The benefits of tax planning as part of the acquisition of an international business.

• Author: Barrett, James H.

In certain situations, the acquisition of a business presents an opportunity for a buyer to structure a company's operations into a more optimal tax structure. Many businesses, especially start-up businesses, have grown from the ground up. Tax planning in the early stages of a business generally will allow the business to be structured in a tax-efficient manner. However, in the real world, during the early stages of a business, allocating funds to tax planning is often not done. Thus, many businesses could benefit from proper tax planning. Furthermore, as tax law changes occur over the years, tax planning that was efficient may become inefficient. Finally, what is good for one business owner is not necessarily good for another. For example, tax planning for a nonresident of the U.S. is not the same as it is for a U.S. citizen business owner.

In an acquisition, especially an asset deal, the acquirer may be able to structure his or her affairs in a manner that is most beneficial to the business and its owner(s). Tax planning is unique to each particular business and to its owner. However, the general goal in any situation is to minimize the enterprise's global effective tax rate. It is a basic tenet of U.S. federal tax law that as long as the transaction has adequate economic substance, taxpayers generally are free to structure their business transactions as they please, even if motivated by a goal of tax minimization. (1) The tax planning that commonly has been used by multinational corporations and is statutorily permitted by the Internal Revenue Code (IRC), (2) is equally available to closely held businesses. Such planning generally involves the allocation of profits that are generated outside of the U.S. to corporations that are created outside the U.S. Thus, the profit generated abroad is earned by an entity that is formed abroad and profit generated in the U.S. is allocated to an entity that is formed in the U.S. Certainly, a foreign business owner would not want to import into the U.S., and pay U.S. tax on, non-U.S. profits of his or her business.

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Managing the tax exposure of an international business is a complex endeavor. A business that operates internationally should be aware of the tax effects of its cross-border transactions in the relevant countries in which the business operates, and in which its owners reside. Tax-efficient operations for international business can vary widely based on variables such as, among others, the business owners' country of residence, the number of shareholders, the countries in which the business operates and the industry in which the business operates. For example, a U.S. citizen is taxable on his or her worldwide income, whereas, a nonresident is generally only taxable on his or her U.S. source income.

Some of the common inefficient tax structures that are frequently found in the real world include the incorrect choice of entity, needlessly importing profits into high-tax jurisdictions, mismatching intellectual property ownership with its jurisdiction of use, or not taking advantage of local tax minimization techniques. During the acquisition of a business, these inefficiencies can be corrected so that the purchaser does not have to suffer the same inefficiencies as the seller. Thus, an investor in a newly acquired business may have a very different tax reality than the previous owner did. More importantly, with proper planning a purchaser may significantly improve his or her tax position when compared to the previous owner.

Even in the case of stock deals, opportunities exist for the purchaser to improve upon the acquired entity's tax position. At the very least, the purchaser should be fully aware of whether a target would operate in a tax-inefficient manner after the acquisition. For example, when a U.S. citizen purchases stock of an entity from a non-U.S. seller, the possibility exists that the buyer could have issues with the anti-deferral provisions known as Subpart F, or the Passive Foreign Investment Companies (PFICs) rules, or could simply have put himself or herself in an inefficient structure to receive dividends, especially if the foreign entity owns a U.S. corporation. Pre-acquisition, the buyer likely could have an opportunity to avoid such problems that would be much more difficult to solve after the acquisition.

Pre-acquisition planning generally involves a review of the target business' operations and the design of a tax structure for that business which would be the most tax efficient and commercially reasonable from an operational perspective. Thereafter, the next step is to create a series of transactional steps to reorganize the business into the structure that is desired for the buyer. It is important to work with tax counsel in the local country jurisdictions in which the business operates to ensure the plan works from a U.S. and a foreign perspective. Sometimes these steps will not have a detrimental tax effect on the seller and, thus, should be readily agreeable to the seller. Conversely, in other situations, the restructuring may cause detrimental tax liabilities or be unacceptable from a business perspective, so that the seller would consider the proposal to be unacceptable. This article discusses some of the many issues that should be considered in the acquision of a multinational enterprise.

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