Frontiers in Tax People Thinking Beyond Borders in Financial Services December 2013

frontiers in tax People thinking beyond borders in financial services December 2013

Featuring: European Financial Transaction Tax (FTT)

Automatic exchange of information

Developing business models and structures

Optimizing VAT and Transfer Pricing in a changing world In this issue

Topics Introduction: Knowledge 20 Unfinished business 1 New KPMG thought leadership 20 Global Financial Services Tax European Financial Leadership Team 21 Transaction (FTT): Quo vadis? 2 Opposition 3 Enter the lawyers 3 Alternative scenarios 3 2 Implications 4 Automatic exchange of information: The emerging framework of international tax transparency 6

The move to automatic exchange 7 How will it work? 7 A new standard? 8 7 Act now: Preparing for compliance 8 Developing business models and structures: The new tax and transfer pricing environment 10 Introduction 11 Bank tax and transfer pricing issues 11 Investment management: Substance not form increasingly 10 important 14 Conclusion 15 Optimizing VAT and Transfer Pricing in a changing world 16 Ring-fencing retail banks 16 VAT group benefit under threat? 18 Follow us OECD VAT/GST guidelines 19 KPMG Tax 16 Conclusion 19 KPMG

© 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. frontiers in tax / December 2013 Introduction: Unfinished business There are natural cycles in public concern. However traumatic the original disaster, in due course attention moves elsewhere. In the wake of the financial crisis, we have seen acute public concern dissipate, leaving behind a vague sense of chronic unease and a lingering distrust of financial institutions.

This is partly because genuinely good Stability Board, Mark Carney, claimed that In this issue of frontiers in tax, we look news stories are emerging to offset major progress was being made: at a number of these aspects: at the continuing anxiety: there is an apparently continuing political debate over the We are building more resilient financial real, if faltering, return to economic introduction of a financial transactions institutions and more robust markets growth in Europe; stock markets across tax in the European Union; at the way through substantially strengthened the world are at or near 52-week highs; the increasing global drive for financial international standards. We are the shale gas revolution in the United transparency and automatic information addressing the problem of too-big- States is promising major economic exchange is transforming the international to-fail. We are working to prevent benefits. Indeed Charles R Morris, who tax environment; and at the interaction regulatory arbitrage, so that tightening published a prescient analysis of the with transfer pricing issues, business regulation in one sector or region does origins of the credit crisis six months models and the specific impact on VAT. not lead to risky activity migrating before the Lehman Brothers collapse in I think that together these articles shed elsewhere. And we are building a 2008,1 is now forecasting that the US is interesting light on current developments. framework for robust market-based “on the threshold of a long-term economic finance so that markets will remain In closing this, my first introduction boom” thanks to shale gas.2 continuously open.3 to frontiers in tax, I should like to pay However, major uncertainties persist. The tribute to my predecessor as KPMG’s Nevertheless, much remains to be done. eurozone remains fragile, with sovereign Chairman – Global Financial Services Tax, Away from the public eye, concerns debt issues unresolved. Government Hugh von Bergen. I hope that we can remain and efforts continue to address deficit financing continues to drive up continue to sustain the standards he set the underlying causes of financial debt and distort economic activity across for the publication, and that it will remain instability. the developed world. Looming above both interesting and relevant in a rapidly everything is uncertainty over the ultimate Also out of the spotlight, and largely changing world. inflationary impact of quantitative easing, unremarked except by professionals, is especially in the US where a growing the growing impact that these regulatory asset price bubble is accompanied by a developments are having in the world stagnating real economy. of tax. In some cases this is deliberate, where tax is being used as a direct Away from the spotlight, policymakers instrument of public policy; in others there and regulators continue their efforts to are collateral tax impacts of initiatives create a more stable and resilient global whose primary focus is elsewhere. financial system. Once again, encouraging Taken together, these trends mean that signs can be seen. In his recent report to Hans-Jürgen A. Feyerabend tax considerations are an increasingly G20 leaders, the Chairman of the Financial Chairman – Global Financial significant factor in the way financial Services Tax services companies seek to respond to Industry Leader – Global the new regulatory environment. Investment Management Tax KPMG in Germany

1 Charles R Morris, The Trillion Dollar Meltdown, PublicAffairs, 2008 (subsequently revised as The Two Trillion Dollar Meltdown, 2009) 2 Charles R Morris, Comeback, America’s New Economic Boom, PublicAffairs, 2013 3 Mark Carney, letter to G20 Leaders, Progress of Financial Reforms, 5 September 2013 1 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. frontiers in tax / December 2013

European Financial Transaction Tax (FTT): Quo vadis? The EU’s proposed financial transaction tax continues to trace its tortuous path towards implementation. Some form of new, harmonized tax is likely to be agreed among core member states eventually. But its final shape and form remain uncertain. This uncertainty is casting a long shadow over how companies can plan to respond.

