As we prepared to release our findings, the COVID-19 pandemic was declared, resulting in almost immediate global economic upheaval. Many of the challenges multinationals had been grappling with prior to the declaration — such as Brexit and the U.S.-China trade war — suddenly became less urgent in the face of public health concerns, lockdowns, closed borders, broken supply chains and other realities that continue to evolve. We knew the results from the January survey remained relevant, but we decided to extend the release of our findings so we could put them in the context of the crisis.
CFO Research conducted another survey in April that specifically addressed finance leaders’ pandemic-related concerns. Together, the January and April surveys provide insight into the persistent challenges of international expansion and operations — including M&A activity — along with how those challenges are changing in light of the pandemic.
Experts at Vistra and CFO Research together reviewed the January and April survey results. A summary of the results, along with our observations and conclusions, appear in our recent report Cross-Border Operations Regaining Momentum in 2020 and Beyond.
Saul Howerton had a hand in drafting the survey questions and providing observations that helped shaped the report. He was well-equipped to do so. Saul has spent over a decade providing information and recommendations to businesses expanding and operating across borders. He heads Vistra’s global HR and mobility advisory services and U.S. tax services, along with all advisory services to U.S.-based clients.
We asked Saul to talk about the Vistra-CFO Research survey findings in this interview.
The initial survey was conducted prior to the pandemic announcement, and nearly 9 out of 10 financial leaders said they were considering expanding into a new country. At the same time, about 80 percent of respondents’ companies were already operating in two or more countries outside the U.S. Do these findings surprise you?
The expansion numbers wouldn’t have surprised me at all if this had been a survey of Vistra clients, because we support companies expanding and operating internationally. But the survey was conducted by CFO Research and didn’t involve our client base. These were financial leaders from essentially a random sampling of U.S. companies with over $100 million in revenues, so in that sense the numbers are striking. They speak to how almost all companies of a certain size regard cross-border operations as essential to their success. This in turn speaks to how globalized our economy has become.
Do you find that interest in expanding across borders has waned during the pandemic?
I wouldn’t say that interest has waned, though given lockdowns, restricted borders, supply-chain disruptions and general economic headwinds, it’s certainly true that many companies are taking a wait-and-see attitude. The report makes the point that companies are pausing rather than abandoning plans to expand internationally, and I think that’s right. This strategy makes a lot of sense, and I think most experts agree that 2021 will be a period of strong recovery and growth. I saw recently the IMF projected worldwide economic growth of over 5 percent for next year. [See the IMF’s projections here.]
You mentioned supply chains, which were a topic of concern in both the pre- and post-pandemic surveys. Was it a surprise to you that finance leaders expressed concern about their supply chains even before the coronavirus crisis?
It certainly makes the first group of respondents look like they were forward-thinking and concentrating on the right issues! Of course, as I mentioned we live a globalized economy, so a preoccupation with supply chains is almost inevitable. The initial survey responses are also a reminder that we weren’t exactly living in a period of absolute economic certainty or stability before the pandemic. We had Brexit and the U.S.-China trade war, all of which led to concerns about tariffs and other trade issues that affect supply chains. We were also living — and of course still live — in an evolving, increasingly restrictive regulatory environment, including transfer pricing, data protection and other global regulations that make maintaining supply chains challenging. In many cases, you have to also ensure your supply chain partners are compliant in order to reduce your risks, it’s not just a matter of ensuring compliance at your own company.
The January survey revealed that a significant number of respondents had little confidence that their organizations were keeping abreast of regulatory changes in all their countries of operations. Is that your experience when working with clients?
Yes, this is a very common client discussion because the global regulatory landscape is constantly changing. Staying on top of evolving local regulations, especially at present, is critical to not only stay compliant, but also benefit from recent pandemic-related incentives, such as those related to tax and payroll. Obviously, when you’re remotely managing a global operation, the challenges grow exponentially.
Can you give an example of a major area of recent regulatory change?
There are many, from stricter transfer pricing obligations to economic substance laws to new digital services taxes. One good example is the evolution of data protection obligations, especially the EU’s General Data Protection Regulation. The GDPR has been in effect for just over two years now, and before that, data protection may not have been a major concern for U.S. multinationals. In our January survey, it was a top concern. Again, here’s an area where you don’t just have to comply as one organization. Companies can be held liable for instances of data breaches caused by them or their partners. Here again we’re confronted by the global nature of our economy. U.S. companies have to comply with the GDPR because virtually all U.S. companies do business with EU-based customers and many have EU-based operations.
