Vistra Insights

Legal entity rationalisation and beyond: Optimising your organisation

Early this year, CFO Research and Vistra conducted a survey of over 200 CFOs and other finance executives from US$100 million-plus companies. The companies were primarily U.S.-based, but virtually all were multinational organisations. About 80 percent were operating in at least three countries, and nine in 10 were engaged in cross-border mergers and acquisitions.

The survey was conducted just prior to the coronavirus pandemic declaration, but the above numbers speak to a truth that’s unlikely to change any time soon: In our global economy, large and medium-sized companies tend to be international concerns that expand in part through cross-border M&A. 

As multinational organisations grow through acquisition, organically or some combination, their corporate structures become increasingly complex. It’s not uncommon for an organisation to grow so fast it actually loses track of all its legal entities, which can be scattered in various countries around the world. This lack of insight and control can lead to major inefficiencies and compliance risks.

To optimise their structures and reduce risks, multinationals must regularly take stock of their entities. Conducting these evaluations and taking subsequent action — a process commonly called legal entity rationalisation — is critical in part because maintaining entities can be costly and administratively burdensome. Each country has its own entity types and related compliance requirements — such as those related to tax and accounting — that are subject to change. Non-compliance with these requirements can lead to fines, reputational damage and even restrictions on operating in the relevant country.

Essentially, rationalisations account for an organisation’s entities and help determine if they’re all necessary. Rationalisations can identify potential cost savings that may be realised through consolidation and/or winding down certain entities.

Most CFOs of multinationals are well aware of the benefits of legal entity rationalisations. In the CFO Research-Vistra survey, a full 61 percent of respondents said their companies were at the time considering or engaged in legal entity rationalisations. The top two reasons they gave were cost savings related to entity maintenance and the simplification of their corporate structures.

The report analysing the survey results points out that it’s reasonable to assume legal entity rationalisations will become even more widespread in the future. Organisations that undertake them will achieve cost savings and structural efficiencies that will better position them to thrive as they recover from the effects of the pandemic.

A holistic view of rationalisations

While the steps involved in conducting a legal entity rationalisation are varied and occasionally complex, the concept of examining a legal structure for potential inefficiencies and compliance risks is a simple one that can be applied to all areas of an organisation. Needless to say, in an era of prolonged economic headwinds, business leaders are looking to optimise their respective businesses in any way possible, and a comprehensive rationalisation effort can provide long-term value.

The rest of this article provides brief summaries of areas other than legal structures that may benefit from rationalisations. In some cases, these other types of “rationalisations” may be more commonly referred to as reviews, audits, health checks or by other terms.

Whatever terms you use, multinationals looking to take a holistic approach to optimising their organisations should consider undertaking rationalisations in the departments and practice areas below. These — and the related review areas listed by bullets — are not intended to be exhaustive. (For example, we don’t address such important subjects as accounting and intellectual property.) They are rather intended to highlight the kinds of business areas and functions executives should consider when developing an organisation-wide rationalisation strategy.

You should consider each rationalisation area in light of any new organisational goals and strategies, and in light of each country of operation. For example, in the area of HR, each country has its own regulations, cultural expectations and norms related to salaries, benefits, office behaviours and more. As a result, there can be no such thing as a “global HR policy.” Consider also that public health challenges, political trends and other factors can change regulations and cultural expectations overnight, which can in turn expose organisations to new risks and liabilities. As a result, rationalisations should be conducted on a regular basis.

