practical international/media/files/videncenter... · 2013. 2. 27. · tax planning, public and...

------>

------>

------>

------>

January 31, 2013Volume 17, Number 2

Articles

International Tax PlanningRelieving and Clarifying Changes to Canadian Basis Bump RulesBy Paul Stepak and Scott Wilkie (Blake, Cassels & Graydon LLP) .............................................................p. 2

US--How Will FATCA Impact Multinationals?By Arne Riis, Manuel Tamez, Luis Monroy, Kevin Hindley, Juan Carlos Ferrucho, Jonathan S. Adelson, and Blake Davis (Taxand) ...........................................................p. 3

China--Transfer Pricing: State Administration of Taxation Addresses Challenges with OECD Guidelines By Windson Li (DLA Piper, Beijing) ............................p. 6

China to Postpone Widening of Property Tax Pilot ProgramBy Pete Sweeney (Reuters) .......................................p. 9

Colombia--Colombia Cuts Corporate Income Tax; Enacts General Anti-Abuse RuleBy John Salerno, Jose Leiman and Carlos Chaparro (PricewaterhouseCoopers) .........................................p. 10

EU--New Financial Transaction Tax: Why the EU Seems Set to Impact Financial Institutions Worldwide, and Why Legal Challenges are LikelyBy Dan Neidle, Chris Bates and Habib Motani (Clifford Chance) ......................................................................p. 12

France--French Budget Introduces Important Corporate Tax Changes and Incentives By Guillaume Glon, Guillaume Barbier, Samia Tighilt and Renaud Jouffroy (PricewaterhouseCoopers LLP) ......p. 15

A Twice-MonThly RepoRT on inTeRnATionAl TAx plAnning

Advisory Board page 8

Proposals Would Reduce Tax Risk in Acquisitions of Canadian Companies Newly released proposals by the Canadian government should provide more commercial flexibility when a Canadian company is being acquired by a foreign company through a newly formed Canadian acquisition entity. The elimination of many of the technical restrictions should allow for smoother M&A transactions. Page 2

When OECD Rules are Not Enough: China Pleads Special CircumstancesIn a recent release by the China State Administration of Taxation, the agency says that the OECD guidelines are insufficient for the Chinese operational environment. The paper suggests changes that would provide better results from transfer pricing arrangements when a party is in China. Page 6

Practical Challenges to the Promises of the EU Financial Transaction TaxThe EU recently approved a FTT, in theory, for 11 of the EU member states. Beyond the theoretical application however, many problems remain, not least of which could be a tax that far exceeds that which is being discussed. 2

In Colombia, Tax Reform Gives and Takes AwayThe Colombian government has cut the corporate income tax on branches and permanent establishments of non-Colombian companies, but has effectively offset the reduction by a newly created tax. Other changes include a new GAAR, new thin cap rules, and a new definition of permanent establishment. Most multinational corporations in Colombia will be affected. Page 10

In ThIs Issue

WTEPRACTICAL INTERNATIONAL

TAX STRATEGIESWORLDTRADE EXECUTIVEThe International Business Information SourceTM

2 www.wtexec.com/tax.html

International Tax Planning

canada

(Basis Bump Rules, continued on page 4)

On December 21, 2012, the Minister of Finance released for consultation draft legislative proposals (December 21 Proposals) to implement certain technical amendments to Canada’s Income Tax Act (ITA). Included in the December 21 Proposals are draft changes to the Canadian basis “bump” rules. Such changes are, for the most part, relieving in nature and should reduce uncertainty and risk when utilizing the bump. The government has invited comments by February 19, 2013.

The Basis BumpTypically, a purchaser seeking to acquire a Canadian

Target corporation (Target) will form a Canadian acquisition company (Canco) to acquire the shares of Target, following which Canco will amalgamate with Target to form a new company (Amalco), or, less frequently, Target will be wound-up into Canco. Such a merger allows for the push-down of acquisition financing (Canada has no tax consolidation) and the step-up of cross-border paid-up capital (PUC), subject to the application of the recently enacted foreign affiliate (FA) “dumping” rules in section 212.3 of the ITA.

It is generally not tax efficient for a Canadian corporation to be “sandwiched” between a foreign parent and foreign subsidiaries, especially given the potential impact of the FA dumping rules.1 Where a foreign purchaser (Parent) acquires a Target which owns shares of foreign subsidiaries, it will generally be desirable to distribute the foreign subsidiaries out from under Canada following the merger described above. On such a transfer, Amalco (including, in this article, Canco if Target is wound-up into it) will be deemed to dispose of the shares of the

foreign subsidiaries for proceeds equal to their fair market value. Assuming that the fair market value is greater than the adjusted cost base (i.e., tax cost) to Amalco of those shares at the time of disposition (which apart from the bump will be the historic tax cost to Target), Amalco will recognize a gain that will be taxable in Canada.

When shares of a Target are acquired, there is generally no ability to “push-down” the tax cost of the acquired shares to the assets of the acquired corporation. A limited exception is the basis bump rule in paragraph 88(1)(d) of the ITA, which generally allows for an elective step-up in basis of non-depreciable capital property (including shares of foreign subsidiaries), potentially to fair market value at the time of the change of control of Target. A bump election, if available, is made in respect of the winding-up or amalgamation of a wholly owned acquired corporation with its Canadian parent (i.e., Target and Canco, respectively). If the bump is available, any shares of foreign subsidiaries can generally be transferred by Amalco out of Canada promptly after acquisition without recognizing any gain or loss. Further, the distribution may be effected free from Canadian non-resident withholding tax by way of return of PUC or intercompany debt repayment. However, no bump is available if the “bump denial” rule applies.

The Bump Denial Rule The purpose of the bump denial rule is to preclude

the bump from applying in circumstances where selling shareholders (beyond those who held a de minimis aggregate interest in Target) have somehow retained an indirect interest in Target. While the bump denial rule is quite complex in its application, basically, the bump is denied if, as part of the overall series of transactions, any “restricted persons” acquire any property of Target (distributed property) or any “substituted property.”

Restricted persons generally mean one or more persons who own or are deemed to own 10 percent or more of the shares of any class or series of Target. Also included are any one or more persons who own or are deemed to own 10 percent or more of the shares of any class or series of a corporation that is related to Target, and that has a significant direct or indirect interest in any issued shares of the capital stock of Target. “Specified persons” (i.e.,

These new provisions should provide more commercial flexibility

when structuring transactions.

Paul Stepak ([email protected]) and Scott Wilkie ([email protected]) are Partners with the Toronto office of Blake, Cassels & Graydon LLP. Mr. Stepak’s practice is concentrated in corporate and partnership income taxation, including cross-border inbound structuring, domestic and cross-border income tax planning, public and private mergers and acquisitions, corporate reorganizations, private equity investment, and financing. Mr. Wilkie’s practice is focused on international taxation, including international corporate tax planning, transfer pricing and tax treaty advice.

Relieving and Clarifying Changes to Canadian Basis Bump RulesBy Paul Stepak and Scott Wilkie (Blake, Cassels & Graydon LLP)

January 31, 2013 Practical International Tax Strategies® 3

us

(FATCA & MNCs, continued on page 18)

How Will FATCA Impact Multinationals?

By Arne Riis, Manuel Tamez, Luis Monroy, Kevin Hindley, Juan Carlos Ferrucho, Jonathan S. Adelson, and Blake Davis (Taxand)

The Foreign Account Tax Compliance Act (FATCA) was enacted in 2010 to create transparency and combat what was perceived as tax evasion by U.S. persons holding investments in offshore accounts. The primary goal of FATCA is to allow the Internal Revenue Service (IRS) and U.S. Treasury to identify offshore income earned by U.S. persons with offshore accounts or investments; and to identify U.S. persons with non-U.S. assets. Denmark, Mexico and the UK have since agreed concluded FACTA exchange of information agreements. This article examines the impact of these developments on corporations operating globally.

Which Organizations are Affected?FATCA will not just impact financial institutions, but

will also affect other foreign entities, regardless of whether they have U.S. account holders or owners, or hold U.S. stocks or securities. Under FATCA, certain foreign entities will be compelled to identify U.S. persons that may qualify as account holders or owners of these foreign entities. Foreign entities that do not comply with FATCA will face a stiff penalty: a 30 percent withholding tax on certain U.S. sourced payments received by the foreign entities.

