The top 5 mistakes made during IBR restructuring projects (and how to avoid them)
February 2023
An extended version of this article was first published on 20 January 2023 on the Tiang & Partners website. Tiang & Partners is an independent Hong Kong law firm that works closely with PwC.
A corporate group may have many objectives in mind when it embarks on a solvent corporate restructuring, also known as an International Business Reorganisation (IBR) project. IBR projects may be undertaken to achieve operational changes, tax-optimised structures, entity rationalisation/simplification, business separation, pre-IPO tidy-ups, to accommodate changes in law or tax rules or indeed for many other reasons.
As a result, many advisors and disciplines are likely to be involved. In addition to tax and accounting input, legal support is likely to be needed from various advisory teams to support the project, not only in different jurisdictions but also in different areas of specialisation (corporate, finance, intellectual property (IP), employment, etc.). Such advisors may be in-house teams, or they may be external advisors, depending on the characteristics of a particular project (for example: its scale and complexity, urgency, available resources, local law capabilities, budget and so on).
Whilst all those involved in an IBR project strive to ensure the reorganisation proceeds smoothly, this article explores the darker side of what can go wrong and the mistakes that may haunt the unwary. Some of these mistakes entail minor hiccups and inconvenience, but others may lead to major headaches. Crucially, we also consider how such mistakes can be avoided, as those forewarned are thereby forearmed.
Failing to take adequate tax advice and produce a restructuring steps plan
Typically, a tax (and later legal) structuring paper or steps plan forms the basis or ‘road map’ of an IBR project. The steps plan will set out the objectives of the restructuring together with the relevant legal entities involved as well as document, in chronological order, the proposed implementation steps to be undertaken. More importantly, it will set out any material tax implications from the proposed steps (and in due course legal implications) – this is critical for assessing the risks of effecting the restructuring or otherwise considering any alternative steps that may be able to reduce or mitigate relevant risks.
Common tax issues resulting from an IBR project could include capital gains tax (on direct or indirect transfers of assets), transaction and transfer taxes (including stamp duties) that arise when transferring assets/shares, indirect taxes (GST / VAT) and even withholding taxes arising on any cash or other distributions to be made through the corporate structure.
Without a proper tax and legal steps plan (be it a short-form strawman or a detailed restructuring analysis paper), the project team may struggle to easily identify the documentation required to effect and implement the project or to anticipate potential difficulties with its implementation. Further, absent a thorough consideration of tax and legal issues and risks, there could be unexpected exposure in the future, which may need to be rectified or be further negotiated if, for example, the business is later divested (noting that rectification mechanics can often end up being more complicated than simply effecting a correct implementation from the get-go).
Failing to do a legal feasibility assessment
Not involving competent legal advisors (in-house or external) or involving them too late in the process can have major implications on the proper finessing of steps and the timeline to implement them. Some examples follow:
- Failing to check the provisions of important contracts and of constitutional documents – A change of direct/indirect control or shareholding in the course of a restructuring could potentially trigger a change of control clause which automatically terminates or grants the counterparty a right to terminate the relevant contract. Likewise, the existing constitutional documents of a relevant entity may not allow for intended steps such as capital reductions, distributions of assets as dividends in specie / in kind, alterations to share capital or may prohibit certain borrowings. Failure to act in accordance with the requirements prescribed by constitutional documents or the law can lead to void or voidable transactions and expose the entities and directors involved to the risk of claims from shareholders and third parties such as creditors.
- Failing to address minority shareholdings in the structure – in particular where the IBR project involves a distribution of assets/shares up through a chain of entities and one or more entities in the chain has a minority shareholding. It is also necessary to check the rights of the parties under any shareholders’ agreement, joint venture agreements or other similar shareholder governance documents and accommodate those rights and/or obtain any required or advisable consents.
- Providing for insufficient or improper consideration/value for transfers of non-cash assets – Transfers as a gift or without adequate consideration can also often cause tax and legal issues. Where consideration is given, the team will also need to consider in advance how assets are to be valued (for example, net book value or fair market value) and whether there are any other requirements to be met. Getting this wrong can cause directors to be in breach of their corporate duties and result in issues if there is any subsequent entity insolvency. The consideration used for transfer will also potentially have an impact on the amount of tax on gains (if relevant) as well as the amount of any applicable transfer taxes.