HR rationalisation

For most organisations, labour expenses are the biggest cost of doing business, comprising salaries and other rewards, benefits, social security and income taxes, and more. Managing a global workforce is particularly costly and challenging. Each country (and in some cases each jurisdiction within a country) has its own evolving regulations related to hiring, termination, vacation time, benefits and more. Here are some common areas to review during an HR rationalisation:

  • Employee handbooks and other policies
  • Recruitment practices
  • Orientation and training practices
  • Practices related to collecting and maintaining employee information
  • Employment contracts
  • Compensation and benefits, including benchmarking
  • Benefits management
  • Termination practices
Corporate governance rationalisation

Sound corporate governance reduces risk and promotes regulatory compliance, and assures investors and other stakeholders of a business’ integrity. A corporate governance rationalisation will in fact typically involve a legal entity rationalisation, in part to ensure that each entity is compliant with applicable laws and regulations. Here are some other areas to review when conducting a corporate governance rationalisation:

  • Corporate governance frameworks and relevant adopted codes
  • Registered offices and locations
  • Company secretaries and locations
  • Annual compliance obligations for each office, including required filings
  • Entity management policies and practices
  • Board and committee practices and effectiveness
  • Terms of reference (TOR)
Supply chain rationalisation, including transfer pricing and VAT

Supply chain management has always been a complex and essential part of running any multinational organisation. The importance of supply chains has recently been thrown into relief by trade wars, the pandemic and other factors. Scrutinising the many regulatory areas related to supply chains is more important than ever. A supply chain rationalisation should include a review of the following:

  • Vendor contracts
  • Vendor controls
  • Indirect tax (VAT/GST) obligations
  • Transfer pricing rules, including country-by-country reporting obligations
  • Immigration policies and practices related to supply chain maintenance
  • Updated tax laws, including those that might provide reliefs, incentives and benefits.
Data protection controls rationalisation

The CFO Research-Vistra survey indicated that data protection was one of the respondents’ top three compliance concerns related to global operations. The EU’s General Data Protection Regulation — widely considered the gold standard of data privacy regulations — has been in effect for over two years now, and compliance with it and other country-specific data protection laws is more important than ever. Penalties for non-compliance can be steep — the greater of up to 20 million euros or 4 percent of annual global turnover in the case of the GDPR — and reputational damage is a major concern. Few areas of negative publicity can rival that of a data breach. Here are some areas to consider when conducting a data protection controls rationalisation:

  • Data protection policies and handbooks
  • Cybersecurity controls
  • Data management
  • Data transfers, including cross-border transfers
  • Data breach procedures
  • Data controller registrations
  • Vendor data controls and agreements
  • E-commerce activity
Global mobility controls rationalisation

With the rise of remote work and a general trend of tightening immigration controls, managing employee global mobility is an increasingly complex and risky business area. Expat assignments don’t just involve visas and work permits. They can also trigger tax presences, social security and payroll tax obligations for the employer and employee, the need to establish shadow payrolls, and more. Here are some areas to consider when conducting a global mobility rationalisation:

  • Global mobility policies
  • Expat compensation schemes, such as tax equalisation policies
  • Systems to track workers’ cross-border assignments
  • Locations of expat employees and related tax and social security obligations
  • Shadow payrolls
  • Visa sponsorships and work permits
  • Third party expat services, including moving and repatriation services
Legal affairs rationalisation

Just as legal structures can get extended and complicated, so can the rights and obligations — and the assets and liabilities — that lie within those structures. For example, a company or private equity firm that performs adequate legal due diligence on a major acquisition may be inclined to relax those procedures when vetting future deals. This tendency is particularly common when later acquisitions are part of a buy-and-build strategy involving small companies that are consolidated. When the buy-and-build phase ends, the acquirer is often left with a tangle of legal questions, such as: Which entities own what assets, and what are the outstanding debts of each entity? The acquirer is faced with an increased risk of defaults, a lack of clarity on title to assets, and doubts about what intercompany trading arrangements can lawfully be put in place. In other words, a thorough legal rationalisation covers not just the entities within the group, but what lies within each entity. Here are some areas to consider when conducting a legal affairs rationalisation:

  • Group assets, rights, legal obligations, and ownership within the group structure
  • Known problems, such as any ring-fenced liabilities or toxic assets
  • Intercompany legal arrangements, such as loans, licences, trading and services
  • Local requirements in all jurisdictions where the company owns assets and/or carries on operations
  • Approvals required under any major agreements to which the group companies are directly or indirectly party, such as finance agreements and securitization arrangements

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