Loyens & Loeff 4th Annual Outbound Investments...
Transcript of Loyens & Loeff 4th Annual Outbound Investments...
Agenda
• M&A in Europe – Thierry Lohest
• BEPS, State Aid… How to do business in a brand new tax climate – Carola van den Bruinhorst
• Panel Discussion – Moderated by Tom Mitchell - Cathy Buggenhout, Consul General of the Kingdom of Belgium - Luc Decker, Consul General of the Grand Duchy of Luxembourg - David Naves, Deputy Consul General of the Kingdom of the Netherlands - Willem Jarigsma, managing partner Loyens & Loeff
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How 12 months make a dramatic difference!
• 2014: is this the year of renewal for M&A? • 2014 was a turning point. Q1 2015 beats all expectations • Biggest month ever for M&A activity in USA was May 2015 (USD 243bn, compared to USD 226
bn in May 2007 and USD 213 bn in January 2000). First 5 months in 2015 accounted for USD 1.85 trillion – annual record in USD 4.6 trillion in 2007.
• What happened? • Combination of cheap credit, market confidence, executives confidence, solid performance of
stock exchange, renewed interest of industrial players • ‘Return of animal spirits’ • Previous M&A peaks coincided with equity and debt bubbles • M&A bankers insist it is different this time!
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Factors spurring or driving the revival
Source: Mergermarket & RR Donnelley: The M&A Revival, May 2014 Edition
Trademarks of the M&A market in 2015
• Mega-deals • Industrial players are leading the way • Global private equity deals are on the increase • Deals are done faster • Auctions are again the favoured way to sell companies • Main negatives are:
- Antitrust complexities - Tax inversions are becoming less acceptable
• Some large deals are done without investment bankers or with smaller banks
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Market trends for PE
• Private equity is still an important player • Private equity dictates the rules • Advocates of dual track: sale in IPO • Have to reconsider strategy because they are losing out to industrial players • Can re-invent themselves
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How about Chinese investors?
• Chinese companies have become big players in the global M&A stage (FT) • See Wanda €1 billion purchase of Sports marketing group Infront Media • No bank advised Wanda • Same for Alibaba and Tencent and their M&A deals since 2010 • These companies have hired top M&A advisors and handled valuation process in-house
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Deal process
• The ‘classic’ auction is back • Buyers increasingly prepared to pay a premium to buy ‘off-market’ • A trend towards very short exclusivity periods
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What is new in M&A documentation?
• One of the fundamental considerations in preparing transaction documentation for the purposes of a M&A transaction is the pricing mechanism to be included in the SPA.
• Closing accounts have historically been the default mechanism of choice for this purpose, and are generally considered to be buyer friendly.
• Enthusiasm for locked box deals waned during the recession, but has recently come back in favor and is being used more widely (i.e. corporates as well as private equity sellers)
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Where does this stem from? Valuation – a refresher
• Typical valuation method of target business is on a ‘debt free/cash free basis’, assuming a normalized level of working capital
• Starting point for valuation for the buyer is to determine the ‘enterprise value’ of the business – typically a multiple of EBITDA, predicated on the assumption that this measure represents the sustainable level of cash profit generated by the target
• From the starting point of the enterprise value, the following items will be taken into account to determine the equity value of the target business (i.e. the price payable for the shares): - Specific negative adjustments – e.g. pension deficits/capex requirements - Net debt adjustment – i.e. cash less debt - Other relevant adjustments – e.g. capital spent vs budget
• We call this the ’equity value bridge’
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Closing accounts deals – key aspects
• The buyer pays for the ‘actual’ balance sheet delivered as at closing (i.e. the assets and liabilities of the target business at that time)
• The assets and liabilities to be taken account of in the pricing adjustment (net cash/debt working capital and/or net assets) depend on what is negotiated in the SPA
• However, while the price is determined by the level of specified assets and liabilities at closing, these will not be known at the time the SPA is entered into or closing occurs (even simultaneous signing and closing due to the lead time to prepare accounts)
• Accordingly, the buyer will pay at closing an amount reflecting the enterprise value adjusted by reference to an estimated balance sheet as at closing
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Closing accounts deals – key aspects (cont.)
