5 minute read 6 Mar 2019
Lady with long hair on rock climbing wall

Tax continues to play a key role in divestment success

Authors

Bridget Walsh

EY Global Head of Transaction Tax

Recognized private equity strategic advisor. Entrepreneurial businesswoman with track record for building and growing new business markets. Passionate about the power of digital transformation.

Paul Hammes

EY Global Transaction Diligence and Divestiture Advisory Services Leader

Leader in transformational global divestitures. Catalyst for profitable growth. Innovator. Value driver. Passionate about diversity in business. Husband. Father.

Ian Scott

EY Asia-Pacific Transaction Tax Leader and Private Equity Executive Sponsor

Experienced in providing Australian and international corporate tax advice. Focuses on private equity and large-scale M&A.

Rocio Reyero

EY EMEIA Transaction Tax Leader

Transaction tax leader. Loves traveling, gardening, reading, listening to music and enjoying life with her family.

5 minute read 6 Mar 2019

Tax can be a powerful tool in preserving value in divestments.

According to the EY Global Corporate Divestment Study, companies that intend to divest remain at record levels, with 84% of companies looking to divest within the next two years. C-suite executives say tax continues to play a key role in divestment success, providing significant opportunities to reduce value erosion, manage risk and enhance deal flexibility.

Tax policies continue to have a major impact on businesses. The continuing impact from US tax reforms and Base Erosion and Profit Shifting (BEPS), alongside reputational risk, has meant companies have to adapt to a constant backdrop of change. With 45% of companies reporting an increase in tax challenges impacting the ease of executing deals (up from 31% last year), finding ways to address these challenges has never been more important.

With the right preparation up-front, a seller’s tax approach can be a powerful tool to preserve value by providing flexibility in sales structure and build defenses to support tax uncertainties. This approach can also enhance value by supporting tax attributes (ensuring their value is considered in the commercial negotiation) and ensuring that tax is appropriately considered in the effectiveness of changes to the operating models.

Here we focus on three of the key tax findings coming out of the study — value erosion, flexibility and operational integration.

Value erosion

Lack of preparation around tax risk has consistently ranked as a top cause of value erosion year over year.

Value erosion

66%

of companies say lack of preparation in dealing with tax risk was a cause of value erosion in their last divestment.

Conversely, 63% of companies say they undertook pre-sale preparation to mitigate the price reduction for tax risk. So why is value still being lost?

Preparation often begins with sell-side due diligence. Commonly, value is lost when sellers identify tax risks in the first stage of preparation, but then fail to act to clarify and potentially mitigate those risks before the process starts. Bringing tax into the divestment strategy earlier can allow sufficient time to undertake an open assessment of the business through the eyes of a buyer, address issues identified, and only then commence diligence. It is not only how a vendor sees tax risk and opportunities that is important, but how a buyer would look at them from the outside in — which is easier said than done.

Negative value adjustments can occur where a seller underestimates the tax perspectives from a widening pool of buyers, including private equity and cross-sector. Preparing for these conversations may require sellers to review historical tax advice and the trail of why positions were taken to help provide the reassurance and granular data a purchaser requires — in some cases resulting in pre-sale tax authority clearances and negotiations.

If it is not possible to bridge the gap in tax views between buyers and sellers, the warranty and indemnity and tax insurance market can be an effective way to take protective measures around exposures.

Flexibility in sales structure

While 57% of companies say lack of flexibility in the sales structure eroded value, a significant number of companies who demonstrate flexibility are seeing a positive impact on their sale price. To improve flexibility, companies can start by weighing the tax impacts of different structures.

Tax teams should work alongside M&A teams early in the process to fully understand all commercial options, analyzing and modeling tax cost or saving of different structures. In tax free spin-off or demerger transactions, early analyses should include evaluation as to whether the proposed transaction can meet the tax requirements and regulations to achieve a tax-free transaction. This allows time to dive down into key tax variables, including potential exit structures, vendor costs, tax attributes and highlighting value perception on the buy-side (e.g., tax benefit of basis step-up) leading to a fuller and more flexible set of options, tax costs and benefits.

