Case Studies. Case Study I

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1 Introduction This Panel will focus on tax planning to minimize the overall tax burden on cross border investments through use of foreign tax credits, participation regimes and other methods and strategies. We will address the investment in, and financing of, subsidiary operations and activities. We have two case studies through which we will illustrate the relevant tax rules and key planning points in each jurisdiction. 2

2 Case Studies 3 Case Study I US Parent borrows $2,000x from a third party bank to invest in its non-us subsidiary for acquisition purposes or funding ongoing operations. US Parent either on-lends the funds to the subsidiary or transfers the funds to the subsidiary as equity capital. Income at the subsidiary level is subject to tax at a local rate of (35%). The jurisdiction of the non-us subsidiary withholds on dividends at a (10%) rate. Interest is not subject to withholding under the applicable treaty. 4

3 Case Study I Lender $2,000x U.S. Parent Debt or Equity AustriaCo GermanyCo ItalyCo SpainCo SwissCo RomaniaCo 5 Questions for US Parent: Is US Parent in excess credit or excess limitation position? What differences in strategy does this dictate? Can US company absorb interest deductions? Can interest be deducted in the country of the subsidiary as well? Should the US Parent check the box on the subsidiary? Is a flow through of foreign losses to the US Parent possible or desirable? How can the US tax cost on repatriated earnings be minimized? How can offshore royalty or finance companies be employed to reduce group tax cost? Accounting treatment of tax on unrepatriated earnings. 6

4 Case Study II Sub 1 borrows $2,000x from a third party bank to invest in a foreign subsidiary for acquisition purposes or funding ongoing operations. Sub 1 either on-lends the funds to its subsidiary or transfers the funds to its subsidiary as equity capital. Income at the sub level is subject to tax at a local rate of (35%). The jurisdiction of the foreign subsidiary withholds on dividends at a (10%) rate. Interest is not subject to withholding under the applicable treaty. 7 Case Study II U.S. Parent Lender $2,000x Sub 1 Jurisdiction 1 Debt or Equity US Co AustriaCo GermanyCo ItalyCo SpainCo SwissCo RomaniaCo 8

5 Questions for Subsidiary: Is participation exemption available? Are dividends taxed to some extent? What differences in strategy does this dictate? Can foreign subsidiary obtain deduction for interest? Can interest be deducted in the country of the investment subsidiary as well (a double dip )? What intermediate entities or structures are advisable? Is a flow through of foreign losses of the foreign subsidiary possible? How can offshore royalty or finance companies be employed to reduce group tax cost? Accounting treatment of tax on unrepatriated earnings. 9 U.S. 10

6 United States: Overview of Relevant Tax Objectives Maximize use of foreign tax credits. Use of debt vs. equity. Allocation of interest expense against foreign source income. Location of debt. Use of hybrid entities and hybrid instruments. Maximize benefit of interest deductions. Minimize withholding tax on cross-border dividend and interest payments. Utilize tax treaties to minimize tax burdens on cross border cash flows. 11 Brief Overview of Relevant US Tax Rules: Foreign Tax Credit Rules A US person is taxable on its worldwide income, including dividend income and income of CFCs when includible under subpart F (as deemed dividends). Thus, in a cross-border context, double taxation may result because the same income may be taxed both in the source country and in the U.S. Double taxation of foreign profits is mitigated in the U.S. through the foreign tax credit ( FTC ) system. Subject to certain limitations, a taxpayer may use the FTC to reduce U.S. federal income tax on a dollar-for-dollar basis. U.S. law allows a taxpayer to take a credit (a direct FTC) against its U.S. federal income tax liability for income taxes it is required to, and actually does, pay or accrue to a foreign government. U.S. law also allows a domestic corporate shareholder to claim a credit (an indirect FTC) against U.S. federal income tax for the foreign income tax paid by the foreign subsidiary. In general, an indirect credit may be claimed with respect to dividend income (including subpart F inclusions in respect of a CFC) from a foreign corporation in which the U.S. corporation owns 10% or more of the voting stock. Interest income does not generate an indirect credit. Under U.S. law, to claim the credit, the amount of foreign taxes paid by the payor must be included in the shareholder s gross income (the gross-up ). 12

