legislation, while also carefully considering potential future ‘BEPS unwind costs.’

Some uncertainty in the Americas M&A market

In the US, while the 2016 transactional market was affected by broad uncertainty over multiple factors, including legislative and regulatory changes, the introduction of BEPS-related legislation, Brexit and the US presidential election, momentum grew by the end of 2016 and expectations are high for 2017.

While optimism prevails for the US market, however, uncertainty over the changing legislative, regulatory, economic and political environments cannot be dismissed, particularly the OECD’s BEPS initiative.

From a US perspective, while the US Treasury and IRS are responsive in issuing guidance, it is too early to speculate on the impact of the Trump administration’s agenda and proposed changes. Tax reform could be enacted in the US, although the extent of the reform is still unclear.

Currently, rules that were issued over the past year remain in effect, including rules regarding earnings stripping, inversions, cross-border partnership transfers between related parties, and the transfer of intellectual property from the US to a foreign jurisdiction. Undoubtedly, these rules will need to be considered in future transactions. 

In Latin America, we see a move towards greater transparency, substance, thin capitalization, and other BEPS-influenced reforms. For example, Brazil and Argentina both employ a list of disfavored jurisdictions subject to higher withholding tax rates. Mexico and Chile have introduced more stringent thin capitalization rules and reporting requirements for transactions involving entities in their jurisdictions, with Chile also adopting a general anti-avoidance rule. Colombia recently passed a comprehensive tax reform that includes increased information exchanges, adoption of country-by-country reporting, anti-avoidance rules and the reinforcement of anti-tax haven legislation.

These legislative changes highlight a rapidly changing regulatory landscape in Latin America that demands increased attention when structuring acquisitions in the region. Additionally, the region will not only be subject to local political uncertainty, but also to the potential impact of Brexit and any changes in US legislation. However, certain trends, such as continued low commodity prices, currency devaluations, a rising middle class, and a need for infrastructure partners in the wake of the Odebrecht corruption scandal shocking the region, may encourage investment through M&A for 2017.

Asia Pacific outlook remains robust

In the Asia Pacific region meanwhile, the M&A market continues to be robust in China (in- and out-bound), Japan, Singapore, Australia and India, with the tech sector sustaining activity across the region, and PE and Infrastructure on the increase.

From a tax perspective for the region, the most notable changes are largely the continued evolution of domestic laws dealing with M&A in China and India, plus the increased focus and resources of the Australian Tax office.

There is prevailing optimism overall that M&A deal volumes will continue to increase and that outlook seems well founded considering economic factors. The level of tax authority activity and domestic and international tax reform are more likely to influence pricing and execution risk, as opposed to deal flow. Certainly, BEPS-related concerns are significantly influencing deals taking place and the way they are structured. Substance in holding jurisdictions for CIVs is probably the most significant influence of all the BEPS reforms in the region.

Tax due diligence will mean gaining an understanding of the state of a target’s BEPS appropriateness. Quantifying the precise dollar value of recent BEPS reforms is difficult and there is much to be done concerning due diligence and the need for post-deal documentation and restructures as a result. On a positive note, several tax treaties in the region are undergoing renegotiation and in some instances, new treaties are coming into existence.

Overall, it will indeed be interesting to see how 2017 shapes up as optimism and a ‘business as usual’ outlook prevail globally, tempered by a backdrop of uncertainty over the potential impact of developments on the political, legislative, regulatory and economic fronts. 

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