Global tax ambiguity will not stunt mergers and acquisitions: analysts

Singapore

THE increasing uncertainty in tax legislation and tax policy design will not dampen cross-border mergers and acquisitions (M&As), but it will pose challenges for various aspects of a deal, experts say.

Adam Rees, principal adviser, Tax-Deals, M&A at KPMG in Singapore, told The Business Times that such challenges include how the deal is structured between parties, the extent of tax due diligence undertaken and the shaping of protections in transaction documents.

"However, we do not expect uncertainty on global tax policy and direction to stunt cross-border M&A activity or deal making. Deal activity has rebounded strongly, with the easing of uncertainty caused by the global pandemic," Mr Rees said.

International taxation is at a cross-roads. The more than a decade-long push by the Organisation for Economic Co-operation and Development (OECD) for reforms is being escalated by the US' call for a global minimum corporate tax rate. Recently, the US called for a 15 per cent floor, compared to 21 per cent earlier this year.

Darryl Kinneally, partner, International Tax and Transaction Services at Ernst & Young Solutions LLP, noted that nobody likes uncertainty.

"Having said that, as evidenced during this pandemic, uncertainty can create opportunities and we are seeing an extremely active M&A market both regionally and globally."

Deals are powered by record amounts of capital available for deployment.

"Whether it is a corporate buying a competitor or making a complementary acquisition with perceived synergies or private equity (PE) acquiring companies for capital growth particularly in the technology and life sciences sectors, there is a lot of activity," Mr Kinneally said.

A natural pipeline for cross-border deal opportunities will also continue to be created by geographical expansion to secure supply chains and increase customer reach, as well as corporates reassessing and reshaping their portfolios.

While strategic and commercial objectives are typical drivers of acquisitions, tax impact and risks remain important issues to be addressed in cross-border deals. "These include the tax rate in the target country, whether tax loss and capital allowance carry-forwards are transferable, and the survival of grants and incentives post-transaction," Mr Rees said, adding that it is important to understand how a change of control will impact the tax position of the acquirer or target.

Understanding the impact will become a key aspect of the tax due diligence process, said Agnes Lo, partner, head of M&A, Tax at KPMG in Singapore.

"Changes in tax may affect the acquisition/exit structure, ownership/holding structure, operating structure and financing/capital structures of the acquiring, selling and/or target groups," she added.

Tax can have a dramatic impact on asset valuations. With companies not certain of how and when US tax rates and policies will change, deal assumptions become less reliable.

"For taxpayers that fall within the scope of these proposed rules, there will likely be an increasing tax cost in one or more tax payment jurisdictions - and this will naturally have an impact on future valuation multiples," Ms Lo said.

With the potential onset of the OECD proposed global minimum tax rate, multinational acquirers will need to identify entities in a target group that are taxed a rate below the global minimum rate, as an additional "top-up tax" may be levied to make sure the global minimum threshold is achieved.

Mr Rees said: "This has the potential to impact valuation multiples for deals. Thus, for multinationals, tax due diligence processes may need to factor in potential post-transaction effective tax rates, taking into account potential 'top-up tax', and include separate base erosion and profit shifting (BEPS) or risk assessment processes for the combined group as a whole."

Currently, Asean has an average corporate income tax rate of about 21 per cent. However, many countries - including Singapore - use targeted tax incentives such as tax holidays, tax deductions or tax credits to promote certain investment activities.

"These can result in very low effective tax rates that likely will be caught up under these potential changes," Mr Kinneally said.

"The key implication will be the impact on after-tax cash flows for investors, and as such may impact the amount of debt used to fund M&A, thereby either directly or indirectly having some impact on valuations," he added.

There are also implications for the private equity industry. Measures are already implemented by various countries to prevent base erosion and profit shifting; and other restrictions in domestic tax rules of certain countries may also limit the amount of interest businesses can deduct, reducing the degree to which companies can use leverage within transactions.

"This has particular implications for the private equity (PE) industry, which often uses substantial leverage within its transaction financing structures. As such, we may see PE industry players starting to explore other ways of generating value in deal making," Mr Rees said.

Depending on how the organisation is reshaped after the sale or acquisition, these incentives may no longer be available.

The tax changes can also have significant impact where a buyer may be acquiring a group with a legacy structure which is no longer effective for tax purposes.

"There is then a potential tax cost if the buyer retains the structure or the expense and potential tax costs associated with unwinding the legacy structure," Mr Kinneally said.

But there are ways businesses can navigate this looming tax ambiguity and safeguard themselves from potential disputes with tax authorities.

Eugene Lim, head of Tax Risk, Private Equity and M&A Services at Marsh Asia, said tax liability insurance can help companies mitigate risk when pursuing M&As, given that it can help unlock cash and increase returns on investments as well as speed up the deal execution process.

He explained: "When negotiating a deal, it is to the buyer's interest to take the most conservative view on all tax risks, although the risk may be low or remote, and request specific tax indemnity from the seller for any potential tax risk, which may be unnecessary.

"If the seller provides such indemnity, it will need to hold back cash for the potential tax liabilities and will not be able to distribute all of the sales proceeds to the investors. Such need to hold back cash will affect the return on investments - therefore tax indemnity is usually negotiated extensively between both parties, and may hold up the transaction or even cause the deal to fall through."

Mr Lim said to speed up the negotiation, tax insurance can be used by sellers to back an indemnity, or taken up by buyers when their sellers are unwilling to stand behind the potential liability on specific tax issues.

"As the insurer will be the one liable for any potential tax liabilities, neither the seller nor the buyer will be taking on the tax risks," he said.

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