A key milestone in the Base Erosion and Profit Shifting (BEPS) project was achieved on 7 June 2017 when Japan, Hong Kong, Mainland China, Korea, India, Singapore, Indonesia, Australia and 60 other jurisdictions signed the ‘Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS’ (referred to as the multilateral instrument or MLI) during a signing ceremony hosted by the Organisation for Economic Co-operation and Development (OECD) in Paris.
With the momentum of BEPS implementation at both domestic tax law and tax treaty levels building, the international tax landscape is becoming increasingly complex and uncertain.
What does BEPS mean for cross-border M&A?
As BEPS evolves and tax authorities move towards implementation, reviewing the potential impact of BEPS on business, including its impact on M&A is increasingly important. Companies need to carefully consider their current corporate structure, as well as their future expansion strategy in navigating this new and complex tax environment.
BEPS will result in enhanced transparency through increased reporting requirements and exchange of information between tax authorities, which could lead to increased levels of scrutiny.
From an M&A perspective, here are five key issues professionals need to be aware of:
The MLI changes to specific bilateral tax treaties will only enter into effect after both parties of the treaty have deposited their instrument of ratification, acceptance or approval of the MLI and a specified time has passed.
Deal structuring — strategies around holding and exit
In a post-BEPS world, additional tax impost at various layers of a holding structure may arise given the increased substance requirements for availing of the tax treaty benefits. BEPS Action 6 focuses on treaty abuse by examining the purpose of a transaction, and/or limitation of benefits and specific treaty abuse rules covering certain dividend transfer transactions, dual-resident entities, etc.
Assessing historical tax risks in due diligence
Certain BEPS action points are likely to affect the historical tax positions of targets, and the traditional tax due diligence scope may need to be expanded to cover such additional risks inherited by the acquirers.
Additional tax costs in acquired structures
In assessing the historical tax position of a target, BEPS Action 7 should also be considered. Action 7 recommends changes to the definition of permanent establishment in the OECD Model Tax Convention, and addresses strategies used to avoid having a taxable presence in a country under tax treaties.
In funding subsidiaries, groups may have used hybrid financial instruments which possess the characteristics of both debt and equity whose distributions are considered as tax deductible interest from the subsidiaries’ perspective, and as non-taxable dividends from the holding entity’s perspective. The effectiveness of such “tax arbitrage” needs to be re-examined with the recommendations of BEPS Action 2.
Approaching BEPS is a wider challenge than tax
The implications of the historical tax position and future effective tax rates of acquired structures will inevitably affect M&A strategies across the transaction life cycle. Multinationals are advised to proactively manage the risks brought about by BEPS and revisit their approach to pre-deal structuring, due diligence, pricing, acquisition structure and funding, holding and repatriation as well as divestures.
Active engagement and coordination with relevant stakeholders within an organization and external advisors, including those from legal, finance, business operations, sales team, boards, investment committees and above all, tax, is essential to ensure the wider business challenges of BEPS are adequately addressed when executing cross-border M&A deals.
Management and key stakeholders should keep themselves abreast of the development of BEPS, bearing in mind the varying implementation across jurisdictions and industries.
Ultimately, while it is always best for organizations to brace themselves against the waves of legislative changes with BEPS through early planning and revisiting strategies, they should realize the need for sustainable and durable structures, and in certain instances also be prepared to accept an increased tax cost and heightened uncertainty.
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