Author: itsupport

The pole position – a blessing or a curse for FDI?

Posted on by itsupport

Slovenia’s business makeover has not been a bumpy ride experienced by other economies in transition at the beginning of the 1990s. Slovenian companies were a target for foreign interest as early as in the late 1970s thanks to Slovenia’s manufacturers of household appliances, cars and commercial vehicles, furniture and garments. Conveniently nestled between Austria and Italy, Slovenia has traditionally served as a gateway for exports to the discerning markets of West Europe even in former Yugoslavia.

Much has been done to boost the country’s attractiveness as a place to do business between Slovenia’s independence and today. The call for political action was backed within the framework of effort to become a full EU Member State and awareness that the Slovenian internal market was not fully integrated, which in turn meant a lack of competition in some sectors and increased operating costs for foreign investors.

Following the political consensus, liberalisation of the internal market has been built continuously since 2000 as the Slovenian economy become fully integrated with the EU economies, joined the EU in 2004, qualified for Eurozone and adopted the euro on January 1, 2007, and entered the EU Schengen in December 2007.

Adding value
Despite the country’s good economic performance, the government is committed to continuing efforts to improve micro-economic conditions to enhance GDP growth. This includes measures to increase competition by liberalising previously sheltered industries such as electricity, energy, telecommunications, and to dismantle administrative hurdles. In response to the critics quoting Slovenia’s excessive red tape and the shortage of land for industrial use, the Slovenian authorities got down to the business of changing the country’s business landscape attractive to foreign investors. Since 2000, registering a company in Slovenia has been greatly facilitated in many ways including electronic access to practically all public administration services, and the number of locations for property development and redevelopment to technological parks and economic zones has jumped.

When foreign investors consider locations to relocate or expand operations, the attractive tax regime of the eastern Alpine country bordering the Adriatic Sea is a reason to shortlist it. The present government deserves much of the credit for Slovenia’s tax reforms: a gradual corporate tax rate reduction aimed at promoting a pro-growth economy, phasing out of pay-roll tax, a relief on personal income tax. Tax allowances are in place for investment in research, technology and development, while greenfield foreign investment projects in manufacturing and sectors with high value added are eligible for financial incentives when they create new jobs. With tax revenue accounting for some 40 percent of GDP in 2005, Slovenia’s tax rates are lower than in many other European countries and converge with the EU27 average.

While traditionally taxes have been one of the key reasons for locating and investing away from home, transparent and stable political, legislative and administrative environment, the ease of getting about: good transport to airports, good rail links, availability of schools and good quality accommodation, as well as quality of life in general, should tip the scale in favour of Slovenia. The government’s ambition is to make Slovenia the leading European choice of international companies for locating international/European headquarters, an R&D centre, or a centre for administration and/or accounting functions. The government reforms have helped Slovenia’s economy increase its competitive edge and appeal to foreign investors without overheating the economy. Thanks to a wide-spread use of the first common financial reporting standard – IFRS – investors can compare statements produced in one country with those produced in another and exploit the advantages of mobile technology and broadband penetration where Slovenians themselves are early adopters both for business and private purposes. Today investors can benefit also from lower transaction costs arising from the single currency and the implementation of the Single Euro Payments Area (SEPA) where the current differentiation between national and cross-border payments no longer exists. This means that customers within the SEPA are able to make payments throughout the whole euro area as efficiently and safely, and above all at the same price, as in the national context today.

More ingredients for a recipe to attract FDI
Many Slovenians speak English, German and Italian and the Slovenian economy has all the attributes of an open and dynamic system without high leverage. Its budget revenues and expenditures are balanced, services generated 64.4 percent of GDP (2007 estimate) leaving industry behind (33.5 percent), gross fixed investment accounted for over 27 percent of GDP (2007 estimate), value added grew most in construction (well over 18 percent) followed by manufacturing (slightly more than 8 percent). Financial intermediation, trade and transport enjoyed high growth rates, and the only figure to spoil the picture of prosperity was the fact that in 2007 consumer prices increased by 5.6 percent.

In other words, the level of external debt is sustainable leaving room for more private equity and M&A activity. The Resolution on National Development Projects for the Period 2007-2023 lists several national projects worth some €24bn of which some €15m in private equity through public-private partnership.

In conclusion, although foreign direct investment (FDI) is generally perceived a source of economic development and modernisation, income growth and employment, it should truly be a ‘win-win’ situation for both the investor and the recipient country. Over the past seven years, Slovenia has established a transparent and effective enabling policy environment for investment and has built the human and institutional capacities to attract foreign investors. If its FDI stock appears modest in comparison with other CEE countries, it has something to do with the proverbial prudency of its people and their system of values where diligence and loyalty go hand-in-hand with creativity and innovation that are often key to the success of a business. A good pole position seems to make people more prudent and more environment-concerned. In the long run, it should be good for the investor and the host country.

Why invest in Slovenia?

A strategic location as a bridge between Western Europe and the Balkan States boasting strong levels of efficiency and productivity.

A well developed transport infrastructure both on dry land and through the sea port at Koper to serve some of Europe’s major transit routes.

A proficient and skilled labour force boasting a high degree of IT and technological prowess, from electronics to financial services.

All attributes to become a location of choice of international companies for international or European headquarters, an R&D centre, or a centre for administration/accounting functions

Slovenian Ministry of the Economy identifies development priorities
The priorities of the Slovenian EU Presidency in the field of energy, telecommunications and industrial policy – sustainability, competitiveness and security of energy supply with focus on the internal gas and electricity markets, renewable energy sources, energy technology and external energy policy. Energy and waste management offer a host of opportunities for foreign investors (PPP).

The Resolution on National Development Projects for the Period 2007-2023 lists several national projects worth some €24bn of which some €15m in private equity through public-private partnership.

The areas of wholesale and retail trading such as in electronics and garments, as well as consultancy services remain investors’ favourites, but further opportunities exist in sectors such as IT, pharmaceuticals, banking, insurance and telecommunications. Niche sectors and boutique companies may not be high-profile but thanks to specialisation stand to fare better than large household names that often lack flexibility in meeting customers’ needs. From electronic components to sailing boats, from racing skis to roulettes, from ultra-light aircraft to motor exhaust systems – these are some of the products ‘Made in Slovenia’ that do not fear competitors.

Efforts to improve macro-economic conditions to boost GDP growth and attract FDI have delivered the following preliminary figures for 2007:

GDP growth                    6.1 percent
GDP (at current prices)      €33,542m
GDP per capita                     €16,616
Exports growth                 13 percent
Imports growth              14.1 percent
Employment growth         2.7 percent

Showcasing Caribbean investment opportunities

Posted on by itsupport

The Ministry (MTI), Telecommunications Services of Trinidad and Tobago (TSTT) and RBTT Bank Limited have joined forces to sponsor the event, which is the flagship inward trade mission of the Trinidad and Tobago Manufacturers’ Association (TTMA

).

TIC 2008 takes place from April 30 to May 3, 2008. It is the Caribbean’s biggest business-to-business event, and includes a multi-sectoral 292-booth tradeshow, structured networking opportunities and a topical business education programme. A wide cross-section of companies from around the world will showcase goods and services to thousands of local, regional and international buyers – including specially organised trade missions and buyer delegations.