7 Brief Overview of Relevant US Tax Rules: Foreign Tax Credit Rules (cont d) The U.S. limits the amount of the foreign tax credit to the same proportion of U.S. tax as foreign source income bears to worldwide income. The rules are complex, but taxpayers generally must allocate foreign-source income and related income taxes to various categories of income known as baskets. For taxable years beginning after December 31, 2006, there are two baskets of income passive and general. Foreign taxes allocated (for U.S. purposes) to one category cannot offset U.S. tax otherwise due on income in another category. The FTC allowable with respect to income in a basket is limited to the U.S. tax otherwise due on worldwide income multiplied by a fraction, the numerator of which is the foreign source income in that basket and the denominator of which is worldwide income (both U.S. source and foreign source) in all categories. This rule operates to limit the credit in any year to the amount of U.S. tax otherwise payable on foreign-source income. Thus, the effective rate of tax on the foreign-source income of a U.S. taxpayer is the higher of the U.S. or the foreign rate. Credits in excess of the limitation can be carried back to the previous taxable year and forward to the succeeding ten taxable years. 13 Brief Overview of Relevant US Tax Rules: Foreign Tax Credit Rules (cont d) Money is generally treated as fungible -- borrowing will generally free other funds for other purposes. Thus, under U.S. law, some portion of the U.S. shareholder s interest expense must be taken into account for U.S. tax purposes in calculating the foreign source income amount in the limiting fraction for the foreign tax credit. An allocation of interest expense against foreign source income can reduce the overall limitation and, thus, reduce the amount of FTC that may be claimed. The rules for apportioning interest expense between US and foreign source income are very complex. Members of a US affiliated group are generally treated as a single domestic corporation, and interest is apportioned among the members based on relative amounts of foreign and US assets. Under these rules, a US group may wish to borrow at the US parent level and relend to CFCs, rather than borrow directly at the CFC level. 14

8 Brief Overview of Relevant US Tax Rules: Debt vs. Equity Generally, whether an instrument will be classified as debt or equity for US tax purposes depends on the relevant facts and circumstances. U.S. courts look to a number of factors. No single factor is controlling. Important debt factors include: A fixed maturity date in the not too distant future. The presence of creditor s rights (e.g., acceleration on default, etc.) that may be enforced by the lender. Repayment is expected to be made in accordance with the terms of the instrument. Evidence that a third party would have advanced the funds as debt under the same terms. Significant equity factors include: A long term to maturity (e.g., 30 years or more, and it is helpful if term can be further extended at the sole option of the issuer). Lack of creditors rights. Subordination to trade creditors. Limitation and payment if the debtor is (or would be) rendered insolvent or bankrupt. Thin capitalization. Debt is held proportionally with stock. Debt may be repaid with shares of the issuer. 15 Brief Overview of Relevant US Tax Rules: Debt vs. Equity (cont d) From the issuer s perspective, debt may be preferable because interest is deductible, while dividends are not. From the holder s perspective equity treatment may be preferred, since (subject to certain exceptions for constructive dividends) dividend income is generally reported only when cash is actually or constructively received. Dividend income may also generate FTCs for the holder. Hybrid instruments may be used to obtain the benefits of debt treatment for the issuer without the disadvantages to the holder. For example, a hybrid instrument may be classified as debt in the source country (to obtain an interest deduction) but as equity for US tax purposes (to avoid current income inclusion of the coupon). Also, a hybrid entity may be used to generate an interest deduction in the source country without giving rise to any interest. 16