In general, a person making U.S. sourced payments to foreign persons (i.e., a “withholding agent”) will be

Arne Riis ([email protected]) is a Partner with Taxand Denmark. His practice is focused on national and international taxation aspects of mergers and acquisitions, corporate restructurings, refinancing, and financial products. Manuel Tamez ([email protected]) is a Partner, and Luis Monroy ([email protected]) is an Associate, with Taxand Mexico. Mr. Tamez specializes in tax planning related to investment projects and corporate restructurings for national and international companies. Mr. Monroy’s practice is focused on international tax and corporate restructurings. Kevin Hindley ([email protected]) is a Managing Director with Taxand UK. His practice is focused on corporate and international tax, and particularly related to multinational companies active across UK and US jurisdictions. Juan Carlos Ferrucho ([email protected]), Jonathan S. Adelson, ([email protected]), and Blake Davis ([email protected]) are Managing Directors with, respectively, the Miami, New York, and San Francisco offices of Taxand US. Mr. Ferrucho specializes in complex cross-border transactions for multinationals. Mr. Adelson’s practice is focused on minimizing tax risk and improving tax profiles of multinationals. Mr. Davis specializes in international tax, and particularly outbound and inbound tax issues of multinationals.

Even exempted FFIs and NFEEs will likely be subject to FATCA reporting

requirements if they receive withholdable payments.

required to withhold 30 percent from the U.S. sourced payments (“withholdable payments”) unless the foreign payee complies with FATCA. Withholdable payments may include:

• U.S. sourced dividends, interest, rent; • other fixed or determinable annual or periodical

(FDAP) gains, profits, and income; and• gross proceeds from the sale of U.S. properties that can

produce interest or dividends from sources within the United States, even if the sale would not otherwise be subject to U.S. taxation.

The complexity of the reporting requirements under FATCA varies depending on whether the foreign entity being analyzed is a “Foreign Financial Institution” (FFI) or a “Non-Foreign Financial Entity” (NFFE).

FFIs: The 30 percent withholding tax will not be imposed as long as the FFI meets the following requirements: (1) The FFI enters into an agreement with the IRS to comply with FATCA, (2) The FFI provides certain information regarding its account holders to the IRS, (3) The FFI deducts a withholding tax from certain account holders that do not provide the required information and from other foreign financial institutions that are not complying with FATCA, and (4) The FFI provides the withholding agents with a valid certification that it is in compliance with FATCA.

NFFEs: The 30 percent withholding tax will not be imposed as long as the NFFE provides a valid certification to a withholding agent that (1) it is an NFFE and (2) that it has no substantial U.S. owners, or alternatively, provides certain information about any substantial U.S. owners.

Determining Whether FATCA Applies to YouTo determine whether an entity is an FFI, it is necessary

to analyze the overall business activities of the foreign entity. Generally, an FFI is a foreign entity that (a) accepts deposits in the ordinary course of banking or similar business, (b) holds financial assets for the account of others as a substantial portion of its business, or (c) holds itself out as being engaged primarily in the business of investing, reinvesting or trading interest in securities. If the entity is not an FFI, then it is an NFFE. Thus, any foreign entity


canada

(Basis Bump Rules continued on page 5)

Canco and entities that are related to Canco prior to the acquisition) are carved out of restricted persons.

“Substituted property” generally includes any property (other than certain “specified property”) the fair market value of which is wholly or partly attributable to any property of Target. Substituted property also includes any property the fair market value of which is determinable primarily by reference to the fair market value of, or the proceeds from a disposition of, any property of Target. This extremely broad definition of substituted property is frequently problematic, as explained below.

Persons are deemed to own shares actually owned by other persons who are “related” or otherwise not dealing at arm’s length under Canadian tax rules. This feature of the rule has proven to be challenging to apply even where the essential requirements of the bump are otherwise readily satisfied.

The potential consequences of the bump denial rule are significant. Because the bump does not offer protection for any post-acquisition appreciation in value, it is generally considered advisable to distribute any foreign subsidiary shares out of Canada promptly after

where Target is a public company (thus making it difficult if not impossible to identify all restricted persons). This is made even more difficult where Parent is a public company, because Parent cannot control who acquires its publicly traded securities.

The December 21 Proposals implement changes proposed in the comfort letters (reaching back as far as 2001), and in some cases go even further, to eliminate many of the technical and factual concerns that have led to uncertainty and/or commercial constraints.

Selected Bump IssuesSet out below are some common examples of issues

presented by planning to effect a bump that can give rise to uncertainty (prior to release of the December 21 Proposals).

Transaction Financing Generally, any equity or debt issued by Parent, Canco

(except as described below) or other entities in the chain of ownership in connection with the acquisition would typically be considered to be substituted property, since some of its value seemingly would be attributable to assets of Target. If the holders of the debt or equity (combined with any other persons acquiring substituted property) in aggregate own 10 percent or more of the shares of any class or series of Target, then the bump could be denied. Where Target is public, or owned by one or more entities with ultimate disparate ownership such as a private equity fund, it may be very difficult, if not often impossible, to identify all restricted persons without some residual uncertainty. Thus issues can arise if Parent is public (as its equity could be acquired by restricted persons as part of the series, especially if Parent finances the acquisition with an equity offering), or if debt is offered to the public or loaned by a bank syndicate, as Parent would want to be reasonably certain that the persons acquiring indebtedness, or members of the public acquiring equity, as part of an acquisition do not, in aggregate, own 10 percent or more of the shares of Target.

Incentives for Target Employees/Directors Any equity-based compensation to be received by

management of Target (or its subsidiaries) as part of their future compensation package, especially if received as an inducement to continue on with the company post-closing, possibly could be considered to be substituted property. If, for example, senior management of Target and its subsidiaries (combined with any other persons acquiring substituted property) own in total 10 percent or more of the shares of any class or series of Target, and those individuals are to receive options or other equity-based management incentives post-closing in connection with the transaction, then that could disqualify the bump.

Basis Bump Rules (from page 2)

The potential consequences of the bump denial rule are significant.

the acquisition of Target. It is therefore important to be reasonably sure that the bump is available before closing, because the distribution will crystallize any gain or loss. If it is determined after the fact that the bump denial rule applied, remediation may be difficult.

Because of the absolute nature of the bump denial rule (i.e., the whole bump is denied), purchasers and their tax advisers devote considerable resources to obtaining as much comfort as possible that the bump denial rule will not apply in a given situation. In certain circumstances, as is explained in greater detail below, the commercial aspects of a transaction can be affected by bump considerations.

Over time, the Canadian tax community has identified seemingly remote “technical” issues that can arise in circumstances that in no way offend tax policy or are inconsistent with the legislative context of the bump. In many instances the Department of Finance has responded by issuing “comfort letters” (agreeing to recommend relieving changes) that are typically relied upon for planning and financial reporting purposes. The Canada Revenue agency also has a number of favorable (and practical) administrative positions that address some of the more arcane technical concerns.

Practically, it is often challenging to identify all circumstances that can put the bump at risk, especially

January 31, 2013 Practical International Tax Strategies® �

canada

Basis Bump Rules (from page 4)

Equity Rollover Under existing bump rules, shares of Canco issued in

consideration for the shares of Target are specified property, meaning that shareholder rollovers at the Canadian level will not typically taint a bump. However, any equity “rollover” that Parent may be prepared to entertain is typically at the Parent level, especially where Parent owns other assets. Equity of a foreign Parent is not included in specified property, which means that acquisitions of foreign Parent equity as part of the series is problematic as described above.

The December 21 Proposals There are three key elements of the December

21 Proposals that should ease the uncertainty and administrative and commercial burdens associated with bump planning. In particular, these elements should alleviate the concerns described above in certain circumstances, while reinforcing the legislative policy of the bump:

• Introduction of a de minimis threshold for attributable property: From and after December 21, 2012, substituted property will exclude property 10 percent or less of the fair market value of which at the time of acquisition is attributable to distributed property. Thus, where Parent’s value is “large” relative to the value of Target, the acquisition by restricted persons of debt, equity, options and other property the value of which is based on the value of Parent will generally not invalidate the bump. This is a new measure, not previously announced in a comfort letter.

• Indebtedness issued for money is specified property: this rule now confirms, from and after 2001, that indebtedness issued solely for consideration consisting of money will not generally cause a bump problem if acquired by restricted persons. This alleviates much of the concern when acquisition financing is provided by a bank (or banking syndicate) and the lender’s related entities may have been shareholders of a public Target. This also alleviates concerns regarding the need to obtain historic Target ownership information from bondholders in a public debt offering.

• References to a share in the definition of specified property includes a right to acquire a share: this rule now confirms, from and after 2001, that the right to acquire a share is assimilated to a share for purposes of the relieving definition of specified property. This means that certain transactions involving options and warrants (e.g., the issuance by Canco of options in consideration for options or shares of Target, or the acquisition by Canco of Target options in exchange for Canco shares or indebtedness) will not create any additional bump risk.

The December 21 Proposals also included other measures that “fix” some of the more obscure technical issues, such as the concern that where Target had a controlling shareholder, each of Target’s subsidiaries would be a restricted person, and the concern that Parent entities above Canco would not be specified persons before Canco is incorporated.

