The tax challenges associated with transatlantic mergers and
acquisitions (M&A) have changed. However, this is not
simply due to US tax reform. While US tax reform may have
introduced a new set of sticks and carrots relevant to deal
making, its impact on the approach to tax in M&A must be
seen in the context of a wider evolution.
Post-reform transatlantic M&A activity
The available data show that deal volume in 2018 between
North American and Western European companies was down 12% on
2017 (and 8% on the five-year average).
The fall was particularly pronounced in the case of deal
flow from Western Europe into the US, with volume down 22%. The
fall in deal flow from the US into Western Europe, on the other
hand, was down only 4%.
The outlier in all of this was the volume of deals from the
US into the UK, which was up 17% on 2017 (and 11% on the
These trends continued into early 2019, with the US M&A
market enjoying its strongest opening quarter since 2000, but
M&A activity in Europe has been depressed.
One must be cautious in attributing these developments to US
Some might say that European M&A activity has for a long
time been propped-up by US-headed groups seeking to deploy cash
that US tax rules encouraged leaving offshore. They might then
also say that the decline in European M&A activity can be
explained by the removal of the relevant tax obstacles to
However, it must be recognised that there have been plenty
of other significant factors (including geopolitical
uncertainty) which have affected cross-border M&A activity
since the end of 2017. It is also worth noting that even in
situations where cash is being repatriated to the US, it is not
clear that it is necessarily funding capital expenditure.
Furthermore, while reform has certainly helped create a
favourable backdrop to domestic M&A (lower tax rates have
helped to increase earnings), people are still adjusting to the
new regime. Many details continue to develop and uncertainty
around the US tax system persists, particularly regarding the
long-term future of (among other things) the 21% corporate tax
Types of deal making
Looking beyond activity levels and considering the types of
deals taking place, one of the more interesting market
developments we are seeing in global M&A activity is an
increased focus on portfolio structures and an appetite to
divest non-core businesses.
The vast majority (84%) of the companies interviewed as part
of EY's 2019 Global Corporate Divestment Study reported that
they are looking to make divestments within the next two
There are many factors encouraging this, including sector
convergence, shareholder activism, and perceived weaknesses
around the conglomerate model. Nevertheless, for US-headed
groups, tax reform has offered an incentive for divestment.
The market is still exhibiting an interest in tax-free spin
transactions (including reverse Morris Trust structures) in
commercially viable situations. Nevertheless, the 21% US tax
rate has taken a lot of the sting out of deals that would have
previously been taxed at 35%.
In addition, immediate expensing provisions that apply to
acquisitions of certain depreciable property have provided
incentive for incremental and creative deal structuring by
providing enhanced tax benefits to the parties.
On the buy side, while cost synergies continue to be
prominent in how deals are justified in an environment of
increasingly high valuation multiples, we also see a broader
trend towards M&A activity that focuses on enhancing
capability (often digital) and opening up new markets to deal
with disruption and achieve growth.
Tax challenges in contemporary transatlantic deal
Taking a step back from these market trends and looking more
specifically at the role tax now plays in transatlantic
M&A, two themes stand out.
First, deal-related tax thinking needs to be more long-term,
commercial and strategic. Secondly, structuring deals tax
efficiently is more difficult and complex, and relies
increasingly on balancing a complex range of international
factors. We see these themes throughout the transaction
lifecycle, from due diligence and valuation, through to
acquisition and finance structuring and post-acquisition
Developments in due diligence
US tax reform has not motivated all targets to unwind
structures that present significant tax risks in a post-BEPS
world, and when it comes to due diligence, it is not uncommon
to find that US-headed multinational groups have supply chain
(and internal financing) structures that, from a tax
perspective, are no longer fit for purpose.
For example, prior to BEPS, the tax incentives for keeping
intellectual property (IP) offshore were often greater than
they are now where structures like CV/BV (where IP is held by a
Netherlands Antilles CV and licenced to a Dutch incorporated BV
acting as a European hub) were very popular.
