Taxing matters: tools to add value post M&A in Latin America
Miguel Llovera, Eduardo Vivanco and Gabriela Sansores of Deloitte Spanish Latin America consider the strategic tax options available to companies after a merger or an acquisition as the region experiences an exponential rise in activity.
In recent years, there has been a significant increase in M&A activity, with a record-breaking value of deals completed globally. Cross-border M&A activity has reached record levels, with businesses looking to expand their operations into new markets and diversify their revenue streams. Latin America is no exception, as companies seek to take advantage of new opportunities to expand into new geographies. At the same time, the region shows a rise in consumption, government reforms, rich natural resources, and benefits surrounding supply chain objectives.
While M&A transactions can be a powerful tool to help businesses to grow, they also have significant pressure to deliver on synergies and transformation. Shareholders increasingly expect leaders to accelerate synergy realisation and deliver transformation quickly. Failure to do so can result in losing shareholder confidence and potential value destruction. Leaders develop clear integration plans to meet expectations to achieve their strategic goals, considering taxes on any post-M&A agenda.
This article highlights some tax tools to add value post M&A in the Latin American region.
An opportunity for tax to add value
When executing an M&A transaction, it is essential to consider the tax implications during and after the transaction process, including:
Understanding local tax laws;
Finding ways to minimise negative impacts on a company's tax bill; and
Making sure that all aspects of the deal are structured advantageously and developing a transition plan after the transaction.
In addition, digital transformation has become an increasingly important aspect of M&A transactions. This trend is expected to continue as businesses seek to leverage technology to drive growth and competitiveness while tax authorities adhere to digital standards for compliance and audit.
Early adoption of digital tools allows for quick and efficient tax analysis in the context of a fast-paced M&A transaction and subsequent takeover but also allows for improving operational efficiency, such as reducing working capital needs and aligning the tax function with the broader business strategy. An example of improved cash management due to tax regulation is the delivery of electronic invoices and company portals to accelerate billing and collection, reducing invoicing errors, disputes, and delinquent accounts.
This framework generally revisits:
Governance (roles, policies, and responsibilities for tax reporting);
Processes for tax compliance, reporting, and planning;
People (skills, knowledge, and experience);
By investing in digital transformation in tax, businesses create a foundation for long-term success and deliver on shareholder expectations.
The M&A landscape in Latin America
Latin America has experienced an exponential rise in M&A activity in recent years. Given their size, demographics, and market potential, Brazil, Mexico, Colombia, and Chile have had a booming market for M&A activity, with many deals being intra-regional. Private equity, venture capital, and strategic investors have equally participated in several industries. Transactions in the internet, software and IT services, banking, retail, and real estate sectors have been sought more actively.
Private equity firms have been a significant force in M&A activity in Latin America, and this trend is expected to continue, because many are sitting on available cash ready to deploy on new deals. Private equity firms bring innovative and flexible deal structures to entice sellers and incentivise management, including earn-out arrangements as part of the purchase price on the future performance of the business and management incentive plans.
Post-M&A tax matters in Latin America
Cross-border M&A can be challenging, as companies must navigate different legal and regulatory frameworks, cultural differences, and other potential barriers to entry. The importance of tax matters must be recognised in the region.
Tax law in Latin America can be complex due to several factors, including frequent changes, the need to raise tax collection, and a greater weight on substance requirements. In this context, tax authorities throughout Latin America have specific regulations and rules which can impact the structure and value of an M&A transaction. Proper tax planning can reduce transaction costs, improve the deal structure and create tax efficiencies that add value to the transaction.
Tax planning has become a critical factor in M&A transactions in Latin America, given the variety of applicable corporate income rules, capital gains and withholding taxes, local state taxes, and indirect taxes.
The tax treatment of M&A transactions varies significantly from country to country in Latin America. For example, Colombia and Mexico have enacted special free trade zones allowing reduced tax rates, and Brazil, where the tax system can be complex, also provides opportunities for tax planning.
Some tax aspects affecting the tax situation of the companies may be more local. For example, tax structuring has taken on an added emphasis in Mexico since its 2020 tax reform. It requires additional disclosure for certain transactions that comply with the standards set by the OECD and the use of foreign tax credits on non-Mexican source income. Additionally, Mexico's participation exemption regime should be considered to ensure capital gains are exempt from Mexican taxes if specific requirements are met.