These new provisions should provide more commercial flexibility when structuring transactions, especially where Parent is comfortable that the 10 percent de minimis fair market value threshold is met. Also, elimination of many of the more technical concerns should allow for smoother M&A transactions, as the more onerous practical requirements of bump planning are less likely to interfere with the transaction.

1 For a detailed discussion of the FA dumping rules, see S. Wong and P. Stepak "2012 Budget Implementation Bill: Extensive Changes to Canada’s International Tax Rules." Practical Int Tax Strategies, Nov 1�, 2012 p. 3. q

Senior Editor: Scott P. Studebaker, [email protected]

Assistant Editor: Dana Pierce Contributing Editor: George Boerger, Esq.

Special Interviews: Scott P. StudebakerMarketing: Jon Martel

Production Assistance: Dana Pierce

PRACTICAL INTERNATIONAL TAX STRATEGIES

is published by WorldTrade Executive,

a part of Thomson ReutersP.O. Box 761, Concord, MA 01742 USA

Tel: 978-287-0301, Fax: [email protected]

www.wtexecutive.com

Copyright © 2013 by Thomson Reuters/WorldTrade ExecutiveThis publication is sold or otherwise distributed with the

understanding that the authors, editor and publisher are not providing legal, accounting, or other professional service. If legal

advice or other expert assistance is required, the services of a competent professional person should be sought. Reproduction or photocopying — even for personal or internal use — is prohibited

without the publisher's prior written consent. Multiple copy discounts are available.

WorldTrade Executive

WTE PRACTICAL INTERNATIONAL

TAX STRATEGIES


chIna

(Transfer Pricing Exceptions, continued on page 7)

In the past ten years, the China State Administration of Taxation (SAT) has been following the OECD Transfer Pricing Guidelines (OECD Guidelines) to set up China transfer pricing rules and practice. The major China transfer pricing regulation, i.e., the 2009 Implementing Measures for Special Tax Adjustments, to a very large extent was consistent with the OECD Guidelines. The latest China transfer pricing documentation and practice also resembled those in OECD countries.

In October 2012, the SAT published a paper in Chapter 10 of the United Nations’ Practical Manual on Transfer Pricing for Development Countries (the Paper). Titled

Transfer Pricing in China: State Administration of Taxation Addresses Challenges with OECD Guidelines By Windson Li (DLA Piper, Beijing)

Windson Li ([email protected]) heads the DLA Piper tax group in Beijing office. He is a certified PRC tax agent and PRC Lawyer. His practice is focused on PRC corporate tax consulting and on PRC transfer pricing services. He advises on a variety of China corporate tax and transfer pricing matters, including corporate tax compliance, tax incentive application, tax dispute resolution, inter-company transaction arrangements, transfer pricing structuring, documentation, and audit defense.

Identification and Quantification of LSAsThe Paper proposed additional returns to Chinese

enterprises based on LSAs. The Paper did not provide a clear definition of LSAs, but instead, presented an example to demonstrate various LSAs enjoyed by a China automobile manufacturing enterprise. The listed LSAs included location savings, market premium, and miscellaneous concepts such as the inelastic demand of the China market, customers’ preference for foreign brands, duty-saving from importation of parts, and benefit of high quality and low cost domestic supplies.

The Paper also provided an example of contract R&D services to demonstrate a suggested method for quantifying return derived from location savings. This method, in brief, is to recognize the difference between the cost base of a China contract R&D service provider, and its comparables in developed countries, and then allocate an additional profit to the China contract R&D service provider by way of applying Full Cost Mark Up (FCMU) of the comparables on the cost base difference.

LSAs are still a controversial concept in the transfer pricing community. Although the SAT took a pragmatic approach towards LSAs in the Paper, it did not clearly define the boundary of LSAs. Neither did SAT discuss how to quantify other sub-concepts of LSAs, such as market premium, inelastic demand of China market, and customs preference, which apparently would be very difficult (if not totally impossible).

In spite of the incompleteness of the LSA concept and the quantification methods, the Paper nonetheless delivered a clear signal—the SAT is considering, and to some extent has determined, to push this LSA concept in China transfer pricing practice. If this concept becomes part of China practice, the open-ended LSA concept and the unprecedented quantification methods very likely will pose significant transfer pricing challenges for MNCs in China.

Challenges Against Traditional Transfer Pricing Arrangements

The Paper challenged some typical inter-company transactions structured based on OECD Guidelines, and suggested new/adjusted approaches to arrive at the arm’s length return for Chinese enterprises engaged in such transactions. These approaches and examples, to a large extent, represent the SAT’s thoughts on future development of China transfer pricing rules and practice.

The SAT expressed concerns upon the reasonableness of the material import

price between the China subsidiary and its overseas affiliates.

“Bridge the Gap—Applying the Arm’s Length Principle in Developing Countries,” the Paper discussed several challenging issues pertinent to development countries and position adopted by the SAT.

In the Paper, the SAT believed that there are significant gaps between the OECD Guidelines and the transfer pricing practice in China. In particular, the SAT considered it necessary to address the following subjects based on the environment in China, which are not yet addressed in the OECD Guidelines.

• Lack of reliable public comparable information for enterprises in developing countries;

• Under-evaluated Local Special Advantages (LSAs) enjoyed by enterprises in developing countries;

• Overstated foreign intangibles and under-evaluated local intangibles in developing countries; and

• Alternative methods to the traditional transactional net margin method.


chIna

Transfer Pricing Exceptions (from page 6)


Contract Manufacturing Contract manufacturing service is a frequent inter-

company transaction between a Multi-National Company (MNC) and its China manufacturing subsidiary. The China subsidiary purchases a majority of its material supplies from overseas affiliates, and exports the finished products also to overseas affiliates. The China subsidiary is usually characterized as a strip risk manufacturing service provider, and given a target FCMU based on the Transactional Net Margin Method (TNMM).

In the Paper, the SAT expressed concerns upon the reasonableness of the material import price between the China subsidiary and its overseas affiliates. A lower material import price may not change the profit margin of the China subsidiary, but could reduce its absolute profit. In this connection, the SAT believed that a check on the arm’s length nature of the material import price should be included in transfer pricing review, and any unreasonably low material import price on the custom declaration records should be questioned.

In practice, this would require MNCs to closely monitor the material import price against available market price information. Proper and continuous documentation of uncontrolled price for similar materials in the market could become a necessary part of the China subsidiary’s transfer pricing defense strategy, especially for industries subject to frequent material price fluctuation.

Toll Manufacturing Toll manufacturing is also a popular business model

for MNCs that provide products ‘made-in-China’. The China toll manufacturer imports most materials and components from an overseas affiliate on consignment basis, completes the manufacturing process, and then exports the finished products to the same overseas affiliate. As the material and product title remain with the overseas affiliate, there would be no (or very limited) Cost of Goods Sold in the P&L of the China toll manufacturer. The China toll manufacturer normally would charge a service fee to the overseas affiliates based on:

• The volume of products processed; or• The total processing cost and expenses on book, plus

a mark-up.As the Paper notes, many MNCs use either FCMU

or Return On Asset (ROA) of contract manufacturers to directly benchmark the profit level of a China toll manufacturer. The SAT believed that, due to the difference between a contract manufacturer and a toll manufacturer, either FCMU or ROA would underestimate the return to the China toll manufacturer.

As an alternative, the SAT suggested the following three-step approach to arrive at the arm’s length return for a China toll manufacturer:

• Step 1—recover the full cost of the manufacturing operation, by way of adding back the material costs (as available in customs system upon importation) to the toll manufacturer’s costs and expenses;

• Step 2—approximate the return (such as in FCMU) for contract manufacturers engaged in similar operation by way of benchmarking;

• Step 3—arrive at the return for toll manufacturers by adjustment for facts like inventory carrying costs.While acknowledging that the above method

would depend on the availability and reliability of customs information on the material costs, the SAT also emphasized that this approach “works well”

In practice, this would require MNCs to closely monitor the material

import price against available market price information.

when customs information is available. Judging from the Paper, it would not be surprising if the SAT starts to implement this approach in more China localities.

Royalty MNCs very often provide certain IP to their China

subsidiaries for manufacturing, distribution and business operation. Such IP is usually in the form of manufacturing technologies, know-how, and trademarks. A fixed royalty rate would be used for expatriation of extra profit from the China subsidiaries.

In the Paper, the SAT questioned the situation where a straight-line royalty rate has been applied for years without change. The SAT believed that in current China transfer pricing practice, IP life cycle has not been given proper consideration, and it is necessary to assess the value of an IP from time to time to arrive at the proper royalty payable. Moreover, the SAT emphasized that the China subsidiaries theoretically should be entitled to additional return, if they have improved the IP, or developed new IP through their China operation.