TIC is celebrating its ninth anniversary, and, says Minister Rowley, “has grown to become a critical nexus for business, trade and investment, providing opportunities for manufacturers and buyers, investors and financiers, suppliers, service providers, regulatory agencies, consultants and media operators to network, share ideas, and develop business partnerships. This productive, dynamic interaction is critical for our regional business sectors as we compete on the global stage.”

Spanning the sectors
TIC’s evolution in a very real way, reflects the growth, vibrancy and diversification of the economies of T&T and the Caribbean. What began as a small show, with about 30 exhibits devoted to manufacturing has grown into a massive display of regional business capabilities, spanning all sectors. For overseas exhibitors, buyers and investors, TIC offers a unique introduction to the warmth and culture of the peoples of the Caribbean and insights into the way business is done in the region. Central and South America are also major participants in the Convention, a direct result of the deepening of south-south ties.

TIC takes place in the Caribbean’s most dynamic (and fastest growing) market. Energy has powered Trinidad and Tobago to success as Caribbean’s largest and strongest economy (GDP Growth 2006: 12 percent). Today, it is one of the world’s leading energy producers, the world’s fifth largest producer of Liquified Natural Gas (LNG) and the largest provider to North America (T&T also supplies the US with 56 percent of its ammonia and 77 percent of its methanol imports). Now, propelled by this wealth of energy and leveraging its natural, geographic and human resources, T&T has embarked on an ambitious programme of diversification, partnering with businesses across the globe.

Trinidad and Tobago’s open and increasingly diversified economy offers an investment and business friendly environment, characterised by a stable political system, strong legislative and regulatory framework and progressive investment policies encouraging fair competition. The prospects for investors are boundless and they’ll all be on show at TIC’s new Investment Portal.

The bottom line: $350m-plus in trade in just nine years makes TIC a force to be reckoned with. From small transactions, to orders for containers of goods, to massive construction deals – just about every type of deal is done on the TIC Tradeshow floor.

Significant contact
Mrs Katherine Kumar, Managing Director of RBTT Bank Limited, says TIC “has brought tremendous benefits to our clients and our bank in the domestic market — with unprecedented value added in regional and extra-regional markets,” noting that that “it was through the Trade and Investment Convention that RBTT was able to make that significant contact which led to a vibrant merchant banking and corporate banking business in Costa Rica… Joining the Convention will pay dividends. A chance visit to your booth or a chance conversation can lead to new horizons for your business, as RBTT discovered with our Costa Rican connections.”

TSTT’s Chief Executive Officer, Mr Roberto Peon adds: “Trinidad and Tobago may be a relatively small landmass at the tip of south America but TSTT has worked hard to ensure that the country is plugged into to every major hub around the world and vice versa. The TTMA has also worked extremely hard to plug Trinidad and Tobago into the rest of the world and the Trade and Investment Convention is an excellent example of how communications enables the creation of a global village. The TTMA has continued to successfully network to bring together a diverse group of buyers and sellers from the Caribbean, North America, Central America, South America, Europe, and Asia.”

Specialising in economic analysis

Posted on by itsupport

It isn’t just corporate bombast. It’s a reality many US businesses have already witnessed. For many corporates, transfer pricing is the most important issue any large global business has to face up to during the next five years. Tax authorities – including Her Majesty’s Revenue & Customers (HMRC) – are getting tough with any company which may have pushed the envelope when it comes to clearly explaining their transfer pricing regime. But it’s also an environment where tough, intellectual rigour is increasingly valued says Dr Ted Keen of Ballentine Barbera, the US-based transfer pricing boutique specialist. “A lot of countries have already adopted the OECD Guidelines and the arm’s length principle into law, but though that gives countries the same basic rules, each country interprets the rules slightly differently. And you’ve got to remember that the OECD guidelines are just that – guidelines: there is no one correct transfer price! Producing economic evidence and analysis in support of your transfer pricing policy is critically important.”

Know your way in a changing landscape
The issue has certainly been underscored by Sir David Varney, former executive chairman of HM Revenue & Customs (HMRC). HMRC has taken a much tougher line with business, especially large operations. Varney repeatedly underlined that more resources were being ploughed into transfer pricing enquiries and would follow a clear action plan when not enough information is offered. “We’re expecting to see a lot more recourse to litigation generally,” says Keen, “especially in the UK. We’ve already seen a lot of action in the US, Canada and Australia. Certain types of companies, such as the largest drug companies, are being targeted. So the government isn’t wasting time on small fry. There’s a huge amount of money at stake.”

Litigation of transfer pricing matters is also quite a change in culture too. Tax authorities traditionally have had a close relationship with accounting firms – many tax partners in UK accounting firms got their start as tax inspectors. “So when taxpayers and their accountants go into negotiation with HMRC, they’re dealing with people who already know each other.” But with increasing prospects of litigation, lawyers are now starting to challenge the accounting firms’ dominance in the transfer pricing arena says Keen. ‘Law firms traditionally have been much more involved in the transfer pricing area in the US than in the UK. We’re now seeing law firms in the UK and Continental Europe getting more involved in transfer pricing. That has to give multinationals an advantage when it comes to litigation. Lawyers know the litigation process better. So the landscape is definitely changing.”

A more positive message
However, Ballentine Barbera’s Gerben Weistra says the EU is gradually developing a more consensual view on transfer pricing issues to prevent double taxation via the EUTP forum. In addition, “the OECD recently issued a paper suggesting changes to the 1995 guidelines. What they’ve done is incorporate some of the practices in the guidelines. You could say that there will likely still be differences in interpretation of transfer pricing regulations between countries, of course, but it’s becoming more about being less dissimilar than different, I’d say. In terms of transfer pricing, the EU has focused on the free flow of capital growth, taking away practical barriers to growth. . So it’s really about overcoming the differences at the theoretical side now.”

He says it’s useful to remember that many European countries are still working out their own transfer pricing initiatives. “Still, even if the now suggested changes are implemented some countries, of course, will interpret it to the letter, while others will be trying to find their own way with it.”

Weistra also says he is surprised some companies are still – within varying degrees – not aware of the huge financial ramifications as they should be. “Some companies still say things like ‘oh, our transfer pricing is audited out’, or they ‘don’t consider it a material issue’. Frankly, that surprises me.” He says some operations remain preoccupied with the process of transfer pricing issues, rather than the technical side and implementation of their policy. “Since Sarbanes Oxley, we see more people again who are interested about pricing procedures, and who is involved therein. They’re less interested in the technical side and implementation of a policy. But the process, actually, is not that different to what it was 10 years ago, although there are obviously new reporting rules for audit purposes. The key question however is about whether you have in fact a proper and consistent transfer pricing policy, how it is applied and communicated and what deviations might lie inside it. That is where possible transfer pricing corrections would arise.”

It’s also about getting a sense of where the legal argument really lies. For example, Greg Ballentine, a founder of Ballentine Barbera, has been involved in many landmark transfer pricing court cases helping build Ballentine Barbera’s reputation and invigorating debate on all the issues. Plainly it’s not about following tried-and-tested formulas that may have worked a few years ago. Something more demanding is now needed.

