Episode Transcript
[00:00:00] Speaker A: Foreign.
[00:00:04] Speaker B: Hello everyone and welcome to our podcast series where we bring you insights into the latest developments in the global tax policy and controversy matters. My name is Jade Thompson and I'm a Managing Director and the leader of our corporate and international tax practice at A and M Australia.
Joining me today is my colleague Hang Vo. Hang is a Senior Director also from our international tax practice based out of Melbourne, Wang. Welcome back. Hang.
[00:00:31] Speaker A: Thanks Jade. Good to be back. Hi everyone.
[00:00:35] Speaker B: So in this episode it's about transaction readiness in a Pillar two world. So we're going to be discussing key Pillar two considerations in the context of MA transactions.
You've heard from our colleagues in previous podcasts on the proposed amendments to the Pillar two regime coming out of the OECD side by side package.
The OECD side by side package introduced four new safe harbours and the proposed extension of the existing transitional C by CR report Safe Harbour.
Please check out our previous podcast for more details on each of the safe harbours introduced under the side by side package.
But today we'll also touch on how those changes are expected to impact Pillar two planning in an M and A context going forward.
So so Hang, perhaps we start with a general stocktake of how Pillar 2 is starting to influence M and A activities.
What are we seeing?
[00:01:32] Speaker A: There's definitely been a noticeable shift in focus with respect to Pillar two in an M and A context. Jade.
Traditionally, tax due diligence has primarily focused on income tax and indirect taxes.
But in a Pillar two world, now we're slowly but increasingly seeing the topic of Pillar two becoming part of the upfront deal screening process and early stages of due diligence.
That said, it's still very much a work in progress for many organisations.
One of the key challenges is that the people driving deals and restructures often sit outside the tax function, which makes it critical to bring Pillar two into the conversation much earlier in the process and to broaden the scope of tax due diligence to cover Pillar two considerations.
If it's not addressed early, the downstream impact can be significant, whether that's on acquisition structuring, deal terms, target valuation or post deal integration and ongoing compliance.
And I guess that's why early effective tax rate modelling of Pillar two outcomes is becoming essential rather than something that's dealt with after the fact.
[00:02:42] Speaker B: Jade yeah, absolutely, Hang. I'd also probably add that while Pillar two is starting to shape M and A, there's still a lot of unknowns because the rules are evolving, interpretations are developing, and many organizations are still trying to figure out what they don't know yet. And all of this needs to be managed carefully and proactively.
So with that in mind, hang. When we're looking at pre deal considerations, where do you suggest that we start?
[00:03:11] Speaker A: I would suggest we start with scope and threshold considerations by asking a simple but critical question up front. Is pillar two relevant to the transaction?
It's important not to jump in and assume a way that pillar two is not relevant to the deal.
That means stepping back and looking at the Pillar 2 profile of all the parties involved, not just the target, but also the seller and the purchaser.
Take the sell side as an example. If the seller is within scope of pillar two, whether they're selling 100% of the target or only a partial interest can make a difference in a partial sale scenario, you need to consider how the transaction changes the pillar 2 classification of the target.
Does it become a joint venture or perhaps a partially owned parent entity? For pillar two purposes?
Each of those outcomes carries different pillar two consequences. So getting that analysis right at the outset is critical.
[00:04:08] Speaker B: And having the profile of the bidders can also have an impact on the deal, right?
[00:04:14] Speaker A: That's right, Jay. The profile of the bidders themselves can actually become a differentiating factor in terms of deal competitiveness.
So where you have bidders that are excluded entities for pillar 2 purposes, such as government entities or pension funds, they are not subject to pillar two.
And so from a pillar two perspective, that can put them in a stronger position to bid more competitively because we know the way they assess and price pillar 2 top up tax risk will be fundamentally different to a corporate buyer that sits within scope of pillar two.
[00:04:47] Speaker B: So what about from the buyer side? What are the key threshold considerations there?
[00:04:53] Speaker A: From the buy side, if the purchaser is within scope of pillar two, you need to consider how might the transaction impact the combined group post acquisition.
This is where expanding the scope of the tax due diligence process to include pillar two considerations will become critical.
However, if the seller is not yet within scope of pillar 2, the question becomes whether the acquisition could actually push the combined group over the revenue threshold of 750 million euros.
It's important to note that there are specific rules for revenue threshold testing in the context of mergers and demergers and how in practice.
[00:05:30] Speaker B: We have seen the rules relating to mergers push a lot of M and E groups over the line.
And that's really because the rules for mergers require M and E groups to to aggregate their annual revenue with the revenue of the target group for preceding fiscal years to test whether at least two of the four years exceed the revenue threshold of 750 million euros.
And we've seen on live transactions recently that this has caused acquiring groups which were not previously within scope of Pillar 2 to fall into Pillar 2 as a result of the acquisition.
And once you've assessed that Pillar 2 is relevant to the deal, it's important to then extend the scope of the standard tax due diligence RFIs to include pillar two focused questions.
So hang do you want to maybe take us through examples of some key Pillar 2 ETR drivers as part of the tax due diligence?
[00:06:29] Speaker A: Yeah, sure. Jade, it's important to note that it's it's important to tailor the RFI based on the particular profile of the target group.
