Deal maker or deal-breaker: why tax needs to be part of M&A planning from day one

A combination of new regulations and changing public perceptions have restricted tax arrangements that had been at the heart of deal value optimisation within M&A. Yet, with change, there are also opportunities.

Where the business led on M&A, tax once followed and often quite late in the process. Historically, a tax workstream could run separately from the main commercial and operational analyses. These days are gone.

Regulatory overhaul
The spearhead of disruption is the OECD’s Base Erosion and Profit Sharing (BEPS) Action Plan. Key plans include a ceiling on the level of net interest expense that a business can deduct against profits (in most countries to 30% of taxable earnings before EBITDA).

Businesses also have to ensure that taxable earnings are aligned with the substance of value creation. Now, there is the need to align the returns to where the value adding activities happen (‘substance’). For example, the rights to intellectual property and related tax liabilities from the proceeds need to locate where the main functions concerning that intellectual property are carried out.

Public perception
The public focus on the use of aggressive tax planning also creates significant reputational risks, especially for consumer-facing businesses. The potential result can be damaging media coverage and even boycotts.

Managing the impact
These shifts are game-changing from an M&A perspective, not only through the potential for higher tax liabilities, but also their knock-on impact on strategy, operations and talent management. For example, if the need to demonstrate substance requires some form of operational relocation, is the necessary talent and infrastructure available locally? How many of the existing team would need to move, would they want to go and how could they be incentivised? Yet, there are also emerging opportunities to optimise deal value, especially if tax is built into wider M&A strategy and operational planning from the outset. So how can your organisation manage the changing tax landscape and make the most of the opportunities?

1. Bring strategy, operations and tax teams together

Tax should be built into the M&A blueprint, which outlines the growth opportunities, the operational capabilities needed to capitalise and who is responsible for delivering.

Strategy, operations and tax teams should come together to identify potential issues and develop the solutions. This shouldn’t be a case of the tax “tail” wagging the business “dog” – the strategic potential of the deal is always the most important source of value. But, it is still necessary to look at all aspects of the deal also from a tax perspective.

2. Consider both traditional and new tax issues

The traditional tax issues in M&A transactions are still critical. They include designing acquisition structures, assessing the tax liabilities of the combined business and eliminating any potential dividend traps, including ensuring that the financial needs are taken properly into consideration.

It is now also vital to assess and address a new set of tax and non-tax issues, including how to align tax approaches with growth aspirations, while identifying potentials risks – reputational as well as regulatory.

Cross-functional collaboration is needed to ensure that transfer pricing policies reflect substance and tax risks are managed appropriately. It is also needed to manage the heightened risk of investigation and audit: in a Private Equity backed business in particular, it is not just by tax authorities, but also by buyers when the business is sold on. Ideally, there should be a dedicated ‘Deal Value Architect’ to bring teams together, manage the process end-to-end and co-ordinate the response.

Some deals may no longer be viable as a result of the tax evaluations – there are already examples of buyers pulling out because of concerns over what they see as artificial tax structures in target groups. Yet, closer collaboration between tax and operational teams can also identify deal drivers – ‘value bridges’. Potential examples include centralising value-adding functions in a single jurisdiction, which can reduce costs and strengthen transparency and management control.

3. Plan for the long-term

Beyond the immediate ramifications of tax reform, it is important to consider the impact on long-term strategies. If the business has identified the Far East as the key source of future growth, to be driven by regional management, it would pay to develop the necessary capabilities organically over time, in the right location, rather than facing the cost and dislocation of relocation, and the inevitable business disruption. For example, relocating operations from Europe to Asia would not only create talent challenges, but also runs the risk of a sizeable bill for capital gains tax.

Don’t wait until it’s too late
So, tax may be, in some cases, a “deal-breaker”, but it can also be a “deal maker” - it can help your business realise total value earlier on, and ensure efficiencies are both met and acted upon. The key is identifying the implications up front, rather than tackling tax at the end of the M&A process, by which time it may be too late or eye-wateringly expensive.

Contact us to find out how we can help you address tax early on in your dealmaking.

Our M&A report with Mergermarket, Creating value beyond the deal, uncovers how the most successful dealmakers have made M&A pay at every stage of their deal lifecycle. We share detailed insights on what makes an effective value creation approach, the role of people in culture in value planning, as well as insight into the first-hand experiences of executives on both sides of the deal. Download the report.