Imagining the future
So how will the role of transfer pricing develop? Dr Ted Keen thinks that Europe, including the UK, will need to get used to a great deal more transfer pricing litigation. “In the past, HMRC, for example, would have been quite reluctant to penalise tax payers and they would often give them the benefit of the doubt. But we’re seeing a lot more pressure from a variety of special interest groups who are interested in governance and how companies make their money. Just read the front page of The Guardian newspaper. You’ll see frequent challenges to multinationals’ transfer pricing practices to avoid paying UK taxes.”

Is there any way to avoid the expensive and lengthy litigation process? Some companies will certainly want to explore the use of advance pricing agreements (APAs) in greater detail. The advantages of APAs are simply certainty and consistency, especially useful for companies with less predictable audit cycles. Keen says the French government, for example, are increasingly looking hard at such arrangements. “There’s a lot of APA activity in France right now and certainly the French government seem quite eager to enter into APAs. The bigger you are, the easier it is to bear the fixed cost in terms of money and time. But others still prefer to handle transfer pricing issues if and when they arise under audit.” The Germans, on the other hand says Keen, have changed their transfer pricing rules slightly but significantly. “Germany is a very high tax country for business so many companies have attempted to scale back their operations there. The Germans don’t like this, of courses, so have implemented new rules on how they will look at supply chain reorganisation and disposals of business.”

Of course, it’s always quite a judgement call when considering your taxable footprint in one country compared to another. And a change your transfer pricing policy will inevitably upset at least one tax authority. But a rigorous examination of the facts and a thorough knowledge of your industry and market will help to support your case.

No right way
What are the key issues for transfer pricing going forward? Much of the real debate says Keen remains focused on intangible property and just where and how those after-tax profits are declared. “Much of the issue arises from licences to use intangible property, like patents or brands, to develop, manufacture and/or distribute goods or services. Where you incurred the costs and risks of developing your valuable intangible property will dictate where profits arising from those intangibles should be recorded. Multinationals who have a clear and well-documented strategy and policy for funding the development of their intangibles will be in much better shape than those who don’t. There is no one right way to do this, and what’s right for one might be completely wrong for another. It’s up to each multi-national to work with their economic and legal advisors to figure out the best strategy for them within the bounds of the OECD Guidelines. This will help them avoid costly litigation down the road.”

In other words, each case is different, and the OECD guidelines are just that – guidelines. “That’s why you need very tight economic analysis of your own operation and circumstances – that’s our specialty.”

New rules for Italian covered bonds – worth the wait?

Posted on by itsupport

The new covered bonds regulation provides for an exceptionally safe regime according to procedures set out in articles 69-70 of Royal Decree 2440 of November 18 1923. These ensure they effectively grant a transfer against the assigned debtor/public entity. This is done through:

1) Notification to the assigned debtor/public entity of the transfer agreement through a Court Bailiff

2) Acceptance by the assigned debtor/public entity of such transfer agreement) that would not be applied unless the agreement from which the receivables originate expressly sets out that, notwithstanding the new legislation, the procedure of Royal Decree 2440 still needs to be complied with to consider any assignment valid

Assets purchased by the SPV represent a segregated portfolio, which may be used by the originating bank as a guarantee for the originating bank’s issued bonds, or in connection with their funding when the SPV is remote from an insolvency.

The guarantee from the SPV must be irrevocable, payable on first demand, unconditional and independent from the obligations of the bank issuing the covered bonds. It will be also enforceable on the issuing bank’s failure to pay or on insolvency, within the limits of the assigned assets, on the basis of the bankruptcy remoteness of the SPV.

Receivables fall into several categories, such as:

Residential mortgage loans provided that the ratio of the value of the mortgages issued by the originating bank and any other mortgage on the same property to the value of the property (LTV) is less than 80 percent of the value of the property, if the assets are in the EU or Switzerland and the terms of any applicable claw-back periods have expired in the relevant jurisdiction.

 

Commercial mortgage loans provided that the LTV is less than 60 percent (if the assets are in the EU or Switzerland and the terms of any applicable claw-back periods have expired in the relevant jurisdiction).

 

Loans to all public administrations including ministries, public territorial entities and any other public entity or body – both national and local – of any member state of the EU or Switzerland, provided the risk weighting of exposures to that entity under the standardised approach credit risk capital requirements under Basel II is no higher than 20 percent.

 

Loans to public administrations of any non-member State provided that they must have a zero risk weighting in the case of central governments or 20 percent risk weighting in the case of public territorial entities and other non-economic public entities, both national and local.

 

Asset backed securities that represent no less than 95 percent of the value of the segregated portfolio and have risk weightings no higher than 20 percent, whose repayment is not subordinated to the issue of other assets in the same transaction.

New changes, new limits
Under the original 2006 provisions, in order to issue covered bonds the originator/issuer needed consolidated regulatory capital (CRC) of € 500 m, a CRC ratio of at least 10 percent and a consolidated Tier 1 capital ratio of at least 6 percent. These parameters were much criticized by the Italian Banking community as being too restrictive. But the final version of the Bank of Italy Regulation of May 2007 imposes a lower minimum CRC Ratio of 9 percent and accordingly it opens the market to the most significant national players.

These limits are defined as:

Banks with a CRC Ratio of at least 11 percent and the Tier 1 Ratio of at least seven percent face no limits to the amount of assets that can be transferred to the SPV

Those with CRC Ratio between 10 percent and 11 percent and a Tier 1 Ratio of at least 6.5 percent can transfer 60 percent of their assets to the SPV

 

Banks with a CRC Ratio between nine percent and 10 percent and a Tier 1 Ratio of at least six percent can transfer only 25 percent of assets to the SPV. The thresholds of capital position (CRC Ratio and Tier 1 Ratio) for each range must be met together. In case only one of the two ratios above is met, the lower range must be applied


Rating agency criteria risk
Most importantly, the new Italian legislation appears to be in line with the criteria envisaged by rating agencies. Fitch has identified four key areas that need to be considered (and the relative weights to be given to each) when measuring the risk that payments owed to investors might be interrupted in the event of an insolvency of the issuer. They are as follows:

1) Segregation of cover assets backing the issues of covered bonds from the bankruptcy estate of the issuing financial institution (50 percent weight) – under the new Italian legislation, asset segregation is achieved by the transfer of the assets to a bankruptcy remote special purpose vehicle acting as a guarantor of the issued covered bonds

2) Alternative management of the cover assets and the covered bonds (15 percent weight) – the legislation provides that in the event of the issuer’s mandatory winding up (liquidazione coatta amministrativa) the SPV shall represent bondholders vis-à-vis the issuer

3) Liquidity gaps between the respective amortisation profiles of the cover pool and the covered bonds (30 percent weight) – the Bank of Italy’s prescriptions provide that the net value of the segregated assets must be at least equal to the net value of the covered bonds and that interests and other revenues generated by the cover pool must match all the costs due on the covered bonds; also, the supervisory legislation introduces specific strategies of asset and liability management for banks to follow in order to bridge potential maturity mismatches

4) Dedicated covered bonds oversight (5 percent weight) – the Bank of Italy imposes specific transaction guidelines and will supervise banks implementation as part of its overall mission to safeguard the stability of the domestic banking environment.