9 Brief Overview of Relevant US Tax Rules: Earnings-Stripping Rules A current deduction for certain interest paid or accrued by a U.S. corporation to a related foreign person may be denied, where the foreign person is not subject to US tax on such interest, or benefits from a reduced rate of tax under a treaty. A current deduction may be denied to the extent interest expense exceeds 50% of adjusted taxable income for the year. However, under a safe harbor, this limitation does not apply if the debt-to-equity ratio is 1.5-to-1 or lower. This rule is known as the earnings stripping rule. It also applies where a related foreign person guarantees a loan made by a third party. Where the rule applies, the portion of interest expense that is not currently deductible is generally carried forward and tested for deductibility in future years. Thus, the earnings stripping rule is less onerous than equity treatment, since equity treatment results in a denial of an interest deduction altogether. 17 Brief Overview of Relevant US Tax Rules: Section 956 Limits on Debt Security A deemed dividend to a US shareholder may arise where the US shareholder incurs debt and its CFC is the lender, or provides credit support for the debt. Credit support may be direct or indirect. Credit support arises where the CFC pledges its assets or provides a guaranty in support of the US shareholder s debt. Credit support also arises if more than two-thirds of the voting stock of the CFC is pledged to secure the debt. If this rule applies, the US shareholder is taxed on an amount equal to the lesser of the CFC s earnings and profits or the outstanding principal amount of the debt. 18

10 Brief Overview of Relevant US Tax Rules: Dual Consolidated Losses The dual consolidated loss (DCL) rules operate to limit use of a DCL. Goal: To prevent double-dipping. Double dipping occurs where a dual resident corporation (DRC) uses a single economic loss once to offset income subject to US tax (but not foreign tax) and a second time to offset income subject to foreign tax (but not US tax). Rules also apply to losses attributable to a separate unit (e.g., a branch or partnership) of a domestic corporation. Use of DCL is limited unless the taxpayer demonstrates to the IRS that no foreign use of the loss can occur, or a domestic use election is made. 19 United States: Case Study I Additional Facts: Assume the US Parent has domestic assets with an adjusted basis of $2,000, and the basis of the stock of subsidiary is $2,000. Interest expense on the third party debt is $200. US Parent earns $200 before interest and taxes. The subsidiary also earns $200 before tax and distributes $130 ($200-$70 (tax at 35%)) to US Parent. The distribution is subject to withholding tax of $13 (10%). US Parent receives $117 but includes $130 in income. In addition, to claim the indirect FTC, US Parent must also include $70 in income (the gross-up). US Parent thus has to include income of $200. US Parent incurs tax of $70 ($200 x 35% tax). To determine the available FTC, US Parent must allocate interest expense between US source and foreign source income. Under the asset method of allocation, assume that 50% of the interest expense would be allocated against foreign source income. Thus, the FTC limitation is $35, computed as follows: $70 (total tax) x $100 (foreign net income) $200 worldwide income. The residual US tax is therefore $35 ($70 - $35 (FTC)). The combined tax burden is $118 ($83 (foreign tax) + $35 (US tax)). 20

11 United States: Case Study I (cont d) Suppose debt financing were used instead, and US Parent received $200 in interest income from the foreign subsidiary. The foreign subsidiary would owe $0 tax ($200 (income) - $200 (interest expense)). US Parent would owe US tax of $70 ($200 (operating income) + $200 (income from sub) - $200 (interest expense) X 35%). Result: Debt financing produces a lower overall tax burden for US Parent. 21 Questions for US Parent: Is US Parent in excess credit or excess limitation position? What differences in strategy does this dictate? Can US company absorb interest deductions? Can interest be deducted in the country of the subsidiary as well? Should the US Parent check the box on the subsidiary? Is a flow through of foreign losses to the US Parent possible or desirable? How can the US tax cost on repatriated earnings be minimized? How can offshore royalty or finance companies be employed to reduce group tax cost? Accounting treatment of tax on unrepatriated earnings. 22

12 Austria 23 Austria: Overview of Relevant Rules - General 25% corporate income tax. Participation exemption for dividends from domestic and foreign subsidiaries (unless foreign subsidiary has low taxed passive income). No CFC legislation: no Austrian tax on income of foreign subsidiaries (unless a dividend is declared and participation exemption does not apply). Tax treaties with more than 90 countries. Limited use of FTCs because of prevailing use of exemption method and participation exemption: FTCs usually limited to foreign WHT, in general per country limitation, no carry forward or backward of FTCs. Indirect FTC is available where participation exemption does not apply. 24

