SAVANT is an acronym for: Strategy, Anticipation, Value-adding, Negotiating, and Transforming. For a transaction to be properly tax managed [and thus best increase firm value], managers should consider all of these aspects. In this post, I discuss SAVANT concept, a transaction based approach to tax management . If you love and is looking for fundamental tax planning concept and strategy guides, this post may a worth reading [and considering approach] to follow. Enjoy!
What and Why SAVANT Concept?
To increase firm value, managers engage in transactions. Of course, firm value can increase for other reasons. For example, the value of the firm’s assets simply can appreciate due to market factors beyond the control of managers. However, transactions must have occurred when firms acquire such assets, and it takes transactions to convert such assets into cash flow.
Managers do things like buy, sell, rent, lease, and recapitalize. If managers structure transactions such that each is value-maximizing, then by year-end the sum of such transactions will have maximized firm value. However, note that each transaction has an uninvited third party: the government. In strategic tax management, when a firm chooses transactions, it keeps tax management in mind.
Firm look to engage in transactions that maximize end-ofperiod value. It can chose from a constellation of entities or transactions, and the choice then is put through the lens of the firm’s strategic objectives. If the transaction (including tax effects) is consistent with the firm’s strategic objectives, it may accept the transaction. Otherwise, even if the transaction is highly tax-advantaged, the firm should consider rejecting the transaction. Similarly, the tax aspects of the transaction can be managed in a strategic manner.
Next, the firm anticipates its future tax status and chooses the timing—this year or a future year—of the transaction. Because the effects of transactions often span more than one year, the firm projects tax effects into the future, using current and expected future tax rates and rules, and factors in management’s expectations as to the future tax status of the firm. If there is tax advantage to adjusting the timing of a transaction, the firm should do so, provided that the nontax economics still make sense.
Taxes are also negotiated between the firm and the other entity. The firm seeks to shift more of the tax burden away from itself (and potentially, onto the other entity) by negotiating the terms of the transaction. The firm attempts to minimize tax costs by transforming transactions being considered into ones with more favorable tax treatment. For example, managers can work to restructure transactions that might generate nondeductible costs into ones where costs are deductible ones, or work to transform what would have been ordinary income into capital gain income.
What is left, after taxes, is value-added to the firm. Like taxes, valueadded often inures to the firm over time. Because it is a fundamental principle that cash inflows are more valuable now than later, tax management takes into account the time value of a transaction as well. The time value of a transaction, after taxes and transaction costs, is what increases firm value in the future. One aspect of a transaction that affects value-added comprises transaction costs, such as sales commissions or attorney fees. As discussed in the section entitled “Value-Adding,” transaction costs reduce the net value of the transaction to the firm. If the transaction costs exceed the net value, the transaction should be rejected.
Illustration Of SAVANT Concepts
As CFO of a computer manufacturing company, it has come to your attention that a computer chip manufacturer is for sale for $10 million. It is privately held by the five engineers who started the company. The value of the net underlying assets is $9 million, with $1 million of value attributable to its highly successful R&D department. The reason the company came to your attention is because each year it throws off about $1 million in tax benefits through rapid tax depreciation of equipment and tax credits for its R&D. The tax benefits are very attractive, but you ask these questions to determine whether the acquisition makes sense from a strategic tax-management perspective:
Does the acquisition fit with the firm’s strategic plan?
On further inquiry, you determine that the company’s chips could be used in the manufacture of your company’s computers. Moreover, some management personnel in your company have had experience working for chip manufacturers. Most important, the vertical integration fits with your firm’s mission to be a dominant (in terms of quality) computer manufacturer. The acquisition could assure quality by having control over chip manufacture. In that sense, it would give you a strategic advantage over your competitor.
What is the anticipated effect of the sale?
Your major competitor has a net tax loss, so it may not make a play for the chip manufacturer, or it may make a lower bid. You anticipate that the tax benefits will continue, with R&D tax credits actually increasing due to a more liberal tax policy that will go into effect next year. Because of the anticipated change in R&D rules and an expected increase in the tax rate, the timing should be early next year.
Will there be an increase in value-added?
The acquisition would be financed with 8% debt; after tax-deductible interest expense, the cost of this capital is 8% × (1 – 34%) × $10 million, or $528,000. After-tax operating profit for the acquisition is $800,000 per year. Thus, valueadded is $800,000 – $528,000 = $272,000; this is also the net increase in financial-accounting earnings and the annual cash flow.
What transaction costs would be involved?
