Taxes

Newsletter of the International Bar Association Legal Practice Division

Vol 19 No 2 SEPTEMBER 2013 INTERNATIONAL BAR ASSOCIATION CONFERENCES

UP TO 6 CPD HOURS AVAILABLE

Rethinking international taxation as we know it What senior practitioners should learn from younger ones

22 November 2013 OECD Conference Centre, Paris, France

A conference presented by the IBA Taxes Committee, supported by the IBA European Regional Forum

As various nations, regulators and international bodies reassess a number of key parameters and guidelines relating to international and domestic corporate tax, this conference will examine what these changes might mean to practitioners from various jurisdictions involved in the field today, and how they may impact younger practitioners over the next 30 years.

Topics include: s 4RANSPARENCY AND ENHANCED MUTUAL ASSISTANCE IN TAX MATTERS WILL TAX PLANNING SUFFER s 7ILL TAX COMPETITION IN THE %5 n AND BEYOND n SURVIVE THE @BASE EROSION AND PROlT SHIFTING DEVELOPMENTS s 4AX PLANNING AND ABUSE OF TAX TREATIES NAVIGATING WITHIN TAX UNCERTAINTY s #AN 3OURCE 3TATES PROTECT THEIR TAX BASE THROUGH THE 0ERMANENT %STABLISHMENT #ONCEPT

,ONDON 3ÍO 0AULO 3EOUL 7ASHINGTON $#

TH &LOOR  3T "RIDE 3TREET ,ONDON %#! !$ 5NITED +INGDOM 4EL      &AX      WWWIBANETORG INTERNATIONAL BAR ASSOCIATION CONFERENCES

UP TO IN THIS ISSUE Contributions to this newsletter are always welcome 6 CPD and should be sent to the Newsletter Editor: HOURS From the Co-Chairs 4 Francesco Capitta Di Tanno e Associati, Rome From the Editor 5 AVAILABLE Tel: (06) 845 661 / (06) 8456 6219 Committee officers 6 Fax: (06) 841 9500 [email protected] IBA Annual Conference, Boston 6–11 October 2013, our Committee’s sessions 7 International Bar Association Second IBA/CIOT Conference reports 4th Floor, 10 St Bride Street Rethinking international London EC4A 4AD, United Kingdom Interest deductibility 11 Tel: +44 (0)20 7842 0090 Financing transactions in this environment 13 Fax: +44 (0)20 7842 0091 www.ibanet.org Hedging including credit default swaps, © International Bar Association 2013. taxation as we know it equivalent payments and managing All rights reserved. No part of this publication may be foreign tax credits 18 reproduced or transmitted in any form or by any means, or stored in any retrieval system of any nature without the Taxation of offshore income of financial prior permission of the copyright holder. Application for institutions 21 permission should be made to the Director of Content at What senior practitioners should the IBA address. Use of finance companies by multinationals 24

Transfer pricing considerations including Terms and Conditions for submission of articles 1. Articles for inclusion in the newsletter should be sent to the Newsletter Editor. guarantees 27 2. The article must be the original work of the author, must not have been previously learn from younger ones published, and must not currently be under consideration by another journal. If it Capital raising for banks 30 contains material which is someone else’s copyright, the unrestricted permission of the copyright owner must be obtained and evidence of this submitted with the article and the material should be clearly identified and acknowledged within Withholding and reporting compliance issues 32 the text. The article shall not, to the best of the author’s knowledge, contain anything which is libellous, illegal, or infringes anyone’s copyright or other rights. Impact of GAAR on financing 35 3. Copyright shall be assigned to the IBA and the IBA will have the exclusive right 22 November 2013 OECD Conference Centre, Paris, France to first publication, both to reproduce and/or distribute an article (including the abstract) ourselves throughout the world in printed, electronic or any other medium, Distressed debt issues 39 and to authorise others (including Reproduction Rights Organisations such as the Copyright Licensing Agency and the Copyright Clearance Center) to do the same. Following first publication, such publishing rights shall be non-exclusive, except that Reports from the 13th Annual Tax Planning publication in another journal will require permission from and acknowledgment of A conference presented by the IBA Taxes Committee, supported by the IBA European Regional Forum strategies: US and Europe, London the IBA. Such permission may be obtained from the Director of Content at editor@ int-bar.org. 4. The rights of the author will be respected, the name of the author will always be How does the arm’s length method work clearly associated with the article and, except for necessary editorial changes, no in today’s economy 43 substantial alteration to the article will be made without consulting the author. As various nations, regulators and international bodies reassess a number of key parameters and guidelines relating to international and domestic corporate tax, this conference will examine what these changes might mean to practitioners from FATCA 48 Advertising various jurisdictions involved in the field today, and how they may impact younger practitioners over the next 30 years. Debt equity characterisation 51 Should you wish to advertise in the next issue of the Taxes Committee newsletter please contact the IBA The meaning of beneficial owner today 55 Advertising Department. [email protected] Topics include: Distressed assets – tangible and intangible 59 s 4RANSPARENCY AND ENHANCED MUTUAL ASSISTANCE IN TAX MATTERS WILL TAX PLANNING SUFFER Recent cross-border M&A and restructuring transactions 60 This newsletter is intended to provide general s 7ILL TAX COMPETITION IN THE %5 n AND BEYOND n SURVIVE THE @BASE EROSION AND PROlT SHIFTING DEVELOPMENTS information regarding recent developments in taxes Executive compensation and mobile law. Views expressed are not necessarily those of the employees 64 s 4AX PLANNING AND ABUSE OF TAX TREATIES NAVIGATING WITHIN TAX UNCERTAINTY International Bar Association. s #AN 3OURCE 3TATES PROTECT THEIR TAX BASE THROUGH THE 0ERMANENT %STABLISHMENT #ONCEPT The service permanent establishment 67 Article

Tax and morality 71 by Simon Yates

,ONDON 3ÍO 0AULO 3EOUL 7ASHINGTON $#

TH &LOOR  3T "RIDE 3TREET ,ONDON %#! !$ 5NITED +INGDOM 4EL      &AX      WWWIBANETORG TAXES NEWSLETTER SEPTEMBER 2013 3 FROM THE CO-CHAIRS

Sonia Velasco Cuatrecasas, Gonçalves From the Co-Chairs Pereira, Barcelona sonia.velasco@ cuatrecasas.com his year is shaping up to be a year sponsored by the IBA, the ABA and the Tax of tumult and, perhaps, of drastic Executives Institute. Stuart Chessman change in the tax world. Such topics We are now looking forward to our most Vivendi, New York as ‘base erosion’, ‘profit-shifting’, important event of the year, the IBA Annual T stuart.chessman@ transfer pricing, taxation of digital businesses, Conference in Boston which will be held vivendi.com transparency and tax justice are receiving from 6–11 October 2013. The programme almost daily attention in the press and before has already been set and the panellists are the investigative committees of legislatures. preparing the sessions. The programme will The very concept of ‘tax planning’ has received address the hot topics in the international tax massive publicity – usually negative and often world, such as taxation of e-commerce, transfer uninformed. Obviously such traditional pricing, basis erosion and profit shifting. players as the EU, OECD and the taxing Leading representatives of the OECD and the authorities themselves remain very active in US Treasury will speak at our panels and give these developments. Finally, some jurisdictions their perspective on these developments. (eg, the United States) will be considering We extend a warm invitation to you to join fundamental reform of their entire approach to us in Boston and attend our sessions and also taxing international transactions. ‘International take advantage of the unique opportunity taxation’ is no longer an affair just for us to network with lawyers from almost every specialists but is now is in everybody’s mouth – country in the world. The Committee officers for good or for ill. have put together an outstanding programme It has been also a busy year so far for the which should keep you busy from Monday Taxes Committee. The second London morning on 7 October until Friday morning Conference on Current International Tax on 11 October inclusive. Issues and Cross-Border Finance, sponsored In addition to the technical programme, we in conjunction with the Chartered Institute want to point out the social and business events of Taxation, held in February 2013, was sponsored by the Committee. First, we will host extraordinarily well attended. The conference a breakfast at the conference venue for the on European-US Tax Strategies held in London National Reporters on Monday, 7 October at in April, jointly sponsored with the American 0800 – 0900. Immediately after the breakfast, Bar Association and the International Fiscal Robert B Stack, Deputy Assistant Secretary, Association, was also a great success in terms of International Tax Affairs, of the US Treasury attendance and the quality of the panels. Department, will give an address to launch the Launched last year, the IBA Taxes Committee first session of the week. Secondly, our traditional International Liaison initiative has continued Taxes Committee dinner will take place on to engage on international tax matters by Tuesday 8 October at the Boston Harbor Hotel preparing a submission to the OECD on overlooking the harbour. Finally, our open the Commentary to Article 5 (Permanent business meeting will take place over lunch at Establishment) of the OECD Model Tax the conference venue on Thursday 10 October. Convention and by the representation at The agenda will include the presentation of the OECD International Tax Conference in the topics for next year’s conference in Tokyo. Washington DC by a Committee officer. Anyone interested in speaking on a panel next The IBA Taxes Committee Scholarship year or in participating more intensively in the Programme had another successful year in activity of the Taxes Committee should take 2013 with 21 participants in the Scholarship advantage of these opportunities to speak to the Programme. In addition, the Scholarship Committee officers. We look forward to seeing Programme has expanded with the potential you in Boston! of a second scholarship being granted To conclude the year, we will be sponsoring, annually to a young lawyers programme. with the OECD in Paris, the Young Lawyers Another appointment for which the IBA Conference on 22 November 2013. The Taxes Committee worked hard is the annual theme of the conference will be ‘Rethinking Latin American-US Tax Strategies conference International Taxation as we know it: What held in Miami on 12–14 June (including Senior Practitioners should learn from the 12 June pre-meeting programmes) – Younger Ones.’

4 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION FROM THE EDITOR

Francesco Capitta Di Tanno e Associati, Rome Editor’s note [email protected] s the Editor of the IBA Taxes readers throughout the most recent trends in Committee Newsletter, I am international taxation and give a flavour of the delighted to welcome all members current tax climate in the countries represented A to the second issue of 2013. in the panels. Our appreciation goes to the Further to the first issue at the beginning volunteers who devoted their time and effort of this year, this mid-year edition intends to in preparing the reports in a short timeframe inform readers about the activities carried out as well as to the co-chairs and panellists who by the Taxes Committee during the first half reviewed the reports. Special thanks go to of the year and the plans for the future. Margriet Lukkien for her precious work in In the introductory article to this edition, sourcing and coordinating the session reporters. the Co-Chairs of the IBA Taxes Committee, Moreover, an insightful contribution from Stuart Chessman and Sonia Velasco, illustrate Simon Yates will take us into the recent past activities and future initiatives. debate on tax and morality which is ongoing The Newsletter contains the reports from in the UK as well as in other countries. the sessions of the successful conferences in As a final remark, let me remind you that London: the ‘2nd IBA/CIOT Conference: we are happy to receive contributions for the Current International Tax Issues in Cross- Newsletter from the members of the IBA Taxes Border Corporate Finance and Capital Committee. Articles should not exceed 2,500 Markets’ and the ‘13th Annual Tax Planning words and should cover subjects of broad Strategies Conference – US and Europe’. In interest. Anyone who is interested in writing an total, 18 reports from the above-mentioned article for the Newsletter is welcome to contact conferences have been collected and will guide me (details above) for further details.

Global Professional Training with the International Bar Association and the University of Law – LL.M in a career-enhancing commitment to excellence. International Legal Practice

The benefi ts of the LL.M in International Legal Practice You choose what to study s 4AILOR WHAT YOU STUDY TO YOUR CAREER PATH ANDOR PRACTICE AREA s !LL MODULES ARE PRACTICE LED WITH CONTRIBUTIONS FROM LEADING GLOBAL LAW lRMS

You choose how to study s 3TUDY YOUR ,,- AT A TIME AND PLACE THAT SUITS YOU

Full-time LL.M in London &OR FURTHER INFORMATION AND TO REGISTER s 3TARTS IN 3EPTEMBER  AT OUR ,ONDON -OORGATE CENTRE PLEASE EMAIL [email protected] s 4HREE WORKSHOPS PER WEEK n  HOURS EACH s 3UPPORTED BY I 4UTORIALS ONLINE TEST AND FEEDBACK EXERCISES AND www.law.ac.uk/llm INDEPENDENT LEARNING AND RESEARCH

S-mode modules Module First available start date s 3TART IN *ANUARY OR *ULY EACH YEAR Business, fi nance and the legal services market January 2014 s /NLINE STUDY WITH ONE TO ONE ONLINE SUPERVISION FROM A 5NIVERSITY TUTOR s .INE UNITS PER MODULE International intellectual property practice January 2014 International commercial legal practice January 2014 s 7E SUPPLY AN EXTENSIVE SUITE OF USER FRIENDLY PRACTICAL COURSE MATERIAL International public companies practice January 2014 INCLUDING ELECTRONIC LEARNING AIDS International capital markets and loans practice January 2014 You choose your pace of learning International mergers and acquisitions practice January 2014 s -ODULAR COURSE DESIGN ENABLES YOU TO DETERMINE YOUR OWN PACE OF LEARNING International antitrust practice January 2014 s 3 MODE MODULES START IN *ANUARY AND *ULY EACH YEAR International business organisations January 2014 International arbitration practice January 2014 Register now and take that step for educational and International joint ventures January 2014 career development COMMITTEE OFFICERS

Committee officers

Co-Chairs Corporate Counsel Forum Liaison Officer Stuart Chessman Gordon Warnke Vivendi, New York Dewey & LeBoeuf, New York Tel: +1 (212) 572 7140 Tel: +1 (212) 258 3070 Fax: +1 (212) 572 7575 [email protected] [email protected] Sonia Velasco Young Lawyers Liaison Officers Cuatrecasas Goncalves Pereira, Barcelona Friedrich Hey Tel: +34 (93) 290 5590 Debevoise & Plimpton, Frankfurt am Main Fax: +34 (93) 312 9588 Tel: +49 (69) 2097 5000 [email protected] Fax: +49 (69) 2097 5555 [email protected] Vice-Chairs Andrew Loan Alain Ranger Macfarlanes, London Fasken Martineau DuMoulin, Montreal Tel: +44 (20) 7489 2688 Tel: +1 (514) 397 7400 / (514) 397 7555 Fax: +44 (20) 7831 9607 Fax: +1 (514) 397 7600 [email protected] [email protected] Alejandro Torres Scholarship Officer Chevez Ruiz Zamarripa y Cia, Mexico City Paul Carman Tel: +52 (55) 5257 7000 Chapman and Cutler, Chicago Fax: +52 (55) 5257 7001 Tel: +1 (312) 845 3443 [email protected] [email protected] Ewout van Asbeck Van Doorne NV, Amsterdam Membership Officers Tel: +31 (20) 678 9202 Ana Lucia Ferreyra Fax: +31 (20) 795 4202 Teijeiro y Ballone Abogados, Buenos Aires [email protected] Tel: +54 (11) 5199 6522 Fax: +54 (11) 4777 7316 Secretary [email protected] Sam Kaywood Wolf-Georg von Rechenberg Alston & Bird, Atlanta CMS Hasche Sigle, Berlin Tel: +1 (404) 881 7481 Tel: +49 (30) 203 601 806 Fax: +1 (404) 881 7777 Fax: +49 (30) 203 602 000 [email protected] [email protected]

Treasurer Newsletter Editor Bernadette Accili Francesco Capitta Paul Hastings, Milan Di Tanno e Associati, Rome Tel: +39 (02) 3041 4000 Tel: +39 (06) 845 661 / (06) 8456 6219 [email protected] Fax: +39 (06) 841 9500 [email protected] Conference Coordinator Reeves Westbrook Website Officer Covington & Burling, Washington, DC Agnes de l’ Estoile-Campi Tel: +1 (202) 662 5150 CMS Bureau Francis Lefebvre, Neuilly sur Seine Fax: +1 (202) 778 5150 Tel: +33 (1) 4738 5663 [email protected] Fax: +33 (1) 4745 8046 agnes.delestoile-campi@cms-bfl.com

6 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION IBA ANNUAL CONFERENCE, BOSTON 2013, TAXES COMMITTEE SESSIONS

Session Reporters Liaison Officer Xenia Legendre Margriet Lukkien Hogan Lovells, Paris Loyens & Loeff, Amsterdam Tel: +33 (1) 5367 4747 Tel: +31 (20) 578 5418 Fax: +33 (1) 5367 4748 Fax: +31 (20) 578 5854 [email protected] [email protected]

International Organisations Liaison Officers LPD Administrator Claire Kennedy Charlotte Evans Bennett Jones, Toronto [email protected] Tel: +1 (416) 777 6150 Fax: +1 (416) 863 1716 [email protected]

Taxes Committee session

Monday 0830 – 0930 will review recent developments in areas such as defining ‘permanent establishment’ (PE) and allocating income to a PE National rapporteurs breakfast and in the context of e-commerce. How is e-commerce taxed in meeting various countries? What are the current international structures Presented by the Taxes Committee for owning IP, servers and websites? What are the new revenue protection measures and Google tax lookalikes adopted around All national rapporteurs are invited to attend a breakfast the world? How do VAT, US state sales and use taxes and similar meeting on the Monday morning in order to meet each other, non-income taxes apply to sales made by the internet? the Co-Chairs of their session and some of the Taxes Committee officers. Monday 1430 – 1730 Monday 0930 – 1230 New challenges in obtaining interest deduction and in financing group E-commerce: a modern approach to activities taxation Presented by the Taxes Committee Presented by the Taxes Committee Financing corporate groups in a tax-efficient manner is Keynote address: becoming more and more challenging in light of various Robert B Stack Deputy Assistant Secretary (International Tax initiatives adopted by several countries. The panel will review Affairs) US Treasury Department, Washington DC, USA, will some of these new limits on interest deductions, repatriation of open the session with a keynote address on ‘US policy initiatives, profits, depreciation of loans (eg, the so-called non-commercial interesting developments and international matters.’ loan doctrine in the Netherlands) and debt push-downs and The explosive development of e-commerce is creating challenges will walk the audience through some of the pitfalls a corporate for tax practitioners in a wide range of disciplines. The panel group needs to avoid when restructuring its finances.

Continued overleaf

TAXES NEWSLETTER SEPTEMBER 2013 7 IBA ANNUAL CONFERENCE, BOSTON 2013, TAXES COMMITTEE SESSIONS

Tuesday 1430 – 1730 Thursday 0930 – 1230 Mind the ‘tax’ gap: a global reaction to Cutting your losses: where did all my base erosion and profit shifting NOLs go? Presented by the Taxes Committee and the Organisation for Presented by the Taxes Committee Economic Co-operation and Development (OECD) Most jurisdictions allow a company to set off tax losses against In a globalised economy, base erosion constitutes a major profits in other periods. In addition to limiting the period for risk for tax revenues. The worldwide spread of MNEs and the loss carry forwards, many countries have restricted the use crystallisation of new business models in the so-called digital of tax losses and have established or tightened loss forfeiture economy make profit shifting one of the major sources of base rules upon change of ownership. This session will explore the erosion. Also, other challenges such as targeting effectively situations in which a company or corporate group may be hybrid mismatches, re-assessing transfer pricing guidelines, the unable to claim relief for its tax losses and how to address this effectiveness of anti-avoidance measures, the need for increased problem proactively. transparency are being faced in the short run by policy makers in the area of international taxation. At the request of the G20, the OECD launched a comprehensive initiative to address base Thursday 1230 – 1430 erosion and profit shifting (BEPS). Work in the area of aggressive tax planning is also being undertaken by the EU Commission. Open committee business meeting and In this session, co-organised with the OECD Secretariat, a panel lunch of experts will debate about these initiatives and the possible Presented by the Taxes Committee measures to tackle BEPS instances in an effective manner. An open meeting and lunch of the Taxes Committee will be held to discuss matters of interest and future activities. Wednesday 0930 – 1230 Tax residency: coming or going: do you Thursday 1100 – 1230 know where you are? Exchange of information and collection Presented by the Taxes Committee assistance: is transparency trumping This panel will review where companies and other entities are taxpayer confidentiality? treated as being resident for tax purposes, a question which has Presented by the Taxes Committee become more important due to globalisation, executive mobility Revenue authorities are stepping up efforts to protect their and the growth of online business. Passing or failing the tests tax bases. Pressured by some countries, with support from for corporate residence has significant implications for the tax intergovernmental bodies such as the OECD and G20, many position under both domestic law and international treaties. The jurisdictions are being forced to exchange bank customer panel will also consider the technical and practical aspects of information, automatically or upon general request. In corporate redomiciliation, migration and inversion transactions, addition, countries that have traditionally resisted enforcing intended to change the corporate seat and tax residence or foreign tax claims have given way. This panel will discuss the domicile of a company or corporate group. current international trends, including automatic exchange of information, mutual assistance procedures, FATCA, use of money laundering tools, savings taxes, informer programmes Wednesday 1430 – 1730 and tax amnesties. Family business: benefits of family trusts and their alternatives Presented by the Taxation Section Thursday 1430 – 1730

Control without ownership, creditor proofing, reduction in total Recent legislative developments and new income taxes, succession planning – those are only few of the case law in transfer pricing: is this the end many benefits family trusts offer to family-owned businesses. of the arm’s length principle? This panel discusses how families with substantial businesses Presented by the Taxes Committee structure their corporate and personal affairs. We will focus Protecting the tax base is becoming a key driver these days as on the issues of control of wealth planning vehicles, and on some countries find that the arm’s length methodology is not governance of the underlying corporate structures. The panel leading to satisfactory results. The panel will provide a transfer further investigates which vehicles, jurisdictions and governing pricing update in several jurisdictions and will review the laws are popular, and why. Recent changes in tax policies across formulary apportionment approach that is now being considered the globe affect family-owned structures. The panel will suggest (OECD draft report and EU consolidation approach). how to respond to these changes in the interest of your client.

8 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION IBA ANNUAL CONFERENCE, BOSTON 2013, TAXES COMMITTEE SESSIONS

Thursday 1430 – 1730 Friday 0930 – 1230 Tax fraud: causes and cures Acquisition, holding, restructuring and Presented by the Business Crime Committee and the Taxation realisation of value assets Section Presented by the Taxes Committee

The panel will first examine the underlying elements of tax Market liquidity is an asset’s ability to be sold without causing fraud – is it pure greed or are there other reasons why avoidance a significant movement in the price and with minimum loss steps over the line and becomes evasion? What parts do lack of value. Value buying generally involves buying securities at a of resource on the part of investigators and widely different tax discounted price so as to generate through restructuring and/ rates play and what perceptions surround the chances of being or realisation higher returns to investors. The panel will explore found out and prosecuted? the various international structures used by funds to invest It will then look at the alternative attempts made in various in distressed assets (both equity and debt), including the use, jurisdictions to cure this widespread and international where appropriate, of aggregators to reorganise the assets, problem, from the imposition of severe custodial sentences and the ways (eg, securitisation) and the instruments (eg, at one extreme, to offering an amnesty from prosecution participating loans) aimed at marketing the non-participating and fixed penalties at the other. assets while at the same time trying to avoid international tax exposures (eg, establishment of PE by collecting agents).

INTERNATIONAL BAR ASSOCIATION’S HUMAN RIGHTS INSTITUTE (IBAHRI)

The International Bar Association’s Human Rights Institute (IBAHRI), established in 1995, has become a leading global force in human rights, working to promote and protect the independence of the judiciary and the ability of lawyers to practice freely and without interference under a just rule of law. The IBAHRI runs training programmes and workshops, capacity building projects with bar associations, fact-fi nding missions, trial observations; issues regular reports and press releases disseminated widely to UN bodies, international governmental and non-governmental organisations and other stakeholders; and undertakes many other projects working towards its objectives.

All our activities are funded by grants and individual donations.

Become a member for just £40 a year – less than £4 a month – to help support our projects.

Visit www.ibanet.org/IBAHRI.aspx for more information, and click join to become a member. Alternatively, Our work around the world email us at [email protected]. Work carried in 2012 Work carried out prior to 2012

www.ibanet.org/IBAHRI.aspx http://twitter.com/IBAHRI http://facebook.com/IBAhumanrights he energetic and prosperous city of Boston is renowned for its cultural facilities, world-class educational establishments, and T its place at the forefront of American history. As New England’s social and commercial hub, home to a number of major national and international businesses, and one of the oldest operational sea ports in the western hemisphere, Boston is a fi tting and inspiring setting for the International Bar Association’s 2013 Annual Conference. WHAT WILL BOSTON 2013 OFFER? s 4HE LARGEST GATHERING OF THE INTERNATIONAL LEGAL COMMUNITY IN THE world – a meeting place of more than 4,500 lawyers and legal professionals from around the world KEYNOTE SPEAKERS INCLUDE: s -ORE THAN  WORKING SESSIONS COVERING ALL AREAS OF PRACTICE RELEVANT TO INTERNATIONAL LEGAL PRACTITIONERS s 4HE OPPORTUNITY TO GENERATE NEW BUSINESS WITH THE LEADING lRMS IN THE WORLDS KEY CITIES s ! REGISTRATION FEE WHICH ENTITLES YOU TO ATTEND AS MANY WORKING Madeleine K Albright Former US SESSIONS THROUGHOUT THE WEEK AS YOU WISH Secretary of State, Opening Ceremony s 5P TO  HOURS OF CONTINUING LEGAL EDUCATION AND CONTINUING Keynote Speaker PROFESSIONAL DEVELOPMENT Justice Stephen Breyer Associate Justice, US Supreme Court s ! VARIETY OF SOCIAL FUNCTIONS PROVIDING AMPLE OPPORTUNITY TO Paul Volcker American Economist and NETWORK AND SEE THE CITYS KEY SIGHTS AND AN EXCLUSIVE EXCURSION former Chairman of the Federal Reserve and tours programme

www.ibanet.org/conferences/Boston2013

OFFICIAL CORPORATE SUPPORTERS SECOND IBA/CIOT CONFERENCE, LONDON 2013

Second IBA/CIOT Conference: Current International Tax he energetic and prosperous city of Boston is renowned for its Issues in Cross-Border cultural facilities, world-class educational establishments, and Corporate Finance and T its place at the forefront of American history. As New England’s social and commercial hub, home to a number of major national and Capital Markets international businesses, and one of the oldest operational sea ports in the western hemisphere, Boston is a fi tting and inspiring setting for the London, 11 February 2013 International Bar Association’s 2013 Annual Conference. 11 FEBRUARY 2013 Matthew Interest deductibility – WHAT WILL BOSTON 2013 OFFER? Herrington McDermott, Will & current state of play and s 4HE LARGEST GATHERING OF THE INTERNATIONAL LEGAL COMMUNITY IN THE Emery, London world – a meeting place of more than 4,500 lawyers and legal [email protected] direction of travel professionals from around the world KEYNOTE SPEAKERS INCLUDE: s -ORE THAN  WORKING SESSIONS COVERING ALL AREAS OF PRACTICE RELEVANT TO INTERNATIONAL LEGAL PRACTITIONERS Speakers Debt bias – consequences and remedial Michel Collet CMS Bureau Francis Lefebvre, actions s 4HE OPPORTUNITY TO GENERATE NEW BUSINESS WITH THE LEADING lRMS Neuilly sur Seine As a general proposition, debt is typically Fergus Harradence HM Treasury, London IN THE WORLDS KEY CITIES more attractive to corporate taxpayers than Friedrich Hey Debevoise & Plimpton, equity. This is principally because interest s ! REGISTRATION FEE WHICH ENTITLES YOU TO ATTEND AS MANY WORKING Frankfurt am Main payments on debt are usually tax-deductible Madeleine K Albright Former US Tom Scott McDermott Will & Emery, London SESSIONS THROUGHOUT THE WEEK AS YOU WISH and so are in theory an easy way in which to Secretary of State, Opening Ceremony Jeffrey Trinklein Gibson Dunn & Crutcher, reduce a company’s effective tax rate. But Keynote Speaker New York s 5P TO  HOURS OF CONTINUING LEGAL EDUCATION AND CONTINUING interest deductibility is only the beginning; Phil West Steptoe & Johnson, Washington DC PROFESSIONAL DEVELOPMENT Justice Stephen Breyer Associate Justice, debt is fundamentally more flexible and US Supreme Court advantageous than equity in several respects. s ! VARIETY OF SOCIAL FUNCTIONS PROVIDING AMPLE OPPORTUNITY TO Introduction For example: Paul Volcker American Economist and UÊ`iLÌÊV>˜ÊLiÊÀi«>ˆ`ÊÜˆÌ œÕÌÊÌ iʘii`Ê NETWORK AND SEE THE CITYS KEY SIGHTS AND AN EXCLUSIVE EXCURSION former Chairman of the Federal Reserve This session focused on the phenomenon for the company in question to have and tours programme of debt bias and considered some of the ‘distributable reserves’; ways in which it is currently addressed and UʈÌÊV>˜ÊLiÊÌÀ>˜V i`]Ê돈Ì]ÊÃÕLœÀ`ˆ˜>Ìi`Ê>˜`Ê discouraged by selected national tax systems traded; (such as the UK, France, Germany and the Uʈ˜ÌiÀiÃÌÊ«>ޓi˜ÌÃÊV>˜ÊLiÊV>«ˆÌ>ˆÃi`ʜÀÊ US). The report includes a brief summary of rolled-up; the OECD’s recently-released ‘base-erosion UʈÌÊV>˜Êˆ˜VœÀ«œÀ>ÌiÊViÀÌ>ˆ˜Êvi>ÌÕÀiÃʜvÊ and profit-shifting’ report, which is presented equity (such as profit participation) whilst contextually as a recent development at the retaining certain features of debt (such as international level in combating the debt priority of repayment over shareholders in a bias, and concludes with a brief speculative winding-up); and consideration of some changes that could UʈÌÊV>˜ÊV>ÀÀÞÊÀˆ} ÌÃʜvÊVœ˜ÛiÀȜ˜Ê>˜`ɜÀÊ be made to the UK’s corporate tax system exchange in respect of the common stock in order to further combat debt bias in the of the borrower or another company. www.ibanet.org/conferences/Boston2013 supply chain planning of multinational Over time, these numerous benefits have corporations (MNCs). contributed to the so-called ‘debt bias’ in

OFFICIAL CORPORATE SUPPORTERS

TAXES NEWSLETTER SEPTEMBER 2013 11 SECOND IBA/CIOT CONFERENCE, LONDON 2013

the supply chain planning of MNCs, which connected with a tax evasion motive); typically tends to exhibit a strong preference UÊ >˜Ìˆ‡>ÀLˆÌÀ>}iÊÀՏiÃÊ­Ü ˆV ÊÀiÃÌÀˆVÌÊÌ iÊ1Ê for funding to be sourced in the form of debt deduction where there is an element of rather than equity. cross-border arbitrage involved, such as the This debt bias is generally thought to have ability of the taxpayer in question to claim several negative potential ramifications. Most deductions in more than one country in obviously, excessive leverage is generally respect of the same interest payment); accepted as having been one of the key causes UÊ Ì iʼܜÀ`܈`iÊ`iLÌÊV>«½Ê­Ü ˆV Ê«ÀiÛi˜ÌÃÊ of the ‘credit crunch’, which was damaging ‘debt dumping’ in the UK by limiting a UK not only to domestic financial systems in their company’s interest deductions by reference own right but also to the global economy as a to the amount of third party debt in the whole. Furthermore, although it is not always consolidated accounts of the group); and easy to distinguish causation from correlation, UÊ Ì iÊÃÌ>ÌÕ̜ÀÞÊ}i˜iÀ>Ê>˜Ìˆ‡>LÕÃiÊÀՏi° it is a fact that a debt bias tends to go hand-in- Other jurisdictions have rules that are similar, hand with ‘base erosion’, that is, the tendency but have also added their own domestic twists. of MNCs to locate their debt financing in the The US, for example, has long-standing same jurisdictions in which their profits are anti-debt bias rules around late paid interest generated in order to shelter or wipeout any and earnings stripping. Germany applies two potential tax. Taken a step further, a debt bias limits to interest deductibility known as the can result in the location of a company in a Trade Income Tax (which restricts 25 per cent given jurisdiction solely for the purposes of of otherwise deductible interest in respect of drawing-down debt, where that jurisdiction certain modified income) and the interest offers a favourable regime for interest barrier rule (which applies where companies deductibility and perhaps also the ability to have a net interest expense position in surrender deductions into the wider group. excess of €3m and effectively caps interest A debt bias can therefore fundamentally deductions at 30 per cent of the company’s affect not only the way in which companies do modified taxable EBITDA). In France, there business where they are already based, but can are three cumulative layers of legislation also encourage structures to be established that an interest payment must safely navigate solely for the purpose of exploiting favourable through in order to achieve deductibility: interest deductibility regimes and arbitraging UÊ Ì ˆ˜ÊV>«ˆÌ>ˆÃ>̈œ˜Ê­Ü ˆV ]ʈ˜Ê>Êȓˆ>ÀÊv>à ˆœ˜Ê differences between domestic regimes to the to the UK rules, looks both at the rate of benefit of an MNC. This can in theory be interest and the ratio of debt to equity); just as undesirable as the basic phenomenon UÊ >˜Ìˆ‡>LÕÃiÊÀՏiÃÊÀi>̈˜}Ê̜ÊÌ iÊÀi˜V Ê of over-leverage, which can itself present participation exemption (which aim to a systemic risk for national governments restrict the availability of the exemption generally. Most developed taxing jurisdictions where a French company is purchased in a therefore have rules that are intended to leveraged acquisition); and reduce the attractiveness of debt finance to UÊ Ì iʈ˜ÌiÀiÃÌÊÌ>ÝÊL>ÀÀˆiÀÊ­Ü ˆV Ê>««ˆiÃʈ˜Ê>Ê MNCs and to curb the tendency towards a similar way to the German interest barrier debt bias in their supply chain structuring. rule described above).

