Strategising M&A tax in Mexico
Miguel Llovera, Gabriela Sansores Fernandez and Eduardo Vivanco of Deloitte Mexico describe how strategising M&A tax while conducting a deal supports the value creation journey.
Achieving the expected outcomes in a merger and acquisition (M&A) transaction depends on many factors. While multiple areas converge (i.e. information technology, human resources, commercial, operational, legal and of course financial due diligence) tax, labour and social security help identify, analyse and quantify potential tax implications, risks and impacts on recurring earnings.
It further enhances the development of a negotiation position. Strategising for tax aims to achieve accuracy with speed, bring clarity to complex issues, and gather the level of compliance with transparency.
Record-breaking transaction volumes in 2021 signal high expectations for this year. Despite the uncertainty, M&A transactions have increased in size, values, and quantity globally. The M&A activity in Latin America expects to be driven not just by the abundance of natural resources and competitive labour costs. The rising macroeconomic conditions and increasing consumption signal an attractive market for newcomers.
For jurisdictions like Mexico, a strategic approach can minimise uncertainty, flagging potential issues that must be reflected in the negotiation with contractual mechanisms, such as price, condition precedents or guarantees.
Strategising for tax becomes even more relevant in the Latin American region, due to the complexity of its politics and economy. A targeted analysis of the companies’ tax, labour and social security profile provides elements of judgment on all steps of the M&A process.
From evaluating targets with the right risk profile, to modelling tax implications on the envisioned structure and expecting law changes, these are all tax aspects that might contribute to achieving expected results.
An early-stage phased approach to tax involves assessing a target’s profile where more than just the level of compliance is tested. It involves the understanding of the target’s business model, geography, tax regime, tax elections, and practices. This would not only provide for a framework to focus on the tax due diligence but also to detect potential exposures, available attributes, and impacts on modelling.
Furthermore the tax, labour and social security due diligence provide a thorough analysis into the target’s degree of compliance on those areas. This develops in the evaluation of potential exposures, by analysing significant impacts on the financial statements along with interviewing with management and advisors. This is a key element in the deal-specific risks and opportunities for the negotiating position.
How to add value to the M&A process
The M&A process starts first by defining the transaction strategy, followed by target identification and evaluation stages, estimation of the value range of the target company, negotiating a Letter of Intent, conducting due diligence, negotiating the final transaction terms, and support for post-merger integration.
Whether in a slow economic scenario or a fast-paced economy, strategising for tax is one of the tools to add value to a business. This should be analysed carefully due to the complexity of the local tax rules and continuous changes in the regulations in Mexico where a big proportion of businesses that often offer good investment opportunities require additional screening with special attention to tax, labour, social security and regulatory compliance.
“The M&A activity in Latin America expects to be driven not just by the abundance of natural resources and competitive labour costs.”
For example, in transactions where human capital is a part of the deal, buyer and advisors should focus on change management and talent retention, which also generate tax consequences while securing deal value.
It is worth mentioning that strategic tax M&A is as relevant for a sell-side as for vendor processes. In a divestiture transaction, sell-side due diligence allows for a better negotiation position and also increases the chances of lowering acquisition costs for the buyer and maximising selling price flows. Such analysis might both accelerate the return of the investment and reduce capital gains.
Furthermore, sell-side (vendor) due diligence allows the seller to keep control of the process. It also allows the seller to formulate migration strategies, speed up the process and improve the sale price. This should be analysed in the disinvestment context (whether refinancing, financing new projects, restructuring, capitalisation or raising debt or equity).
Joint Ventures, alliances, consortiums, asset deals, and other alternatives provide for a more complex analysis as it normally involves new transactions to enter a market and hence derive in several tax implications.
In tax compliance, recent changes in Mexico are relevant such as additional reporting requirements, thin capitalisation rules changes, valid business purposes for restructuring, mergers, and spin-offs.
Further, post-merger integrations might be impacted with changes in provisions related to authorisations to defer income tax for capital gains in corporate reorganisation carried out by non-residents. Changes in transfer pricing rules and application for foreign tax credits are also relevant aspects to consider for non-Mexican investors doing business in Mexico as of 2022.
Envisioning key tax elements embedded in the process
Although tax, labour and social security aspects are not a motivator for establishing an M&A deal, they can end up impacting significantly, especially in Mexico where complex laws and hefty compliance has monetary repercussions.
Envisioning the role of tax in the different stages might include the following:
To confirm investment hypothesis and financial model with applicable tax laws and expectations on law changes, allows for the tax department and dealmakers to bring confidence to the investment strategy. Hot topics include the availability of NOLs, tax credits and incentives, financing structure, cash repatriation, investments deductibility and, if applicable, tax contingencies. This is the start of an ongoing process to create value and avoid pitfalls.
A relevant need is to assess the debt and equity sources. The tax department can provide value not only by harmonising the costs and maturity period but also by reflecting on the thin capitalisation rules, effects of the exchange rate, and other tax deduction requirements concerning interests and capital gain upon repatriation.