Financial transaction taxes (FTTs) have most notably the United Kingdom, attacked the legality of what it claims is been proposed in a number of different from financial institutions and from the ‘extra-territoriality’ this implies. circumstances; and many countries large multinationals. Some alternative Supporting this challenge, the EU across Europe already have stamp duty proposals would: Council’s legal service delivered a major regimes applied to various categories • exempt pension funds and sovereign blow to the proposals in September. The of financial and property transactions. bonds lawyers concluded that the tax would FTTs can have a number of different indeed: objectives, but the proposals currently • limit the FTT’s application so that it being advanced in the European Union operates more like a stamp duty (on • exceed member states’ jurisdiction (EU) are perhaps unique in the range – shares only) • infringe the taxing competences of and potential inconsistency – of their • introduce the FTT in phases. non-participating member states targets. As we have outlined previously,1 the explanatory memorandum to In July 2013, the European Parliament • be discriminatory and lead to the European Commission’s original (EP) approved the Commission’s distortion of competition. proposal suggested that such a tax proposals, but also put forward a On the other hand, Algirdas Šemeta, would: number of amendments. Among these EU Commissioner for Taxation and are measures to: • avoid fragmentation of the internal Customs Union, Šemeta commented market by coordinating national FTTs • extend the FTT’s scope to cover on this challenge that the lawyers of currency spots on foreign exchange his department confirmed that the • ensure a fair contribution by the markets procedure and the proposal are in line financial sector to the costs of the with the EU treaty. recent crisis • introduce a legal title principle (i.e. no transfer of legal title without payment • ensure a level playing field between of FTT due) Alternative scenarios the financial sector and other sectors • permanently reduce rates on The political context remains uncertain. • remove certain distortions from the repurchase agreements and It has been argued that the result of the financial markets temporarily reduce rates on trades recent German elections will strengthen • provide a source of own revenue for in sovereign bonds and trades of support for an FTT. Conversely, Christian the EU. pension funds Noyer, the governor of France’s central bank, has said that the current proposals In its current form, the tax would be • provide an exemption for market pose “an enormous risk in terms of levied on financial institutions carrying makers. the reduction of output in the FTT out transactions in securities and jurisdiction; increased cost of capital derivatives, in general at a rate of Enter the lawyers for governments and corporates; a 0.1 percent for shares and bonds and significant relocation of trading activities In the meantime, the UK launched a 0.01 percent for derivatives. Estimates and decreased liquidity in the markets”.2 of the potential yield vary, but a figure legal challenge to the proposals in April of Euro (€) 30-35 billion is frequently at the European Court of Justice. The Algirdas Šemeta, continues to maintain quoted. core of the case may appear narrowly that the measures proposed are legally technical: it disputes the validity of sound and fully compliant with EU the use of the enhanced cooperation treaties. But it is increasingly likely Opposition procedure to allow the FTT-11 to go that the proposals will be abandoned The Commission’s proposals have ahead without the agreement of the or seriously modified. A number of divided member states. A core group remaining member states as to its final scenarios can be envisaged: of 11 states (the FTT-11), including form. In fact, this goes to the heart of Abandonment Germany and France and accounting the current design of the proposals, for more than 90 percent of eurozone which would impose a tax on both Neither the UK’s court challenge nor GDP, are pressing ahead under a financial institutions which are party the Council’s legal advice can formally special procedure known as ‘enhanced to a trade even if only one was within stop or delay the enhanced cooperation cooperation’– but in the face of the FTT-11; this is referred to as the process. But in practice, the FTT-11 opposition from other member states, counter-party principle. The UK explicitly member states will be increasingly

1 Euro-FTT: Politics over principle? frontiers in tax, July 2012 2 France central bank chief says Robin Hood tax is ‘enormous risk, Financial Times, 27 October 2013

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cautious about pressing ahead with yielding 2 x 0.1 percent of the value of the tax in its current form. The Financial the deal to the German treasury. If the The political context remains Times has reported that German counter-party principle were dropped, officials have privately raised substantial only one party to the transaction would uncertain. 3 concerns. More Machiavellian be caught, delivering 1 x 0.1 percent. It has been argued that the commentators have speculated that Such a change would draw some of result of the recent German the recent legal opinion was actually the sting from the current argument of elections will strengthen intended to provide some cover to those extra-territoriality, but not entirely, as tax support for an FTT. states which are now looking to water would still be levied on parties based down the proposals. Nevertheless outside the FTT-11 member states complete abandonment, and the loss under the ‘issuance principle’ if they of face which it would entail, seems were party to a transaction involving Implications unlikely. securities issued in an FTT-11 member It is clear that the Commission’s original state, such as shares in a German Alternative proposals target date for FTT implementation, company. Ironically this issuance 1 January 2014, is now unachievable. One alternative which has been put principle is embedded in the UK’s stamp More likely is the formulation and forward is a (low) flat rate tax imposed duty system, so any arguments that negotiation of various compromise on financial institutions rather than the FTT would still be discriminatory proposals during 2014, leading to a on transactions – a financial activities and hence anti-competitive could raise more limited regime coming into force tax (FAT). This could be applied to issues as to the compatibility of the UK’s after 2015. ‘excessive’ remuneration or ‘excessive’ own system with EU law. profits. This approach was originally Whatever the final outcome, the biggest National FTTs and/or stamp duties rejected by the Commission. But it impact on financial services firms is could be argued that it would better A further alternative would see a formal likely to be on systems, products and achieve at least some of the economic FTT within the 11 supporting states processes. For example, the FTT could objectives. However, like most taxes, give way to a patchwork of more limited affect processes such as securities it would in the end, be passed on to unilateral measures, perhaps along the settlement, intermediation functions consumers; and it could still be avoided lines of the new French arrangements, or access to market liquidity. At best, by judicious relocation of companies. perhaps more like enhanced stamp FTT may require changes to business duty regimes. Even the UK has said models. At worst, it could make them no Removal of the counter-party principle it is not opposed to such taxes in longer viable. Compliance and reporting As we have seen, as currently conceived principle, acknowledging its own very and payment obligations raise some the FTT would apply to both legs of a long-standing stamp duty on share of the biggest concerns. Companies transaction even if only one party was transactions. Since a formal FTT-11 tax need to keep up with developments and within the FTT-11. For example, if a would itself have to be implemented prepare for the potential impacts. bank in Frankfurt traded a listed stock by national legislation in participating However, whether any of these with a UK-based insurance company, states, it may be that the end result measures contribute to enhancing the each party would be liable to the tax, would be not very different, especially stability of the global financial system – if the rates and structures of such taxes the original context in which the G20 first were harmonized. proposed an FTT – remains debatable.

