Tax and talent: Hidden hurdles on the path to value creation

By Novella De Renzo and Natalie Nash

Our research shows that too much value is lost unnecessarily in deals. What’s surprising is how much of this lost value is due to human capital; of the companies that lost significant value during their last acquisition, a staggering 82% of companies who say significant value was destroyed in their latest acquisition lost more than 10% of key employees following the transaction.

In the age of the ‘great resignation’, the risk of losing critical talent during or immediately after a deal has risen significantly. According to our latest UK Hopes and Fears Survey, almost one in five UK workers say they are very or extremely likely to change jobs in the coming 12 months.

Our colleagues Victoria McCullagh and Alex Murray have put forward strong arguments for putting people top of the agenda from the outset of a deal. As they say, talent can often be an afterthought in strategic evaluation and due diligence, only moving to the forefront of the agenda once the deal is sealed. There are many reasons why this is an increasingly risky approach, not least a frequently overlooked element – tax and transfer pricing.

Having the right people in the right places

Where people work creates tax risk – through permanent establishment rules, for example. But more than this, the operational design decisions taken during a deal could potentially break an organisation’s tax model. The result could be unforeseen tax penalties, financial cost, inefficient use of resources (because some people have to travel too much), and a distracted leadership that has to spend time fixing problems they didn’t predict.

In any deal, the starting point should be where the business will be heading, not what it is now or where it has been. Management typically devotes a lot of time to the new operating model but talent should always be an integral part of that discussion. Where people work matters, even more so in this new world of hybrid and flexible working.

It matters because to retain critical talent, employers may have to be endlessly flexible over where some people work. And it matters because where people work has profound tax implications.

The reality is that talent, the operating model, organisational design and the transfer pricing model are so closely intertwined that they cannot and should not be separated during deal planning. The new operating model has implications for tax strategy and for talent management; mitigating talent risk and tax risk go hand in hand.

So what can dealmakers do?

There are four main points to remember if you are to maximise deal value:

Start with the asset perimeter – and that includes talent. Who are the critical talents under that perimeter? What skills will you need for the new future, and where are the skills gaps? The asset perimeter will be based on roles rather than the people who fill them, so carrying out due diligence (on the leadership team immediately, and on other employees when the information is available) is essential.
Think beyond leadership. Organisational design and talent mapping should take account not just of the future leadership, but the levels below that. There will be employees – informal leaders – at all grades within the organisation and target company that will have real value in terms of their depth of knowledge, positive influence and importance to maintaining the culture of the organisation. Who are they? How can you make sure that they stay?
Design the target operating model with people in mind. Before locking in tax and transfer pricing commitments, analyse what that means for how people will work within the business to make sure the business model is efficient and sustainable and that the tax model is robustly aligned. Collaboration is essential – if functions are left to design their own operating model independently, interdependencies and wider tax implications will be missed.
Align the operating and transfer pricing model. Where will talent work? What does that mean for permanent establishment? Where will you need to recruit? If you need to set up operations in a new jurisdiction, do you have the people on location that you need? If you are exiting a country, will exit penalties apply?

Organisations often commit significant resources to persuading key talent to stay after a deal, but the tax costs and inefficiencies that result from delaying talent planning could easily eclipse any retention budget. Talent is critical to a deal, not just in terms of identifying and keeping the people you need, but in terms of the tax implications of where and how they work. So think ahead, plan early and take advice. Talent is too important to be an afterthought.