Selected national tax systems – International action combating the debt bias Perhaps the clearest sign of the growing Presently, the UK rules dealing with interest political desire to address the debt bias deductibility include: in supply chain structuring is the OECD’s UÊ Ì ˆ˜ÊV>«ˆÌ>ˆÃ>̈œ˜Ê>˜`ÊÌÀ>˜ÃviÀÊ«ÀˆVˆ˜}Ê work on base-erosion and profit-shifting (which restrict interest deductibility where, (BEPS). This has become a key focus for for example, the ratio of debt to equity many countries that in recent years have is too high, the level of debt is supported seen a reduction in tax revenues which by a connected company guarantee that they feel cannot fully be attributed to the would not be available to an unconnected global recession. borrower or where the rate of interest The BEPS report was released on charged is excessive); 13 February 2013. Whilst in general terms UÊ «ÕÀ«œÃi‡L>Ãi`ÊÀՏiÃÊ­Ü ˆV ÊÌi˜`ÊÌœÊ it presents nothing new (as it substantively prevent interest deductions where either simply restates previous work such as the the interest or the related principal are Report on Harmful Tax Competition and

12 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013 the Harmful Tax Project), the report clearly an interest payment will be tax-deductible demonstrates that BEPS has now become a in line with the recognition of the interest political issue and there is a real momentum expense in the borrower company’s accounts behind the OECD’s work on this issue. is not easily disturbed in normal structuring. The report concludes that the current This has caused some commentators to query rules on international tax are outmoded whether the UK’s corporate tax rules are because they have failed to keep pace actually now too competitive (for example, with the way in which MNCs do business there is a generous participation exemption, nowadays. In particular, there is a recurrent no withholding tax on outbound dividends, focus in the report on what have become an exemption for foreign branches and ‘the usual suspects’ in any discussion about no tax is levied on foreign or UK source the efficacy of the current principles on dividends received by a UK company). international tax; namely, transfers of The UK Government has until now intellectual property, e-sales/digital business ruled-out any changes to the deductibility and the tendency towards a debt bias in of interest. In general, this was because it supply-chain structures founded on the was believed that changes would have been principle of separate legal personality. disruptive for business, would undermine The report also touches on the impact stability and certainty, and could have of state-sponsored tax incentives. It notes damaged the UK’s competitiveness. It was that these may lead to an MNC having a low also thought that it would be difficult to effective tax rate in an entirely uncontroversial design a workable rule that operates fairly manner (eg, where a government policy to for all businesses without creating complexity encourage investment in a particular sector or uncertainty. gives rise to a tax-break), but also flags the However, given the generally favourable potential for distortion in a global economy and competitive corporate tax regime the where sovereign states compete with each UK now has, it is possible that the rules on other to attract inward investment by offering interest deductibility are now ideal candidates competitive tax systems. for unilateral action by the UK; they could be The report recommends that an action amended at a purely domestic level, would be plan be drawn up by June 2013, with unlikely to place the UK in breach of any of concerted international action to take place its double tax treaty obligations and should be as soon as possible thereafter in order to compliant with the UK’s EU law obligations. implement the plan. As debt bias is one of We can only speculate as to the form of any the aspects of BEPS (arguably one of the such changes, but these would in theory be principal aspects), the OECD’s work in this likely to borrow certain features from some of sphere will be of great relevance to MNCs the regimes outlined above. For example, the going forward. UK could introduce an interest barrier rule or could restrict the availability of its participation exemption in a similar fashion to the French Possible tax law changes to combat equivalent (at present, debt financing has no debt bias effect per se on the availability or operation Aside from the work of the OECD on BEPS, of the UK’s participation exemption). Such it is likely that individual countries may wish changes may be limited to certain sectors, to take unilateral action to combat debt with carve-outs for particular industries. The bias. Although multilateral action at the UK might also look to overhaul its generous international level will be more effective rules on the carry-forward of losses (perhaps in combating debt bias globally, unilateral introducing a time limit to replace the current action taken by a given country changing position of indefinite carry-forward) and its domestic tax rules is likely to yield results possibly also review its rules on the availability more quickly (albeit on a smaller level). of losses when a change of ownership takes By way of example, the UK offers what is place (perhaps seeking to narrow the scope of in general terms still a relatively generous these rules in line with the equivalent regime interest deductibility regime for corporate in Germany). Alternatively, the UK could taxpayers. Although a taxpayer seeking an focus on levelling the playing field between interest deduction must navigate its way debt and equity by introducing an allowance through an extensive battery of rules that for corporate equity. Any such changes would can restrict or deny in full the deduction need to be looked at holistically in the context being sought, the starting proposition that of the UK’s corporate tax system as a whole.

TAXES NEWSLETTER SEPTEMBER 2013 13 SECOND IBA/CIOT CONFERENCE, LONDON 2013

Conclusions upon debt bias. In the meantime, MNCs should be aware that individual countries The debt bias is a prevalent feature of MNC may move to address debt bias through supply chain structuring and results from the changes in their domestic legislation in an inherent tax and non-tax advantages of debt attempt to block base-erosion unilaterally; over equity. Whilst many countries already MNCs will need to monitor any such have their own domestic rules in place to developments carefully and factor them into combat debt bias, it is likely that multilateral the ongoing maintenance and development action at the international level will take of their supply chain planning. place over the coming years (principally in the wider context of BEPS) that will impact

11 FEBRUARY 2013 Financing transactions in Amelia O’Beirne Mason Hayes & Curran this environment including Solicitors, Dublin conduits, hybrid entities and [email protected] hybrid instruments

Speakers The Irish changes focussed on the issue of Paul Carman Chapman and Cutler, Chicago profit participating notes by Irish section 110 Carlos Ferrer Cuatrecasas Goncalves Pereira, Madrid companies. An Irish section 110 company is James Somerville A&L Goodbody, Dublin a ‘normal’ Irish company which is subject to Gerald Rokoff DLA Piper, New York Irish corporation tax and resident in Ireland for Irish domestic tax and treaty purposes. he purpose of the session was to The legislation provides for it to be treated discuss recent tax developments as ‘trading’ allowing it a full deduction affecting international financing for expenses incurred including ‘profit transactions, including the treatment dependant’ interest (overriding normal T rules). It is typically financed by way of profit of conduit and fiscally transparent entities, hybrid entities and hybrid instruments. participating loan notes, the return on which leaves only nominal profit within the vehicle taxable at 25 per cent. Irish section 110 Ireland companies are typically used for financing James Somerville began by discussing transactions and must meet certain conditions. hybrid instruments and noted that it was It was not immediately clear what triggered a topical issue at OECD and EU level the 2011 changes; however, the recent focus on during 2012, evidenced by the publication hybrid instruments and double non-taxation by the EU of a consultation document on suggest that the Irish government’s aim was to the subject in December 2012. Ireland combat such arrangements. The Irish Revenue anticipated these moves and took steps Commissioners engaged in consultation with in 2011 to limit opportunities for double industry representatives with a view to ensuring non-taxation through the enactment that only offensive transactions would be of domestic legislation. Pre-2011, it was affected by the new legislation. Irish section 110 possible to have an Irish company issue a companies are typically used in a wide range hybrid instrument which would give rise to of legitimate financing transactions and there an interest deduction without taxation of were concerns that the changes, if not carefully the corresponding income in the considered, could affect Ireland’s standing as an recipient country. international financial services centre.

14 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

Interest deductibility is now denied in the considered subject to tax. Where there are case of certain offensive structures which non-US investors in the LLC, interest will be result in either: considered subject to tax only to the extent UÊ `œÕLiʘœ˜‡Ì>Ý>̈œ˜ÆʜÀÊ that it is immediately (ie, within 20 days) UÊ >Ê`i`ÕV̈œ˜Êˆ˜ÊÀi>˜`ÊÜˆÌ Ê˜œÊÌ>Ý>̈œ˜Êˆ˜Ê paid to a taxable EU/DTT investor. the recipient jurisdiction. Whilst certain offensive structures In broad terms, following the 2011 changes, are no longer viable, the Irish Revenue interest deductibility is now dependant on Commissioners recognise the importance of the profit dependant interest element being maintaining the ability to carry out public taxable in the recipient country without transactions through Ireland and for this a participation exemption or a notional/ reason many similar transactions may still deemed deduction. be implemented through the use of listed/ Interest deductibility is not, however, wholesale debt instruments or hybrid restricted by the new anti-avoidance instruments, the foreign deduction in respect provisions where: of which is not computed by reference to the UÊ ˆ˜ÌiÀiÃÌʈÃÊ«>ˆ`Ê̜Ê>Ê«iÀܘÊÜˆÌ ˆ˜ÊÌ iÊ amount of Irish interest paid. charge to Irish corporation tax; The Irish Revenue Commissioners are UÊ ˆ˜ÌiÀiÃÌʈÃÊÌ>Ý>Liʈ˜Ê>˜Ê 1É`œÕLiÊÌ>ÝÊ taking further steps to address other hybrid treaty (DTT) country without a deemed or issues. Irish regulated funds which are notional deduction calculated by reference established as corporate entities can currently to the amount of interest received; only be established as plcs which are per se UÊ ˆ˜ÌiÀiÃÌʈÃÊ«>ˆ`Ê̜Ê>Ê«i˜Ãˆœ˜Êv՘`]Ê entities for US tax purposes. A new form of government body or equivalent in an EU/ corporate fund is being formulated which DTT country in which that entity is exempt will not be a plc and will have the ability from tax; to check the box for US tax purposes. A Uʈ˜ÌiÀiÃÌʈÃÊ«>ˆ`ʜ˜Ê>ʼµÕœÌi`Ê ÕÀœLœ˜`½Ê further anomaly which is being addressed or a ‘wholesale debt instrument’ provided is the tax treatment of Irish investment that it is not paid to a ‘specified person’ limited partnerships. These entities are (which broadly means a person who currently treated as opaque from an Irish controls the section 110 company or tax perspective but transparent from a legal from whom the section 110 company has perspective. The Irish Finance Act 2013 will acquired 75 per cent of its assets). change the tax status of these entities so that Whilst the legislative changes were relatively they are regarded as transparent from both a brief, they resulted from a long consultation legal and a tax perspective. process and gave rise to long guidance notes issued by the Revenue Commissioners United States clarifying Revenue’s approach to the changes and the treatment of certain foreign entities Paul Carman discussed recent developments receiving interest. in the interpretation of the meaning of the A number of practical issues arise for term ‘beneficial owner’ for DTT purposes. advisors, for example, the requirement that The OECD released a revised commentary the recipient of profit dependant interest on the subject in October 2012 and he noted is subject to tax in an EU/DTT country that the commentary is likely to have a broad can necessitate a complex analysis where impact on financing transactions, both in the there are many recipients in different application of DTTs and in the interpretation jurisdictions. The treatment of partnerships of intergovernmental agreements. The was also initially unclear. However, the Irish April 2011 OECD commentary required Revenue Commissioners have clarified that the recipient to have ‘the full right to use the interest will be considered subject to tax and enjoy the dividend unconstrained by a if it is taxed on an arising basis on receipt by contractual or legal obligation to pass the a partner in an EU/DTT country. Further payment received to another person’. This clarity was also provided in respect of certain was not commercially viable in most cases US entities. In the case of ‘check the box’ as almost every company has obligations entities, the interest will be considered which must be met. The October 2012 OECD subject to tax if it is treated for US purposes commentary has removed this requirement as paid to a US person who is subject to and whilst there are still certain issues with tax on an arising basis. In the case of US the interpretation from a tax advisor’s LLCs with only US investors, interest will be perspective, it is a friendlier version.

TAXES NEWSLETTER SEPTEMBER 2013 15 SECOND IBA/CIOT CONFERENCE, LONDON 2013

Paul Carman discussed the international jurisdictions, Circular 601 overrides treaty context in which the OECD commentary provisions. Subsidiaries of public companies has developed. also benefit from Announcement 30 provided they are formed and tax resident in the same jurisdiction as the parent. Indofood Finance Limited v JP Morgan Chase As many multinationals hold their Chinese Bank NA London Branch investments through tax havens, this is likely The Indofood case involved a Mauritian to cause problems with the beneficial owner finance subsidiary which granted a loan to analysis in many cases. A tax haven subsidiary its Indonesian parent. The DTT between must formally disclaim that it is the beneficial Mauritius and Indonesia was terminated owner before the parent company can assert during the term of the loan resulting in a the DTT and this presents difficulties for all withholding tax charge. The issuer sought parties involved. to accelerate the notes and this was resisted on the basis that withholding tax could be OECD commentary avoided through the interposition of a Dutch company. The matter was heard by a contract The general rule which was set out in the court in the UK which considered whether April 2011 OECD commentary stated that the Dutch company would be the beneficial if the recipient was obliged to pass on the owner of interest payments received by it. payment received, it would not be treated Whilst there were timing differences in the as the beneficial owner of that payment. payments, identical amounts would be paid The October 2012 commentary draws straight through the Dutch entity. The UK back a little from this position in that the court held that the Dutch finance subsidiary obligation to pay on must now be related would not be the beneficial owner of the to the obligation to receive in order for payments received by it. beneficial ownership to be denied. For example, the Indofood case involved clear related obligations to pay on the amount The Queen v Prévost Car Inc and Velcro received immediately and would be likely Canada Inc v The Queen to be caught under the new guidelines. These Canadian cases looked at the Financing subsidiaries typically lend and meaning of beneficial owner in the context borrow on a regular basis rather than of payments of dividends and royalties entering into one-off transactions. It may (respectively) by a Canadian company to be arguable that, in these scenarios, an a Dutch holding company. The Velcro case obligation to pay on is not directly related applied the Prévost analysis and ultimately to the payment received; however, this will considered whether the recipient company need to be explored over time. had any discretion with respect to the The word ‘unrelated’ is mentioned twice funds received. Both rulings were in favour in the commentary and both instances are of the taxpayer. relevant. The best factual situation which could arise is a situation where, in the ordinary course of business, a financing SAT Guoshuihan [2009] No 601 entity borrows money to finance its The Chinese tax authorities issued a circular operations and also receives payments from in 2009 containing a list of bad facts which subsidiaries which are unrelated. There are would indicate that an entity should not be also grey areas such as multi-transaction regarded as the beneficial owner of payments securitisation programmes where there is received by it. Some of these indicators could no one-to-one correlation of payments. It be regarded as commonsense while others go remains to be seen how these transactions much further than that. will be treated. There was concern initially as to whether Whilst the specific guidance provided in this guidance would act as a treaty override relation to collective investment vehicles is and this was clarified in announcement welcomed, the actual wording is relatively 30 issued in June 2012. The Chinese tax restrictive. Only funds that are legal persons, authorities confirmed that in the case of are widely held, hold a diversified portfolio public companies in treaty jurisdictions, and are subject to investor protection Circular 601 is not a treaty override, however regulation stand to benefit. in the case of private companies in treaty In summary, under the new commentary:

16 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

UÊ Õ˜Ài>Ìi`Ê`iLÌʜLˆ}>̈œ˜ÃÊ>ÀiÊ«iÀ“ˆÌÌi`Æ transaction. The provisions were introduced UÊ «ÕLˆVÊw˜>˜Vˆ˜}ÊÛi ˆViÃÊ>ÀiÊ}ˆÛi˜Ê to combat certain offensive transactions preference over private financing vehicles; whereby multinationals used intragroup and financing to buy foreign group companies UÊ Ãˆ˜}iÊÌÀ>˜Ã>V̈œ˜Ê-*6ÃÊÌ >ÌÊȓ«ÞÊ«>ÃÃÊ creating a tax deduction in Spain. As there through the payments will have challenges. were historically very few limits in Spain on interest deductibility this led to artificial erosion of the Spanish taxable base. Spain Carlos Ferrer began by discussing trends in General limitation Spain in re-characterisation of transactions. He explained that Spain has a wide variety of This rule was introduced to replace Spanish anti-abuse legislation ranging from general to thin capitalisation rules with effect from specific and recent changes have enhanced 1 January 2012. The rule limits the level of the powers of the Spanish tax authorities. deductibility of financing costs to 30 per General anti-abuse provisions include rules cent of the borrower’s EBITDA (excluding setting aside sham transactions and the the first €1m which is always deductible). doctrine of fraus legis. These provisions allow Excess expenses may be carried forward the Spanish courts to set aside transactions (for up to 18 months) and unused and disregard legal entities which are validly thresholds may be added to the following incorporated in circumstances where a year’s threshold (for five years). The rule transaction is solely tax driven. applies to both intragroup and third party The computation of Spanish corporate financing regardless of whether transactions income tax is based on accounting results, are arm’s length (with certain exceptions in as adjusted for tax purposes. Spanish the case of financial institutions, insurance GAAP contains similar substance over form companies etc). provisions to IFRS. Spanish tax authorities Another key issue currently is the treatment can modify the accounts of a company based of foreign hybrid entities. In assessing the on the substance over form principle even nature of a foreign entity, the Spanish tax without invoking sham transaction provisions. authorities look at: This is a very powerful re-characterisation UÊ i}>Ê«iÀܘ>ˆÌÞÆ tool which may be used in circumstances UÊ Ì>ÝÊ«iÀܘ>ˆÌÞÆ where the tax authorities are of the view the UÊ «œÜiÀÃʜvÊÌ iÊà >Ài œ`iÀÃÆÊ>˜`Ê underlying transaction is different to what has UÊ ˆ>LˆˆÌÞÊvœÀÊ`iLÌÃʈ˜VÕÀÀi`ÊLÞÊÌ iÊi˜ÌˆÌÞ° been recorded in the accounts. Foreign entities will be disregarded for Spain has typically been a good jurisdiction Spanish tax purposes and Spanish DTTs for tax planning because of the fact that to the extent that these characteristics are profits for tax purposes are based on similar to a Spanish disregarded entity. The accounting profits. For example, where an treatment of a vehicle (eg, foreign fund/ instrument is treated for accounting purposes securitisation vehicle) as transparent in as debt/equity, the tax treatment typically a foreign jurisdiction and opaque under follows. Once international accounting Spanish law can give rise to difficulties, standards are met, the treatment of the return particularly in the context of withholding tax as interest/distribution follows this analysis. and treaty access. Recent substance over form changes will give rise to significant room for re-characterisation United States in this regard. Two very important limitations were Gerald Rokoff began by highlighting the introduced this year affecting interest commercial and tax friendly aspects of the US deductibility. tax regime including: UÊ 1-Êi˜ÌˆÌÞÊV>ÃÈwV>̈œ˜ÊÀՏiÃÊ>œÜˆ˜}Ê foreign and US entities to elect whether Intragroup transactions to be treated as pass-through (taxation at Financing expenses incurred by a Spanish member/owner level) or blocker/corporate company on an intragroup loan to acquire (taxation at entity level). This gives rise shares of/make an equity contribution to to opportunities for the US tax burden to a group company are no longer deductible be reduced without a corresponding US unless there is a valid economic reason for the inclusion. Even in the case of per se entities,

TAXES NEWSLETTER SEPTEMBER 2013 17 SECOND IBA/CIOT CONFERENCE, LONDON 2013

it is typically the case that these can be Interest is deductible against operating converted to non-per se entities tax free in profits or may be used to create an operating non-US jurisdictions. loss which can be set against future gains. UÊ ¼ œÕLiÊ`ˆ«½Êœ««œÀÌ՘ˆÌˆiÃÊ>œÜˆ˜}Ê>Ê Withholding may be reduced or eliminated deduction for the same interest in more under US DTTs or by borrowing from an than one jurisdiction on both outbound unrelated entity. Provided the ultimate and inbound payments. shareholding is diverse (ie, no ten per cent UÊ 1-ÊÀՏiÃÊ>ÀiʼÃÕLÃÌ>˜Vi½ÊL>Ãi`ÊÜ ˆiʈ˜Ê shareholders), the acquisition vehicle may be many non-US jurisdictions, rules are ‘form’ leveraged with shareholder debt creating an based, permitting varying characterisations interest deduction and avoiding withholding. of the same transaction. More complex investment structures exist UÊ
ÃÊ1-Ê«>ÃÃ‡Ì ÀœÕ} Êi˜ÌˆÌˆiÃÊ>ÀiʘœÌÊÃÕLiVÌÊ which give rise to enhanced tax benefits. For to US tax simply as a result of organisation/ example, high yield debt instruments may formation under US state laws, non-US be used to convert operating profits/gains joint ventures have utilised US LLCs with on disposal to ‘portfolio interest’ which is no commercial activity or income in the not subject to US federal or state taxation. US as ‘tax haven’ entities because of the Whilst this alternative dramatically reduces minimal administrative costs and robust US taxation, there are strict criteria which legal regime. must be met in order to ensure favourable UÊ / iÊÕÃiʜvÊ ÞLÀˆ`É`ˆÃÀi}>À`i`Êi˜ÌˆÌˆiÃÊÌœÊ tax treatment is achieved in respect of the avoid what would otherwise be bad income debt instrument. For example, the equity for Subpart F. should be held by an unrelated party with He went on to discuss the main aspects of favourable tax attributes which will acquire the ‘check the box’ rules, the types of hybrid the real estate. entities and their interaction with US DTTs. Another alternative for foreign investors Whilst certain structures no longer work, in US real estate is to use a multi-tiered it is still possible to use hybrid entities in investment structure involving both foreign acquisition/capitalisation financing to create and US blocker entities. US federal/state inbound and outbound double dip structures. corporate income tax will arise on sale Significant tax planning opportunities of the underlying property together with exist for foreign investors investing in US potential withholding tax on distribution of real estate. The most common and simplest the proceeds offshore. The sale of shares in structure is to use a US corporate blocker, the offshore entity will not trigger a US tax which acquires real estate directly or through charge. Prior to the sale, the US company a US pass-through. The US taxes gains on the can do a section 1031 exchange which sale of real estate but it is possible to mitigate will establish the value of the real estate the US tax charge if the US pass-through and purchase a property the stock buyer is entity is capitalised in part with debt. willing to own.

11 FEBRUARY 2013 Hedging including credit Scott Newman K&L Gates, New York default swaps, equivalent scott.newman@ payments and managing klgates.com foreign tax credits

Speakers Messrs Leblang, Andrade and Newman were Richard Andrade Goldman Sachs, London the speakers on the panel on ‘Hedging, Stuart Leblang Akin Gump Strauss Hauer & Feld, including credit default swaps, equivalent New York payments and managing foreign tax credits’. Scott D Newman K&L Gates, New York Messrs Leblang and Andrade focused

18 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013 their remarks on section 871(m) of the US Under IRC section 871(m), which is Internal Revenue Code of 1986, as amended generally effective for payments made on (the ‘IRC’), which was enacted in 2010 and or after 14 September 2010, the ‘foreign- provides that any ‘dividend equivalent’ will be to-foreign’ exception under Notice 97-66 treated as a dividend from US sources for all is no longer applicable. Rather, section withholding tax purposes (regardless of the 871(m) treats as dividend equivalent residence of the payor) and, in connection payments the following transactions that therewith, the temporary and proposed are contingent on or determined by regulations issued by the US Internal Revenue reference to US source dividends: Service (IRS) in January 2012 that expand UÊ ÃÕLÃ̈ÌÕÌiÊ`ˆÛˆ`i˜`ÃÊ«ÕÀÃÕ>˜ÌÊ̜Ê>ÊÃiVÕÀˆÌˆiÃÊ and modify the scope of IRC section 871(m). lending or sale-repurchase transaction; Mr Newman concentrated his remarks on UÊ >˜ÊiµÕˆÌÞÊÃÜ>«Ê«>ޓi˜ÌÊ«ÕÀÃÕ>˜ÌÊ̜Ê>Ê legislative proposals introduced on ‘specified notional principal contract’; and 24 January 2013 by Representative David Camp, UÊ œÌ iÀʼÃÕLÃÌ>˜Ìˆ>ÞÊȓˆ>À½Ê«>ޓi˜ÌÃÊ>ÃÊ Chairman of the US House Ways and Means determined by the IRS and which have been Committee, which, if enacted into law, would addressed, to some extent, in the temporary dramatically change the US tax treatment and proposed regulations. of financial instruments and simplify the tax In addition, Notice 2010-46, which formally rules with respect to the identification of withdraws Notice 97-66, provides a new hedging transactions. Messrs Leblang and exemption for ‘Qualified Securities Lenders’ Newman also commented on IRC section (QSLs) and a ‘credit forward’ mechanism for 1411 which imposes a 3.8 per cent tax on ‘net proof of withholding in a series of loans. In investment income’. this regard, Mr Andrade commented on the difficulties that QSLs may be facing under Notice 2010-46 while noting that some QSLs IRC section 871(m) and the temporary and may be ‘warehousing’ US withholding taxes as proposed regulations thereunder a credit against the tax in foreign jurisdictions Mr Leblang’s presentation essentially in which they are resident. tracked the slide presentation prepared Under Notice 2010-46, a withholding agent by Rom P Watson of Ropes & Gray and may limit aggregate US gross-basis tax within himself in advance of the conference.1 Mr a ‘series of securities lending transactions’ to Leblang reviewed the state of the law with the amount of US gross-basis tax applicable to respect to ‘dividend equivalent payments’ the foreign taxpayer bearing the highest rate prior to the enactment of IRC section of US gross-basis tax; thus, the aggregate taxes 871(m), commencing with the US Treasury paid in such transactions should not exceed Regulations issued in 1997. Under the 1997 the US statutory rate of 30 per cent. Excessive regulations, a ‘look-through’ approach was tax may be relieved by amounts previously adopted under which substitute dividend withheld to the extent there is sufficient payments in connection with securities loans evidence of prior tax withheld. and repos of US equities are treated for cross- A notional principal contract (NPC) border tax withholding (and all treaties) as relating to a US equity security is within the ‘dividend’ payments sourced in the US. By ambit of IRC section 871(m) if (in connection comparison, all dividend payments in the with entering into the contract): context of equity swaps (and other notional UÊ >˜Þʼœ˜}Ê«>ÀÌÞ½ÊÌÀ>˜ÃviÀÃÊÌ iʼ՘`iÀÞˆ˜}Ê principal contracts) were sourced based on security’ to a ‘short party’; the residence of the recipient. Accordingly, UÊ >Êà œÀÌÊ«>ÀÌÞÊÌÀ>˜ÃviÀÃÊÌ iÊ՘`iÀÞˆ˜}Ê a non-US party’s income with respect to an security to a long party; equity swap that references the stock of a UÊ Ì iÊ՘`iÀÞˆ˜}ÊÃiVÕÀˆÌÞʈÃÊ«œÃÌi`Ê>ÃÊVœ>ÌiÀ>Ê US issuer, including any notional dividend by any short party with any long party; amounts, was generally not subject to US UÊ Ì iÊ՘`iÀÞˆ˜}ÊÃiVÕÀˆÌÞʈÃʘœÌʼÀi>`ˆÞÊ withholding tax. tradable’ on an established securities market; Notice 97-66 further limited the or withholding tax for substitute dividend UÊ Ì iÊVœ˜ÌÀ>VÌʈÃʈ`i˜Ìˆwi`Ê>ÃÊ>ʼëiVˆwi`½Ê payments by applying incremental tax rate NPC by the IRS. percentages and hypothetical rates, not A ‘long party’ is a party entitled to receive any actual tax paid. In addition, same country/ payment pursuant to an NPC which is same borrower type securities loans were contingent upon, or determined by reference to, generally exempt. the payment of a dividend from US sources