Whatever the final outcome, the biggest impact on financial services firms is likely to be on systems, products and processes.

3 Europe financial transaction tax hits legal wall, Financial Times, 01 September 2013.

For further information, please contact: Victor Mendoza Sarah Lane Barry Larking Hans-Jürgen A. Feyerabend Partner Partner Director Partner KPMG in Spain KPMG in the UK KPMG in the Netherlands KPMG in Germany T: +349 1 456 3488 T: +44 20 7311 2483 T: +31206 561465 T: +49 69 9587 2348 E: vmendoza@kpmg.es E: [email protected] E: [email protected] E: [email protected]

5 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. frontiers in tax / December 2013

Automatic exchange of information: The emerging framework of international tax transparency

Banks, insurers and other financial companies are typically obligated to report relevant information about their clients to national tax authorities. Traditionally, they have balanced their obligations against the responsibility to maintain customer confidentiality. However, an emerging international standard of automatic information exchange could significantly extend institutions’ responsibilities. It would also require certain companies to implement new systems and processes to foster compliance.

One of the key themes in attempts at a to move towards exchanging domestic tax authorities, which in turn coordinated reform of the global financial information automatically with their exchange details between themselves system since the economic crisis has treaty partners… We look forward to and third-party governments. This been the pursuit of greater international the Organisation for Economic Co- approach was adopted in part to ease transparency. In an increasingly operation and Development (“OECD”) legal and other concerns over directly globalized world, it is correspondingly working with G20 countries … in revealing details of citizens’ financial easier for taxpayers to move assets into developing a new multilateral standard affairs to a third-party government. By offshore financial institutions in order to on automatic exchange of information, contrast, Model 2 envisages direct potentially evade – tax. taking into account country-specific automatic information exchange with characteristics.”2 the US Internal Revenue Service. This approach is also being adopted in the The move to In May 2013 the OECD, which had OECD’s Treaty Relief and Compliance previously revised its Tax Convention automatic exchange Enhancement package, which allows to bring it in line with the international withholding tax relief at the source on A significant recent development has standard on exchange of information, portfolio investments. been the move towards automatic called on all jurisdictions to move exchange of information between towards automatic exchange of The structure adopted has important sovereign authorities, replacing the earlier information and to “improve the implications for how institutions design standard of information exchange on availability, the quality and the accuracy and implement the relevant systems. request. At the Cannes Summit in 2011, of information on beneficial ownership, But a number of general consequences the G20 agreed to consider exchanging in order to effectively act against tax are clear: information automatically for tax purposes fraud and evasion.”3 Also in May, the • there is an ever-increasing need for on a voluntary basis. In 2012, in the EU Council agreed to give priority to financial institutions to implement context of implementing their response to efforts to extend automatic exchange effective Know Your Customer regimes, the US Foreign Account Tax Compliance of information at the EU and global level not only for Anti-Money Laundering Act (FATCA), the so-called EU5 (France, and welcomed the on-going efforts (AML) and sanctions purposes but now Germany, Italy, Spain, UK) developed a made by the G8, G20 and OECD to for tax reporting as well. model inter-governmental agreement develop a global standard.4 At a meeting (IGA) with the US providing for automatic in St Petersburg in September 2013, • this will include establishing: information exchange.1 the G20 announced that they expected – where the customer is resident for In April 2013, the EU5 agreed to work to begin automatic exchange of 5 tax purposes towards a multilateral exchange facility information (AEoI) by the end of 2015. between their countries as part of the – whether an individual customer creation of a new international standard. How will it work? holds US citizenship The G20 Finance Ministers and Central Different models of automatic exchange – the type of business operated by Bank Governors’ Meeting in Washington are possible, with different potential corporate entities. welcomed these moves: implications for systems and processes. In particular, it should be noted that “More needs to be done to address the In the FATCA context, the model IGA information gathered for AML purposes issues of international tax avoidance exists in two basic forms. Model 1 may not be sufficient to meet tax and evasion, in particular through tax provides for financial institutions in reporting requirements without additional havens, as well as non-cooperative the participating countries to transfer due diligence. Remediation in respect jurisdictions… We urge all jurisdictions customer account information to their of existing customers may very well be necessary in many cases.

1 cf Model Intergovernmental Agreement to Improve Tax Compliance and to Implement FATCA, US Treasury July 2012 2 Para 14, Final Communiqué, 19 April 2013. 3 Chair’s Summary – OECD Ministerial Council Meeting, 29-30 May 2013 4 Council conclusions, 22 May 2013 5 Tax Annex to the St Petersburg G20 Leaders’ Declaration, September 2013