• Depending on the timing between signing and closing (if any) and the nature of the business, the price payable on closing may be (i) baked into the signed SPA or (ii) based upon updated figures provided shortly before closing (the objective being to ensure the buyer pays an amount close to the actual equity value)
• Following closing, closing accounts will be prepared, reviewed and agreed or determined via an agree dispute mechanism
• To ensure seller and buyer’s expectations as to pricing are met, the SPA will need to include appropriate general and specific accounting policies (usually the subject of extensive negotiation) for the purposes of the preparation of the closing accounts
• Once the closing accounts are agreed or determined, the purchase price will be adjusted to take account of any discrepancy between what the buyer paid for and the actual assets and liabilities at closing
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Locked box deals – key aspects
• The buyer pays a price reflecting the equity price calculated using a recent historical sheet of the target
• A locked box is therefore a fixed price deal. Levels of cash, debt and working capital are identified pre-signing of the SPA and the equity value is written into the document. No closing accounts are prepared and there is no post-closing adjustment mechanism
• The buyer’s risk is a ‘leakage’ of value to shareholders and their connected persons in the period between the locked box balance sheet date and closing. Solution is: - The parties agree on ‘permitted leakage’ in this period (f.e. dividends of a specified amount) - The seller indemnifies the buyer on a $ for $ basis against any leakage which is not
‘permitted’ - The buyer also gets comfort via warranties from the seller regarding the management of the
business since the locked box balance sheet date • Generally claims for ‘leakage’ must be brought by the buyer within a much shorter time than
they would under usual warranty limitation period (commonly between 3-12 months)
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Locked box deals – key aspects (cont.)
• However, claims for leakage are generally not subject to other customary limitations – e.g. caps (justification for which being that shareholders have illegitimately extracted value from the company impacting upon price – i.e. ‘stolen from the company’). F.e.: - Parties typically agree in SPA that transaction between bonuses payable to management
shareholders (up to a capped sum) constitute permitted leakage - If management shareholders take transaction bonuses in excess of that capped sum, they
should be liable to make the buyer whole for that excess • A common misconception that closing accounts deals and locked box deals use different
valuation methodologies/pricing methods – this is not in fact correct. The main difference (putting aside respective pros and cons to be discussed) is the timing of the passing of the economic interest (and risk) in the target
• This occurs on the locked box date in a locked box deal and on closing in a closing accounts deal
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Timing of passing of economic risk
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Economic interest passes
Locked box
Closing accounts
Due diligence on locked box balance sheet, projected cash flows and cash profits
Due diligence on financial statements – agree to enterprise value and target working capital
Calculation of estimated cash, debt and closing working capital
Review estimates of cash, debt and working capital; dispute, if applicable; true up payments
Economic interest passes
Locked Box Date Signing Date Closing Date
Restrictions on leakage
Timing of passing of economic interest (cont.)