TAXES NEWSLETTER SEPTEMBER 2013 19 SECOND IBA/CIOT CONFERENCE, LONDON 2013

with respect to the underlying security. A ‘short Under the Camp proposals, the ‘mark-to- party’ is any party to the NPC that is not a long market’ method of accounting under IRC party with respect to the underlying security. section 475 (which is mandatory for securities The ‘underlying security’ with respect to an dealers and applies to commodities dealers NPC is the security with respect to which the US- and securities and commodities traders source dividend is referenced. An index or fixed who elect to be taxed under IRC section basket of securities is treated as a single security. 475) to investors. More precisely, the Camp IRC section 871(m)(3)(B) requires that proposals would introduce new IRC sections payments made after 19 March 2012 on any 485 and 486, under which investors would NPC contract will automatically be treated be required to ‘mark-to-market’ at the end as made pursuant to a ‘specified’ NPC, of each year their derivatives as if they had unless a determination is made by the IRS sold such derivatives for their fair market that the ‘contract is of a type which does not value and any changes in the value of such have the potential for tax avoidance’. The derivatives would result in taxable gain or Temporary Regulations defer this date until loss. Moreover, all such gains or losses would 31 December 2013. be treated as ordinary (rather than capital) The related proposed regulations create gain or loss. If enacted, new sections 485 and additional new categories of ‘specified’ 486 would eliminate IRC section 1256 (and NPCs and also modify the statutory certain other statutory provisions relating to categories. Mr Leblang noted that other capital transactions), under which investors significant aspects of the proposed are required at the end of a year to ‘mark- regulations include the following: to-market’ certain kinds of derivatives such UÊ `ˆÛˆ`i˜`ÊiµÕˆÛ>i˜ÌÃÊ>ÀiÊÌ iÊ}ÀœÃÃÊ>“œÕ˜ÌÃÊ as regulated futures contracts and specified of US-source dividends used in computing ‘foreign currency contracts’ as if they had any net amounts transferred to or from a been sold for their fair market value. Under swap counterparty; IRC section 1256, gain or loss is treated as UÊ >ÊVœÕ˜ÌiÀ«>ÀÌÞÊ̜Ê>ÊÃÜ>«ÊVœ˜ÌÀ>VÌʓ>ÞÊ short-term capital gain or loss to the extent have a withholding obligation even if not of 40 per cent thereof and as long-term required to make an actual payment; and capital gain or loss to the extent of 60 per UÊiˆÌ iÀÊ«>ÀÌÞÊ­ˆ˜VÕ`ˆ˜}Ê>ÊvœÀiˆ}˜Ê cent thereof. Complex rules/elections also party) to a swap contract could be a apply to ‘mixed straddles’ under current law US withholding agent with respect to a and would also apply under certain ‘mixed dividend equivalent payment. straddle’ provisions of the Camp proposals. Because new IRC sections 485 and 486 would apply to all taxpayers not otherwise Chairman Camp’s proposed legislation subject to the ‘mark-to-market’ method with respect to the taxation of financial of accounting under IRC section 475 derivatives and hedging transactions (except for derivatives entered into as part Mr Newman began his remarks by noting of a hedging transaction in the ordinary that while Chairman Camp’s proposed course of business and certain real estate legislation would result in material changes transactions such as options to acquire real with respect to the tax treatment of financial estate), it would apply to both privately- derivatives and instruments, they would issued and publicly-traded instruments. Mr not necessarily effect ‘wholesale’ changes. Newman commented that in connection For example, the proposals do not address with privately-held derivatives, valuation active financing, the treatment of carried issues will arise of necessity and that under interests, the distinction between debt and the proposed legislation the IRS to deal with equity, and the deductibility of interest. The such valuation issues in future regulations. thrust of the proposals regarding financial Mr Newman also noted that the definition derivatives is to bring uniformity to the US of a ‘derivative’ is intended to be quite broad tax treatment of derivatives which under and, in addition to options, forward contracts current US tax law can vary significantly and futures contracts would include, among depending on the type of derivative (for other things, the embedded conversion example, futures, forward contracts, swaps feature of a convertible bond and most types and options), the taxpayer’s profile and of credit default swaps. various other factors which can result in very The Camp proposals with respect to different tax consequences for ‘economically the taxation of financial derivatives and similar’ transactions. instruments would be effective with respect to

20 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

property acquired, positions established and/ with the rules under Subpart F of the Code in or transactions entered into after the case of ‘controlled foreign corporations’ 31 December 2013. or under a QEF election with respect to a PFIC, as the case may be. However, under the proposed regulations such taxpayers IRC section 1411: the ‘Unearned Income would not seem to be required to include the Medicare Contribution’ tax amount of such inclusions under Subpart F Messrs Leblang and Newman closed the or a QEF election in ‘net investment income’ session by commenting on IRC section 1411, for purposes of IRC section 1411 until the which imposes a 3.8 per cent tax on ‘net amounts of such income previously taxed investment income’ of individual taxpayers to such persons under Subpart F or a QEF (and trusts and estates to the extent treated as election are actually distributed to them, individuals) whose adjusted gross incomes (as unless such taxpayers make an election modified by IRC section 1411) exceed certain under section 1411 to be taxed currently on ‘threshold’ amounts. such income inclusions as ‘net investment Mr Leblang noted that for ‘United States income’ in the same year as such amounts shareholders’ (as defined under IRC section are otherwise taxed for regular tax purposes 951(b)) of a ‘controlled foreign corporation’ under Subpart F of the Code or a QEF (as defined in IRC section 957) and United election. The ostensible purpose of this States persons owning stock in a ‘passive election under the proposed regulations foreign investment company’ (PFIC) who under IRC section 1411 is intended to relieve have made a ‘qualifying electing fund’ the taxpayer of maintaining ‘two sets’ of election (QEF) as to a PFIC, the recently ‘books’ (ie, one for regular tax purposes and proposed regulations under IRC section 1411 the other for IRC section 1411 purposes), appear to create ‘two sets’ of books with although in the absence of such an election it respect to income inclusions under Subpart F appears that in many instances the tax on ‘net of the Code with respect to such ‘United investment income’ under IRC section 1411 States shareholders’ of a ‘controlled foreign can be postponed with respect to current corporation’ and United States persons who income inclusions under Subpart F of the have made a QEF election with respect to Code or a QEF election. This concluded the stock held by them in a PFIC. For regular panel’s presentation. income tax purposes (ie, chapter 1 of the Code), such taxpayers would continue to include in income their pro rata share of a Note foreign corporation’s income in accordance Unfortunately, Mr Watson was unable to attend the conference due to a severe snowstorm that blanketed Boston.

11 FEBRUARY 2013 Bruno Santiago Taxation of offshore income of Morais Leitão, Galvão Teles, Soares da Silva e financial institutions Associados, Lisbon [email protected]

Speakers by the German Supreme Court on a hedged Peter Blessing Shearman & Sterling, New York tax sparing credit (Supreme Tax Court Matthias Geurts Noerr, Frankfurt am Main judgment I R 103/10 of 22 June 2011). Guglielmo Maisto Maisto e Associati, Milan Shortly after, a German Corp bought a Pano Pliotis GE Capital Solutions, London short-term note in Brazilian currency issued by Bank A, hedging with Bank B its currency exposure with a forward sale having the same Presentation on hedged tax sparing credits maturity as the note. and hedging of internal transactions The tax idea underlying these transactions was The panel started with a presentation by to use the tax sparing credit of 20 per cent on the Dr Matthias Geurts related to a case decided gross income against the German tax due on the

TAXES NEWSLETTER SEPTEMBER 2013 21 SECOND IBA/CIOT CONFERENCE, LONDON 2013

net income. At the time the case was judged, only Presentation on transfer pricing, guarantee expenses which directly related to the income fees, GAAR and foreign tax credits had to be taken into account. In the meanwhile, Transfer pricing and guarantee fees the law changed and required that business expenses and decreases in business assets Professor Maisto presented a case related with economically related to the respective revenues the arm’s length remuneration of guarantees to be also deducted to the net income available provided by parent companies to their to credit the foreign tax. subsidiaries, a topic that is receiving more The Supreme Court held first that the tax attention by the Italian tax authorities. credit is determined on the basis of the gross In the case presented, the Italian parent amount of the foreign income. However, company provided a guarantee to the secondly, the income against the foreign bonds issued by its Dutch subsidiary whose taxes that can be credit has to be determined proceeds were directed to finance other according to the German income tax rules. overseas subsidiaries of the group. The Dutch In this respect, the Supreme Court held the subsidiary paid a guarantee fee of 0.05 per opinion that if at the acquisition of a debt cent to its parent that was subsequently in a foreign currency the sale of the debt recharged to the financed overseas companies with a fixed currency exchange rate was of the group at the same rate. predetermined, the gain or loss occurred in The relevance of the theme was related the currency was an inherent element of the with the arm’s length remuneration for the income (interest). Consequently, the basis guarantee granted by the parent. It may be against the foreign taxes that can be credit argued that the arm’s length guarantee fees will be minimal. should correspond to the difference between The question that comes up is if the same the interest rate applied on un-guaranteed reasoning applies if instead of the forward sale, bond issuing and the interest rate applied the parties entered into a swap agreement or a on guaranteed bond issue, being that the put-call combination. Furthermore, if between interest rate on un-guaranteed bond issuing is the debt contract and the forward agreement, determined based on the subsidiary average is there no timing congruence? Or only if the credit rating. coupon has been hedged? Another question related with this case In this respect, whether the income at was whether the recharge of the guarantee least is predetermined will be key, that is, the fees to the overseas subsidiaries should economic interest is fixed. include a mark-up. According to Professor The panellist ended his presentation Maisto, there should be no mark-up if the with another example relating to hedging subsidiary’s credit rating equals or is higher transactions: the acceptance of internal than the parent’s credit rating. However, if transactions (an internal swap between the the subsidiary’s credit rating is lower than trading and the treasury departments of a the parent’s credit raking, in principle, there financial institution that may be located in should be a mark-up. different jurisdictions) for accounting and their relevance for tax purposes. The application GAAR and foreign tax credit is relevant to avoid potential accounting mismatches (mark-to-market for the derivatives The other case presented by Professor Maisto and at cost for the loan). However, there is was a case decided by Italian courts on the a risk of a split hedge if the hedging and the applicability of the GAAR in a situation basis instrument (ie, the loan) are in different related with the double use of foreign tax jurisdictions. Therefore, the acceptance for credits in two different jurisdictions. tax purposes might only be granted in cases In the case presented, a UK company issued where the basis and the hedging instrument a bond to a UK bank. By a repo agreement are in the same jurisdiction. Additionally, these entered into between the UK bank and an types of transactions shall be market priced, Italian bank, the bond passed on to the documentation should be available, they Italian bank. The UK company paid interest should have hedging purposes and be part of a to the Italian bank related with the bond regulatory risk management. On these grounds, that was subject to withholding tax in the UK until the hedge relationship is given then both and the Italian bank was entitled to a foreign legs should be booked through the p&l or, tax credit because of the withholding tax avoiding the volatility within the p&l, one single suffered in the UK. As remuneration for the ‘frozen’ position should be shown. repo, the Italian bank paid a manufactured

22 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013 interest to the UK bank corresponding to enforcement, etc). As explained by the the interest paid by the UK company less the panellist, besides this entity level test, a similar withholding tax. The UK bank also claimed ‘substantially all the activities’ test is applied a tax credit on the withholding tax paid on to each item of gross income earned by the the interest, therefore both the UK bank and CFC in its head office or branch. Finally, the the Italian bank benefited from a tax credit. panellist concluded their exposition with the The Italian tax authorities applied the GAAR presentation of some critical issues that arise and qualified the tax credit benefited by the in connection with this exception. Italian bank as an undue tax benefit. Professor Maisto finished his presentation Additional issues relating to offshore with an overview of the CFC rules in Italy. operations of financial institutions, Regarding the requirement ‘taxes levied’ on particularly from a US perspective the income, he provided an example of a restructuring operation. The session finished with a presentation by Peter Blessing. He started his presentation addressing the proposals for international tax Presentation on an overview of US anti- reform in the US, in particular the proposed deferral legislation – Subpart F and the adoption of a territorial system in line with Active Finance Exception (AFE) some major EU jurisdictions, instead of the Pano Pliotis gave an explanation on the basic current worldwide system. In this context, it framework of the well-known US Subpart F was highlighted that the introduction of the rules created to prevent deferral of tax on exemption method to eliminate international passive income earned and retained by CFCs double taxation of active income would not outside the US. Taking into consideration the replace CFC provisions for passive income topic of the seminar and of the conference, (and foreign tax credits (FTCs)). Certain Pano focused his presentation on the key proposed features are designed to prevent exceptions to Subpart F that are of relevance taxpayers from seeking to have high-taxed to non-US finance operations, such as income brought within the US tax net and the exception for CFC to CFC lending, use of credits for excess foreign taxes paid exemptions for CFC which are dealers in thereon to reduce US tax payable in respect securities, commodities, currencies and of passive income. derivatives, and especially the Active Finance The presentation followed with Peter Exception (AFE) introduced in 1997 which noting that continuation of the AFE (briefly covers a broad range of finance activities explained in the previous presentation), if beyond the scope of traditional investment the exemption method were to be introduced banking/securities dealing. The types of in the US and on what terms, had not been income covered by the AFE generally include addressed in connection with the proposal. income from personal and mortgage loans, Another critical issue regarding the adoption factoring, leasing, credit cards, project of the exemption system relates to the finance, debt/equity securities and cash treatment of foreign branches, which would deposits and other similar types of income. be treated as separate entities (as recently In order to benefit from the AFE exception, done under the UK system) and thus make the CFC must be predominantly engaged in them eligible for the exemption system and the active conduct of a banking, financing subject them to CFC rules, but prevent the or similar activity. Predominantly engaged flow of losses back home. meaning that at least 70 per cent of the Peter Blessing went on in his presentation CFC’s gross income derives from lending or to address certain hedging and FX issues finance transactions with non-US unrelated faced by financial institutions. He followed customers. For fully regulated CFC banking with an example of a subsidiary that obtained entities with substantial deposit funding, the a loan from a third party bank or the capital 70 per cent test does not apply. Furthermore, markets with a guarantee rendered by its the CFC’s own employees located in the parent company. It was assumed that the home country of the CFC (or of its branch) subsidiary could independently obtain a loan must conduct substantially all of the activities from the same market, so the guarantee is necessary for the generation of the income given to lower financing costs, satisfy lender (namely initial solicitation of customers, moral hazard concern or avoid covenants negotiating terms, underwriting/credit risk or need for audited financials. In this analysis, entering into loans, collection/ hypothetical example, the question was

TAXES NEWSLETTER SEPTEMBER 2013 23 SECOND IBA/CIOT CONFERENCE, LONDON 2013

raised whether the parent could contribute view taken by the courts in relation to cross- the guarantee to the capital of the subsidiary border tax arbitrage, demonstrating with (thus making it property of the subsidiary) case law where different views were taken and, if so, whether that could be done depending on whether there was a tax shelter in a tax-free manner. If that is not done, transaction involved. the question of what is the benefit to the Subsequent slides addressed the possibility borrower from the parent guarantee must of offsetting net operating losses of a branch of be faced, and whether the parent company a foreign entity located in the US against the charge a guarantee fee. He presented some profits of a US subsidiary of the same foreign considerations in pricing the guarantee fee, entity, and deemed dividend issues that might and dissented from the notion that proper arise with the use of a profit split by a financial pricing should necessarily disregard in all institution, if regulatory concerns prevent cases the passive association benefit, as payment by one party to the other. suggested by the OECD guidelines and a Finally, the presentation ended with an recent Canadian decision. overview of FTC ‘splitter’ arrangement rules The panellist then turned to certain other in the US, and particularly as they related issues encountered by financial institutions. to group relief, under regulations issued For example, he commented on the bipolar pursuant to IRC section 909.

12 FEBRUARY 2013 Use of finance companies by Leonard Toenz ALTENBURGER LTD, multinationals Zurich zurichtoenz@ alteburger.ch

Speakers on the issue of hybrid mismatch arrangements Marcel Buur Loyens & Loeff, London (‘Hybrid Mismatch Arrangements: Policy and Stuart Chessman Vivendi, New York Compliance Issues, 2012’). On 12 February Sara Luder Slaughter and May, London 2013, the OECD published its report on Klaus Sieker Flick Gocke Schaumburg, Frankfurt Addressing Base Erosion and Profit Shifting am Main (BEPS) which was drafted at the request of the G20. The development in Europe has n the introductory remarks, the panel been initiated by a joint statement of UK pointed to the characteristics of monetary and German officials (5 November 2012) assets: they are mobile and easy to shift proposing a push to make multinational from high to low tax countries. Tax companies pay their ‘fair share’ of taxes. It is I expected that this initiative will give rise to new planning with respect to monetary assets has little impact on business and can prove to be legislation on a country level and to changes of very beneficial. double tax treaties. One of the topics will be to Tax planning in the area of monetary assets combat double non-taxation. is also affected by the current political climate which is driven by the need to increase tax Examples of group finance structures revenues and which scrutinises in particular the multinational companies regarding the Marcel Buur presented the group finance suitability of their overall tax burden and the structures which are most used in Europe. question of the appropriate allocation of the There is the simple Luxemburg structure taxes paid to the involved countries. There in which the parent company establishes are politically motivated developments at a Luxembourg finance company granting the level of the OECD and EU. The OECD loans to group affiliates. Whereas the finance produced a paper on Tackling Aggressive Tax income generated in the Luxemburg Planning through Improved Transparency finance company is taxed at a very low and Disclosure (‘OECD 2011’) and another effective rate, there is now withholding tax levied in Luxembourg on payments to

24 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013 the parent as the Luxemburg company is The new rules are designed to make the financed primarily through Preferred Equity UK corporate tax regime internationally Certificates (PECs) or Preferred Equity Share more competitive. It still remains to be seen Certificates (PESCs), which are considered as whether the new rules are fully compliant debt from a Luxemburg point of view. And with the EU position (Cadbury Schweppes). the same instruments are generally regarded as equity from the parent’s point of view so Status quo in Germany that any payments received by the parent from the Luxembourg subsidiary are subject Klaus Sieker reported on the German status to favourable tax treatment in the hands of as regards the use of finance companies. the parent. Another Luxembourg structure Finance company structures mainly serve is to establish a Luxembourg branch which is German parents to avoid the German holding the Luxembourg finance company. withholding tax of 26.375 per cent which There are two Luxembourg-Swiss structures applies on interest paid on hybrid loans by the which are widely used: one is that the the German borrower. This can be reached Luxembourg finance company maintains a by interposing, for example, a Luxembourg Swiss finance branch which is extending the borrower whereby the Luxembourg borrower loans to group affiliates and the other is that is avoiding any withholding tax and is the Luxembourg finance company is holding lending the funds to the German parent as a Swiss finance company. Both structures a straight loan. This structure is widely used will lead to a combined tax rate on finance and practiced today and the German tax income of two to five per cent. authorities have not really challenged it so far. A special UK-Netherlands structure is used Another structure is the use of hybrid by UK parents involving a Dutch cooperative instruments by the German parent. In this holding a Dutch BV which grants the loans structure, the Luxembourg subsidiary issues to the affiliates. The main feature in this Genussscheine to the German parent; the structure is that the Dutch cooperative is Genussscheine is a debt instrument from transparent from a UK perspective and that Luxembourg’s perspective (no withholding the cooperative and the Dutch BV are treated tax) and an equity instrument from a as one single tax payer. Finally, Marcel Buur German perspective for which a 95 per cent referred to the Belgium-NID structure which exemption from corporate income tax is has become less attractive and is less widely available. There was an initiative to abolish used today then in previous years. such exemption, but the initiative has not yet been pursued and enacted, mainly for political reasons. New UK CFC regime Klaus Sieker furthermore referred to the Sara Luder initiated the audience in the new Columbus Container case on which the ECJ UK CFC regime and the consequence of issued a preliminary ruling (6 December this regime for finance companies. The new 2007). The corporate structure at stake was a regime takes effect as from this year. Belgium coordination centre which was held Non-trading finance income is generally by a German parent; whereas the Belgium subject to CFC charge, but there are exemptions, coordination centre is taxed in Belgium mainly for ‘qualifying loan relationships’ as a corporation, it is a partnership from a (QLR). The centrepiece of the new CFC regime German point of view. The ECJ held that the is the availability of partial or full exemption. German switch-over clause does not make any If partial exemption applies, 75 per cent of distinction between taxation of income from a QLR profits are exempt from CFC charge so domestic partnership and from a partnership that the effective CFC charge rate on finance residing in another EU Member State. So the income is 5.25 per cent taking into account the German law was judged to be compatible with reduction in corporate tax rate to 21 per cent EU law. applicable in 2014. Full exemption is available Klaus Sieker pointed out that Germany to the extent that QLRs are funded from local is not intending to become attractive source profits, assets acquired through certain internationally for finance structures (it is equity – financed acquisitions and rights issue not a place for establishing German finance by group parent. Full exemption also applies subsidiaries of foreign parents), but German for residual QLR profits exceeding a group’s CFC rules allow low-taxed passive income aggregate UK tax deduction for finance costs of EU/EEA finance subsidiaries (including (net of finance income). branches outside EU/EEA) to escape from

TAXES NEWSLETTER SEPTEMBER 2013 25 SECOND IBA/CIOT CONFERENCE, LONDON 2013

German taxation provided that the taxpayer ATRA provides evidence that the subsidiary is The magic word in the context of taxation of engaged in a truly economic activity in its finance companies is currently ‘ATRA’. ATRA country of residence. stands for American Taxpayer Relief Act of 2012 which was signed into law on 2 January Netherlands’ new deduction limitation 2013. Stuart Chessman guided us through the US aspects in this regard. Marcel Buur explained the new Dutch rules There is the extension of the look-through on interest deduction limitations which treatment of payments between related have the ambition to maintain an attractive Controlled Foreign Corporations (CFCs) fiscal investment climate as well as being in the sense that finance income received compatible with EU law. by a CFC from other CFC constitutes, as The takeover holding rules, effective as of a matter of principle, Foreign Personal 2012, provide that the deduction of interest Holding Company Income (FPHCI) in the on acquisition debt is limited to stand-alone hands of the recipient CFC and is taxable profits of the takeover holding company to the US shareholder of the CFC under in fiscal unity with the target holding, but Subpart F rules. The look through extension there is a franchise of €1m which is always is specifically important where a ‘check deductible (so that small and midsized the box’ election to make the payer CFC a companies should not be hit) and there also disregarded entity under the recipient CFC applies a debt cap: the maximum leverage or under a common CFC holding company of 60 per cent of the acquisition cost is cannot be made, for example, in case of a allowed and this maximum is reduced by per se entity. This provision had expired for five percentage points per year after the tax years beginning after 2011, but ATRA acquisition so that the maximum is reduced now retroactively extends the exemption for to 25 per cent in the eighth year and after. tax years of foreign corporations beginning As a result of the ECJ ruling in the Bosal before 2014. case, new rules were introduced which Whereas unrelated party income and other apply as from 2013. Pursuant to these rules, financial income earned by a CFC is subject interest on debt financing with respect to to tax in the hands of its US shareholder as the acquisition of subsidiaries, whether Subpart F income, IRC has provided since Dutch or foreign, is no longer deductible. 1997 an exception from taxation under The main exception to this is that it does Subpart F rules for certain income derived not apply to acquisitions increasing the in the active conduct of banking, financing operational activities. This new limitation or insurance or as a securities dealer. These of interest comes on top of already existing exceptions, introduced as a supposedly provisions aimed at restricting the use of temporary measure, also expired for tax years abusive structures such as a double dip beginning after 2011 and ATRA retroactively through hybrid structures or structures extends these exceptions again to the past. resulting in a tax deduction of interest Stuart Chessman concluded by stating without an adequate compensating levy on that ATRA actually preserves the status quo, the corresponding income or an acquisition but there are new rules expected in this that is mainly tax inspired. context in the very near future. These two described techniques, widely used today by US multinationals, seem to be at risk in the expected new rules.

26 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

12 FEBRUARY 2013 George N Transfer pricing considerations Kerameus KPP Law, Athens including guarantees [email protected]

Speakers (BEPS), which was published the same day, Murray Clayson Freshfields Bruckhaus Deringer, and more specifically to the third pillar of London the project, addressing fundamental transfer Peter Steeds HM Revenue & Customs, London pricing questions, such as whether the arm’s length principle or the separate legal entity his session addressed the current approach properly work under the current theory and practice as regards related- state of play. party loan and guarantee pricing with a Peter Steeds finished his introduction by particular focus on the existing related stating that, starting from the conclusions of T the BEPS report, we may soon see specific international case law. The session began with a short introduction guidance being issued at an international by the two panellists. level on the issue of transfer pricing and Murray Clayson referred to the little light financial transactions, which (guidance) is that international conventions and related currently missing. documentation shed on the issues at hand (eg, The panellists then proceeded with paragraph 7.37 of the OECD transfer pricing commenting on the following case law guidelines (2010) and various paragraphs of (together with the latest administrative part 2 of the OECD Permanent Establishments position of the German tax authorities) on Report (2008) (‘PEs Report’)). transfer pricing of loans and guarantees; the He then pointed out that, however merits of each one were first presented by convenient and easy it may be to implement Murray Clayson. at a group level, the practice commonly seen in the market of adding a spread GE Capital Canada to the lender’s own cost of funds may be inappropriately simplistic, when each and In this case, the Canadian GE Capital every transaction is separately reviewed from a subsidiary obtained funding from market transfer pricing perspective. investors, the claims of which were secured After noting the exemption provided by by a guarantee of the US GE parent company Part II paragraph 31 of the PEs Report in which had a triple A rating at the time. The respect of branches from the general rule of Canadian revenue questioned the deductibility evaluating the creditworthiness by reference of the guarantee fees (100 bps) payable by the to the bank as a whole (perhaps of relevance, borrower entity to the guarantor, assessing that for example, where national laws ring-fence there existed in any case an implicit support by the assets of a branch from the claims of the latter to the former and therefore that the general creditors), Murray Clayson went on to guarantee was worthless. say that the panellists’ focus would be on the At the end of 2010, the Canadian Federal interesting but diverse international case law Court of Appeal dismissed the Crown’s appeal on the subject matter. upholding the decision of the Canadian In his introductory remarks, Peter Steeds Tax Court on the case (issued in 2009) by stated that there has never been a greater virtue of which the guarantee fee was found media and political focus on transfer pricing to be appropriate. The Canadian courts as there is today, and it has been an item emphasised the separateness of entities on the agenda of both the G-8 and G-20 approach, recognising that implicit support latest meetings. He also observed that the was part of the factual matrix, but declining key pressure area now seems to be the tax to take the position that the implicit support treatment of profits derived from the digital of the parent to the subsidiary was equal delivery of goods and services. to a guarantee or, in other words, that the In this respect, he referred to the OECD subsidiary had automatically acquired the report on Base Erosion and Profit Shifting parent’s rating due to such implicit support.

TAXES NEWSLETTER SEPTEMBER 2013 27 SECOND IBA/CIOT CONFERENCE, LONDON 2013

Murray Clayson, who characterised this case interest therefore should be lower than that as a leading one due to the quality of analysis charged by the controlling lender. Murray made in its course, gave an outlook of the two concluded that this is a case in which the methods that may be followed while applying very fact of control is regarded, rather than the arm’s length principle, namely: disregarded, and therefore it could be seen UÊÌ iʘœ‡>vwˆ>̈œ˜Ê“œ`i]Ê«ÕÀÃÕ>˜ÌÊÌœÊ as constituting an unwarranted victory of which the borrower is regarded on a substance over form. stand-alone basis; and At the other end of the spectrum, Peter UÊ Ì iʓ>ÀŽiÌÊ>vwˆ>̈œ˜Ê“œ`i]Ê«ÕÀÃÕ>˜ÌÊÌœÊ Steeds opined that one has to look at the which the wider context, including the substance after having looked at the form, parent’s and/or group’s position, is taken which seems to have been disregarded in into consideration when assessing what the this case, and to that extent he characterised borrower can do; the latter is found to be Diligentia as not such a helpful and consistent closer to the arm’s length principle by Murray, decision. Peter Steeds emphasised that the who also reminded the audience of the reality of the risk undertaken by the lender importance of evidence offered by an analysis must be examined, accepting however that of creditworthiness, while substantiating the these are grey area issues. pricing of financing transactions. After his reference to the lack of UK case law German MoF Decree of 2011 on transfer pricing in the context of financing (including guarantees) transactions, which Murray referred to the Decree issued by the as per his opinion proudly evidence the German Ministry of Finance on 29 March effectiveness of HMRC’s compliance work 2011, which he considered as recognition that has delivered £4.1bn in the last four of de facto security, since it confirms the years, Peter Steeds commented that the principle of implicit parental support and its court in the GE Capital case gave a suitable potential impact on creditworthiness, which and sophisticated answer to the question of should in any case be considered as relative. how someone should take into account the Peter criticised the position taken by the implicit support fact while pricing a related German tax administration due to the absence financing transaction, agreeing with Murray of recognition of degrees of parental support, that the non-affiliation model does not look but also of justification of the existence of de at the whole picture and referring to the fact facto security in the case where the loan by the that the OECD could obtain valuable help by parent is subordinate to existing unrelated but the GE Capital verdict. senior obligations of the subsidiary.

Diligentia AB A Oy In this case a Swedish subsidiary had obtained As in the Diligentia case, this case also involved from its parent company an unsecured the refinancing of existing unrelated debt with loan with an interest rate of 9.5 per cent, related debt, which was more expensive than the proceeds of which had been used to that refinanced, with the extra feature that no repay secured loans previously received profit was being left to the associated lender, from independent (market) lenders with after taking into consideration its sources of a significantly lower interest rate (4.25 per (shareholder and third party) funding. cent). The Swedish competent administrative More specifically, the Finnish tax authorities courts held in this case that actual control disqualified any interest payable by the Finnish of the borrower by the lender should be subsidiary to the Swedish parent to the extent considered as affecting the credit risk taken that it exceeded the interest previously payable by the latter and thus the price chargeable by the Finnish subsidiary to its third party for the financing granted; on such a basis, the lender (a bank) under the loan, which had courts decided to reduce the (deductible) been refinanced by the related funding. interest rate to 6.5 per cent. During the respective administrative Murray Clayson mentioned that this case and judicial procedures, the rate of deals with the debate on assimilation of deductible interest had been raised to unsecured and secured lending pricing, in equal the average cost of the related parent respect of which the Swedish administrative towards unrelated parties (ie, excluding courts took the position that the de facto shareholders’ loans), a proposition control was a proxy for security and that the considered by Murray Clayson as dubious.