Providing for unnecessarily complicated restructuring steps
Unnecessary complexity can result in additional time and cost during the implementation phase. The basic rule is to always use the simplest restructuring steps possible to achieve the final structure, and complexity should be added only as required to address a particular concern (be it a practical concern, a tax concern, a legal concern, an accounting concern or otherwise). Sometimes the determination of what is the ‘simplest’ approach is not without its own challenges.
Piecemeal input and advice from different stakeholders can also result in an overly complex restructuring plan, which can then be difficult, costly and time consuming to implement, or worse, may result in conflicting steps. It is therefore important to appoint a lead team who can manage the overall planning and implementation of the restructuring exercise (and it should not be underestimated how much work is involved in this kind of legal project management or how much value an experienced IBR lead-team can add to a project – see the next top mistake which discusses this point directly).
Underestimating the amount of project management work
It is all-too-easy to see an IBR project as a series of steps, each of which is, in and of itself, simple; therefore an IBR project should be simple. Unfortunately, this is rarely the case. The reality is that as the number of steps, entities, jurisdictions and advisors increase, an IBR project often gets exponentially more complicated with each addition.
It is not uncommon for a medium-sized IBR project to entail a hundred (or several hundred) legal implementation documents, each governed by different laws and drafted by different teams. Albeit that many of these documents may be simple, managing the comments from the in-house teams and any relevant advisors (such as tax, legal, accounting and any relevant sub-specialisms and jurisdiction-specific advisors) and ensuring a consistent approach that is based on the agreed steps plan is always a major workstream in and of itself. Underestimating the amount of project management work can be a recipe for disaster, as it can lead to deadlines being rushed or missed (and these deadlines can sometime be hard deadlines).
In a similar vein, sometimes corporate groups overlook the possibility of supporting a project with technological and/or scaled delivery solutions to enhance project management, delivery standards and/or efficiencies. Part of the PwC value proposition is that clients can leverage the various global PwC service delivery centres (including their paralegal capabilities), as well as jurisdiction-specific corporate secretarial functions, and utilise intra-network software and technology in the course of the team’s work. The team can deploy such resources on IBR projects to the extent that doing so best-facilitates the needs of the particular client and the particular objectives entailed in each project.
Failing to consider the accounting treatment of transactions
Although this is sometimes seen as an afterthought or a post-transaction requirement (which is why we list it last!), failing to consider the accounting treatment of transactions can result in transactions that work from a legal and tax perspective but are not accounted for properly from an accounting perspective, or which may have unintended implications in the future. As mentioned above, failure to properly consider accounting guidance around distributable profits can result in the breach of the relevant companies legislation, particularly for transactions that are characterised as ‘deemed’ or ‘de facto’ distributions from an accounting or legal perspective.
A particular example we have seen would be issues with potentially inappropriate allocation of ‘grandparent contributions’ (i.e. from a company to its indirect subsidiary) to share capital, share premium or merger reserve accounts. This can potentially leave cash trapped in entities and cause ongoing confusion, necessitating corrective advisory work and incurring further costs. Where helpful, we are able to involve an accounting advisory team to advise on the proposed accounting treatment for reorganisations in advance (before accounts are formalised and submitted for audit). Otherwise, once the audit cycle following a restructuring has completed, it can be extremely difficult to make corrective changes to address such issues.
Takeaways
It may seem obvious, but the key solution to the above problems is to ensure proper feasibility work is carried out at an early stage of the project (covering legal, tax, accounting advisory and valuation, each to the extent necessary). If you are interested in exploring this topic further, you can read an earlier article on legal feasibility assessments in IBR projects.
We are always happy to discuss potential IBR projects with prospective clients, and to work towards preventing the kind of mistakes discussed in this article to ensure that your IBR project is a roaring success.
The information contained in this document is of a general nature only. It is not meant to be comprehensive and does not constitute the rendering of legal, tax or other professional advice or service by PricewaterhouseCoopers (“PwC”) and Tiang & Partners. PwC and Tiang & Partners have no obligation to update the information as law and practices change. The application and impact of laws can vary widely based on the specific facts involved. Before taking any action, please ensure that you obtain advice specific to your circumstances from your usual PwC client service team, law firm contact or your other advisers.
The materials contained in this document were assembled in February 2023 and were based on the law enforceable and information available at that time.
This publication was jointly published by PwC and Tiang & Partners. Tiang & Partners is an independent Hong Kong law firm that works closely with PwC.
© 2023 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.
© 2023 Tiang & Partners. All rights reserved.
