frontiers in tax thinking beyond borders in financial services June 2008 FINANCIAL SERVICES Loss is more Managing tax during a credit crunch Taxing the wealth of nations Sovereign wealth funds – their privileged tax status? Passport to Europe Finding the most suitable entry point Introduction frontiers in tax June 2008 Welcome to the second edition of Frontiers in Tax. Thank you for all those of you who provided comments and feedback on our first edition. Our editorial objective is to regularly feature articles on topical issues that monitor trends and developments in the financial sector, and assess how tax can influence the impact these have on financial institutions. We also want to keep you abreast of international Paul McGowan developments in taxation which are being driven by the OECD and Global Chairman tax authorities around the world, and the affect that regulating these Financial Services Tax changes has on taxation. The financial services sector has been in a very dynamic or perhaps even frantic mode since the last edition. The sector has experienced the impact of the credit crunch on the liquidity of major financial institutions, watched the rise of investment in the financial sector by Sovereign Wealth Funds and has begun to understand the greater financial strength that the rise in oil prices has given the Gulf region generally. This edition addresses the tax considerations relevant to some of these issues. Transfer pricing is coming to the attention of more banks in recent times, as the OECD turns its attention more towards the activities of financial institutions. John Neighbour and his colleagues explain why transfer pricing, while certainly a tax risk, can also be an opportunity for effective tax rate management. We are also seeing the development whereby many third country financial institutions are looking at Europe as a focus for their international expansion and we look at the issues such banks should consider when choosing an attractive entry point for this expansion. We also look at a number of other hot topics as they affect the financial services industry. Amongst others these include the changes in the treatment of financial services income from a VAT perspective, the impact of Solvency II on the European insurance market and the variety of approaches that tax authorities take to the taxation of financial derivatives. We hope that you will find this publication both informative and thought provoking! © 2008 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. frontiers in tax – June 2008 2 Contents Loss is more Topics 6 Loss is more 2 Passport to Europe 6 Financial Services Where is my value? 12 Crossed wires across borders 18 Passport to Europe The rise and rise – Islamic finance 24 12 Taxing the wealth of nations 30 Chinese puzzle 34 An open and shut case? 40 Broadening European horizons 46 Singing from the same songbook 50 Trading on their reputation 54 Financial Services Where is my value? 30 Knowledge In this section: 58 Latest financial services Thought Leadership, contacts 40 Taxing the wealth of nations An open and shut case? 50 54 Singing from the same songbook Broadening European horizons © 2008 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. frontiers in tax – June 2008 L SS IS M RE Managing tax during a Credit Crunch Making the best of the situation. Jane McCormick and Hans-Jürgen Feyerabend explains how losses incurred during the Credit Crunch might be used to ease the pain. © 2008 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides 2 no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. frontiers in tax – June 2008 necessarily follow the accounting treatment. In some countries, gains or losses on securities or derivatives are not recognized, for tax purposes, until the securities are sold or the derivatives have terminated. In these countries, no current tax benefits will be recognized and the question is one of deferred tax asset recognition. Even in countries that do allow some categories of taxpayers to mark to market for tax purposes, valuation s in other business methods used for tax may differ from areas the current the accounting valuation. For example, turmoil in financial in the U.S., “fair value” for U.S. GAAP markets is creating purposes is not the same as “fair The rationale for a new challenges for tax market value” for U.S. Federal Income transfer pricing policy management. It has Tax purposes. There are regulations could seem less robust Abeen a while; for one thing, since tax that allow book/tax conformity in managers in the financial services certain situations. when losses rather sector have had to spend much time Some of the write-downs are for than profits are being worrying about how to treat losses. assets classified as “available for sale” allocated, so it’s wise The virtual closure of the securitization securities, which, under IFRS and U.S. markets and wider liquidity problems GAAP are taken through equity, rather to review the position have also obliged companies to seek than the income statement. In the and check the logic new sources of capital and make U.K., immediate tax relief is available significant changes to third party for such write-downs, but this is before the tax and intra-group funding structures. unusual; in many tax jurisdictions such authorities do so. This article seeks to examine the write-downs would only result in the deductibility of booked losses in various potential for a deferred tax asset on tax jurisdictions, and explores the tax the balance sheet. implications of the changes in corporate Transfer pricing should also be financing strategies as a result of the taken into account when determining lack of liquidity in capital markets. what deduction is available for on- balance sheet losses. Tax authorities The deductibility of losses may look closely at transfer pricing and For groups that have sustained attribution questions when they see significant losses, one of the key large credit or valuation losses, questions for tax purposes is the value coupled with claims for repayment of of the tax relief that can be claimed for tax from loss carry-back claims. There them. Clearly if tax or deferred tax have been cases when losses have benefits can be recognized for losses been rejected by tax authorities, with this should significantly mitigate their each insisting that the assets or impact on balance sheets and, in some activity that incurred the loss should be cases, regulatory capital. Whether, and attributed elsewhere. It’s true that tax to what extent, these benefits can be treaties and the Mutual Agreement realized will depend on the territory Procedure should give some comfort where the loss arises for tax purposes, that the losses should be deductible but some general principles apply in somewhere, but this procedure does many cases. not guarantee that the affected tax Many of the losses reported in the authorities will reach agreement within press result from write-downs in the a reasonable time frame. The rationale value of assets recorded on balance for a transfer pricing policy could seem sheets and income statements. In less robust when losses rather than principle, such losses ought to be profits are being allocated, so it’s wise deductible, but the rules for the to review the position and check the recognition of profit and loss do not logic before the tax authorities do so. © 2008 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, norKPMG does KPMG FRONTIERS International IN have FINANCE any such authoritySPRING to obligate2008 or 3 bind any member firm. All rights reserved. frontiers in tax – June 2008 In some countries, such as Germany, anti-avoidance provisions may prevent the carry forward of losses following a change in ownership of the company concerned. Off-balance sheet vehicles Getting value for losses planning will be taken into Some of the losses reported by banks Ultimately losses only have value if account when assessing a DTA. in recent months were incurred on they can be used to reduce tax costs It may be necessary to use profit assets in “off-balance sheet” vehicles, either now or in future. Once it has projections, to establish if there and consequent financial restructuring been determined that the losses are will be sufficient profit over a has sometimes resulted in these deductible in principle, their value, reasonable period of time to absorb vehicles coming on to the originating in reducing either current or future the losses.