13 Austria: Overview of Relevant Rules Debt vs Equity Interest is deductible while dividends are not. Interest is not subject to WHT while dividends are subject to 25% Austrian WHT or reduced treaty rates (where EU parent subsidiary directive does not apply). No statutory debt to equity ratios but re-qualification of debt into equity if shareholder debt financing is not arm s length. Corporate law limitations on credit support by Austrian subsidiary for parent company. Dividend income is tax exempt while interest income is subject to 25% corporate income tax. Use of hybrid instruments is possible outbound but not inbound. 25 Austria: Overview of Relevant Rules Use of foreign losses Losses of foreign first-tier subsidiaries can be offset against the profits of Austrian companies. The use of the foreign subsidiary s losses will be recaptured: if and as soon as such losses can be offset against profits in the foreign jurisdiction (no double-dipping, only deferral), and upon disposal or in other cases where the subsidiary leaves the tax group or where its business has decreased 75% in scope compared to the time when the losses were incurred. In the event of an insolvency or liquidation of the foreign sub resulting in a definitive loss of the invested capital, no recapture takes place to the extent a write-down on the participation in the foreign sub would have been necessary for Austrian Co. 26

14 Austria: Case Study I Assume AustrianCo earns 200 before interest and tax and is fully equity financed by its US parent. The Austrian CIT is 50 (tax at 25%). The dividend distribution to its US parent is subject to withholding tax of 5% (treaty rate). Equity contributions to AustrianCo are subject to 1% capital duty. Therefore, AustrianCo is usually (also) debt-financed which may include an (arm s length) shareholder loan. Interest payments under the shareholder loan will reduce taxable Austrian income. Interest payments are not subject to Austrian WHT. AustrianCo may issue hybrid instruments where payments qualify as interest in Austria and dividends for the recipient. Also perpetual, subordinated and profit linked loans/notes will qualify as debt as long as there is no participation in the goodwill or liquidation proceeds of the issuer. 27 Austria: Case Study II Dividends received by AustrianCo from its foreign subsidiary are tax exempt if: AustrianCo holds foreign sub (at least a 10% participation) for more than 1 year, and foreign sub does not earn primarily passive income which is subject to not more than 15% local tax, and the dividends are not deductible on the level of foreign sub (hybrid instruments do not qualify for the participation exemption). Interest paid by AustrianCo to bank or (at arm s length rates) to a shareholder is fully deductible. Interest received from foreign sub is fully taxable - interest rates agreed with foreign sub must be arm s length. Foreign WHT on dividends cannot be credited against Austrian tax on interest income. 28

15 Austria: Case Study II (cont d) AustrianCo may opt for deduction of losses of foreign sub from its own taxable income (by integrating foreign sub in an Austrian tax group). The losses would be recaptured as soon as they can also be offset against profits of the foreign sub in the foreign jurisdiction. The deduction/recapture also works for losses of a foreign PE even if the tax treaty provides for the exemption method. Alternatively, AustrianCo may opt for deductibility of writedowns of the participation (capital invested) in foreign sub over a seven-year period. In this case, however, also capital gains in respect of foreign sub would become taxable. The respective election has to be made upon acquisition/establishment of the foreign sub. Write-downs on shareholder loans to foreign sub are fully deductible on the level of AustrianCo. 29 Germany 30

16 Germany: Overview of Relevant Rules 15% corporate income tax (CIT). Trade income tax: 7-18% Average in 2010: 13.51% Depends on the collection rate of the local community. Solidarity surcharge (5.5% of CIT). Total tax burden: 23 34% CFC legislation: Resident taxpayer holds more than 50% of the shares or voting rights of the CFC. Passive business activities. Lower level of taxation (less than 25%). 31 Germany: Overview of Relevant Rules (cont d) Exemption: foreign company has its corporate domicile or place of management within the EU/EEA. the shareholders represent and warrant that the company has adequate business substance. the State of residence communicates the necessary information for taxation according to Council Directive 2011/16/EU or Double Taxation Conventions. Foreign Tax Credit: Dividends are tax-exempt tax credit is not possible, if shareholder is a corporation. Permanent Establishment usually tax exemption method - tax credit is not possible. Progressive application of the tax. 32

