In the light of current macro developments such as the interest rate and inflation environment, executing deals successfully is as challenging as ever. To maximize value creation in M&A, dealmakers should also consider an often unexploited lever – namely TP planning and integration.
Rebound and continued dynamic in M&A activities
Following a busy year, and even though the number of M&A transactions decreased in the first quarter, 2022 has still proven to be an active dealmaking period. Overall, the 2022 M&A activity (both in terms of volume and value) has returned close to the recent historical average, with a total annual global value of USD 3.63 trillion. As of July 2022, 22,000 deals were done, valued at USD 1.73 trillion. Large and megadeals seem to follow the same tendency, that is a cooling off compared to 2021, while still being dynamic (e.g., Twitter acquisition in October 2022).
Counterintuitively, geopolitical tensions (especially the Ukraine crisis) acted as a steppingstone for M&A activity. To sever ties to Russia, many companies transferred businesses to local investors. Many industries have already come back to their pre-pandemic activity levels, apart from sectors such as airlines and tourism still experiencing a rebound, resulting in dynamic M&A activities.
Value creation in M&A and where transfer pricing plays a role
For M&A transactions to actually create value, acquirers may look to exploit one or several of the following opportunities, amongst others.
One of the most common ways companies create value through M&A is through cost savings. By acquiring another company, a business can reduce costs by eliminating redundancies in areas such as marketing, operations or administration. Eliminating redundancies almost always has a TP angle, be it due to transfers of functions or businesses and related compensation/exit tax considerations or by ways of an adjusted TP model (or both).
The cost impact of TP, both one-offs and ongoing TP model changes, therefore need to be considered thoroughly when assessing the total cost savings of envisaged measures.
Another way companies create value through M&A is by gaining access to new markets and customers. By acquiring a company that operates in a different geographic region or serves a different customer base, a business can expand its reach and increase its revenue potential. This means that new companies (potentially in new jurisdictions) are integrated into the acquirer’s TP model, posing a number of TP questions ranging from a decent remuneration/target profitability for such companies in their respective regions in the light of their functional profile as well as operational TP and compliance challenges.
In order to avoid any unpleasant surprises and TP compliance gaps, the fit of the acquirer and target’s TP model should be assessed early in the process and any adjustments and related costs considered before PMI starts.
Acquisition of valuable (intangible) assets
In addition to cost savings and market expansion, companies can also create value through M&A by acquiring valuable assets and resources. These assets can include intellectual property, proprietary technology and valuable brands. For example, a company looking to enter a new market may acquire a company with a well-established brand in that market to gain immediate recognition and credibility. As the treatment of IP within MNEs is one of the most complex and most vulnerable TP topics, acquirers should pay particular attention to the acquisition of important intangible assets during the deal structuring phase and in drafting the SPA.
Special attention should be paid to the jurisdiction into which such IP is acquired (location of relevant IP development, enhancement, management, protection and exploitation (DEMPE) functions, tax treaty network (relevant for withholding tax questions if licenses/royalties are to be charged), etc.), the consideration allocated to such IP in the purchase price allocation (PPA), etc.
Increased complexity requires a holistic approach
The above list could be extended indefinitely, leading to significant complexity in assessing TP risks, one-off cost impact and the TP impact on the ongoing profitability of the combined group in the future. It is therefore imperative to not consider the TP aspects of various transaction parameters in isolation but to take on a holistic approach to analyzing the TP impact on M&A value creation, for example by performing a value chain analysis of the target and acquirer’s business, optimally during the due diligence phase and before integration starts. Deal teams supporting acquirers (and similarly targets for separation considerations) should therefore be interdisciplinary and include transaction and transfer pricing specialists that seamlessly work together to maximize value creation of the combined business.