INSIGHT: Understanding U.S. Tax Reform’s Sweeping Impact on Global Tech M&A

The world is changing fast, and the U.S. technology sector is no exception, where disruption continues to accelerate and last week’s breakthrough can easily become today’s leap-frogged legacy. In corporate development terms, this is a climate for everything from joint ventures and tuck-ins to full-bore transformative deals.

Rampant change in the world of taxation is playing a significant role in this disruptive landscape. In particular, companies need to continue to address the evolving and sweeping impacts of the US Tax Cuts and Jobs Act, 2017 (TCJA).

Enter: Tax Reform

The TCJA sets out to make the U.S. a more attractive base of operations for global businesses by eliminating disadvantages inherent in certain policy drawbacks.

As for M&A, one key feature, section 965 of the TCJA, offered businesses a one-time reduced tax rate on the mandatory repatriation of accumulated foreign earnings. So, cash that historically tended to remain offshore, the thinking goes, would now drive capital inflows and domestic investment—including M&A.

As it turns out, whether driven by the TCJA or not, growth in M&A post-passage is decidedly robust. The appetite for global M&A reached a 10-year high in 2019, according to the 20th edition of the EY Global Capital Confidence Barometer (CCB), with 59% of global companies planning to acquire in the coming year—up from 52% 12 months ago. Digging deeper, the CCB highlights that in Q1 2019 there were 11 technology megadeals with a purchase price of $3 billion or more, compared with nine such deals in Q4 2018.

Taking a Closer Look

While a 30% rise is significant, it is difficult to determine what drove this past year’s surge without vastly more detailed data and analysis. Indeed, year-on-year M&A volume over the past 10 to 20 years varies widely.

Upon closer inspection, it is likely that the TCJA—and similar bouts of tax reform the world over—are in fact depressing deal volumes. Consider the following trends and developments:

• Misalignment and unsettled practice: As can be expected amid so many sweeping changes, certain elements of the 2017 tax law can work to cross purposes. For example, three actions—the Foreign Derived Intangible Income (FDII), the Global Intangible Low Tax Income (GILTI) and the Base Erosion and Anti-Abuse Tax (BEAT)—are all intended to drive companies to use the U.S. as a base for their IP. But as currently interpreted, the rules can in many cases suggest the opposite. For now, executives are awaiting all manner of clarifications relating to FDII and GILTI, including in areas such as expense allocation and apportionment provisions.
• Response and retaliation: Across the globe, tax rules and rates are in flux. Prior to the TCJA, national authorities had already been actively applying new OECD Base Erosion and Profit Shifting (BEPS) guidelines to issues of transfer pricing. Today, many are focusing on issues such as permanent establishment and IP, hoping to build stronger cases for claims on larger shares of digital cashflows. France’s recently enacted digital services tax is the latest prime example. Unquestionably, as the net impact of the TCJA on these various economies becomes clearer, jurisdictions will make changes of their own. By its very nature, the TCJA will prove a catalyst in driving further changes in global tax rules and rates.
• New limitations on interest deduction: Section 163 J of the TCJA introduces limitations of the deductibility of certain debt. In the past, businesses had an incentive to load debt into the U.S. because, relative to some foreign jurisdictions, U.S. limitations were less restrictive. But this change introduces new complexities to deal markets, requiring companies to revisit and retool their deal models.
• Trade tensions: Any tariffs on foreign goods can elevate jurisdictional tensions, which can go beyond the imposition of more like-for-like tariffs. However, today’s volatile global tax climate is in many ways a response to today’s trade disputes.

Certainly, more nations are proposing changes to tax provisions and introducing antitrust laws to address perceived abuses among multinationals in transfer pricing and paying their fair share of tax.

Compounded by trade and political headwinds, reforms and regulatory action across the globe can have a far-reaching impact that touches every part of the business, and even require companies to adapt their deal strategies.

The Way Forward

This climate leads us to an era of both heightened risks and opportunities. Transformative deals are in fact taking place all around us, as evidenced by the headlines and deal-making statistics we’re seeing today. But such deals are taking place at a time of unprecedented volatility in tax rules, rates and practices.

In and of itself, the TCJA introduced a wide range of changes and uncertainty. Unquestionably, companies need to continually rethink their strategies, challenging any preconceived notions or prior assumptions. Deal models need to be revamped from the ground-up, paying especially close attention to today’s uncertain and still shifting tax environment.

Along the way, businesses will also find that they need to revisit fundamental deal structures. For example, historically, a U.S. business would often simply acquire the shares of a foreign target company. Next, it would make a Section 338(g) Election with respect to the foreign target and then sell the target assets across internal divisions as desired, without triggering significant incremental U.S. tax on the integration.

But now, BEAT introduces a new U.S. tax cost to manage in integrating foreign assets with high U.S. tax basis. This introduces added costs and complexities for sellers, but for buyers, asset sales continue to be far more attractive than straight purchase of shares.

Overall, the role of tax within transactions for the foreseeable future has been elevated. The risks and complexities are amplified; missteps are more costly. This is particularly true for tech companies, which, whether by chance or intention, reside squarely amid some of the most complex, unsettled and likely contested tax issues. In short, as they pursue opportunities in global M&A, tech companies need to expand their focus on tax-related strategies and due diligence.

Kirsten Malm is a Partner and Zak Perryman is a Senior Manager, International Tax and Transaction Services, Ernst & Young LLP.

The views reflected in this article are the views of the authors and don’t necessarily reflect the views of the global EY organization or its member firms.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.