Tax continues to make front-page news. There is more change in the global tax landscape today than ever before, driven by the confluence of technological advancement, geopolitical and macroeconomic factors, and increasing calls for transparency.
"The rapidly changing tax environment can be driving higher risks, a higher compliance burden and higher levels of overall uncertainty."
Across the global corporate landscape, tax is an increasingly important business issue, and this is having an unprecedented impact on deal-making. We’ve identified three key interconnected issues that we believe will drive tax risks and opportunities for transactions in 2018 and beyond:
- The pace and scope of legislative tax change
- Taxation of the digital economy
- Tax controversy
The pace and scope of legislative tax change
The global tax landscape is changing at an unprecedented pace, with major changes in tax policy on the horizon. Some key examples include the base erosion and profit shifting (BEPS) recommendations from the Organisation for Economic Co-operation and Development (OECD).
Broadly, the BEPS initiative aims to make certain that each country’s tax laws are internationally coherent, profits are taxed where value is created, and taxing authorities have insight into the global operations of taxpayers, sharing information with each other across jurisdictions and with different government agencies and countries. Specifically, the 15-point BEPS Action Plan includes recommendations that:
- Limit interest deductions
- Eliminate the benefits of hybrid financing arrangements
- Place new restrictions on access to benefits of tax treaties
- Require additional, more comprehensive reporting.
The recently enacted US Tax Cuts and Jobs Act has resulted in the most sweeping overhaul of US tax code in more than three decades. The impact of the reform is a lower corporate tax rate, broader tax base and a territorial tax system. It includes such structural changes as immediate expensing of certain capital expenditures, a limitation on business interest deductions and a one-time tax on overseas earnings that are deemed repatriated.
In response, countries around the world are adopting new tax laws or dramatically changing how they interpret existing laws and bilateral tax treaties.
Taxation of the digital economy
Today, the majority of businesses have a digital presence and use digital to derive value or revenue from data. As the response to digitalization evolves, far-reaching implications follow, including shifting the value chain, the manner of customer interaction, the use of data and location of people and physical assets.
Tax authorities worldwide are attempting to catch up with the new, borderless business models and cutting-edge technologies and are adopting new tax laws or changing the way they interpret existing laws and bilateral tax treaties for a digital global economy.
Fundamentally, tax controversy is a dispute between taxpayer and tax authority. International tax reforms, information sharing among tax authorities, digitalization, the media spotlight on tax and subsequent political reaction are all driving controversy to new levels.
Consequently there has been an increase in the number of and size of tax audits, assessments and disputes with revenue authorities worldwide. Particularly in this environment, tax controversy is increasingly a strategic area for businesses to focus on, with a timely, proactive and globally coordinated approach for identifying potential areas of dispute and expeditiously resolving issues.
A wide range of stakeholders, including multinational corporates and private equity (PE) funds, will feel the impact of these changes. The ultimate effect on the M&A market will be determined by deal parameters, buyer/target characteristics, modeling and investment theses.
Developing strategic plans for any restructuring, realignment or transaction in a single country or across borders requires factoring in an ever more broad range of issues — from effective tax rate and legal entity structures to supply chain and operating models, IP strategy to IT needs, and treasury function to exit strategy.
We foresee that this changing tax environment will impact transactions in some foreseeable ways:
- Tax due diligence: tax due diligence is more important than ever, requiring assessment of not only historical tax exposures, but also the impact of changing tax legislation on the target’s tax position and investment model in the future. Moreover, this environment of heightened tax enforcement and controversy demands deeper questions about the target’s approach to managing tax controversy, and new ways of managing tax risk, including additional clauses in purchase agreements and tax-specific indemnity insurance.
- Pricing and valuation: we are increasingly seeing tax impacting the pricing of deals, whether it be from issues identified in due diligence or modeling the impact of tax law changes. Finance costs are central to valuation and transaction pricing, and US- and BEPS-related tax law changes resulting in restrictions on interest deductibility, use of hybrid instruments and access to tax treaties may increase the cost of capital for many multinationals and PE funds.
- Deal financing and structuring: tax can be integral to the structure of a deal. Engaging with tax advisors up front to identify alternative models can translate to a negotiating advantage and help maximize transaction value. Deal structures and sources of financing need to be carefully considered to help make sure that deductibility of interest is achieved and funds can be efficiently repatriated without undue tax leakage.
- Post-deal integration and maintenance: a plan is only as good as its implementation. The increased focus on where value is created means additional scrutiny of where a particular business operates and the effect on future transactions. It also means increased focus on operating model efficiency, including having an efficient supply chain, and integrating direct and indirect taxes. Post-deal reporting and compliance capabilities will need to be assessed to meet the complex and demanding new disclosure requirements following an integration.
The rapidly changing tax environment can be driving higher risks, a higher compliance burden and higher levels of overall uncertainty. Managing tax law changes operationally and determining their impact on acquisition targets is more important and more complex. For 2018, turn uncertainty into transaction opportunity by being proactive and engaging with tax advisors from the outset of the deal.
Key action points
- Involve and seek insight from internal and external tax professionals and advisors early in transaction discussions, allowing them a bigger role in setting strategy
- Undertake a structured assessment of tax issues and tax law changes on your overall operating model
- Factor tax law changes and uncertainties into your M&A strategy
- Expect, plan for and monitor additional uncertainty and rising levels of controversy
This article was first published in Real Deals on 25 January 2018.
How we can help: Transaction Tax Services