M&A IN THE MIDDLE EAST: IDENTIFYING AND ADDRESSING THE REAL CHALLENGES
Authored by: Tim Watkins
Tim Watkins, Partner in the Corporate team considers the concerns and challenges that businesses face when considering M&A activity in the Middle East.
A recent study into global M&A trends undertaken by a prominent global law firm identified and analysed strategic issues and concerns that businesses commonly experience when approaching a potential cross-border M&A deal.
A wide range of companies in diverse business sectors from all over the world were canvassed, and the results as they related specifically to M&A activity in the Middle East were quite striking.
Among the most prominent concerns identified with doing a deal in a Middle East market were due diligence limitations (specifically the perceived lack of available and/or accurate information about a target, including particularly as a matter of public record), complex ownership structuring of target companies, and even the potential for bribery and/or corruption issues to be lurking just beneath the surface - a very hot topic given the now global reach that some Western anti-bribery legislation can have.
But even more than these issues, the two biggest challenges identified by businesses who were contemplating M&A activity in the Middle East were:
a perceived onerous level of regulatory interference, and
an uncertainty regarding the tax environment.
In a region where efforts are continually being made to reduce the burden (albeit perhaps not the volume) of regulation as a means of facilitating more trade, and also where any list of the perceived advantages of doing business in the Middle East usually begins with some mention of a perceived ‘zero-tax’ regime, these two factors might seem surprising.
However, from inside the Middle East looking out, it is easier to identify with these findings (and offer some solutions to them).
The Regulatory Challenge
The occasional, and arguably unfair, labeling of parts of the Middle East as being excessively bureaucratic due to the volume of regulation, is to misinterpret the reality. Regulation in the UAE is something of an enigma because the regulatory ‘burden’ that many companies believe they face in fact derives from a variety of sources, many of them unwritten or misunderstood.
Whilst there is of course published regulation and legislation, much of this is coupled with (and supported by) the ‘common practice’ – i.e. the way in which laws, regulations and practices are actually applied and enforced (whether wholly, partially, or not at all).
It is true that much regulation (as indeed much legislation) published in the Middle East is remarkable more for the fact that it exists, than for what it says. Often, it is at the moment when the Government announces its intention to pass (at some point in the hopefully not too distant future) a law or decree that it receives its most vociferous media attention. The later (often much later) publication of the text of the law itself in the Official Gazette may go unnoticed.
But for the lawyers the publication of any new legislation is always an opportunity, albeit with an unsporting sense of surgical analysis perhaps, to be the first to comment on its pros and cons. Usually, this will involve highlighting any gaps in the legislation, which is to say those clauses and provisions where further and more detailed supporting regulations are clearly intended to follow later.
The problem, however, is the law of diminishing returns. For if it is the case that the announcement of a future (as yet unwritten) law is what makes the loudest headlines, but the law itself slips into being largely unnoticed, then what chance for the secondary regulations? It is too often the case that any such interpretative regulations either never become published or, if they are published, that they then suffer from the same gaps, and/or propensity for misinterpretation as does the primary legislation they were designed to support and explain.
This in turn means that in the absence of supporting regulation to put the ‘meat on the bones’ of the laws, many pieces of legislation (or legislation complemented by regulations that offer no additional clarity) offer a mere skeleton framework of legislative intent, which must then stand subject to interpretation and further analysis by a Court system that is not bound by precedent (the UAE courts, whilst they may refer to previous Court decisions for assistance and guidance, are not bound to follow previous decisions made on similar circumstances).
All of this can burden any attempt to identify in advance the likely regulatory challenges of a particular deal with significant uncertainty. So what to do?
It is too often the case that insufficient time is built into the project timetable for properly researching the potential legal and regulatory hurdles that might apply in the target company’s market. For companies and businesses that are familiar with doing M&A deals, the structure and sequential stages involved (agreeing principal ‘Heads of Terms’, due diligence, preparation and negotiation of transaction documents, through to completion and closing) may be familiar. Many organizations will, over time, have developed their preferred forms of transactional agreements from which they may be reluctant to stray too far during commercial negotiations. And so, in turn, familiarity with the steps involved, and with the documentation being pushed, may cause optimistic project timelines to be set.
But it is the due diligence phase of any M&A transaction that always represents the most bespoke phase in any deal, because unless and until proper due diligence is done no buyer ever truly knows its target. And in addition to investigating and researching the history and circumstances of the target entity, there is also much to be gained by undertaking ‘local market’ due diligence. Knowing all about the Target that one is acquiring, without knowing what external factors the Target is operationally and legally subject to in its market, is to enter the negotiating stage of the transaction only half-prepared. The solution to any regulatory concerns, is to do due diligence on the market with the same degree of analysis and concentration as is done in respect of the Target itself.
So how should local market due diligence be done in practice? How does an outsider, aware that to successfully conclude its deal it may have to navigate a potentially unfriendly regulatory minefield, ensure that it is best prepared for such a task?
The answer to this point is to engage a broad team of local advisors (legal, financial, commercial) at the earliest possible stage - those who have longevity in the market, and who know how to properly interpret and apply the local laws and regulations, and who can therefore help a new foreign investor filter and sift the important issues from the less important, and plan for a successful completion within a realistic timeframe. Advisors are there to advise, not to ‘green-light’ a transaction that the parties believe they have otherwise all but concluded.
External advisors with local knowledge offer double their value for money. They should of course be retained for the professional skills that are invariably universally required (in the legal sense, this might mean conducting and managing the due diligence, as well as providing, drafting, negotiating and ultimately concluding transaction documents). But they can also be utilized as a resource for supplementing any deficiencies in local knowledge, customs and practices.
The Tax Question
These same advisors, if they are worth their reputed credibility, should be equally able to settle any concerns regarding local tax issues. Too many clients wrongly assume that many of the GCC countries ‘have no tax’. This is not strictly correct – which is, unfortunately, a symptom of the same circumstance mentioned above whereby laws may be passed, but not fully implemented.
In the UAE, for example, although there is no federal tax regime, each of Dubai, Abu Dhabi and Sharjah Emirates promulgated their own tax decrees in the late 1960s. These decrees still exist as valid law, though none are fully enforced against most traders and businesses. In practice, only oil, gas and petrochemical companies, and branches of foreign banks are obligated to pay taxes.
No personal or corporate income or revenue taxes are applied in the UAE at present however, and there are also currently no capital gains, withholding, or value added taxes (VAT) imposed anywhere in the UAE (although the possibility of VAT being introduced in the future has been rumoured for some time). Some smaller taxes do apply (such as import duties payable on all goods imported to the UAE (currently 5%), as well as service charges at restaurants, and hotel accommodation surcharges, for example.
As it stands, therefore, the most likely circumstances in which foreign companies doing business in the UAE might need to concern themselves with the issue of tax is in the context of how it might apply to profits or dividends returned to their home jurisdictions, as well as in regard to remaining well informed and up to date regarding the occasional rumours that circulate about the possible future implementation of taxes (particularly VAT). But many countries now also benefit from double tax treaties with the UAE, further mitigating this risk in some respects.
The twin issues of potentially stringent regulation, and potential tax liability in an M&A transaction are therefore both issues that can be easily dealt with – one by way of good transaction preparation and management, and one simply by taking the time to understand the current legal position as it stands in the target jurisdiction or market.
This article was recently published in the Oath Magazine, December 2014 edition.
This article, including any advice, commentary or recommendation herein, is provided on a complimentary basis without consideration of any specific objectives, circumstances or facts. It reflects the views of the writer which may, in some cases, differ from those of the firm, especially in the develop jurisdiction of the UAE