How Pillar Two changes the role of tax in Canadian M&A deals


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Tax considerations have always been a part of mergers and acquisitions (M&A). Buyers review the tax position of acquisition targets during the due diligence process, model the tax implications of a prospective transaction and structure deals with tax costs in mind.

But with the recent release of draft Canadian legislation for Pillar Two, the new global minimum tax regime, we’ll see a new layer added to these considerations. For some multinational enterprises (MNEs), it adds significant costs, complexities and risks to a deal. A transaction could push some MNEs beyond €750 million in annual revenue—the threshold for Pillar Two that requires the MNE to devote significant resources to gathering the required data to calculate top-up taxes.

Pillar Two’s impact on an MNE’s tax rate can even change the return on investment in a transaction. But by integrating Pillar Two into deal modelling, buyers can better understand its tax implications and avoid unpleasant surprises.

A new threshold for M&A tax planning and compliance

In simple terms, Pillar Two requires an MNE with annual revenue of €750 million or more in its consolidated financial statements to pay a minimum 15% effective tax rate—defined as the Minimum Rate—on the net income generated in each jurisdiction in which they operate.

An MNE could inadvertently cross that €750 million threshold as a result of an acquisition. This could more than double a company’s tax compliance costs and require the MNE to source data to perform the necessary Pillar Two calculations following a deal.

This makes it crucial to pinpoint Pillar Two’s implications early. Below, we’ve outlined some of the Pillar Two considerations to include from the outset.

Additional due diligence data requirements

Do you have the necessary information to model the impact of Pillar Two?

It’s important to know if an acquisition target is currently subject to Pillar Two, or if the combined post-transaction MNE group of entities would exceed the €750 million threshold. This requires analyzing financial information that hasn’t traditionally been scrutinized in deals. This includes forecasted revenue, expenses, cash flows, assets and liabilities of the target and its subsidiaries that are expected to be included in the consolidated financial statements of the buyer’s ultimate parent entity. Ideally, the target would also share the data points used to compute its GloBE income, covered taxes and substance-based income exclusion.

Our Pillar Two Data Input Catalog is a helpful resource. It defines the data requirements for Pillar Two and acts as the foundation for modelling what can be expected when the target and its subsidiaries join the buyer’s group.

It’s also important to understand how this information is being sourced. If the target has trouble extracting this data, or must draw it from multiple ERP systems, the buyer may face a more costly and time-consuming integration process before it can perform the Pillar Two calculations for the newly combined MNE group.

In carve-out transactions, certain assets of the target group are packaged up by the vendor group prior to the sale transaction. Therefore, the buyer must be able to access the historical carrying values of assets of the vendor’s group. This sensitive information needs to be provided by the vendor.

Five people sitting in a boardroom

Modelling the post-transaction group

What does the target look like as part of the buyer’s group?

Once the target shares the necessary forecasted financial data, it’s important to model the target and its subsidiaries as part of the buyer’s group—not on its own—to understand the Pillar Two implications of the transaction and its jurisdictional blending results.

This requires a centralized data engine that can apply the Pillar Two rules legislated in each relevant jurisdiction, perform the calculations and allocate top-up taxes to various constituent entities within a jurisdiction. PwC’s Pillar Two Engine is configured to support the unique adoption of Pillar Two rules around the world, including expected legislation from countries such as Canada.

The scenario analysis capabilities of the Pillar Two Engine can help a buyer model jurisdictional blending issues as a result of the transaction.

In particular, buyers can’t rely on a target’s classification as a low-taxed constituent entity (LTCE) when it’s part of the vendor MNE group because of jurisdictional blending. A target may be a LTCE of a vendor MNE group, but not a LTCE of the buyer MNE group (or vice-versa). For example, Canada and the US may be assumed to be high-taxed jurisdictions, but may not be due to various credits, green energy incentives and capital gains exemption rules in Canada.

Avoiding deal structure mismatches

How will the structure of your deal affect your Pillar Two outcomes?

It’s imperative to consider alternative deal structures to account for mismatches between local tax characterizations and financial accounting characterizations. The latter forms the starting point for Pillar Two.

For example, the cost basis step up under the so-called “88(1)(d) bump” rules in Canada is frequently used by foreign buyers of Canadian target companies. The 88(1)(d) bump rules permit  the step up of the inside basis of the Canadian target’s non-depreciable capital assets for tax purposes. Where no Canadian tax is imposed on the vendor’s gain determined by reference to the inside basis of the target’s assets because of the 88(1)(d) bump, the Canadian tax characterization of the gain may depart from the financial statement characterization. That is, there is no basis step up in the underlying assets and no recognition of related deferred taxes for Pillar Two purposes, regardless of any purchase accounting consolidation adjustments.

