What are Cross-border Transactions?
One of the most commonly used word to describe cross border transactions is international deals. But this does not mean that a cross border transaction is limited to international deals only. A cross border transaction can be defined as the transfer of assets and liabilities of one entity to another entity in a jurisdiction other than the country where the assets are located and where the liability has been incurred. This is known as a cross-border transaction, since assets and liabilities are transferred between two entities, while they are located in different countries or have been incurred in different countries.
FIntalent’s Cross-border transactions consultants define it as an M&A deal that involves two or more buyers/sellers having separate legal entities (separate funds) and individuals (separate shareholders), which together form the same corporate entity i.e. the same legal entity. They are often referred to as international deals since they involve a number of countries and/or jurisdictions. The law that regulates cross-border M&A transactions is not uniform across the world, so there are a few issues that need to be examined when conducting a cross border transaction. The issues involved in a cross-border M&A deal are tax issues, legal issues, accounting issues and currency exchange regulations.
Basic Structures for Conducting Cross Border Transactions
1) A triangular structure, where the target company is located in a different country from the acquiring firm. A triangular structure is often used to take advantage of differences in local tax laws between jurisdictions;
2) A collateralized structure, where the target company and borrowing entity are incorporated in the same country. Here the target company is located in the same country as the acquiring firm and they are wholly owned by a holding company that is incorporated in another country, but the target company has limited or no assets. This structure is normally used to reduce borrowings costs;
3) A non-collateralized structure, where both the target company and borrowing entity are incorporated in the same country, which is usually at a lower tax rate than other countries. Cross-border transactions using this type of structure are often seen as abusive transactions since they result in tax avoidance but not in tax planning. The main reason for this is the information asymmetry where a target company, which may have sophisticated knowledge on its own business, may not be aware of the financial size of the acquiring firm.
The Benefits of Cross-Border Structure
Many M&A transactions are structured as triangular structures because such structures often take advantage of differences in local tax laws between jurisdictions. Currency conversion difficulties also arise when a foreign subsidiary incurs liabilities in a foreign currency and there is no local subsidiary to provide currency conversion services. In such cases, it is difficult for an investor to use a non-collateralized structure.
Cross-border M&A transactions may be structured as non-collateralized or collateralized structures. In a non-collateralized structure, the target company is incorporated in the same country as the acquiring firm and has limited liabilities. This structure is used when there are tax benefits to be obtained from having a foreign subsidiary and/or a VAT deduction for financing costs in the target jurisdiction. However, there are still quite some problems with this structure such as lack of control over subsidiaries and currency conversion difficulties caused by dual currency loans. Such problems can be solved using a collateralized structure, but this leads to greater financial risk and cost of capital. In such a structure, the target company is incorporated in a different country from the acquiring firm and has more assets than liabilities. In this structure, the target company is generally easier to control than a non-collateralized subsidiary.
In a collateralized structure, a foreign subsidiary of the acquiring firm takes over all of the equities and liabilities which are issued by the target company located in another country. This type of structure reduces borrowings costs and eliminates currency conversion issues especially when there is no local subsidiary or dual currency loans.
Advantages of Cross-Border Structure
In a triangular structure, the acquiring firm has a subsidiary in a low tax / no tax jurisdiction. Since the subsidiary is a separate entity, it can take advantage of legal loopholes in that country and reduce its overall tax burden. The main advantage of triangular structures is cost savings, since borrowing costs are reduced due to the netting out of the borrowing costs across entities and the interest earned from different sources can be added. There may also be some tax benefits if one of the subsidiaries has a zero or lower tax rate than other jurisdictions involved.
Cross-border M&A transactions are usually triangular structures in that the target company is incorporated in a separate country from the acquiring firm, so it can take advantage of differences between jurisdictions for tax avoidance. There may also be some tax incentives if one of the subsidiaries has a zero or lower tax rate than other jurisdictions involved.
Disadvantages of Cross-Border Structure
The main disadvantages of triangular and cross-border structures are limited control over subsidiaries and currency conversion difficulties caused by dual currency loans, which are often required to finance assets and liabilities issued by another country. These difficulties can be solved using a collateralized structure, but this leads to more financial risk and cost of capital.
In a non-collateralized structure, the target company is incorporated in the same country as the acquiring firm, which may result in lower tax rates. The main disadvantage of this structure is that there is little control over subsidiaries and no currency conversion.
Benefits of Collateralized Structure
In a collateralized structure, a foreign subsidiary of the acquiring firm takes over all of the equities and liabilities which are issued by the target company located in another country. This type of structure reduces borrowings costs and eliminates currency conversion issues especially when there is no local subsidiary to provide foreign currency exchange services.
In a collateralized structure, the target company is incorporated in a different country from the acquiring firm. The main advantage of this structure is that it has more control over subsidiaries and currency conversion problems can be avoided.
Disadvantages of Collateralized Structure
The main disadvantages of collateralized structures are that they are usually expensive and the financing costs can be high due to the use of derivatives. Furthermore, it is difficult to control such structures, which can result in the foreign subsidiaries acting in an opportunistic manner. This structure may also result in target companies having an extended capital structure and a high level of risk.
Theory behind Acquisition Structures
In order to make the best use of acquisition structures, firms must first ensure that a suitable merger strategy is being followed. This can be done through using a due diligence process when considering potential targets. Due diligence allows a firm to assess the strengths and weaknesses of a business in order to enhance the value of an M&A deal. One example is that firms can use a multi-pronged attack by targeting more than one acquisition structure at once.
The main decision which must be made is whether a firm wants just to get under control, gain market share or increase revenue and profits in foreign markets at the same time. If it is decided that the main purpose of an acquisition is financial, then firms will want to use acquisitions to reduce risk.
Firms can use a triangular structure in order to reduce borrowing costs and maximize interest income. This structure has the benefit of having more control over subsidiaries, but the main disadvantage is that it can reduce profits. If a firm wants just to get under control, then it should use a triangular structure. This structure encourages firms to have more than one subsidiary in different countries because they can benefit from interest income and still be under control.
If it is decided that the main purpose of an acquisition is market share, then firms will want to use acquisitions to gain market share in foreign markets. If the firm wants just to get under control in foreign markets then they should use non-collateralized structures that offer little borrowing costs.
If the main purpose of an acquisition is to increase market share and get under control at the same time, then a cross-border triangular structure should be used. This type of structure has a lot of flexibility in determining which subsidiary will be picked and can provide good opportunities for tax-avoidance.
If it is decided that the main purpose of an acquisition is to increase market share but don’t want to pay too much interest on borrowing more than one subsidiary at once, then a non-collateralized structure can be used. This type of structure will have little control over subsidiaries but there will be less interest expense.
Another benefit of a non-collateralized structure is that it allows firms to focus on the target company and subsidiary without having to worry about currency conversion. This structure has little control over subsidiaries and it does have some currency conversion issues, but it also reduces borrowing costs.
