Post-Acquisition Restructuring (aka “The Honeymoon is Over”)
The champagne bottle is empty, and the post-acquisition giddiness of having completed the transaction has faded. Now begins the hard part - how to integrate the acquired company’s operations into your own international operations.
Issues that Prompt Restructuring
There are various factors that will necessitate a reorganization of the newly combined organization. Among them are: 1) business operation synergies that can be capitalized on by combining certain business processes; 2) reducing administrative costs and minimizing risk of legal or tax non-compliance by reducing the number of legal entities in the combined group; 3) facilitating cash flow within the group, including reducing the withholding tax cost associated with such cash flows; and 4) aligning the tax posture / planning of the two companies. Some of these objectives can be achieved by merely reorganizing the legal structure of the group (e.g., inserting a new regional holding company to facilitate cash flow between non-U.S. subsidiaries without incurring incremental U.S. tax), but in some cases they will necessitate an actual movement of assets and personnel between entities either by way of sale, merger or liquidation.
Issues that Arise from Such Restructuring
As most CFOs and tax professionals are always careful not to let the “tax tail” wag the “business dog,” while intra-group restructuring can achieve many tax benefits for the group, there are a host of non-tax considerations which need to be carefully analyzed and dealt with. Among these are: 1) whether there are labor law implications from moving employees from one company to another in the same country, or in a different country; 2) whether new registrations and licenses need to be obtained to continue to fully protect the intellectual property related to the manufacturing of the company’s products in a more tax efficient jurisdiction; 3) whether changes to financial and accounting programs need to be made to account for differences in the intercompany pricing policies of the acquired companies and the existing Company transfer pricing policy; 4) whether the combination of activities or companies in a particular jurisdiction will require anti-trust and/or competition law clearance in that particular jurisdiction; 5) whether administrative and information systems processes need to be modified to support the reorganized group.
Given the spectrum of both tax and non-tax issues that arise in planning to reorganize the post-acquisition group, tax planning alternatives should be considered at the very beginning of any post-acquisition planning process in order to avoid unnecessary plan modifications and changes to accommodate more efficient tax structures down the road, which can be time consuming and costly.
Tax Objectives of Restructuring
While there are many tax objectives which can be accomplished with post-acquisition restructuring of a group, there are a few key objectives which should be included on the initial list of any post-acquisition restructuring plan.
U.S. Tax Basis Step-Up – In order to facilitate post-acquisition restructuring, at least from a U.S. perspective, the ability to effectuate a domestic acquisition (i.e., a domestic target company with foreign subsidiaries) as an IRC §338(h)(10) election (with §338 elections being made for the foreign affiliates), or to make a §338(g) election with regard to an acquisition of a non-U.S. target, should be considered. This will provide for a step-up, for U.S. tax purposes, of the tax basis in the various assets of the target subsidiaries, making it easier to move companies and assets around within the group without incurring incremental U.S. tax. While there may still be local country tax to deal with, depending on the jurisdiction, such tax may be significantly less then what the U.S. tax would have potentially been.
Consolidation / Grouping – One of the key objectives of post-acquisition restructuring will be to maximize the utilization of tax attributes and facilitate the movement of cash and the transfer of assets, by taking advantage of local country grouping or consolidation provisions. In many cases this will require the transfer of legal entities, or possibly merging together entities within the same jurisdiction. In addition to the normal U.S. and local country tax considerations of such share or asset transfers, the possible effect of local grouping or consolidation on the group’s foreign tax credit (“FTC”) position also needs to be considered. While the rules in IRC §901 related to who is the actual “taxpayer” for FTC purposes remains relatively the same, new IRC §909, the so-called FTC “splitter” rules, can apply in situations where local consolidation rules impose tax at the parent level and tax is not allocated to subsidiaries on the basis of income.
Location of Debt Financing – Another key objective of post-acquisition restructuring is to try to locate debt financing at the operating entity that is generating the related income flows. This can act as a natural foreign exchange hedge (depending on the currency of the debt), and simplifies cash flows within the group. In many instances it is possible for debt to be “pushed down” to the appropriate jurisdiction as part of intra-group share transfers or asset transfers effected to achieve consolidation or a holding company structure. In this case, key tax issues that need to be addressed are general debt-equity and thin capitalization issues, possible use of hybrid instruments, and the possible effect of IRC §§988 and 987 (which deal with the tax effect of certain foreign currency and branch transactions), on such financing arrangement.
Holding Company – Finally, an additional key objective of post-acquisition restructuring is to facilitate the movement of cash within the group without incurring incremental U.S. taxes, or to strengthen the group’s position that non-U.S. earnings are not subject to U.S. deferred income taxes under the “indefinitely reinvested” criteria of ASC 740. While the usual holding company “suspects” need to be analyzed (e.g., the Netherlands, Luxembourg, Switzerland, Singapore, etc.), issues such as incremental administrative and accounting costs, “substance” concerns and the need to have local personnel, and ease of access to deal with corporate governance requirements need to be considered. Once again, tax considerations such as: 1) reduced, or no, withholding taxes on dividends, interest and royalties; 2) the availability of an exemption system (or participation exemption system) on dividends and capital gains; 3) reduced or no capital duty; 4) low statutory tax rate or special tax regimes on certain flows of income (e.g., Luxembourg in the case of royalties), while important, are only a piece of the overall “pie” of business and tax considerations that need to be carefully analyzed in selecting a holding company jurisdiction.
In addition to the discussion above, there are numerous other tax and business objectives that can be accomplished by post-acquisition restructuring, including: 1) movement toward contract manufacturing; 2) close down or strip out supply contracts; 3) movement toward limited risk distributorships; 4) movement of intellectual property, and many more. However, the key to successful post-acquisition planning, in order to complete the successful acquisition and create a sustainable and efficient structure, is to ensure that tax objectives and planning alternatives are incorporated, on “day one,” in the Company’s overall post-acquisition planning analysis, and that the top Tax Executive be a key part of the internal Post-Acquisition Task Force. While a daunting task, proper post-acquisition planning with these objectives in mind will go a long way towards keeping the Dom Perignon bottles coming.
Raymond Montero is a Managing Director in True Partners Consulting’s Los Angeles office. Mr. Montero has more than 27 years of experience in corporate and international tax consulting, having practiced in the United States, the United Kingdom and Mexico. For more than 6 years, he was a partner in KPMG’s International Corporate Services (ICS) practice based in Los Angeles. Raymond’s focus while at KPMG was on cross border Mergers and Acquisitions (M&A), outbound and inbound international planning and cross-border structured finance. Prior to joining KPMG in 1996, he was a partner with Arthur Andersen in London. For various years he was the Partner in Charge of Andersen’s US Tax Practice based in London. Raymond can be contacted on +1 818 594 4915 or by email at Raymond.email@example.com
David Wachutka is a Senior Tax Consultant True Partners Consulting’s Los Angeles office.Mr. Wachutka specializes in international tax consulting, specifically, advising on the application of U.S. income tax law to U.S. resident businesses and individuals with foreign business interests. Mr. Wachutka has experience with outbound structuring of business operations, treaty selection, repatriation planning, foreign tax credit utilization and foreign acquisition structuring.
Mr. Wachutka received his Bachelor of Science in Business degree from the University of Minnesota, Carlson School of Management and his Juris Doctorate degree from Pepperdine University School of Law, with a focus on business and corporate law. Mr. Wachutka is a licensed attorney in the states of California and Minnesota. David can be contacted at David.Wachutka@TPCtax.com