Assessing the current and future deal environment in automotive.
A panel of KPMG tax and advisory professionals, moderated by KPMG’s Managing Director of M&A Tax, Katy Chapman, led the Automotive Executive Forum audience through a lively discussion about joint ventures, tax strategies, and driving value in partnerships.
Lenny LaRocca, a partner in Financial Due Diligence, expects 2019 will be an exciting year for deals in the automotive sector.
“What we're seeing in the market right now is a lot of really cool joint ventures and a focus on the future of mobility,” he said. However, he also was quite candid about potential issues and challenges that the automotive sector is waking up to. “In order to play in the future, it's going to be very expensive.”
As such, the deal market has become more energized among core automotive suppliers such as in steel, casting, and plastic injection molding, LaRocca said. Companies are looking to do everything from consolidating their footprint to growing internationally and expanding their customer base, as well as increasing their product portfolio.
However, there has been a struggle to launch new technologies and well as absorb tariffs, among other issues, “so we’re seeing some distress in the space as well,” he said. “That's all leading to transactions, and I think there’s going to be more to come in the next year or so.”
Deal activity today isn’t always leading to an expected return on investment, LaRocca said. “There's been a lot of M&A that...doesn't really generate the value that people really were hoping for,” and companies are truly starting to address that shortfall. They are asking more questions about potential synergies and performance improvements in the due diligence phase.
“When they go into do a deal, it's not just a traditional, ‘let's kick the tire, let's do the due diligence, let's figure out where the risks are.’ It's really turning more focused on ‘how are we going to really create value with this transaction.’”
Phillip DeSalvo, a principal in M&A Tax/Partnerships, noted that about twice as many partnerships than corporations are being created in the U.S. today, and he offered three reasons why these flow-through entities are popular.
The first benefit is flexibility in issuing varying types of equity interests to sponsors or management. “It's a little easier to get into a partnership,” he said, noting that corporations have to meet certain control requirements to create a tax-free organization that don’t apply in the partnership context. “Pretty much at anytime you can influx new cash, new assets, whatever you need in the joint venture, and there's typically no tax to the contributing party.”
The second benefit is that during operations there's only one level of tax. “If you have two corporate taxpayers, that benefit is a bit muted, but in your typical context when you have private equity that's investing in partnerships, it's really beneficial to have that one level of tax,” DeSalvo said, adding that corporate parties can strip out cash, so tax is deferred.
The third benefit involves disposition and increased value delivered to the buyer. “A buyer gets to use a step-up to offset tax income in the future, and therefore...the buyer is willing to pay a little bit more for a partnership than it would for a corporate entity,” he said. Generally, a prospective buyer will pay a premium for the ability to obtain a stepped-up tax basis in the acquired assets from, for example, corporate asset sales, partnership asset sales, or the sale of partnership interests versus a sale of corporate stock.
DeSalvo also cited a number of common risks for operating partnerships, such as inaccurate historical tracking of I.R.C. Section 704(b) and tax capital accounts. In particular, when the partnership owns I.R.C. Section 704(c) property, detailed tracking of the capital accounts is necessary to properly allocate items among the partners.
Other risks involve the issuances of profits interests or options; non-pro rata contributions by partners and non-pro rata distributions from the partnership; and the so-called “mixing bowl” rule that prohibits one partner from putting an asset into the partnership and then sending that asset out to another partner.
Ron Dabrowski, principal, Washington National Tax, discussed new issues involving foreign tax credits and global M&A. He noted that since U.S. multinationals are subject to a worldwide tax base, assets that are invested or transferred through transactions create a ripple effect across various tax regimes based on domestic and foreign tax codes. A number of these provisions have cliffs and clawbacks; BEAT can be a concern; and taxes or expenses might not be deducted. Companies need to question how they could be impacted.
“Can you actually achieve the goal that seems to be out there and the opportunity that's out there? And then certainly for domestic but more for international deals [is] the risk element. What are you actually buying in terms of tax risk? What are the company's postures around the globe?”
Dabrowski said that the market is showing more variability on both the buyer and seller side, with more potential outcomes based on tax.
“I'm selling to X and I know X and they have their attributes, but if I'm selling and I don't know who the buyer is yet [or I’m dealing with] different buyers and different perspectives, the deal will happen differently because of tax and tax planning.”
He concluded by noting that the challenges of current audits, changes in tax law, and greater due diligence were all being addressed in the face of increased pressures to do more deals, faster. “It's all sort of on the table, and as much as anything, this becomes a prioritization exercise in this period of uncertainty and tax.”
To access this panel’s presentation, please click here.