DCF tax in international M&A

When performing a DCF analysis for a U.S.-based company acquiring a foreign company, the tax considerations are critical to ensure accurate valuation. Here's how taxes should be approached:

1. Foreign Corporate Income Tax Rate:

   • The foreign corporate income tax rate should be applied to the income generated in the foreign country. This reflects the local tax obligations of the acquired company in its jurisdiction.

2. Withholding Tax (WHT) on Repatriation:

   • If profits are expected to be repatriated to the U.S., the withholding tax on repatriation should be factored into the analysis. This is because U.S. tax law requires additional taxes to be paid on foreign income when it is repatriated, accounting for the differential between the U.S. tax rate and the foreign tax rate.
   • For example, if the foreign tax rate is lower than the U.S. tax rate, the differential tax will need to be paid upon repatriation, and this should be included in the cash flow projections.

3. Trapped Cash Consideration:

   • If the company plans to leave the profits in the foreign country (i.e., not repatriate them), the cash becomes "trapped" and cannot be used for U.S.-based dividends, buybacks, or investments. This scenario should also be modeled, as it impacts the valuation and cash flow availability.

4. Effective Tax Rate:

   • In some cases, an effective tax rate may be used, which accounts for both the foreign tax rate and any anticipated repatriation taxes. This provides a more holistic view of the tax impact on cash flows.

5. Future Tax Policy Changes:

   • Consider potential changes in tax laws, such as tax holidays or reduced repatriation taxes, which could influence the valuation.

In summary, both the foreign corporate income tax rate and the withholding tax on repatriation should be factored into the DCF analysis. The decision to repatriate profits or leave them abroad significantly affects the valuation and should be carefully modeled.

Sources: The insanity of the US tax code: Bad Laws and Predictable Consequences, Value and Taxes: Breaking down the Pfizer- Allergan Deal, , Value and Taxes: Breaking down the Pfizer- Allergan Deal, DCF Myth 1: If you have a D(discount rate) and a CF (cash flow), you have a DCF!