28 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

At the end of the day however, the Finnish The Indian court rejected the arguments Supreme Administrative Court accepted the of the taxpayer, held that CUP is the most state arguments and restored the original tax appropriate method, unbundled the loan assessment, regarding on a stand-alone basis from the provision of services and declined to the creditworthiness of the Finnish subsidiary, accept as relevant the lender’s cost or source which was better not only from that of the of funds. other group subsidiaries being also charged at After noticing that Indian authorities the same rate by the Swedish parent, but also have been taking rather unusual positions, from the latter’s. whereas the highest Indian courts do respect As a comment to this case, Peter Steeds international standards, Peter Steeds referred took the clear position that the independent to the UK tax authorities’ practice for entity principle should have priority over outbound interest free-debt, stating that they: anything other when addressing transfer UÊ wÀÃÌʏœœŽÊˆ˜ÌœÊÌ iÊvœÀ“ÊœvÊÌ iÊ>}Àii“i˜ÌÊ pricing cases and stated that when there is and then on a subordinate basis any a clear answer on the basis of it, then there substance behind it; is no reason to seek assistance in any other UÊ `œÊ˜œÌʘiViÃÃ>ÀˆÞÊvœœÜÊÌ iÊ«œÃˆÌˆœ˜ÊÌ>Ži˜Ê principle or line of argumentation. by the tax authorities of the borrower; and UÊ ˆ˜ÊܓiÊV>ÃiÃÊÌ iÞÊ`œÊ>VVi«ÌÊÌ iÊ predominance of the equity character of Indian case law the transaction, which however has to be The panellists referred to the controversial proven by the taxpayer. decisions issued by the Indian tax courts, with specific reference to Religare Finvest and Conoco Phillips Aithent Technologies. The Religare case involved payment by an The last case to which the panellists referred Indian borrower of interest on intra-group dealt with an intra-group cash pooling system unsecured loans, which was higher than run through a credit institution, which was interest on unsecured and secured third paying an interest rate of LIBID minus 25bps party loans. Such intra-group loans were on positive balances (that was also the rate used by the Indian borrower to provide being charged within the group) and charged unrelated loans to third parties with an LIBID plus 25bps on negative balances. interest rate higher than its funding cost. The Norwegian tax authorities, as well as The Indian court decided that it is not the competent Norwegian court, took the possible to assume in-built security in a position that the remuneration earned by related party loan and that, therefore, intra- the Norwegian group members, which were group unsecured loans should not be seen as depositing the cash to the pooling structure, secured, as well as that the former may have was inadequate relative to their contribution higher interest rates than the latter. More thereto, and therefore increased income has importantly the Indian court had issued its been assessed at their level. decision on the basis of the CUP method, Murray Clayson commented that Conoco is rather than what multinationals seem to be an interesting case, since it deals with cash commonly applying, that is, their cost of pooling, an issue not often seen in transfer funding plus a margin. pricing case law. He mentioned that the court The Aithent case had to do with the in this case seems to have taken the position provision of an interest-free (ie, more that ‘who has the cash is what matters’ and equity like) loan by an Indian parent considered that investing such cash for the company to its US subsidiary with the specific return was too big of an intra-group purpose of funding the latter’s expansion. favour to accept for transfer pricing purposes, The taxpayer, while justifying its zero profit even though it exceeded bank deposit interest from the loan, sought to apply the TNMM achievable on a standalone basis. method, arguing that: Peter Steeds concluded his presentation UʈÌÊ >`ʘœÊv՘`ˆ˜}ÊVœÃÌÊ­Ã >Ài œ`iÀÊ with some comments and figures in respect of capital injections); the Advance Thin Capitalisation Agreements UÊ ˆÌÊÜ>ÃÊi>À˜ˆ˜}ʈÌÃÊÀiÛi˜ÕiÊvÀœ“ÊÌ iÊÜvÌÜ>ÀiÊ (ATCAs), which form part of the wider UK development services it was also providing framework on Advance Pricing Agreements to its US subsidiary; and (APAs). In the last three years, there have UÊ Ì iʈ˜ÌiÀiÃÌÊVœÃÌÊÜ>ÃÊv>V̜Ài`ʈ˜ÌœÊÌ iÊ been over 450 ATCAs dealing with one service fees. single financing instrument or a whole debt

TAXES NEWSLETTER SEPTEMBER 2013 29 SECOND IBA/CIOT CONFERENCE, LONDON 2013

package of a taxpayer. As to the timeframe, UÊ ˆ˜ÊÀiëiVÌʜvÊVÀi`ˆÌܜÀÌ ˆ˜iÃÃ]Ê ÕÀÀ>ÞÊ Peter illustrated figures, pursuant to which reiterated that credit ratings are useful tools ATCAs are concluded on an average basis and sources of information, whereas he told within a period of seven to eleven months the audience that someone should always and therefore do follow the respective take into consideration that a subsidiary transaction(s), but are in place before filing can sometimes be in a position to borrow of the respective return. at a lower rate than the parent or the Murray Clayson concluded with the group as a whole or, by the same token, a session’s key points: subsidiary can sometimes borrow through UÊ iÊÃÌÀiÃÃi`ÊÌ >ÌÊÌ iÀiʈÃÊ>˜ÊœÛiÀ>Ê˜ii`ÊvœÀÊ an unrelated secured (and therefore at a greater rigour and a ‘whole facts’ analysis lower cost) loan, and therefore not require in transfer pricing cases of financing a related unsecured, more expensive, one; transactions, including cash-pooling; UÊ iÊ>ÃœÊÀiviÀÀi`Ê̜ÊÌ iÊœÌ iÀÊÌiÀ“ÃÊ>˜`Ê UÊ iÊÌ i˜Ê«œˆ˜Ìi`ʜÕÌÊÌ >ÌÊÌ iʓ>ÀŽiÌÊ >ÃÊÌœÊ conditions, as well as the wider context, find out the appropriate manner in which within which a related party loan is the implicit parental support – a concept concluded and the extent to which such now having been clearly recognised by the features may be considered as relevant and OECD, various authorities and courts – fits accepted as valid justifications for the intra- in debt pricing; group debt pricing; and UÊ Ã«iVˆwV>ÞÊÜˆÌ ÊÀi}>À`ÃÊ̜Ê}Õ>À>˜ÌiiÃ]Ê iÊ UÊ w˜>Þ]Ê iÊ«œˆ˜Ìi`ʜÕÌÊÌ >ÌÊ>Êw˜`ˆ˜}ʜvÊ noted that there are only few related court excessive debt (thin cap, etc) may have cases, whereas he opined that now the UK other adverse consequences, for example, legislation, following the addition of the the denial of deductions for impairments phrase ‘reasonable expectation’ of payment and FX losses on ‘excessive’ lending. to section 154 TIOPA, includes almost any kind of support element;

12 FEBRUARY 2013 Capital raising for banks under Flavio Mifano Mattos Filho, São Paulo regulatory constraint fmifano@ mattosfilho.com.br

Speakers context is the discussion on moving from Eugen Buck Rabobank Group, London bail-out remedies, where the taxpayer Michael Nordin Schellenberg Wittmer, Zurich ultimately bears the cost of avoiding Yash Rupal Linklaters, London potential systemic financial collapse, to bail- Jonathan Winstanley Lloyds Banking Group plc, in strategies by which certain convertibility London features would be implemented into debt instruments so as to avoid bankruptcy/ n this panel the speakers addressed insolvency and, with that, prevent the the main tax and regulatory concerns corresponding loss amplifier effects. on capital raising for banks arising as a After tackling the developments in consequence of the global financial crisis such areas since Basel was agreed and I implemented back in 1988, where the which started in late 2008 and has further developed over the following years. solvency requirements for banks were based Taking into account the set of transactions upon simple fixed risk weights, and the that triggered the crisis in the first place, revised version in 2000 (Basel II) that made changes in the regulatory framework such requirements of banks more sensitive to throughout the various jurisdictions was correlated risks, the panel addressed certain unavoidable. One of the key points in this aspects of the package of reforms designed as a response to the global financial crisis, the

30 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013 so-called Basel III, expected to be effected at The panel cited various recent examples of some point in 2013. the issuance of these new style instruments, As explained by the panel, Basel standards are among which is the case of Loyds Banking usually ratified (with certain time mismatch) by Group that issued the first contingent capital the European Commission (EC) to be enforced security essentially designed to protect as part of the European Union (EU) Single depositors through automatic re-capitalisation Market Policy Framework. The last version of to provide a source of Core Tier 1 capital. The the Capital Requirements Directive (‘CRD4’) trigger for the convertibility into common issued by the EC has already adopted certain shares in this particular security is determined measures to strengthen the regulation of the as whenever the Core Tier 1 capital ratio banking sector since July 2011. As to the main falls below five per cent. Other examples recommendations issued by the G20 Financial of new-era capital instruments take into Stability Board, it is worth mentioning the consideration the PONV as a trigger event for recommendation to split bank activities into the convertibility feature. deposit taking and investment banking, and also In this scenario, there are obvious deep that bail-in should be applicable to a particular concerns with the tax aspects involving the category of debt instrument. new-era capital instruments, in particular Regulators urged for ‘more and better those connected to the coupon payments, quality’ in the capital structure of banks. Under convertibility features or with the write-off of Basel regulations, the capital requirements of a the instrument. given bank are determined as a percentage of Concerning the Swiss tax aspects, the its Risk Weighted Assets (RWA), which is eight panel discussed the proposals to abolish the per cent both in Basel I and II. While the eight issuance stamp tax on Swiss bonds, the stamp per cent was maintained all the way since Basel tax upon conversion of the debt instrument I to Basel III, the proportion of the highest into capital, as well as the withholding tax on quality capital was dramatically increased in coupon. As debated, under Swiss income tax Basel III, which requires more than twice the law, coupon is to be split between: (i) taxable Core Tier I Capital (the highest quality capital, bond interest; and (ii) the reminder, which including common equity and additional Tier I should amount to a put option (convertibility capital instruments) of Basel II. feature) premium, a tax free capital gain. On Basel III also requires that banks hold, as the other hand, at present the deductibility of part of Core Tier I capital, certain buffers coupon for corporate income tax purposes is (capital conservation, countercyclical and a matter not entirely clarified. Under Swiss tax systemic risk buffers) that are intended to law the write-off of the instrument constitutes absorb losses whenever needed so that the taxable income. bank can continue running. These buffers After tackling Swiss tax aspects, the panel and Tier I capital instruments are part of the addressed the key tax concerns from the UK so-called ‘Going Concern Capital’. perspective, by which perpetuals, convertibles On the other hand, Going Concern and mandatories are generally deductible, Capital states for instruments like Tier except if the interest payable to the creditor II capital which are intended to absorb depends to any extent on the results/profits losses when a bank reaches a point of non- of the debtor, in case the deduction is not viability (PONV). On top of Tier II capital allowed pursuant to ‘results-dependency’ rules. instruments, new regulation requires a still yet Deductibility is also not allowed in case interest to be determined percentage of the capital payable to the creditor represents more than to be held in new-era capital instruments, a reasonable commercial return for the use the so-called ‘bail-in debt’ instruments, also of the correspondent principal amount. As referred to as contingent capital securities debated, from a debtor perspective the amount or contingent convertible bonds, which are written down is a taxable event under UK tax designed to absorb additional losses once all laws, unlike the extinguishment of liability regulatory capital is consumed. upon conversion into common equity which is The loss absorbency mechanism of bail-in not subject to tax. debt instruments implies either: Recent UK developments addressed by UÊÌ iÊVœ˜ÛiÀȜ˜ÊœvÊ>Ê}ˆÛi˜Êˆ˜ÃÌÀՓi˜Ì]ʈ˜Ê the panel includes discussions on potential whole or in part, into an equity stake in changes in law to address those impacts, the bank; or and the recent papers issued by HMRC UÊ >ÊÜÀˆÌi‡œvvʜvÊÌ iʈ˜ÃÌÀՓi˜ÌÊ̜ʈ˜VÀi>ÃiÊ in August 2011, 26 June 2012 (updated common equity account. September 2012) dealing with the treatment

TAXES NEWSLETTER SEPTEMBER 2013 31 SECOND IBA/CIOT CONFERENCE, LONDON 2013

of perpetuals (true perps would not be As a result of the issues exposed by the deductible, while contingent perps would panel, it is clear that banks currently face be deductible). Under such papers, new-era material challenges when it comes to capital instruments (CRD4 complaints) are likely raising under regulatory constrain, having to be considered results-dependent and to deal with new-era capital instruments to consequently not deductible. comply with the new capital requirements and also with unsolved tax issues derived from the particular features of such instruments.

12 FEBRUARY 2013 Withholding and reporting Niamh Keogh William Fry Tax Advisors, compliance issues (including Dublin niamh.keogh@ FATCA and beneficial ownership) williamfry.ie

Speakers offshore accounts. FATCA requires certain Tim Adam Rabobank Group, London foreign entities (known as Foreign Financial Andrew Solomon Sullivan & Cromwell, New York Institutions or FFIs) to report information Malcolm White HM Revenue & Customs, London to the US Internal Revenue Service (IRS) about US account holders. If an FFI does ndrew Solomon opened by noting not sign an agreement with the IRS and that the initial intention had been satisfy the reporting and other requirements that the panel would address of the agreement, it will be considered a general withholding tax non-participating FFI, and the FFI will be A subject to a 30 per cent withholding tax on compliance issues but it had then been decided to focus on FATCA. However, ‘withholdable payments’ (eg, US source the following additional withholding tax dividend, interest, and principal proceeds) compliance issues were mentioned: made to it by US persons and other UÊ / iÊÀi˜V Ê>˜`Ê«Àœ«œÃi`Ê 1Êw˜>˜Vˆ>Ê withholding agents. FATCA also applies the transaction taxes will give rise to changes 30 per cent withholding tax to ‘passthru’ in the reporting obligations of financial payments made by participating FFIs to institutions. Financial transaction taxes will non-participating FFIs and account holders be as important an issue for some financial that fail to provide sufficient information to institutions as FATCA. determine their status (‘recalcitrant’ account UÊ , ÊnÇ£­“®Ê܈Êˆ˜ÌÀœ`ÕViÊ>ʘiÜÊ1-Ê holders). A payment by a participating FFI withholding tax on equity derivatives with is a ‘pass-thru payment’ to the extent that respect to US stocks and securities. The new it is a US source withholdable payment or rules require final regulations to determine is a foreign source payment that, under the effective date. regulations to be promulgated, is attributable Uʼ
/
‡ˆÌi½ÊÀi>ÌiÃÊ̜ÊÀՓœÕÀÃʜvÊÌ iÊ to a US source ‘withholdable payment’. UK imposing requirements similar to FATCA will impose an administrative FATCA on Crown dependencies/overseas burden on FFIs and to a lesser extent on territories such as the Isle of Man and the withholding agents. An issue which arose was Cayman Islands. that compliance with FATCA would violate data protection and privacy rights under the laws of various non-US jurisdictions, in part FATCA because the provision of information by FFIs Andrew Solomon provided background to to the US government would be voluntary, FATCA. The FATCA legislation was enacted at least in form. This led to the need for in 2010 as a deterrent against offshore tax intergovernmental agreements (IGAs). Two evasion by US persons holding assets through model IGAs have been published. The first

32 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013 was published on 26 July 2012 and provides solution to the issues based on the risk rules for the identification and reporting of level attached to the particular products. It information to local tax authorities, with those was important for HMRC that the burdens authorities then sharing the information with on FFIs and customers and the costs of the IRS. These ‘Model 1’ agreements can compliance are minimised where possible. be either unilateral (a one way information The jurisdictional legal impediments flow) or bilateral, where the US agrees to also needed to also be addressed. A key benefit of supply information. The Model 2 agreement, the IGAs is that if a double tax treaty includes published in November 2012, involves the an exchange of information agreement, this, local jurisdiction directing the FFIs to report combined with the IGA, will provide a legal directly to the IRS. In September 2012, the ability for the FFI to provide information first IGA was entered into between the UK and to the local revenue authority (in this case the US. It follows Model 1. Ireland, Denmark HMRC), which can in turn provide this to and Mexico have also followed Model 1. the IRS. It was noted that the IGA is not Switzerland and Japan are understood to be like a double tax treaty but rather is a ‘full considering a Model 2 agreement. Other blown’ international agreement. This is a countries are in discussions. new development in information exchange. On 17 January 2013, the final US FATCA Previously, information was exchanged by regulations (the ‘Final Regulations’) were request but this will provide for the automatic released. These Final Regulations include exchange of information (both ways in some detail on the IGAs. The Final Regulations cases). It was acknowledged that this would provide for grandfathered instruments, open the door for opportunities for future which means that most existing term debt treaties with other countries and that the UK securities will be outside the rules. The was looking at a similar agreement with the Final Regulations also provide for some Isle of Man. HMRC are also willing to explore simplification in relation to documentation. the possibilities of further agreements with other jurisdictions. The IGAs are based on the location The UK-US FATCA Agreement principle which was explained by way of Malcolm White of HM Revenue and an example of a UK bank with a branch in Customs summarised the UK experience Holland. That branch would be in Holland for of implementing FATCA. The political the purposes of any IGA, even though the UK environment in which the FATCA rules were parent would be an institution governed by developed, including the UBS controversy, UK law. It was noted that there is a list of over was noted. Although the US has published 50 countries which the US is engaging with in the Final Regulations, the fact that they relation to IGAs but that more were likely to exceed 500 pages means that they are still engage. The influence that the agreed IGAs under review by HMRC. The move towards had on the Final Regulations was noted. greater exchange of data was welcomed and The provisions around passthru payments the UK Government supports the US aims were discussed. It was noted that there is no to combat tax evasion, but in a balanced withholding tax if an IGA is in place and that way. It is important for HMRC to have it would be expected that more IGAs will a straightforward mechanism to enable be in place before the passthru rules come compliance. The ramifications of a 30 per into effect in 2017. However, it would be cent withholding tax on businesses would important to deal with the passthru issues in be very serious so it was important that it time. It was noted that some people are of the be as easy as possible for entities to comply. view that the passthru provisions are illegal Negotiations with the US had been good and extraterritorial. and there was an understanding of the UK The issue of the draft UK implementing concerns. The HMRC concerns conveyed to regulations was discussed. Andrew Solomon the IRS were twofold: queried whether HMRC had discussed the UÊ Ì iÊVœ˜ÃÌÀ>ˆ˜ÌÃʜ˜Ê`>Ì>ÊÌÀ>˜Ã“ˆÃȜ˜Ê`ÕiÊÌœÊ regulations in detail with the IRS to ensure data protection and other rules; there was mutual understanding. Malcolm UÊ Ì iÊ>`“ˆ˜ˆÃÌÀ>̈œ˜ÊLÕÀ`i˜ÊÌ >ÌÊ
/
Ê White said that HMRC was for the most would place on FFIs. part implementing the IGAs itself, although HMRC favours a risk-based approach and there was an ongoing dialogue with the IRS. welcomes the Final Regulations and related Although HMRC may not be aware of all IRS statements which seem to offer a better possible scenarios that may arise, HMRC

TAXES NEWSLETTER SEPTEMBER 2013 33 SECOND IBA/CIOT CONFERENCE, LONDON 2013

is clear on the purpose and parameters of only FI with reporting obligations will be the the IGAs and has access to speak to the US trust/fund itself, although it may delegate Treasury if required. the reporting to another entity. This was a Reference was made to the Irish statement good result. The Society of Trust and Estate which was released stating that Ireland would Practitioners (STEP) had concerns that small follow the UK IGA and it was suggested that family trusts might be within scope but there the UK was in something of a pioneer role. is a carve out under the draft UK Regulations Malcolm White said that the UK had spoken to such that only professional trustees will be other countries and because the UK was first considered to be FIs with obligations under they can assist in ensuring consistency across the rules. other jurisdictions. It was noted that the UK The geographical scope of the regime had set the agenda for other countries and was discussed and it includes UK resident that the UK recommends Model 1. Annex II entities (excluding non-UK branches). It is intended to deal with regional differences also includes UK branches of non-resident and this would vary from country to country. entities. Therefore, for example, a UK branch HMRC was grateful to be able to work so of a German legal entity must comply with the closely with the US Treasury on the issue. UK rules. Some discussion took place around the Certain entities are excluded and these benefits of the IGAs, including the eased include deemed compliant FFIs such as requirements for registration. Malcolm White charities and entities with a local client base. noted that if a business wants to trade with In relation to what is a reportable account, another business, it will need to consider in it was noted that clarity is required in relation the future whether the other business is in to certain legal relationships. For example, an IGA country, what model IGA is followed derivatives held in custodial accounts fall by that other country and what the business’s within the definition of financial accounts and status is under the relevant IGA. HMRC had are, therefore, within the scope of the regime strongly made the point that a single global but it is unclear as to whether principal-to- registration system was needed and the Final principal, OTC derivative relationships would Regulations suggest this is the intention with be considered to be accounts. It was further the GIIN system. noted that there is an exclusion for accounts held by listed companies and members of listed groups. FATCA compliance for UK FIs The necessary reporting to HMRC was Tim Adam of Rabobank provided some discussed. Malcolm White spoke about the further comment on issues for UK financial timing of the reports. He noted that the UK institutions (FIs) arising from the UK IGA. Government must provide reports to the US He noted that Finance Act 2013 was expected by 30 September in respect of the previous 31 to contain the UK legislation implementing December. It is proposed that the FI reports FATCA (or it would facilitate statutory to HMRC by 31 May (to be confirmed) for instruments to implement FATCA). the year ended 31 December. The first reports There are four categories of entities for both 2013 and 2014 are due in 2015. affected: (i) custodial institutions, (ii) The issue of penalties for institutions which depository institutions, (iii) investment are non-compliant FIs was raised. Malcolm entities and (iv) specified insurance White noted that UK penalties would be companies. The draft UK regulations define aligned with the existing regime, for example, ‘depository institution’ by reference to the under the European Union Savings Directive. UK Financial Services and Markets Act 2000. In terms of compliance it is expected that IT It will be important to understand which systems may have difficulty coping with data category a client will fall into as this will have but that data issues should not give rise to an impact on what must be reported and significant non-compliance and the IRS can when. It is not expected that it will be difficult deal with the FFI directly on minor matters. to determine which category in general but Should there be significant non-compliance, in the case of collective investment vehicles, the issue is first raised with HMRC and there it could be difficult to decide which entity has would be 18 months to try to agree. If the the reporting obligations. Draft guidance is issue cannot be resolved in the timeframe, the helpful in this respect. For example, in the IGA will not apply and the FI would be within case of collective investment vehicles, the the scope of the US regulations.

34 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

12 FEBRUARY 2013 Luigi Falivene Impact of GAAR on financing DLA Piper UK, London luigi.falivene@ dlapiper.com Speakers basis that the sole or dominant purpose of Aseem Chawla MPC Legal, New Delhi any person who entered into or carried out Eric Chun Ernst & Young, New York the scheme or any part of the scheme was to Heather Gething Herbert Smith, London enable the relevant taxpayer to obtain the Wilhelm Haarman Haarman tax benefit in connection with the scheme. Partnerschaftsgesellschaft, Frankfurt am Main If those elements exist, on a facts-based analysis, the commissioner of taxation may Stephen Hoyle DLA Piper UK, London make a determination to cancel the tax Richard Rogers HM Revenue & Customs, London benefit and impose penalties. Tax benefit Micheal Whalley Minter Ellison, London is widely defined and requires comparison Barbara Worndl Aird & Berlis, Toronto with what would have happened or what might reasonably be expected to have n 12 February 2013, as part of the happened absent the scheme (known as the 2nd IBA/CIOT Conference, a ‘alternative postulate’). panel of senior international tax As a result of high profile losses based Oadvisers from four continents came around the application of the alternative to discuss their experiences of General Anti- postulate by the Australian Taxation Office Avoidance Rules in a global context. Included in cases such as RCI, Futuris, and AXA, among the illustrious speakers was Richard on 13 February 2013 the government Rogers, a member of the team at HM Revenue introduced into parliament the Tax Laws & Customs (HMRC) tasked with drafting and Amendment (Countering Tax Avoidance implementing a General Anti-Abuse Rule in and Multinational Profit Shifting) Bill the UK. 2013 (‘Part IVA Bill’).1 The Part IVA Bill proposes amendments to counter perceived GAAR – the Australian, German and weaknesses with the Part IVA. Under the Canadian experience proposed new law, the commissioner of taxation will effectively have two ways As Michael Whalley, partner at Minter to attack transactions entered into by Ellison, stated, General Anti-Avoidance Rules taxpayers. The first avenue is referred to (GAAR) are not a recent development in as the ‘annihilation approach’. Under jurisprudence and it is a concept that has this approach, to determine whether a tax been around for several decades in Australia. benefit has arisen, the scheme must be The current iteration of the Australian GAAR assumed not to have happened – that is, was introduced in 1981 and is contained it must be ‘annihilated’ or ‘deleted’. This in Part IVA of The Income Tax Assessment approach would typically be used where the Act 1936 (‘Part IVA’). When Part IVA was scheme in question does not produce any introduced, the presiding government material non-tax results or consequences explained that it was intended to legislate for the taxpayer. The second method is the test of tax avoidance enunciated by Lord employed only if an incoherent result is Denning in the Privy Council in Newton. reached using the annihilation approach Pursuant to this test, an arrangement would and is referred to as the ‘reconstruction not be classed as tax avoidance where one approach’. Under the reconstruction could predicate on the face of the transaction approach, it is not enough to simply that it was ‘capable of explanation by ‘annihilate’ or ‘delete’ the scheme in order reference to ordinary business or family to provide a useful and alternative postulate. dealing without necessarily being labelled as a Rather, it is necessary to determine a means to avoid tax’. reasonable alternative to the scheme by Put briefly, Part IVA may apply if there considering what scheme or arrangement was a scheme from which a taxpayer could have taken place instead. Two key obtained a tax benefit and, having regard limitations are placed on the reconstruction to eight factors set out in 177D(b) of Part approach in determining whether the IVA, it would be concluded on an objective resultant alternative postulate is reasonable:

TAXES NEWSLETTER SEPTEMBER 2013 35 SECOND IBA/CIOT CONFERENCE, LONDON 2013

UÊ ˆ“ˆÌ>̈œ˜Ê£\ÊÀi}>À`ʓÕÃÌÊLiÊ >`Ê̜\ rule in an individual tax law [are] fulfilled, – the substance of the scheme; and which shall prevent the circumvention – any result or consequence for the of taxes, then the legal consequences are taxpayer that is or would be achieved by determined in this rule. Otherwise, the the scheme (other than a result arising tax claim arises in case of a misuse in the under the tax laws). meaning of Para. 2 so as it arose in case UÊ ˆ“ˆÌ>̈œ˜ÊÓ\ÊÌ iÊÌ>ÝʜÕÌVœ“iÃʜvÊÌ iÊ of a reasonable legal structuring of the alternative postulate must be disregarded. economic affairs. Limitation 1 effectively means that any (2) A misuse exists if an unreasonable legal alternative postulate must achieve the same structure is chosen which for the tax payer commercial or economic result as the scheme or a third party results in a tax benefit actually entered into. Limitation 2 effectively which is in comparison to the reasonable means that it would no longer be possible structuring legally not intended. This does to argue that an alternative postulate is not not apply, if the tax payer can prove non- reasonable (and would not have been entered tax reasons for the chosen structure which into) on the basis that the associated tax costs are according to the overall picture of the would have been too high. circumstances substantial.’ The proposed amendments also seek Unlike Australia, where the courts have tried to shift the courts’ approach in their but failed to apply their equivalent of a GAAR, application of Part IVA. In recent cases, Professor Dr Wilhelm Haarman of Haarmann the court has approached Part IVA by, first, Partnerschaftsgesellschaft explained that determining whether there is a tax benefit the courts in Germany are very reluctant to and, if a tax benefit exists, only then going apply Sec 42. On the contrary, the German on to consider whether a participant in Parliament has introduced targeted anti- the scheme had the requisite purpose of avoidance provisions (TAARs) to deal with securing that tax benefit. In some cases the such misuse. As these TAARs prevail over Sec court has found that there was no tax benefit 42 and have become more extensive, they and that therefore it was not necessary to have effectively limited Sec 42’s application in consider the issue of purpose. The proposed Germany. amendments seek to unify this approach Barbara Worndl, partner at Aird & Berlis, into a single holistic inquiry about whether explained that GAAR was introduced in a person participated in a scheme for the Canada in 1988 with the intention of giving requisite purpose of obtaining a tax benefit. the Canadian Revenue Agency (CRA) This shift may further increase the scope for increased abilities to target and challenge the application of Part IVA. possible cases of tax avoidance and/or abuses The proposed reform will impact upon in the tax system. Until Canada’s GAAR was transaction alternatives being considered introduced, no anti-avoidance measures had by taxpayers and places greater importance been in place. Up until 1995, subject to a on the need for contemporaneous circular issued by CRA detailing what GAAR documentation recording the purpose of covered, no judicial pronouncements were transactions and steps in transactions. The made. Following 1995, the CRA became reform will make evidence of this nature successful in finding several cases in which the even more critical in subsequent questioning GAAR did apply. by the Australian Tax Office. Clear and The following is the general framework consistent documentation of the reason, provided by the Supreme Court of Canada. In effect of, and purpose for each step of an order for GAAR to apply, lower courts would overall transaction as part of governance need to establish the following: processes will be vital to minimising the risk 1. a tax benefit resulting from a transaction of the GAAR being applied. The ‘purpose’ of or part of series of transactions; the transaction and each step of it will be the 2. that the transaction is an avoidance major focus. transaction – not reasonably undertaken As with Australia, Germany has had an for bona fide purpose other than to Anti-Avoidance (‘Misuse’) clause in section 42 obtain a tax benefit; and of the General Fiscal Code for over a decade 3. abusive tax avoidance – tax benefit not (‘Sec 42’) as set out below: reasonably consistent with object, spirit or ‘(1) By way of misuse of possibilities of purpose of provisions in the Income Tax legal structuring the tax law cannot be Act (Canada) or a tax treaty relied upon by circumvented. [If] the prerequisites of a the taxpayer with the burden on taxpayer

36 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

to refute (1) and (2) and the burden on GAAR – not in place in all jurisdictions the minister to establish (3). CRA has Not all jurisdictions have a GAAR in place. lost on (3) where it has not been able to As highlighted by Aseem Chawla, partner at establish a clear tax policy offended or MPC Legal, India has taken many years to specific abusive tax avoidance undertaken. consider how best to implement a GAAR in If GAAR applies, the tax consequences of its jurisdiction. Aseem noted India’s concern an arrangement will be revised to deny the that GAAR could detrimentally impact the tax benefit that resulted from the series of efficacy of both the India-Mauritian double transactions, but there is no penalty other tax treaty and, more importantly, the India- than interest for any underpaid tax. For Singapore double tax treaty. Eric Chun example in the recent case of Copthorne, from Ernst & Young in New York explained where GAAR was applied by the court that the US model relies on common law to enforce withholding tax in respect of jurisprudence to deal with certain tax abuse a payment to a non-resident, the court matters rather than a specific identifiable refused to apply a penalty for failure to GAAR. However, in March 2010 the US withhold the tax. codified this position, at least in part, with An assessment under GAAR cannot be made the economic substance doctrine in section without approval of the GAAR committee 7701(o) of the ESD. unless the fact situation itself has already Under section 7701(o)(1), a transaction is been approved. The committee is designed treated as having economic substance only if: to ensure consistency and fairness in the UÊ Ì iÊÌÀ>˜Ã>V̈œ˜ÊV >˜}iÃʈ˜Ê>ʓi>˜ˆ˜}vՏÊÜ>ÞÊ application of GAAR across the country. CRA (apart from federal income tax effects) the may assess taxpayers on the basis of GAAR taxpayer’s economic position, and in cases where a specific anti-avoidance rule UÊ Ì iÊÌ>Ý«>ÞiÀÊ >ÃÊ>ÊÃÕLÃÌ>˜Ìˆ>Ê«ÕÀ«œÃiÊ applies; however, GAAR cannot apply unless (apart from federal income tax effects) for and until it is determined that the transaction entering into such transaction. achieves the taxpayer’s desired result. ESD enacts the common law doctrine under CRA has had mixed results in court and which tax benefits with respect to a transaction the rulings made stating that the GAAR are not allowable if the transaction does not did or did not apply seem to conflict one have economic substance or lacks a business another. For instance, in the case of Overs, purpose (section 7701(o)(5)(A)). The in order to repay a shareholder loan payable principal purpose for codifying the ESD was to his corporation, Mr Overs sold shares to to deal with the inconsistency in the Inland his wife. She, in turn, took out a loan to pay Revenue Service (IRS) and courts applying this for these shares and deducted the interest doctrine. Under Notice 2010-62, it is indicated charged on the loan. Mr Overs used the that the IRS would continue to apply the ESD proceeds of the share sales to repay the in the same manner as before codification. shareholder loan. Had he taken out a loan to As well as the codified ESD, substantial repay the shareholder loan himself, his loan administrative guidance has been put in interest would not have been tax deductible. place to safeguard the correct application of Thus, Mr Over avoided taxation but the the ESD. Pursuant to the LMSB 20-0910-24, GAAR was not found to apply. known as the 2010 Directive, before applying In the case of Lipson, the taxpayer’s spouse any penalty under ESD, any examiner must purchased shares of the family company obtain approval of the appropriate director of from the taxpayer using a demand loan. field operations. Further, the LB&I-4-0711-015 The taxpayer in turn used the funds to complements the 2010 Directive by setting purchase a home (as opposed to paying off a out a four-step enquiry procedure providing shareholder loan). The couple then applied a framework for examiners to consider the for permanent financing secured by the elements of the transaction, narrowing the mortgage on the home to repay the spouse’s potential breadth of the ESD. loan. In the Lipson case, however, the court The approaches taken by the US and ruled that the GAAR did apply. India both highlight their concerns with The German, Canadian and Australian implementing a full-blown GAAR, preferring examples illustrate the difficulties in the to either: interpretation and application of GAAR and UÊ `iviÀÊÌ iʈ“«i“i˜Ì>̈œ˜ÊœvÊ

,ÆʜÀ demonstrate that it is not a completely effective UÊ Vœ`ˆvÞÊÌ iÊVœ““œ˜Ê>ÜÊ«œÃˆÌˆœ˜]Ê>LiˆÌʈ˜Ê>Ê method in policing tax abusive arrangements. narrow manner.