But some common examples that could really impact jurisdictional effective tax rate include the presence of nil or low tax jurisdictions and once you've identified them, consider which of those jurisdictions are new to the combined group and which are existing jurisdictions that will have new target entities joining.
This is important due to the jurisdictional blending Mechanism under pillar 2.
Look for the availability of tax incentives and credits and how they are classified and treated under both the current Pillar 2 rules. This is relevant to assess historical risk as well as how they are treated under the new substance based tax incentive safe harbour which may impact the go forward position of the combined group.
Now if there's a tax incentive agreement, do consider whether the change in ownership might impact the agreement.
Assess the deferred tax position of the target as well, focusing on the deferred tax liabilities that are not likely to reverse within five years.
This may trigger the deferred tax liability recapture rule.
Look for intra group transactions involving asset transfers with the target during the transition period which is the period after 30th November 2021 up to when the target comes within scope of the globe rules for the relevant jurisdiction and consider the application of the transitional rules which may prevent the target from receiving a step up in globe basis or the recognition of a dta, though noting there are exceptions and then probably the last example is scrutinising any pre closing intra group restructuring by the vendor.
Often a vendor may do a presale intercompany balance cleanup or rationalisation across the group which may give rise to adverse Pillar two impact.
[00:08:32] Speaker B: Yeah, and one aspect to pay close attention to is any debt forgiveness involving the target which can distort the effective tax rate calculation where there is accounting income but not enough deferred tax to offset it. So so whilst there is an election to Exclude the debt forgiveness amount from globe Income. This does not apply to related party debt forgiveness, but is limited to insolvency or bankruptcy scenarios.
[00:08:59] Speaker A: And Jade it's fair to say some pillar 2 risks will be identifiable through the due diligence process, but others may be latent or just contingent and may only crystallise post completion. I guess that's why negotiating Targeted Pillar 2 warranties and indemnities in the SBA is so important to ensure Pillar two risk is approached appropriately. Allocated between the parties.
[00:09:22] Speaker B: That's right, Hang. The SPA has become central to managing both known and unknown pillar 2 risks. It's no longer just standard legal clauses, it's where buyers and sellers allocate exposures, plan for uncertainties and define post closing responsibilities.
We're seeing bespoke warranties covering globals under tax payments and Safe Harbour eligibility and also qualified domestic minimum top up taxes.
Buyers tend to focus on pre closing compliance, sometimes using indemnities or escrows, while sellers manage exposure with knowledge qualifiers and disclosures.
A clear post closing allocation will be critical to avoid future disputes and a well drafted SPA is a key tool for managing Pillar two risk and ensuring cooperation, information access and accountability.
So Hang, can you take us through the key considerations for deal structuring and also Pillar two modeling?
[00:10:27] Speaker A: Yeah, sure Jane. When it comes to deal structuring and Pillar two modeling, it's important to take a holistic view. Don't just focus on the target, but look at the combined group. And when evaluating potential acquisition structures, it's important to select structures that align with Pillar two policy principles.
So with that, consider moving away from relying on legacy low tax jurisdictions that no longer offer value in a Pillar two. Well, we recommend adopting substance based holding jurisdictions and moving away from financing arrangements that could trigger hybrid mismatches.
Based on our experience, it's fair to say that most groups would have sought to rely on the transitional CYC report Safe Harbour in the early years.
For jurisdictions that have passed Safe Harbour, Safe Harbour modelling will be important to assess whether the combined group can continue to rely on this post acquisition.
For jurisdictions that fail Safe Harbour, Pillar two modelling will need to have regard to the full globe rules, remembering that there are specific rules relating to when a constituent entity joins or leaves an M and E group.
For groups operating in Australia, it's important to overlay these rules with Australian tax consolidation regime considerations and factoring that into pillar 2 effective tax rate forecast modelling.
[00:11:48] Speaker B: And Hang, the modelling should also take into account the proposed amendments for the pillar 2 rules as part of the OECD side by side package.
Given the effective date of these safe harbours, groups may need to consider both the current Pillar 2 rules and existing safe harbour alongside the potential impact under the new safe harbours including the simplified ETR safe harbour or the substance based tax incentive safe harbour to understand the go forward position for the combined group.
This is particularly if the combined group plans on undertaking future entity rationalisation or corporate reorganisations.
And I think also remember that after the deal closes, Pillar two requires careful post deal planning. This includes ongoing compliance, integrating target and acquirer data and systems, preparing audit ready reporting and aligning legal structures or asset disposals.
You may also need to think about for Pillar two purposes, the impact of changes in functional currency, intercompany balance cleanup and updates to cost sharing agreements.
So this brings us to the end of our podcast. Hopefully you can see that Pillar 2 isn't just a post deal box to tick. It needs to be front of mind throughout the entire deal life cycle from early diligence right through to post closing.
Thank you for joining us today. Stay with us as we continue this journey in our upcoming podcasts. And don't forget to follow this channel. There will be regular insights and updates through podcasts coming your way. If you haven't done yet, subscribe to receive the newsletter directly in your inbox. Thanks everyone.
[00:13:33] Speaker A: Thanks everyone.
