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How recent tax developments could impact M&A deals
November 2022
Recent significant changes in corporate taxation — globally and in the United States — have created a direct link between pretax financial income as presented under an accounting framework (e.g., US Generally Accepted Accounting Principles or International Financial Reporting Standards) and the computation of income taxes. While tax calculations have generally used gross income less allowable deductions as a starting point in arriving at the profits subject to tax, various differences between accounting frameworks and tax rules have historically resulted in differences (temporary and permanent) between income reported on financial statements and tax returns. The new rules generally seek to narrow the impact of such differences. This is a monumental change to tax regimes and the effort needed to comply with these rules should not be underestimated. Here’s what companies and dealmakers need to know.
What's changing?
In 2021, a group of approximately 140 countries agreed to a framework under Pillar Two, which introduces a minimum Effective Tax Rate (ETR) on profits attributable to each jurisdiction in which a company operates via a system where multinational groups with consolidated revenue over €750m are subject to a top-up tax on the difference between the calculated ETR in a jurisdiction and 15% under prescribed methodologies. Pillar Two may become effective as early as 2024.
In the United States, the Inflation Reduction Act (IRA) was signed into law by President Joe Biden on August 16. It includes the implementation of a new corporate alternative minimum tax (CAMT). CAMT imposes a minimum tax on corporations with an average annual adjusted financial statement income (AFSI) over a three-year period in excess of $1 billion. CAMT is effective for tax years beginning after December 31, 2022.
While some have speculated that only around 150 companies would incur incremental tax liability under the new CAMT, more companies are expected to be impacted by Pillar Two, and companies without tax liability will nevertheless be subject to documentation and disclosure requirements. Some companies may be impacted by both sets of rules.
What do companies and dealmakers need to focus on?
While imposing a minimum tax on companies is not new, both Pillar Two and CAMT generally require taxpayers to disaggregate their financial income as presented under an accounting framework into individual tax units and legal entities — a concept that has not been prominent in tax computations in recent history.
Preparing standalone financial statements by legal entity is common in divestitures. However, it is not straightforward, and can be time-consuming. Also, in the context of Pillar Two and CAMT many questions of the practical application remain unresolved.
Some of the complexities companies will have to navigate include: multiple Enterprise Resource Planning (ERP) systems with underlying data, availability of legal entity GAAP ledger data, internal controls, the basis of local ledger reporting, and accounting for intercompany transactions. These new tax regimes stand to incorporate specific book adjustments that may require custom modifications to pretax income or modified applications of business combination accounting. Both Pillar Two and CAMT contain divergent adjustments to financial statement income to arrive at the base for the minimum tax.
We are already seeing dealmakers react to the proposed or enacted tax requirements. Some examples of transactions impacted are highlighted below:
- Divestitures: Consideration of whether the transaction is a spin-off or a split-off. While both are potentially tax-free transactions, a split-off typically has a book accounting profit and loss (P&L) impact that could impact the reporting of the minimum taxes, while a spin-off does not.
- Acquisitions: Legal entity restructuring may occur as a result of acquiring a new business or in a common control transaction. Oftentimes, the book and tax treatment of these transactions is different and could impact any potential minimum tax payments under either set of rules.
- Deal value drivers: The potential impact of these top-up taxes may affect the utility of tax losses or other attributes of acquired companies, and may warrant revisiting the effective tax rate impact of deals.
- Capital raising: Up-C transactions (Umbrella Partnership C Corporations) with tax receivable agreements (TRAs) have complex book and tax reporting requirements after an initial public offering that may require further analysis/consideration.
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Next steps
Companies should determine their readiness to comply with the new tax rules, including their ability to prepare legal entity pre-tax financial information. Dealmakers should be mindful of the new tax requirements when executing transactions across the deal continuum. Contact us to learn more about how the new tax landscape could impact your company and deals.
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