Pillar Two: Reshaping the global M&A landscape

The implementation of Pillar Two, the OECD’s global minimum tax initiative, is set to reshape the landscape of mergers and acquisitions (M&A) worldwide. This comprehensive tax reform will have far-reaching implications for deal valuations, due diligence processes, and post-merger integration. As organisations prepare for this new era of international taxation, understanding the nuances of Pillar Two is crucial for successful M&A activities.

Effects on deal valuations and pricing

Pillar Two is poised to influence several aspects of M&A transactions, particularly with regard to tax due diligence, business valuation, and deal structuring. The new tax regime's group-based approach introduces additional complexity to the M&A process.

Key areas affected include:

• Tax due diligence - The scope of tax reviews will expand to encompass Pillar Two considerations.
• Business valuation - The potential tax implications of Pillar Two may impact the overall valuation of target companies.
• Contractual considerations - Warranties and indemnities in M&A agreements will need to address Pillar Two-related risks.
• Deal structuring - The unique nature of Pillar Two compared to traditional tax systems will require careful consideration in structuring transactions.

New considerations for acquirers

When evaluating potential targets under Pillar Two, acquirers must adopt a more holistic approach:

• Group-level analysis - Pillar Two operates on a group basis, necessitating an evaluation of the target within the context of the entire group.
• Jurisdictional blending - The tax implications of acquiring a target must be assessed in relation to other group entities within the same jurisdiction.
• Accounting focus - Unlike traditional tax systems that primarily rely on tax returns, Pillar Two places significant emphasis on accounting practices.
• Election awareness - Understanding any Pillar Two-related elections made by the target company is crucial, particularly regarding reporting obligations.

Pillar Two’s impact on deal structures and holding company jurisdictions

Pillar Two's comprehensive approach to group taxation is likely to influence deal structures and the selection of holding company jurisdictions:

• Minimum tax rate -The 15% minimum tax rate under Pillar Two may diminish the attractiveness of low-tax jurisdictions for holding companies.
• Tax incentives - The effectiveness of certain tax incentives may be reduced under Pillar Two, potentially altering the calculus for structuring deals.
• Holistic approach - Dealmakers must consider the entire group structure when making decisions about holding company locations, rather than focusing solely on individual jurisdictions.

Pillar Two due diligence: Key focus areas

When conducting due diligence on potential targets, buyers should pay close attention to several Pillar Two-specific areas:

• Revenue threshold - Assess whether the combined entity will exceed the €750 million revenue threshold for Pillar Two application.
• Tax accounting practices - Review the target's approach to current and deferred tax accounting, as these will be significant under Pillar Two.
• Tax liability attribution - Understand how Pillar Two tax liabilities are distributed within the group, as they may not always align with the entity responsible for payment.
• Substance requirements - Assess the target's substance in terms of people and assets, as these factors can positively impact Pillar Two calculations.

Post-merger integration challenges following Pillar Two

The implementation of Pillar Two will add new dimensions to post-merger integration planning:

• Group reporting - Integrating the acquired entity into the group's Pillar Two reporting framework will be a critical task.
• Systems and processes - Aligning tax and financial reporting systems to meet Pillar Two requirements may require significant effort.
• Resource allocation - Ensuring adequate resources are available to manage the increased compliance burden associated with Pillar Two.

Private equity considerations following Pillar Two

Private equity firms face unique challenges in managing their portfolio companies under Pillar Two:

• Fund structures - Careful consideration of fund structures is necessary to avoid inadvertently creating a Pillar Two group across portfolio companies.
• Consistency - Maintaining consistency in Pillar Two approach across diverse portfolio companies may prove challenging.
• Compliance management - Coordinating Pillar Two compliance across multiple portfolio companies will require robust systems and processes.
• Impact assessment - Understanding the varied impacts of Pillar Two on different types of investments within the portfolio.

Industries and transactions most affected by Pillar Two

While Pillar Two's impact is not industry-specific, certain types of businesses may face greater challenges:

• Physical presence - Industries requiring significant physical presence across multiple jurisdictions, such as manufacturing and industrials, may be more exposed to Pillar Two implications.
• Global footprint - Companies with extensive international operations and taxable presence in multiple jurisdictions are likely to be most affected.

Preparing for Pillar Two's impact on future M&A activity

Organisations can take several steps to prepare for Pillar Two's effect on future M&A activities:

• Assess current position - Understand how Pillar Two applies to the existing group structure.
• Scenario planning - Model the potential impact of acquiring entities in different jurisdictions.
• Reporting readiness - Develop robust reporting systems and processes to meet Pillar Two compliance requirements.
• Cross-functional approach - Recognise that Pillar Two is not just a tax issue but an organisational challenge requiring input from multiple departments.
• Strategic planning - Incorporate Pillar Two considerations into long-term M&A and expansion strategies.

As the global tax landscape continues to evolve with the implementation of Pillar Two, dealmakers must adapt their approach to M&A. By understanding the key considerations outlined above and proactively addressing potential challenges, organisations can navigate this new era of international taxation and continue to pursue value-creating transactions.
 

If you have any questions related to Pillar Two, or any other tax matters, please contact our Transfer Pricing or Global M&A Tax services team.