• Given that the economic interest in the target business effectively passes to the buyer with effect from the locked date, the buyer has the benefit of the cash profits generated by the business from that date
• In contrast, the seller incurs an opportunity cost as they do not receive payment at closing • The seller will typically seek compensation for this opportunity cost in one of two forms:
- An interest charge on the purchase price (the equity value) between the locked box date and completion (reflecting the opportunity cost of the seller not receiving the proceeds from the buyer at the locked box date when the economic interest passed)
- A proxy for the profits earned (e.g. daily profit rate) as they will not have been able to extract this form the business since the locked box date
• The ability of the seller to negotiate this compensation will depend on bargaining power, time between the locked box date a closing and nature of the business
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Locked box… pros & cons
Seller Buyer Certainty re price Certainty re price
Management not tied up debating completion accounts post completion
Management not tied up debating completion accounts post closing
In auction process – easier for seller to compare offers (due to need for very detailed bridge to equity value)
No costs for closing accounts
Increased control over process Significantly less complicated SPA
No costs for closing accounts ᵡ Significantly more due diligence on balance sheet required
Significantly less complicated SPA ᵡ Buyer must negotiate key items at earlier stage with more limited knowledge (e.g. debt, working cap)
ᵡ Loses benefit of accrued value until closing ᵡ Increased reliance on warranties
ᵡ Interest rate on equity/proxy for profits may not compensate the Seller for the target’s earnings
ᵡ Risk that the target’s business deteriorates during locked box period
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Key considerations for a locked box deal • Leakage position:
- Leakage – widely defined to include all potential categories of value leakage: Any transfer of value to sellers or connected persons e.g. dividends, distributions or returns
of capital Fees and expenses relation to the transaction Transaction bonuses paid to staff Payment of fees (including management fees) to the seller and their connected persons
(i.e. directors’ fees) Waivers of amount owed by the seller to the business Intra-group payments for services or not in ordinary course Tax payable by target in relation to the above matters
- Permitted leakage – specific exceptions to leakage which may include: Intra-group payments in ordinary course & at arms-length Dividends/distributions agreed with the buyer Payments of salary/bonuses to management in the ordinary course Certain costs related to the deal Tax payable by the target in relation to the above matters
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Key consideration for a locked box deal (cont.) • Leakage positions (cont.):
- Common misconceptions/pitfalls Leakage doesn’t cover ordinary course payments of the business – just payments/benefits
in favor of the seller and their connected persons. The buyer must get comfortable around ordinary course payments via its valuation/due diligence process
Buyers should resists ‘general’ disclosure of permitted leakage items (unless they are very comfortable as to the relevant quantum) – it is vital that the buyer is fully aware of the nature and quantum of all permitted leakage items. F.e.: • If permitted leakage includes bonuses payable to management shareholders in the
ordinary course/directors’ fees monitoring fees or similar, the buyer must be comfortable that they are aware of the aggregate amount available
• The amounts of all items constituting permitted leakage (e.g. transaction bonuses, payment of advisers fees, etc.) should be specified or capped
Generally speaking, permitted leakage items will need to be taken into account in the price (unless they have already been taken account of elsewhere – e.g. payments of salary to management shareholders). There is no problem with having an extensive list of permitted leakage items from a buyer’s perspective PROVIDED that the list can be precisely quantified and matters that impact the price are addressed in the enterprise value to equity value bridge
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Key consideration for a locked box deal (cont.)
For this reason, it is very important that the seller’s proposed list of permitted leakage items is flushed out early so they can be taken into account in calculating the equity value (very easy to be forgotten if left in schedule…).
• Practical considerations:
- Are systems set up to identify all transactions between the target and the sellers/connected persons between the locked box date and closing?
- Does the buyer have sufficient visibility over potential leakage in distant territories? - If there are concerns about the ability of the buyer to identify leakage, consider timing of audit
cycle in terms of the length of the limitation period for leakage claims
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‘Recently more and more enterprises organized abroad by American firms have arranged their corporate structures (…) - so as to exploit the multiplicity of foreign tax systems and international agreements - in order to reduce sharply or eliminate completely their tax liabilities both at home and abroad.’
a. John F. Kennedy b. George W. Bush c. Barack Obama
Who said this?
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‘Recently more and more enterprises organized abroad by American firms have arranged their corporate structures – aided by artificial arrangements between parent and subsidiary regarding intercompany pricing, the transfer of patent licensing rights, the shifting of management fees, and similar practices which maximize the accumulation of profits in the tax haven – so as to exploit the multiplicity of foreign tax systems and international agreements in order to reduce sharply or eliminate completely their tax liabilities both at home and abroad.’
Special Message to the Congress on Taxation. April 20, 1961
John F. Kennedy:
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Multinational companies currently being publicly criticized for their tax structures…
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Recent press
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Starbucks’s Tax Practices Draw European Scrutiny (WSJ) Coffee chain paid less than 1% in corporate tax last year in the Netherlands, where its regional head office was based
The Telegraph (2012) “George Osborne threatens big business with global tax crackdown”
”Britain has joined forces with Germany to declare war on tax dodging multinationals and called for an end to loopholes that have allowed them to siphon off billions in profits to tax havens. [….]”