Sales, Marketing and Distribution Services China has become the largest consumer market for

many MNCs. Many MNCs characterize their Chinese distribution subsidiaries as limited risk distributors that are entitled to low or limited profit margins. The Paper argued that such transfer pricing arrangement ignores the function intensity, market difference and market intangible associated with the Chinese distribution subsidiaries. For assessing the return for the Chinese


chIna



Richard E. AndersenWilmer Cutler Pickering Hale and Dorr LLP (New York)

Joan C. ArnoldPepper Hamilton LLP (Boston)

Sunghak BaikErnst & Young (Singapore)

William C. BenjaminWilmer Cutler Pickering Hale and Dorr LLP

(Boston)

Steven D. BortnickPepper Hamilton (New York)

Joseph B. Darby IIIGreenberg Traurig LLP (Boston)

Rémi DhonneurKramer Levin Naftalis & Frankel LLP

(Paris)

Hans-Martin EcksteinPricewaterhouseCoopers

(Frankfurt am Main)

Jaime González-BéndiksenBéndiksenLaw

(Mexico)

Alan Winston GranwellDLA Piper (Washington)

Jamal Hejazi, Ph.D.Gowlings Ottawa

Keith MartinChadbourne & Parke LLP

(Washington)

Jock McCormackDLA Piper (Australia)

William F. RothBDO USA, LLP

Kevin RoweReed Smith (New York)

John A. SalernoPricewaterhouseCoopers LLP

(New York)

Michael J. SemesBlank Rome LLP (Philadelphia)

Douglas S. StranskySullivan & Worcester LLP (Boston)

Edward TanenbaumAlston & Bird LLP (New York)

Guillermo O. TeijeiroNegri & Teijeiro Abogados

(Buenos Aires)

David R. TillinghastBaker & McKenzie LLP (New York)

Eric TomsettDeloitte & Touche LLP (London)

Advisory Board

distribution subsidiaries, the SAT believed that it would be more appropriate to include a comparability adjustment based on the cost-base difference of the comparables,

Furthermore, the SAT highlighted the situation where some R&D entities claims to be of routine functioned and are compensated on a FCMU basis, and at the same time obtain the "high and new technology status," which enables a preferential 1� percent Enterprise Income Tax rate (as opposed to the standard rate at 2� percent). The SAT considered such dual identity declaration contradictory, and specifically stated that cost plus compensation may not be sufficient for such a company. As the SAT suggested, using a different method like profit split to arrive the arm’s length return for such a contract R&D service provider would be a more appropriate to approach its arm’s length return.

OthersThe SAT also presented its opinions on the following

issues.

Comparable Search The SAT acknowledged the lack of publicly available

data in development countries, and noted that most of the

The SAT questioned the situation where a straight-line royalty rate has been applied for years without change.

and additional return should be attributable to the extra function/costs of the Chinese distribution companies.

Contract R&D Service The SAT argued that significant LSAs are enjoyed by

contract R&D service providers in China. In the example provided in the Paper, the SAT showed a median of 8 percent of the arm’s length ranges established by the comparable companies, and then adjusted it up to 12 percent as recognition of the return created by LSAs.


chIna


comparable sets used by MNCs usually contain companies from a more mature market. To bridge such a gap, the SAT considered geographical adjustments advisable and to some extent necessary, though the SAT did not indicate how to conduct such geographical adjustment.

Holistic View of Multiple Entities in China An interesting idea presented by the SAT in the Paper

was to take a holistic view of multiple entities in China. Because many MNCs have a group of single functioned subsidiaries in China, the SAT considered that a group view of the functions and risks of all China entities should be considered by tax authorities to assess the overall profitability return of all entities. However, again, it is unclear when, where and how this holistic approach would or could be taken.

Alternative Methods to TNMM Another remarkable point was the SAT’s

recommendation of alternatives to TNMM. As the SAT

believed, profit split and a global formulary approach may be more ‘realistic and appropriate’ than transactional or profit-based method, if the majority of a group’s functions and headcounts are inside China.

Observations Taxpayers, especially those of simple and single

functions, such as contract manufacturers, toll manufacturers, and contract R&D service providers, should pay close attention to the gap between their pricing policies and the Chinese tax authorities’ expectations, and follow the latest transfer pricing development in China. The SAT intends to enlarge its tax base and explore ways to increase income as being “reasonable” from the cross border transactions. It is unlikely that the SAT will pursue all the ideas presented in the Paper in the short term. However, the SAT will continue to explore transfer pricing theory and practice, and the China transfer pricing practice, even if such practices differ from the OECD Guidelines. q

chIna

China will postpone the expansion of a pilot program to implement a property tax, the official China Securities Journal reported, citing anonymous official sources, who added that Beijing intends to keep a tight lid on the property market through other means. The officials were quoted as saying the market was not yet mature enough for wider implementation of the tax, citing the general complexity of the residential housing market, the lack of clarity regarding property rights and technical issues as reasons for the delay.

If confirmed, the report would represent a change in direction from September, 2012, when the State Administration of Taxation suggested that the program was about to be expanded beyond its original sites of Shanghai and Chongqing in order to cool rising property prices.

China’s plan for a nationwide property tax is designed to unify its present array of property-related taxes and replace the many restrictions on multiple and speculative home purchases, in response to a 10-fold surge in property prices over the past decade.

Administrative measures that restricted mortgages and targeted speculative behavior caused housing prices to decline for part of 2012, as Beijing attempted to rein in

destabilizing consumer price inflation, but the property market has shown signs of reheating in recent months.

The risk that inflationary pressure might increase in 2013 has caused some economists to predict that Beijing will need to tighten monetary policy later in the year, after loosening it in 2012.

The decision to hold off on expanding the pilot would mark a setback in efforts to wean local governments from what many economists see as an unsustainable dependence on land sales for revenues.

Because property is not directly taxed after sale, experts say local governments see sales of new proprties as a way to generate funds to invest in infrastructure projects that generate positive GDP figures, which are considered key to secure promotions. This has led to a widespread and unpopular practice of forcing residents to relocate from existing developments so the property can be resold to property developers.

The result has been an explosion in rents that has cut into the incomes of lower- and middle-class Chinese citizens unable to afford to buy a home.

The government should continue to explore other tools, including other forms of taxation, to regulate the market, the report said. q

China to Postpone Widening of Property Tax Pilot ProgramBy Pete Sweeney (Reuters)


ColoMbIA

(Tax Changes, GAAR, continued on page 11)

Colombia recently introduced significant changes to its tax regime. These changes, published in the Colombian Official Gazette as Law 1607 on December 26, 2012, are effective January 1, 2013. This tax reform likely will affect most multinational corporations (MNCs) operating in Colombia.

This article summarizes those aspects of the tax reform that may interest international investors.

Corporate Income Tax Rate Reduction and ‘CREE’ Tax Introduction

Law 1607 reduces the corporate income tax rate applicable to Colombian-resident entities and branches or permanent establishments of non-Colombian companies to

current or accumulated net operating losses (NOLs). The CREE’s taxable income amount may not be less than three percent of the taxpayer’s net equity as of December 31 of the preceding taxable year.

Since taxpayers may not offset the CREE with NOLs, there may be a U.S. GAAP and IFRS1 impact on deferred tax assets.

Capital Gains Tax Rate ReductionLaw 1607 reduces the capital gains tax rate for both

Colombian and non-Colombian residents from 33 percent to 10 percent provided the capital assets were held for at least two years. Gains from the sale or exchange of assets held for less than two years are subject to ordinary rates. For residents, this means a 2� percent corporate income tax rate plus the 9 percent CREE tax rate (8 percent after 201�). For non-residents this means a 33 percent income tax rate.

After-tax distributions of profits derived by a Colombian entity from income subject to the 10 percent capital gains tax should generally not be subject to further taxation.

Dividend Calculation, Introduction of a Branch Profits Tax

While the tax imposed on dividend distributions to non-residents has not changed under the tax reform (i.e., no dividend withholding tax should be imposed provided that the dividends are paid out of previously taxed earnings), Law 1607 introduces certain amendments that impact the effective taxation of dividend distributions to non-residents.

One amendment provides a new formula to calculate the dividend amount. The formula determines the portion of a dividend attributable to previously taxed earnings and therefore not subject to further taxation upon distribution.

Another amendment introduces a branch profits tax by changing the definition of dividends. Dividends now include profit remittances by a branch or permanent establishment. Prior to Law 1607, branch remittances were not included in the definition of dividends, thereby allowing for tax-free remittances of branch profits, even if paid out of non-previously taxed earnings.

New Thin Capitalization RulesThe tax reform introduces thin capitalization rules,

while simultaneously respecting cross-border related-party

law 1607 introduces certain amendments that impact the effective

taxation of dividend distributions to non-residents.