Strict asset segregation satisifies Fitch
Fitch expressed a favorable evaluation on the Italian covered bond regulation in its last research report, published at the end of last January 2008. In particular, Fitch expressed satisfaction for the assets segregation mechanism provided by Italian regulation. Given such strict asset segregation mechanism, Fitch states, “a high degree of credit is given to the ‘true sale’ transfer of the assets to the SPV. In fact, in the case of issuer insolvency, this segregation mechanism will allow,” continues Fitch, “to grant the repayment of the covered bonds holders through the covering assets and the cash flows deriving from them.”

A favorable opinion is expressed also with reference to the supervision role assumed by the Bank of Italy (BoI) in respect of the covered bond issuance. On this point however, Fitch points out that while BoI is the first regulation authority on covered bonds which imposed specific insolvency limits for prospective originators, the Italian framework is less detailed and prescriptive than in some other European jurisdictions, in particular with respect to the ongoing surveillance of asset and liability management. In fact, although there is a generic requirement that issuers have to report to BoI on the proposed management of maturity mismatches and on the system in place to control specific risks, there is no specific provision for a regular audit by BoI to take place, nor is any reference made to stress testing under different scenarios.
Positive feedback sets the tone

The general evaluation made by rating agencies on the Italian covered bond regulations certainly seems positive. The new regime appears to be characterized by a high level of innovation, both legally and commercially. It has introduced liquidity safeguards and robust strategies of asset and liability management designed to maintain a balance between protecting the interests of creditors and the creation of a potentially large covered bond market.

So, when can we expect to see the first Italian covered bond issuance? Due to the recent news in the financial markets – Banca OPI has officially announced its plans to launch a public sector backed deal while UBI Bank recently communicated to have mandated Barclays Capital to arrange its program – maybe by the end of 2008. Meanwhile the foundations for growth have been laid and the future of the Italian covered bond market seems much brighter.

For further information:
Tel: +39 06 362 271
Email: mbaldissoni@tonucci.it
Website: www.tonucci.it

Adding attraction

Posted on by itsupport

Since its inception, the Firm has been advising clients with an international focus, on tax, legal, and accounting matters and whilst the firm has grown considerably since its formation, many of its people have been with the firm since its early years. Umberto Belluzzo comments: “Foreign investors in Italy face with the particularities and complexity of the Italian business framework together with the dominant ‘family business’ structure of Italian Industry. We work alongside these investors to bridge and facilitate their understanding of Italian industry.”

“The various issues that our clients face and the multi-faceted nature of our own service offering, led the business to evolve into the functional structure that it is today, with eight departments each of which, is led by an associate.” says Luigi Belluzzo, managing partner of the Firm.

Overseas office
The Firm has strong experience in assisting Italian companies with the process of internationalisation. The Firm soon identified a need for an overseas office an opened an office in London’s St James’ headed by Alessandro Belluzzo. From this base in London, Alessandro Belluzzo consults on Internationalisation and, on Foreign Investments in Italy, commenting: “From London we coordinate an international network of 100 correspondents in major markets and business centres around the world and work with European and Asian Private Equity , looking to invest into Italy and the Italian brand.”

The Firm maintains a classic tax&legal approach which enables the international investor to achieve results in the Italian market, also advising on legal matters such as contracts, company law, tax law and M&A operations.

“Our understanding of the Italian market, the family businesses that preside over much of it, and our strong relationships in Italy are of relevance to foreign investors who upon entering the Italian market, need to consider cultural factors and the existing driving forces in place as much as the pure logistics.” Francesco Lombardo who leads Corporate Law Counselling department says.

Having worked on numerous deals with foreign investors, private equity funds and Italian investors, Luigi Belluzzo says “Our policy is to maintain strict privacy; we seek to ensure where possible, that deals emerge when clients wish them to” adding further: “Perhaps today more than for many years, the way a Firm behaves in Italy and the trust it is able to command, is of fundamental importance. We pride ourselves on the high standing that we have built over time with our colleagues, banks and financial institutions as well as other professionals and entrepreneurs within industry.”

The Firm’s professionals are highly trained and have strong capabilities and qualities that they bring to the firm. We encourage involvement in the wider community through publishing of opinion and articles and teaching activities. Many of the firm’s associates are linked with Universities and professional bodies (eg IFA, STEP) and regularly publish articles in the key trade and industry journals on tax&legal matters, M&A, Estate Planning and more.

The Italian Budget 2008
The following measures announced in the recent Italian Budget can be seen as having created a more favourable tax environment in Italy:

Corporate taxation: For tax periods starting from 1st January 2008 onwards, the corporate tax rate (IRES) is reduced to 27.5 percent (previously, 33 percent), and the regional income tax rate (IRAP) is reduced from 4.25 percent to 3.9 percent

PEX Regime: From 2008, the exempt portion of capital gains on shares realized on years starting from 1st January 2008 onwards is increased to 95 percent (previously 84 percent). The holding period requirement is reduced from 18 months to 12 months.

Extraordinary transactions: The proposed rule, relating to the applicability of a substitute tax of 18 percent payable on goodwill derived from extraordinary transactions, has been amended as follows; in the case of contribution of going concern, the receiving company may elect to apply a substitute tax in order to obtain the step-up of the fiscal value of the assets received. The step-up is available also on the assets received by way of merger or de-merger. The substitute tax applies at the rate of 12 percent, 14 percent and 16 percent depending on the amount of the revaluation: up to €5m, from €5m to €10m, more than €10m, respectively.

The revaluation is disregarded if the stepped-up assets are disposed before the end of the subsequent four years. The new provision applies for tax periods starting from 1st January 2008 onwards.

Application of IAS: The 2008 Budget introduced a new provision, applicable to companies drafting their financial statements under the IAS, stating that the criteria set forth by International Accounting Standard (IAS) are relevant for IRES purposes. In particular, the qualification, timing of accrual and classification of items pursuant to IAS is valid also for IRES.

Stefano Barone, head of Accountancy, Tax and Compliance Advisory, comments: “This measure can be regarded as a positive move for foreign investors into Italy and I am optimistic that we may see further such enhancements in the future”.

Emanuele Lo Presti who leads the M&A, Governance and Corporate Reorganization team comments further on the Budget 2008: “Systematic (fiscal) changes aside, there are still some challenges for the domestic Italian market namely, in opening up to a more international and global environment. This is where we seek to assist clients both Italian and overseas clients by both making the ‘unknown’ more familiar in both a cultural and practical sense, and crucially providing the tax, legal and accounting framework to facilitate cross border deals.”

Investments and trusts
During the last year new rules have been introduced which have modified the Italian stance on the taxation of trusts. The most important of these, was the new legislation regarding the residence of some international trusts that are administered in countries ‘blacklisted’ under Italian tax law (e.g. Guernsey, Jersey etc.), with Italian resident settlors and beneficiaries.

What this means is that where an Italian resident is asked to prove that the trust’s main activities are indeed managed in the country where that trust is resident, there is a potential loss of confidentiality. Where the residence status of the trust is not sufficiently proven, the trust would be treated as ‘Italian resident’ with Italian tax rules therefore applicable.