TAXES NEWSLETTER SEPTEMBER 2013 37 SECOND IBA/CIOT CONFERENCE, LONDON 2013

UK GAAR is coming form which could readily be opined on nor is expected to be. Like other jurisdictions, the journey to UK GAAR provides for the counteraction implement a UK GAAR has been a long one. of tax arrangements that are abusive, applying Heather Gething, partner at Herbert Smith to transactions which occur after Royal Assent Freehills, highlighted a number of elements (scheduled for July 2013). Described as a which have instigated this journey: general ‘anti-abuse’ rule rather than ‘anti- UÊ Ì iʈ“«i“i˜Ì>̈œ˜ÊœvÊÌ iÊ ˆÃVœÃÕÀiʜvÊ/>ÝÊ avoidance’ rule, on the basis that the centre Avoidance Arrangements in 2004 resulted ground of tax planning must be protected, it in vast quantities of rule changes to counter will take precedence over any other existing specific schemes, most of which would not legislation. For any counteraction to be made have worked in any event; there must be a tax arrangement and such UÊ >ʓœ`iÀ˜Ê`À>v̈˜}ÊÃÌޏiÊv>VˆˆÌ>̈˜}Ê>LÕÃiÊ arrangement is abusive. as there are no umbrella provisions from An arrangement is a ‘tax arrangement’ if, which purpose can be readily ascertained; having regard to all of the circumstances, it and is reasonable to conclude that the obtaining UÊ i>Ži`Ê`iÌ>ˆÃʜvÊ ˆ} Ê«ÀœwiÊVœ“«>˜ÞÊ>˜`Ê of the tax advantage is a/the main purpose. individual settlements and the investigation This being an objective test, HMRC are not by the Commons Public Accounts concerned with the actual motivations of Committee which increase political pressure the participants in the arrangements. The to adopt a general anti-avoidance provision tax arrangement is abusive if entering into and put a stop to the adoption of tax or carrying out the arrangement cannot avoidance schemes. reasonably be regarded as a reasonable In consequence, Graham Aaronson QC course of action in relation to the relevant was asked to form a committee to consider tax provisions having regard to all of the whether a UK GAAR was required and, after circumstances including whether: wide consultation, to create a draft UK GAAR UÊ Ì iÊÃÕLÃÌ>˜ÌˆÛiÊÀiÃՏÌʜvÊÌ iÊ>ÀÀ>˜}i“i˜ÌÊ which was the genesis of the provisions to be is consistent with the express or implied enacted later this year. principles on which the provisions are based Stephen Hoyle, partner of DLA Piper and the policy objectives of the provisions; UK, highlighted the statement by Graham UÊ Ì iʓi>˜ÃʜvÊ>V ˆiۈ˜}ÊÌ iÊÀiÃՏÌʈ˜ÛœÛiÃÊ Aaronson QC to the Finance Bill Select one or more contrived step; or Committee on 21 January 2013 as illustrating UÊ Ì iÊ>ÀÀ>˜}i“i˜ÌʈÃʈ˜Ìi˜`i`Ê̜ÊiÝ«œˆÌÊ>˜ÞÊ the political motivations behind the GAAR shortcomings in the provisions. succinctly: There are a number of indicators to ‘… the whole inception of the UK GAAR determine if an arrangement is abusive: study Group was predicated on the basis that UÊ >ʏœÃÃʈÃÊV>ˆ“i`Ê}Ài>ÌiÀÊÌ >˜ÊÌ iÊ we are entering into a period of austerity and commercial loss; it will be intolerable to have people playing UÊ>ÊÌ>Ý>LiÊ«ÀœwÌʈÃʏiÃÃÊÌ >˜ÊÌ iÊ fast and loose with tax planning….’ commercial profit; or Against this backdrop is the fact that HMRC UÊ Ì iÀiʈÃÊ>ÊV>ˆ“ÊvœÀÊÀi«>ޓi˜ÌʜvÊÌ>ÝÊÌ >ÌÊ is successful in more than 90 per cent of all has not actually been paid. cases it litigates, so it is questionable whether The critical question is how can a court it is needed. determine whether an arrangement can Richard Rogers of HMRC commenced his reasonably be regarded as a reasonable course address to the attendees by simply stating that: of action in relation to a provision (known as UÊ 1Ê

,Ê܈ÊLiʈ˜ÊvœÀViʜ˜Ê,œÞ>Ê
ÃÃi˜ÌÊ the double reasonable test). If the purpose of (expected sometime in July 2013); the legislation is clear from the words construed UÊ Ì iÊvœÀ“ÊœvÊ1Ê

,ʈÃÊ՘ˆŽiÞÊ̜ÊLiÊ in context there will be no problem, but then materially different to the provisions UK GAAR was not needed to achieve that published on 11 December 2012 in the result. If no purpose can be discerned from the Finance Bill 2013; and legislation, so-called closely articulated legislation, UÊ 1Ê

,ʈÃʘœÌʓi>˜ÌÊ̜ÊVÕÌÊ>VÀœÃÃÊÌ iÊ the legislation then requires us to consider: centre ground, but agreed it would create UÊ Ì iÊVœ˜ÌÀˆÛi`ʘ>ÌÕÀiʜvÊÌ iÊ>ÀÀ>˜}i“i˜ÌÆÊ an effective shadow which would have a however, one person’s contrivance is deterrent effect on aggressive tax planning. another’s creative solution so this seems to Richard Rogers also did not expect that UK require the subjective view of the judge on GAAR, at least at the outset, would be in a the degree of contrivance; and

38 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

UÊ Ü iÌ iÀÊÌ iÊ>ÀÀ>˜}i“i˜ÌÃÊ>Àiʈ˜Ìi˜`i`ÊÌœÊ It is with this backdrop that the UK GAAR exploit any shortcoming, which requires will arrive in the UK in July this year. If we consideration of the intention of the can take anything from the experiences of parties and is subjective if a purpose can be other jurisdictions, it will not operate as the discerned in the legislation a ‘shortcoming’ desired panacea for tax abuse in the UK. will be obvious, but if purpose cannot be However, until we see some judicial decisions discerned a shortcoming is difficult, if not on its application, it will inevitably create the impossible, to discern. shadow over tax planning which HMRC and Although the judiciary will have to consider a political pressure require. range of reasonably held views, can it ever be reasonable to plan to mitigate taxation except through the use of tax incentives? Accordingly Note the range of reasonably held views is likely to See: www.aph.gov.au/Parliamentary_Business/Bills_ Legislation/Bills_Search_Results/Result?bId=r4965. be a range of one.

12 FEBRUARY 2013 Jessica Kemp Distressed debt issues Travers Smith, London jessica.kemp@ including debt buybacks traverssmith.com

Speakers The case studies covered the modification Richard Clegg Wolf Theiss, Sofia of debt conditions (including debt waivers), Albert Collado Garrigues, Barcelona the tax effects of debt buy-ins and the Jean-Marc Groelly Nauta Dutilh, Luxembourg consequences of debt equity swaps. In many Mark Weinstein Hogan Lovells, New York cases, the tax treatment of the transactions Simon Yates Travers Smith, London was thought to follow the relevant accounting rules, with specific exceptions where legislative he session addressed the question policy required a different economic outcome. of distressed refinancings and the However, it was noted that legislation was trading of distressed debt in a number often unclear and could give rise to surprising of different jurisdictions, being results. Each of the case studies is considered T in detail below. While a variety of topics Bulgaria, Luxembourg, Spain, the UK and the US. The speakers considered both the were covered, including the effect of the markets in those jurisdictions and how the tax transactions on transfer pricing, stamp duties, regimes affected companies in distressed debt accrual of original issue discount and carried situations. It was noted that given the current forward losses, the focus of the workshop was global economy, a number of practitioners on the initial impact of each transaction for were increasingly encountering groups the debtor and creditor entities. needing assistance with their debt and that tax efficiency was often paramount. Case study 1: modification of debt conditions, Two key topics were covered: first, dealing including debt waivers with distressed refinancings, including the questions of debt waivers, debt buy backs This was discussed for each relevant jurisdiction and debt for equity swaps; and secondly, the both in the context of a bank loan and of a challenges created by the increasing market holding company (‘Holdco’) loan. As a general in the trading of distressed debt. rule, there is a potential for tax charges to arise in each jurisdiction as a result of debt waivers or fundamental modifications to the terms of Distressed refinancings a debt, with the tax effect often mirroring the Three distressed refinancing case studies were treatment in the company’s accounts. More presented, with each speaker addressing the detailed analysis in relation to each country consequences arising in their own jurisdiction. discussed is set out below.

TAXES NEWSLETTER SEPTEMBER 2013 39 SECOND IBA/CIOT CONFERENCE, LONDON 2013

BULGARIA US It was noted that in Bulgaria, the waiver of a It was noted that the US rules were uncertain debt (and the modification of a debt if the and that they could be improved by ensuring result is a substantially different debt) would that tax consequences are matched to result in taxable income for the debtor. For the economic consequences. In relation to creditor, a waiver would not be tax deductible the detailed rules, it was explained that since it is regarded as a tax abusive transaction. cancellation of debt (COD) income should A modification may be tax deductible unless it be recognised by the debtor on the waiver of is requalified as a partial waiver. a debt or if there is a significant modification of the debt instrument. The tax consequences LUXEMBOURG for the creditor will depend upon whether In Luxembourg, there would be a tax the instrument issued constitutes a ‘security’, charge for the debtor on the amount which would generally include any debt waived but modification of the conditions instrument with a term of more than five years. should not usually give rise to income for In the case of a security, no gain or loss would the debtor. It may be possible to exempt be allowed. Where the debt is not a security, the income subject to certain limits and the creditor would be required to recognise conditions and (in the case of a Holdco a gain or loss on the waiver or modification. loan), if the waiver were treated as an Where the debtor and creditor are part of informal capital contribution. An unrelated the same US consolidated tax group, income, creditor would be able to claim a deduction gains, losses and deductions can be deferred for the amount waived but for a Holdco under the consolidated income tax rules. loan, there would be no deduction to the extent that the waiver had been treated as Case study 2: purchase of debt at a discount/ an informal capital contribution. debt buy back This case study was considered both in the SPAIN context of a purchase of debt by a Holdco The Spanish rules mean that there would be or a third party and of a debt buy-back by a a charge for the debtor on a waiver of a third borrower. In each jurisdiction, a borrower debt party loan amount, including if a modification buy-in was thought to be treated in a similar of conditions such as interest rate or maturity way to a waiver. The rules on debt buy-ins actually lead to a lower liability. In the case of from Holdcos or third parties varied between a Holdco loan, however, the waiver is likely to jurisdictions with some jurisdictions making a be treated as an informal equity contribution clear distinction between the two and treating with no charge arising, save where there a Holdco buy-in as more closely related to an are minority shareholders, when tax may be effective waiver. More detailed analysis on third payable. A bank waiving a loan would be able party and Holdco debt buy-ins is set out below. to claim a loss as an unrelated third party. In the case of a Holdco loan, Holdco should BULGARIA be entitled to a step-up in its tax basis in the portfolio company. In case of a Holdco or third party debt buy- in, there should be no tax charge for the UK borrower company provided that there is no subsequent waiver or substantial modification The UK provisions provide that in relation to to the terms of the debt. The seller of the a third party debt, any release shown in the debt would be entitled to a deduction if the accounts (because there has actually been a acquisition cost exceeded the sale price, release or because of a fundamental change although there may be a time delay in to the terms of the debt) would result in a claiming certain impairment losses. tax charge. The third party creditor will be able to claim the loss as and when it provides LUXEMBOURG against the loan. In contrast, on a release of a loan between grouped companies, no tax There should be no income recognition for charge should arise on the release but Holdco the borrower on a Holdco or third party buy- would not be entitled to a deduction in in unless there is a subsequent waiver of the respect of the release. debt. The seller of the debt should also be entitled to a deduction.

40 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION SECOND IBA/CIOT CONFERENCE, LONDON 2013

SPAIN is impaired. For the holder, the swap may be No income recognition would occur on a treated as giving rise to a loss to the extent Holdco or third party debt buy-in unless there that the debt is impaired, unless it is treated as were a subsequent waiver or modification of an additional equity contribution under the debt conditions. The seller of the debt should relevant accounting rules. be entitled to a deductible loss. LUXEMBOURG UK The treatment for the debtor follows the On a third party debt buy-in the treatment accounts such that there may be income follows the accounts and if they show a profit, recognition if the debt is contributed at a tax charge will arise. A third party seller fair market value. In the case of a Holdco should be able to claim a loss in respect of the transaction, the contribution may in certain sale. Specific rules relating to Holdco buy-ins circumstances be treated as an informal mean that (with some limited exceptions) a tax capital contribution and constructive charge will arise to the extent of the discount distributions issues (including potential to par paid by Holdco on the purchase. The withholding tax exposures) may result from seller should be entitled to a loss on the sale, the presence of minority shareholders. An although it is possible that the loss will have unrelated creditor may claim a deduction in been claimed at an earlier stage and if the sale respect of the swap. is for more than the tax written down value of the debt, the seller will have a taxable profit. SPAIN Following the accounts, the debt is deemed to US be contributed at market value and therefore On a third party debt buy-in there should be income or loss is recognised for the amount no income recognition by the borrower unless of the discount. An unrelated holder would there is a subsequent waiver or modification of be entitled to a loss on the swap. A Holdco the debt, the seller of the debt will be entitled transaction may be treated as an equity to a deductible loss. On a Holdco buy-in, the contribution with a subsequent step-up in acquisition is treated as the acquisition of the the tax basis of the portfolio company. Only debt by the borrower, with COD income being distressed debt previously acquired by Holdco recognised on the excess of the adjusted issued at a discount will trigger an accounting (and price of the debt over purchase price. It is thus taxable) gain at the subsidiary level when possible that the COD income may be excluded converted into equity. under the general rules. An unrelated seller will generally be entitled to a capital loss. UK No tax charge should arise provided that the equity into which the debt is swapped constitutes Case study 3: debt equity swap ordinary share capital, with a specific exemption The group considered the effects of debt existing for this even where the accounts would for equity swaps. As with the other case reflect a credit. HMRC are reluctant to allow studies, this was addressed both in the case this capitalisation relief if shares are rapidly sold of a third party bank debt and a Holdco by the lender. On a swap into shares other than debt. The rules varied quite widely between ordinary share capital (except a Holdco swap, jurisdictions with certain jurisdictions having assuming that that companies are grouped), specific exemptions on debt equity swaps, and a taxable credit would arise for the borrower others requiring income to be brought into company. No loss will be available on the swap for account. A summary of the position in each a Holdco lender but an unrelated party should jurisdiction is set out below. be entitled to a deduction in relation to the swap. The base cost in the shares going forward would BULGARIA be the lower of the market value of the shares on It was noted that there is a general requirement issue and the market value of the debt when the under Bulgarian corporate law that a valuation capitalisation occurs. is carried out and that the value of shares issued in debt for equity swaps should be equal US to the fair market value of the debt released. Under the debt for equity exchange rule, Usually there would be no income recognition the borrower would be required to recognise for the borrower on the swap unless the debt COD income equal to the difference between

TAXES NEWSLETTER SEPTEMBER 2013 41 SECOND IBA/CIOT CONFERENCE, LONDON 2013

the adjusted issue price of the debt over the losses. There was also discussion of the UK fair market value of the stock transferred. rules around debt buy-ins and the potential The tax consequences for the holder will for charges to arise if the relatively limited depend upon whether the debt instrument corporate rescue exemption did not apply. is a security and, if so, the exchange may qualify as a tax free recapitalisation; if not, the Investing through arrangers holder will be required to recognise a gain or loss equal to the difference between the fair The final section of the workshop considered market value of the stock received over its a case study including an investment by adjusted basis in the original debt. an arranger in distressed debt followed by trading or syndication through contractual arrangements such as trusts and participating Trading of distressed debt loans. The discussion on this case study focussed The section of the workshop dealing with on the position in Spain, the UK and the US. trading in distressed debt focussed on the In relation to Spain, it was noted that use of intermediate vehicles including the there was no recognition of the concept of a use of SPVs, the reorganisation of debt in trust and no explicit regulation of beneficial aggregating vehicles and investments made ownership (although the concept was accepted through arrangers. by the Spanish courts). This led to some uncertainty around the tax treatment of such SPVS AND AGGREGATING VEHICLES arrangements particularly around the true It was noted that intermediate vehicles were beneficial owner of the loan and whether the often used by offshore funds for both tax beneficial owner is simply the person who and other reasons. From a tax perspective, bears the risk of insolvency of the borrower. It they were often useful in accessing relevant was indicated that the Spanish authorities have treaties but the use of the vehicle and choice an emphasis on the importance of business of vehicle (for example, as between standard purpose and economic substance in this area. companies and securitisation vehicles) was In the UK, the key consideration in often driven by other non-tax issues. relation to such arrangements is often the Key tax considerations on the use of risk of creating a permanent establishment intermediate vehicles were managing the in the UK (although this could be mitigated beneficial ownership position (including if the collecting agent can be viewed as the through ensuring adequate local substance, independent agent of the buyer). In addition, using double as opposed to single tier structures withholding tax will need to be considered and introducing mismatches in funding and the beneficial ownership position instruments), ensuring a low effective tax rate managed, although it was noted that the in the vehicles themselves and ensuring that no UK law on beneficial ownership was more withholding tax exposures arose, for example, generous than the standard Indofoods position. by listing relevant instruments. In the context Finally, the position in the US was discussed, of withholding tax, the risks around debts with the key issue raised being how to avoid being taken out of a Luxembourg holding being caught in the US tax web. This could be structure on the enforcement of security and relevant to a person originating more than a the potential to lose the ability to pay gross was small number of loans in the US, although may emphasised. In particular, in jurisdictions taxing be avoided if the loans can be originated by one by reference to accounting results, the right party and sold by another. As a general rule, the answer can be difficult to identify when the IRS will consider whether the person has regular amount is derecognised from the intermediate and continuous activity in the US directly related vehicle’s accounts altogether. to the active pursuit of profit as well as where its The case studies in this area addressed core profit making activities occur. Independent the use of European debt platforms and collection agents will not normally be caught as a investments through ‘loan to own’ entities. result of a safe harbour provision. It was noted in the context of a case study on It was concluded that similar issues were faced European debt platforms that the US rules in each of these jurisdictions in attempting to on pools of loans in particular can lead to ensure that the investment did not create a strange results where loans are pooled through taxable presence in the relevant jurisdiction and an intermediate vehicle, since allowable tax that the true beneficial ownership of the debts losses will not always match real economic could be properly established.

42 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

13th Annual Tax Planning strategies: US and Europe, London

11 APRIL 2013 Plenary case studies: how does Bas Pijnaker Loyens & Loeff NV, the arm’s length method work Eindhoven bas.pijnaker@ loyensloeff.com in today’s economy? Intangibles assets and profit allocation

Co-Chairs in view of the intangible nature of the Peter H Blessing KPMG, New York property. Although the difficulties and issues Peter H M Flipsen Simmons & Simmons, may not have changed, the importance Amsterdam has ratcheted up as taxpayers have more assiduously identified and segregated IP Speakers from other assets when advantageous and as Jos Beerepoot Unilever, Rotterdam the value ascribed to IP in today’s economy Mark Carnduff HM Revenue & Customs, has increased. A related development is the London ability to sell remotely into a country and Stephen Edge Slaughter and May, London so more easily achieve local sales without a Klaus Sieker Flick Gocke Schaumburg, physical presence. Frankfurt am Main Supply chain case study Introduction The first case study discussed was the Based on several case studies, it was discussed supply chain case study and was discussed during this session how the arm’s length by Jos Beerepoot. principle is functioning in a world in which Several different units are mentioned, such the weight of IP as contributor to the profits as the principal, a sourcing unit, a service unit of multinationals (MNEs) has increased. and the IP owner. Jos Beerepoot mentioned Peter Blessing provided, as background, that, in the beginning, he was sceptical a brief overview of the difficulties faced by about separate service units supporting tax systems with respect to intangible assets the principal, especially with respect to the and assets allocation. The problems are not avoidance of permanent establishments (PE). new problems; they have existed for years. Furthermore, he mentioned that the IP is The problems include difficulties relating often structured in separate companies for to the identification of IP as opposed to, several legal issues. for example, services, the contribution of After explaining the model, he explained one generation of IP to future generations that the question where a unit should and other useful life issues, the inability be situated is not only affected by tax to accurately project revenues at the time considerations but also by important non- of transfers, the fact that all relevant tax business reasons. MNEs are challenging information often is not available to both different markets and several drivers to a sides, and the commercial ease of transfer change in structure were described, such as the of possession and other ownership rights growth of customers and further globalisation.

TAXES NEWSLETTER SEPTEMBER 2013 43 TAX PLANNING CONFERENCE REPORTS

The BEPS report also shows that it is Hypothetical US Group case studies difficult to answer the question where profits Several methods have been used to migrate should be located and how the real world ties intangibles from the US. Amongst others, to the paper world. these include licensing, cost sharing and Three main issues were mentioned with corporate reorganisations. respect to business restructuring: Based on a study of the corporate structures UÊ i݈ÌÊV >À}iÃÊÜˆÌ ÊÀiëiVÌÊ̜ÊÌ iÊ of six companies as relevant to their use restructuring transactions; of IP prepared by the US Joint Committee UÊ ÌÀ>˜ÃviÀÊ«ÀˆViÊ>vÌiÀÊÌ iÊÀiÃÌÀÕVÌÕÀˆ˜}ÆÊ>˜`Ê on Taxation, two different examples of IP UÊ * ʈÃÃÕiÃ°Ê structuring were discussed. Another important issue with respect to the transfer of IP is VAT. It is also important to place tax analysis Delta Company: summary of in perspective, taking into account business transaction flows reasons to change the IP structures from local The first example, Delta Group (a fictitious to global. With respect to the pricing of the name), involved Delta US, which granted IP in such cases, query whether a third party a licence to Delta Singapore, an offshore would pay for any existing inefficiencies. company, and Delta Netherlands, a Dutch Steven Edge affirmed Jos Beerepoot’s intermediate company. Delta Singapore suggestion that there are often business manufactures and sells the products to Delta reasons to restructure, by stating that business US and foreign distribution companies. considerations typically drive the decisions Delta Singapore pays a royalty to Delta US, and that tax considerations follow thereafter. but also receives compensation from Delta US for the products manufactured for the Cost sharing/centralised IP case study US market. Overall, a substantial part of the offshore profit of Delta Group is low Klaus Sieker discussed the cost sharing/ taxed. From a US tax perspective, there will centralised IP case study. This case study be taxable income from licensing income is based on a simple example in which and US low risk distribution activities on an American company (‘A’) acquires a behalf of Delta Netherlands; the licensing German company (‘B’). A and B are both income will produce foreign source income pharmaceuticals and invest heavily in that will permit use of foreign tax credits. R&D. The business objective is to integrate Furthermore, there will be no Subpart F both R&D operations. This objective can income due to the manufacturing exception. be reached in a number of ways, but the tax implications are very different. The assignment of the existing R&D by B, for Bravo Company: summary of instance, will most likely result in a huge tax transaction flows burden in Germany. A suggestion is to use Bravo Company (again a fictitious name) a cost sharing agreement. For completely was the second example. In this situation, new developments, there are no upfront tax the IP has been migrated from Bravo US to costs. Each party pays a pro rate part of the Bravo Switzerland. cost that relates to the expected future sales Bravo Netherlands is the entrepreneur, in its own market. While this works easily but only has a small taxable basis because it for new products, it is difficult for products has to pay substantial royalty fees to Bravo in progress. What is the buy-in payment for Switzerland. The royalty income Bravo these products? Switzerland receives is taxed at a rate of less Klaus Sieker also discussed two examples than five per cent. from the BEPS report (Annex C) and the risk From a US tax perspective, Bravo US that cost sharing is used for (aggressive) tax receives compensation for its limited risk planning. The OECD is afraid that the buy-in distributor activities and performance payment is not high enough and that the IP of support services. Furthermore, there will be placed in low taxed countries. Both is no Subpart F income due to the Germany and the US have special rules with manufacturing exception as well as the respect to cost sharing agreements to avoid disregard of intra-group transactions under (too large) payments to low taxed companies. Bravo Bermuda. Cost sharing is not per se aggressive, but has a huge potential for disagreement.

44 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

Delta Company: summary of transaction flows

Bravo Company: summary of transaction flows

TAXES NEWSLETTER SEPTEMBER 2013 45 TAX PLANNING CONFERENCE REPORTS

The Netherlands

Typical use of NL in principal structure (see figure C 2 in OECD BEPS Report)

Based on the above example, which Peter Flipsen mentioned that the is comparable to one of the examples Netherlands have been frequently mentioned mentioned in the BEPS report, Peter Flipsen in the publicity about aggressive tax planning discussed the typical use of the Netherlands and there is currently a political debate in a principal structure. Both IP royalty and in the Netherlands to stop the use of the remuneration of LRD’s or commissionaires Netherlands as a tax haven. He emphasised are based on transfer pricing analyses and that the Netherlands are no tax haven. There thus at arm’s length. In the Netherlands, is no low tax rate in the Netherlands, no an advanced pricing agreement (APA) or specific tax freedoms and no bank secrecy. advanced tax ruling (ATR) can be obtained The Dutch share of the taxable profits from to acknowledge and confirm the Dutch tax royalty structures is based on the application implications of the structure in advance. of the OECD arm’s length principle and

46 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

OECD transfer pricing guidelines, taking into that there should be international initiatives account the location of the risk and where to tackle the issue of aggressive tax planning functions are performed. The examples by making use of hybrid mismatches and mentioned in the BEPS report are mainly instruments and no unilateral approach. based on the possibility under US tax law to defer taxation. Given the tax competition Fragmentation case study in Europe, and in order to avoid a negative impact on the Dutch investment climate, the In the last case study, Mark Carnduff and Dutch Government has stated in Parliament Steven Edge analysed the several individual

TAXES NEWSLETTER SEPTEMBER 2013 47 TAX PLANNING CONFERENCE REPORTS

functions. They noted that a fragmented In case of a fully fragmented structure, other operational model can be more efficient. important questions arise. How should you They presented several illustrations, starting value the several transactions? Should the total with a single jurisdiction manufacturer and of all compensation be equal to the overall exporter and modifying the structure until he profit? Or should all transactions be priced reached a fully fragmented structure. separately and if so, where should any residual In the single jurisdiction, all profits of the be taxed? It was noted that every case has its manufacturer and exporter will be taxed in own facts and should be assessed accordingly. the home jurisdiction. One of the structures in between is a situation in which the fragmentation Conclusion is only limited to overseas buying, storage and customer support. Mark Carnduff mentioned At the end of the session, the co-chairs and that the compensation for these functions would speakers had their final remarks about how normally be limited to a cost plus. the arm’s length method should evolve. The An example of a more fragmented situation common idea is that centralisation is real, that is where the IP has been transferred to an companies have to go forward and that they overseas company. To stand up for tax purposes, must order their tax affairs taking account of the reality and economic substance must the interests of their shareholders and the law support the transfer. One question is whether as currently in effect. Future changes in the law the crown jewels (the IP) can ever really leave may well come and will take the form both of the home jurisdiction. Issues regarding how a unilateral changes, including anti-abuse rules, fair royalty payment can be determined and and, with much more effort by tax authorities, how a correct valuation for the transfer of IP multilateral changes. Taxpayers can make their can be determined were raised. contribution to the process by engaging in their transfer pricing in a transparent way.

11 APRIL 2013 FATCA – it is here, now do Joshua D Odintz Baker & McKenzie, something about it! Washington DC joshua.odintz@ bakermckenzie.com

Co-Chairs income regardless of where they reside, and Peter R Altenburger Altenburger LTD, Küsnacht FATCA is designed to require reporting Stanley C Ruchelman The Ruchelman Law Firm, on accounts of US persons held by foreign New York financial institutions (FFIs). If an FFI does not participate or is not deemed to Speakers participate, then it is subject to 30 per cent withholding on certain payments of Laura Charkin SJ Berwin, London US-source fixed, determinable, annual Lizzy Conder Sapient, London or periodic payments. By 2017, FATCA Stefano Grilli Gianni Origoni Grippo Cappelli & withholding applies to gross proceeds from Partners, Milan the sale or disposition of assets that give rise Stefan Ritter Advokatur Ritter & Partner AG, Triesen to dividend or interest income. Peter Utterström Stockholm The purpose of this panel was to explore FATCA in practice, or in the tranches, and Introduction how to manage FATCA to avoid penalties. To that end, the focus of the panel was The US Congress enacted the Foreign on intergovernmental agreements (IGAs) Account Tax Compliance Act (FATCA) executed between the United States and in 2010 in response to concerns that US various countries and how certain industries persons were hiding assets in foreign are addressing FATCA. More than 50 jurisdictions without reporting the income. countries are in the process of negotiating US persons are taxed on their worldwide and executing IGAs with the United States.

48 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

The United Kingdom, Denmark, Germany, The United Kingdom’s experience France, Italy, Mexico, Norway, Switzerland The UK was the first country to enter into an and Spain have signed or initialed agreements. IGA. It saw the benefit of FATCA, specifically Initially, European countries disliked that the US would obtain information FATCA, but now governments realise it is regarding its citizens. The UK wanted similar a good tool and a method for obtaining information regarding its citizens. Ms Charkin through automatic exchange information noted that the UK is the first country to regarding their residents. As a result, IGAs publish regulations implementing an IGA. have become the main part of FATCA, and FATCA does not end with the signing of the panel was devoted to exploring the the IGA. Each country will need to enact perceived benefits and obligations of FFIs local laws to implement the IGAs. FFIs will under these agreements. want consistency across jurisdictions to avoid Mr Utterström made a few observations duplicate reporting and gaps in reporting, about FATCA and IGAs. First, practitioners but implementation will be tricky. Part of the should learn all of the abbreviations, as difficulty is that the IGAs are drafted on US FATCA has its own language. Secondly, tax principles and not on local law principles the reason IGAs exist is due to the local (eg, corporate residence versus managed concerns of partner countries regarding and controlled for purposes of determining information exchange with the US Internal whether a corporation is a UK corporation). Revenue Service (IRS). The IGAs provide a These complications also extend to when and method of solving these issues and making how FATCA and an IGA apply to funds and local law changes. Thirdly, from the Swedish partnerships. The UK is working with industry perspective, potential FFIs are hiding their to try to make the UK IGA work. heads in the sand, which is scary because The UK draft regulations are 60 pages and FATCA withholding begins on 1 January are not detailed. They contain a set of rules 2014. Finally, FATCA is not about taxes; it is a to address IGA implementation. However, compliance tool, and it is important for FFIs the US issued the final FATCA regulations in to establish compliance systems. January 2013, well after the UK entered into an IGA with the United States, and the UK IGAs business community is waiting for the final UK regulations. Ms Charkin hopes that the final UK There are three model IGAs. Model 1 has regulations match the US final regulations, as UK two versions, reciprocal and nonreciprocal, FFIs do not want to break UK data control laws that are otherwise identical. Model 1 by disclosing account information to the IRS. IGAs provide a system for gathering local The final regulations will likely exceed 200 pages information, which is then reported to and were due to be released on 17 May 2013. the local government, who then transmits The UK is also working through finance the information to the IRS. The IGA documentation to determine who has the negotiations between the US and foreign risk with respect to FATCA withholding. In countries has been a take it or leave it the US, the risk is typically on the lender, approach, other than Annex 2, which while in the UK, the issue has not been contains local specifications (eg, exempt resolved. One open issue is whether there accounts, exempt institutions). Annex 1, should be a gross-up clause for FATCA which contains the due diligence provisions, withholding. Moreover, another issue is is generally fixed. When comparing IGAs, whether a purchaser can conduct FATCA Annex 1 is generally the same, while Annex 2 due diligence in a merger or acquisition. contains variations. The Model 2 IGA provides that the FFI sends US account information directly to Switzerland’s experience the IRS and requires the FFI to enter into an Mr Altenburger made a few observations FFI agreement with the IRS. These are the about FATCA and the Swiss IGA, which was main differences between the two models. signed on 14 February 2013. First, FATCA is a Consequently, Model 1 requires the IGA paradigm shift. It is the first global automatic partner country to implement the system, information exchange agreement. Secondly, thereby increasing costs to the government. FFIs will bear enormous costs under the Model 2 shifts the costs to the reporting FFIs. Model 2 IGA. Thirdly, FATCA has offspring, which are more dangerous than FATCA itself.

