ey why legal entity management matters issue 1 q1 2014

Why Legal Entity Management MattersIssue 1.0

This paper captures the themes of discussion from EY’s Why Legal Entity Management Matters webcast on 6 March 2014. The session was attended by over 150 participants from major corporates across a broad range of sectors.

Why now?Keeping on top of an organization’s legal entitiy structure is generally not considered by many as part of the “day job.” Companies have had other priorities in recent years: coping with an uncertain business environment, changing legislation and positioning for growth as markets recover.

But global businesses are coming under pressure to address their structures. A growing regulatory burden and continued cost focus are driving the need to simplify compliance, improve transparency,

current Organization for Economic Cooperation & Development (OECD) reporting proposals.

This is putting the effectiveness of companies’ legal entity structures under close scrutiny. Organizations are grappling with a number of complex questions:

What will be the impact of regulatory change on our business?

What additional resource will we need to cope with a changing compliance landscape?

Q1 2014

Global businesses are coming under pressure to simplify their legal entity structures.

Country-by-country reporting (CbC) update

Please note that since this webcast took place several changes to CbC and especially to the CbC template have been proposed. These changes are highlighted on Pages 4 and 5.

2 | Why Legal Entity Management Matters

a pressure which has yet to ease. With operational costs

to trim budgets.

Boards are therefore turning their attention to the cost of

arrangements needed to support them.

Eliminating redundant entities from a group offers a number of

Streamlined compliance and reporting requirements

Reduced need for outsourced and shared services

Lower headcount

driving the need for them. The session also featured advice on how legal entity management can address the challenges at hand, and achieve real value for complex organizations.

Regulation

Compliance and reporting

businesses. Yet only 13.2% of webcast participants listed compliance and reporting as a driver of legal entity management

complications and burden for many groups. Particularly as we see many of those groups growing beyond borders and expanding into new markets.

The challengesTwo of the more serious risks are:

Global complexity

In a global business environment, large organizations routinely

500 and 2000 companies found that 40% had operations in more than 50 territories.

This can be a problem when it comes to compliance and reporting. Different countries have different accounting and reporting regimes, which are continually evolving.

It can be all too easy for a complex organization to misinterpret

27.9%

26.5%

13.2%

5.9%

26.5%

Eliminating surplus entities

Tax effectiveness

and alignment

Statutory compliance and reporting

None of the above

compliance and reporting risks.

Fig. 1: For which of the following reasons does your organization review and manage its legal entity structure?

Source: webcast polling question data.

3Why Legal Entity Management Matters |

A structural disconnect

There is often a structural disconnection between reporting at group and local level in multi-national organizations, especially listed companies. This can give rise to a series of potential risks and costs:

local reporting comes under multiple accounting frameworks, each with its own formatting and disclosure requirements. As such, the more entities in a group, the higher the cost of statutory reporting; and the greater the scope for inconsistent approaches and duplicated processes.

Control issues: a lack of oversight of subsidiaries can mean

result in tax exposures, penalties or advisory costs as groups take remedial action.

Time lag: local reporting is generally done after group reporting, delaying the communication of local decisions to group level. This can lead to inconsistent approaches to

inconsistent balances between entities.

Given these challenges, we asked webcast participants about their

Simpler structures offer a range of compliance and reporting advantages:

Streamlined requirements due to fewer entities

Reduced reporting costs at group and local level

Lower risk of breaching local regulation

Less scope for inconsistencies in group reporting

Greater transparency

Better understanding of local issues

16.7%

19%

7.1%

28.6%

28.6%

Already implemented

Currently planning or implementing

Prefer a decentralized approach

Not been considered

None of the above

Close to half (45.3%) are either operating or moving towards a standardized approach, while decentralized systems are in the minority. These results suggest that many groups in our audience are well placed to deal with statutory reporting requirements through a standardized approach. However, our experience also shows that organizations with decentralized structures may wish to look more closely at their operating models and processes to see if improvements could be made.

EY were concerned that their local accounting and reporting lacks standardization.

Fig. 2: Has your organization considered or implemented a standardized approach to local reporting?

Global warning Intricate global structures create complex reporting challenges.

in Nigeria, a country which recently adopted International

public interest of a business’ local operations. On this basis,

country from 2013.

statements. The sanctions for this in Nigeria go as far as

previous year, while providing on-the-ground support by liaising with the Nigerian regulatory authorities. This helped to minimize the penalties incurred and ensured a continued positive relationship with the regulator.

