The recent rise in deal failures brings opportunities for tax directors on the sell-side to use their expertise to reduce risk and raise the bottom line. Phil Brook and James Sia look at ways tax can increase the focus on seller value during the course of a transaction.
You may be aware of the following statistic – the failure rate for M&A sits
between 70 and 90 percent.
Unrealistic expectations, boardroom clashes and disagreements over strategy are often cited as reasons for failure. Tax is rarely mentioned, but it can be a factor in delaying and derailing deals.
Clearly the tax system is going through some significant changes, many of which have implications for M&A.
World leaders are reforming international tax laws to counter perceived corporate tax avoidance and tax authorities are scrutinising multinational groups more closely for signs of transactions primarily designed to avoid tax.
As an example, earlier this year the U.S. Treasury Department issued new rules against corporate inversions – transactions in which U.S. companies take a foreign address following a merger with another, usually smaller, business.
In the current political and economic landscape, tax is therefore both a value driver and a risk to be managed. This an opportunity for tax leaders to use their expertise to both help facilitate the sale and reduce the likelihood of unexpected tax costs.
So how do you begin to get your company’s tax affairs in order before it’s sold?
Your first step should be to prepare for the due diligence process by thinking about what information a buyer is likely to need and what areas of tax complexity will need to be addressed. Upfront preparation for how these areas of complexity will be presented to a buyer will help reassure the buyer and help both parties spot tax problems at an early stage in negotiations and find
solutions for them.
Given the current tax climate it’s important to begin the due diligence process as soon as possible. Much of the early work is fairly straightforward but extremely time-consuming. You typically have to analyse up to six years of financial transactions and tax records; check the reasons for commercial transactions; track cash flow; transfer data between centres, software packages, subsidiaries and so on.
The sooner you start, the more time you’ll have to spot any anomalies. Big Data technology and data analysis techniques can help with this.
Judgement remains the vital quality in tax due diligence. It’s about spotting risks and the possibility that a tax authority might challenge the structure of the deal and working out how to mitigate these risks and reassure the buyer.
Pay close attention to inter-company transfers of assets, goods and cross border pricing arrangements services as these are increasingly areas of focus for tax authorities.
Many of us are still digesting the implications of Base Erosion and Profit Shifting (BEPS) actions. The proposed changes, which are being led by the Organisation for Economic Co-operation and Development (OECD), include a requirement for companies to reveal how much profit they make in each country they operate.
The disclosure of this information could damage the reputation of a company if it’s paying very little tax compared to its profits and could trigger investigations by the government or national tax authority. It is important to make sure that your tax due diligence procedures consider this risk.
Being able to explain existing tax arrangements to tax authorities is becoming increasingly important. The position a seller takes on such matters can create uncertainty in a buyer’s mind.
Resolving areas of dispute with HMRC before a transaction takes place is therefore of critical importance and can allay a buyer’s concerns about the tax risks faced by a potential target.
Sellers can also, of course, pay for indemnity insurance to ease a buyer’s concerns around tax arrangements or previous transactions. However, it can be more beneficial to anticipate problems and fix them early on in the process.
Part of the solution to any problems identified during due diligence can involve some restructuring of the target group’s affairs or unwinding of particular structures. Any necessary restructuring may raise legal or other issues and may take some time, meaning that early issue-spotting is essential.
Tax due diligence isn’t just about removing risk. It can also create value. Deals
can be structured to make a business or one of its assets more tax efficient and therefore financially attractive to the seller. For example, claiming capital allowances can be delayed or even left depending on the sale structure.
The overhaul of tax rules and increased media coverage of companies’ tax arrangements probably won’t slow the M&A market. However, tougher rules on perceived tax avoidance and more scrutiny from tax authorities over deals that are seen as tax-driven create new challenges for stakeholders.
In particular, unusual or complex existing structures may not be attractive to
potential purchasers and may require restructuring. Alternatively, a seller may be able to take steps pre-sale to improve its own position. Legal considerations and timing considerations may affect the ability to execute any necessary restructuring.
Companies that prepare thoroughly for divestment opportunities and potential purchaser concerns will be able to move more quickly and successfully through the sale process. This makes it all the more important for tax directors to push for earlier involvement in pre-deal discussions. This will allow you to identify areas in which value may be created in a sale, rather than lost.