Trying to build in flexibility in the middle of a deal, with competing asks and time pressures, can mean value is lost when there is insufficient time to react with any degree of accuracy. Thinking about this up front supports greater agility, allowing sellers to make changes as external circumstances move, buyers’ priorities change or other issues arise.

One of the side effects of US tax reform is that US multinationals are generating even more detailed tax attribute information on a current basis to assist in new computations required under US tax reform. Having data regularly updated and on hand can assist tax functions in evaluating alternative disposition structures as they look to build in flexibility on the sale.

Flexibility in sales structure

48%

of companies report that the ability to achieve a higher sale price by offering flexibility in sales structure has increased in the last 12 months.

Operational integration

Businesses built on years of acquisitions, complex operating models or shared service centers are often intertwined across many functional levels. And fifty percent of companies say failure to present the business as stand-alone “scared off” potential buyers, eroding value on their last divestment. Sellers need to articulate a clear plan to achieve a stand-alone operating model and communicate a day one transitional operating model. Thus, time can be well spent disentangling the business for sale before the formal process.

Divestitures can create tax value as the stand-alone operating model of a business is restructured to better match the post-sale commercial strategy and synergies. The key is to think of the divested business as a business in its own right which means for that business:

  • What is the most efficient operating model
  • Where should its people be based
  • What capital structure should it have

Understanding the tax profile is a key consideration in this process.

Where the deal team has operations and tax working together, tax implications of separation (e.g., intercompany loans, historic transfers of assets) and their impacts on tax can flow seamlessly into wider workstreams. Understanding this is critical to avoiding surprises and managing messaging to wider teams.

For a divested business to continue operating without significant business interruption, companies are frequently using delayed close mechanisms — a period where the legal ownership remains with the seller, but the net economic benefit is with the purchaser. Tax can often bear the brunt of risks in such situations with complexity and interdependency from direct taxes, indirect taxes and increasingly, tariffs. Close operational workstream alignment, including tax, can help manage the additional risks this arrangement can create.

Using insurance to achieve certainty on tax risks 

A growing trend in the market has been the use of tax insurance to bridge the perception gap between buyer and seller. Where a seller is unwilling or unable to provide contractual protection in respect of historic tax liabilities, the insurance market can often provide a commercial solution, avoiding the need for protracted negotiations and saving significant time and cost.

In our experience the market for insurance has shifted significantly over recent years, both in terms of pricing and extent of cover. For example, with the right fact pattern it can now be possible for low risk/quantum diligence exposures not to be carved out from policy coverage, as was previously the market standard. Further, specific more significant tax risks can now often be insured separately as insurers have greater in-house tax expertise and capacity to insure specific tax risks.

However, insurers will require sufficiently detailed diligence to be comfortable they can provide cover. Matters and jurisdictions which have not been covered in diligence will not be insured. Identification of tax risks that may need to be insured prior to sell-side due diligence is vital to ensure the scope of that due diligence is sufficient.

Summary

The EY Global Corporate Divestment Study focuses on how companies should approach portfolio strategy, improve divestment execution and future-proof their remaining business.

About this article

Authors

Bridget Walsh

EY Global Head of Transaction Tax

Recognized private equity strategic advisor. Entrepreneurial businesswoman with track record for building and growing new business markets. Passionate about the power of digital transformation.

Paul Hammes

EY Global Transaction Diligence and Divestiture Advisory Services Leader

Leader in transformational global divestitures. Catalyst for profitable growth. Innovator. Value driver. Passionate about diversity in business. Husband. Father.

Ian Scott

EY Asia-Pacific Transaction Tax Leader and Private Equity Executive Sponsor

Experienced in providing Australian and international corporate tax advice. Focuses on private equity and large-scale M&A.

Rocio Reyero

EY EMEIA Transaction Tax Leader

Transaction tax leader. Loves traveling, gardening, reading, listening to music and enjoying life with her family.