Hot topics in transatlantic M&A (2023)

Friday 31 March 2023

Session Chairs

Devon Bodoh, Weil, Gotshal & Manges, New York

Susanne Schreiber, Bär & Karrer, Zürich

Panellists

Dean Andrews, BMS Group, London

Amie Colwell Breslow, Jones Day, Washington DC

Wiebe Dijkstra, De Brauw Blackstone Westbroek, Amsterdam

Riccardo Michelutti, Facchini Rossi Michelutti, Milan

Marc Schneider, Syngenta Crop Protection, Basel

Reporter

Andrea D’Ettorre, Facchini Rossi Michelutti, Milan

Introduction

The panel discussed: (1) the potential implications in connection with the upcoming implementation of the Organisation for Economic Co-operation and Development’s (OECD) Pillar Two Model Rules (also referred to as the ‘Anti Global Base Erosion’ or ‘GloBE’ rules) in deal structuring, purchase price determination and contracts; (2) tax insurance solutions to address the tax risks in mergers and acquisitions (M&A) transactions; and (3) the determination of the appropriate jurisdictions in corporate redomiciliations.

Panel discussion

M&A and Pillar Two in deal structuring, pricing and contracts

Amie Colwell Breslow started the panel by outlining the goals of the Pillar Two initiative, which seeks to ensure that multinational groups pay a minimum tax rate of 15 per cent in every country in which they operate, and describing the three primary GloBE rules, namely the Qualified Domestic Minimum Top-Up Tax (QDMTT), the Income Inclusion Rule (IRR) and the Undertaxed Profits Rule (UTPR).

Breslow pointed out that, although the GloBE rules are not yet effective, it is critical to already consider them when structuring M&A transactions, since the GloBE rules could have an impact on the acquiring company/group’s tax profile. In particular, some key issues to consider are: the disallowance of purchase accounting for acquisitions of entities, even in the case of United States tax elections for the step-up basis for US tax purposes; the application of transitional rules to intercompany transactions occurring after 30 November 2021; the elimination of the amortisation benefit from the purchase of long-lived intellectual property (IP); and the allocation under the UTPR of the top-up taxes to/from non-wholly owned entities.

Breslow and Devon Bodoh presented two case studies showing examples of how the GloBE rules could affect M&A transactions.

Sale of CFC stock with a section 338(g) election

• A US seller company (USS) has a controlled foreign company (CFC) and a non-US parent company that wants to buy 100 per cent participation in the CFC through a US buyer company (USB). The USB would typically be interested in exercising the section 338(g) election[1], as a result of which the built-in gains in the assets of the CFC are subject to a global intangible low tax income (GILTI) tax, which drops the US tax rate to around 13 per cent (below the 15 per cent tax rate).
• If the US does not implement Pillar Two, the section 338(g) election could trigger a top-up tax under the GloBE rules outside the US. This scenario will likely result in a negotiation exercise as to the party that should bear the potential top-up tax cost and how such cost should be factored into the purchase price and/or subsequent price adjustments.   

Allocation of the top-up tax to the consolidated owner

A foreign parent (FP) and X own 51 per cent and 49 per cent, respectively, of a joint venture holding company (JV) with a subsidiary (the ‘JV Sub’). The FP also owns 100 per cent of a foreign subsidiary (FS). The FS, JV and JV Sub are included in the consolidated financials of the FP. The following two situations can be considered:

• Situation one: Country A (FS) adopts the GloBE rules. Countries X (FP), Y (JV) and Z (JV Sub) do not. Country Z’s tax rate is below 15 per cent. Because countries X, Y and Z do not have QDMTT or IIR rules, the UTPR rules apply and 100 per cent of the top-up tax is allocated to Country A. The FP gets 100 per cent of the cost and only 51 per cent of the related tax savings.
• Situation two: Countries A (FS) and X (FP) do not adopt the GloBE rules, while countries Y (JV) and Z (JV Sub) do. Country A’s tax rate is below 15 per cent. Because countries X and A do not have GloBE rules, the top-up tax of FS will be allocated to JV in Country Y. The FP gets 100 per cent of the related tax savings, but only 51 per cent of the cost.
• The JV would normally have some form of tax sharing and distribution arrangements in the JV documents, which relate to the JV, including provisions to rebalance the economics between the FP and X in case there is a change in the law. It is likely that implications deriving from Pillar Two will be addressed in the JV documents in the future and that issues may also arise for existing joint ventures, which only have general provisions in their JV documents.    