Alessandro Belluzzo comments: “This change is significant not least because the Trust is commonly used to hold real estate property or Italian companies. We have advised several clients on the impact of these new rules some of whom, have taken the option of moving the trust’s residence to a ‘white-listed’ country in order to avoid the potential requirement for exchange of information and loss of privacy.”

Even given this change though, Italy is by no means a hostile environment for trusts. Indeed, another very notable recent statement on the taxation of trusts was the clarification of the direct tax-exempt status of distribution capital received from a trust, by an Italian resident beneficiary. This was the first time that this had been explicitly clarified and this move, together with a low (between 4-8 percent) indirect rate of tax on distributions by a trust, represents a favourable tax environment for trusts in Italy.

Luigi Belluzzo comments; “There have been considerable moves to take up Italian residence in recent times. The above development in the taxation of trusts, together with the generally low taxation (12.5 percent in some cases) on financial income for Italian residents represents a welcome environment. Any less than positive changes in other tax regimes in Europe – the recently proposed taxation changes for non-domicile in the United Kingdom being one example – may add further to Italy’s attractiveness in this respect.”

Tax reform seeks to attract more investment to germany

Posted on by itsupport

Transferring money abroad became a tradition for Germans after World War II. Political instability forced many to divert their assets toward more secure holdings. The post-war revival that followed saw Germany climb the ranks of the world’s strongest economies, but it failed to stem the outflow of cash altogether. The reason: tax rates – among the highest in Europe. But things have just got better for Germany.

Large-scale tax reforms came into force on January 1, 2008. The German Parliament’s decision – criticised in many quarters as not going far enough to enhance economic development – could have a major impact. Domestic businesses and foreign investment should benefit, but there are doubts over whether the reforms have gone far enough.

The 2008 Company Tax Reform Act was essential for many reasons – not least to make Germany more internationally competitive. In the broadest sense, most believe this is where the government has succeeded. The decision to reduce the corporate tax rate from 25 percent to 15 percent is the key. RP RICHTER&PARTNER – one of Germany’s leading tax, audit, accounting and legal service consultants – provides tailor-made solutions to clients with an international approach.

Managing partner Wolfgang Richter, a former senior partner in and head of the tax department at Ernst&Young Munich, welcomes the positive change, but has mixed feelings about other aspects of the reform. “In our opinion the Company Tax Reform Act 2008 is an important step towards a more internationally competitive tax environment in Germany,” he says.

“However, a simplification of the German tax system, which had been planned, did not become reality.”

Complex legal system
If reducing the corporate tax burden was seen as crucial to Germany’s competitiveness, tackling the complex legal system was one of the several requirements that failed to materialise. But it was not all bad. Some simplification was realised following many months of consultation and talks between experts on all sides.

The non-deductibility of the trade tax as business expense, from the trade tax basis and the corporate-income tax basis, was one such benefit. This non-deductibility had no significant impact on the trade tax burden, because the general multiplier to calculate the taxable amount was decreased from 5 to 3.5 (the abolishment of the progressive tariff of the general multiplier for partnerships and sole proprietorships could have an impact on the trade tax burden, but this change will only affect small businesses).

The improvement of this method was that deductibility of the trade tax was such a complex calculation issue. But German tax reform 2008 has been as much about missed opportunities as improvements.

The failure to abolish trade tax – seen as major step towards simplification – is generally perceived as a serious flaw. There is little doubt the predominance of the municipalities, and the anticipated loss of local tax revenue, forced legislators to think again. Numerous transition rules between the old and new also conspired to undermine the anticipated move from old to new, according to experts such as Richter.

His firm operates fully integrated tax, audit, accounting and legal services.

Recognised as one of the leading consultancies in Germany, especially in the tax business (see rankings of JUVE, Legal 500, Tax Directors Handbook and World Tax by International Tax Review), the company has a unique insight of the challenges facing the business sector.

“After much deliberation, the German tax authorities, including the Ministry of Finance, became anxious because they could not calculate the impact of tax revenue loss from the transition rules,” he explains. “Fearing significant losses could have resulted in tax base, simplification failed to materialise.”

Draft publication
Many had feared the worse during the long months leading up to publication of a final draft and the Act being formally adopted by the Bundestag and Bundesrat. Concerns were not just limited to matters of trade tax. Worries surrounded the thin capitalisation rules (so called interest-barrier rule,) which apply not only to shareholder loans but also to any bank loan. The new rules are seen as a significant limitation for high leverage buy outs/investments.

“The tax legislators listened, but made only few changes,” says Frank Schönherr, tax law expert and another founding partner of RP RICHTER&PARTNER. “New rules for shifting of functions and transfer pricing brought quite some disturbances, especially the question of whether the doubling of functions is a taxable shifting of functions.” But while changes to the final draft were small, some amendments were a surprise.

One example was the interest barrier rule. Many businesses successfully raised concerns about the rule, leading to a change. The draft had been tied to the EBIT, but by the latter stages of the legislation process it was aligned to the EBITDA. This led to a higher amount of deductible interest expenses (30 percent of EBITDA is deductible interest expense).

Winners and losers
So who were the major winners and losers from reform? There are two groups of taxpayers that are expected to benefit most:

Low debt financed domestic corporations;
Foreign corporate entities.

The first, benefits most from the reduction of corporate tax rate, which was lowered from 25 percent to 15 percent. Taking the trade tax burden into account, the average corporate tax rate was reduced from about 40 percent to 30 percent varying from 23 percent to 33 percent depending on the municipal rate fixed by the municipality (´Hebesatz der Gemeinde´).

Foreign corporations could do even better. Non-resident corporations for example, holding German real estate (PropCos), could under some circumstances be free of trade tax. They will have to calculate with an aggregate tax burden of 15 percent instead of 25 percent. And the losers: highly debt financed companies with low income. This is primarily due to the interest-barrier rule.

“The so called German ‘Mittelstand’ could also be loser of the reform if they do not adjust their structure to the new rules,” says Schönherr. “The Mittelstand is organised generally as the partnerships. “The partnership is liable to trade tax, the individuals holding an interest in the partnerships are liable to income tax. The progressive tax tariff had been increased from 42 percent to 45 percent (so called Rich Tax).” No compensation has been introduced for this increase despite earlier reassurances by the government. To equalise the tax burden of partnerships and corporations, the tax reform introduced a special tax rate for retained earnings of partnerships.

However, if these monies are distributed, the aggregate tax rate on the income derived from the partnership is higher than the taxation of income derived from the partnership at the new top tax rate of 45 percent (plus solidarity surcharge, plus church tax, if any).
Estimates over whether the reforms will result in an aggregate rise in total tax revenues remain in the balance.

“It cannot be excluded that the counter financing of the tax rate reduction through broadening the tax base (new thin capitalisation rules, new add-backs for trade tax purposes) could lead to a higher aggregate tax revenues in total,” explains Schönherr. “But the government is of the (official) opinion that the broadening of the tax base equals the lowering of the tax revenue, resulting from the reduction of the corporate tax rate finally.”