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A new standard? structure of the reporting process needs Act now: Preparing to be fully understood and synchronised As the move to a new standard of AEoI if possible with existing reporting for compliance gains momentum, a number of potentially requirements. As specific measures continue to evolve, significant issues still need to be resolved, financial services companies will need including: It is clear that these new approaches are having a significant impact, and to develop and implement appropriate • if the AEoI regime is unilateral, then are reshaping the international tax responses; it is important that they what is the enforcement mechanism environment and the policies of maintain awareness of proposals for foreign financial institutions? a number of important players. In under discussion and their potential implementation timetables (see chart) • what is the penalty structure for non- May 2013, Austria, Luxembourg and in order to formulate effective steps that compliance and will some countries Singapore were among nine countries may need to be taken. impose stricter penalty structures which signed up to the OECD Tax based on local law? Convention; Switzerland, one of the Many systems and processes can be world’s biggest offshore financial reviewed now to determine whether • does the AEoI conflict with applicable center s, followed suit in October. José they can be readily modified. data protection laws? Ángel Gurría, OECD Secretary-General, In particular, many financial companies • is the AEoI reporting requirement fully commented that this “sends a clear are presently implementing their reciprocal, partially reciprocal or non- and strong signal that Switzerland is responses to FATCA, and it is important reciprocal? part of the community of states which that any new measures to satisfy consider international tax co-operation AEoI regimes are integrated with the • even with OECD model agreements, 6 as a necessity.” FATCA process, to foster consistency how much consistency will be and avoid duplication. The tax function achieved with other bi-lateral Banking secrecy, ‘tax havens’ and their needs to work closely with other agreements already negotiated? potential use for tax evasion appear to be rapidly disappearing with these new functions such as AML and compliance It is likely that reporting may need to emerging global standards. Financial to determine tax requirements are be directed to the local tax authority. institutions will be expected to play their accurately interpreted and built into Nevertheless, the mechanism and part in facilitating the necessary AEoI. processes affected.

... And the timeframe

EU Revised administrative EU Revised savings EU AEoI on Financial EU Revised savings Cooperation Directive potentially Directive potentially to Income is effectively Directive to be effectively EU to be adopted in 2014? be adopted in 2014? (subject to OECD developments) applied 1/1/2015* applied 2017?

2014 2015 2016 2017

OECD: Technical OECD AEoI among OECD Framework for AEoI is G20 to take place ﬁnalized mid 2014 end of 2015

FATCA New Account FATCA Reporting FATCA Reporting (IGA FATCA Identiﬁcation (US Regulations) countries EoI with the requirements 1/7/2014 31/3/2015 IRS) 30/9/2015

OECD Trace Initiative PLUS: Various bi-lateral agreements

Note: * by virtue of the Administrative Cooperation Directive Source: Illustration created by KPMG International

6 Switzerland signs Multilateral Convention on Mutual Administrative Assistance in Tax Matters, OECD 15 October 2013 8

Banking secrecy, ‘tax havens’ and their potential use for tax evasion appear to be rapidly disappearing with these new emerging global standards. Financial institutions will be expected to play their part in facilitating the necessary AEoI.

Key areas for review include: • monitor compliance and identify For further information, please contact: instances of non-compliance • onboarding forms and policies and Victor Mendoza procedures will need to be re- • provide a governance and reporting Partner designed to capture necessary data structure that enables divisions and KPMG in Spain legal entities to document, record T: +349 1 456 3488 • specific new tax forms introduced and report on their compliance; and E: [email protected] by tax authorities will need to be therefore set up for information capture and Tom Aston transmission • give sufficient comfort to key Partner stakeholders that they can attest to KPMG in the UK • IT systems will need to be updated, the firm’s compliance. T: +44 20 7311 5811 and so should benefit from review, E: [email protected] updating and data cleansing in Financial services companies face readiness significantly increasing regulatory and Rachel Sexton reputational risk, and corresponding • monitoring arrangements to capture Partner risk of financial penalties. They are also changes in customer information and KPMG in the UK under growing scrutiny from external status can be developed alongside T: +44 20 7694 8907 stakeholders. This means that boards periodic reviews done as part of AML E: [email protected] are taking much greater interest in these compliance. areas too, a trend which we expect to Iain Hebbard An assurance and attestation continue. Consequently, it is increasingly Director framework should be designed to: important that companies should be KPMG in the UK developing the necessary frameworks T: +44 117 905 4163 • determine that the firm is compliant now to facilitate the smoothest possible E: [email protected] with the regulations implementation of specific measures when they are required.

9 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. frontiers in tax / December 2013

Developing business models and structures: The new tax and transfer pricing environment

Financial services companies are restructuring and reorganizing. This is in part a result of attempts to build sustainable long-term business models for the post-crisis environment; and it is in part also a direct result of regulatory pressures. Banks and investment managers need to develop appropriate strategies for the future. In doing so, it is vital that they ensure tax considerations are given full weight, especially given the focus on Base Erosion and Profit Shifting (BEPS).

11 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. frontiers in tax / December 2013

