The impact of BEPS in M&A transactions

The 2015 calendar year set a new record for global mergers and acquisitions (M&A) activity (by reference to the total value of transactions), driven by a series of megadeals, including ABI's proposed takeover of SABMiller, Shell's acquisition of BG Group, and Pfizer's proposed blockbuster $160 billion takeover of Ireland's Allergan.

Despite the growth in aggregate transaction value, driven by a wave of megadeals and particular strength in the US M&A market, deal volumes remain below their 2007 peak. However, the momentum in transactional value, coupled with growing levels of Chinese outbound activity (Chinese investors transacting abroad), as China rebalances its economy, could see the volume of transactions rise in 2016.

Indeed, respondents to EY's 13th Global Capital Confidence Barometer indicated their expectation that the recent wave of M&A activity will continue – 59% of global companies noted they are planning acquisitions in the next 12 months. With the OECD's BEPS Action Plan gaining significant momentum, this article looks at what BEPS – and the tax law changes it may bring – might mean for M&A transactions.

Specifically, we set out our views on the BEPS Actions we believe are most relevant in a deal setting; what BEPS means for investors commercially; how we expect transaction processes to adapt to the 'new normal'; and what we are advising our clients to do now. To illustrate points, we generally refer to acquisitions; however, BEPS considerations are equally prevalent in disposals, IPOs, joint ventures and other capital market transactions.

BEPS will impact on all aspects of the deal processes: due diligence; transaction structuring; and deal valuation. In the post-transaction period: impacting integration; compliance and reporting; as well as the operation and maintenance of structures.

In summary, we see the main interactions between BEPS and M&A transactions as being:

The transition towards single taxation under Action 2 (hybrid mismatches) and the tightening of relief under Action 4 (interest deductions) could reduce the value that can be accessed from transaction financing and foreign tax credits.

Professional fund investors, such as private equity (PE) funds, pension funds and sovereign wealth funds, may be impacted by Actions 6 (treaty shopping) and 7 (permanent establishment), at fund and holding structure levels, by restriction of access to tax treaties, requirement for increased levels of substance and ongoing maintenance of structures, and by the potential for fund management activities to trigger taxable presences.

Trading companies will have their choice of operating models impacted, as well as the allocation of profits between functions and their ability to access to special tax regimes, such as patent boxes and other innovation supporting regimes, under Actions 8–10 (transfer pricing).

Action 13 (CbCR) will lead to increased and complex compliance and reporting obligations, particularly for professional fund investors, with CbCR potentially required at fund, holding, management and portfolio levels, with consequent impact on costs.

Specific issues facing fund investors Tax transparency: we expect to see the trend towards greater tax transparency result in increasingly detailed information reported by funds to their investors. Substance in holding structures: we expect that holding companies will need to clarify how their management and decision-making functions meet wider commercial purposes. This may lead to increased costs of operating structures. We may also see PE groups withdraw from traditional 'tax haven' and low-tax holding jurisdictions that have sometimes included lower levels of substance. Caution with regard to beneficial ownership leading to reduced reliance on tax treaties: given the typical five-to-seven-year PE industry investment holding period, we expect to see a preference for transactions to be structured to access 0% WHT rates and capital gains exemptions where available under domestic law, rather than relying on the reduced tax rates available through tax treaties, until tax treaty changes are effected and taxpayers have more certainty as to how these provisions may impact their structures. Fund management activities creating permanent establishments: with the OECD definition of what constitutes a permanent establishment likely to broaden significantly, we expect to see certain activities that previously did not create a permanent establishment now doing so and therefore establishing a taxable presence.

With BEPS expected to increase tax costs for companies, and within fund structures, investors will need to assess the potential impact of how BEPS-driven tax law changes could affect transaction risks, structures and value.

With years of potential uncertainty ahead, structures that follow single taxation are more likely to prove sustainable and durable when faced with revenue authority scrutiny – where investors rely on 'less than single taxation' structures, the ability to restructure tax-efficiently will be critical.

With higher overall levels of tax expected and an increase in the breadth of tax risks, a knock-on downward effect on deal pricing and investment returns appears inevitable – when divesting, investors who think ahead may be better placed to mitigate adverse pricing impacts.

With reputational tax risk under increased focus by politicians and mainstream media alike, boards and investment committees will need to take a broader, non-financial and future-focused approach to assessing potential tax risks and costs – considering this also in the context of potential changes in regulatory and political environments.

In areas of higher potential tax risk, in particular within fund and holding structures, investors will need to regularly assess whether structures are following their operating parameters.

These factors taken together indicate a need to increase the prioritisation and focus on tax within transaction processes.

Gaining an accurate estimation of a target's future tax rate will become harder – this uncertainty may reduce the investor community's confidence. Opportunities will arise for investors that can accept this risk and gain appropriate adjustments to purchase prices.

Acquisition structures and operating models will be increasingly developed based on the core concepts of sustainability and durability – tax structuring to access less than single taxation may prove short-lived, and hence lead to over-valuation of transactional opportunities, and consequential low returns on investment. Investors who understand and accept higher tax costs need to be prepared to walk away from deals where the returns they seek cannot be generated.

The potential breadth of BEPS impacts expected in M&A transactions will add significant financial and operational complexities within the decision-making processes for investors. Factoring these complexities into deal time-lines, and having open channels of communication with tax teams, or moderating the need for certain detail, will be necessary to ensure that boards and investment committees are presented with the facts they need to make transaction decisions.