You ascertain that $400,000 of legal, accounting, and loan fee costs would be incurred. Half of them are tax deductible, so the after-tax cost is $400,000 – (.34 × 1/2 × $400,000) = $332,000. You note that this is $60,000 in excess of the first-year value-added. However, assuming you hold the company for 10 years, there is still a positive net present value of –$60,000 (year 1) + $4,625,360 (sum of years 2 through 10), or $4,565,360. The latter figure uses an 8% cost of capital, for 10 years of annuity, with a resulting factor of 6.7101 less 0.9259 (year 1 factor), or 5.7842 × $800,000 per year.
Should there be an adjustment for risk?
You assign a necessary 10% risk premium, because chip manufacturing is subject to intense competition. There is no risk that tax authorities will challenge any of the tax benefit.
Can the tax benefits be negotiated?
Yes. They are worth $1 million to you each year, but worth nothing to the chip manufacturer or to your rival.
Can any income (gain) or deduction (loss) be transformed?
If the acquisition turns out to be bad, it can be sold or part of it spun off to a separate business in a transaction qualifying for capital gain treatment. Alternatively, regarding negotiation, you can give the target company’s shareholders stock in your firm in exchange for their stock, which would qualify as a tax-deferred transaction for them. This might result in a lower purchase price.
Therefore, based on SAVANT analysis, you decide to acquire the chip manufacturing company.
SAVANT Concept Summerized
Effective tax management means employing the SAVANT principles to every important transaction. It also means periodically scanning the environment to see what has changed that would require new tax-management strategies. Both the transaction-oriented and the time-oriented approaches are discussed in the next section.
Involvement in Transactions:
All too often, important business transactions are structured without considering taxes. Subsequently, tax specialists are brought to see how taxes can be saved (if at all), given the already agreed-on form of the transaction. Instead, managers should consider taxes simultaneously with all other costs. The power to tax a firm’s income effectively makes U.S., foreign, state, and local governments partners in the firm. Managers should strive to minimize such partners’ shares of the firm’s value-added.
Scanning the Changing Tax Environment:
If the world around the firm never changed, tax management of each transaction would be enough. However, the environment does change, and a manager’s due diligence is to scan the environment to see what changes affect the firm and how the firm should react. While such nontax environmental changes are in the purview of other business school texts, there are two key aspects related to tax management. First, such scanning might necessitate a transaction that requires tax management. For example, suppose a competitor drops its price below that of the firm.
The firm might respond by lowering prices. To maintain profit margins, the firm might try acquiring components from another firm that had previously been manufactured internally. If the latter approach is taken, there may be tax costs. Such a manufacturing downsizing could produce: (1) extra income taxes, as equipment is sold; (2) possible sales or import taxes, depending on where the new vendor is located; or (3) possible increases in unemployment taxes due to worker layoffs. These tax effects raise the cost of replacing components currently made inhouse with those made by other companies, possibly making the outsourcing strategy result in lower profits.
A second type of scanning is for tax-law or tax-rate changes. Taxes constantly evolve through deliberate government policy and through administrative and judicial modifications and interpretation. With Internet availability, important changes can be monitored constantly. It is important to note that a tax change does not beg a reaction: The tax tail should never wave the economic dog. As an extreme example, suppose the government of Malaysia announces a no-tax policy on foreign investment. If the firm’s strategic plan is to become a leader in the Latin American market, it may make little business sense to move the firm’s plants to Malaysia. However, an increase in Latin American country taxes invites a review of whether plants should be repatriated to the United States.
Here is a sampling of tax changes that have occurred in recent years:
- The U.S. tax rate on capital gains was reduced to 20% (and, in certain cases, to 10%) from 28%.
- The U.K. corporate tax rates were reduced by 1%.
- The U.S. Congress exempted Internet transactions from new taxes by states such as California.
- Tariffs and duties between NAFTA countries, and between EU countries, were reduced.
- U.S. check-the-box rules were passed allowing a business entity to pick whether it will be a taxable corporation or a tax-free flow-through entity.
There are many ways for managers to stay current on tax-law changes throughout the world. At a very general level, The Wall Street Journal frequently publishes brief summaries of U.S. tax-law changes, as does the Financial Times for EU changes. Some more commonly used research tools available both in hard copy and electronically include Westlaw, LEXIS/NEXIS, CCH, and RIA. These are all proprietary services. A low-cost alternative to them may be tax resources on the Web.
IRS Related Web Sites
Big Four Accounting Firms Web Sites
Other Web Sites
Are you interested in SAVANT framework? Have I given enough clue? Follow it on my next discussion for more detail of each SAVANT tax planning aspects…[Strategy, Anticipation, Value-adding, and Transforming], a transaction based approach of fundamental tax management.