TAXES NEWSLETTER SEPTEMBER 2013 49 TAX PLANNING CONFERENCE REPORTS

Switzerland signed a Model 2 IGA, the Implementation in Italy is a compliance first country to do so. It pursued a Model issue, not a tax problem. Italian banks view 2 IGA in order to preserve bank secrecy. compliance as an information technology Holders of US accounts existing as of driven issue. 31 December 2013 must sign a waiver One open issue is how FATCA should allowing a Swiss FFI to exchange be addressed in loan agreements with information with the IRS. If an account counterparties, specifically who should bear holder does not consent, then the account the risk of the FATCA withholding tax. holder’s information will be provided on an aggregate basis with other non-consenting Lichtenstein’s experience account holders to the SFTA, which may transmit the information to the IRS Lichtenstein has a robust financial services pursuant to a group request. The IGA does industry that has been dealing with FATCA not affect a US taxpayer’s right to appeal and other transparency issues since 2008. to the Swiss Federal Administrative Court. On 12 March 2009, Lichtenstein issued a The Swiss IGA provides that non-consenting declaration that it is committed to enter into account holders will become recalcitrant tax information exchange agreements and account holders and subject to FATCA’s bilateral double tax treaties. It is committed 30 per cent withholding within eight months to following foreign tax laws and OECD from the IRS’ request to the SFTA. transparency. Recently, the US asked for the The IGA is not self-executing and is number of foundations with US connections, treated like a treaty that must be approved and Lichtenstein provided the data. This is a first by the Swiss parliament and then by the significant shift in behaviour. public through a facultative referendum. As a result of FATCA and other transparency The Swiss Government will then release a initiatives, Lichtenstein realises that it must federal law to implement the IGA. The Swiss change. In the past, it relied on trusts and IGA relies on the recent US-Swiss double foundation for its economy. Now, it needs to tax treaty, which has not been ratified by change clients to include business beyond the the US senate, which may complicate the financial industry. It must convince clients to implementation of the Swiss IGA. play by the rules. Also, Lichtenstein will need There are still some unresolved issues to implement the variety of international laws, under FATCA, and the multiple sources of which will pose a challenge due to the tight information will create confusion. There implementation timeframe. are still some unresolved issues, such as Mr Ritter observed that Lichtenstein has whether a bank deposit box is a financial entered into several transparent agreements, account, and whether Switzerland will issue and all of these agreements will be implemented a memorandum of understanding regarding at the same time. Additionally, implementation the IGA. will greatly increase labour costs. Automatic exchange of information will lead to more costs, less tax collected than under withholding, Italy’s experience and concerns about bank secrecy and privacy. For Italy, FATCA is the first step in a wider Lichtenstein will continue to focus on exchange of information strategy. The non-tax structures to be the lead place for US will exchange information with Italy investment. In any event, the transition to pursuant to a Model 1 reciprocal IGA. Italy FATCA will be rocky. has signed an English version of the IGA. The US state department is checking the Italian The in-house perspective translation, and once the parties agree on the adequacy of the translation, Italy will enact FATCA is ultimately a client communication local laws to implement FATCA. and relationship issue, followed by reporting. The Italian IGA will replace the due The first goal in preparing for FATCA is diligence standards in the final FATCA to remove the internal tax function from regulations with the Italian anti-money leading FATCA projects. Tax should provide laundering standards. Also, Italian FFIs will the technical support rather than act as the be able to rely on self-disclosure/declarations project sponsor. FATCA not only includes the by account holders. Thirdly, one qualified tax department, but also the financing team, intermediary will act as a clearing house and the treasury function, investment relations with holding agent for Italy’s FFIs. and client teams.

50 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

From an in-house perspective, FATCA did participate or is deemed to participate, even if not provide enough detail until this year with the lack of participation is due to a local law. the publication of the final regulations. The The next issue is how to classify and IGAs helped to a certain extent, but they communicate with clients. A client may have have also made the problem bigger. FFIs will multiple accounts in multiple locations or need to rationalise and implement 544 pages entities. A major issue is what to do with a pre- of final regulations and more than 50 IGAs. existing client who is a US person or recalcitrant The key point is that FFIs will want to be account holder? FFIs need a communication compliant, but FFIs will also need to develop plan in order to obtain data once from clients. practical solutions. FFIs need to create automatic systems to reduce Venture capital and private equity funds the number of times the FFI must contact were worried about recalcitrant accounts. The clients for documentation. final regulations require FFIs to withhold on FATCA compliance is more challenging and eventually close recalcitrant accounts. with the voluminous final regulations and A recalcitrant account is an account where 50 IGAs that have been signed or will be the account holder refuses to provide signed in the near future. The reality is that documentation that would permit the FFI to FFIs need one set of classification rules and determine if the account holder is a specified process controls to obtain the appropriate US person. The UK IGA varies from the final data from clients. FATCA regulations and does not require UK One question is whether anyone will check the FFIs to close recalcitrant accounts. controls that an FFI establishes. The Model 1 IGA Organisations need to set a plan. It is permits the IRS to directly audit an FFI. important for an FFI to determine how many entities within the expanded affiliated group The future: FATCA for everyone? (EAG) are FFIs. The organisation needs to determine the following for each potential The G-5 (France, Germany, Italy, Spain and FFI: (i) the ownership, (ii) location where it the UK) is trying to bring FATCA to the does business, (iii) place of incorporation, European Union by creating a multilateral (iv) its principal business, and (v) if dormant, system based on FATCA. Also, the UK has a should the entity be retained. Additionally, an FATCA-like agreement with the Isle of Man FFI needs to figure out if there are local law and the Channel Islands. The panellists agree conflicts with FATCA, and if so, whether it is that tax transparency is on the radar. worth keeping the entity with the conflicts. One unresolved issue is how FATCA will FATCA requires all FFIs in an EAG to work with US FDAP withholding, which the US participate (eg, report on US accounts). The treasury will address in subsequent guidance. EAG is tainted if one or more FFIs does not

11 APRIL 2013 Catherine Debt equity characterisation Richardson Jones Day, London and interest allocation issues crichardson@ jonesday.com

Co-Chairs n many jurisdictions, the characterisation Ossi Haapaniemi Hannes Snellman, Helsinki of an instrument as either debt or Kevin Keyes Fried Franck Harris Shriver & equity will have a significant bearing Jacobson, Washington, DC Ion its tax treatment. Tax asymmetries can also arise where the same instrument is Speakers characterised as debt in one jurisdiction and as equity in another. The panel (made up of Gerald Gahleitner Leitner Leitner, Linz tax experts from the US, Finland, Austria, Werner Heyvaert Jones Day, Brussles Belgium, Germany and Spain) discussed the Guillermo Canalejo Lasarte Uría Menéndez, Madrid characteristics of debt and equity instruments Wolfgang Sonnleitner Marccus Partners, Dusseldorf in their respective jurisdictions, developments

TAXES NEWSLETTER SEPTEMBER 2013 51 TAX PLANNING CONFERENCE REPORTS

in the approaches taken by their domestic tax case with debt treatment being preferable as authorities to such instruments and various tax interest payable in respect of debt should be a planning issues that may arise. deductible expense for the debtor. To illustrate the relevant tax rules and Whilst traditionally the US tax authorities the various issues that may arise, each panel have sought in certain cases to recharacterise member applied the facts of a simple case debt as equity, the point was made that this study to their respective jurisdictions. To approach is changing, with there now being the extent necessary, panellists referred to a trend towards recharacterising equity as this case study and adapted it to illustrate debt. Cases such as Pritired I LLC v United particular points of interest. In broad terms, States and Hewlett Packard Co v Commissioner the facts of the case study were: were cited to highlight this changing trend. UÊ >Ê1-ÊVœÀ«œÀ>ÌiÊ­¼1- œ½®ÊˆÃÊ̜Ê>VµÕˆÀi]ÊiˆÌ iÀÊ In these cases, the courts looked at not directly or indirectly, the whole of the issued only the terms of the instruments involved share capital of a target holding company (such as the expected maturity of those (such target holding company could be instruments) but the actual arrangements organised in any jurisdiction) (‘HoldCo’); entered into by the parties to conclude that UÊ œ` œÊ >ÃʘՓiÀœÕÃÊÃÕLÈ`ˆ>ÀˆiÃʜÀ}>˜ˆÃi`Ê the instruments were debt. On the basis in various jurisdictions (including those of that conclusion, FTCs were disallowed jurisdictions represented on the panel); in these cases. It was noted that the UÊ 1- œÊ“>ÞÊvœÀ“Ê>ʘiÜÊVœ“«>˜ÞÊ­¼ iÜ œ½®]Ê arrangements in both the case of Pritired which may be organised under US or non- and Hewlett Packard were at the aggressive US law, to act as the acquisition vehicle for end of the tax planning spectrum. The the purchase of the shares in HoldCo; and case of Pepsico Puerto-Rico Inc v United States UÊ iˆÌ iÀÊ1- œÊœÀÊ iÜ œÊ܈Ê>««ÞÊ>Ê was also mentioned as representative of combination of its own funds and money less aggressive tax planning and this case raised through external finance to fund the illustrated the tension that can arise where acquisition of the shares in HoldCo. there is an asymmetrical treatment in different jurisdictions. United States Finland On any cross-border transaction like the case study, the key objectives of US tax planning The discussion concerning Finland began would be to maximise foreign tax credits with a summary of some proposed Finnish (FTCs) (which can mitigate double taxation on legislative changes. Under current Finnish such transactions) and, in relation to any debt law, debt-financed acquisitions are attractive or equity instruments, maximising the benefits owing to the availability of tax deductions for of interest deductions whilst minimising any the debtor in respect of interest expenses. withholding taxes on dividend and interest However, with effect from 1 January 2014, payments. It was noted that tax treaties can Finland is proposing to introduce interest play an important function in minimising tax deduction limitation rules (similar to those burdens on cross-border cash flows. that already exist in Germany) which will The facts of the case study was used to reduce the attractiveness of debt-financed illustrate the different tax burdens that acquisitions. Broadly, these new rules will would be borne depending on whether an limit the deductibility of net interest expense instrument could be characterised as debt (ie, interest expense exceeding interest or equity and to demonstrate some of the income) to 30 per cent of ‘Tax EBITDA’ advantages of ‘pushing down’ debt within the subject to a ‘safe harbour’ of €500,000. Any acquisition structure. interest expense that is not deductible under When considering US tax planning these new rules can be carried forward with on transactions like the case study, the relief given in subsequent periods (subject to preferences of the parties to the proposed the application of these rules to those future arrangement would also need to be taken periods). It was noted that these new rules will into account. In this regard, it was noted have a particularly pronounced effect on loss- that investors would typically prefer to making companies. receive equity treatment as FTCs may then Although case law in Finland has be available to such investors. From the historically been both flexible and favourable perspective of an entity looking to raise to the taxpayer, the point was made that tax funds, the opposite would generally be the anti-avoidance rules and transfer pricing rules

52 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS were increasingly being used by Finnish tax instrument with a foreign subsidiary. As authorities to challenge interest deductibility a result of new legislation introduced as (it was noted that Finland does not, however, of 2011, payments made under hybrid have a statutory thin capitalisation rule). instruments issued by an Austrian company Acquisition branch structures are being will no longer be tax exempt under the challenged applying an OECD functional participation regime if those payments are analysis to deny the availability of interest tax deductible in the source country. This deductions. Other areas that were being applies to hybrid instruments as well as increasingly challenged include intra-group dividends which are tax deductible under debt push-downs which are being challenged foreign local law, subject to the provisions of under general anti-avoidance rules. For this the EU Parent Subsidiary Directive. reason and in the context of the facts of the The case study was discussed against the case study, it was suggested that consideration background of the introduction in 2005 of should be given to effecting debt push-downs a favourable tax regime (including a group prior to completion. tax regime) and the further introduction A further measure which was referred to in of new rules in 2011 that prevented an the context of recharacterising debt as equity interest deduction being obtained where a was the OECD Transfer Pricing Guideline 1.65, participation interest was acquired, either which may in extraordinary circumstances directly or indirectly, from an affiliated allow the tax authorities to disregard the company or a controlling shareholder. The parties’ characterisation of a transaction purpose of the 2011 rules was to eliminate and recharacterise it in accordance with its unacceptable intra-group structuring and substance. This guideline has been used in to prevent the deductibility of artificially a few ‘pilot’ cases in which the Finnish tax generated tax expenses relating to debt authorities have sought to recharacterise both financed intra-group sales of group hybrid debt (debt that carries certain equity participations. In relation to these types like features) and excessive shareholder debt of transactions, it was suggested that, as as equity. Constitutional issues and a lack of a practical matter, consideration should foreseeability were flagged as two potential now be given to changing a loan for the concerns with respect to the approach of the acquisition of an intra-group participation Finnish tax authorities and their reliance upon into a loan for the funding of a dividend. this guideline. Once the dividend had been paid, the shareholders would pay an amount equal to that dividend to the Austrian company as an Austria equity contribution. The Austrian company Important to the discussion regarding debt would then use those ‘new’ funds to repay and equity financing in Austria is the fact that the loan in respect of the acquisition of Austria imposes a one per cent stamp duty the participation. This proposal would, on equity contributions whilst there has been however, still be subject to various Austrian no stamp duty on debt or loan financing with anti-avoidance rules which would require effect from 2011. further consideration. Like Finland, Austria does not have a statutory thin capitalisation rule. Typically, Belgium the Austrian tax authorities require Austrian companies to have a 3:1 or 4:1 debt to The discussion in the context of Belgium equity ratio. However, shareholders tend to started with an overview of some basic agree how to debt/equity finance a vehicle. Belgian legal principles. Debt and equity Recharacterisation by Austrian tax authorities characterisation in Belgium is governed by the of debt into equity is generally only possible Belgian Civil Law Code. A particular Advanced if the arrangement concerned has not been Ruling of note relates to the tax treatment of entered into on arm’s length terms. The profit participating loans (PPLs), and confirms burden of proof in respect of recharacterisation that an instrument with equity features can lies with the Austrian tax authorities and it was be compatible with a debt characterisation. noted that this has proved to be a hindrance The features of an instrument dealt with by to the tax authorities when challenging the this ruling were highlighted, including the characterisation of an instrument. term of the instrument, payment of principal Another issue that often arises is where and interest, subordination, transferability an Austrian company enters into a hybrid and profit participating characteristics.

TAXES NEWSLETTER SEPTEMBER 2013 53 TAX PLANNING CONFERENCE REPORTS

‘Interest’ amounts in respect of PPLs within rate of taxation in Germany is 30 per cent this ruling were characterised as ‘dividends’ (corporate and trade income tax and the and, in this particular case, were exempt ‘solidarity surcharge’). Where a shareholding by virtue of the Luxembourg participation exceeded ten per cent, withholding tax on exemption regime. dividends are imposed at the rate of five Further developments have included per cent or where the requirements of the the introduction of the ‘notional interest ‘super limitation-on-benefits clause’ are deduction’ rules with effect from 1 fulfilled, the withholding tax rate is reduced January 2006, which effectively replaced to zero. Accordingly, the need to establish the coordination centre regime. The the ‘substance’ of intermediate holding notional interest deduction rules provide companies in order to minimise withholding for a deduction at a set rate calculated by tax obligations and the effect this has on reference to the ‘adjusted statutory book incentivising equity was also discussed. equity’ as at the end of the previous fiscal In the context of debt funding to year. One of the most important adjustments the German NewCo, it was noted that relates to participations benefiting from the Germany does not tax the interest income participation exemption regime and, in this of the shareholder and that the interest regard, it was noted that this adjustment is, in principle, deductible, subject to the disincentivises the establishment of holding provisions of the interest barrier rules. The companies with high levels of equity. However, interest barrier rules set out circumstances the Advocate General of the Court of Justice in which the deductibility of interest will be of the European Union has concluded that limited. The interest barrier rules are also the notional interest deduction rules impose applicable to hybrid debts. On this basis, an unjustified restriction on the freedom whether debt-financing or equity-financing is of establishment of Belgian companies with preferable will depend upon the profitability foreign permanent establishments. As at the of the German NewCo. The interest barrier date of the conference, a preliminary ruling rules have been of particular concern in had not yet been issued. recent years as loss-making companies have Reference was also made to Belgium’s thin been taxed on ‘profits’ that have effectively capitalisation rules. Under new rules which arisen as a result of the application of the took effect from 1 July 2012, the debt-to-equity interest barrier rules. ratio is 5:1 (the ratio was previously 7:1). By reference to the case study, it was The scope of ‘tainted debt’ has also been explained how a debt push-down is possible expanded to include loans directly or by financing German subsidiaries (within indirectly owed to group companies (in the HoldCo group) with equity and a addition to debt ultimately owed to persons subsequent repayment of the equity by way or entities established in ‘tax havens’, as was of a loan from those German subsidiaries the limited scope under the old regime). to USCo. These arrangements would be Finally, the case study was discussed in subject to transfer pricing rules and interest order to demonstrate how a ‘double-dip’ barrier rules. In the context of debt and could be obtained using the notional interest equity characterisation, it was noted that the deduction rules. The facts of the case study tax treatment usually follows the German were modified in order to demonstrate how a GAAP treatment. An alternative proposal ‘double-dip’ could be obtained using the PPL was discussed whereby German NewCo ruling and a Luxembourg company. The case and ant German subsidiaries (within the study was also discussed in the context of debt HoldCo group) would form a tax group. push-downs, which are not easy to achieve in The formation of a tax group would allow Belgium, lacking a tax consolidation regime. German NewCo to allocate the total income at this level so that the deduction of the interest may be more acceptable. A third Germany structure involving leveraged dividends was The German position was discussed with also discussed, however, it was observed particular reference to the case study with that tax audits tend not to accept these NewCo being established under German law. structures as the interest is not incurred The discussion in respect of Germany as a consequence of the business itself but was prefaced by a brief discussion of various rather that the interest is incurred to finance taxation rates. It was noted that the average dividend distributions.

54 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

Spain interests in Spain. In addition, it was noted that interest paid to persons resident in an The discussion started with a brief explanation EU member state is generally exempt from of the advantages and disadvantages of the Spanish withholding tax. Spanish tax system in relation to acquisitions. The Spanish tax characterisation of certain Advantages include the deduction of goodwill hybrid instruments, such as the joint account and losses of domestic-foreign subsidiaries, agreements, Brazilian ‘juros’ and perpetual very limited change-of-control provisions for loans was discussed, with emphasis made on the disallowance of tax credits, an extensive tax the different tax, legal and even accounting treaty network and tax-free waivers of intra- rules at play. group loans. This is balanced by disadvantages In relation to the case study, the jurisdiction which include the limitation on the use of net of incorporation and residence of NewCo operating losses in 2013, the challenge of intra- will be influenced by tax haven anti-abuse group reorganisations, potential transfer taxes provisions and the provisions of the EU on the acquisition of real estate companies, Parent Subsidiary Directive. It was also noted arm’s length rules and documentation that the new US-Spain tax treaty will provide requirements in respect of transfer pricing, and further tax planning opportunities. both specific and general anti-avoidance rules. A potential ‘optimal’ Spanish structure With regards to the financing of a Spanish was discussed. This structure involved the subsidiary (within the HoldCo group), it establishment in Spain of a limited liability was noted that there are ‘safe harbour’ NewCo which would acquire subsidiaries rules in relation to the tax deductibility of (Spanish and Latin American) from HoldCo. interest and that tax grouping allows for It is then proposed that the Spanish NewCo the deduction of interest within a Spanish would elect to be within both the favourable group. However, interest expenses derived Spanish holding company and tax grouping from intra-group reorganisations are non- regimes which would confer certain Spanish tax deductible unless the reorganisations benefits on the shareholders of Spanish NewCo resulted from a third party acquisition or as well as facilitating interest deductibility. when there is a real management of the

12 APRIL 2013 Pieter van Os What is the meaning of De Brauw Blackstone Westbroek, Amsterdam beneficial owner today? pieter.vanos@ debrauw.com

Co-Chairs Income and on Capital (OECD MTC) since René Beltjens Alter Domus, Luxembourg 1977. Article 10, paragraph 2, provides that Dominic Stuttaford Norton Rose, London dividends may be taxed in the contracting state Barbara J Worndl Aird & Berlis, Toronto of which the company paying the dividends is a resident and according to the laws of that Speakers state (source state). But if the beneficial owner of the dividends is a resident of the other Pia Dorfmueller P+P Pöllath & Partners, Frankfurt contracting state (home state), the source state am Main will be limited in its taxation rights. Article Fred R Gander KPMG, London 11, paragraph 2 has a similar provision in Anders Oreby Hansen Bech-Brunn, Copenhagen connection with interest arising in the source Paul H Sleurink De Brauw Blackstone Westbroek, state, and Article 12, paragraph 1 provides that Amsterdam only the home state is allowed to tax royalties arising in the source state if the recipient is the he term ‘beneficial owner’ has been beneficial owner. included in Articles 10 (dividends), The concept of ‘beneficial owner’ has given 11 (interest), and 12 (royalties) of rise to different interpretations by courts and Tthe OECD Model Tax Convention on tax administrations. Those interpretations

TAXES NEWSLETTER SEPTEMBER 2013 55 TAX PLANNING CONFERENCE REPORTS

range from the extremes of a formal to Netherlands, the UK and the US, on the basis an economic approach. In a more formal of recent case law and case studies. Although approach, only nominees and agents disqualify a more detailed overview with respect to each as ‘beneficial owner’. In an extreme economic of those states is provided below, four aspects approach, only the ultimate shareholders were remarkable: would be considered the beneficial owners of UÊ ˆÀÃÌ]Ê>Ì œÕ} ÊLœÌ ÊiÀ“>˜ÞÊ>˜`ÊÌ iÊ income and thus holding companies would US are familiar with the term ‘beneficial be disregarded for beneficial ownership owner’, it does not play a prominent role purposes. Given the risks of double taxation for them in attacking tax treaty shopping and non-taxation arising from these different situations. interpretations, the OECD Committee on UÊ -iVœ˜`Þ]ÊLœÌ Ê >˜>`>Ê>˜`ÊÌ iÊ iÌ iÀ>˜`ÃÊ Fiscal Affairs has worked on proposals aimed tend to have a formal approach to the at clarifying the interpretation that should term; however, for the Netherlands it is only be given to that concept in the context of the relevant in relation to dividends whereas for OECD MTC. As a result, the OECD released a Canada it is also relevant for interest and public discussion draft entitled ‘Clarification royalties. of the meaning of “beneficial owner” in the UÊ / ˆÀ`Þ]ÊÌ iÊ1Ê >ÃʓœÀiʜvÊ>˜Ê>˜Ìˆ‡ OECD Model Tax Convention’ on 29 April abuse approach to the term, in which the 2011, followed by a revised public discussion substance of the recipient may be relevant draft entitled ‘Revised proposals concerning to a certain extent. This approach clearly the meaning of beneficial owner in articles tends more to an economic approach than 10, 11 and 12 of the OECD Model Tax to a formal approach. Convention’ released on 19 October 2012, UÊ
˜`Êw˜>Þ]ÊvœÀÊ i˜“>ÀŽÊÌ iʓi>˜ˆ˜}ʜvÊ which also discusses comments received on the term is rather in development given that the first draft. It is expected that the OECD a number of cases are currently pending commentary to the OECD MTC in connection before the court and new legislation in with the meaning of beneficial ownership will which the meaning of the term is crucial be updated in 2014. has been adopted as per 2013. When determining the meaning of the Barbara Worndl stated that in Canada, term ‘beneficial owner’ for a state, a number ‘beneficial ownership’ has been used by the of questions are relevant. First, does its Canada Revenue Agency (CRA) to attack domestic tax law provide for a withholding the use of holding companies in treaty- tax on dividends, interest or royalties? To friendly jurisdictions, together with general the extent this is not the case, the term will anti-avoidance arguments. Section 3 of the not be very relevant. But to the extent there Income Tax Conventions Interpretation Act is such a withholding tax, a second question provides that if a term is not defined in a is whether its domestic tax law provides for DTC, it has the meaning it has for purposes the term ‘beneficial owner’ or whether that of the Income Tax Act. There is no definition term is included in an applicable double of beneficial owner included in the Income taxation convention (DTC). Third, given Tax Act. When interpreting DTCs, Canadian that including the term ‘beneficial owner’ courts have tried to determine what the in its domestic tax law or DTC is a way of contracting states intended when they entered addressing treaty shopping situations in into the DTC. For that purpose, courts take general and conduit companies in particular, the most recent OECD commentaries to the how relevant is the concept of ‘beneficial OECD MTC into account, even if they have owner’ in dealing with those forms of been amended after the conclusion of the tax avoidance? There are many ways of DTC and the protocols thereto (dynamic or addressing treaty shopping situations and ambulatory approach), provided that they conduit companies for a state, including clarify (so they do not conflict with) the specific anti-abuse rules (SAARs), either in OECD commentaries in place at the time the its domestic tax law or in a DTC, general DTC and its protocols were concluded. anti-abuse rules and substance-over-form or The landmark Prévost decision (2009, economic substance approaches. dividends) and Velcro decision (2012, royalties), The panel, chaired by René Beltjens, which both dealt with beneficial ownership, Dominic Stuttaford and Barbara Worndl, were discussed by Barbara Worndl. In Prévost, discussed the meaning of beneficial a Canadian company paid dividends to its ownership today in six OECD Member States, sole shareholder, a Dutch holding company specifically Canada, Denmark, Germany, the (‘DutchCo’). On the basis of the applicable DTC,

56 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

DutchCo could benefit from a reduction of the term ‘beneficial owner’, the legislative of the Canadian domestic withholding tax history explicitly refers to the OECD public rate on dividends, whereas the shareholders discussion draft released on 29 April 2011, of DutchCo could not. According to a which has later been revised. shareholder agreement (which was not Further, Anders Oreby Hansen presented binding on DutchCo itself), DutchCo’s a recent decision by the Danish National Tax two shareholders had to cause DutchCo to Tribunal, dated 23 November 2012, which distribute at least 80 per cent of its earnings as has been appealed before the court. It dealt dividends. The CRA contested that DutchCo with a Bermuda parent that indirectly held, was the beneficial owner of the dividends via a double tier LuxCo structure, all the and denied entitlement to reductions of the shares in a Danish subsidiary. The latter paid withholding tax. The Tax Court of Canada interest and dividends to its Luxembourg decided that ‘because [DutchCo] was not parent. Both LuxCos were not recognised as bound to the shareholder agreement, it had the beneficial owner of the income because free use and enjoyment of the monies received they were stripped of all corporate powers as dividend’, which decision was upheld by the and had no employees, although it did have Federal Court of Appeal. The Velcro decision offices. The beneficial ownership requirement was generally in line with Prévost. The issue was deemed to be in compliance with the in Velcro was whether a DutchCo was the EU Interest/Royalty Directive (Article 1, ‘beneficial owner’ of royalties paid by a related paragraphs 4 and 7) but not with the EU Canadian company, and therefore entitled to Parent/Subsidiary Directive because it does a reduced rate of Canadian withholding tax not contain such an explicit requirement: under the applicable DTC, whereas DutchCo the general anti-abuse clause in Article 1, was contractually required to remit a specific paragraph 2 was not incorporated in Danish percentage of all amounts received from the law in relation to beneficial ownership. As a Canadian company to its parent company result, the decision was only in favour of the located in the Netherlands-Antilles, which taxpayer in relation to dividends. Further, the company would not have been entitled to a tribunal seems to have decided in line with reduced rate. The Tax Court of Canada ruled its earlier decisions dated 22 December 2010 that DutchCo was indeed the beneficial owner (on interest; appealed) and 16 December of the royalties because it had possession, use, 2011 (on dividends; appealed). Interestingly, risk and control of the royalties and it retained substance was considered relevant by the some discretion as to the use of the royalties tribunal in order to determine the beneficial while in its possession. ownership of the LuxCo. In Denmark, the relevance of beneficial Pia Dorfmueller argued that generally, ownership only seems to increase given beneficial ownership is not relevant in cases a number of recent cases and recent where Germany is the source state because legislation. As to the latter, Anders Oreby the German tax authorities will invoke a Hansen discussed that due to negative SAAR in supposed treaty shopping situations. media attention, a new act intends to She stated that the term ‘beneficial owner’ remove Denmark as an intermediate is not included in German domestic tax law, holding jurisdiction. The act mainly affects but is provided for in DTCs concluded by international structures in which a Danish Germany with Italy, Norway, Sweden, Australia company is used as an intervening holding and the US. According to those DTCs, the company to funnel dividends received from beneficial owner of dividends, interest or a foreign subsidiary to its foreign parent, royalties is the resident who is the economic and cannot be considered the beneficial owner of the assets on which the dividends, owner (under the definition of the Danish interest or royalties are paid. Under German tax authorities) of the dividends received domestic tax law, the economic owner is the from its foreign subsidiary. In that event, person exercising actual domination over an Denmark will impose dividend withholding asset such that the person is typically able, in tax on the otherwise tax exempt dividend economic matters, to exclude the legal owner distributions from the Danish company to from control of the asset for the duration of the foreign parent that are made in or after its usual life. And further, a withholding tax 2013. This anti-abuse rule does not apply if on interest does not exist in Germany (unless the distribution of dividends from the Danish the loan is secured by real estate), but there company is covered by the EU Parent/ is one on dividends and royalties. Apart from Subsidiary Directive. As to the interpretation a 1988 case, there are no cases dealing with