The consequences of failing to comply will not generally be so draconian. But the experience is a sober reminder of the risks local compliance issues can cause for global organizations.



Simplifying your legal entity structure will deliver

Local dynamicsRationalizing group structure to simplify local reporting should be a two-stage exercise:

Group and local dynamics:

How aware are you of the differences between group and local reporting processes?

How much visibility does group have over your local reporting activities?

when issues arise?

function and shared service centers?

Financial implications of local reporting:

What is the total cost of your local reporting requirements?

Consistency of approach:

subsidiaries?

reporting — by asking:

fewer entities and a more consistent approach?

Would more proactive legal entity management enhance distributable reserves and cash management?

What is the right balance between centralized control and standardized processes on one hand, and devolved local responsibility on the other?

Country-by-country reporting The compliance stakes are about to be raised further still, by OECD

The initiative is part of the OECD’s Action Plan on Addressing Base

countries, as it erodes the amount of corporate tax going into the public purse. The Action Plan is the international community’s response, and has strong backing from the G8 nations.

to be seen. But given the support behind it, companies need to be ready for its introduction in all countries where they have operations or investments.

The proposals A key aspect of the Action Plan is a proposed new template for

It’s probably fair to say that this has caused a stir in the market.

CbC update

Please note that since this webcast took place several changes to CbC and especially to the CbC template have been proposed. Some of these important changes include, but are not limited to:

The removal of inter-company transactional data from the template (the last six columns of the template shown in

with either group accounting data or statutory accounts (effectively either a top down or bottom up approach), as long as this is applied consistently.

Tentatively, there will be no exceptions provided on a materiality basis. This means companies would have to report activities in all jurisdictions. No decision has been made yet as to the provision of an exception for small and medium enterprises with respect to the reporting template.

The reporting template will be populated based on aggregated country information, not on a separate entity

business activity (which is to be designated through an expanded list of codes), which would be reported on an entity-by-entity basis.


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Fig. 3: Proposed OECD template on CbC reporting



The challengesWe asked participants for their views on the impact of the CbC

Fig. 4: Which is the most likely outcome of the OECD CbC reporting proposals?

the resources of companies and tax authorities. However, when we examine the issue more closely we can identify the need for changes to tax authorities’ audit approaches, as well as the substantial changes required to the transfer pricing framework. Not surprisingly, all of the above was the clear favourite response

regime presents.

The OECD is proposing that groups report on every entity and every branch, in every country of operation. This has far-reaching implications.

30%

5%

47.5%

17.5%

Additional burden on resources (for companies and tax authorities)

Changes to tax authorities’ audit approaches

to the transfer pricing framework

All of the above

Organizations face an enormous task to get to grips with the

collate the data required.

Completing the template at entity and branch level would add up to thousands of entries for complex groups. In most cases, data

standards and currencies. What’s more, companies rarely hold the information in the suggested form.

Rationalizing your legal entity structure has the potential to minimize the impact and cost of implementing the new CbC reporting rules.

Given the template’s complexity, there is a real risk of misunderstanding or misinterpreting the provisions. And as proposed, the template would also present some serious practical hurdles:

Obtaining data on stated capital and earnings by branch

Placing a monetary value on certain elements, for example

employee costs)

Retrieving and aligning data from legacy databases, for

In addition, the timetable for the introduction of the new rules is uncompromising. Having proposed the template in January this year, the OECD aims to release its approved version by September. A rapid rollout is then anticipated in many parts of the world.

considerable increase in the compliance and reporting burden. Assessing your legal entity structure could help minimize its impact.

Removing unwanted entities would leave fewer subsidiaries to report on and less information to gather. It would also mean simpler taxation architectures and policies.

However, rationalization cannot be done in a hurry. As we’ll see, the process demands time and effort from stakeholders across the business (see Best Practice). With the new CbC regime imminent, it is something companies need to consider now.



business’ tax position.

TaxSimplifying structures can also be a valuable way to enhance an organization’s tax position. Group structures can become ineffectual over time, as tax rules change and treaties are updated.

In a climate of increased tax transparency, groups are also under pressure to reassess the use of tax haven jurisdictions.