2015: George Osborne to serve another term as UK Minister of Finance
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Trend: “Fair Share” approach is gaining momentum
Fair share
Apple Amazon
Revenue raising from
MNE’s
BEPS reports
Competition for
investments Media and politicians
EU State Aid
Lux Leaks
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Tax Avoidance Tax Evasion
Blurred line between Tax Evasion and Tax Avoidance
• Illegal: Tax Fraud • Criminal offence • Mounting international
exchange of information and coordination
• Legal • Freedom versus morality • International planning
opportunities • Harmful tax competition
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Overview main relevant developments
G20 •G20/G8, parliaments, NGO’s & press
OECD • BEPS Action Plan: root out inappropriate tax avoidance through 15 actions • Continuing and unprecedented stream of draft reports. Deliverables: fall 2015 • Global exchange of info system: “Common Reporting Standard”
EU
• State Aid scrutiny into tax ruling of multinationals in Luxembourg, Ireland, the Netherlands and Belgium
• Anti-abuse and anti-hybrid provision in the Parent-Subsidiary Directive • Transparency initiatives: UBO-register, exchange of information on tax rulings • Last but not least: more anti-abuse provisions by harmonising the corporate tax base: CCCTB
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4 main themes to fight “inappropriate” tax avoidance
Transfer Pricing
Anti-Abuse
Trans- parency
Mis- matches
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Objectives through 15 actions BEPS Action Content
1 Digital Economy Modernization
2 Hybrid Mismatch Coherence / Anti-mismatch / anti-hybrid 3 CFCs
4 Interest Deductions
5 Harmful Tax Practices
6 Treaty Abuse Anti-abuse / Substance
7 PE Status
8 Transfer Pricing Outcomes 9
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11 Methodologies and data Transparency
12 Mandatory disclosure
13 Transfer Pricing Documentation Certainty
14 Dispute resolution
15 Multilateral Instrument Implementation
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BEPS OECD Documents A large number of discussion drafts, interim reports, public consultations and even final reports has been produced.
See - http://www.oecd.org/ctp/discussiondrafts.htm
Unprecedented speed! Goal: declare victory on tax avoidance in September 2015!
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EU is ‘overtaking’ the OECD
EU State Aid investigations
Anti-abuse provisions in P/S Directive (intra group dividends)
IP Regimes: “Modified Nexus”
CCCTB (harmonising corporate taxable basis
Transparency package
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Treaty abuse, BEPS Action 6
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Investor
OpCo
15 % WHT rate on dividend payments, no capital gains protection or favourable treaty.
No treaty between Investor country and OpCo country.
Treaty abuse, BEPS Action 6
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Investor
HoldCo
OpCo
Reduced WHT rates and capital gain protection under the treaty between HoldCo country and OpCo country.
Reduced WHT rates under the treaty or domestic rules and no tax on capital gain based on domestic exemption in HoldCo state
HoldCo country (e.g. NL/Lux) has favourable treaties with both Investor country and OpCo country.
Treaty abuse BEPS Action 6
Prevent the granting of treaty benefits in inappropriate circumstances
Clarify that tax treaties are not intended to be used to generate double non-taxation
Identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country
A
B
C
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Summary main contents
Action 6 – Tax Treaty Abuse
Core of OECD proposals on Action 6 is to include in tax treaties a common minimum standard to tackle treaty abuse
In particular intended to end treaty shopping by non-residents mainly affects foreign owned companies
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Increased transparency
• Action 13 Purposes of increased transfer pricing documentation requirements: 1. Transfer pricing risk assessment (i.e. to avoid TP mismatches)
2. Taxpayer’s assessment of its compliance with the arm’s length principle
3. Provision of information necessary to conduct an audit
• Required
− Country by country report for each jurisdiction in which they do business
• Will likely not be before 2016.
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Threats and Challenges
Less base erosion / Hybrid mismatches
Transfer Pricing: same profit in more countries
Upstream of profits: more tax leakage
Increased costs of compliance
More disclosure of wealth, UBO’s, etc.
Risk of distortion of competition grows
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Where do we stand today?
BEPS
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State aid
Anti-abuse Transfer pricing
CRS CbC
Hybrids
Treaty abuse
Transparency
EU OECD
Dispute resolution