Those who hoped that the OECD’s Base Erosion and Profit Shifting (BEPS) project would simplify and standardise a globally diverse corporate tax landscape may be feeling more than a little disappointed at the moment. Announcements and launches of consultation documents and discussions drafts from the OECD, EU and UK government have been flowing thick and fast, and much of the current activity is focusing on those BEPS actions which relate to financing and investment.
The link between tax impact and broader commercial impact is perhaps most obvious when we consider financing: restrict the availability of tax deductions for interest expense and eliminate advantageous tax mismatches on cross-border financing and there will be an immediate read across to the group’s effective tax rate. This will quickly filter through to earnings per share and other financial metrics.
There may also be secondary effects: on the cost of capital, the cost of debt finance, forced early-refinancing. Companies will need to become adept at predicting future profitability in order to ensure their financing arrangements are efficient. This is, to say the least, not straightforward. Relief under a double tax treaty will also come under pressure.
Read more from our series on BEPS
In order to continue to benefit from reduced withholding tax rates on cross-border financing transactions, it will be increasingly necessary to demonstrate that there is appropriate substance in all relevant jurisdictions. In practice this means having sufficient people on the ground who, importantly, have the appropriate skills and level of responsibility. Groups that have complex financing structures, involving multiple entities in multiple jurisdictions, may well have a decentralised treasury function model. This is in sharp contrast to the recent trend of many companies towards centralisation of core functions.
M&A will face challenges too. The (backward-looking) due diligence scope will need to be updated to take account of the (forward-looking) changing tax environment. Deal values will need to incorporate the potential impact of BEPS, and this is fraught with uncertainty. The due diligence exercise will give you a snapshot of the position now which will be informative - but overlaying the impact of BEPS onto forecasts will require a good understanding of a number of variables: for example, the value of revenue streams and, critically, the territory in which they arise, details of the actual or anticipated implementation of the BEPS proposals (again by territory), the timeframe for implementation.
The commercial effect of this is the very real potential for market distortion. Each bidder will put forward a price which will take into account the due diligence it has undertaken, the tax efficiencies assumed to arise from its proposed acquisition and the funding structure. Those need to be accurate. Tax efficiencies in a post-BEPS world could mean very different things for different bidders, whether corporate or private equity.
Post-deal synergies - arising from the business combination or from the opportunity for group restructuring - will now need to take BEPS into account. Even for those groups with a steady revenue flow and no material transactions or investments on the horizon the road ahead may not be smooth. Much of the legislation being introduced is very mechanical in nature, or may be firmly anchored to the current economic environment.
The proposed new interest deductibility regime in the UK is a good example of this: once implemented in 2017, it will restrict UK interest to a fixed 30% of tax-adjusted EBITDA, with certain exclusions such as a £2m de minimis allowance. Certain multinational groups with a very stable revenue profile and no plans for expansion into new markets or products may feel that they are able to manage the new rules with minimal impact. But an increase in interest rates or a sudden change in fortunes for a specific region could have a significant impact on the funding profile of the group. This could force a refinancing, leading to both cost and business disruption.
You may be forgiven for feeling this paints a somewhat ’doomsday’ scenario for multinational financing and investment. It is true that many of the proposals are a departure from the traditional financing models. But those groups with well informed and agile tax, treasury and financing teams will also see opportunities arising from the changed environment – perhaps the chance to restructure and refinance to ensure that they are as efficient as possible going forward.
Robin Walduck, international tax partner at KPMG UK