Colombia Cuts Corporate Income Tax; Enacts General Anti-Abuse Rule

By John Salerno, Jose Leiman and Carlos Chaparro (PricewaterhouseCoopers)

John Salerno (646-471-2394, [email protected]) and Jose Leiman (305-381-7616, [email protected]) are part of the Latin American Tax (LATAX) team of PricewaterhouseCoopers in the U.S., based in New York and Miami, respectively. Carlos Chaparro (+57 1 634 0555, [email protected]) is part of the LATAX team of PricewaterhouseCoopers in Colombia, based in Bogotá.

2� percent (from 33 percent). The rate for non-Colombian residents remains at 33 percent.

However, the rate reduction applicable to Colombian-resident entities and branches or permanent establishments of non-Colombian companies is effectively offset by a new so-called ‘equality tax’ (CREE is the Spanish acronym) computed on a calendar-year basis. The tax rate is 9 percent from 2013 through 201�, and 8 percent thereafter.

According to Law 1607, the CREE’s taxable basis equals annual gross revenue, excluding, among other items, certain tax-exempt income and capital gains. That amount is then reduced by, among other items, ordinary and necessary expenses, interest and depreciation. When calculating the CREE’s tax basis, some items are not deductible. These include the super-deduction (which is still available for certain grandfathered taxpayers) and


ColoMbIA

Tax Changes, GAAR (from page 10)

debt. Colombian-resident companies must comply with a 3:1 debt-to-equity ratio in order to deduct interest accrued on any type of loan, whether foreign or domestic, and with related or unrelated parties. Any amount of interest attributable to debt principal in excess of this ratio is non-deductible for Colombian income tax purposes.

These rules will not apply to loans to finance public infrastructure projects by special entities or loans received by other regulated companies (such as banks).

Tax-Deferred Capital Contributions to Colombian Entities

Deferred gain recognition is available for contributions (e.g., in-kind) to the share capital of Colombian resident for both the contributor and contributee, provided that the following requirements are met:

• the contribution is in consideration for newly-issued stock by the contributee;

• the contributee entity takes transferred basis on the assets received; and

• the basis of the newly issued shares received by the contributor equals the aggregate basis of the contributed assets, etc. Furthermore, in the contribution agreement, both contributor and contributee must expressly state which provision of the income tax law applies. This non-recognition treatment does not apply to

similar contributions by a Colombian resident to a non-Colombian entity. Instead, such outbound contributions would be taxable to the extent of any recognized gain and subject to the Colombian transfer pricing rules.

Additionally Law 1607 does not indicate whether a non-resident contributor is subject to the above-described requirements. Thus in principle, a non-resident contributor may claim non-recognition treatment when making an in-kind contribution to a Colombian entity provided the requirements (noted above) are satisfied.

Foreign Portfolio Investors • Law 1607 significantly changed the tax regime that

applies to foreign (i.e., non-Colombian) portfolio investors (e.g., investments in Colombian-listed stocks). These changes are as follows:

• Law 1607 provides that foreign portfolio investors are now considered taxpayers with regard to profits derived from investments. Notwithstanding this characterization as taxpayers, their income tax liability shall be paid and reported on a monthly basis to the Colombian tax authority by their local investment/asset managers. In this regard, Law 1607 states that portfolio investors are now liable as taxpayers, but are not subject to filing obligations.

• Generally a 14 percent withholding income tax should apply on profits derived by a foreign portfolio investor who is not a resident in a tax haven (as indicated by the

Colombian government under the authority granted by Law 1607), otherwise the Law imposes a 2� percent tax rate on such income. In calculating the 14 percent or 2� percent rate, foreign portfolio investors may deduct administrative expenses. There is an exception when the foreign portfolio

investor’s profits are derived from dividend distributions of a Colombian entity. If dividends are paid out of non-taxed earnings, the distributing entity should apply a 2� percent withholding tax at source, regardless of the portfolio investor’s residence (i.e., the 14 percent rate is not available).

Netting of gains and losses incurred in the same year is now allowed. Foreign portfolio investors may carry over losses sustained in any given month in order to offset gains

Netting of gains and losses incurred in the same year is now allowed.

realized in subsequent months within the same calendar year. A special rule applies to losses accumulated as of December 31, 2012: they may be carried forward to offset 2013 profits only. Any unused losses will expire.

Permanent EstablishmentsThe tax reform defines “permanent establishment”

(PE) for Colombian tax purposes for the first time. This definition is OECD-based and refers to a fixed place of business located in Colombia through which a non-resident enterprise or individual wholly or partially conducts its business, including a branch; an office or agent; a factory; a workshop; and a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

A PE may also be created where a person, other than an agent of independent status, acts on behalf of a non-resident enterprise and this person has or regularly exercises the authority within Colombia to conclude contracts that are binding for the non-resident enterprise. In general, auxiliary or preparatory activities do not create a PE.

Note that Law 1607 diverges from the OECD-based PE definition by not including a reference to building sites or construction or installation projects.

Law 1607 provides that Colombian income taxation should be imposed on income attributable to the PE-based on different criteria such as the functions, assets, risks and staff involved to generate the income. For such purposes, Law 1607 requires PEs to keep separate accounting records in order to clearly identify the attributable revenues, costs and expenses. PEs should also support such accounting records with a study relating to the functions, assets, risks and staff involved in earning the income.

(Tax Changes, GAAR, continued on page 12)


ColoMbIA

(Financial Transactions Tax, continued on page 13)

General Anti-Abuse (GAAR) ProvisionsLaw 1607 also introduced anti-abuse provisions

that allow the Colombian tax authorities to disregard or recharacterize certain transactions according to the general principle of substance-over-form when there is evidence of abuse. Note that the anti-abuse provisions allow the Colombian tax authorities to ‘pierce-the-veil’ of the corporations engaged in abusive conduct. The provisions apply to conduct or transactions occurring on or after January 1, 2013.

Tax Changes, GAAR (from page 11) ConclusionThe 2013 tax reform provisions are far-reaching and

are expected to affect the entire Colombian tax system. In addition to its already far-reaching provisions, the reform package includes several other important items, including changes to the transfer pricing rules, rules addressing goodwill, amendments to the VAT rules.

One other item of note is that it is unclear as to whether the CREE may be viewed as creditable for U.S. federal income tax purposes. Taxpayers should further analyze this new tax to assess its creditability for U.S. tax purposes.

© 2013 PricewaterhouseCoopers LLP.

1 U.S. Generally Accepted Accounting Principles; International Financial Reporting Standards. q

eu

The ECOFIN (Economic and Financial Affairs Council of the Council of the European Union) meeting on January 22 resolved to use the “enhanced cooperation procedure” to implement an EU Financial Transaction Tax (FTT) across France, Germany, and the nine other EU Member States that wish to do so. Most equity, debt and derivative transactions in these jurisdictions will be subject to the tax—starting as early as 2014. The FTT looks likely to have wide extra-territorial effect; those who hoped London wouldn’t be affected are likely to be disappointed. Many in the U.S. and Asia may be surprised to find themselves subject to the tax.

Meaning of the ECOFIN Decision In September of 2011, the European Commission tabled a proposal for a Directive implementing an FTT on most financial transactions in the EU.

The proposal required unanimity, and, given the opposition by several Member States, it became clear that this would not be achieved. In the Autumn of 2012, 11 Member States requested permission to proceed with a form of FTT based on the Commission’s original proposal, but using the enhanced cooperation procedure. This would enable a smaller group of Member States to proceed with an FTT that would apply in these Member States only. The European Parliament adopted a resolution in December calling for a Council Decision to allow enhanced cooperation, and the Council formally approved the enhanced cooperation procedure January 22. The Czech Republic, Luxembourg, Malta and the United Kingdom abstained. The 11 countries that will form the so-called “FTT Zone” are Belgium, Germany, Estonia, Greece, Spain, France, Italy, Austria, Portugal, Slovenia and Slovakia.

How the FTT Will Work A substantive proposal will be published in the next few weeks. Based on information released to date we expect the FTT to be based on the original 2011 proposal but with several modifications in light of discussions and debate since. If that is right, the FTT will work broadly as follows:

• The scope of the FTT will include all financial instruments (e.g., equities and debt securities) and derivatives, but not loans.

• The FTT will be charged on:

New Financial Transaction Tax: Why the EU Seems Set to Impact Financial Institutions Worldwide, and Why Legal Challenges are LikelyBy Dan Neidle, Chris Bates and Habib Motani (Clifford Chance)

Dan Neidle ([email protected]), Chris Bates ([email protected]) and Habib Motani ([email protected]) are Partners with the London office of Clifford Chance. Mr. Neidle’s practice is focused on UK and international tax treatment of corpo-rate and financial transactions, including restructurings, corporate and portfolio disposals, acquisition finance and structured finance transactions. Mr. Bates’ practice is con-centrated in financial services and mergers and acquisi-tions in the financial sector. He leads the firm’s financial regulatory practice. Mr. Motani specializes in derivatives, capital markets and financial markets.


eu

Financial Transactions Tax (from page 12)


– transactions in debt securities, equities and entry into/modification of derivatives where at least one party is a financial institution and at least one party is resident in the FTT Zone;

– transactions in debt securities and equities where at least one party is a financial institution and the issuer of the underlying debt/equity is established in the FTT Zone; and

– certain other intra-group transactions that transfer risk between entities.