Tax due diligence may increasingly become future-focused as well as backward-looking, and include looking for risks that could arise under differing scenarios as to how countries will implement the BEPS recommendations into their domestic laws. As these uncertainties will continue to exist for a significant period of time, regularly reviewing risks and structures post-acquisition will enable investors to correct their course where needed.

Risk assessments that take a broader view, rather than focus solely on financial impacts, will be demanded by boards and investment committees – this breadth will need to include reputational risk, and the risk of regulatory or political change.

As we have seen over the last decade, tax due diligence processes have adapted for new technologies – in particular, the use of electronic or virtual data rooms. We expect this rate of change to continue, with software used for data mining, benchmarking and analysis adding speed and value to deal processes. Consider for a minute this scenario: benchmarking tells you that your target company has a tax rate in the lowest quartile for its sector – do you consider this to be an optimised tax structure creating future value, or an indicator of aggressive structuring and therefore likely to leak future value?

with BEPS increasing uncertainty generally, we expect taxpayers generally to increase their use of APAs. In an M&A context, the reliance an APA can provide presents an opportunity for a seller to show where value exists; equally for a buyer, obtaining an APA can provide security of tax costs. Aligning deal time-lines and APA processes is an obvious challenge here, so we would expect sellers to be more proactive.

As investors consider how BEPS will impact their existing operations (including holding structures, financing structures, IP and supply chains) on a stand-alone basis, they need to overlay how proposed transactions may impact on the existing business, and vice versa – for example, could the TP policy of the target, and its CbCR footprint, potentially undermine the current group's carefully applied TP policy?

The increase in tax rates triggered by BEPS may, in some cases, undermine the financial performance of existing business units. Where they no longer meet their targeted capital returns, (hurdle rates), we expect some companies will start divesting businesses, or closing or scaling back activity.

These factors, taken together, suggest that investors will need, as ever, tax advice that is technically robust, but increasingly commercially and strategically focused.

Essentially, from a tax technical perspective, it comes down to asking, and being able to answer, the following four questions:

• What are the historical BEPS risks within your holding and funds structures?

• What are the historical BEPS risks within your operating companies?

• What are the future holding and fund structures you need to put in place to be BEPS compliant?

• What targets are you looking to invest in or acquire? How could BEPS impact value?

But approaching BEPS is a wider challenge that tax technical aspects alone do not address. Our clients who are meeting the wider business challenges of BEPS, and taking them into account when executing M&A deals, are the ones who are best positioned to navigate the changing tax world successfully.

These challenges include:

• Communicating widely within their organisations the BEPS changes that are known and the likely direction of travel where they are unknown, and converting this into jargon-free business understanding; engaging in particular with legal, finance, treasury and business operations (including supply chain and sales leaders) and, of course, with boards and investment committees.

• Planning for change, understanding what might need to happen and when, the cost and resources needed for change and the likely impact on, and possible disruption to, the organisation;

• Being proactive in this area, and prioritising the time to think through potential implications under different scenarios; and

• Keeping a constant eye on the organiaation's reputational tax risk.

At EY, in an M&A setting, we cannot pretend to have all the BEPS answers, and to have done this all before – nobody can. We are helping our clients to think ahead and anticipate the future, in a commercial, practical and strategic way.

How we expect governments to react Introduce transaction reporting. We see the possibility that some governments will use Action 12 (disclosure of aggressive tax planning) to introduce transaction reporting procedures to enable the capture of data around fund flows, the acquisition of tax assets, commercial rationale for deals and to understand the tax effects of acquisition structuring. Aggressively target CbCR mismatches. We believe that the increased transparency driven by Action 13 (CbCR) will lead corporate investors to integrate and align TP policies of the companies that they acquire with their existing group policies more regularly, rather than seek to explain differences, which may not be apparent from the data provided under CbCR, to multiple revenue authorities that may be using financial metrics as a basis to determine when to raise tax audits. Dispute resolution. The agreed minimum standards under Action 14 (dispute resolution) are expected to have a positive impact for taxpayers in a deal context, with commitments to minimise uncertainty and the risk of double taxation arising for taxpayers, and reduce the time lines for resolving disputes. We expect governments who seek to attract foreign direct investment to commit to fund dispute resolution procedures, enabling them to provide a timely service to taxpayers who are transacting.

Adam Eagers EY Tel: +44 (0) 20 7951 1946 aeagers@uk.ey.com Adam is a director who leads EY's food & beverage sector transaction tax offering in the UK. A chartered tax adviser, Adam has more than 14 years of tax experience in the UK, M&A and international taxation. Before joining EY in 2011, Adam worked in industry as a tax adviser. Adam predominantly advises corporate clients on multinational acquisitions, divestments and joint ventures, supporting them with tax aspects of due diligence, financial modelling, transaction structuring, negotiation, pre-transaction preparation and post-transaction integration.

Mark Bennett EY Tel: +44 (0) 20 780 69257 mbennett2@uk.ey.com Mark is EY's EMEIA transaction tax leader and a member of the global transaction tax executive group, based in London. He is a chartered accountant who holds bachelor's degrees in law and commerce. Mark has more than 16 years of experience working across Europe and Asia Pacific with a focus on financial services clients. His experience spans carve-out and sell-side transactions, acquisitions, international tax restructuring, reorganisations and restructuring and capital and equity market transactions.