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US tax reform and BEPS boosting global M&A market

Many companies are abandoning their ‘wait-and-see’ approach to M&A activity as BEPS uncertainty clears and the US tax reform incentivises taxpayers to alter their tax structures, in-house tax directors and advisers have said.

A buoyant global economy is the most important driver of M&A activity, but US tax reform and BEPS are two of the five key factors aside from this, according to a new report by Taxand.

Records confirm that 2017 was the fifth most active year for M&A, and high-value deals are more common so far in 2018. Deal volume is lower so far in 2018, but the value of those deals is rising – the number of deals worth more than $5 billion is set to be twice as high in 2018, says Thomson Reuters.

“Although global economic strength clearly is providing fuel to this hot deal market, the following key factors are also fanning these flames, encouraging active market participants to continue engaging in M&A and those sitting on the sidelines to abandon their wait-and-see approaches,” said Jim Stanley, head of the M&A tax service line at Alvarez & Marsal, a Taxand member firm.

However, one experienced US tax director doubts that there is a clear trend in M&A relating to BEPS.

“While there now may be a bit more certainty as most of the BEPS recommendations have been finalised and we now know which of the largest economies are going to implement which of the BEPS recommendations… most of the BEPS changes do not directly encourage M&A activity,” he said.

But of course, the M&A market in the world’s largest economy has been given a shot in the arm by the Tax Cuts and Jobs Act (TCJA).

“There have been noticeable changes in the US M&A market that can be directly linked with tax reform, and I think those changes will continue, as the full implications of the reforms are not yet fully understood,” said the now retired tax director. “Some of the effects appear to be counter-intuitive and could encourage both investment within the US, as the President hopes, but also overseas investment as all the implications are worked through.”

US tax reform incentivises companies to change the way their international tax structures are arranged, mainly due to the base erosion anti-avoidance tax (BEAT) and global intangible low-taxed income (GILTI) provisions.

“Moody’s estimated that at the end of 2017, US companies were holding roughly $1.4 trillion in offshore cash; if repatriated, these large cash reserves will likely boost corporate involvement in M&A and potentially whip up the already frothy valuations the market exhibits,” said Stanley.

One area of the high-end transactional market, which has been effectively curtailed by tax reform, is inversions. This opens up a new line of work for inverted companies, though.

"There is no reason why an inverted company cannot create or expand US operations to enjoy the new 21% US tax rate, which was the principal corporate tax benefit of the TCJA, while continuing to enjoy the benefits that caused the company to invert in the first place," said Jim Ditkoff, senior tax adviser at US multinational Danaher Corporation, in a recent interview with International Tax Review.

“Getting cash back to the US for investment is no longer the problem it once was and after-tax returns could be higher, justifying higher prices for assets,” said the tax director. “Depending on profile and activities, investing outside the US could also have higher post-tax returns.

“To set against that, the changes apparently intended to discourage some foreign investment in the US through the BEAT seem to be having some effect although that could perhaps make some targets’ values more attractive for US investors,” he concluded.

BEPS uncertainty clears as Actions 6 and 15 take hold

As the BEPS project has progressed, the OECD has been able to provide more clarity on how the measures will be implemented. This is increasing M&A activity, says Taxand.

The fog is clearing, and the impending completion of Actions 6 and 15 (concerning tax treaty benefits and the multilateral instrument (MLI), respectively) has been key to the transactional market.

In Chile, an OECD member country, tax treaties consistently follow the OECD Model Tax Convention, meaning that changes arising from the MLI will be largely uniform and predictable.

“The most recent tax conventions concluded by Chile, such as those concluded with Japan and Italy, have included provisions that prevent treaty abuse,” said Carola Trucco and Fernando Barros, partner and founding partner at Barros & Erráruiz Abogados.

Chile is also part of an ad hoc group of 94 jurisdictions in charge of developing the MLI, giving it the inside track on developments in that space. For these reasons, transactional activity in Chile is no longer seeing much of a negative effect from BEPS.

In Russia, some aspects of Action 6 are already part of national law, reducing the uncertainty it could bring and allowing the transactional market to move more freely.

For example, beneficial ownership is a well-defined concept that the tax authorities apply to passive income coming from abroad to prevent treaty abuse, meaning new BEPS-inspired legislation in this area is not necessary.

But, BEPS has necessitated defensive structuring activity in other areas.

“New legislation has been implemented, including new CFC rules, residency criteria, the definition of beneficial ownership with regards to double tax treaties, CbCR rules, modified thin cap rules, and VAT on digital services provided by foreign companies,” said Andrey Tereschenko and Irina Schtukmaster of Pepliaev Group.

Exceptions to the rule

It is worth noting, however, that BEPS has not impacted transactions in every country. In Brazil, for example, there isn’t a great deal of BEPS-related legislation passing through the legislature.

The effect of BEPS on areas such as interest deductibility and the use of debt in acquisitions are not yet known, says the Taxand report.

“Brazil is engaged in the OECD discussions, but few references have been formally made regarding BEPS in Brazilian tax legislation,” said Trucco and Barros.

Exceptions include Action 13 (country-by-country reporting) and Action 5 (harmful tax practices). Normative Instruction 1,634, issued in May, concerns ultimate beneficiary disclosure and Brazil’s corporate taxpayer registry (Cadastro Nacional da Pessoa Jurídica; CNPJ) regulations.

Since July 2017, companies have had to disclose ultimate beneficial owners when they update their records with the CNPJ – or, if no updates are made, by December 31 2018 at the latest.

The legislation affects all Brazilian-registered companies, as well as authorised clubs and mutual funds, foreign owners of assets including but not limited to real estate, vehicles, ships and financial investments, importers, foreign banks that trade currencies, and more.

Sanctions can be severe, meaning many companies have had to rearrange their assets or re-evaluate their corporate structures to be compliant with the new legislation.

Similarly, there has been little action in the US on Actions 6 or 15. The US is unlikely to become a signatory of the MLI at all, and “for domestic political reasons the United States has not ratified any new income tax treaties in the last several years” – though the US model treaty does contain limitation on benefits articles, said Adam Benson and Ernesto Perez of Alvarez & Marsal.

Although tax is only one aspect in M&A considerations, its impact on decisions is being noticed. While a few years ago tax considerations could be a factor in deciding not to undertake a transaction, today the opposite is true. Although tax professionals have been very busy in 2018 they are now able to share positive outcomes in boardroom meetings rather than urging caution.

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