Managing Risk in Global Transactions

The M&A market continues to be very active despite the pressures of rising interest rates and inflation.  With these market pressures it is even more important that sellers are prepared, and buyers are conducting the appropriate tax diligence with the unprecedented and drastic changes in global tax laws that have occurred the past few years. Kyle Dawley from CLA’s Global Tax Services team has summarized some of the key issues impacting recent global transactions executed by private equity and other multinational businesses –

Transfer Pricing

Global companies must structure their intercompany transactions in accordance with arm’s length principles, otherwise there is a risk of transfer price adjustments, including potential recharacterization of transactions, and thus additional tax payments from those respective tax jurisdictions. Countries are facing monetary pressures resulting in higher tax audit risks for global companies.  CLA Global has seen transfer pricing continue to be a top risk in any deal. Not infrequently, underwriters have elected to  exclude transfer pricing risk from coverage in the purchase of a global business.  

Permanent establishments

The global markets have naturally been one of the easiest paths for companies to grow.  Sending employees into these markets or hiring local sales representatives can lead to a large tax risk that the company has a taxable presence through a permanent establishment.  Additionally, since the pandemic there has been a steady rise in the number of companies allowing employees to work remotely outside of the U.S. Even if there is no formal permanent establishment as such, there may be local registration obligations abroad, where non-compliance can lead to penalties. CLA Global through its member firms has been navigating companies through these risks in advance and buyers quantify the potential exposure for companies that have not complied in the relevant jurisdictions.

As companies continue to sell into new markets there is always the risk of failure to register for VAT and other sales taxes abroad especially if the company is the importer of record into that jurisdiction.

U.S. tax law changes

The Tax Cuts and Jobs Act, signed into law on Dec. 22, 2017, was the most drastic change to the Internal Revenue Code since the enactment of the Tax Reform Act of 1986. The TCJA dramatic affected the ownership of foreign companies by U.S. individuals and businesses. 

Global Intangible Low-Taxed Income (“GILTI”)

GILTI is a significant change from pre-TCJA rules under which non-U.S. earnings were generally not included in income of a U.S. shareholder until repatriated or where otherwise subject to certain other anti-deferral rules. Understanding a company’s global footprint is even more critical given that every dollar a foreign investment makes now has an impact on U.S. taxable income.  CLA Global has a very firm grasp on the new anti-deferral tax regime and is well-positioned to help companies understand the impact of owning an interest in certain foreign corporations as well as with the annual calculations and reporting required with such ownership.

Transition Tax/Section 965/Toll Tax

The transition tax is imposed on U.S. shareholders of certain non-U.S. corporations on the last day of such entities’ last taxable year that began before Jan. 1, 2018. Generally, such U.S. shareholders are subject to current tax on their pro rata share of the amount of previously untaxed accumulated earnings of such corporations as of (i) Nov. 2, 2017, or (ii) Dec. 31, 2017, whichever is greater. The tax is imposed at an effective rate of 15.5 percent to the extent of cash and cash equivalents held by such corporations and 8 percent on the remainder of such earnings. Taxpayers may elect to pay the tax over eight years. The transition tax raises several issues, both because of the potentially significant amount of liability and the ability of U.S. shareholders to elect to pay the liability over an extended eight-year period along with the statute of limitations for the IRS to audit and adjust was increased to six years. CLA Global has been helping buyers’ factor these in any diligence and eventual purchase price.

U.S. partnership withholding

TCJA codified that the sale or exchange of certain partnership interests will be treated as effectively connected income, or ECI to the extent the transferor would be allocated ECI upon a sale of assets by the partnership. A buyer now must deduct and withhold tax equal to 10 percent of the amount realized on the disposition of a partnership interest unless the seller furnishes an affidavit to the buyer stating, among other things, that the seller is not a foreign person. Identifying when a partnership structure may have to determine which of its assets may be considered effectively connected for purposes of this exercise is critical and careful diligence is needed.

General U.S. tax compliance

Private equity investors can help their U.S. investments ensure compliance with U.S. tax and FinCEN disclosures by cooperating with requests from tax advisors. Below is a list of potential requests from U.S. tax advisors that may at first glance seem to be irrelevant to U.S. tax compliance:

• Request: Details regarding ultimate beneficial ownership of the investment vehicle
• Why a tax advisor may need this information:
  • To confirm eligibility for preferential rates of U.S. withholding tax under applicable income tax treaties;
  • To confirm whether the U.S. company is a “reporting corporation” for purposes of Form 5472 filing.
  • Coming soon, to comply with upcoming required disclosures under the Corporate Transparency Act.

• Request: Information about indirect owners’ other investments
• Why a tax advisor may need this information:
  • To confirm whether the U.S. company may need to file Form 5472;
  • To identify related parties for purposes of conforming with U.S. transfer pricing rules and regulations.

The filings referenced above carry severe penalties for failure to comply, and lack of full disclosure of ultimate beneficial ownership can ultimately hurt the investors’ returns on their investment. By coordinating with your U.S. investment’s tax advisor, private equity investors can do their part in assuring full compliance with the increasingly broad requests from IRS and FinCEN, and an increasingly knowledgeable pool of potential purchasers.

How We Can Help

CLA Global is here to help you add value when executing cross-border transactions. We can help you and your legal counsel manage risk and navigate these complex issues.