3 steps for effective tax strategy in international deals
The right deal and the right organizational structure help drive success
INSIGHT ARTICLE |
A wide variety of factors shape an enterprise’s decisions around organizational structure to support the strategy of a new, combined organization after a merger or acquisition. In the case of a cross-border acquisition, those decisions are often more complicated. Decisions will be driven by the unique facts and circumstances of each particular transaction, overall or global profit drivers of the enterprise, and the entities and jurisdictions involved. Below are a few key issues to consider as you evaluate structural considerations of pending transactions, and after the deal is consummated.
First, understand your target
As the acquirer, you need to understand your target. Conduct an in-depth analysis of the target’s business. Assess the target’s products and services, its access to and penetration in new markets and how they support your strategic global plans and footprint. Next, consider the target’s tax position and its attributes, as well as how the acquisition may impact these features. Questions to consider include:
- How are the target’s foreign operations organized from a legal and corporate perspective? The answers to these questions will help you make the best short- and long-term decisions about structure. For example, the target’s choice of entity can affect the company’s after tax cash flows in a variety of ways. Did the target make strategic choices about its legal structure to produce the best after-tax consequences or did the target grow without much thought to these concerns?
- In what countries does the target have a presence and what activities does it conduct there? Without a solid understanding of the target group’s global business and tax footprint, you can’t make sound decisions on structure.
- What are the foreign currency risks and exposures of the target?
- Is there political risk associated with target’s foreign operations?
- Do the foreign operations support each other in the target structure from a service, product procurement, or treasury and finance perspective? If so, are such intercompany transactions based on sound business and economic purpose? Where are the target’s U.S. and foreign intangible profit drivers located and how are they deployed and exploited? Are intercompany transactions substantiated from a legal and tax perspective to support transfer pricing decisions?
- What is the target’s tax compliance and reporting history both in any foreign jurisdictions and in the U.S.? Jurisdictions around the globe are getting tougher on compliance across the board. The target’s previous history can help indicate whether you are likely to inherit beneficial tax attributes or unresolved tax problems. When doing compliance due diligence, focus on past audits, open tax years, and transfer pricing to the extent the target has intercompany payment streams. Having an understanding of the target’s tax history will also help predict the relationship you can expect with taxing authorities in the jurisdictions where you will now be doing business. It will also help you understand whether target has an efficient tax reporting process in place.
Second, pick the right transaction type
Next, consider the corporate, commercial, and legal form that will drive the negotiations and ultimately be used to execute the transaction. How the deal is financed and whether you pursue a stock or asset sale are key considerations. This will significantly affect the tax consequences of the deal for both the buyer and the seller. From the acquirer’s perspective, buying assets typically:
- Allows the buyer to purchase only those assets and liabilities that it wants—it does not have to buy the entire target
- Gives the buyer a step-up in basis on the acquired assets, which will help to minimize taxes on any future sale of those assets
- Means that goodwill is tax deductible
- Likely means a more complicated and expensive transaction, as the purchased assets need to be identified and valued
- Means that seller may be taxed at both the corporate and shareholder levels if the target is liquidated which could result in seller demanding a higher price
In contrast, in a stock sale:
- The buyer acquires the entire target, including its liabilities
- The buyer receives no step-up in basis in target’s assets
- Goodwill is not deductible
- The buyer retains the target’s tax attributes, such as net operating losses, which can be valuable. Be aware, however, that many jurisdictions, such as Germany, have rules that severely limit a buyer’s ability to make use of those losses
- The transaction is likely to be less complicated and less expensive
- Proceeds from the sale are taxed only at the shareholder level but entity level gains that have accrued on the assets of the target through closing along with associated potential tax liability will shift to the buyer potentially diminishing the future value of the target
All of these considerations must be considered from a U.S. and foreign perspective.
There is, however, a middle ground. In the domestic and foreign context, under U.S. law, the acquirer and seller can agree to structure a stock sale as an asset transaction, which allows the buyer to realize many of the benefits of an asset sale without the related complexities and added costs of a stock sale.
Third, choose a structure that fits your strategy
Finally, choose the right corporate organizational and tax structure to support your future strategy. In many cases, this may involve forming a centralized headquarters or holding company in a jurisdiction with favorable tax laws. Ireland, Luxembourg, the Netherlands, the United Kingdom, and Switzerland are jurisdictions that, with the right business purpose and added corporate substance and functions, can serve as a tax efficient base for international businesses.
A holding company can be a wise choice if you plan to make additional overseas acquisitions, as it will give you more structural flexibility as you consider how to best integrate new entities into your global strategy. Use of a holding company can also drive foreign expansion by facilitating planning and deployment of foreign earnings, and allowing your business to implement effective U.S. tax deferral and repatriation strategies.
Choosing an efficient corporate structure and managing it in an appropriate manner will help you manage your U.S., foreign, and overall worldwide effective tax rate. This will ultimately drive earnings per share and increase enterprise value.
The best post-merger structure after any given transaction will be based on its unique characteristics and the company’s global strategy. However, by fully understanding the target’s current tax characteristics, structuring your deal appropriately and choosing the global structure best suited to your global goals, you will have a roadmap for making an informed decision.