• The FTT will likely also apply to repos, securities lending and collateral transfers.

• The definition of “financial institution” will be wide, including insurance companies, pension funds, most retail and private funds and special purpose vehicles (SPVs). Many M&A transactions and restructurings will be subject to the FTT.

• The headline rate will be a harmonized minimum of 10 basis points of purchase price in the case of financial instruments (with a reduced rate for repos), and a minimum of 1 basis point of notional principal for derivatives.

• The effective rate will be higher. Each financial institution party is separately liable for the tax, so transactions between two financial institutions will be taxed twice. Cascade effects could make the effective rate higher still (see below).

• There will be an exemption for primary market transactions (i.e., subscription/issuance). However there will likely be no exemption for brokers, financial intermediaries or market-makers, and no exemption for intra-group transactions.

How Wide is the Extra-Territorial Effect? Very wide. An FTT Zone financial institution’s branches worldwide will be subject to the FTT on all of their transactions. So, for example, French and German banks’ London branches will be fully subject to the FTT on all their securities and derivatives businesses. The expected design of the FTT also means that non-FTT Zone financial institutions (e.g., those in London, New York and Asia) will be taxed whenever they transact with parties in the FTT Zone, and whenever they deal in securities issued by an entity established in the FTT Zone. The secondary liability rule means that FTT Zone governments do not need to enforce against those persons outside the FTT Zone, but can simply collect the tax from their own residents. Clearing systems may magnify the extra-territorial effect, since transactions cleared through clearing systems in the FTT Zone may be subject to the FTT even where the

parties and underlying issuer are all established outside the FTT Zone. An obvious example is Euroclear—as Belgium seems likely to be part of the FTT Zone, all transactions cleared through Euroclear may be taxed. Non-FTT Zone financial institutions that do not want to be liable to the FTT directly will need to monitor the status of their counterparties. To avoid being indirectly liable, they will need to either ensure their terms and conditions do not permit the cost of the FTT to be passed on, or police each participant in the chain of clearing/settlement (which may not be possible). So, while there are reports that the FTT is good news for London, we are not so sure. Some businesses may migrate from the FTT Zone to the UK. But, given the way the FTT works, and the interconnectedness of modern financial markets, we think it is likely a significant amount of FTT will be collected from UK financial institutions and businesses. It follows that if, as many believe, the FTT causes markets to decline and increases the cost of capital for business, then the UK will be adversely affected (and without benefiting from any of the FTT revenues).

Doesn’t UK Stamp Duty Show that FTTs are Workable?

We fear not. The UK and a number of other jurisdictions have imposed stamp duties and transfer taxes on equities for some time, and those taxes are generally considered to work well. However taxing debt securities and derivatives in the manner proposed by the FTT is quite novel, and its economic effect is unclear, both in terms of the impact on financial markets and the cost of capital and hedging for corporates. Second, most of the existing stamp duties/transfer taxes are based on an issuance principle—so, for example, the UK and France tax worldwide transactions in UK/French equities. There is therefore no incentive for UK and French businesses or funds to relocate from the UK and France, as their stamp/transfer tax liability would be unaffected. But the FTT also applies on a residence principle—a company or fund in the FTT Zone will now be subject to the FTT on its worldwide transactions; if it moved outside the FTT Zone it would not be. Many businesses and (in particular) funds may therefore consider relocating. This seems to us a poor design decision. Third, the existing stamp duties/transfer taxes generally exempt brokers, market-makers and financial intermediaries. This is the case for the UK, Irish, French and Italian taxes, for example. However, by design, the original FTT has no such exemption, and the Commission has repeatedly stated it does not intend to introduce one. So the sale and purchase of a debt security within the FTT Zone would be charged at multiple stages of the chain of settlement, as indicated by the diagram below:

Vendor Clearing member

Clearing system

Clearing member Broker FundBroker

0.1% (if FI) 0.1% 0.1% 0.1% 0.1% (exempt) 0.1% 0.1% 0.1% 0.1% 0.1%


eu


The effective rate in this example, which we believe to be fairly typical, will therefore be 1 percent and not 10 basis points. This “cascade effect” is characteristic of Tobin-style financial transaction taxes. There would be a similar impact for on-exchange derivative transactions and OTC derivatives subject to central counterparty clearing. If the Commission continues to resist an intermediary exemption, then the cascade effect seems to us a serious problem with the proposal:

• The adverse economic impact of the FTT may be considerably greater than anticipated by the European Commission, as its impact assessment modeling did not model cascade effects and the resultant additional costs and distortions.

• Brokers and other intermediaries typically make a very small profit on “risk less principal” transactions such as in the above example—this profit will almost always be less than the FTT charge (perhaps one basis point as opposed to twenty), and therefore the charge will

• What will be the timescale for implementation? 2014 seems highly optimistic given the complexity and novelty of the tax; 201� or later seems more achievable.

• Is the cascade effect really intended and, if not, what kind of intermediary exemption will be included?

• How will the FTT apply to the exchange of collateral under derivatives and other financial arrangements?

• How precisely will the FTT apply to derivatives? Taxing the notional principal seems arbitrary, given that in many cases it bears no relation to the actual value of the contract.

• How will the FTT apply to collateral transfers, particularly where there is daily margining?

• What measures will be introduced to prevent relocation? And how far can these measures go without falling foul of EU law (i.e., the prohibitions on restrictions of the freedom of establishment and the free movement of capital)?

• Will the Commission prepare and publish an impact assessment showing the effect of the FTT on Member States within and outside the FTT Zone?

Possible Challenges to the FTT If the FTT works as outlined above, it is not clear to us that it will be compliant with EU law. There are very limited precedents for the use of the enhanced cooperation procedure, and no precedent for the EU imposing any taxes other than VAT—but the key difficulties seem to us to be:

• Enhanced cooperation must not undermine the internal market or economic, social and territorial cohesion and must not constitute a barrier to or discrimination in trade between Member States or distort competition between them. It is reasonably clear that the FTT would distort competition between Member States as a whole. A U.S. bank would, for example, be subject to the FTT when transacting with a German client, but not when transacting with (say) a London client. This is a problem recognized by the Commission in its explanatory notes to the original FTT Directive.

• Enhanced cooperation must respect the competencies, rights and obligations of those Member States that do not participate in it. But the extra-territorial effect of the FTT means that residents of non-participating Member States will be subject to the FTT. Indeed, they may be taxed twice—a UK pension fund buying UK equities from a French bank would pay the FTT plus UK stamp duty. The FTT may therefore represent an indirect infringement on the non-participating Member States’ competencies and rights.

• There are serious grounds for believing the FTT could constitute a restriction on the free movement of capital, and therefore be contrary to EU law. The Commission has conceded that an FTT that applied to forex would

The Commission will release a detailed proposal, likely in February 2013.

inevitably be passed to the ultimate purchaser of the securities. This potentially represents a very significant hidden cost increase for end purchasers—insurance companies, pension funds, collective investment schemes and others.

• The cascade effect will incentivize parties to transact over the counter rather than on-exchange, at a time when the regulators are encouraging markets to move in the opposite direction.

Next Steps We expect the next steps to be:

• The Commission will release a detailed proposal, likely in February 2013.

• The Commission’s FTT proposal would then be negotiated, with the aim that the final wording of a Directive would be agreed between the participating Member States (following a non-binding opinion from the European Parliament) by September 2013.

• An FTT Directive will be enacted if at that point at least nine Member States wish to proceed (i.e., the other Member States have no vote or veto).

• The participating Member States would then implement the Directive in local legislation.

• The original aim was for the FTT to be effective from January 1, 2014.

Key Questions We hope that by the time a detailed proposal is published, we have answers to the following questions:


January 31, 2013 Practical International Tax Strategies® 1�

eu

(Corporate Tax Changes, continued on page 16)


be contrary to the free movement of capital—but EU case law draws no distinction between forex, securities and derivatives—all are “movements of capital.” So, once the forex point is conceded, it is not obvious how an FTT that applies to securities and derivatives can be said to be lawful.

• A key rationale for the FTT was that it was taxing the banks the Commission viewed as responsible for the financial crisis. The difficulty with this argument is that the FTT applies, directly and indirectly, to many entities that have never been blamed for the financial crisis—charities, pension funds, insurance companies, unit trusts and others. The FTT may therefore fail the fundamental EU law requirement of proportionality.