Often, the non-depreciable capital assets bumped include shares of foreign corporations owned by the Canadian target. These shares are then commonly sold or transferred out of Canada. To the extent that any gain on the shares of the foreign corporations qualify as Excluded Equity Gains, there should be no Pillar Two impact, notwithstanding whether the Canadian target continues to hold the bumped shares or there is a subsequent sale out from under Canada.

Clearly, the complexity of the Pillar Two rules makes modelling a necessity to determine whether Canada’s combined federal and provincial tax rates continue to be higher than the Pillar Two Minimum Rate.

Three people walking down a hall

New complexities for both asset and share deals

How will Pillar Two affect the tax treatment of asset acquisitions?

Pillar Two also adds new considerations to other aspects of deal structuring. Already, buyers and sellers often have different preferences for structuring a transaction around the acquisition of the target’s assets or its shares. Generally speaking, asset deals typically come with fewer accounting and tax complexities than share deals.

Pillar Two adds new complexities that may make asset-based deals even more attractive to buyers, given constraints on the availability of data and resources. At the same time, there are still unique issues with a simple arm’s-length asset acquisition.

For example, if a Canadian corporation acquires assets from an arm’s-length person, there should be no difference between the treatment of the carrying value of those assets for financial accounting and tax purposes—and therefore, no initial adjustments for Pillar Two purposes. But there may be adjustments required for deferred tax liabilities (DTLs) related to intangible assets acquired that don’t reverse within a five-year period. In Canada, this may include the capital cost allowance (CCA) permitted for goodwill under Class 14.1. Since covered taxes must be adjusted for DTLs on intangible assets that don’t reverse within a five-year period, an acquisition of goodwill by a Canadian corporation may ultimately be dilutive to the effective tax rate computation under Pillar Two.

Another noteworthy aspect of Pillar Two is the application of the transition rules to certain intra-group asset transfers and transactions, giving rise to deferred tax assets. These rules require MNEs to review transactions that took place between December 1, 2021 and when the global minimum tax regime takes effect.

Upcoming Pillar Two developments

How will Pillar Two’s adoption in the US affect Canadian transactions?

Looking ahead, it will be important to monitor whether Pillar Two rules are adopted in the US, given the large number of Canadian deals that involve US companies. The Administrative Guidance released by the OECD in February 2023 confirmed that the current form of the Global Intangible Low-Taxed Income (GILTI) rules in the US meets the definition of a Controlled Foreign Company (CFC) Tax Regime under the Pillar Two Model Rules. But the simplified allocation applied to Blended CFC Tax regimes, including GILTI, is only available for a limited time period under the guidance.

It’s unlikely that the US Congress will enact legislation conforming GILTI to the OECD’s Pillar Two standards before the presidential election in 2024. It’s more likely that any legislative changes to GILTI will come after the 2024 US election.

Maximizing the value of Pillar Two compliance

Many companies looking to grow through acquisition may perceive Pillar Two to be a non-issue because of their current size. But the consequences of crossing the €750 million threshold are so significant that Pillar Two needs to be considered in the diligence, modelling and structuring of virtually every deal.

In some cases, Pillar Two may change certain decisions in the deal-making process, as well as the tax risk profile of a target. This is especially true if the buyer faces resource and cost constraints.

Where deals have already closed, challenges may exist in obtaining access to relevant information from the vendor. Since share acquisitions remove the purchase accounting consolidation adjustments for Pillar Two purposes, it may be difficult—if not impossible—to obtain information on the historical carrying value of assets for Pillar Two from the vendor after the deal has closed. It may be more challenging where this post-closing information and cooperation was not provided for in the transaction agreements.  

Pillar Two requires new standard indemnity clauses to allocate risks between the vendor and buyer. For example, the tax indemnity clause should include liability for top-up taxes under the Income Inclusion Rule and UTPR from a buyer’s perspective. The representations and warranties should also cover the fulfillment of various disclosure requirements of the GloBE rules. 

But entering a deal with foresight does more than pinpoint Pillar Two issues early and avoid unpleasant surprises. It lets buyers consider how to allocate internal resources, engage an external service provider and price in additional integration costs. And a proper integration, in turn, can help sustain the expected value of a transaction—as well as maximize the value of any eventual exit.

How will Pillar Two affect your next deal?

Schedule a workshop with our team.

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Ken Buttenham

Ken Buttenham

National International Tax Leader, PwC Canada

Tel: +1 416 509 5203

Kara Ann Selby

Kara Ann Selby

Risk and Regulatory Platform Leader, Partner, International Tax, PwC Canada

Eoin Brady

Eoin Brady

National Mergers & Acquisitions Tax Leader, PwC Canada

Tel: +1 416 869 2354