Although Schönherr agrees the impact of reform is likely to be positive, he warns it is impossible to rule out the possibility that broadening might have a negative impact on key sectors of the economy. Real estate investors and real estate leasing companies in particular could suffer from the new interest-barrier rule and the new add-backs for trade tax purposes, he says. Highly leveraged investments are likely to be affected negatively too.

Thin capitalisation rules
There is less doubt about the ‘negative impact’ of the new thin capitalisation rules. When European courts issued a ruling in 2002 declaring German thin capitalisation rules contrary to law, change became inevitable. The first solution of the tax legislators after the Lankhorst-Hohorst case in 2002 was to broaden the scope of application by including loans from domestic shareholders. Due to problems with these early amendments, the Company Tax Reform Act 2008 introduced additional changes to thin capitalisation rules.

The new system applies to any loan irrespective of the status of the lender, as a shareholder or not, and irrespective of whether the lender is a domestic or a foreign one. The effect is that general loans could lead to the non deductibility of interest expenses, according to Claus Lemaitre, international tax partner at RP RICHTER&PARTNER.

“In our opinion many of the unsolved application problems of the old thin capitalisation rules will still arise by the application of the new thin capitalisation rules,” says Lemaitre. “The new rules have a negative impact on the economy in Germany in our opinion because a tax burden could arise even in cases where no positive income is earned by the company.”

The application of the new thin capitalisation rules, flawed or otherwise, meant the legislators did make a significant step towards preventing a shift of interest to foreign countries. But alongside the changes of the add-backs on trade tax, thin cap’ rules will have the most affect on how companies operate in future.

Worrying changes
Changes of the rules regarding the loss of loss carry-forwards have proven a worry too. “This new rule will lead to many unexpected tax issues in the M&A and restructuring context,” Mr Lemaitre says. The write-offs of shareholder loans were ruled by changes of the Tax Act 2008 ‘Jahressteuergesetz 2008’.

In many cases shareholder loans can no longer be written-off. The German tax authorities’ description of this ‘change’ as a ‘clarification’ has not been universally accepted.

“In our opinion and in the opinion of many other tax practitioners the change is not a clarification but the implementation of an unfavourable new rule,” Mr Lemaitre explains. The legislators will perhaps demur, arguing their reforms have certainly made Germany more attractive to overseas companies looking to invest. As for the domestic market – despite the reform set backs, 2008 could be the year that sees the Germany economy out perform some of its rivals.

For further information:
RP RICHTER&PARTNER
Phone: +49 (0)89 55 0 66 – 310
Website: www.rp-richter.de

Getting his house in order – Peter Panayiotou

Posted on by itsupport

What are the main challenges of Islamic banking – and for GFH currently?
I would say that there a number of principal challenges. The first is the need to create liquid capital markets for Islamic financing instruments such as Sukuk. This requires market makers with sizeable balance sheets to come forward to create liquid markets where bid and offer spreads are narrow and tradable. Secondly, the industry needs to develop a wider suite of acceptable ‘derivative’ products that allow banks and market participants to buy or sell exposure to assets with a risk profile that permits effective hedging or mitigation of risk. This will require banks to come forward to offer such products on an ‘over the counter’ basis or to create a liquid market with narrow spreads. Thirdly, there must be standardisation of structure and legal documentation for Islamic financing instruments. Finally, the industry must do more to promote the ethos of Islamic banking around the world so that misperceptions are avoided. The main challenge GFH faces is the one that all banks in the Gulf face when they are poised to grow and reach the next level. That is the lack of people in the labour market of the Gulf with the right investment banking and investment management experience. Accordingly, we have retained some of Europe’s top headhunters to help us in our search for the right talent. Recently, I have been greatly encouraged by the high quality of professional staff that have indicated a strong interest in joining GFH. Certainly our listing on the London Stock Exchange has done a lot to strengthen our image outside the GCC.

Given the turmoil of international markets, is GFH still looking hard at private equity and asset management?
Yes we are. We have a very strong niche in economic development infrastructure but our strategy is also to build up our asset management business and our European private equity and Gulf-based venture capital businesses as well. We see very good value creation opportunities in all of these businesses in the medium term. Recent volatility in the quoted securities markets has no direct bearing on these businesses in the longer term. Short term volatility comes and goes. Markets have a habit of retracing after a period of sustained rises. You only have to study price charts to see this happens all the time and is to some extent predictable. I am pleased to say that we have made good progress building our businesses with the completion of some high profile recruitments. Also, the Board of Directors of GFH have recently approved a suite of asset management products to be offered this year. As for our venture capital business, it is already making a substantial contribution to the bank’s profits.

What is your ongoing strategy for developing new Shariah compliant products and services? What are the key areas?
Our marketing strategy is client centric. This means that we seek to meet our client’s demand rather than allow the business to be product driven. Accordingly, we will continue to meet our clients’ very strong demand to invest in Shariah compliant economic infrastructure projects located in the rapidly developing economies of the GCC, MENA and Asian countries. In addition, we will continue to analyse our clients’ demand for products in venture capital, private equity and asset management.

Do you look at Europe as a potentially promising market for Islamic banking?
Certainly – and our listing on the LSE and the listing in London of our $200m Sukuk issue are testament to that. Our presence in London’s equity and debt capital markets has given us a great deal of exposure to the UK and Europe. The establishment of our new London office will be formally announced in a few weeks and this move reflects the opportunities we see in Europe for our asset management and private equity businesses. The British government is trying to position London as the European hub for Islamic banking so, logically, this is where we should be. More generally, my view is that Islamic investment banks are behaving much in the way the old European ‘merchant’ banks used to do. They enter into partnerships with their clients to create businesses and promote and participate directly in commerce and infrastructure. I believe that ethos will be in great demand in Europe and even the US.

Where do you feel Islamic banking should be investing to maximise returns?
The simple answer is wherever value can be identified or created. The GFH approach to investment is to create value. If you look at our activities you will see that a high proportion of our deals are in the nature of ‘start ups.’ However, we lock in value very early in our deals and that helps to reduce the risk we and our clients face in the deal. In terms of geography, we are still bullish on the GCC and the current wave of redevelopment but we prefer projects with specific economic drivers rather than speculative deals. There is value in India if you can find the right local partners. There is also good potential in North Africa but again that depends on delivering the right deal with the right local partners. I would avoid going long on mainstream American and European equity markets right now. In my view there remains a strong possibility of some further falls or sideways action. The GCC equity markets look stronger but I don’t think we have tested the highs sufficiently to say that they will continue to rise.

Some accuse Islamic banking of focusing too much on their own product rather than the needs of investors. What is your response?
I don’t think this is fair. It may be true of some banks but GFH’s strategy is based around the client – our most important business asset. We have introduced sophisticated customer relationship management systems to enhance our capability and ensure that our clients’ needs and preferences are recorded. We know that without our clients we have no business.

How dependent is the growth and success of Islamic banking on the effect of high oil prices?
The price of oil has a direct effect on the amount of liquidity available for investment. So the answer is yes there is a direct connection between oil and the growth of Islamic investment and financing in the Gulf countries. Having said that, the surpluses that have been created so far need to be invested. In practical terms a gradual and gentle fall in the price of oil will not have a dramatic effect on Islamic banking in the short to medium term.