Given the politics of the situation, it seems unlikely that any Member State will itself launch a legal challenge to the FTT. However, once the FTT comes into force, anyone

subject to the FTT could challenge the legality of the tax in their local courts; this would likely be eventually referred to the Court of Justice of the European Union. The prospects of a challenge are more than theoretical. There are many precedents of taxing measures being successfully challenged on the basis that they contravene EU law. For example, the CJEU ruled in 2009 that the UK’s application of stamp duty to the issue of shares into clearance and depositary systems was unlawful, and this is expected to cost the UK up to £� billion in refund claims. Any challenge to the FTT would be considerably more controversial, and the prospects of success unclear. But given the vast sums involved, legal challenges seem certain, and the potential cost to the FTT Zone States very substantial. Whether this will give EU institutions and Member States pause before proceeding with the FTT remains to be seen.

© Clifford Chance 2013 q

FrANCE

In Brief On December 19 and 20, the French parliament approved the Finance Act for 2013 and the 3rd Amended Finance Act for 2012. The bills are subject to formal publication and Constitutional review. These Finance Acts contain corporate tax measures designed to improve the competitiveness of the French economy while also addressing the French budget deficit by raising tax revenues, closing tax loopholes, and tackling tax abusive situations. Most measures will have immediate or even retroactive application and will affect U.S. multinationals (U.S. MNCs) with French operations or subsidiaries. The Acts also include a number of provisions affecting wealth tax, individual taxation, and VAT. Those provisions are not discussed in this article.

French Budget Introduces Important Corporate Tax Changes and Incentives By Guillaume Glon, Guillaume Barbier, Samia Tighilt and Renaud Jouffroy (PricewaterhouseCoopers LLP)

New Tax Credit to Boost Competitiveness and Employment

To improve the competitiveness of the French economy and reduce employment costs, the Finance Act introduces a new tax credit for companies. Scope The new tax credit generally will be available to most French and foreign enterprises subject to corporate tax in France. Partnerships will pass through their tax credit benefits to their partners, in proportion to their interests in such entities, provided the partners are subject to French corporate tax or individual tax on their trade and business income. There are no requirements regarding the nature of the activity carried out in France. The regime applies from January 1, 2013.

Computation The tax credit will be calculated as a percentage of the wages paid, during the calendar year, to employees receiving less than 2.� times the French minimum wage (SMIC). The current gross monthly SMIC is €1,426. The rate of this tax credit will be 4 percent for calendar year 2013 and will be increased to 6 percent for 2014 and subsequent years.

Guillaume Glon ([email protected]), Guillaume Barbier ([email protected]) and Samia Tighilt ([email protected]) are with the France Desk of PricewaterhouseCoopers LLP in New York. Renaud Jouffroy ([email protected]) is with the Paris office of PricewaterhouseCoopers.


Corporate Tax Changes (from page 15)

FrANCE

Use and Offset The tax credit can be offset against the income tax liability payable by the taxpayer for the calendar year during which the wages are paid. Any excess credit can be carried forward and offset against the tax liability of the taxpayer during the next three years. Any remaining or unused credit after three years will be refunded to the taxpayer. However, the unused credit may be refunded immediately to the following taxpayers:

• “small or medium enterprises” as defined by the EU: i.e., companies with less than 2�0 employees and with annual turnover not exceeding €50 million or a total balance sheet not exceeding €43 million;

• “new enterprises,” as defined by French tax law, whose share capital is fully paid up and in which at least �0 percent of shares have been held continuously by: individuals; a company whose share capital is at least �0 percent held by individuals; or venture capital companies, private equity funds, regional development funds, financial innovation companies or personal investment companies (SUIR) provided there is no related-party relationship between the enterprises and such latter companies or funds;

The following enterprises may obtain an immediate refund for the first four years:

• “young innovative enterprises” as defined by the French Tax Code; and

• enterprises subject to receivership and assimilated procedures.

The receivable can be transferred or sold only to banks and credit institutions. Finally, special provisions apply in the case of mergers and assimilated restructuring operations. A decree and further guidance are expected early in 2013.

Research Tax Credit The current R&D tax credit regime will be continued, with certain changes. Currently, the rate of the R&D tax credit applicable to R&D expenses is 40 percent for the first year and 35 percent for the second year for first time beneficiaries or companies that have not benefitted from a R&D tax credit during the last five years. From the third year onwards, the rate of the tax credit is 30 percent. The Finance Act eliminates these 40 percent and 3� percent rates. Going forward, the 30 percent rate will be the only applicable rate. The new rate will apply to R&D expenses incurred on or after January 1, 2013. Additionally, the scope of the R&D tax credit will be extended to certain innovation expenditures, such as prototypes, design, and pilot plants for new products incurred by small and medium-size enterprises (SMEs).

For these expenses, the credit rate will be 20 percent, and will apply to a maximum of €400,000 of innovation expenses.

New Exit Tax Rules in case of Transfer of French Head Office or Establishment

Under current law, in the case of a transfer of assets as part of a transfer of a head office or an establishment outside France, unrealized gains are, in principle, immediately taxable. To comply with recent decisions of the European Court of Justice, the Finance Act provides taxpayers with the following options: The total amount of the corporate tax assessed on the unrealized gains or deferred capital gains relating to the transferred assets can be paid within two months of the transfer. Alternatively, the taxpayer can elect to pay one-fifth of the tax due within two months of the transfer. The balance then must be paid each year in four equal installments payable no later than the anniversary of the first payment. An advance payment of the entire amount due can be made at any time within this period. This will apply to transfers to another member State of the European Union or, under certain conditions, to a member of the European Economic Area Member State. The tax becomes immediately due if the assets are sold or transferred outside the European Union (or the European Economic Area) or if the taxpayer is liquidated. Similarly, the tax is immediately due if the taxpayer fails to pay the installments in accordance with the payment schedule described above. This new rule applies to transfers completed on or after November 14, 2012.

Additional Limit on Interest Deductions The Finance Act introduces a new limit on interest deductions for companies subject to corporate tax in France. The new limit applies in addition to existing limits such as the interest rate cap on related-party debt, thin capitalization rules, and the so-called “Amendment Carrez” that denies a deduction for interest relating to the financing of the acquisition of shares when the purchaser does not actually make decisions relating to the shares and does not exercise control or influence over the target. Under the new limit, 15 percent of net finance expenses of a company subject to French corporate tax will not be deductible. In a tax consolidated group, this limit applies at the level of the tax result of the group. This is a permanent disallowance; there is no mechanism to carry the disallowed interest forward to subsequent tax years. “Net finance expense” is defined as the total amount of finance expenses incurred as a consideration for financing granted to the company, reduced by the finance income received by the company in consideration for financing



FrANCE



granted by the company. Rents incurred as part of a rental agreement between related parties or a leasing agreement also are included in finance expenses after deduction of the amortization or financial amortization of the lessor. However, rents paid in relation to real estate rental agreements between related parties should be excluded. Finance expenses relating to assets acquired or built within the framework of delegation of public utilities, concession of civil/public engineering, and public-private partnership agreements are excluded from this new limit, but only under agreements signed before the promulgation date of the Finance Law. The new limit applies to both related- and third-party financing and regardless of the purpose of the financing. This limit will not apply if a company’s net finance expense is lower than €3 million. In a tax unity, this applies if the net finance expense of the group is lower than €3 million. In addition, in a tax consolidated group the new limit does not apply to the portion of the net finance expense resulting from financing transactions between members of a French tax unity. The new limit applies “retroactively” to financial years ending on or after December 31, 2012. For financial years starting on or after January 1, 2014, the percentage of non-deductible financial expenses will increase from 1� percent to 2� percent.

Tighter Participation-Exemption Rules on Long-Term Capital Gains

Under the current regime, 90 percent of long-term capital gains resulting from the disposal of participating shares are exempt from tax. The taxable portion of the capital gain is subject to CIT at the standard rate or offset against tax losses brought forward. “Net capital gain” is defined as the algebraic sum of long-term capital gains and long-term capital losses resulting from the disposal of participating shares during a given year. The Finance Act changes the basis for calculation of the taxable portion of the capital gain. When, for a given financial year, the overall result of the disposal of participating shares is a net long-term capital gain, the taxable portion of the gain will now be based on the gross gains. Long-term capital losses cannot be offset against long-term capital gains. Even if the drafting of the law is somewhat unclear on this point, the effect should be that if the overall result of the disposal of participating shares is a net capital loss, the long-term capital loss still should be offset against the long-term capital gain so that no tax is due. In addition, the exempt portion of the capital gain will be reduced from 90 percent to 88 percent. The new regime should apply to financial years on or after December 31, 2012.

Tighter Rules Governing Loss Carryforwards Currently, a company may carry forward tax losses indefinitely. Under the new rule, tax losses carried forward will be available to offset €1 million plus 50 percent the current taxable income exceeding that amount (instead of the current 60 percent). The tax losses that cannot be offset in a given year are still eligible to be carried forward and offset against future taxable profits. In addition, the €1 million thresholds should be increased by the amount of the waiver of debt granted within the framework of a bankruptcy or receivership procedure. The new regime applies to financial years ending on or after December 31, 2012.