Wiebe Dijkstra and Susanne Schreiber confirmed the increasingly higher relevance of Pillar Two for M&A transactions, also in the European context, especially for pre-acquisition due diligence. In practice, this proves to be a quite challenging exercise, since multinational groups are still modelling the impact of Pillar Two on their business. Dijkstra and Schreiber clarified that, so far, provisions regarding Pillar Two are not yet common in M&A transactions, but both expect that there will be increasingly specific provisions in the future (eg, representations and warranties on elections made under the Pillar Two rules), since the buyer will seek certainty on the Pillar Two implications of the deal.    

Addressing tax risks in M&A transactions via tax insurance solutions

Schreiber introduced the topic by highlighting that, in M&A transactions, ‘unknown tax issues’ can generally be covered by a ‘warranty and indemnity’ insurance agreement (WI). However, WIs exclude certain matters (eg, transfer pricing) and ‘known tax issues’ (eg, risks disclosed in the due diligence) for which the parties may enter into difficult negotiations that can potentially hinder the deal. In this context, an increasingly more common tool to manage the risks associated with known tax issues is represented by ‘tax liability insurance’ (TLI) policies, which can be subscribed to by the buyer, seller or target, depending on the peculiarities of the deal.

Dean Andrews pointed out that TLI policies may cover: the estimated quantum of the tax liability exposure; the potential interest and penalties imposed by a tax authority; the costs of defending the claim; and the gross-up. The amount of risk the policyholder retains depends on the perceived level of risk of a challenge. Subscription costs include: the premium, typically around two to six per cent of the limit purchased for EU and US risks, rising to six to ten per cent for matters under audit, depending on the jurisdiction, size of the risk, strength of opinion and nature of the risk; and the underwriting fees to cover the cost of the insurer’s external counsel.  

Andrews added that, while when the TLI market was in its infancy, market appetite tended towards more standardised risks, TLI policies are currently also used to cover complex tax risks qualified as low/remote. There is still low appetite to insure risks relating to potential challenges on the grounds of general anti-avoidance provisions (GAARs), and substance and beneficial ownership requirements, although exceptions exist (eg, in Spain). In any case, despite a consideration of the opposing arguments, a risk is generally insurable if the advice concludes on a ‘should’ or, at least, a ‘more likely than not’ level tax opinion. If it is not possible to obtain such a level of opinion, a TLI may still be viable (eg, in the US) depending on the risk and the jurisdiction involved, most likely at a higher price.

Marc Schneider pointed out that a TLI policy can be useful also from a company perspective, but the accounting aspects (eg, the TLI impact on the financial statements of the company in case a tax risk provision is fully insured), as well as its enforceability, need to be carefully considered.

Schreiber and Dijkstra highlighted that, although in some cases it may be possible to obtain clearance from the tax authorities on a future transaction through a tax ruling, there may be time constraints as well as matters on which the tax authorities are reluctant to rule. In these cases, TLI policies may still prove to be the most efficient solution compared with a tax ruling, even considering that, if the tax ruling is negative, this would then impact the price of the TLI policy afterwards.

Choice of jurisdiction in corporate redomiciliations

Dijkstra pointed out that that the key interesting aspect of corporate migrations/redomiciliations, which have been common transactions for multinational groups for many years, is the variety of the forms and shapes that such transactions can take, which have evolved significantly over the last years. Historically, tax considerations were an important driver of such transactions but, over time, several different drivers have come into play. In particular:

• the key non-tax drivers include: dual class/loyalty shares, capital markets, (consolidated) regulatory supervision, politics/neutrality, poison pill; and
• the key tax drivers include: tax residence and substance, tax neutrality, participation exemption (PEX) rules, CFC legislation, and relief from source taxation (treaties (including limitation on benefits (LOB)/stock exchange tests), EU directives, etc).