As a result, groups are reviewing their legal entity structures from a tax standpoint. In our experience, this is being driven by the need to:

group structure.

Ensure that existing structures are aligned to current tax regulations and commercial objectives.

Reduce the cost of tax administration in light of the new CbC reporting regulations outlined above.

Depending on local tax rules, proactive entity management can unleash several tax advantages. Rationalization has the potential to:

Manage effective tax rates: by removing multiple tiers of taxation, reducing tax leakage from inter-company transactions and optimizing the value of tax assets.

Generate additional tax value: by releasing cash from inactive companies, and more effectively offsetting losses

Release new value from existing tax assets: by generating capital losses when dissolving entities.

Cost

to estimate the average cost of carrying a legal entity.

Almost half put the cost between £10,000 and £50,000 per entity and our experience shows the same. However, costs do vary between industries and are a good deal higher in closely regulated

gas, for example.

Legal entity rationalization typically removes a third of a group’s subsidiaries. This represents a substantial cost saving.

Fig. 5: What does your organization estimate the average cost of carrying a legal entity to be?

21.4%

23.8%

7.1%

19%

4.8%23.8%

£10,000 or less

£10,000–£25,000

£25,000–£50,000

Don’t know



In our experience, an effective legal entity rationalization process might typically remove a third of a group’s subsidiaries. This represents a substantial cost saving.

Suppose a group operates 300 entities worldwide, each costing £15,000–£30,000 per year to run. Eliminating 100 of these would drive £1.5m–£3m of annual savings in administrative costs alone.

to streamlining legal entity structures. More often than not, groups are able to:

Release capital: one rationalization project liberated almost £2b of capital by eliminating around 80 entities.

Release trapped dividends: another redesign generated reserves to fund dividend payments for the following

Enhance value: complexity can cause concerns for investors and bondholders. Simpler structures can reduce transaction costs when a business is carved out and divested, or reduce integration costs on acquisition.

functions to focus on value-added activities like maximizing

Best Practice The case is clear. Having fewer legal entities will streamline compliance, reporting and administration, reduce risk and cost,

However, rationalizing entities can be a major undertaking. It involves a number of business functions, for whom simplifying group structure is not business as usual. With this in mind, setting up the project in the right way is vital to success.

As is stakeholder management. Stakeholder objections can be one of the greatest hurdles to effective legal entity rationalization. Projects often come up against challenges, concerns and objections from the various parties affected. Not everybody is willing or able to see the bigger picture, or dedicate the time and resource that rationalization requires.

The upshot is that the pace of projects frequently stalls. Worse, value can be left on the table at the end of the exercise.

The processTo overcome these barriers, legal entity rationalisation should

the following lines:

1. Conduct a high-level review of your legal entity structure.

2. make them happen. This will help establish momentum,

effective approach to project management.

3. Create a blueprint for reorganization and removal. This manages disruption to the business and maximizes the

clear plan is not in place from the outset.

4. Proactively manage your structure. Once rationalization is complete, legal entity management must remain a continual focus to achieve sustained results. This is especially important for businesses that make regular acquisitions.

5. should include policies on the creation of legal entities, and procedures for eliminating them once their purpose is served.

6. Revisit your legal structure regularly and at critical

determine the best structure moving forward and eliminate unwanted entities. Or in preparation for a divestment, to streamline the carve out business, enabling value to be maximized, as well as easing the due diligence process.


Review: conduct a high-level review of your existinglegal entity structure

Isolate: identify quick wins and make

them happen

Revisit: rethinkyour structure at critical junctures

process for ongoinglegal entity

management

Manage: proactivelymanage your structureon a continual basis

Plan: create ablueprint for

reorganization and entity removal

Six steps to success: The legal entity

management process

12

3

4

5

6

Next steps Legal entity management needs to be an integral part of everyday business operations, for important commercial,

costs, complexities and risks associated with compliance and reporting.

With the regulatory burden mounting, groups urgently need to embrace entity rationalization. And they need to ensure that their structures are managed and optimized on an ongoing basis.

Fig. 6: The six steps to success: the legal entity management process


Samantha KeenPartner

E: [email protected]

Russell PayneDirector


Graham RobertsDirector


John HintonAssociate Director


Jelgar BuitelaarSenior Manager


EY ContactsPlease contact one of our team if you have any questions:


Notes

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.

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