Optimize PE tax strategy via self-reflection

tax optimizationAll too often the tax function in an organization is viewed as simply a cost center. The C-suite’s general focus, and rightfully so, is to make sure the organization effectively uses and deploys its capital, i.e., neither overpays nor underpays taxes. The point is to manage costs to preserve and deploy capital to drive future organizational value. But erroneous assumptions can lead organizations to pass up on opportunities to maximize value. As in the “Matrix” movie, the choice is between perception — a compliance-based tax function and related cash outflow are acceptable — and reality — a profit center can be produced by collaborating with operations on a tax strategy. Choosing reality is the start to discovering hidden rewards.

There’s much more to the tax value equation than meets the eye. An optimized tax strategy tailored to key performance indicators “wraps around” your business growth strategy and can supercharge your private equity investment returns.

Operational and tax strategies are inextricably bound Like all activities in business, tax strategy is based on a value proposition. The value proposition, according to many stakeholders, is owned by the internal operations group. It follows that the tax team should work closely with the operational team to uncover benefits and co-develop a sound tax strategy. The tax strategy becomes a “wrapper” around the business operational plan.

For more about the optimizing the tax function to drive value, register to replay the Oct. 31 webcast, Tax optimization strategies for private equity. The discussion provides an overview of tax optimization opportunities and risks across a portfolio.This perspective is a departure from tradition. Historically, a stakeholder concentrated on value creation through financial engineering or the opportunistic entry and exit points in an investment. Today’s environment demands that stakeholders focus on driving value through optimizing core operational capabilities, which may include reconfiguring supply chains, relocating facilities, analyzing the efficiency and capabilities of the core corporate operations such as benchmarking cash taxes against competitors. The common linkage in these actions is taxes. A sound tax strategy plays an integral role in any operational evaluation and execution, whether through incentive-based programs by government mandate, devising a plan to minimize tax leakage on synergy realization, or optimizing the tax reporting structure.

The time is right for this approach. Competition is high in the private equity space, and investors are more sophisticated than ever before. They’re scrutinizing the way returns are produced, looking for sustainable value. Proof of a portfolio’s worth can be delivered in an accounting of optimal operational and tax functions. “More equity groups are focusing on tax optimization,” said Grant Thornton Partner in Transaction Advisory Services Tom Freeman. “Why now? To be best-in-class.”

Review the business operational strategy, then consider the tax wrapper To maximize value, it is critical to assess the overall business and then align the business and tax strategies. The first step is assessing the organization’s strengths, weaknesses, opportunities and threats. Next is identification of value-creation opportunities and challenges. Then, a value-driven tax strategy is established to augment the business plan. Areas of attention could include product sourcing, strategies to assist in facility openings or closings, and understanding state, city and local taxation benefits and/or clawbacks. The focus on tax is for not only minimizing tax and developing synergies, but also understanding dis-synergies.

Take steps to maximize value
1.  Assess the organization’s strengths,      weaknesses, opportunities and threats
2.  Identify value-creation opportunities and      challenges
3.  Establish a value-driven tax strategy
This is key, said Grant Thornton Managing Director of M&A Tax Services Barry Grandon: “There have been instances of companies studying a series of operating locations and deciding, based on utilization statistics, to move production from Plant A to Plant B. But they failed to realize that the shuttering of Plant A has a significant clawback on historical state or local benefits. If the order were reversed, there would be no clawback. It is not uncommon to see the dis-synergy value not being considered unless the operations team is talking with the tax team. These situations are tough to deal with after the fact, when everyone has had a belated epiphany that there is a significant liability due to the state or local government tax structure. Getting the operations and tax teams together is the way to achieve your business objective with better results.”

To ensure harmonized business and tax strategies, take inventory of your tax position. “Get an overview of areas to pursue, then take a deeper dive into high-value areas that your business strategy has identified,” advised Grandon.

A thorough current-state assessment or “tax physical” reveals the status of your operations, as well as opportunities to advance to a future state. The assessment might include:
  • Benchmarking effective tax and cash tax rates
  • Identifying quick hits, and short-, medium- and long-term tax opportunities
  • Determining the vulnerability or impediments on using tax attributes  
  • Evaluating tax and tax-related inefficiencies, e.g., if your organization’s legal chart is unduly complicated, causing an internal and external cost drag
  • Identifying straightforward issues, e.g., mismatch of income and expense, failure to assess carryback claims.
  • Identifying more subtle income and non-income-tax technical issues related to the organization, e.g., revenue recognition, industry-specific issues, and sales/use

Compare the company’s cash tax rate to industry-specific cash tax rates to gauge how your organization stacks up against its peers. Examine the leverage profile of various peers. “For a public company,” said Grandon, “there is a significant amount of data in the public domain. For private companies, data can be much tougher to come by unless you start pulling data by SIC codes that have relevance.”

Collaboration between the operations and tax teams — sharing plans, concerns and goals — produces practical, real-world strategies to strengthen the business and drive value through the organization. The result is a company poised for growth and delivering superior investment returns.     

Learn more
Register to replay the Oct. 31 webcast, Tax optimization strategies for private equity, for a discussion of optimizing the tax function to drive value for private equity investment professionals and executives at their portfolio companies, as well as an overview of tax optimization opportunities and risks across a portfolio.

Barry Grandon
Managing Director
M&A Tax Services
T +1 212 542 9690

Tom Freeman
Transaction Advisory Services
T +1 216 858 3700

Melanie Krygier
Senior Manager
Tax Services
T +1 415 318 2202