TAXES NEWSLETTER SEPTEMBER 2013 57 TAX PLANNING CONFERENCE REPORTS

beneficial ownership. The German SAAR but who receives dividends based on dividend referred to above limits the entitlement of a coupons, is regarded as the beneficial owner foreign company for (partial or full) relief of the dividends if he or she may freely from German withholding tax under a DTC dispose of: (i) the dividend coupons; or or an EU Directive. Such entitlement is (ii) after the conversion of the coupons, of limited to the extent that: the dividend payments; and (iii) provided UÊ Ì iÊà >Ài œ`iÀÃʜvÊÌ iÊvœÀiˆ}˜ÊVœ“«>˜ÞÊ>ÀiÊ that he or she does not act as an agent or a persons who would not be eligible for tax relief nominee upon conversion of the coupons. if they had directly received the income; and Thus, ‘substance’ was not taken into account. UÊ ViÀÌ>ˆ˜Êv՘V̈œ˜>ÊÀiµÕˆÀi“i˜ÌÃÊ>ÀiʘœÌʓiÌÊ And although at the time the Market maker (harmful earnings). case was decided the dividend stripping rules In the Netherlands, a withholding tax on were not yet adopted, Paul Sleurink views it as dividends solely exists so that the concept questionable whether the negative definition of ‘beneficial owner’ is in principle only of ‘beneficial owner’ in those rules would relevant in that context. Paul Sleurink have influenced the tax treaty interpretation noted that Dutch domestic tax law does by the Dutch Supreme Court, whose only include a definition of what is not a approach can generally be characterised as beneficial owner: Article 4, paragraph 7 of autonomous, taking account of the (latest) the Dutch Withholding Tax Act (dividend OECD approach. stripping rules) provides that the recipient Furthermore, Paul Sleurink noted that is not considered the beneficial owner of international criticism of the use of conduit the profit distribution if the following three companies in the Netherlands led to the requirements are cumulatively met: introduction of Article 8c in the Corporate the recipient paid a consideration Income Tax Act in 2002. It provides that if (tegenprestatie) in cash or in kind; a company with intragroup activities (eg, UÊ Ì iÊ«>ޓi˜ÌʜvÊÌ iÊVœ˜Ãˆ`iÀ>̈œ˜ÊÜ>ÃÊ«>ÀÌÊ intragroup financing activities) does not have of a sequence of transactions; sufficient equity to cover the risks relating UÊ ˆÌʈÃʏˆŽiÞÊÌ >Ì\Ê to those activities, the income and expenses ż an individual or company effectively relating to those activities will be excluded benefited in whole or in part from the from that company’s tax base, and the Dutch distribution, and such individual or tax authorities will not allow that company company would have been entitled to to claim a credit for foreign withholding tax a less favourable dividend withholding and consider it as an agent, which might tax treatment than the recipient of the encourage the source state of the income to distribution would be in the case of deny the benefits of an applicable DTC, for direct receipt; and example, applying the local withholding tax ż this individual or company, directly or rates instead of the lower DTC rates. indirectly, retains a position in the shares, As to the UK, Dominic Stuttaford profit rights or profit sharing bonds that argued that ‘beneficial ownership’ is one is comparable with his position in similar of the treaty shopping weapons of the HM shares, or profit sharing bonds he or she Revenue & Customs (HMRC), although it had prior to the sequence of transactions. is not very clear what it means. In 2006, the If this provision applies, a profit distribution English Court of Appeal ruled in Indofood to an individual or company that can be that when determining whether an entity considered the beneficial owner of the profit has beneficial ownership it is necessary to distribution would under all circumstances be consider an international fiscal meaning subject to the domestic dividend withholding rather than the narrow technical UK tax rate of 15 per cent. domestic law meaning. Thus, if recipients The term ‘beneficial owner’ is included in are bound in legal, commercial or practical virtually all DTCs the Netherlands entered terms to pass on the income, they will not into force after 1977. For those DTCs, the be considered the beneficial owner thereof. Market maker decision (1994) is relevant. And further, particular regard should be had This case clarified the meaning of the term to the ‘substance of the matter’. This line ‘beneficial owner’ under the DTC concluded of reasoning was considered consistent with between the Netherlands and the UK in 1980. the purpose of DTCs, being the avoidance On the basis of the treaty’s context, the of double taxation and the prevention of Dutch Supreme Court ruled that a tax evasion. And thus, the Court adopted dividend recipient who does not own shares, a more anti-abuse approach. As English

58 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

courts generally do, the English Court of off the concept of beneficial ownership as Appeal took a dynamic approach to the a means of addressing tax treaty shopping OECD commentaries on the OECD MTC: for purposes of avoiding US withholding the 2003 OECD commentaries clarifying taxes on dividends, interest or royalties. the term ‘beneficial owner’ were taken into Nevertheless, beneficial ownership of income account, whereas they were amended after is determined under the provisions of section the conclusion of the applicable DTC and the 7701(l) and any other applicable general US protocols thereto. tax principles, including principles governing After Indofood was decided on, the HMRC the determination of whether a transaction published detailed commentary on beneficial is a conduit transaction. For example, the ownership and guidance on Indofood. The partners of a partnership are considered guidance was supplemented in 2012 and lists the beneficial owners of the partnership’s a number of practical points to be considered income. Nominees, agents and conduits are when determining whether a claimant not, though. Further, benefits of the 2006 has beneficial ownership of the income in US Model Treaty apply to residents with question. Substance of the claimant is also respect to dividends, interest and royalties argued to be relevant, but it is not clear to what only if the resident is the ‘beneficial owner’ extent. Given the absence of a withholding tax of the amount. The technical explanation of on dividends, beneficial ownership is irrelevant that treaty states that: ‘[t]he term “beneficial with respect to dividend distributions made by owner” is not defined in the Convention, and a UK company. is, therefore, defined as under the internal Finally, Fred Gander concluded that in law of the country imposing tax (i.e., the the US, inter alia, the domestic anti-hybrid source country). The beneficial owner of regulations, domestic conduit financing the dividend for purposes of Article 10 is the regulations, and extensive limitation on person to which the income is attributable benefits provisions in virtually all DTCs under the laws of the source State.’ concluded by the US have taken the pressure

12 April 2013 Ewa Bienkowska Distressed assets, tangible and World Trade Institute, Berne intangible ewa.bienkowska@ wti.org

Co-Chairs the tax implications various financial transactions Richard M Lipton Baker & McKenzie, Chicago between the real estate developer BigCo, investors, Peter Maher A&L Goodbody, Dublin bank and investment fund SmartCo have in the respective tax jurisdictions. Speakers The panel looked at the topic of distressed Ewout van Asbeck Van Doorne NV, Amsterdam assets and, in particular, considered two case studies: the first involving a distressed Claudio Giordano Studio Macchi di Cellere situation in relation to real estate, and the Gangemi, Rome second case study dealing with distressed debt Eduardo Gracia Ashurst, Madrid secured over intangible assets. Marcus Oliver Mick Flick Gocke Shaumburg, Peter Maher led the panel discussion on the Frankfurt am Main first case study which involved a company in Bradley Phillips Herbert Smith Freehills, London country 1 developing a mega golf/shopping/ residential/commercial/retail project funded uring the session, tax professionals by contributions of US$50m from investors from the US, Ireland, the in country 1 and borrowings of US$300m Netherlands, Italy, Spain, Germany from a lender in country 2. Five years after Dand the UK presented two case studies the fundraising, the project is completed, but on distressed intangible and tangible assets and the underlying assets are only worth US$100m

TAXES NEWSLETTER SEPTEMBER 2013 59 TAX PLANNING CONFERENCE REPORTS

and the amount due and owing (principal and the publishing company a year before to the accrued but unpaid interest) to the lender in investment fund. country 2 is US$400m. Again, each of the panellists outlined The various panellists from the UK, the tax position in their countries for the the Netherlands, Italy, the US, Germany publishing company, the investment fund and and Spain considered how the release of the private equity fund on the assumption indebtedness by the lender would be treated that each was in their particular jurisdiction. in their countries from the perspective of The position of the publishing company and the debtor and the creditor and how that the investment fund was also considered in treatment might differ if the debtor and the context of the publishing company issuing creditor were connected. Each panellist also equity to the creditor as a swap for the debt. dealt with the most likely work out option in In conclusion, co-chair Peter Maher said their jurisdiction from a tax perspective. that what was obvious from the contribution Dick Lipton led the discussion on the of the panellists is that: second case study which involved an UÊ Ì iÊÌ>ÝÊ«œÃˆÌˆœ˜Êˆ˜ÊܓiÊVœÕ˜ÌÀˆiÃʈÃÊ ˆ} ÞÊ investment fund making an unsecured dependent on the accounting treatment loan to a publishing company in a different whereas in other countries it is less so; country. Arising out of plummeting share UÊ Ãœ“iÊVœÕ˜ÌÀˆiÃÊ >ÛiÊÜiÊ`iÛiœ«i`ÊÌ>ÝÊÀՏiÃÊ values, a private equity fund subsequently relating to cancellation of indebtedness acquires all of the stock of the publishing and debt for equity swaps whereas other company which it financed with US$25m countries have limited tax rules; and of its own money and US$225m of newly UÊ Ì iÊÌ>ÝÊÌÀi>̓i˜Ìʈ˜ÊÌ iÊÛ>ÀˆœÕÃʍÕÀˆÃ`ˆV̈œ˜ÃÊ issued publicly traded debt which was senior of the different transactions discussed in priority to the unsecured note issued by varied considerably.

12 APRIL 2013 Recent cross-border mergers Michał Nowacki WardyĔski & Partners, and acquisitions and Warsaw michal.nowacki@ restructuring transactions wardynski.com.pl

Co-Chairs Tyco/Pentair cross-border combination Albert Collado Garrigues, Barcelona transaction Hal Hicks Skadden Arps Slate Meagher & Flom, The Tyco/Pentair cross-border combination Washington, DC has been one of the most recent notable US related transactions. It involved a distribution Speakers to the public by a publicly traded Swiss Caroline Devlin Arthur Cox, Dublin corporation (Tyco) of a Swiss subsidiary Reinout de Boer Stibbe, Amsterdam (SwissCo) with significant US operations, Thomas Meister Walder Wyss & Partners, Zurich followed by the acquisition of a public US Christian Wimpissinger Binder Grösswang, Vienna target (Pentair) by the now public SwissCo. This was a business driven combination with he aim of the panel was to provide an significant tax structuring considerations. overview and discussion of selected Pentair was a publicly traded US recent high profile and interesting corporation engaged in the valves and cross-border M&A and restructuring flow control business, mostly in the US but T increasingly outside the US. Tyco was a transactions. The transactions discussed involved various jurisdictions and were publicly traded Swiss corporation engaged in presented in a case study format. valves and flow control, ADT home security, and commercial fire and security businesses.

60 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

The transaction was initiated by a non- was an increase of qualifying contributed taxable Tyco spin-off of valve/flow business, surplus/share premium of SwissCo equal which entailed spin-off of Tyco’s 100 per to the fair market value of Pentair – it cent Swiss subsidiary running valve/flow substantially increased the Swiss dividend business (SwissCo) to Tyco Public. SwissCo withholding tax free distribution capacity of next acquired Pentair, this being structured SwissCo. as a non-taxable reorganisation transaction and was preceded by SwissCo establishing Inversions of US publicly traded two US SPVs, that is, the acquisition company companies into Ireland and its subsidiary which was then merged with Pentair (Pentair survived), with issuance One can observe inversion of US publicly of shares in SwissCo to Pentair Public. As traded companies into Ireland. For instance, a result of the transaction, Tyco’s historic the following companies have been re- shareholders own more than 50 per cent of domiciled in Ireland as part of mergers with the combined company and Pentair historic existing Irish companies: shareholders own 47.5 per cent. UÊ >̜˜Ê œÀ«œÀ>̈œ˜ÊqÊÌ ÀœÕ} ʈÌÃÊ>VµÕˆÃˆÌˆœ˜Ê A number of US tax rules were taken into of Cooper Industries in a US$11.8bn cash account when planning the transaction. In and stock deal (for details, please see order to assure tax neutrality of the Tyco spin- below); off of valve/flow business, it was necessary UÊ
ŽiÀ“iÃʘVÊqÊÌ ÀœÕ} ÊÌ iÊ>VµÕˆÃˆÌˆœ˜ÊœvÊ to provide sufficient corporate business the drug formulation and manufacturing purpose and there was a requirement for business unit of Elan in a US$1bn deal; and active businesses at Tyco and SwissCo. Section UÊ >ââÊ* >À“>ViṎV>ÃÊqÊÌ ÀœÕ} ʈÌÃÊ>VµÕˆÃˆÌˆœ˜Ê 355(e) did not apply at the Tyco level because of Azur Pharma in a US$500m deal. Pentair Public acquired less than 50 per cent The section 7874 US Anti-Inversion Rule of SwissCo (it would have mattered if Tyco was an issue in all the above transactions. had undertaken certain restructuring steps to Section 7874 applies where: form SwissCo). UÊ iÜ œÊ>VµÕˆÀiÃÊÃÕLÃÌ>˜Ìˆ>ÞÊ>ÊœvÊÌ iÊ The next step, that is, the acquisition of properties held directly or indirectly by USCo; Pentair by SwissCo, was structured as a tax- UÊ >vÌiÀÊÌ iÊ>VµÕˆÃˆÌˆœ˜]Ê>Ìʏi>ÃÌÊÈäÊ«iÀÊVi˜ÌʜvÊ free stock-for-stock exchange. It was not NewCo stock by vote or value is owned by taxable to Pentair Public under the anti- former shareholders of USCo by reason of inversion rules of section 367(a) because they their prior ownership of USCo stock; and acquired less than 50 per cent of SwissCo UÊ Ì iÊiÝ«>˜`i`Ê>vwˆ>Ìi`Ê}ÀœÕ«ÊœvÊÜ ˆV Ê (and other requirements were met). NewCo is part does not have ‘substantial After the transaction, SwissCo is considered business activities’ in NewCo’s jurisdiction. as a foreign corporation for US tax purposes If section 7874 applies, then the following applies: – anti-inversion rules of section 7874 do not UÊ Ü iÀiÊvœÀ“iÀÊà >Ài œ`iÀÃʜvÊ1- œÊœÜ˜Ê apply because Pentair Public owns less than more than 80 per cent of NewCo – NewCo 60 per cent of the combined company. is treated as a domestic US corporation for From the Swiss perspective, the spin-off all US tax purposes; and of SwissCo was tax neutral for dividend UÊ Ü iÀiÊvœÀ“iÀÊà >Ài œ`iÀÃʜvÊ1- œÊœÜ˜Ê withholding tax provided that distribution was between 60 per cent and 80 per cent of made out of qualifying contributed surplus/ NewCo – NewCo is treated as a surrogate share premium of SwissCo. As regards foreign corporation, that is, the taxable income tax, the spin-off resulted in income income of USCo and its over 50 per cent US recognition on the part of shareholders affiliates, for a ten-year period following the (including corporate shareholders) holding inversion, may not be less than the inversion shares in Tyco as a business asset. For gain for such year. individual shareholders of Tyco holding There are a number of reasons for which the shares as a non-business asset, spin-off was inversion into Ireland takes place, including income neutral. As regards further steps the possibility of applying US GAAP, the fact in the transaction, the merger of SwissCo’s that Ireland is a common law jurisdiction, as subsidiary with Pentair with issuance of well as a friendly tax environment (eg, low SwissCo shares to Pentair shareholders was income tax rate), access to EU directives, considered as a share-for-share exchange (so- tax treaty network, tax incentives, no tax on called ‘quasi merger’). This meant that there capital gains, no CFC rules, limited transfer was no distribution by SwissCo and that there pricing, no thin cap rules, etc.

TAXES NEWSLETTER SEPTEMBER 2013 61 TAX PLANNING CONFERENCE REPORTS

One of the good examples of inversion of a The following facts and tax issues have been US public company into Ireland is the Eaton taken into account in connection with the Corporation/Cooper Industries transaction. combination: At the preparatory stage, a new holding UÊ i˜VœÀiÊ >ÃÊÃÕLÃÌ>˜Ìˆ>ÊµÕ>ˆvވ˜}Ê structure was set up for Eaton, where New contributed surplus/share premiums, while Eaton holds shares in EU Sub-HoldCo, which Xstrata has modest qualifying contributed then holds shares in another EU Sub-HoldCo. surplus/share premiums – since there is The latter holds shares in US Merger-Sub a Swiss withholding tax of 35 per cent on established in order to merge with Eaton US. distributions other than stated nominal share In the merger procedure, EU Sub-HoldCo capital or qualifying contributed surplus/ and US Merger-Sub deliver New Eaton share premium, the goal was to preserve/ shares to Eaton shareholders. Acquisition increase (with no dilution) the qualifying of Cooper Industries takes place once the contributed surplus/share premium; Eaton structure is ready. Under a scheme of UÊ >ʏi}>Ê“iÀ}iÀÊܜՏ`ʘœÌÊ>œÜÊvœÀÊ>Ê arrangement under Irish law, existing shares substantial increase of the share in stated in Cooper Industries are cancelled and nominal share capital or qualifying Cooper Industries issues new shares to New contributed surplus/share premiums of Eaton, in return for which New Eaton issues the surviving company (dilution effect); shares and pays cash to Cooper shareholders. moreover, if by operation of the exchange ratio the merger would lead to an increase of the share of the Xstrata shareholders Debt push downs in Austria in available stated nominal share capital In case of acquisitions of Austrian targets or qualifying contributed surplus/share by US investors, the US acquirer usually premiums, a constructive distribution sets up an Austrian acquisition vehicle would be assumed, triggering the 35 per (AcquiCo) in order to buy the target. The cent Swiss dividend withheld tax charge goal of the structure is to have the interest – as a consequence, legal merger was not on the acquisition financing taken up at the attractive from a Swiss tax perspective; level of AcquiCo to reduce operating profits UÊ µÕ>ÈʓiÀ}iÀÊ­Ã >Ài‡vœÀ‡Ã >ÀiÊiÝV >˜}iÊ of the target. The Austrian group taxation without dissolution of Xstrata) would allow rules allow such debt push down for tax for a substantial increase of the share capital law purposes (such an effect would not be and qualifying contributed surplus/share possible in the case of a corporate merger premiums of the offering company (up of AcquiCo with the target). The double to the fair market value of the shares held use of expenses and the double use of losses by the tendering shareholders of Xstrata); becomes an option if check the box election moreover, quasi merger would not result in is made in the US in order to treat the effective or constructive distribution being Austrian AcquiCo as a look through entity. assumed for Swiss dividend withholding tax The above-mentioned benefit of deducting purposes – as a consequence, quasi merger interest expenses on acquisition financing was attractive from a Swiss tax perspective. and certain other benefits (eg, good will The post-combination final structure is deduction) apply only in the context that Glencore (renamed Glencore Xstrata of an acquisition from a third party (ie, plc) holds 100 per cent of the shareholding they shall not apply in case of intra-group in Xstrata. Before that, Xstrata shares are reorganisations). split into A and B shares, where B shares are then exchanged for new Glencore shares (so shareholders of Xstrata other Glencore International/Xstrata combination than Glencore and its related entities could Glencore/Xstrata is a transaction involving two become shareholders in Glencore). The listed companies, that is, Glencore International applied transaction scheme results in a plc, a Jersey law public company being tax final structure where there are no minority resident in Switzerland, and Xstrata plc, an shareholders in Xstrata, Xstrata is not English law public company which is a tax directly listed and where an extra qualifying resident in Switzerland. This means that both contributed surplus/share premium is companies are incorporated under foreign law created, which means that Swiss withholding but they are Swiss tax residents. In the pre- tax free distribution capacity is increased combination structure, Glencore owns over (re-load of qualifying contributed surplus/ 33 per cent of the shareholding in Xstrata. share premium).

62 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

NYSE/Euronext/Deutsche Börse combination under Dutch tax law (Dutch Holdco shall value assets it receives at fair market value). By cross-border combination under a new However, in the case at hand, using tax Dutch holding company, NYSE-Euronext book value would have no adverse Dutch tax (a US publicly traded corporation) and consequences because Dutch participation Deutsche Börse (German publicly traded exemption would apply to the future sale corporation) were expected to create the and transfer of Deutsche Börse shares. The world’s largest exchange group by revenue, Dutch tax authorities agreed with the use of the shares of which were to be listed on tax book value to accommodate the German the New York, Frankfurt and Paris stock roll-over facility. exchanges. The combination was very advanced (approval of shareholders, tax rulings in place) when it was called off in Distressed transactions in the Spanish market February 2012 due to competition objections (2012) from the European Commission. In 2012, there was an increase in the number A number of tax issues had to be taken and value of transactions on distressed debt into account when planning the transaction, in Spain. The forecast for 2013 is a growth of including the choice of holding company this type of operations caused, inter alia, by jurisdiction, tax residency questions (board favourable evolution of price gap, sentiment composition, board meetings, etc), German of decrease of risk in the market and moving roll-over facility, dividend withholding tax and towards the end of the financial sector the issue of US tax-free merger. recapitalisation. Distressed assets are usually The planned structuring for the transaction acquired so far by specialised investment funds. included the following main steps: In terms of Spanish taxes, structuring of UÊ ˆ˜VœÀ«œÀ>̈œ˜ÊœvÊ ÕÌV Êœ` œÊLÞÊ the transactions should take into account the independent Dutch Foundation following factors: (‘Stichting’); UÊ Ì iʘ>ÌÕÀiʜvÊÌ iÊ`ˆÃÌÀiÃÃi`Ê`iLÌÊ­Ãi˜ˆœÀÊ UÊ ˆ˜VœÀ«œÀ>̈œ˜ÊœvÊ1-Ê iÀ}iÀ œÊLÞÊ ÕÌV Ê loans, consumer loans, etc); HoldCo; and UÊ Ì iÊvÕÌÕÀiÊ«>˜ÃʜvÊÌ iÊLÕÞiÀ\ʏœ>˜‡Ìœ‡œÜ˜Ê UÊ Ã >Ài œ`iÀÃʜvÊ 9- ‡ ÕÀœ˜iÝÌÊ>˜`ɜÀÊ or loan-to-trade; Deutsche Börse were to receive shares in UÊ Ì iÊÃÌÀ>Ìi}ÞʜvÊÀiÌ>ˆ\ʈ˜ÛiÃ̓i˜ÌÃʓ>`iÊ Dutch HoldCo (Deutsche Börse brought through arrangers versus investments under Dutch HoldCo through an exchange directly made by specialised funds; offer; NYSE-Euronext brought under Dutch UÊ ÀiœÀ}>˜ˆÃ>̈œ˜ÊœvÊÌ iÊ`iLÌʈ˜ÌœÊ>ʓ>ÀŽiÌ>LiÊ HoldCo through a merger of US MergerCo asset: the use of ‘aggregating vehicles’; and into NYSE-Euronext). UÊ «œÌi˜Ìˆ>Ê«iÀ“>˜i˜ÌÊiÃÌ>LˆÃ “i˜ÌʈÃÃÕiÃÊ After combination, HoldCo would have dual usually in connection with collection headquarters for the combined group in function. NYC and Frankfurt. Responsibilities of Dutch The typical structure for a transaction is to HoldCo board members (17 directors) use investment vehicles being tax residents would be limited to strategic matters and in the EU, such as Luxembourg Soparfi or there would be no Dutch resident board Irish ‘Super-QIF’ structures. Contractual members. There would also be a very arrangements (such as participation loan limited number of board meetings in the agreements) are not often used so far as Netherlands. Nevertheless, the Dutch tax purchases made by funds, as opposed to authorities agreed that HoldCo should arrangers. It is worth mentioning that be considered as having Dutch residency structuring the debt in tradable portfolios provided that it would not be considered using trusts as aggregators is not advisable in effectively managed in Germany (which Spain, as trusts are not recognised in Spain was to be confirmed by the German tax (Spain did not sign the Convention of the authorities) or the US (under an analysis of Hague on trusts). US tax law and the Dutch-US tax treaty). One of the issues with Spanish tax is As regards the German CIT roll-over proper qualification of income derived from facility, in order to apply this to exchange distressed assets, that is, whether it should of Deutsche Börse shares for Dutch HoldCo be qualified as interest income or capital shares, the latter should value the Deutsche gain. However, an exemption is available in Börse shares in its balance sheets at tax case of EU resident investors for interest and book value, which is in general not possible

TAXES NEWSLETTER SEPTEMBER 2013 63 TAX PLANNING CONFERENCE REPORTS

qualifying capital gains, so the discussion with respect to assets contributed were 46–49 becomes more theoretical than practical. per cent in the case of loans to developers In any case, the tax residency of ultimate and 63–66 per cent in the case of assets investors, GAAPs and beneficial ownership acquired by enforcement (developments in issues should be observed. Moreover, progress, land and houses). potential permanent establishment issues In order to efficiently organise the should be taken into account in the event future sales of assets, tax arranged pools of there is a collecting agent in Spain. distressed assets (Fondos de Activos Bancarios As regards the Spanish market for – FAB) have been ruled out. FAB is a distressed assets, it should be pointed out specialised fund, consisting of a separate that a Spanish bad bank has been established estate with no legal personality (represented – the SAREB – which has €50.8bn of by a securitisation asset management assets (loans to developers and real estate company). It is subject to a tax regime similar property) and equity of €4.8 bn (9.4 per cent to mutual funds (one per cent CIT) but there on total assets). It has 28 investors, including is an exemption available for capital gains 55 per cent of the shareholding kept by and dividends obtained by foreign investors private investors such as Spanish banks, (including tax havens). Moreover, indirect tax foreign banks, and Spanish and foreign exemptions apply for transfers from SAREB insurance companies. The average haircuts to FAB or from FAB to FAB.

12 APRIL 2013 Executive compensation and Alison Cheung White & Case, London mobile employees acheung@ whitecase.com

Co-Chairs where she becomes a member of the board Friedrich Hey Debevoise & Plimpton, Frankfurt of directors of US Group’s Swiss subsidiary. In am Main each year, she spends 25 per cent of her time Susan P Serota Pillsbury Winthrop Shaw Pittman, in the UK on matters for the UK subsidiary, New York and 30 days in the US. Ann receives an annual salary of €1.2m Speakers and is entitled to an annual discretionary Nicholas Greenacre White & Case, London bonus. She also receives a sign-on bonus on Russell E Hall Towers Watson, New York 1 December 2012. She receives all of her Christina Melady Taj Société d’avocats, Paris compensation from US Group, with the Henk Verstraete Liedekerke Wolters Waelbroeck French subsidiary reimbursing US Group for Kirkpatrick, Brussels 75 per cent of her salary and bonus, and the Silvia Zimmermann Pestalozzi Attorneys at Law, UK subsidiary reimbursing for the remaining Zurich 25 per cent. Ann receives 20,000 non-qualified stock Hypothetical fact pattern options on 1 December 2012 under US Group’s stock option plan, which vests in 20 Ann is a UK national tax resident. On 1 December per cent increments at the end of each of the 2012, she joins the executive team of US Group, five-year anniversaries of the commencement a US public company. Ann spends her first of Ann’s employment. month at the US headquarters. On 2 January On 1 July 2015, Ann relocates to US 2013, she is relocated to France where she Group’s headquarters in New York City. She works for US Group’s French subsidiary. She sells her London flat prior to moving to the then moves to Switzerland on 2 January 2015 US and leases an apartment in Manhattan.

64 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

Shortly afterwards, US Group is subject With regards to the income Ann receives to a takeover and Ann is entitled, under from the UK subsidiary, the way in which it the change of control provisions in her is taxed will depend on Ann’s residence and employment contract, to a cash payment. Ann domicile status. Under the new statutory moves to Bermuda on 15 December 2015 and test for residency, an individual is deemed a resigns on 24 December 2015. UK resident if he or she satisfies either the ‘automatic residence’ test or the ‘sufficient ties’ test. A UK domicile will be taxed on General compensation considerations an arising basis on their worldwide income In France, social security charges can be up to as and when it arises. A non-UK domicile, 45 per cent for employers. If, as in Ann’s case, however, can be taxed on the remittance the employee earns more than €250,000, this basis: they will only be taxed on their offshore is reduced to 26 per cent. Employees pay income/gains if they remit them into the UK. a basic rate of 22 per cent, which is reduced As a UK national, Ann is likely to be a UK to nine per cent on the uncapped portion of domicile so will be taxed on an arising basis compensation. Most inpatriates can avoid social on her worldwide income. charges, however, because they remain covered The taxation of the income Ann receives under their home social security system. whilst in the US will, similarly, depend on Income tax is set at a marginal rate of 45 per Ann’s residence status. US residents are cent. There is also a CHR tax for high earners, taxed on a worldwide income basis, whereas with a four per cent rate being applicable to non-US residents are taxed on a source basis. Ann on the basis that she earns more than Residency status is based on an individual’s €500,000. There is, however, a special income immigration status or physical presence in the tax inpatriate regime, under which significant US. Ann will not be a US resident in the years portions of Ann’s employment income can up to 2015 as she is not physically present in be carved out, provided her contract of the US for at least 31 days in the year and at employment is appropriately drafted. least 183 days over a three-year period. As such, Investment income is subject to social in the years up to 2015, Ann will only be surtaxes, amounting to 15.5 per cent. Ann charged US tax on her US-source income. can reduce her liability for investment From 2015, however, Ann will satisfy the income by moving her investments to physical presence test and, as a US resident, a capitalisation vehicle which does not will be taxed on her worldwide income. distribute and will not generate taxable income whilst Ann is in France. Special payments Income derived from dividends and interest are subject to withholding tax. This triggers Ann receives her sign-on bonus on burdensome responsibilities for taxpayers 1 December 2012 during her time at the with investment income in non-French bank US headquarters. As discussed, at that time accounts, as in Ann’s situation; she will be she is not a US resident so it is necessary to required to file a monthly return and send a consider whether the sign-on bonus is US- monthly payment to the tax authorities. In light source income. The case law in this area is of these onerous duties, Ann should negotiate uncertain, but it may not be appropriate to tax assistance in her employment contract. tax the bonus according to the compensation If Ann moves to Belgium instead of France, sourcing regime (ie, based on the location income tax will be applied to everything where the services are performed) as Ann she obtains in her professional activity, is not required to perform any extra work irrespective of the payor or the form of the in order to qualify for the bonus, she need compensation, be it cash remuneration, stock only be present at work. In relation to the options, etc. Tax rates range from 25 per cent change of control payment, Ann must to 50 per cent, with income of over €36,000, pay an additional 20 per cent tax on any as in Ann’s case, being subject to 50 per cent payment of compensation contingent on a tax. Ann will, however, fall within the scope of change in control of US Group if this and the special expat regime whereby as a non- other payments that are contingent on the Belgian national, she will be deemed to be a change in control equal or exceed three- non-Belgian tax resident so will only be taxed times Ann’s average compensation from US on her Belgian-source income. This regime Group over the preceding five years (or, if will apply even if Ann would be considered a less, Ann’s total period of employment). By Belgian tax resident under the normal rules. contrast, a different tax situation will result

TAXES NEWSLETTER SEPTEMBER 2013 65 TAX PLANNING CONFERENCE REPORTS

if Ann’s employment is terminated and she calendar date of exercise and delivery of the receives a severance payment. In that case, shares, and Ann will not be able to choose the severance will be sourced like other that date. The conditions are that: compensation based on the location of the UÊ Ì iÊiÝiÀVˆÃiÊ«ÀˆViÊV>˜˜œÌÊLiʏiÃÃÊÌ >˜ÊÌ iÊv>ˆÀÊ services within and outside of the US during market value of the stock on the date of grant. the relevant period over which the severance For a public company such as US Group, the accrued. The severance payment will be fair market value is the value on the principal exempt from 409A restrictions and potential market on which the stock is traded; and tax penalties if paid in a lump sum shortly UÊ Ì iʜ«Ìˆœ˜ÊV>˜˜œÌʈ˜VÕ`iÊ>Ê`iviÀÀ>Ê after Ann is terminated. feature, that is, anything that would allow If Ann was a UK resident upon receiving Ann to delay US income tax beyond the her sign-on bonus, such bonus would be exercise date of the option. subject to UK tax. Under the double tax In Belgium, the employee can choose the treaty between the US and the UK, the moment of taxation. Ann may opt to be US is entitled to tax the bonus as Ann was taxed upon grant under a beneficial tax working at the US headquarters. There is an regime. The tax paid, however, will not be exception, however, where the employee is recoverable, even if she never exercises the present in the US for less than 183 days in option. Most employees, therefore, choose to a 12-month period, the bonus is paid by an be taxed upon exercise of the option at the employer who is not a US resident, and the normal tax rate. remuneration has not been charged back With regards to the UK, under the tax to a permanent establishment held by the treaty, there is an apportionment of gains employer in the US. In this case, however, the according to the time spent in the various exception will not apply since it seems clear countries. If Ann was resident in the UK when that the US is funding Ann’s sign-on bonus, the option was granted, HMRC would seek to and it will therefore be subject to US taxation. charge tax on exercise. If, however, she spent By comparison, the sign-on bonus will not only 25 per cent of her time over the period be taxable in France; French residency is from grant to vesting in the UK, HMRC would based on the date of arrival, and the bonus charge tax on only 25 per cent of the gain. was paid before Ann arrived in France in January 2013. Special tax issues

Stock options FATCA and FBAR Under the new tax regime in Switzerland, The FATCA rules target offshore tax evasion options are taxed at exercise. Therefore, for of financial assets by US tax residents by the six months from January to June 2013 imposing an individual obligation to report when Ann is working in Switzerland, she must any specific foreign financial assets if they pay tax if she exercises her options. exceed a certain threshold. Ann will only fall The situation is more complicated in within the scope of FATCA in 2015 when she France. For qualified options and restricted becomes a US tax resident. From this date, stock units, employees can benefit from Ann will need to report, among other items, a deferral of tax until the shares are sold. her UK pension scheme since it is funded by Mobile employees such as Ann, however, will a foreign financial institution. Her options generally be under non-qualified plans and are exempt as they are issued by a US entity, will be taxed when they exercise their options, but otherwise would be subject to reporting. not when they sell their shares. As such, if The FBAR rules, by contrast, cover a more Ann exercises her options whilst in France, narrow set of accounts, for example, Ann’s she will be taxable, although the level of tax equity income will not need to be reported will be reduced if Ann is under the special regardless of the status of the issuer. income tax inpatriate regime. If Ann exercises her options after leaving France, she will be Swiss caps on compensation taxable on the French-source portion. In the US, stock options must comply with A new article has been incorporated into the conditions under 409A in order for Ann the Swiss constitution concerning the to have a whole period of years to decide compensation of the board of directors when to exercise the option. If the conditions and the executive management of listed are not complied with, there must be a single companies incorporated in Switzerland.