Introduction Bank tax and transfer CoCos raise novel tax implications. Their particular attraction arises when A number of forces are making transfer pricing issues their equity aspects make them qualify pricing issues – and the organizational, Political leaders and regulators are against regulatory capital requirements, structural and operational decisions driving large, multi-national banks to while their debt characteristics mean the which drive them – increasingly hold much higher levels of capital. In associated interest payments might be important. Since the financial December 2011, the Basel Committee tax deductible. Interest on convertible crisis, fiscal agencies have focused on Banking Supervision published debt is generally treated as deductible. greater attention on extracting ‘fair’ final rules to increase the quality and However, where convertibility is fixed tax revenues from transfer pricing quantity of capital required to be and predetermined, interest may not be arrangements especially through the held by internationally active financial deductible, since unlike ‘true’ debt the BEPS project. Rising protectionism institutions. Regulators in both Europe purchaser has no right to a definite sum and competition between jurisdictions and the US require banks and certain on maturity. Under the US law, interest are spurring more intense scrutiny by holding companies to 'maintain a deductions are disallowed if a substantial individual tax authorities. minimum amount of contingent capital portion of principal or interest may be At the same time, regulatory authorities that is convertible to equity in times paid in, converted to, or otherwise are increasingly imposing change in the of financial distress'; and generally determined in reference to equity at the pursuit of a more stable global financial requires banks to replace certain non- option of the issuer or the holder. system: to shrink balance sheets, to equity securities with instruments that Where CoCos are issued in one increase capital and liquidity, to simplify function more like equity. jurisdiction (e.g. the UK) and held by structures to allow orderly resolution, As a result of these regulatory investors in another (e.g. the US), they to increase transparency and limit the pressures, contingent convertible may be treated as debt in the first attractions of ‘tax havens’. securities (‘CoCos’) are rapidly jurisdiction and as equity in the second, All these developments carry potential becoming very popular. These resulting in a double benefit: deductible implications for intra-company cross- instruments are generally issued as interest and favorable capital treatment border flows and they have the long-term, subordinated debt, but in the UK and attractive dividend yield in potential to attract more intensive automatically convert into equity – the US. Regulators are tending to look scrutiny of transfer pricing issues strengthening the capital base – when favourably on new forms of risk-bearing by fiscal authorities. Unless the tax the bank’s capital declines to a specified capital such as CoCos because they help issues are considered thoroughly as level, or when the regulator deems strengthen bank balance sheets. However, key aspects of corporate strategy, the company’s viability is under threat. fiscal authorities are increasingly focusing alongside those of structure and Major banks which have issued CoCos on restricting the abuse of artificial BEPS; operations, significantly adverse tax over the last couple of years include this may lead them to change the tax rules 1 results may follow. The argument can be Credit Suisse (2013 & 2011); Barclays in respect of hybrid instruments. It is illustrated by considering some current (2013, 2012 & 2011); Bank of Cyprus unclear, then, whether and to what extent issues in banking and in investment (2011); Bank of Ireland (2011); Lloyds CoCos may continue to enjoy the tax management. Banking Group 2009); Rabobank (2010). benefits of debt for the payer.

Financial services companies are responding to the new environment with a range of changes to business models and structures, for example through off-shoring, outsourcing, consolidation and rationalization.

Increasing bail-in capital through assessments of value and performance: differential credit ratings be applied convertible securities also raises rational economics as well as fiscal between a parent and subsidiary? significant cross-border transfer pricing pressures imply that the cost of the Should subsidiaries in territories with issues. If interest-bearing instruments additional regulatory capital should be weaker – and riskier – economies, are raised at the group parent level, and transferred through the group. However, where capital raising is more expensive, retained there, this will permanently this raises critical issues of how risks pay an additional country risk premium? depress the parent’s profitability. and benefits should be priced and The diagram below illustrates in Retaining a permanent structural transferred across borders and between simplified form some of the structural loss-maker at group level distorts jurisdictions. For example, should and cross-border implications.

Funding issues Bank Plc Market Bail In Debt Long Term Funding Booking location Depositis

Treasury

Funds Funds Subsidiaries PE PE

Trading activities Trading activities Trading activities Deposits Deposits Deposits

Source: Illustration created by KPMG International

Fiscal authorities everywhere are contradictory pressures. It will be entity carrying its own liquidity and seeking to maximise tax revenues. important to develop a clear strategy capital. The key strategic challenge Those in weaker economies, in in full awareness of the regulatory, tax therefore is to determine a clear particular, are likely to resist the and operational implications. The aim position – whether separate legal imposition of additional inward cost should be to get ahead of the game entities, permanent establishments transfers which reduce their domestic by making the necessary structural or branch structures – and create a tax takes. The potential for competition changes when raising the additional defensible case for capital structures, between national authorities is clear, bail-in capital and other longer term interest charges and the associated and disputes are likely to increase. debt for liquidity purposes. results. Tax and Transfer Pricing considerations need to be at the Banks are unlikely to find a solution The broad direction of current heart of these decisions over the which suits all parties. Instead, they developments is clear: regulators are coming period. will come under increasing and increasingly focusing on each legal

1 cf: Action Plan on Base Erosion and Profit Shifting, OECD 2013 13 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. frontiers in tax / December 2013