Dijkstra added that Pillar Two considerations may become important in the context of future corporate migrations/redomiciliations, especially in cases where such transactions entail a change in the accounting standards of the ultimate parent company.

Schneider mentioned from the inhouse perspective that dual resident companies are less commonly used and rather unwind after an acquisition.   

Dijkstra and Riccardo Michelutti briefly analysed some case studies based on real corporate migrations/redomiciliations concerning EU-based multinational groups, providing examples of the different tax and non-tax considerations made in the context of such transactions.

• Case study one regards a Dutch listed multinational group operating in different jurisdictions that migrated the corporate seat of its ultimate parent company to Bermuda, while remaining tax resident in the Netherlands. As a result of the migration, the group ceased to be subject to group regulatory supervision in the Netherlands. Although the migration was driven by non-tax considerations, several tax implications needed to be carefully considered (eg, in relation to the continuation of the fiscal unit in the Netherlands).
• Case studies two, three and four regard Italian multinational groups that migrated the corporate seat of the Italian holding company to the Netherlands mainly for corporate law reasons (eg, the Dutch loyalty shares regime) and, in some cases, also their tax residence. While the mere transfer of the corporate seat of the Italian holding company was quite a smooth transaction from both a corporate and tax perspective, the migration of the tax residence to the Netherlands required complex tax analyses. The most controversial tax aspect related to the application of the PEX on the exit gains on the participations held by the Italian parent company, which were not left in an Italian permanent establishment. In a public ruling issued in 2021, the Italian tax authorities took the view that the PEX does not apply to capital gains on participations realised upon migration of the tax residence of a holding company if such participations are included in a broader branch of businesses moved outside Italy. On this basis, the Italian tax authorities tend in practice to argue that the transfer of the headquarters of a holding company outside Italy implies the transfer of a branch of business represented by the participations in the subsidiaries together with the functions and risk relating thereto, thus denying the PEX. The consequence of this is that exit gains on participation are fully subject to Italian corporate income tax (CIT) instead of being 95 per cent exempt under the PEX regime.
• Case study five regards a company incorporated under UK law that acquired the Italian tax residence by moving its place of effective management to Italy, while the legal seat of the company remained in the UK. The UK company was the legal owner of several IPs and the migration was mainly driven by Brexit and the desire to concentrate in Italy the legal ownership of such IPs with the development, enhancement, maintenance, protection and exploitation (DEMPE) functions relating thereto, which were carried out by the Italian parent company. The migration to Italy proved to be efficient taxwise, since it entailed the step-up in tax basis of the IPs at their fair market value upon migration giving rise to higher amortisation for Italian tax purposes. Furthermore, the UK company could join the fiscal unit with the Italian parent irrespective of its legal form in the UK.
• Bodoh presented case study six, which discussed a paradigmatic de-special purchase acquisition company (SPAC) transaction where the SPAC was a US company. The central issue was moving the equity ownership of the SPAC from a US entity to a non-US entity. In its most easy form, as presented, the transaction was executed as a ‘horizontal double dummy’, where a new non-US holding company acquires the US SPAC and the non-US target. In order to satisfy the anti-inversion regime in the US, the US SPAC shareholders could receive no more than 60 per cent of the Topco NV’s equity (calculated with a certain methodology, such as on a pre-redemption basis of the SPAC). If the US SPAC shareholders received 60 per cent to 80 per cent of Topco NV’s equity, among other detriments, Topco NV would not be able to provide US shareholders with qualified dividend income (approximately half the rate of tax) for dividends. If the US SPAC shareholders received 80 per cent or more of Topco NV’s equity, Topco NV would be taxed as a US corporation (despite the Netherlands assertion of tax).