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M&A due diligence: Why tax matters

M&A due diligence: Why tax matters

The global focus on corporate tax avoidance means that tax due diligence is more important than ever when planning an M&A process. With both regulation and technology now playing important roles in the due diligence process, Alistair Haley lays out the risks and opportunities that tax stakeholders should be considering.



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Merging train

2015 was the biggest year ever for M&A with over US$5 trillion worth of deals globally[1]. The market in 2016 is largely maintaining this momentum, but as tax authorities tighten rules against corporate tax evasion, there’s an increased risk that tax issues can delay – or even derail – your deal.

Government intervention over M&A tax matters is becoming more common. According to the Financial Times, the total value of US deals, made between 2012 and the present day, abandoned following government intervention to block a company from moving its tax base abroad increased to around US$400bn[2]

The changes to the global tax landscape – the most far-reaching for at least three decades – make pre-deal tax due diligence more important than ever. As a result, both buyers and sellers need to focus on understanding the impact of future tax law changes rather than focusing solely on historical tax data.

Tougher scrutiny on tax strategies

As governments around the world begin to implement
a number of global initiatives (such as BEPS), it’s crucial to consider how these new regulations dictate your approach to tax due diligence.     

The BEPS impact
One of the most important upcoming changes to international tax law is the proposed Base Erosion and Profit Shifting (BEPS) initiative led by the Organisation for Economic Co-operation and Development (OECD). BEPS, which is designed to stop companies shifting profits from high to low or no-tax jurisdictions, will affect different aspects of M&A, and covers a number of agreed Action Points over three broad areas: 

  • First, the establishment of minimum standards that were agreed to tackle issues in cases where the absence of action by some countries would have created adverse impacts of competitiveness on other countries. These actions assume consistent implementation of rules around the prevention of treaty shopping, Country-by-Country Reporting, fighting harmful tax practices and improving dispute resolution. 
  • Second, existing standards will be revised, which will involve for example, current model treaties or OECD standards being updated in the areas of Permanent Establishment avoidance and transfer pricing.
  • Finally, there is an agreed framework of best practice where countries have agreed a consistent general tax policy direction, for actions involving hybrid mismatch arrangements, interest deductibility, CFC rules and mandatory tax disclosure initiatives.

An understanding of the manner in which different countries will implement these action points, as well as the impact on a target group’s particular structure, will also need to be factored into pre-deal due diligence.

New limits on interest rate relief
From 1 April 2017 in the UK, the amount of tax deductions that companies can
claim for financing costs will broadly be capped at 30% of Earnings Before
Interest Tax Depreciation and Amortisation (EBITDA). This means that some
companies may be able to claim significantly less tax relief for financing costs
as compared with the position pre-1 April 2017. 

Consequently, some deals may be less attractive if your board has anticipated a particular level of deductibility in tax modelling forecasts. Many groups will be currently examining their interest deductibility profiles, and this should be factored into tax due diligence procedures.      

New requirements for tax reporting
From 1 January 2017, country-by-country (“CbC”) reporting will be required to
be submitted in a number of jurisdictions. Businesses must now be aware and informed of what information must be reported to tax authorities around the world, and the level of reporting readiness that is required should be understood during due diligence processes – especially given the knowledge that relevant CbC reports will be shared between different tax authorities.

Why it matters to you

The potential for tax to complicate or derail a deal is increasing. The tax
component of due diligence processes can no longer afford to be on the
fringes of the deal-making process. Keeping track of international tax law is
more important than ever and there is a real importance to understanding the
extent to which proposed changes to tax rules in different countries could
impact on the tax profile of a target in those countries.

Due diligence is a collaborative process and requires input from a wide range of parties and teams. However, company boards will be increasingly reliant on their tax departments to avoid any pre- or post-deal surprises or difficulties. 

Tax may never make a deal, but it can certainly break one.

Key considerations

  • Examining both legacy tax matters and understanding the impact of future tax law changes are now crucial parts of the M&A process.
  • New global tax initiatives such as BEPS mean that both buyers and sellers need to be aware of upcoming changes to tax law across a number of jurisdictions. 
  • An M&A process requires input from a wide range of parties - the tax function is critical to this and can no longer afford to be on the fringes of the deal-making process.
  • Post-deal tax structuring should be implemented with anticipated tax legislative changes in mind so additional structuring work is not required.

M&A Due Diligence: a tax checklist

  • Keep up to date with regional tax laws. How will planned changes affect the tax bills of your acquired business? Work out if the planned business structure will be sustainable with ongoing harmonisation of international tax rules. 
  • Can you justify post-deal arrangements to tax authorities? Under the
    UK’s diverted profits tax rule for example, companies need to show that any amounts paid to low tax or no-tax countries are for commercial reasons and not purely to avoid tax.
  • Do your overseas jurisdictions have real substance (eg staff on the ground)?  Increasingly tax authorities challenge the existence of companies with little
    activity. Tax and finance directors need to understand the post-deal structure of a company and potentially be prepared to explain it to tax authorities. And CbCR will give them the visibility of potantial risk areas.
  • Make sure your tax due diligence is prioritised early during the M&A process negotiation. Check that different teams (tax, financial, law, IT and commercial) share information.       
  • The use of data and analytics in tax due diligence can uncover valuable insights across the M&A lifecycle.


This article was written by Alistair Haley. Director, Corporate Tax. 




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