Why legal entity restructuring transactions require careful planning

Legal entity restructuring can be very beneficial in achieving the following objectives:

• Better alignment of tax, regulatory and operational issues, from a holistic perspective, to allow flexibility with regard to future organizational or business system changes.
• Centralization of functions, contracting, risks, and intangibles within key regional hubs.
• Consolidation of recent acquisitions and creation of a platform for expansion into new markets.
• Flexible deployment of cash throughout the organization.
• Competitive global effective tax rate.

Although transactions vary, almost every transaction — from acquisitions, to divestitures, to Up-C IPOs — will have overlapping tax, treasury, statutory, and consolidated accounting implications (see diagram). Cross-border transactions are further complicated by the jurisdictional nature of tax laws, foreign currency considerations and local GAAP requirements.

Challenges and judgments

Many developments resulting from restructuring can create challenges and judgments that could impact financial reporting, such as:

• Foreign currency exchange gains and losses
• Consolidation or deconsolidation of some entities
• Potential gains from distributions
• Accounting for income taxes, including book vs. tax differences
• Common control transactions
• IFRS vs US GAAP differences
• Accounting for intercompany debt
• Potential new basis if pushdown accounting is not applied
• Segment reporting, including changes in the reporting packages

Also, reorganizations often involve detailed transaction step plans, which require a careful evaluation of the accounting implications. Some plans can include hundreds or more transaction steps that need to be closely evaluated.

Examples

Restructuring takes many forms, but a couple of examples help illustrate some of the issues companies need to identify and address:

Regional support restructuring

Company X expanded globally but is decentralized. X decides to implement a regional support structure aligned globally with regional management. Its objectives include: aligning tax, regulatory, and operational issues to create flexibility for future organizational or business system changes; centralizing functions within regional hubs; consolidating recent acquisitions and creating a platform for expansion; future flexible cash deployment; and a competitive global effective tax rate.

X’s proposed internal restructuring could impact several areas:

• Foreign currency exchange gains and losses could arise when X uses intercompany notes denominated in a different currency than an internal entity’s functional currency, or when two internal entities have different functional currencies.
• Consolidation or deconsolidation of selected subsidiaries with multiple owners, depending on whether another X entity requires consolidated financial statements.
• The parent could also potentially recognize a gain from a distribution in excess of capital. This gain would be included on a “stand alone” financial statement.
• Consideration of country-specific tax laws for any distributions and recognition of deferred taxes, as well as assessment of deferred taxes in multiple jurisdictions.
• Ability to apply hedge accounting for certain strategies may be affected.

Legal entity restructuring, with foreign branches

Company Y, a U.S.-based multinational manufacturer changed its legal structure seeking tax benefits and operational efficiencies. Y opened branches in three European countries. Subsequently, three existing European legal entities (that are also part of the consolidated group) transferred a portion of its business (“Domestic business”) to the newly created branches. Y funded the transaction by transferring cash to the parent company of the branches, which then transferred the cash to the branches for the acquisition of the domestic business.

The restructuring impacts a variety of areas:

• Depending on the functional currency determined for the parent entity of the branches, the loan from the U.S. entity will create foreign currency exchange gains and losses that survive in consolidation.
• Management must determine whether the sale of the domestic entities is the sale of assets or the sale of a business between entities under common control. The resulting intercompany accounting will create deemed dividends and capital contributions due to the difference in the carrying amount of the net assets and the fair value consideration, resulting in changes to the outside book basis for the Company’s investments.
• Common control transactionscan affect the prospective basis of the assets/liabilities transferred. If the carrying amounts of the assets/liabilities transferred differ from the historical cost of the ultimate parent, for example (because pushdown accounting had not been applied) then the financial statements of the receiving entity should reflect the transferred assets/liabilities at the historical cost of the ultimate parent.
• Potential US GAAP and Local GAAP differences.

How PwC can help

These examples illustrate a few of the issues that can arise during restructuring. Our Capital Markets and Accounting Advisory Service (CMAAS) specialists can help you navigate many types of restructuring transactions, including:

• Conducting an early review of the restructuring plan to identify potential accounting implications.
• Partnering with your tax team to identify tax-related issues.
• Conducting an initial assessment and documenting accounting implications under applicable guidance (i.e., US GAAP/IFRS).
• Coordinating with CMAAS foreign teams to identify and assess local regulatory, legal, and accounting
• Drafting accounting entries, including consolidation considerations and tax implications.

An early, cross-functional approach can yield significant benefits, including:

• Early identification and evaluation of key financial reporting implications, including common control, FX, consolidations, and income taxes.
• Better alignment between accounting and tax specialists.
• Documentation detailing the financial reporting implications for each step within the plan.

Contact your PwC advisor to discuss the details of your transaction.