Exceptional 5 Percent Corporate Tax Surcharge Further Extended

The fourth Amended Finance Act for 2011 created a temporary and exceptional corporate income tax surcharge of � percent of the gross CIT liability (before the offset of any available tax credits) of companies with a turnover (gross income) in excess of €250 million. Including this surtax, the maximum effective French CIT rate may be as high as 36.10 percent. This tax originally applied for financial years closed from December 31, 2011, through December 30, 2013. This tax now will be applicable until financial years closed through December 30, 201�.

Change in VAT Rates The standard VAT rate will increase from 19.6 percent to 20 percent. The intermediary rate will increase from 7 percent to 10 percent. The reduced rate will be reduced from �.� percent to � percent. These changes will apply beginning January 1, 2014.

Accounting Records to be Provided in Computerized Format in case of Tax Audit

Companies in France currently may present computerized or other non-paper accounting records for the purposes of a tax audit, but that is merely an option. Under the Finance Act for 2013, companies will be required to keep their accounting records in computerized form and to provide them to the tax authorities in the same format. Printed records no longer will be accepted. Taxpayers failing to comply with this new rule will be liable for penalties as high as 0.� percent of the declared or reassessed gross revenue. More important, a company’s failure to present computerized accounting records could be considered “willful opposition” to the French tax authorities (FTA), which then could determine the taxable basis of the company unilaterally.


FrANCE


(FATCA & MNCs, continued on page 20)

This new provision will apply to tax audits for which an audit notification is sent by the tax authorities to the company after January 1, 2014. Because tax audits launched in 2014 will cover previous financial years, this measure is effectively retroactive.

that receives U.S. source income will likely be subject to FATCA.

Although certain FFIs and certain NFFEs are exempted from the 30 percent withholding tax, qualifying for such exceptions is not an automatic process. The application of any such exception requires a factual analysis. Entities qualifying for an exception are still required to provide to withholding agents a valid certification to establish the entity’s exempt status in order to avoid the penalty withholding tax. Thus, even exempted FFIs and NFEEs will likely be subject to FATCA reporting requirements if they receive withholdable payments.

In February, the Treasury Department and the governments of France, Germany, Italy, Spain and the United Kingdom outlined their intention to explore a reciprocal reporting agreement between the U.S. and each of these countries to facilitate FATCA compliance. Under a partner agreement, FFIs in a “participating country” would comply with FATCA by reporting to their local government, as opposed to reporting directly to the IRS. Since then, Treasury has signed three bilateral agreements and is negotiating agreements with additional countries as discussed below.

Effective Dates and DeadlinesAlthough FATCA is generally effective for payments

made after December 31, 2012, the IRS issued guidance extending the deadlines of the first requirements to 2014. The following requirements begin in 2014: new account opening procedures; withholding on U.S.-source FDAP income; and due diligence on prima facie FFI accounts and on high-value accounts must be completed in 2014. The IRS has also extended the first FATCA reporting for FFIs to 201�.

Countries with Bilateral FATCA AgreementsUnited Kingdom, Denmark and Mexico have all signed

agreements with the United States to help manage FACTA requirements.

The U.S. Treasury has announced that it is now also pursuing agreements with the following countries: Argentina, Australia, Belgium, the Cayman Islands, Cyprus, Estonia, Hungary, Israel, Korea, Liechtenstein, Malaysia, Malta, New Zealand, the Slovak Republic, Singapore, and Sweden.

Actions to Consider U.S. MNCs with operations or subsidiaries in France should carefully review the potential impact of these tax changes and incentives.

© 2012 PricewaterhouseCoopers LLP q

us

Additionally, the U.S. Treasury is discussing viable options for bilateral cooperation with the following countries: Bermuda, Brazil, the British Virgin Islands, Chile, the Czech Republic, Gibraltar, India, Lebanon, Luxembourg, Romania, Russia, Seychelles, Saint Maarten, Slovenia, and South Africa. Additionally, Treasury informed that it is in the process of finalizing intergovernmental agreements with France, Germany, Italy, Spain, Japan, Switzerland, Canada, Finland, Guernsey, Ireland, Isle of Man, Jersey, the Netherlands, and Norway.

By means of these FATCA agreements, the tax authorities of each signatory country agree to the annual exchange of the information described below with the tax authorities of the other country on an automatic basis.

In general, FFIs of the signatory countries will be obliged to obtain and report certain information with respect to financial accounts maintained by financial institutions and held by certain citizens or resident individuals of the other country, partnerships or corporations organized in the other country or under the laws of the other country, and certain trusts.

The information to be obtained and exchanged includes:

(i) the name, address, and tax identification number of the person or entity that is an account holder of such account;

(ii) the account number (or functional equivalent in the absence of an account number);

(iii) the average monthly account balance or value during the relevant calendar year or other appropriate reporting period;

(iv) in the case of any Custodial Account (an account for the benefit of another person that holds any financial instrument or contract held for investment):

• the total gross amount of interest, dividends, and other income generated with respect to the assets held in the account during the calendar year or other appropriate reporting period; and

• the total gross proceeds from the sale or redemption of property paid or credited to the account during the calendar year or other appropriate reporting period with respect to which the Mexican financial institution acted as a custodian, broker, nominee, or otherwise as an agent for the account holder;

FATCA & MNCs (from page 3)


us


us

Subscribe Today to:

Practical International Tax StrategiesOne year (20 issues): q $785 q $835 (delivery outside US)

Name

Company

Address

City

State/Country/Zip

Telephone/Fax

Credit Card No./Expiration Date q VISA q MC q AMEX q Diners Card Signature Fax: + 1 978.287.0302 ____________________ [email protected]: + 1 978.287.0301 ____________www.wtexecutive.com

FATCA & MNCs (from page 18)

(v) in the case of any Depository Account (any commercial, checking, savings, time, or thrift account, among others), the total gross amount of interest paid or credited to the account during the calendar year or other appropriate reporting period;

(vi) in the case of any account not described above, the total gross amount paid or credited to the account holder with respect to the account during the calendar year or other appropriate reporting period with respect to which the financial institution is the obligor or debtor.

Failure to obtain and report the abovementioned information by a foreign financial institution or a domestic branch of a foreign financial institution may result in the 30 percent FATCA withholding tax discussed above.

Set forth below are the most relevant details to date with respect to three of the countries that have recently concluded the exchange of information agreements with the United States with respect to FATCA:

a) United KingdomThe United Kingdom and the United States signed

an intergovernmental agreement on September 12, 2012 after which there was a short period of consultation on the proposed implementation legislation (the response to the consultation will be published on December 18). The agreement means that UK financial institutions will not have to report the account details set out above to the U.S. but rather to HMRC who will then be able to share with the U.S. under existing tax information exchange arrangements.

FATCA places new burdens on UK businesses, and the UK government has sought to reduce the impact of these, which will come into place in 201�, while removing the risk of the 30 percent withholding. This is a helpful development but at the same time has increased the information sharing powers of HMRC.

b) DenmarkThe FATCA treaty with Denmark was signed on

November 1�, 2012. Once the treaty is implemented into Danish law, Danish resident investors can provide the information required under the FATCA to the Danish Tax Authorities instead of to the IRS.

In order to ensure compliance with the provisions of the FATCA treaty, the Danish Ministry of Taxation expects that an amendment to Danish national legislation will be necessary and is likely to be introduced in 2013. The Danish Ministry of Taxation is currently analyzing the extent to which the FATCA treaty implies a need for additional information to be reported to the Danish Tax Authorities by Danish resident banks and financial institutions, other than the information already reported today and how such further reporting requirements should be implemented.

The first reporting to the Danish Tax Authorities of information to be exchanged with the IRS is to be made in September 201�.

c) MexicoAfter two years of negotiations, on November 19, 2012,

in Washington, D.C., the Mexican government and the U.S. government signed the agreement for the exchange of information with respect to FATCA. The agreement entered

into force on January 1, 2013. However, the Mexican tax authorities have not established a mechanism for such an exchange of information with the IRS. By entering into the Agreement, Mexico has positioned itself as one of the countries with best practices in exchange of information according to the standards of the Organization for Economic Co-operation and Development (OECD) and the G20.

ConclusionThe number of countries with

exchange of information agreements will increase over the coming years. Financial institutions must assess whether they or their foreign branches will be subject to the provisions of FATCA. Foreign financial institutions should also be prepared for the administrative burden and the time and costs that this exchange of information will represent. Failure to comply with FATCA may result in a 30 percent withholding on U.S. sourced payments. q

practical international/media/files/videncenter... · 2013. 2. 27. · tax planning, public and...

Documents