How actively does your organisation promote women in the workforce?
Only talent and commitment to our business determine one’s place in GFH. We employ many women as well as many races. Our objective is to employ the greatest talent we can find, irrespective of gender, age, ethnicity or creed.

What do you say to critics that claim Islamic bankers do charge interest – something Islamic law specifically prohibits – though they conceal it through clever legal formulae?
Islamic banking is a relatively new sector and perhaps this leaves it open to misinterpretation.  Of course the primary reason for its very existence is the need to provide Shariah compliant financial products and services to Muslim audiences. One of the guiding principles of Islamic finance is the complete prohibition of interest charges and GFH employ an extremely eminent board of scholars to make absolutely certain all our products and services comply with the Shariah. So I’d encourage those who are still of the view that Islamic bankers are applying interest charges to look a little closer at the intention behind the product.

Iceland cometh?

Posted on by itsupport

Although traditionally better known for its hot springs, fishing and whaling industries, Iceland has steadily transformed itself into a financial powerhouse in the last 20 years. Icelandic investment firms have continued to buy up, for example, significant tranches of the UK retail High Street. Icelandic investment firm Baugur and FL Group now own House of Fraser and MK One, for example and is now tipped to buy Debenhams.

Iceland’s business turn-around is reflected in the former state-run banks which have all been privatised. Prosperous, well-run Icelandic businesses have increasingly been forced to look overseas for M&A targets, given the lack of appropriate targets at home. Hence the slew of Icelandic companies and investment houses chasing cross-border deals.

The UK, unsurprisingly, has been a target for much of the cross-border interest: many Icelanders speak English and the UK economy is one of the most open and dynamic in the world. So Icelandic-Brit deals look unlikely to abate, especially if UK interest rates continue to slip, as looks likely. According to a recent survey by M&A intelligence and research service Mergermarket, more than half of senior Icelandic managers are considering a deal in the next 12 months.

Iceland’s economy though is one that’s increasingly highly leveraged with significant levels of external debt thanks to the large amounts of M&A and private equity activity. Which means the economy has, to say the least, sizeable imbalances and therefore remains vulnerable to economic crisis. The diminutive population means that the financial players generally are likely to know each other and there’s an abundance of cross-company ownership.

Iceland’s racy makeover
So, what is behind Iceland’s makeover from grey, dull fish exporter to hot tourist spot and international financial mover and shaker? At first glance, Iceland remains a country riddled with contradictions. It is not a low tax economy. Its aggregate tax burden is roughly 40 percent of GDP, significantly higher than the UK and the US, though lower than many other European countries. More revealingly however is Iceland’s corporate tax rates are low at 18 percent. Although this is not quite Ireland or Hungary territory (12.5 and 16 percent respectively), it’s still impressive.

Former Icelandic prime minister David Oddsson, who oversaw much of Icelandic’s key economic reforms in the 1990’s, has to take much of the credit for Iceland’s economic rejuvenation. Corporate rate reductions were slashed in order to promote a pro-growth economy; wealth taxes were abolished and a flat tax rate was also forced through. Widespread financial de-regulation followed.

Domestic investment firms have been astute in making the most of Iceland’s economic comeback, embracing cross-border opportunities. Despite high interest rates, many Icelandic investment companies in the 1990’s were able to borrow money from countries with lower interest rates before depositing this cash on home ground, allowing them to quickly build up reserves. Meanwhile, old state-run industries were also being privatised, with new property rights created.

Iceland’s re-vamp has also been helped by environmental issues and concerns. Blessed with a super-abundance of hydroelectricity and geothermal power sources, Iceland is now actively looking at ways it can export hydroelectric energy to mainland Europe. Icelanders themselves are early adopters of mobile technology and broadband penetration is amongst the highest within the OECD.

Still fiercely independent
Today, Iceland’s economy looks generally highly robust: unemployment rates are one of the lowest in the world. Oddities remain though: Iceland is not a member of the European Union, nor does it seem much interested in joining. This is premised on the concern that Iceland would have to give up control over much of its natural resources, including fishing grounds, were it to join. Given Iceland’s booming economy and high growth curve, there seems no pressing urgency – at least for the moment – for it to join, so say Iceland’s powerful anti-EU lobby.

On the other hand, pro-EU Icelanders point to Iceland’s formidably high cost of living, even by central London or Scandinavian standards. Rising Icelandic inflation continues to make imports expensive. However, Iceland is a member of the European Free Trade Association and in 1992 Iceland became a member of the European Economic Area, allowing Iceland – and other countries including Norway – to join in the EU single market without formally having to join the EU.

Another hot issue is the unwillingness by Icelanders to give up sovereignty to Brussels. It remains a fiercely independent nation as well as an increasingly wealthy one: according to the Organisation for Economic Cooperation and Development (OECD) and the International Monetary Fund, Iceland now ranks as the world’s fifth-richest nation.

FDI remains patchy
Iceland’s own internal FDI – most of it from Europe and the US – is rather muted in comparison with its strenuous investment efforts overseas. However, plenty of FDI has been channelled towards Iceland’s own IT and software industry. It’s estimated since 2003 around $800 million has been invested. Some significant FDI investment in Iceland’s aluminium industry has also taken place.

Supporters of Icelandic FDI point to its strong levels of efficiency and productivity (amongst the highest in the world) and one of the lowest corporate tax rates in the world (18 percent), as well as its strategic location as a bridge between the US and Europe. Tax benefits to overseas investors includes no net wealth tax, no legislation on thin capitalisation; there’s also no branch profits taxes on repatriated profits.

Iceland’s legal market remains small. There are no large international legal players based in the capital Reykjavik and most domestic law firms focus on dispute resolution and family law. However, specialty legal work is booming, helped by the buoyant corporate M&A market.

Tourism ramping up
Away from the business news headlines however, Iceland’s economy – an odd mixture of capitalistic market economy supporting an extensive welfare state – is still strongly dependent on the fishing industry. In recent years, Iceland though has cottoned on increasingly as a tourist destination, particularly with eco-tourists and whale-watching.

In 2006, Euromonitor estimated tourism accounted for more than six per cent of Iceland’s gross domestic product. The main attraction for tourists is the unspoilt nature of much of its glaciers, lakes and lava field.

Although whale watching has also proved popular, Iceland is increasingly popular with adventure tourist and farm holidays. However, extreme seasonality means the tourist industry has to be flexible and focused. There also remains concern about the possible resumption of commercial whaling – and the impact this could have on Iceland as a green or nature lovers holiday destination. There is also a question mark about just how successful Icelandair is likely to be in developing its network and also being able to maintain growth.

Real estate prospects remain positive
Icelandic real estate roughly doubled between 2001 and 2007. The average price of an apartment ballooned from almost ISK 15 million in 2001 to beyond ISK 30 million by the end of 2007. Recently, as in the US and in some parts of Europe, there has been concern about falling price inflation, however the Icelandic market appears, so far, robust.

House prices are forecast to stay more or less at a standstill in 2008, due to tighter access to loans and a cooling labour market, followed by an uplift in 2009 when interest rates are anticipated to fall again.