Looking at things from a purely US perspective (and not
seeing an effective 10.5% charge on global intangible low-taxed
income, or GILTI, as unduly onerous), some of the groups that
implemented these structures have not hurried to either
collapse or adapt them following US tax reform.
As a result, due diligence exercises continue to identify
supply chain structures with insufficient substance in key
jurisdictions, and thus with post-BEPS vulnerabilities when it
comes to withholding taxes (WHT), controlled foreign
corporation/company (CFC) charges and transfer pricing (TP),
not to mention the UK's diverted profits tax. State aid risk
resulting from old local tax rulings is another symptom.
From the perspective of a buyer, these vulnerabilities and
risks represent potential future costs.
In a private deal, it may be possible to address potential
pre-acquisition liabilities contractually, but that will not
alleviate the need to collapse or adapt the structure in order
to reduce potential exposure in the post-acquisition
Furthermore, that remedial exercise will not necessarily be
straightforward. Sophisticated buyers are increasingly
conscious of the need to have substantive activity in
jurisdictions to support IP ownership and corresponding profit
allocations. It is fundamental to have a modern operational
supply chain model that aligns IP to global business
Achieving that requires an understanding of not only the
group's international footprint, but also its strategy and
vision for the future, which necessitates close collaboration
between the group's business and its tax function. Although
worthwhile overall, the task is not to be under-estimated, and
buyers need to be conscious of this going into the deal.
The need to scrutinise targets from a BEPS perspective
applies whether the buyer is US or European-headed, and whether
the target is US or European. Nonetheless, we have often found
US purchasers are more interested in the target's US-relevant
tax profile (in particular, the likely Subpart F and GILTI
implications) and exposure to political change.
With regard to the latter point, it is not uncommon to find
prospective US purchasers of UK-headed or otherwise UK-heavy
groups concerned more about future-proofing for tax changes
which might be brought in by a potential Labour government than
they are about Brexit.
One of the ways in which the world of transatlantic M&A
has changed the most is in relation to financing. The days of
funding the acquisition of European targets by leveraging the
US and passing the funding down in a way that generates more
than one net deduction overall are more or less over.
The US's restriction of interest deductibility to 30% of
earnings before interest, tax, depreciation and amortisation
(EBITDA, and in the longer term EBIT), taken together with
anti-hybrid rules in the US and elsewhere, mean that most
leveraged US buyers are happy with a single net deduction.
The key challenge for a US buyer once it has worked out the
maximum amount for which it can expect to obtain tax relief for
financing expenses at home is to find one or more jurisdictions
where the rest of the debt can be used more effectively, and
where tax relief for the financing expenses can be
This again requires an international, forward-looking
perspective, and an understanding of the target business. One
must typically not just look at the extent to which the target
group has substance in different locations, but also give
careful consideration to where the target business is likely to
be most profitable, most quickly. It also involves being open
to possible alternatives to debt – not least where
notional interest deductions against equity may be
Life for European buyers of US assets has changed too. The
norm would once have been to on-lend into the US and take
deductions there against the 35% tax rate. However, buyers
wishing to take deductions in the US (even against considerably
lower rates) now encounter the problem of the base erosion and
anti-tax abuse tax (BEAT). Although there is still scope for
pushing debt down into the US, we have therefore seen increased
interest in practice in having external debt taken on at the US
level (again, to the extent that the US interest restriction
rules permit deductibility).
Prior to US tax reform, the default strategy following any
European acquisition of a US-headed group was to implement a
partial or full 'out-from-under' reorganisation of the US
target's non-US subsidiaries, for example through a
de-controlling share issuance to a related non-CFC. This would
remove those non-US subsidiaries from the US CFC regime and
reduce or eliminate US taxation on future profits.
Notwithstanding the introduction of a limited dividend
exemption for certain distributions from CFCs, the GILTI
inclusion and other changes to the CFC regime, have sustained
this appetite for 'out-from-under' reorganisations. However,
these new provisions make it considerably harder to execute
such transaction tax efficiently. Opportunities remain, but the
challenges associated with them are not to be
Of greater, and increasing, prevalence is a focus on supply
chains, inter-company flows, and the type of income generated
by foreign subsidiaries of US targets, with a view to managing
foreign tax credit limitations and CFC/GILTI inclusions.
