How early tax input improves outcomes in carve-outs

Companies pursue carve‑outs for many reasons: shifting market conditions, changing customer demand or a desire to focus on core operations. In diversified groups, carve‑outs are often driven by value creation – individual business units may be worth more on their own than when embedded in a larger organization.

Why does tax accounting matter in a carve‑out?

Tax accounting plays an important role in how a carved‑out business is valued and ultimately separated from its parent.

Unlike a standalone company, a carved‑out business typically does not have its own historical legal, accounting or tax structure. The income tax positions and tax attributes of the carve-out business often are embedded not only in a wider consolidated group, but within various legal entities within a group. As a result, the income tax provision, tax attributes and even cash taxes must be allocated to the carve‑out business — frequently for the first time.

These allocations impact carve-out financial statements, affecting the economics of the transaction and potentially the resulting “day-one” tax profile of the carve-out business. Tax accounting for a carve-out business is especially complex for several reasons:

Key considerations in carve‑out tax accounting

When done well, carve‑out tax accounting can improve outcomes. High-quality carve-out tax accounting can support higher confidence in valuation, clearer communication with buyers and investors, fewer surprises during diligence and post‑close, and a smoother path to accounting and reporting for separation, remaining operations and standalone operations.

In many cases, strong tax accounting also helps organizations better understand the carve-out “perimeter” and true performance of the carve‑out business. Here are three actions companies should take to improve outcomes for carve-out tax accounting:

1. Start with a comprehensive financial analysis and monitor market conditions: Preparation of carve‑out financial statements starts with having a deep understanding of the historical business — legal, tax, transfer pricing, treasury, accounting, unique and discrete events, etc. — to ensure a proper definition of the carve-out business “perimeter” and transactions to be included in the carve-out financial statements. 
   
   Political, policy and regulatory developments, as well as macroeconomics, interest rates and capital market dynamics all influence the market and timing for divestitures. Personnel responsible for tax accounting and reporting should remain aware of potential strategic transactions that could require urgent attention and reprioritize resources. Often the “window of opportunity” for a divestiture is small, requiring intense, accelerated efforts to complete a transaction with limited lead time.
   
   
2. Inform stakeholders and involve professionals: For most organizations, a carve‑out transaction is a unique transaction that recurring accounting processes and procedures are not designed to address. Understanding the scope and timing of a carve-out transaction, developing an awareness of potential tax technical, tax accounting and financial reporting issues, informing key stakeholders of such issues and involving professionals to address such issues are important to managing tax risks and achieving transaction success.
   
   
3. Plan for post-separation tax reporting: Tax accounting and reporting do not end at the completion of the carve-out transaction. The completion of the transaction will impact the ongoing tax accounting and reporting for the remaining group. Companies should assess the efficacy of tax processes, procedures and controls to ensure changes in legal and tax structure, data, systems and personnel are considered and updates made as needed. Companies also should consider and plan for treasury flows, one-time tax filings and unique tax technical issues related to a divestiture – all of which can influence tax consequences of the divestiture and the continuing operations of the remaining group.
   
   For the carve-out business, if a new standalone group, the business will need to operate on its own, designing and implementing processes and controls to enable standalone reporting, including completing financial reporting and tax compliance as a standalone group. If the carve-out business was acquired by an existing group, the acquiring group will need to integrate the carve-out into its tax accounting and reporting framework, without delaying ongoing financial reporting timelines.