Valuing an ownership interest in a company with operations outside the U.S. — for U.S. tax purposes — is a complex process, involving several nuanced considerations, that requires an understanding of both U.S. tax laws and the economic, tax, regulatory, and political environment of the local country. At a high level, there are two types of issues that are commonly overlooked in these situations:
- The valuation employs standards consistent with U.S. tax purposes but does not appropriately incorporate the local country dynamics.
- Conversely, the valuation appropriately captures the local country dynamics but incorporates approaches and/or assumptions that are inconsistent with accepted standards for U.S. tax purposes.
This article serves to highlight some of the key areas where these issues most frequently arise, and the impact of these on the estimates of fair market value within the underlying valuation analysis.
Valuation of Non-U.S. Companies
The valuation of a non-U.S. company can sometimes be problematic if the analysis is conducted with a U.S.-centric mindset. In these situations, numerous considerations that are vital to the analysis can be misapplied, overlooked, and simply not taken into account.
- Local Factors: The economic stability and growth prospects of a non-U.S. country can affect the company's valuation. Factors such as inflation rates, interest rates, tax rates, general economic conditions, local industry environment, and political stability play a crucial role. Understanding the legal framework governing business operations in a non-U.S. country is essential, which includes compliance with local tax laws and regulations that may affect the company’s operations and valuation.
- Financial Projection Currency: The ideal approach when conducting a valuation for U.S. tax purposes is to utilize financial projections in the local currency to value the company and then convert that value to U.S. dollars at the prevailing spot rate. This approach incorporates all local factors to conduct the valuation while providing the conclusion of value in U.S. dollars. Another acceptable approach is to convert the local currency projections into U.S. dollars. However, one often overlooked step is that the local currency projections must be converted utilizing a forward exchange curve to ensure expected fluctuations in the currency are captured in the valuation. Utilizing a spot curve to convert the projections can result in a material misstatement of the value of the company due to swings in the strength of the relevant currencies.
- Weighted Average Cost of Capital: The issue we encounter most frequently is the Weighted Average Cost of Capital (WACC) — which is a vital part of the income approach as it is utilized to discount the future cash flows to net present value — is often miscalculated. Common errors include utilizing a WACC with local-country data when the projections are in U.S. dollars or, conversely, utilizing a U.S.-based WACC with projections in the local currency. In hyperinflationary markets where the WACC incorporates local data, the WACC can be understated due to the local risk-free rate not actually being risk-free, given there is a risk of default of the government bond. In this situation, the risk-free rate should be based on U.S. dollar denominated government bonds, and the difference between the local country and U.S. inflation rates should be added to the risk-free rate. Not incorporating this approach will understate the WACC and overstate the fair market value of the company.
Understanding U.S. Tax Implications
The Internal Revenue Service (IRS) has specific guidelines and practices for valuing companies and fractional interests, particularly with regard to the transfer of ownership interests.
- Application of Discounts: One of the most common issues arises from the selection of discounts for lack of control and marketability as part of the valuation of a fractional interest. Understanding the range of discounts that are typically applied in a valuation for U.S. tax purposes and how to support the selected discounts is vital. Utilizing discounts that are outside this range can quickly bring attention to the valuation analysis, subject the valuation to increased scrutiny, and increase the risk that the valuation conclusion is challenged. Having the appropriate support — both qualitative and quantitative — is an important aspect in ensuring the selected discounts are not easily challenged.
- Selected Methodologies: Incorporating at least two methodologies — preferably the income approach and the market approach — should be the default for any valuation. This not only provides the ideal support for the valuation conclusion, but it also precludes a challenge to the valuation by simply introducing a methodology that results in a materially different value than the sole selected approach. The goal is to not leave the door open for a challenge that would be difficult to refute. That said, there are instances where one approach — often the market approach — is not applicable due to a lack of comparable publicly traded companies and reported transactions of comparable companies. In instances where the income approach is the only relevant methodology due to a lack of comparable publicly traded companies, it is helpful to use the market approach to corroborate the conclusion of value from the income approach rather than as a direct indicator of value. At a minimum, the valuation report should clearly state why the market approach was not utilized as a direct valuation methodology. We have also encountered situations in which a thorough search for comparable transactions was not conducted, and there was, in fact, publicly available information regarding acquisitions of comparable companies that provided a utilizable indication of value.
- Subsequent Transactions: There are situations in which a valuation is conducted as of a certain date, and in the not-too-distant future, the subject company is sold to a third party at a value that is significantly different from the valuation conclusion. The first question is how — if at all — should this be considered in the valuation? As the valuation is based on facts that were known or knowable as of the valuation date, it is important that any potential sale of the company is discussed, and consideration should be given to whether this should be reflected in the valuation. In this scenario, one approach is to probability weight the value concluded by the analysis and the potential sale price. A second scenario is that, as of the valuation date, there was no thought by the company to sell the business or any indications of interest from any parties to acquire the company. There clearly was no possibility of considering a subsequent sale of the company in the valuation; thus, that is not an issue. However, if the subsequent sale price was significantly different from the valuation conclusion — and there were no changes in conditions between the valuation date and the sale date that would explain the difference in values — the subsequent sale price could be a usable data point indicating that the valuation conclusion was flawed.
Conclusion
Valuing a non-U.S. company for U.S. tax purposes requires a careful balance. Missteps in either incorporating local dynamics or adhering to U.S. tax guidelines can lead to significant valuation inaccuracies. It is essential to thoroughly understand local economic, legal, and political conditions while ensuring compliance with IRS guidelines. By employing a well-rounded approach that considers both local and U.S. perspectives, the result should be a more accurate and defensible valuation that withstands scrutiny and aligns with tax requirements.
Sign up to receive all the latest insights from Ankura. Subscribe now
© Copyright 2025. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.