17 Germany: Overview of Relevant Rules Foreign losses Losses of a foreign subsidiary cannot be used by the German corporation (principle of separation). Exemptions: Profits of the subsidiary are added back due to CFC-rules. The subsidiary is resident in a EU-Member State and: has exhausted the possibilities available in its State of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods and where there are no possibilities for those losses to be taken into account in its State of residence for future periods; and based on the "Marks & Spencer" and Lidl judgment by the European Court of Justice. Tax group (vide infra case 2). 33 Germany: Overview of Relevant Rules: Debt vs. Equity Distribution to a German corporation Generally no taxation at the level of the receiving company, but 5% of the dividends are treated as nondeductible expenses, i.e., 95% of the dividends are taxexempt. Exception: trade income tax on dividends from minority shareholding (up to 15%). 34

18 Germany: Overview of Relevant Rules: Debt vs. Equity (cont d) Distribution to a US corporation. Art. 10 para 2 DTT. Based on the Double Taxation Treaty dividends paid by a German company are generally taxed in the US. Germany may also tax the dividends if the tax does not exceed: 5% of the gross amount of dividends if the beneficial owner is a company that holds directly at least 10% of the voting shares of the company paying the dividends; 15% of the gross amount of the dividends in all other cases. 35 Germany: Overview of Relevant Rules: Debt vs. Equity (cont d) Exemption from withholding tax: Art. 10 para 3 DTC Requirements: a company that is a resident of the US. holds directly at least 80% of the voting shares in the distributing company. has been holding these for a 12-month period until the entitlement to the dividend is determined. complies with one of the four special alternatives concerning the limitation on benefits ( super LOB clause ): stock exchange trading test ownership, base erosion and activity test derivative benefits test determination of the Contracting State in which the income in question arises in due consideration whether the establishment, acquisition or maintenance of the company or the conduct of its operations has or had as one of the principal purposes the obtaining of benefits under the Treaty. 36

19 Germany: Overview of Relevant Rules: Debt vs. Equity (cont d) Deductible interest. Generally, interest is deductible from taxable income. Since 2008, German law provides for a interest barrier. No deductibility if interest exceeds 30% of EBITDA (earnings before interest, tax, depreciation and amortization). 37 Germany: Overview of Relevant Rules: Debt vs. Equity (cont d) interest expenses interest income No exceeding interest expenses < 3 million No exceeding interest expenses 30 % of EBITDA yes yes yes Deduction of the whole amount of interest expenses No Business does not belong to a group and is not a corporation yes 38

20 Germany: Overview of Relevant Rules: Debt vs. Equity (cont d) Business does not belong to a group No harmful equity ratio No No yes equity ratio of business equity ratio of group (escape clause) No Business does not belong to a group No harmful debt financing Deduction of the whole amount of interest expenses The exceeding interest expense is only deductible as business expenses up to 30% of EBITDA No No yes yes 39 Germany: Overview of Relevant Rules: Debt vs. Equity (cont d) Harmful debt financing Regarding non-affiliated corporations interest barrier is only applicable in cases of harmful dept financing. Requirements: Interest is paid to a shareholder holding directly or indirectly more than 25% of the share capital. a party related to such a shareholder. a third party lender with harmful recourse to the persons mentioned before. and this interest expenses exceed 10% of the net overall interest expenses. Harmful equity ratio The "escape-clause" is only applicable to affiliated corporations if the aforementioned requirements are fulfilled. 40

21 Germany: Case Study I Loan funding to GermanCo: Germany does not have the right to tax interest (Art. 11 para. 1 DTC). Interest is deductible Exemption: cf. aforementioned interest barrier. Equity funding to GermanCo: German taxation amounting to 23 31% if GermanCo earns 1,000: distribution: Taxation of dividends: normally 5% WHT. Shareholding less than 10%: 15% WHT. Requirements of Art. 10 para. 3 DTC and "super LOB clause" are fulfilled: 0% 41 Germany: Case Study II Loan funding to subsidiaries of GermanCo: Interest paid by GermanCo is deductible. Exemption: cf. aforementioned interest barrier. Interest barrier also applicable to interest paid to a bank. Interest paid by the subsidiary to GermanCo is subject to German tax liability. Foreign Tax Credit. if the subsidiary is resident of a EU-Member State, the State of residence will not tax the interest (Interests and Royalties Directive). DTT: limited to the right of taxation of the State of residence regulated by the DTT. 42

