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The Tax Implications CFOs Should Consider When Divesting a Business Unit

Executing and achieving Day Two readiness to not only protect value but also create it

Tax and finance leaders must have a good grasp of a corporate carve-out’s implications for operations and business models to develop the most effective business structure. From the very start of the execution process, they must understand what Day Two will look like.

In a “corporate carve-out”—a corporate reorganisation method in which a parent company divests a business unit—the overwhelming focus for the management team is on execution and achieving Day One readiness. While execution is certainly key, “not destroying value” is very different from “creating value.”

One way CFOs can create more value for their businesses during a corporate carve-out is by intentionally working with tax and finance leaders to design Day Two from the start.

There can be massive tax implications of a corporate carve-out, not just in how the new company (NewCo) is structured but also in how it will operate. New service agreements, supplier contracts, facilities, and business models have tax impacts. Splitting a company very often changes the realities of the business. An organization might find that the allocation of its taxable profits shifts as a result of changes to the centers of activity, where the decision makers for NewCo sit, or where capital is invested. The same goes for the remaining part of the company (RemainCo). If your tax calculations were based on certain research and development (R&D) incentives and you are now carving out your R&D division, your tax assumptions will clearly change.

Tax and finance leaders must have a good grasp of the corporate carve-out’s implications for operations and business models to develop the most effective business structure. From the very start of the execution process, they must understand what Day Two will look like.

Planning for business after the corporate carve-out allows tax leaders to provide better advice to the CFO on how the future businesses should be structured. And that can improve both financial value and business flexibility. Day Two planning is about aligning the business structure and profit profile to ensure NewCo is maximising its potential tax benefit. It is also about creating greater flexibility for both NewCo and RemainCo. The business environment will continue to change after the corporate carve-out. By focussing too much on Day One readiness, businesses might miss an opportunity to create the right environment for both organisations’ success.

There are many reasons why CFOs and tax leaders should not delay thinking about Day Two. Perhaps the biggest is that planning for Day Two directly influences the financing that the deal can attract. The sources of financing will have a direct effect on how the deal gets financed. At the same time, tax operating models will also shift. Corporate carve-outs can provide a blank sheet on which to design the optimal tax operating model for NewCo. The same can apply to RemainCo.

Preparing a corporate carve-out is difficult work. But in most corporate carve-out situations, tax and finance leaders may be missing out on opportunities—not just to protect value but also to create it.

Are you ready?

Read the full article as seen on Harvard Business Review

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