January 17, 2017
PwC’s stratified forecasting framework solves valuation challenges
It may be 2017, but many companies still handle tax planning like they did years ago. Those policies might have worked well in the past, but they fall short in today’s global business environment. Now, variations in business practices, local policies and regulations often present obstacles for those stuck in the past. However, these same factors pose enormous opportunities for tax directors who plan for them.
Nowhere is this clearer than in the area of income tax expense where advanced planning around taxable events can bolster the bottom line to improve shareholder returns. Tax is key to unlocking shareholder value, which is why many M&A deals are driven by it. Even in a non-deal environment, reorganization of legal entity structures has deep tax implications. In these cases, the alignment of legal entity forecasting with the commercial outlook is critical to unlocking value.
Strategic decisions often demand valuation of legal entities and their underlying assets. That, in turn, requires the creation of credible legal entity forecasts. To address this, PwC has established a Stratified Forecasting Framework that solves a range of problems in establishing valuations and reconciling them with the commercial plan.
Traditionally, forecasts were generated by applying growth trends to historical legal entity results. That, however, raises the risk of errors in forecasting that can, among other things, trigger reviews by local tax authorities. This results in at least two related problems. First, historical results may not be aligned with the transfer pricing policy of the legal entity. Second, the growth and margin improvements underlying the forecast may be inconsistent with the commercial plan. And that leads to even bigger problems.
Instead, a forecast used in the valuation of a legal entity or its underlying assets should be consistent with the targeted transfer pricing underlying its functional activities, as well as the commercial outlook and all related functions. To be effective, forecasts must reflect these nuances.
If transfer pricing targets are combined with commercial forecasts through our Stratified Forecasting Framework, the result is a supportable, legal entity forecast that reflects both the commercial and legal entity outlooks. To work properly, the framework requires a detailed understanding of the commercial forecast and targeted transfer pricing policies, leading to questions such as these:
- Legal Entities: What functional activities do the legal entities perform? What are the targeted returns for those activities, and why? To what product-geography combinations do these activities relate? Does the legal entity hold any intellectual property rights?
- Products and Services: What are the underlying products to which the entities perform functional activities or hold IP rights? For each product, what are the targeted functional returns?
- Geographies: Do the above functional returns and IP rights vary by geography? If so, how?
The primary benefit of this approach is the legal entity forecast that is consistent with both the commercial outlook of that entity and the arms-length returns to which it is entitled. And it will stand up to scrutiny by local tax authorities.
The framework also yields better insights into the pieces of the business on a granular detail. This helps to study value drivers and fosters transparency around forecasts. It can also help to identify and analyze carve-out opportunities for potential divestitures and quantify the value of post-deal tax planning.
This is just the start. Today’s smart business leaders are already using tax as the lever to generate shareholder value.
For a deeper discussion, please contact us to find out how PwC’s holistic approach through a Stratified Forecasting Framework can help your company clear the hurdle to higher shareholder returns.