Tax due diligence
This essential process allows for the discovery of liabilities, tax contingencies and allows for further understanding of the business model and the infrequencies of the interaction of different elements of the book to tax reconciliation. This is by far the greatest component of the feedback in the determination of the value. A Knowledgeable tax department may use this to their advantage in the price setting of the target and encompass this with the overall business structure.
Adjust the post-acquisition business model
Upon acquisition, implementing an efficient control system soothes the transition. Likewise, implementation of post-deal changes while having a deep knowledge of the tax rules ensures the efficiency of the tax department. Relevant topics include top-line taxes, social security charges, depreciation and amortisation rules, and corporate tax along with indirect taxes.
Exit taxes have increased relevance as the investment thesis accelerates. An acquisition considering exit options such as a sale to other competitors, an initial public offering, or a plain sale reduces the risk of losing expected returns.
Cross-border transactions merit a special focus, as transfer pricing and withholding taxes play a relevant role in the determination of the ultimate value generated by an investment.
Framework of execution
M&A activity seeks to add value thru the acquisition or disinvestment of assets and businesses. Likewise, tax embedded into the deal-making processes seeks to ensure transparent compliance, with accuracy, with speed, and bring an understanding of complex issues.
Different methodologies are used to tackle the main limitations of a tax due diligence process:
Speed and accuracy
All M&A processes have a timeline and expected results. Within a short timeframe, the most significant aspects of the target should be addressed. This is achieved with proper planning and deep knowledge of the target’s business model and industry expertise. It is key to gather relevant information thru proper requests and meetings with management, allowing not only for a swift process but also to expect the outcome including correct validation and valuation of contingent issues.
Technology is increasingly being used as a tool to process and analyse large amounts of information that are meaningful for the deal. This is more latent in jurisdictions like Mexico where significant tax compliance is going digital and every transaction in the ecosystem is under tax authorities’ scrutiny.
Compliance and transparency
An acquisition process requires mutual collaboration between seller and buyer where the bulk of compliance is made transparent to the parties. An efficient process requires that the right focus be made in compliance, as it could hinder the process and the future negotiation.
One of the main caveats of a tax due diligence process is that it deals with highly technical issues which sometimes require multiple disciplines (not only tax but also labour, regulatory, transfer pricing, customs and social security experts among others) but also subject-matter experts with practical experience in the application of the tax regime.
This is further heightened in regimes such as Mexico where constant changes may exist. All of this fast-paced multidisciplinary and practical expertise creates value creation that surpasses its costs.
Embedding tax, labour and social security aspects into the M&A strategy generate value in all processes. Strategising for M&A tax provides for the early identification of key aspects into the transaction pricing, identifying historical exposures, implementing risk mitigation strategies and contractual protections, validating availability of tax attributes, modelling the business for future optimisation, and allowing for the exploration of proposed acquisition structures.
These elements add value when executed in a swift and orchestrated manner using insight, expertise, various disciplines and technology.
Streamlining and integrating tax, legal, regulatory, labour and social security topic into the M&A strategy is essential to become a data-forward mindset dealmaker using the power of data, processing power and analysis for the deal calculation pinpointing facts in real-time to respond to risk and empower the organisation to make well informed strategic decisions.
This seeks a more efficient, accurate, and effective approach despite the mass amount of data and changing tax, legal and regulatory environment. Bringing transparency, accuracy, speed and clarity to complex deal making.
T: +52 55 5080 6535
Miguel Llovera is a partner at Deloitte Mexico.
For more than 20 years Miguel has served companies, private equity, multinationals, governmental and financial institutions delivering business-focused tax solutions in a wide range of overarching situations — including going public, expansions, acquisitions, dispositions, joint ventures, cash repatriations and business optimisations focusing on M&A processes on some of Latin-American’s biggest transactions.
While enhancing business returns due to the identification of specific contingencies, hidden costs and opportunities Miguel has developed and implemented effective strategies on direct and indirect tax.
Gabriela Sansores Fernandez
T: +52 55 5080 7579
Gabriela Sansores Fernandez is a partner at Deloitte Mexico.
Gabriela has served multinationals delivering tax solutions in a wide range of situations including tax consulting, expansions, acquisitions, dispositions, cash repatriations and business optimisations. With solid knowledge in VAT and corporate taxation she has developed and implemented effective strategies in areas such as tax attributes and effective tax rate management, tax-free reorganisation, transfer of goods and intangibles.
Gabriela has worked with clients of the real state, oil and gas, power, pharmaceuticals, retail and consumer industries, among others. For the last six years, she has been participating in hydrocarbon projects, giving integral tax advisory for the new energy market participants, to comply with the new obligations.
T: +52 55 5080 7013
Eduardo Vivanco is a partner at Deloitte Mexico.
Eduardo has more than 26 years of professional experience, including significant service and tax advice to both national and multinational companies, involved in the communication, pharmaceutical, transportation, oil and gas industries among others.
Eduardo has served private equity funds and multinationals delivering tax solutions in a wide range of overarching situations including going public, expansions, acquisitions, dispositions, cash repatriations and business optimizations focusing on merger and acquisition processes, including compliance services.