Proceed with caution
Despite growing complexity and uncertainty, respondents in an EY survey had predicted that deal making would remain robust in 2017. Our Global Capital Confidence Barometer, a survey conducted earlier this year of more than 2,300 executives in 43 countries, found that 56% of executives surveyed planned to make an acquisition within the next year.
“Geographical expansion to secure supply chains and increase customer reach will accelerate cross-border M&A,” Steve Krouskos, EY Global Vice Chair Transaction Advisory Services, wrote in the report. “Private equity is returning to replenishing mode. Lastly, corporates are increasingly reassessing and reshaping their portfolios, creating a natural pipeline of deal opportunities.”
Tax is among the risks that companies must address today when making acquisitions.
Our M&A survey found that 76% of respondents had failed to complete or had cancelled an acquisition over the past year, and tax implications was cited as the primary reason by 33% — behind issues discovered during due diligence, and concerns about cybersecurity and regulatory or antitrust reviews, but ahead of economic and political instability.
Amid widespread change in the tax world, “there is no time in memory where pricing the risk and cost of taxation within M&A deals has been so challenging,” says Bridget Walsh, EY Global Head of Transaction Tax, who is based in London.
The changes begin with a global tax reform plan, developed by the Organisation for Economic Co-operation and Development (OECD), aimed at increasing transparency and consistency.
“Nations have access to vastly more information about each company doing business within their borders stemming from expanded reporting requirements [e. g., country-by-country reporting],” Walsh says. “The information is being used to reevaluate transfer pricing — essentially where profits can be taxed — and that creates uncertainty within M&A.”
Another new guideline stemming from the OECD initiative limits the amount of interest businesses can deduct, reducing the degree to which companies can use leverage within transactions. The objective of the guidelines and regulation is to prevent profit shifting from jurisdiction to jurisdiction by financial means.
This has particular implications for the private equity (PE) industry, which often uses substantial leverage within its transaction financing structures.
“Private equity investors are having to rethink their approach to the M&A marketplace,” says Erica Lawee, EY Global Development Leader, Transaction Tax, who is based in London. For the most part, this means looking for ways to generate value through less leveraged deal making.
Certain aspects of M&A transactions may be dramatically affected by other changes in the tax environment.
Tax rates are changing, as are rules related to grants and incentives as well as the transferability of loss carryforwards. And tougher enforcement actions and uncertainty about tax rates make the modelling of deals much more difficult.
Yet another source of uncertainty arises from the many unknowns associated with US tax reform.
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.
“Not knowing when or how the rules will evolve complicates any transaction involving the US,” Lawee says. “It’s a challenge both for existing portfolios and future deals.”
The global-based nature of today’s business environment poses yet another challenge in terms of accurately assessing and determining a deal’s tax implications.
“M&A has become increasingly global and competitive in nature,” Walsh says. “For example, we see an attractive asset in France being chased by a China-based fund that is, in turn, largely financed by US investors as well as PE bidders from the UK and Canadian pension funds. These types of combinations have now become typical.”