66 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

As a member of the board of directors of shareholder approval. In addition, she US Group’s Swiss subsidiary, these rules will will no longer be entitled to receive any be of concern to Ann. golden parachute payment or bonuses for Shareholders will be given a binding vote acquisitions and sales. This will, again, hugely on the compensation of board members and impact Ann given the size of her annual executive directors. This is likely to have a bonus. As well as this, Ann’s appointment on significant impact on Ann’s compensation the board of directors will be subject to an as it will, for the first time, be subject to annual shareholder election.

12 APRIL 2013 Anton R Greber The service permanent Greber Tax Consulting, Zurich establishment: the latest anton.greber@ greber-taxlaw.ch trends in relation to the taxation of cross-border service

Co-Chairs OECD Model Tax Convention on Income and Patricia A Brown University of Miami School of Law, on Capital (‘OECD MC’). According to Article 5 Coral Gables OECD MC, a source country can basically Stefano Petrecca Di Tanno e Associati, Rome only tax a foreign enterprise if such enterprise carries on its business through a fixed place of Speakers business or a dependent agent in the source country. The Service PE allows conceptually the Patrick J Brown General Electric Company, source country to broaden its taxing rights by Stamford taxing a foreign enterprise which is providing Martin Busenhart Walder Wyss & Partners, Zurich services through its employees in the source Christoph Kromer Luther country for a certain period of time, even if the Rechtsanwaltsgesellschaft mbH, Frankfurt am Main classical requirements of a PE (fixed place of Edouard Milhac CMS – Bureau Francis Lefebvre, Paris business or agent) are not fulfilled. Clemens Philipp Schindler Wolf Theiss, Vienna The Service PE was first introduced in the UN Model Double Taxation Convention (‘UN Introduction MC’) mainly at the request of the developing and emerging economies. Although the The last panel of the conference gave a most expression ‘Service PE’ is not specifically used interesting insight into the concept of service in the wording of Article 5 paragraph 3 letter permanent establishment (‘Service PE’) and b UN MC, this relevant clause reads as follows: its implementation. Beyond the specific issues ‘The furnishing of services, including related to the Service PE, the panel showed consultancy services, by an enterprise in a quite a revealing way how the rules of the through employees or other personnel game concerning the allocations of the taxing engaged by the enterprise for such purpose, rights between residence and source country but only if activities of that nature continue are being redefined in the globalised world (for the same or a connected project) and how this impacts on the general concept within a Contracting State for a period or of permanent establishment as such. periods aggregating more than 183 days Stefano Petrecca, one of the co-chairs of the in any 12-month period commencing or panel, explained in his introduction that the ending in the fiscal year concerned.’ concept of PE is becoming more and more Although the Service PE is not foreseen in the important in a globalised world. The Service PE OECD MC, the 2008 update of the OECD MC was developed as an extension of the classical Commentary foresees the possibility of including PE definition according to Article 5 of the such a clause in a double taxation treaty.

TAXES NEWSLETTER SEPTEMBER 2013 67 TAX PLANNING CONFERENCE REPORTS

PE definition in domestic law and in allocates the taxing rights to France, France double taxation treaties of specific can tax such income even if the domestic countries tax law does not foresee the taxation of such income (this, however, applies only if After Stefano Petrecca’s presentation, the French tax law does not specifically exempt different speakers of the panel explained the such income). Hence, a Service PE will be PE concept in domestic and in international taxable in France if a double taxation treaty treaty law of their respective countries concluded by France has a clause with a (Austria, France, Germany, Italy and Service PE. Switzerland) and to what extent the Service All the above-mentioned countries have PE was relevant in their country. Without concluded double taxation treaties which in going into the details of each country, the some cases do foresee a Service PE clause. panel showed that there is a rather wide range UÊÌ>ÞÊ >ÃÊVœ˜VÕ`i`Ê`œÕLiÊÌ>Ý>̈œ˜Ê of PE definitions at the domestic level: treaties with a Service PE clause with the UÊ -܈ÌâiÀ>˜`Ê >ÃÊ>ʘ>ÀÀœÜÊ* Ê`iw˜ˆÌˆœ˜]Ê following countries: Azerbaijan, China, since Swiss tax law foresees only the physical Israel, Indonesia, Jordan, Kazakhstan, PE with a fixed place of business. Lebanon, Malta, Pakistan, Saudi Arabia, Sri UÊ / iÊÌ>ˆ>˜Ê`œ“iÃ̈VÊ`iw˜ˆÌˆœ˜ÊVœÀÀi뜘`ÃÊ Lanka, Uganda and Vietnam. According substantially to the OECD definition to Stefano Petrecca, there are no specific foreseeing the classical trias: the physical court cases in Italy concerning a Service PE, the agency PE and the construction site PE. It seems, however, that the Italian tax PE, whereby the latter constitutes a PE after authorities are investigating certain foreign a period of three months. internet companies with respect to a UÊ / iÊ
ÕÃÌÀˆ>˜Ê`œ“iÃ̈VÊ`iw˜ˆÌˆœ˜ÊˆÃʈ˜Ê possible PE in Italy. some aspects broader than Article 5 UÊ -œ“iÊÌÀi>̈iÃÊVœ˜VÕ`i`ÊLÞÊiÀ“>˜ÞÊvœÀiÃiiÊ of the OECD MC: it does foresee the a Service PE clause (eg, China, Philippines). classical trias (six months or more for the UÊ
ÕÃÌÀˆ>Ê >ÃÊVœ˜VÕ`i`ÊÃiÛiÀ>ÊÌ>ÝÊÌÀi>̈iÃÊÜˆÌ Ê construction site PE). Under Austrian tax a Service PE clause: Albania, Czech Republic, law, a Service PE is taxable as well (even Greece, Hong Kong, New Zealand, Saudi if the classical requirements of PE are not Arabia, Singapore and Vietnam. Clemens fulfilled). Accordingly, income from trade Philipp Schindler presented the practice and business earned from commercial or developed by the Austrian and Czech tax technical consultancy services are taxable authorities with respect to the double taxation in Austria under a Service PE. It seems, treaty concluded with the Czech Republic. however, that this clause is not very relevant Since the Czech Republic is a neighbouring in practice, since a double taxation treaty country of Austria, it is not surprising that will apply in most cases. A further activity Service PE issues arise under this double taxable under a Service PE is the leasing taxation treaty. One of the issues was the of personnel income (income from trade calculation of the relevant period. In order to and businesses earned from temporary exceed the required six-month period stated provision of employees for work performed in the treaty, the service must be provided for in Austria). more than 183 days (within any 12-month UÊ iÀ“>˜ÞÊ >ÃÊ>ÊLÀœ>`Ê`œ“iÃ̈VÊ`iw˜ˆÌˆœ˜Ê period). Further, the 183 days are not of PE. The domestic PE definition is not calculated per project, but rather by the sum only relevant in the international context, of all working days on all services provided but also in the national context for the local in Austria combined, which must exceed 183 taxes such as the trade tax (Gewerbesteuer). days. In another case, it was confirmed that if In the domestic context, Germany also there is a fixed place of business in which the considers warehouses, purchasing and services are provided, then the PE qualifies sales agencies and preparatory/auxiliary as a physical PE and not as a Service PE. In activities as a PE. Construction sites also one case where a distributor of merchandise qualify as PEs after a six-month period. was using his own car for carrying out his UÊ ˜ÊÀ>˜Vi]ÊÌ iÊ`œ“iÃ̈VÊ`iw˜ˆÌˆœ˜ÊœvÊ* Ê >ÃÊ activity, it was concluded that since there was mainly been developed by case law and is to no taxable event according to the Austrian a large extent in line with the OECD MC. domestic tax law, then the application of the Under French domestic tax law, a Service double taxation treaty was not required. This PE is not taxable. However, French tax law was the case despite the fact that according to foresees that if a double taxation treaty the double taxation treaty, such activity would

68 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX PLANNING CONFERENCE REPORTS

have qualified as a Service PE. With respect initiated. A further question in connection to restaurants on international trains, the with secondments is the handling of the costs Austrian Ministry of Finance took the position of the employee. If the employee is paid by that the providing of ready-made food and the subsidiary, does such an arrangement beverages qualifies only as a supply of goods differ from the one by which the employee and not as a qualifying service for a Service is performing services in their capacity as PE. In a further case, the Austrian Ministry employee of the parent company and the of Finance considered that the leasing of parent company is compensated by the personnel does not qualify as a qualifying subsidiary (eg, at cost plus)? service for a Service PE under the tax treaty, In order to limit the consequences of even though such activity would qualify as having a foreign PE, many US multinationals Service PE under Austrian domestic tax law. have been setting up so-called ‘employment UÊ À>˜ViÊ >ÃÊVœ˜VÕ`i`Ê`œÕLiÊÌ>Ý>̈œ˜Ê companies’, whereby the parent company treaties which foresee a Service PE clause transfers the relevant employees in a domestic with the following countries: China, affiliate. This employment company then Kazakhstan, Philippines and Chile. sends the employees abroad and concedes According to Edouard Milhac, these treaties a PE in the host country. As a consequence, do not give rise to specific issues in this the employment company is ‘walled off’ from respect. The French tax authorities are the major operating entities in order to avoid much more concerned in finding ways to having significant profits pulled into any PE tax the internet industry (see below). that is created. Can the host country challenge UÊ-܈ÌâiÀ>˜`Ê >ÃÊ>ÃœÊVœ˜VÕ`i`ÊÃiÛiÀ>Ê such a set up and tax a higher income than the double taxation treaties which provide effective income of the employment company? for a clause for a Service PE, for example, According to Patrick J Brown, it seems that with China, India, Kazakhstan, Philippines, the latest OECD developments concerning PE Thailand and Vietnam. would allow this. The developments of the last decade at the OECD level would have given rise to more uncertainty in this area, whereas The PE issues from the viewpoint of a multinational companies would need clear multinational corporation rules. Also, the concerns articulated by some Patrick J Brown gave the view of a tax authorities to the effect that companies multinational corporation confronted with PE persistently stop just short of the defined PE issues in its day-to-day business. He explained status would be out of touch and go against the that even a rather standard practice for business case. The trend to decentralisation of multinational companies, such as sending decision-making within multinational groups engineers or other technical personnel from would also lead to PE issues. The co-chair the home country to be on location at the site Patricia A Brown agreed with the need for of a foreign customer to install or overhaul clearer rules for multinational companies, equipment that the customer has purchased although she wondered if multinational (eg, a powerplant, a locomotive, etc) gives companies only asked for clearer rules if these rise to PE implications for which there are no were in their own interest. certain answers. The secondment of employees The development of the digital world also raises PE issues, since the legal form is would also give rise to PE issues according to becoming less relevant. As a consequence Patrick J Brown, even in cases where there of a more economic approach, the topical is no physical presence of an employee in question then is whether the seconded the host country. He mentioned as examples employee is doing business for the subsidiary the overhaul of equipment, for example, or for the parent company. If the employee via software upgrades or monitoring via is performing work in connection with the cameras. Would such services constitute business of the parent company, the latter a PE? Hence, the broader question may have a PE in the host country. In cases, would be whether the new economy has however, in which the business of the parent fundamentally changed the business world company and of the affiliate are the same and whether under this assumption the or similar, the question for which entity the existing rules concerning PE would have employee is performing work might not be to be changed. Or is the new economy just so easy to answer. Documentation will play an an excuse for trying to change the existing important role in such cases if investigations allocation of taxing rights between the by the tax authorities of the host country are country of residence and the source country?

TAXES NEWSLETTER SEPTEMBER 2013 69 TAX PLANNING CONFERENCE REPORTS

At any rate, it seems that physical presence monitoring of internet users. Hence, the should still be relevant for a PE definition, added value for the internet firm is not created as this will still be of vital importance in by the firm itself but by the clients/users international business transactions. themselves. This fact is a radical departure from the classical theory of the firm and would constitute the main explanation for the huge Latest developments at the OECD level value of internet firms. Since the ‘free work’ The latest OECD development with respect performed by the internet users contributes to PEs was also subject to the critical view of to a large extent to the profit of these firms, Christoph Kromer. From a German point a part of this profit should also be taxable in of view, the revised draft of the OECD- the country where the users are located. It is Permanent Establishment Paper, dated expected that France will try to promote this 19 October 2012, continues the trend of new alternative for source country taxation at softening the requirements for establishing a the OECD level. PE. The two main areas of concern are: UÊ/ iÊ܈`i˜ˆ˜}ʜvÊÌ iʘœÌˆœ˜Ê¼>ÌÊÌ iÊ`ˆÃ«œÃ>Ê Concluding remarks of’ requirement. Accordingly, an employee who has a security card for the premises As Martin Busenhard mentioned in his of the client’s office building would be summarising remarks, the digital world makes sufficient to fulfil the requirement. Also it more difficult to make a fair allocation of the an employee having a home office would taxation rights between residence and source constitute a PE of their foreign employer country. The Service PE according to the UN if the home office were used on a regular Model Convention would not allow dealings and continuous basis. Even contractual with the problems arising in connection access rights without an actual presence with the digital industry, since it is still based would be sufficient to fulfil the ‘at disposal on the classical way of doing business. The of’ requirement. This would mainly be rise of the emerging markets and the huge aimed at construction companies which amounts flowing from these countries makes it would sub-contract all or part of a project understandable that these countries also want (eg, building of a power plant, airport a share of these profits and are thereby trying etc) to sub-contractors in the country of to extend the taxation rights of the source the client. In such cases, the activity of country. The current Service PE discussion the sub-contractor would be attributed to would be very illustrative in this respect. the foreign main contractor and the sub- However, the Service PE discussion does not contractor would create a PE of the main only take place in the global context of a contractor (so-called sub-contractor PE). confrontation between developed countries UÊ/ iÊ̈“iÊÀiµÕˆÀi“i˜ÌÊvœÀÊÌ iÊi݈ÃÌi˜ViÊ and emerging countries, but also within of a business is watered down to such an integration processes such as in the European extent that even ‘one-shot-businesses’ would Union. Workers moving freely within the constitute a PE thereby increasing the risk European Union and performing services of a double taxation. will increasingly lead to issues concerning taxation rights, whereby Member States will understandably try to protect their tax basis. Reconceptualisation of the PE concept for The Service PE still raises many questions and it the digital world is as yet unclear where the discussion will end. The redesigning of the PE concept does not Patricia A Brown mentioned in her only take place at the level of the OECD. concluding remarks that the post-World War As Edouard Milhac explained, France is in II consensus which had been built up among view of the developing digital world trying to a limited number of countries was now being reconceptualise the PE definition in order to challenged by numerous new countries give the source country more taxing power. which had in a first phase taken over the In January 2013, the so-called Colin and OECD MC without really being aware of Colin Report was issued which, based on an the consequences. The PE discussion which analysis of the business model of the digital should have happened at that time was now industry, tries to deduct new rules for its taking place. Thus, uncertainty will prevail taxation. According to the report, the digital until a new consensus for the allocation of industry relies heavily on the exploitation of taxing rights between the source residence data created from the regular and systematic and the source country is found.

70 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX AND MORALITY

Simon Yates Travers Smith, London simon.yates@ Tax and morality traverssmith.com

‘Governments are keen to make tax a moral issue. premise that indiscriminately killing someone But morality is an elusive concept, which cuts is morally wrong, regardless of their view on both ways.’ the derivation of morals. But other, highly significant, moral questions are far from K Chancellor George Osborne universally resolved, whatever Western liberals caused something of a stir when, such as myself would like to think. Should in his 2012 Budget speech, he citizens be free to criticise their governments? Uannounced that ‘I regard tax Should homosexual acts between consenting evasion, and indeed aggressive tax avoidance, adults be permitted? Should women have the as morally repugnant.’ Whilst of course all same rights as men? Is abortion ever acceptable? governments will loudly oppose tax avoidance, This slight digression into jurisprudential this was a level of inflammatory rhetoric which and moral philosophy was intended to was new. Also new was his equating, at least highlight two points which will be useful as in moral terms, of evasion (ie, knowingly we come to tax. First, there are surprisingly breaking tax laws in order to pay less) with few principles which can truly be considered aggressive avoidance (ie, working within the universal morals; and secondly, the law, although possibly taking a robust view proposition that the letter of the law must of how it might be construed, to deliver an always be obeyed – never mind its spirit – is advantageous tax result). most certainly not one of them. This is not the place for a long discussion It follows from this that even tax evasion, on the theory of jurisprudence. Many learned with the breach of the law that it necessarily professors have written many lengthy books involves, is not inherently morally repugnant. dealing with philosophical questions such as What if a tax is so unfair as to itself be why must one obey the law, and whether there immoral? In the extreme case of the UK’s are any circumstances in which one might attempts to impose stamp duty on its properly not do. What is abundantly clear increasingly rebellious American colonies, from both theory and history, though, is that this perception gave us the Boston Tea Party there are occasions when laws are passed which in 1773. Back home in the UK, in 1990, the do not meet any widely accepted standard of ‘community charge’, a widely loathed local justice. In turn, many philosophers will then tax where a fixed amount was paid per head accept that there comes a point when it may by each individual regardless of means, was be moral for a citizen to break the law. In instrumental in bringing about the downfall extreme cases, most commonly associated with of prime minister Margaret Thatcher as oppressive legislation passed by totalitarian middle-class pensioners marched in protest regimes, it may even be arguable that in order through central London. to act morally, a citizen must break the law. That said, particularly in democracies, it Morals themselves are subjective. Many is possible to take a contractual view of the believe that there are higher principles authority of law. Citizens choose to live in the derived from a deity or deities, and they look country in question and accept its legislative to their religion for guidance: God says thou machinery in return for the benefits they shalt not kill, so don’t. Others may take the obtain through living there. They must view that morals are principles which assist in therefore obey the law whether they like it the formation of a successful society: killing or not. The Boston Tea Party is the classic people is wrong not because of some inherent example of what can happen when this is higher law, but because people living in a not the case: the aggrieved people subject to society where they are constantly afraid of the UK stamp duty did not have votes they being violently attacked will not be able to could exercise in relation to its imposition, function as effectively as people who feel safe, hence the well-known slogan ‘no taxation meaning that the society as a whole will be without representation’. They felt entirely less prosperous. morally justified in refusing to pay the tax. Most people, of most cultural backgrounds, The community charge example shows that in most countries will happily sign up to the sometimes a measure can be so unpopular

TAXES NEWSLETTER SEPTEMBER 2013 71 TAX AND MORALITY

as to be perceived to lose its democratic Tax policy itself is in significant part a legitimacy even when adopted in accordance matter of highly subjective judgments with with the constitution of a democracy. moral components. Should tax rates be more Fortunately, in mature democracies, tax progressive, or flatter? Is it right, through measures commanding as little popular social security contributions, to tax earned consent as the community charge are rare, income at higher rates than unearned although the imposition of new austerity- income? Should capital gains be taxed at a driven taxes in a number of European different rate to income? Is there a level of states is clearly in danger of raising the taxation which cannot be justified regardless same issues. It follows that it can probably of the circumstances? (Currently, despairing be said that most of the time, in most French people might care to recall that the countries, tax evasion – the deliberate non- UK’s top rate of tax on unearned income in payment of taxes, contrary to law – can be the 1970s was a rather magnificent 98 per said to be reprehensible. This is doubly cent. At least one good thing came of this, the case where the country in question is in that the Rolling Stones were inspired to a democracy with open borders, so that record Exile on Main Street whilst in tax exile, if a measure does become sufficiently ironically in France). At an even higher level, unsupported, a mechanism exists (however should tax policy be used as an instrument to remotely) for it to be changed by popular drive behaviour? Especially where the desired will – and of course if an individual hates a behaviour reflects a government’s own moral measure enough, they can always emigrate. preferences, such as giving tax breaks to Furthermore, for all the discussion above encourage marriage? None of these questions around stamp duty and the community has an easy answer. None indeed has a right charge, the moral position is surely different answer. Most importantly for the purposes – and worse – for a surreptitious tax evader of our discussion, there is no widespread under-declaring his or her income than consensus on the issues. someone openly refusing to pay a tax on Consider a taxpayer who passionately principled grounds. believes that government tax policy is wrong What, however, of avoidance, whether it and that they are unfairly over-taxed as a be aggressive or otherwise? Avoidance is of result. They may even believe that the policy course a famously difficult concept to define, is immoral (certainly one could find plenty but in loose terms it must encompass using of support for the proposition that a 98 per the law to achieve a tax result which the cent rate amounted to legalised theft). They legislators who introduced the law in question realise that there is a defect in the relevant would not have considered acceptable if they legislation which enables them to greatly had been aware of it at the time. What are the reduce their overall tax rate, so they do this. moral questions here? A person who agrees with the government’s Most importantly, the law is not being policy may well consider what the taxpayer broken – that is the distinction between is doing to be morally reprehensible (and avoidance and evasion. We do not therefore if that person is not hypocritical, they need to get into the questions of whether might therefore feel obliged to refuse the the law must always be obeyed, and how avoidance opportunity if it was offered to law derives its legitimacy, which have been them). But the avoider will feel morally considered above. We cannot use the same entirely justified: they will see themself as arguments to conclude that avoidance is escaping an unfair tax. Most can probably immoral that we can use in relation to the agree that it is immoral to avoid a fair tax, great majority of evasion. Is there also some but not whether any given tax is fair. moral duty to uphold the spirit of the law as Take a different, more specific, example. well as its letter? The UK has a fiendishly complex set of rules The author’s view is that there is no such dealing with the taxation of life assurance duty. Once you take away the question of policies. They are intensely formulaic, breaking the law, you are left with citizens and frequently give rise to tax outcomes being able to conduct their affairs as they at variance from the economic results of see fit. That does not, of course, imply the transactions. These rules were utilised in the adoption of an amoral stance: any given sale of a marketed avoidance scheme which taxpayer may well have their own moral generated tax losses to order, without the scruples which may lead them to reject a need for any corresponding economic loss. given avoidance opportunity. This scheme was upheld by the UK courts in

72 INTERNATIONAL BAR ASSOCIATION LEGAL PRACTICE DIVISION TAX AND MORALITY the case of Mayes: invited by HMRC to find widely seen as fair, any perception of uneven against the taxpayer on the basis that this enforcement will undermine the moral outcome was contrary to the purpose of the authority of the system. legislation, the court held that the results of Consider the following examples: the legislation in question were so irrational UÊ
ÊLÕȘiÃÃÊL>Ãi`ʈ˜Ê>ÊȘ}iÊVœÕ˜ÌÀÞʈÃÊ that it was impossible to discern a purpose trying to compete with multinationals who behind the law. are able to reduce their overall effective Then, in a later case, Joost Lubler (a tax rates to close to zero using legitimate Dutchman resident in the UK) stumbled transfer pricing methods. The business into these rules inadvertently and inflicted a utilises an aggressive loss generation scheme very large taxable profit on himself despite to reduce its own tax rate (and hence cost making a material commercial loss. In finding of capital) to a comparable level. against Mr Lubler ‘with a heavy heart’, an UÊ
Ê«Àœ«iÀÌÞÊv՘`ʜLÃiÀÛiÃÊÌ >ÌÊVœ“«ï̜ÀÃÊ unusually outspoken tax tribunal noted that are using schemes to avoid land transfer this was ‘an outrageously unfair result’, and taxes. It starts to do this too, as otherwise its ‘more repugnant to common fairness... than returns will instantly be several percentage to permit other taxpayers to avoid tax on points lower than those of its competitors, undoubted income’. and it may well fail in consequence. Where is the morality here? A piece of UÊ
Ê1ÊÀiÈ`i˜ÌÊ>˜`Ê`œ“ˆVˆi`ʜܘiÀʜvÊ>˜Ê law has made it to the statute book which, investment property in the UK realises that apparently by deliberate design, often delivers their resident but non-domiciled colleague tax results wildly different from economic who also owned such a property, but outcomes. For sure the taxpayer in Mayes through an offshore trust structure, has just deployed quite a convoluted series of steps sold it free of capital gains tax. They think to obtain his tax loss, but his scheme worked it is unfair that they should be subject to by the letter of the law. As the court found, it capital gains tax on an exactly equivalent could not try and go beyond that letter of the transaction, and they employ a loss creation law to underlying purpose or policy because scheme to put them on the same footing as none was apparent. Had we reached a point their colleague. where, morally, the government deserved UÊ
ÊÛiÀÞÊ ˆ} ÞÊ«>ˆ`ÊܜÀŽiÀʈ˜ÊÌ iÊw˜>˜Vˆ>Ê to see the law abused by Mayes? Is there a sector undertakes a scheme in conjunction Darwinian argument that bad law will only with their employer to reduce the effective evolve if taxpayers do abuse it? No number of rate of tax on their bonus from 47 per cent Joost Lublers is likely to turn policymakers’ to 15 per cent. They want to secure the tax eyes to the need to change a law, but one saving in order to be able to buy the new Mayes tends to get their attention. model Ferrari Enzo out of their bonus. It simply is not possible to dismiss all tax These are all cases of aggressive avoidance in avoidance as objectively morally repugnant. the pure technical sense. However, whatever Tax policy is a matter of balancing competing one’s view as to where the line should be factors in a highly subjective way. It is not drawn, they should surely not be lumped reasonable to say to a person who feels that together as morally identical. And to dismiss they are over-taxed that they are acting all these behaviours as equivalent, and objectively immorally by engaging in morally repugnant, is as unhelpful as it is avoidance. A person may only feel morally inaccurate and simplistic. obligated not to avoid tax if they feel the Most people can probably agree that system as it applies to them is entirely fair in evasion is morally wrong almost all the time, both conception and execution. One suspects on the basis of jurisprudential arguments that if one asked Mr Lubler for his views as around the authority of law. There is then a to the morality of the UK tax system, as he category of avoidance which borders evasion, faces bankruptcy due to an enormous tax involving advisers taking fairly extraordinary bill arising from a loss making transaction, views of the meaning of law in order to permit one might get a fairly colourful response. the sale of tax products in which they have Morality in tax is a double-edged sword, and a significant financial interest: much of this the more complex a tax system becomes activity can confidently also be described as (and in particular the greater differentials morally reprehensible most of the time. in rates it delivers), the harder it becomes However, avoidance which does not for governments to preach from the moral overly strain the law is a very different beast. high ground. Likewise, even if tax laws are Any discussion of its morality also requires

TAXES NEWSLETTER SEPTEMBER 2013 73 TAX AND MORALITY

consideration of the morality of the policy the purpose of depleting the taxpayer’s behind the tax being avoided, and indeed of pocket. And the taxpayer is, in like the wider tax system. That is not a matter on manner, entitled to be astute to prevent, which any consensus is ever likely. This led in so far as he honestly can, the depletion of the UK to a very famous judicial conclusion: his means by the Inland Revenue.’ ‘No man in this country is under the Or in summary: if the law says you are taxed, smallest obligation, moral or other, so you are taxed. If it doesn’t, you aren’t. as to arrange his legal relations to his Morality does not come into it. Personally, I business or to his property as to enable find it hard to disagree. The UK Government, the Inland Revenue to put the largest unsurprisingly, does not, which is why we are possible shovel into his stores. The getting a General Anti-Abuse Rule which will Inland Revenue is not slow – and quite overturn this excellent judgment. Morally, all rightly – to take every opportunity which tax policy will thus henceforth be deemed to is open to it under the taxing statutes for be fair. That’s us told.

IBA PUBLICATION

IBA E-Book: Mediation Techniques

Editor: Patricia Barclay, Co-Chair of the IBA Mediation Techniques Subcommittee

Although there are many books about mediation, most of them concentrate on a single topic or have a bias towards the theoretical or philosophical. This book aims to take a different approach. The Mediation Techniques Subcommittee of the International Bar Association felt that there was a need for a practical collection of tips from and for practising mediators of different styles, facing different sorts of issues and still be usable by mediators at an early stage in their career but also to contain suffi cient variety to still be interesting to more experienced mediators.

The format of this e-book is a series of short essays by practitioners covering the topic from pre-mediation planning through to post mediation follow through, interspersed with pages of short hints and tips to which we hope users will add their own points as their practice develops. The fi nal section of the book deals with the use of mediation in different fi elds and is intended to provoke debate as to how mediation could be advanced into new areas as well as providing information about topics with which many readers will be unfamiliar. You will fi nd some duplication and much contradiction of advice throughout the book as what works for one person in one situation will be inappropriate for another. It is this fl exibility that makes mediation such an PUBLISHED OCTOBER 2010 attractive form of dispute resolution and this book a valuable resource. To order, please visit: www.ibanet.org/publications/ This book is available as a PDF download (to mobile devices, to PCs or to print off) and a more mediation_book/Medbook_ interactive version of the book is available on the website. A discussion area for people who buy/ home.aspx subscribe to the e-book is also available.