An Ever-Complex Global Tax Environment Requires Strong M&A Risk Solutions

Merger and acquisition dealmakers face a variety of economic headwinds as global M&A activity seeks to rebound in 2023 after a 35 percent decline during the first nine months of 2022.¹ Further, an ever-complex international tax environment is creating additional complexity and uncertainty, requiring companies to not only heighten scrutiny in tax due diligence, but seek new ways of mitigating deal-related tax risks.

Today’s international tax structures and their legal, financial and business implications have grown rapidly in both size and complexity, and the impact of an unexpected tax challenge can significantly compromise the value from a deal. Of global significance:

• In the last decade international revelations around tax evasion and aggressive tax planning led G20 countries and the Organization for Economic Co-operations (OECD) to address these issues through Base Erosion and Profit Sharing (BEPS) 1.0, published in 2015.
• Its potential successor, BEPS 2.0 and its pillars one and two, addresses tax challenges arising from the digitalization of the economy. The OECD expected BEPS 2.0 to be delivered as early as 2020. While it has been agreed upon by participating countries it has yet to be implemented. Of note, pillar two would require multinational businesses with revenues higher than EUR750 million to pay at least 15 percent tax in each jurisdiction in which they operate. This would likely have wider-reaching consequences for international M&A activity as it would have an uneven impact on the attractiveness of different target companies and may favor certain types of bidders over others.
• Tax authorities in a number of international jurisdictions are scrutinizing transactional activity, particularly in relation to private equity capital structures. As a result, tax due diligence is critical, both for improving buyer visibility on deal-related tax risks and mitigating any potential valuation impact.²
• In the U.S., meanwhile, as the IRS staffs up amid an $80 billion funding boost, corporations and business owners are bracing for the possibility of more IRS audits and enforcement. This influx of funding is an overdue correction for the agency, which has endured steep budget cuts over the past decade.³

It’s no wonder then that tax risk is on the rise in the minds of dealmakers. Half of those surveyed warn tax risk is now significantly more acute to deal success than in the past, according to Aon’s M&A Risk in Review 1H 2022. Dealmakers also warn of growing tax risks on multiple fronts. More than a quarter (28 percent) name the proliferation of anti-abuse rules as their most pressing concern. Others include entity classification rules and increases in tax rates.⁴ Fortunately, there is a way to mitigate these risks, and other M&A-related tax exposures as well.

Tax Insurance as an Evolving Risk Management Tool

Tax insurance and other forms of contingent risk insurance are some of the evolving M&A strategies being implemented in response to emerging trends and changing market needs. Tax insurance is a potential solution to tax complexity that transfers the risk of successful tax authority challenges to an insurer.

Its usage has grown in M&A as a precautionary measure against unexpected tax assessments, clawbacks of anticipated tax benefits and future cash outlays. Tax insurance was designed to help protect businesses in the event a position fails to qualify for its intended tax treatment, and can be used to mitigate risk in a variety of transactional situations:

1. To cover losses including taxes payable, interest and penalties, and gross-up amounts for tax due on insurance proceeds. It can also cover contest costs tied to the defense of the position.
2. To protect buyers from unanticipated pre-closing tax liabilities on positions inherited from sellers in an M&A transaction. It has also been popular among renewable energy investments involving tax credits to protect anticipated tax benefits.
3. In the case of an acquisition of a target with a large potential tax exposure, tax insurance can help move both parties past a difficult or even insurmountable negotiation.
4. As a strategic financial tool, tax insurance can benefit a seller looking to cover its indemnity obligation for pre-close tax exposures or allows a buyer to insure itself against a heightened tax issue rather than seek a special indemnity that can hinder the deal.
5. As a financial planning tool, it can provide a backstop should an investment or tax position fail to qualify under different interpretations by covering assessed amounts (tax, interest, etc.) and defense costs to make the policyholder economically whole.

Tax insurance appetite extends beyond M&A activities to non-transactional corporate risk as well. That can include corporate tax planning, restructurings, and high net worth personal or estate tax exposures.

M&A Tax Insurance: What Success Looks Like:

Transfer pricing across multiple jurisdictions

A business was exiting a global joint venture but retaining the U.S./Canadian operations of its business. In connection with the transaction, the existing transfer pricing model was terminated, and a new model was implemented with its former partner for use with certain intellectual property.

Revising the intellectual property structure included termination of existing licensing agreements, entrance into new licensing agreements, and assignment of certain intellectual property/“know-how” to which minimal value was attributed. The business was also treating the entrance into the new licensing arrangements as a “sale” of intangibles allowing it to amortize its basis. Due to the complexity and large potential exposure, the business was seeking protection for the transfer pricing involved in the transaction. The broker was able to structure and secure a $280 million tax insurance program with A-rated or better insurers, protecting the business from potential transfer pricing adjustments on the actions taken to revise the intellectual property structure across multiple jurisdictions as well as other tax risks associated with the transaction.

In the event of a successful tax authority challenge, the insurance would cover the additional withholding and/or income taxes, plus interest and penalties, in U.S. dollars, Euros, or Canadian dollars, depending on the relevant jurisdiction.

How Tax Insurance Helped Multinational Group Reorganization in the EU

A multinational company sought to re-domicile intellectual property from one EU jurisdiction to another. Its tax advisors developed the transaction steps plan and were confident that the transaction would not give rise to capital gains tax, corporate tax or stamp duty as various exemptions should apply.

Due to the complexity of the transaction steps and criteria for exemption qualification, the business used tax insurance to protect against a successful challenge to the tax-free nature of the transaction. Use of tax insurance was “baked in” to process from its earliest planning stages.

The business was then able to complete its restructuring and has a “sleep easy” that no unexpected and catastrophic tax event will occur in future as a result.

¹ M&A rebound unlikely in 2023 after 35% slump: S&P Global

² Maximizing Deal Opportunities with M&A Insurance in a Buyer’s Market

³ Tax Insurance May Serve as a Salve to Fears of IRS Enforcement | Bloomberg Tax

⁴ M&A Risk in Review 1H 2022 | Aon

Talk With Us

If you would like to discuss any aspects of these insights please do not hesitate to get in contact with our team.

David McCann
Executive Director, M&A and Transaction Solutions - EMEA
[email protected]

Jessica Harger
Managing Director, M&A Transaction Solutions – North America
[email protected]