To that end, European buyers of US assets and US buyers of
European assets recognise that depending on the particular
circumstances, it may be preferable for US group members to
have 'foreign branch' or Subpart F income rather than GILTI
Despite favourable proposed regulations regarding interest
expense allocations for the purposes of foreign tax credits
(FTCs) against GILTI, the general allocation of expenses to the
new GILTI basket may lead to residual US tax by reducing
foreign tax credit capacity limitations, even where the foreign
income is subject to a tax rate of 13.125%. Also, excess GILTI
credits cannot be carried forward or back.
Part of the post-acquisition integration exercise following
US tax reform therefore involves optimising the overall
structure to maximise the benefits associated with the 10.5% US
tax rate differential between GILTI and other income streams,
while minimising FTC limitations by driving the non-US
effective tax rate on GILTI earnings to as low as possible.
Converting high-tax, non-US earnings into Subpart F income or
placing them into a US branch structure may help to further
mitigate FTC leakage.
In practice, much of this must be considered ahead of the
acquisition as part of the due diligence and valuation
Of course, it has always been necessary to consider the
target's tax profile for both the past and the future, while
taking into account acquisition related impacts and appropriate
post-closing planning. However, US tax reform has added a new
degree of complexity, requiring a different approach to
information gathering and modelling.
The interaction of different parts of the new code (e.g.
immediate expensing provisions, the interest deductibility
limitation, the BEAT, foreign derived intangible income (FDII),
GILTI, etc.) is far from straightforward, and is to a large
extent dependent on the facts, meaning that an understanding of
the target business and of commercial projections associated
with it is now more important than ever.
Future transatlantic M&A trends
Another difficulty associated with building an effective
post-acquisition strategy following US tax reform is the
impossibility of knowing how long the benefits it has
introduced (in particular, the 21% corporate tax rate) will
This uncertainty has been a feature of all parts of the tax
work undertaken in transatlantic deals since December 2017, and
has rightly checked some of the excitement that the reform
Whatever the future holds, it seems clear that in the
context of cross-border M&A, US tax regime will continue to
form just one part of a complex, international landscape.
Navigating that landscape effectively will require a global
view, and a long-term, strategic approach rooted in a deep
commercial understanding of the businesses involved.
*The views expressed in this article are those of the
authors and do not necessarily reflect the views of Ernst &
Young or any other member firm of the global Ernst & Young
Tel: +44 20 7951 2036
James Hume is a tax partner in EY's London office.
Prior to joining EY in 2018, James spent 12 years
practicing as a tax lawyer with one of the UK's leading
corporate law firms.
James advises on the tax-related aspects of private
and public mergers, acquisitions, disposals and joint
ventures. He has extensive experience in assisting
clients with each stage of a transaction, ranging from
structuring and due diligence to negotiation,
execution, post-transaction integration and tax
Much of James' work is cross-border and
multi-disciplinary and sees him working closely with
other tax, legal and financial advisers around the
James' clients include large multinationals,
sovereign wealth funds and private equity houses. In
addition to assisting them with M&A, James advises
them with the UK and international tax aspects of
business and transaction structuring more
Principal, international tax services
Tel: +44 20 7951 0253
Joe Toce is a member of EY's US tax desk in London
and leads the desk's US transaction tax group.
Previously, Joe spent nine years as part of EY's
transaction tax practice in New York City.
Joe advises corporate and private equity clients on
the US domestic and international tax aspects of
mergers, acquisitions, divestitures, restructurings,
and joint ventures. He has worked on a wide range of
transactions, providing innovative solutions to complex
tax structuring issues involving taxable acquisitions,
tax-free reorganisations, cross-border restructurings,
and consolidated returns. Joe has significant
experience with the development of tax efficient
structuring alternatives for post-acquisition
integration, divestitures and pre-sale planning, and
cash repatriation planning.
Joe received his AB in economics and english from
Georgetown University, and his juris doctor from the
Georgetown University Law Center. He is admitted to the
Bar in Connecticut and New York State.