Investment simplify their corporate structures – minimal substance. Tax authorities using one legal entity to perform are likely to require that profits be management: roles in all jurisdictions through more closely aligned with the relevant Substance not branches. Marketing and investment components of the value chain. management activities can be Where AIFMD stresses new or form increasingly performed in any European jurisdiction, enhanced functions, as we have exploiting regulatory approval in the important seen in the case of risk management, ‘host’ EU nation. Regulatory pressures are imposing it is appropriate that firms attach increasing change on the investment The Directive also places greater an economic value to the function management sector in the wake of the emphasis on the risk management and ensure that it is charged out financial crisis. Concerns over global role: risk management needs to be accordingly. However, the principle is financial stability are less acute than undertaken directly by the AIFM, and easier to state than to translate into they are in the banking sector; however, must be organizationally separate transfer pricing arrangements which the transparency and consumer from portfolio management. Identified will hold water in a BEPS environment. staff such as individuals who are able protection agendas are equally as These considerations mean that to influence significant risks assumed significant. And the investment investment management companies by the fund will have to have part management industry is also subject face a series of novel challenges: to general public and political concerns of their remuneration deferred. The over what is perceived as improper tax administration of this deferral may be • reconfiguring organizational structure avoidance and use of tax havens like more easily achieved if all employees and the location of functions such as the Cayman Islands. are employed by one legal (AIFM) marketing and management entity, rather than many entities • reflecting the changes to the value In Europe, a key measure is the seeking to administer the regulatory chain which follow from regulators’ Alternative Investment Fund Managers requirement individually. Directive (AIFMD).2 This came into stronger focus on functions such as force in July 2011, giving Member Portfolio management can still be risk management delegated. However, the fund manager States two years to transpose in local • aligning the substance of needs to retain overall responsibility, law. Under the Directive, all alternative organizational functions with the sufficient seniority and control to investment fund managers (AIFM) theoretical structure to ensure that be able to oversee the functions established in the EU or which manage profits are correctly located EU alternative funds or which market delegated. • determining the transfer prices AIFs into the EU are subject to a new These issues are focusing closer for various functions across the authorizing and monitoring regime. attention on the different components organization in a defensible manner Fund managers will have to apply for of the investment management so that fees charged for marketing authorization in order to manage an value chain, and on ensuring or management reflect services Alternative Investment Fund if the that the form and substance of delivered. amount of assets under management organizational structures are more exceeds certain thresholds. Managers closely aligned, more effectively The EU passporting provisions authorized in one EU jurisdiction will regulated and appropriately taxed. offer some flexibility. For example, be eligible for ‘passports’ which will The OECD Action Plan on BEPS3 is opportunities around the new emphasis allow them to offer management and likely to lead to greater scrutiny of on risk management, but impose an marketing services throughout the EU. the substance underlying offshore additional layer of complexity when tax AIFMD will drive a number of changes structures and individual functions considerations are taken into account. in corporate structure, either directly such as management, marketing and Effective arrangements for group or because companies will find them ownership of brands and intellectual domicile and the location of different desirable in the new environment. For property. Country by country reporting functions can help minimize the overall example, the passporting provisions will shine a spotlight where profits are tax burden, avoid double taxation and in create an opportunity for groups to located in low tax jurisdictions with a number of cases limit liability to VAT.

2 cf AIFMD: Beware the tax impacts, Frontiers in Tax, December 2012 3 ibid

A typical passported AIFM structure

Fund

Provision of investment management Payment of Portfolio management Performance of portfolio Portfolio management branch management function management fee attribution (cost +)

Marketing attribution AIFM legal entity Marketing branch Performance of (percentage of management fees or cost +) marketing function Performance of risk management function Asset management Asset management branch Performance of asset attribution (cost +) management function

Key tax aspects

• Location of AIFM in the tax effective jurisdiction will help minimize overall tax burden on the Group • Proﬁts of the branches would not be doubly taxed when AIFM is located in the UK, the Netherlands or Ireland • Currently, attributions between a branch and the legal entity of which it is part are not treated as a VAT-able supplies

Source: Illustration created by KPMG International

For further information, please contact: Conclusion John Neighbour Partner The lesson is clear: tax considerations specifically the impact of BEPS, need KPMG in the UK to play an integral role in the development of strategy in responding to current T: +44 20 7311 2252 regulatory developments. E: [email protected] Thorsten Schaus There are risks unless existing structures are adapted to the new environment: Partner • for banks especially in the areas of Transfer Pricing models for capital and KPMG in Germany T: +49 69 9587 2795 liquidity; and E: [email protected] • for Investment Managers, the transparency brought by country by country Burcin Nee reporting, where profits are allocated to countries with insufficient Principal substance. KPMG in the US T: +1 415 963 7073 However, taking tax, transfer pricing and VAT into account in the design stage E: [email protected] should enable business models to be constructed that meet regulatory requirements but are still efficient from a tax perspective. Fred Gander Principal KPMG in the UK T: +44 20 7311 2046 E: [email protected]

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Optimizing VAT and Transfer Pricing in a changing world

As we have seen elsewhere in this issue, banks and other financial services companies are restructuring and reorganizing. Regulatory developments are largely driving this significant structural change. Political leaders are committed to creating a more resilient, stable, and competitive banking sector; reducing the severity of a potential future financial crisis; and protecting taxpayers in the event of such a crisis.1 There are significant tax issues associated with these regulatory changes, with some of the key impacts arising from the potential VAT and Transfer Pricing implications of the related restructurings. Four important current developments are outlined below which companies should think carefully about and how then to respond and mitigate any potential tax implications.

to implement the recommendations of group members are disregarded for VAT Ring-fencing retail the Independent Commission on Banking purposes with no VAT being chargeable banks (ICB) to this effect. 2 thereon. Further, as confirmed in the FCE Bank case,3 supplies between head- One of the key measures being pursued in The separation and ring-fencing of retail office and overseas branches also do not many jurisdictions is the separation of retail banking activities carries a number of constitute supplies for VAT purposes. In the banking from investment and wholesale implications from a VAT perspective. By UK, VAT grouping extends to allowing an banking activities. In the UK, the Financial way of background, banks typically operate overseas entity with an establishment in Services (Banking Reform) Bill is designed as a VAT group. Supplies between UK VAT the UK to be a member of a UK VAT group.