22 Germany: Case Study II (cont d) Equity funding to subsidiaries of GermanCo. Tax exemption 5% of dividends are treated as non-deductible expenses. German law does not require a minimum holding or an activity test Exception: trade income tax on minority shareholdings. Foreign Tax Credit: not available if dividends are exempted from tax. Consideration of the CFC-rules. 43 Germany: Case Study II (cont d) Formation of a tax group. management of the subsidiary in Germany. GermanCo holds the majority of the voting rights. profit transfer agreement for at least five years. controlled subsidiary commits itself to distributing all its profits to the GermanCo. in return, GermanCo may use the losses of the subsidiary. Modifications probable (French model). Uncertainties deriving from European Case Law. 44

23 Italy 45 Italy: Overview of Relevant Rules - General 27.5% corporate income tax CIT (3.9% local tax IRAP disregarded for the purpose of this presentation). Foreign Tax Credit = tax definitively paid abroad can be deducted for an amount up to the fraction of the foreign income on a per country basis - over the total income, multiplied by the total CIT due. 8-year carry forward and 8-year carry-back apply. Losses can be carried forward with no expiration and can offset up to 80% of each following year s taxable income (except for losses of the first three fiscal years). Losses of foreign branches can be utilized. Losses of foreign subsidiaries only within a worldwide tax consolidation. 46

24 Italy: Overview of Relevant Rules General (cont d) White List Countries = Countries or territories allowing a sufficient exchange of information, as listed by a yet-to be enacted Ministerial Decree. Italy has entered into Tax Treaties with more than 90 countries. CFC Rules In certain cases to the Italian parent, irrespective of actual distribution, is attributed the income of subsidiaries not resident in a White List Country; or resident in a White List Country, if (a) its effective tax rate is less than 50% of Italian tax and (b) more than 50% of its total income derives from (i) passive income or (ii) intercompany services. Confirmatory Ruling - pursuant to Law n. 212/ Italy: Overview of Relevant Rules Participation Exemption 95% dividend participation exemption for dividends from domestic and foreign subsidiaries (neither minimum size nor minimum holding period is required). Foreign dividends qualify only if they are totally non deductible for the paying company. 95% capital gain participation exemption on stock of domestic and foreign subsidiaries (no minimum size but certain conditions, including a 12/13-month minimum holding period, must be met). If a foreign subsidiary is not resident in a White List Country, dividends and capital gains are fully taxable, unless a positive Confirmatory Ruling is obtained. 48

25 Italy: Overview of Relevant Rules Interest Active interest is fully taxable. No debt-to-equity ratio Arm s length principle applies. Net passive interest (i.e., passive interest less active interest) can be deducted only up to 30% of ItalianCo s G.O.R. (gross operative results). Excess passive interest and excess GOR can be carried forward with no expiration. Outbound interest is subject to 20% Italian withholding tax or to a reduced treaty rate (usually, 10%). Zero rate applies to interest paid to a EU company qualifying under the Interest-Royalty directive (25% ownership and 12-month holding period). 49 Italy: Overview of Relevant Rules Equity Dividend income is generally 95% tax exempt. 3% of the new equity (with respect to December 31, 2010) is deductible for CIT purposes. Effective benefit equal to 0.825% (27.5% of 3%) of such new equity. Outbound dividends subject to 20% withholding (with the recipient s right to claim a refund of up to 5%) or to the applicable reduced treaty rates. Dividend paid to EU company, if the Parent-Subsidiary directive does not apply, and Norway is subject to 1.375% withholding. Zero rate applies to dividends paid to EU companies qualifying under the Parent-Subsidiary directive (10% ownership and 12-month holding period). 50