Other aspects are applicable in the region. For example, tax professionals are adept at anticipating the impact of changes on a deal structure and monitoring these changes. One of the most critical considerations is transfer pricing across the region and ensuring that both parties to a transaction are adequately protected against potential liabilities resulting from changes in transfer pricing once an M&A transaction occurs.
The general trend since 2012 has been to allow foreign investors more opportunities to minimise their exposure to taxation to incentivise investment. Tax structuring can be used to create value out of an M&A transaction, as it can provide advantages from a cost standpoint and optimise the transfer of assets, considering the different tax liabilities imposed in each jurisdiction.
Additionally, debt financing is one of the critical sources for M&A transaction financing in Latin America, accounting for more than half of the most significant M&A transactions over the past few years. Companies should consider how debt financing affects the overall tax burden in their transactions and leverage any available incentives (such as those for strategic economic sectors in Mexico) around debt capitalisation.
Working capital post M&A
Working capital is a crucial measure of a company's liquidity, indicating whether it has enough cash and assets to cover its short-term obligations. In the context of an acquisition, the level of working capital is fundamental because it can affect the purchase price of the target company. However, it is also relevant to consider the target liquidity post M&A.
The pandemic created inevitable disruptions across emerging markets, especially Latin America. Correctly accessing internal sources of liquidity is more relevant than ever. Industry analysis indicates that Latin American companies may tap into additional resources by shortening their cash position, which may be excessive due to supply chain disruption, recession, and currency risk.
Working capital can have a significant impact on a company's tax obligations. For example, a company with a large amount of working capital tied up in inventory can face higher tax obligations. Similarly, suppose a company has a significant amount of accounts receivable. This can also result in higher tax obligations as the company is deemed to have earned revenue even if the cash is yet to be received.
Advantages of a proactive approach
Proactive tax management can optimise working capital. For example, by taking advantage of tax incentives and deductions or swiftly recovering tax receivables, a company can reduce its tax obligations and free up more cash.
It is advisable to evaluate how to mitigate the impact of taxes on the financial situation after a merger or an acquisition. Further to reducing the effective rate, improving the timeliness and accuracy of tax and cash provisions adds value to the business by reducing the cost of financing.
Tax assimilation of business problems and objectives results in substantial cash benefits; for example, the tax write-off of uncollected accounts and location of the activities. Similarly, after a merger or an acquisition, extracting a business from a group can also be expensive. For example, if it is involved in a group of companies that determine their results on a combined basis, there was a prior restructuring or merger, or if there is a significant capital gain or recoverable tax losses that may be lost in the event of a change of control.
However, extraction can also have an advantage. For example, a significant investment no longer helpful for the business strategy might generate a loss that, in some cases, can be used against corporate income tax.
Financing is a topic in itself, as there are several conditions under which interest ends up being non-deductible. Rethinking tax depreciation and ensuring the effective use of fiscal attributes is also valuable while taking advantage of available tax stimuli such as those for R&D programmes.
Tax assessments due to tax audits generate a challenge for the financial position of companies. Aligned with the corporate objectives, the objective of the tax function should include an organised approach to reducing the chance of inconsistencies or challenges. This approach includes continuously updating processes, policies, procedures, and work papers as taxes change, keeping documentation to support filings, and frequently revisiting tax positions.
Other tax-related processes to maximise value post M&A include documenting and automatising the refund of credit balances, and continuously researching and applying tax attributes such as the set-off of tax balances, the use of net operating losses, and maximising tax credits. These activities are effectively implemented by measures such as changing the business model, geographical location, or tax elections on revenue recognition.
Furthermore, it is essential for buyers to understand the implications for their basis, given different tax treatments for dividends, capital redemptions, and debt service. Early planning can help buyers and sellers to capture greater value regarding tax considerations embedded into the dealmaking process.
M&A activity in Latin America is on the rise, driven by the improving economy. Furthermore, Latin America is sought not only because of its demographics and market potential but as a region where a significant opportunity could be seized.
Tax is an essential component of successful M&A transactions in Latin America. It is important to understand the local tax regulations and how they may affect the value of the transaction. This evaluation can be conducted through professional advice and a detailed analysis of the potential benefits and risks associated with the transaction.
It is vital to have a clear understanding of the goals, such as to reduce the costs of a deal over the short term or to achieve long-term tax savings. Depending on the transaction, tax can be structured to create value at the time of sale, when funds are received from the sale, or over the long run.
Post M&A, multiple strategies can be implemented to use cash effectively in the context of a company-wide strategy.