1 cf. Cm 8660, Banking reform: draft secondary legislation, UK Treasury July 2013 2 Independent Commission on Banking, Final Report, September 2011 3 Services rendered by a head office to a branch in another Member State are not taxable services for VAT, even if the cost of such services is allocated to the branch, Advocate General opinion, Case C-210/04, September 2005 16

Given that financial services entities are could impose significant additional VAT the explanatory notes where it states generally not in a position to recover all the costs on services provided between that the impact of removing ring-fenced input VAT they incur, VAT grouping (and corporate group members. It may also banks from their VAT groups would have branch structures) represent avenues for result in the need to consider transfer to be considered. In this regard, the UK reducing the amount of input VAT within pricing on intra-group transactions that government recognizes that its proposals a corporate group. Clearly, removal of a previously did not exist. In its most recent may imply major additional operational member from a VAT group or the transfer consultation on the draft legislation for costs, suggesting a figure of up to British of activities for an existing member to a introducing ring fencing in the UK, the Pound (£) 105 million per bank per year. separate company outside the VAT group only reference to VAT is in para 57 of

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Investment Fund Managers (“AIFM’s”) “Do supplies of externally purchased Once again, issues of with a “marketing passport” for EU AIFs, services from a company’s main in addition to a “management passport” establishment in a third country to its VAT and of corporate providing a legal basis for AIFM’s to branch in a Member State, with an structure are closely manage fund vehicles cross-border. allocation of costs for the purchase intertwined in the The introduction of these passporting to the branch, constitute taxable functionalities will increase the amount transactions if the branch belongs to a development of of cross-border activity – this will create VAT group in the Member State?5” opportunities to structure in VAT-efficient appropriate responses The Court has yet to give an opinion. ways, for example by taking advantage However, the analysis previously to regulatory change. of VAT group arrangements in relevant advanced by the Commission was that Member States or by taking advantage there was a taxable transaction in these of the Member States’ non-harmonised Although, it may in principle appear circumstances. Consequently, if the CJEU practical approach regarding the scope of perverse to manufacture additional sustain the Commission’s view it would the VAT exemptions. It may additionally tax cost as a side-effect of measures imply that VAT would become chargeable provide Corporate Tax benefits through to improve financial stability, this is on such supplies. The Commission argues the use of branches and any exemptions nonetheless a potential fallout of the ICB that a VAT group is a legal fiction in which on taxing non-domestic income. Transfer proposal. Where banks continue to share all members lose any individual identity Pricing will however be necessary when functions and capabilities (e.g. IT) in a and, crucially, any possibility of remaining determining how to value either intra- post separation environment, there will part of any other legal entity. They state: group transactions, or the attribution of be considerable challenges in structuring profits to branches. “by joining a VAT group, the taxable to mitigate the VAT consequences. person becomes part of a new Maximizing available VAT exemptions Once again, issues of VAT and of taxable person, the VAT group and, and maximizing input VAT recovery corporate structure are closely consequently, dissolves itself for VAT through the use of appropriate partial intertwined in the development of purposes from its fixed establishment exemption methodologies, in addition to appropriate responses to regulatory located abroad.6” optimized VAT group structures, will be change. necessary. In addition, consideration of If the CJEU concludes that the supply appropriate transfer pricing policies and VAT group benefit in the Swedish case is indeed liable to methodologies will be required. VAT, the implications could be profound under threat? for financial services and other VAT AIFMD Where the regulatory environment is exempt companies. The impact could be Elsewhere in this issue we consider how developing in a number of directions at especially severe in the UK, with its large the European Alternative Investment once, from a pure VAT perspective, one financial sector and extensive VAT group Fund Managers Directive (AIFMD) is of the key uncertainties currently is over provisions with their extra-territorial reach. creating a radically new environment for the future of the VAT group provisions Transfer Pricing would continue to be 4 the investment management sector. themselves as they apply to the treatment applied in the same way, irrespective of The introduction of AIFMD brings with of branches. whether VAT grouping continues or not. it significant potential VAT implications However, its impact will clearly have a which need to be reflected upon. The As we have noted, the present significant indirect tax impact if grouping first issue relates to the VAT liability interpretation of VAT law in the EU allows provisions disappear. of services provided to Alternative that transactions between parts of the Interestingly, the recent CJEU decision Investment Funds (“AIFs”) and, whether same corporate entity – for example in Credit Lyonnais could be viewed as similar to traditional fund vehicles (e.g. between head office and branch – carry providing a signal to how the European UICTs funds), those supplies would no liability to tax. However, a current judiciaries currently view VAT group fall to be VAT exempt. This particular referral by Sweden to the EU Court of member status for VAT purposes. In point has not yet been bottomed out Justice (CJEU) questions whether this that case a head-office and branch were with no specific guidance coming from is valid where the branch receiving a effectively viewed as separate persons HMRC in relation to the VAT liability of charge passed on from its headquarters for VAT purposes for the purpose of the types of funds caught by AIFMD. outside the EU is itself within a VAT group. determining recovery of input tax in Secondly, AIFMD provides Alternative Specifically, the CJEU has been asked: different jurisdictions.

4 Developing business models and structures: the new tax and transfer pricing environment 5 The Skandia America Corporation USA case, C-7/13 6 ibid 18

OECD VAT/GST intangibles should be taxed in their proposes a two-step method (the jurisdiction of consumption. ‘recharge method’) to allocate taxing guidelines rights to the jurisdictions where the If generally adopted, the destination customer establishments using the The OECD has become concerned principle could have major implications service are located. in recent years that the development for the taxability of services acquired by of VAT and other forms of goods a headquarter and supplied onward to The effect for multinational financial and services tax (GST) regimes has multiple branches. institutions with branches in the EU and increased the potential for double other jurisdictions with EU Model and Currently, where there is a single supply taxation and unintended non-taxation. VAT systems would be to bring relevant deliverable to a number of branches In 2006, the organization began to services within the scope of VAT, with under a global contract, the entirety of develop guidance for governments on potentially substantial costs. This could 7 the service is taxed according to the applying VAT to cross-border trade. In represent significant additional VAT location of the branch most closely February 2013 it published for comment cost for financial services entities if not connected to the supply and the onward a draft consolidated version of these considered properly. Companies will branch-to-branch allocations are not guidelines, which build on two core have to review the structure, location 8 subject to VAT. The OECD guidelines principles: and direction of services provided, with would mean that internationally traded potentially profound consequences • the neutrality principle, whereby VAT services would be taxed according to for operating models. Transfer Pricing is a tax on final consumption that the rules of the jurisdiction of the place will again have an impact on how the should be neutral for business of consumption. When a supply is made attribution of this expense is made to to a legal entity that has establishments • the destination principle, whereby the branches and therefore will in part in more than one jurisdiction, the OECD internationally traded services and determine the VAT cost.

