How Do You Tame A Tax Authority?

Author: Leon Harris

Tax is a major item of expenditure for every business. Shareholders rarely approve paying tax. Even if a business makes losses, city taxes and VAT/Sales Tax may apply. So how can the taxman be tamed? What should be included in an M&A due diligence review?

Here is our take.

Tax strategy – general:

A tax strategy is generally needed. Care is needed with tax planning. Tax evasion is illegal. Tax avoidance is generally legal. But a grey area exists which has evolved over the years in most western countries thanks to pronouncements by the OECD, EU legislatures and courts, as applicable. A sham transaction or preordained series of transactions that happen to exploit a loophole will typically be classified as evasion (illegal) in many countries. Tax strategies to consider may relate to supply chain management, using losses, using legislated incentives, etc.

Tax strategy – M&A:

In an M&A deal, the buyer’s advisors will want to review the seller’s tax strategy, especially if buying the shares (stock) of the buyer’s company.

Also, an M&A deal presents an opportunity for the buyer to do some tax planning. A reorganization is sometimes taxable – will tax payable anyway by the seller be enough? Not always. If the buyer acquires shares of the target company then extracts its assets, such as IP (intellectual property) after the M&A deal – that may trigger double or triple tax.

In our experience, many major tech deals involving famous multinational groups turned sour because of such issues.

Solutions do exist, they are not always obvious, but they can save the day financially speaking.

Tax compliance:

Are all tax returns and payments up to date?

Other taxes:

Aside from income tax, other taxes also matter e.g. VAT/ GST / Sales taxes, payroll taxes, social security, stamp duty, etc.

E-commerce tax challenges:

As a reaction to trading over the internet, it is now possible to owe taxes where you have no presence, e.g. the US, EU, UK and elsewhere. Check it out. In applicable cases, consider adapting the e-commerce business model e.g. drop shipments for orders instead of using fulfillment houses, local warehouses or local points of sale.

Offshore intellectual property (IP)?

Going offshore legally is now much harder but still possible sometimes. The usual test is whether “substance” exists. The OECD has clarified that in the case of IP, it is necessary to review where humans perform or oversee DEMPE functions that help create IP value. DEMPE stands for development, enhancement, maintenance, protection and exploitation.

Global active CFC/ GILTI / central management and control:

The US and many other countries have rules that impose tax on global operations of resident companies.

OECD:

The OECD has issued a range of tax pronouncements for taxing e-commerce and offshore operations. These include BEPS base erosion and profit shifting) counter-measures, Pillar 2 (15% minimum corporate tax rate for larger groups), and a so-called multilateral instrument (MLI) which catches fulfillment houses and warehouses.

Taxman taming techniques:

Despite the above challenges, tax liabilities can often be legitimately mitigated. Things to check out include:

transfer pricing studies – detailing functions, assets and risks within a group and each country – especially DEMPE functions.
Back office activities – often overlooked.
Claiming tax and grant incentives offered by many countries – for R&D, patents, industry, employment, environmentally friendly energy generation, etc.
Consider all taxes – income tax, VAT/GST/sale tax, stamp duty, social security, etc.
Consider double tax relief – macro and macro reviews are advisable.
Consult experienced advisors for further ideas in specific countries relevant to you.

In conclusion:

Tax is a major expense worth considering in detail. In our experience, loopholes that work today often don’t work later on as tax authorities use technology and get smarter. Tax planning is possible as discussed above if done reasonably and legally. Advice should be obtained in each country concerned.

For more information:

Email us at: leon@hcat.co