This is the third and final installment of our series on the ‘Great Carve-Out Comeback’ of 2023 and implications for talent management, presented by Andrew Lindquist, a partner from GoGlobal, and Yvette Chan, Managing Director and Asia M&A Tax Practice Leader from Alvarez & Marsal (A&M).
Talent management is crucial for merger and acquisition (M&A) deals because it helps to retain key staff, minimizes disruption, bolsters company culture and develops new talent.
When a carve-out deal goes through, effective talent management involves a range of stakeholders, including HR, legal, accounting, finance, and workers at every level of the company. It’s all about teamwork.
As Steve Jobs said, “Incredible things in the business world are never made by a single person, but by a team.”
In this blog post – the final in a three-part series – Andrew Lindquist, a partner from GoGlobal, and Yvette Chan, Managing Director and Asia M&A Tax Practice Leader from Alvarez & Marsal (A&M), discuss how hiring through an Employer of Record (EOR) can help build the team that will drive a successful carve-out deal.
How can an EOR hiring solution help in a carve-out deal?
Andrew Lindquist, Partner, GoGlobal: In a carve-out deal, an EOR solution is often an ideal solution for the acquiring company to simultaneously address the issues of orphaned employees, benefits alignment and compliance.
Essentially, an EOR service provider, such as GoGlobal, offers up the legal vehicle to hire the acquired workers. The EOR will also be responsible for managing the payroll-related compliance and administration that come along with employing a local workforce.
The EOR hiring solution may serve as a transitional bridge for larger headcounts, with the intention of the acquiring company later setting up an in-country entity to directly employ the workers down the line. In some cases, such as when there is a smaller headcount, the EOR hiring solution can stand as a long-term operational solution.
Yvette Chan, Managing Director and Asia M&A Tax Practice Leader, A&M: If the buyer does not have an existing legal entity in the target country, the EOR can help transfer the orphaned employees in a timely manner and fulfill the employees’ tax, social securities and other local compliance obligations.
EOR hiring offers a time buffer to the buyers and allows the company to set up formal operations in the target country with ease and in a proper way.
Further, certain jurisdictions such as China may not allow the direct hiring of local employees by an overseas entity. Even if such direct hire is allowed locally, the EOR hiring solution can also help minimize the potential creation of taxable permanent establishment (PE) risk for the overseas entity if managed properly.
If an overseas entity has PE locally, this means any profits attributable to the local PE will likely be subject to tax in that local jurisdiction. Hence, the EOR solution can help minimize the additional tax costs.
What are the top considerations for applying an EOR hiring solution in a carve-out?
Yvette: There may still be local PE risk if the arrangement is not effectively managed. To reduce the risk, operating protocols should be put in place to ensure the assigned employees are under management with instructions from the EOR instead of from the overseas company. The overseas company will only perform a coordination role in enhancing the management and working skills of the assigned employees. It will have no legal labor relationship or management rights with the employees.
The EOR should be a licensed human resource outsourcing service provider and be regarded as an independent agent or service provider.
The staff costs of EOR vs. non-EOR workers should also be differentiated, as these may trigger different tax implications (e.g., medical expense restrictions in Singapore and salary costs inclusion in China).
EOR arrangements should also be reviewed from a tax perspective to ensure there are no adverse indirect tax implications. An example of this would be considering whether pass-through expenses relating to the EOR are treated as disbursements or reimbursements.
Andrew: Communication is key for ensuring a smooth transition. Whenever an acquisition happens, there can be an air of uncertainty and sometimes even panic within the workforce. Using an EOR provider can quickly go awry if the message isn’t managed well.
The workers should clearly understand the purpose of the EOR model and the benefits of using the EOR provider’s platform. If the right provider is selected, workers will have access to localized HR support and benefits.
A carefully arranged Q&A session involving the service provider, the acquiring company and even the seller can go a long way in alleviating the fears of the worker and boosting morale.
What are the pros and cons of the different options?
Yvette: If the acquiring group does not already have an entity in the jurisdiction where it is acquiring a business, it has the option of opening an entity locally itself, directly using its overseas entity to hire locally, or employing a local service provider to hire them through its overseas entity.
However, direct local hire by an overseas entity may be very difficult in certain jurisdictions like China due to local regulatory restrictions. Further, the direct hiring of employees locally may create a taxable PE risk for the overseas entity in the local jurisdiction. For example, in China, the tax authorities may apply a relatively high deemed profit rate to tax the deemed profits. However, if the group has its own entity in China, the actual profits margin may be lower than the deemed profit rate of a PE, resulting in less tax payable, albeit slightly higher ongoing administrative costs.
On the other hand, setting up a local entity generally takes time. Hence, the additional time will need to be taken into account in the overall deal considerations.
Andrew: There are also long-term and short-term considerations as well. It generally takes six months or more to transition and set up an entity fully in order to hire talent. Often, the setup is not the challenging part. It’s the operational part of it, such as establishing bank accounts. Deals don’t always allow a long runway. In this case, the EOR can serve as a short-term solution.
It’s important to note there’s no one-fits-all solution. It depends on the availability of resources, timing, and internal factors of the buying business.
How does EOR hiring relate to non-resident payroll solutions? What are the differences in terms of tax impact?
Yvette: Directly hiring the local employees by the overseas entity could create a taxable PE risk for the overseas entity, as previously mentioned. As an interim solution, the EOR arrangement can help minimize the tax risk provided the acquiring group as well as the EOR service provider abide by a set of strict operational protocols. For example, if managed properly, the employees will be treated as employees of the EOR service provider rather than the overseas entity.
How can an EOR solution mitigate the risks of PE?
Andrew: EOR hiring serves as a formalized process of hiring workers on behalf of clients, so long as the EOR abides by government-mandated and approved methods of hiring workers. These are the methods we use at GoGlobal.
The payment process for the service involves no payments into the country and no direct payments to the workers themselves. Instead, the EOR assumes liability. The contract comes from GoGlobal, never from the client itself. The workers are never at the direct hand of a client. Furthermore, it is important to develop job titles and job descriptions in ways that mitigate the hiring company’s exposure to PE risk.