Conclusion

Financial institutions face a raft of new regulatory requirements which will drive widespread changes to corporate structures and operating models. Many of the necessary responses will have the collateral transfer pricing and VAT consequences even if these are not immediately apparent. Companies will need to ensure that their evolving strategies take account of the tax consequences to minimize any unanticipated tax costs.

For further information, please contact: Richard Iferenta Greg Martin Partner Director KPMG in the UK KPMG in the UK T: +44 20 7311 2837 T: +44 20 7694 1348 E: [email protected] E: [email protected]

7 The OECD International VAT/GST Guidelines, 2006 8 OECD International VAT/GST Guidelines, Draft Consolidated Version, Invitation For Comments, February 2013 19 © 2013 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated. KPMG member firms provide a wide-range offering of studies, analyses and up-to-date periodicals on the trends and knowledge developments in the financial New KPMG thought leadership services industry.

A new era in international tax: Tax morality, Global Indirect Tax Brief – June 2013 transparency, Base Erosion Profit Sharing – A roundup of developments in VAT, GST, Trade and October 2013 Customs, and other indirect taxes. This edition This publication discusses the factors driving the highlight the increasing importance of indirect tax tax transparency and morality debate, provides as one of the most important sources of revenue an overview of the key developments to date, for governments around the world. summarizes the Organisation for Economic Co-operation and Development’s (OECD) Action Plan on Base Erosion and Profit Shifting (BEPS), and outlines the key actions that businesses must take seriously and address now.

Hedge fund managers making significant frontiers in tax – April 2013 investments to comply with global Today’s economic bright spot, as ever, seems regulatory changes: Industry survey – to be the Asia Pacific region. It has escaped October 2013 relatively unscathed from the global economic crisis and continues to offer evidence of growth. To learn more about the impact that regulation In this edition we focus our attention on key tax is having on the hedge fund sector, KPMG issues in this dynamic region. partnered with the Alternative Investment Management Association (AIMA) and the Managed Funds Association (MFA) to conduct a comprehensive, global survey of hedge fund managers around the world.

frontiers in finance - September 2013 2013 Fund and Fund Management and The financial services industry needs a Hedge Funds Surveys fundamental change in attitude and culture to The on-going turmoil in the financial markets is respond to the new environment. This is why driving major change tax regimes around the we have chosen to devote much of this issue of world and much structural change in the fund and frontiers to issues of culture. We believe culture hedge fund industry. It will be critical for these is the new fundamental challenge. types of companies to keep on top the changes and ensure that their systems and processes are keeping in line. KPMG International has once again collaborated across our member firms to provide you with the annual International Funds and Fund Management Survey and International hedge funds survey that can help you navigate the AIFMD: Re-shaping for the future – Fourth changing environments in which we work. edition – September 2013 In this publication we provide an overview of the AIFMD (Level I and Level 2) legal and regulatory framework that governs the alternative investment fund industry in the EU that has, Follow us on LinkedIn and Twitter. since July 2013, reshaped the operations of managers and the alternative funds they manage. KPMG

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Proposed Introduction of VAT for the Download all publications at: Insurance Sector in China – August 2013 kpmg.com/financialservices This special VAT publication is focused on kpmg.com/tax analysing the likely impacts of the proposed kpmg.com/ftt Value Added Tax (VAT) reforms on the insurance kpmginstitutes.com/ sector in China. kpmg.com/fstax kpmg.com/aifmd

Hans-Jürgen A. Feyerabend Victor Mendoza Chairman – Global Financial LATAM FS Tax Regional Lead Services Tax Industry Leader – Global Banking Tax Industry Leader – Global KPMG in Spain Investment Management Tax T: +34 91 456 3488 KPMG in Germany E: [email protected] T: +49 69 9587 2348 E: [email protected]

Brian Daly Daniel Mayo Industry Leader – Industry Leader – Capital Markets Tax Global Insurance Tax KPMG in the US KPMG in Ireland T: +1 212 872 3427 T: +35 31 410 1278 E: [email protected] E: [email protected]

Joseph J Hargrove Chris Abbiss Americas FS Tax Regional Lead Asia Pacific FS Tax Regional Lead KPMG in the US KPMG in Hong Kong T: +1 212 872 5521 T: +85 22 826 7226 E: [email protected] E: [email protected]

Richard Iferenta John Neighbour Head of Global FS Indirect Tax Head of Global FS Transfer Pricing KPMG in the UK KPMG in the UK T: +44 207 311 2837 T: +44 20 7311 2252 E: [email protected] E: [email protected]

Lucy Iacovelli Partner, Insurance Tax KPMG in Canada T: +1 416 777 3820 E: [email protected]

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This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG member firms. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2013 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: Frontiers in Tax – December 2013 Publication number: 130834 Publication date: December 2013