Taxing issues

PRICEWATERHOUSECOOPERS:Ronan MacNioclais, director, tax & legal services, PricewaterhouseCoopers, on the importance of tax planning in corporate M&A transactions

Coverage of merger and acquisition (M&A) transactions in the general media is typically focussed on the more headline-grabbing features of the deals - purchase price, profit for vendor, new strategies, factory closures.

Such snippets, however, disguise the increasingly complex and sophisticated work required in order to ensure that the transactions are structured on the basis of sound principles ranging from treasury to tax - principles, which, if overlooked or misunderstood, can prevent the potential value of the deal from ever being realised.

Although rarely sensationalist enough in itself to warrant headlines, tax planning is fundamental to the structure of even the blandest of plain-vanilla acquisitions or mergers.

Where there are cross-border dimensions to the deal, the tax issues become more complex, arising as they do from the often divergent tax rules of different jurisdictions.

A typical starting point in discussions is likely to centre on the funding of the deal.

This can include: which group will the company borrow from, how much debt can be borrowed, etc.

As acquisitions and mergers invariably involve a high level of debt, the ability to match the expected future taxable profits with interest arising on the acquisition debt will be a key factor.

Of course, there are a myriad of rules which tax authorities use to restrict the deductibility of interest expense.

"Pushing the debt down" is the term used to try to match the taxable profits with the interest arising on the acquisition debt.

If borrowings are drawn down by an entity in a territory with a low corporate tax rate, such as Ireland, the focus is typically on transferring the benefit of the interest deduction to a higher tax jurisdiction.

How this is done will ultimately depend on the profile of the group (distributable reserves or existing debt for example) and whether tax legislation in the relevant jurisdictions facilitate the transfer, either by means of consolidated group tax rules or group relief provisions.

The absence of tax grouping provisions may mean that a merger is required.

A key issue related to pushing debt down is interest withholding tax. Is there an obligation to withhold tax? If so, can this be overcome by either domestic legislation or Treaty provisions?

Similarly, if interest payments are to be reclassified as a distribution, dividend withholding tax may apply, again unless an exemption is available.

The tax deductibility of certain acquisition costs, such as consultant and advisory fees, will also be crucial both from a corporate tax and VAT (sales tax) perspective.

In Ireland, for example, the tax deductibility of such costs can be problematic.

Thus, in structuring an M&A deal, it may be necessary to investigate whether such costs can be incurred in a jurisdiction which provides for a deduction, or where appropriate, borne by a particular type of entity which is entitled one.

While initial planning may centre on getting funds in to secure the acquisition, the focus of the structuring phase will also need to encompass the tax-efficient extraction of funds at a later date.

For example, will the payer of the dividend be obliged to withhold tax? If so, is there an entitlement in the recipient country to a tax credit for the underlying foreign tax suffered?

Will the dividend be taxable in the hands of the recipient?

Will any tax credits be sufficient to eliminate the tax exposure or will an incremental tax liability arise?

The answers to such questions are fundamental to structuring a deal which will facilitate tax efficient profit repatriation at a later date.

A merger or acquisition may, in itself, act as a catalyst for a reorganisation of the group as a whole - such as expansion into new markets, shift in strategy or a renewed focus on a particular market.

As such, a merger or acquisition can be a powerful catalyst in changing a business model.

Combining this time of change with a review of the existing business model and perhaps including a tax advantaged model, such as an entrepreneur model or limited risk distributors, can be a very powerful way of increasing the after-tax returns of the merger or acquisition.

Although it may seem rather fatalistic to consider possible unwind scenarios at the time of structuring an M&A deal, choices with regard to structure and possible holding company locations are inextricably linked to whether or not future divestment decisions can be made tax efficiently.

For example, if a prospective unwind is planned to take place via a sale of shares in a subsidiary company, does domestic legislation provide for an exemption from capital gains tax on the disposal?

Will the potential purchaser incur transfer taxes on the acquisition of the shares? Could the structure have been tweaked to avoid these potential tax pitfalls?

It may be too late or indeed too costly to revisit these issues once the merger/acquisition has been structured.

Of course, it is not just in the arena of international M&A activity that tax structuring plays such an important role. Issues such as the tax efficient structuring of debt, the eventual repatriation of profits, efficient unwind, etc all play an equally important part in "one-country" or local M&A deals as they do in cross-border transactions, albeit that the focus of the structuring in such local transactions is not muddied by the often discordant tax rules of different countries.

Just as a prospective purchaser would be extremely unlikely to enter into a merger or acquisition without having carried out due diligence on the target company, that same purchaser should be just as reluctant to execute the deal without careful tax structuring.

The purchaser should remember that the sword on which even the soundest of business driven mergers or acquisitions can fall.

So, although tax structuring may not be the most attention-grabbing component of an M&A transaction, a deal which is badly structured from a tax perspective will invariably attract the wrong type of attention from all corners - shareholders, management, tax authorities, potential purchasers . . .