Iceland’s mortgage market, like its banking market, has become more liberalised over the years, resulting in wider access to credit and borrowing, stoking demand and prices.

Summing up
Perched at the top of the Atlantic, Iceland is a tricky country to summarise. There are some glaring contradictions: despite relatively high rates of personal taxation, corporate taxation is amongst the lowest anywhere. Despite close ties to Europe and Scandinavia, it is stubbornly independent of Brussels. Although Iceland has an abundance of cheap, green energy, it has few natural resources. And though Iceland can claim a high degree of IT and technological prowess, from biotechnology to financial services, it still relies heavily on its ages-old fishing industry to provide 40 percent of its total exports. It also belongs to NATO, but has no armed forces (it declared itself a nuclear-free zone in 1985).

Meanwhile Iceland’s centre-right government, led by Geir Haarde, head of the Conservative Independence Party, continues to steer a delicate path of avoiding overheating the economy while promoting a high standard of living. Per capita GDP is estimated at more than €25,000 and Iceland’s pension system is well capitalised.

Iceland fact-box
Population: 312,000 people

GDP total: $18.4bn

GDP growth (2007): 2.6 percent

Inflation rate (2007): 4 percent

Budget (2007) $6bn

Unemployment: two percent

Net public debt: 17 percent of GDP

OECD debates globalisation; WTO agreements

Posted on by itsupport

The valuation of related party transactions, i.e. of transfers of goods, services, intangibles or funding among members of the same multinational enterprise, is not necessarily an exciting topic for managers: in today’s world, multinational groups want to act globally, and transfering resources from one member to another member of the family is not where the focus of the attention should be ‘business-wise.’

But another reality of today’s world is that governments are not global and that direct and indirect taxes are assessed and levied domestically. Beyond differences in tax rates there are a number of reasons including cash repatriation strategies that may explain why it is not neutral for an MNE group to earn its profits in one country or another.

In addition, a number of industries such as the pharmaceutical industry or the financial industry have to deal with strict domestic regulatory requirements and are affected by the valuation of their intra-group transactions. Furthermore, corporate law, rules that protect creditors and labour law may all require, to a lesser or greater extent, that each member of an MNE group be treated as a separate legal entity and, as a consequence, that the terms and pricing of transactions with other parts of the same group be determined independently of the special relationship that exists within the group.

In fact, it is ironic that, with the development of global business models, cross-border transactions between related parties play an increasingly significant role in world trade and economy. While businesses develop operating models that tend to abolish the borders, governments see increasingly important revenue stakes in cross-border flows and tend to reinforce their control over transfer pricing compliance through transfer pricing regulations and audits, with a view to protecting their tax base while avoiding double taxation that would hamper international trade.

A phenomenon
One difficulty arises from the existence of various sets of rules and enforcement agencies looking at the valuation of related party transactions. One obvious example of this phenomenon is found in direct taxes (transfer pricing rules) and customs duties. For direct tax purposes, a higher transfer price may reduce the taxable income in the country of importation and increase the taxable income in the country of export. But for customs purposes, the lower the transfer price, the lower the customs value and the applicable customs duties. Hence, inevitably, there can be some conflicts of interest or contradictions between customs and revenue authorities within the same country, or between the direct tax department and the department in charge of customs duties within the multi-national group. (This, again, irrespective of the possible effects on other aspects such as the price of regulated drugs or the amount to be contributed to employee profit sharing by a particular entity of the group.)

Let’s have a look first at the applicable principles. Direct tax authorities tend to follow the arm’s-length principle and OECD transfer pricing guidelines for multinational enterprises and tax administrations which set the international standard for transfer pricing. Customs authorities apply the relevant provisions of the WTO Customs Valuation Agreement (the WTO Agreement). As a basic principle, both sets of rules require that an ‘arm’s-length’ or ‘fair’ value be set for cross-border transactions between related parties and associated enterprises. That is, the transfer price must not be influenced by the relationship between the parties or it must be set in the same way as if the parties were not related. However, there are significant differences in the application of this broad principle in relation to such major factors as policy objectives, operational functioning, timing of valuation, valuation methods, documentation requirements and dispute resolution mechanisms. Furthermore, it is often the case that two administrative bodies assess or review the valuation of cross-border transactions.

Unnecessarily complicated
The business community has explained on several occasions that the existence of two sets of rules, and, in many countries, of two different administrative bodies to deal with direct taxes and customs duties, can make cross-border trade overly complicated and costly, contrary to the objectives of the international organisations and national governments concerned. Does this situation make sense from theoretical and practical perspectives? Is there a need for greater convergence of the two sets of rules? If so, what should be the conceptual framework at national and international levels?

It is obvious that, while common purposes and similar concepts exist in international transfer pricing and customs valuation rules, there are also significant divergences. Tax and customs authorities are not obliged to accept a value that is calculated in accordance with each other’s legislative requirements. MNEs need to comply with obligations under both tax and customs legislation and regulations as well as other regulatory requirements where applicable.

In May 2006 and 2007, the WCO and the OECD held two joint international conferences on transfer pricing and customs valuation of related party transactions. The common objective of the two organisations was to provide a platform for public and private sector representatives to collectively explore, and attempt to advance, the issues identified and to encourage global coordinated efforts among business and governments, tax experts and customs specialists.

At those conferences, two schools of thought emerged on the desirability and feasibility of having converging standards for transfer pricing and customs valuation systems. The first was made up of those who viewed convergence of rules as highly desirable and largely feasible, pointing out that a credibility question does arise if two arms of the same Ministry can come up with different answers to virtually the same question (what is the arm’s-length / fair value for a transaction?), and that the current situation results in greater compliance costs for businesses which must follow and document two sets of rules and greater enforcement costs for governments which must develop and maintain two types of expertise (i.e. have customs specialists and transfer pricing experts examine the same transactions at different points in time and in light of two different standards). Those who are more cautious about convergence point out that the two systems are grounded in different theoretical principles (direct versus indirect tax systems) and fear that convergence could be more costly than the status quo. Concerns were also raised about the capacity of administrations in developing economies to deal with transfer pricing issues and with possible changes in customs valuation rules or enforcement. In effect, developing economies are often more dependent on customs than on direct tax revenues, and many of them are still experiencing difficulties in the application of the basic provisions of the WTO Agreement.

Looking to the next step
As a follow-up to the joint WCO-OECD conferences, four areas for possible further work were identified:
1) Examination of the interaction between the valuation methods used by customs and revenue authorities.
2) Provision of greater certainty for business, e.g. though the development of joint rulings and of more effective dispute resolution mechanisms covering both direct taxes and customs duties.
3) Achieving greater consistency in the transfer pricing and customs documentation compliance and better flows of information between tax authorities and customs authorities.
4) Improving the administrative capacity of tax and customs departments and reviewing the experience of countries that have merged or demerged their customs, VAT and direct tax departments.

Much remains to be done between direct and indirect taxes; other areas – corporate law and regulatory rules for example – also require that multi-national enterprises continue to pay attention to the valuation of related party transactions. Today’s world is not global in all respects.

The author would like to thank Mr Liu Ping from the World Customs Organisation for his contribution to this article.

This article expresses the views of its author and not necessarily the views of the OECD or of its members.