Why do you think regulations are proliferating and changing so rapidly?
I think laws always have to change to keep up with certain realities and global business themes. Certainly permanent establishment laws — which dictate when a company has a taxable presence in a country — are evolving to account for the reality of cross-border digital services that don’t involve a traditional physical presence in the customer’s country. Many countries, such as France, the UK and India, are implementing or have recently implemented digital services taxes to try to capture revenues from e-commerce transactions. I’m not surprised that in the January survey, 16 percent said their companies were not well-equipped to comply with cross-border e-commerce requirements, since those requirements are changing so quickly that it’s hard to keep up. But companies need to have policies and procedures in place to ensure they do keep up, that they understand the changes and follow them. Non-compliance is not just a matter of fines, but of reputational damage, which can be widespread and swift with both traditional and social media.
A significant number of respondents to the January survey — about 15 percent — said their organizations were either not equipped or poorly equipped to fulfil regulatory obligations related to mergers and acquisitions. That was a top response. Does that surprise you?
In some ways I’m surprised that number isn’t higher. But if you haven’t previously engaged in a cross-border M&A, the chances are you don’t appreciate how complex the local compliance obligations can be. As we often say, “You don’t know what you don’t know.”
On the other hand, the January survey showed that 97 percent of companies were engaged in cross-border M&A, and the April survey showed only 8 percent of companies were delaying acquisitions or takeovers. This shows not only how prevalent cross-border M&A is, but also how companies regard it as an essential element of success. So in that sense, the high percentage of companies that are poorly equipped to deal with compliance obligations related to M&A is a little surprising.
Could you give some examples of the challenges of M&A regulatory compliance?
One of the major challenges of M&A is the fact that there are considerations beyond regulations, such as cultural expectations and local salary and benefits norms which are not necessarily mandated. Acquiring a company or part of a company in another country can be beneficial for a number of reasons, including the fact that you’ll be acquiring employees who know the local laws, market and culture. But you’ll want to do your homework and get third-party advice about the new market as well. I often joke that local employees will be sure to tell you that a company car or transportation allowance is “standard,” but is it? As for cultural expectations, a bad cultural fit is often cited is a primary reason why M&A deals don’t succeed in the long term. Here again, you need to perform due diligence to determine how closely your corporate culture aligns with local cultural norms and with the company you’re acquiring.
So are the compliance obligations related to M&A simply the same as those of traditional international expansion and operations?
In some ways yes, in that you have to fulfil local payroll-related laws when paying your new employees, have a local legal entity in place if you don’t have one already or aren’t acquiring one, etc. In my experience, though, U.S. companies engaging in a cross-border asset deals are often surprised by the target country’s strict laws related to transferring employees. For example, in many countries, the buyer must ensure the acquired employees have the exact same level of benefits they had before the acquisition. This becomes challenging if the size of local operations is vastly different between former and latter companies. You’ll also need to comply with any existing collective bargaining agreements. It can be very different from acquiring a U.S. company or division, where you have more freedom to change the acquired employees’ benefits and even terminate them if you wish. In many other countries, that’s simply off the table.
Any other pitfalls related to M&A?
There are many to watch out for, unfortunately, but I’ll mention just one more. You might think of acquiring a company as in some ways like getting married, in that you’re going to take on that person’s — or in this case company’s — financial and regulatory prior lives. Here is another critical area of due diligence: you need to ensure that the target company is compliant with local employment and tax laws to avoid delays in the deal process and possible fines and administrative headaches after the fact.
Is there anything else from the surveys that we haven’t covered that strikes you as particularly relevant to our global situation now?
Sixty percent of the respondents to the pre-pandemic survey said their organizations were considering or engaged in reviews of their legal entity structures. That number might strike some people as unexpectedly high, but it’s in some ways just another sign of our global economy and the prevalence of cross-border acquisitions. Many multinationals these days have grown primarily through acquisition, and even if they engage in more traditional international expansion, they may find themselves with a sprawling global footprint. As a result, many of their entities may not be providing value. We perform legal entity reviews for clients — they’re also called legal entity rationalizations — and it’s sometimes the case that we actually uncover legal entities that HQ didn’t even know they had. Not only can this be a needless financial burden, it poses a serious regulatory risk, since if your entities aren’t compliant with tax and other regulations they can get hit with fines.
I feel in our current global economic reality legal entity rationalizations will become even more popular with multinationals than they were just a short while ago. Rationalizations will be key to maximising tax and operational efficiencies as companies look to recover and thrive in 2021 and beyond.
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