26 Italy: Case Study I Assume ItalianCo earns 200 before interest and tax and is fully equity financed by its US parent. Equity contributions to ItalianCo is subject to 168 flat capital duty. The Italian CIT is 55 (tax at 27.5%). Please note that 3% of the new equity will be deductible for CIT purposes. The dividend distribution to its US parent is subject to withholding tax of 5% (treaty rate). 51 Italy: Case Study I (cont d) ItalianCo is usually (also) debt-financed which may include an (arm s-length) shareholder loan. Interest payments under the shareholder loan will reduce taxable Italian income only up to 30% of ItalianCo s G.O.R. (gross operative results). Interest payments are subject to 10% (treaty rate). ItalianCo may issue hybrid instruments where payments qualify as interest in Italy and dividends for the recipient. 52

27 Italy: Case Study II Dividends received by ItalianCo from its foreign subsidiaries are 95% tax exempt, provided that such dividends are not deductible for the paying sub. Interest paid by ItalianCo to bank or (at arm s length rates) to a shareholder is deductible only up to 30% of ItalianCo s G.O.R. (gross operative results). Interest received from foreign sub is fully taxable - interest rates agreed with foreign sub must be at arm s length. Foreign WHT can be credited against Italian CIT. 53 Italy: Case Study II (cont d) ItalianCo may opt for deduction of losses of foreign sub from its own taxable income (by integrating all foreign subs in an Italian worldwide tax group). In case of termination of the worldwide tax group, certain recapture rules would apply. No deductibility of write-downs of the value of the participation is allowed. 95% capital gain participation exemption apply, if certain conditions are met. Write-downs on shareholder loans to foreign sub are not deductible for ItalianCo, but would increase the tax base of the foreign sub s stock. 54

28 Spain 55 Spain: Overview of Relevant Rules Spanish corporate tax: 30% (25% or 20% for small/medium companies) Tax benefits available to Spanish companies investing abroad (not necessary to opt for the ETVE regime): Participation exemption on dividends and capital gains. Interest: tax deductible even if to acquire a foreign participation. Capital losses/write offs: tax deductible even if derived from foreign participations. Tax credit on investment in foreign companies to improve exporting activities. Effective inapplicability (almost) of CFC rules. 56

29 Spain: Overview of Relevant Rules (cont d) Participation exemption: No taxation on dividends and capital gains derived from qualifying shareholdings. Non-Spanish resident entities Shareholding 5% or acquisition value > 6 Million Euros (for holding companies). 1 year holding (or commitment, for dividends only). Subject to an identical or analogous tax or Tax Treaty with exchange information clause. No tax haven (except if in the UE and valid economic reasons). 85% of the total income must derive from an active source and from outside Spain. Exemption applicable to income from foreign permanent establishments. 57 Spain: Overview of Relevant Rules (cont d) Dividends and capital gains: the 15% rule Use of a company abroad that works as a mixer could achieve exemption on dividends and capital gains when derived from tax havens or CFC income. ETVE 15% Mixer 85% 85% Mixer 15% Tax Haven Complying Co CFC income Complying Co 58

30 Spain: Overview of Relevant Rules (cont d) Taxation of dividends paid to non-residents: General tax rate: 21% (reduced by tax treaties). Qualifying ETVE shareholders: 0% withholding tax for both: (i) corporations and (ii) individuals. EU shareholders: 0% withholding tax under Parent-Subsidiary Directive. Minimum participation of 5% and one year holding period (or commitment). Taxation of interests paid to non-residents: General tax rate: 21% (reduced by tax treaties). EU lenders: 0% withholding tax. Taxation of capital gains: General tax rate: 21% (reduced by tax treaties). EU recipients: 0% (unless substantial participation 25% or real estate companies). 59 Spain: Overview of Relevant Rules (cont d) Taxation of Royalties paid to non-residents: General tax rate: 24% (reduced by tax treaties). Qualifying EU residents: 0% if EU Interest & Royalties Directive applies (associated entities). 60

31 Spain: Investment in Spain - Funding alternatives Equity: No Capital tax on in cash/in kind contributions. 1% Capital tax on redemption of sharecapital, except share premium distributions. Financing: Thin-capitalization rule applies to direct or indirect financing from foreign (except EU residents) related lenders. Exceeding 3 times the fiscal capital (equity minus profit of the year). Payments in excess are treated as dividends for tax purposes. Incompatible with non-discrimination clause of tax treaties (e.g. US Spain tax treaty). Supreme Court decision 7 December Spain: Investment in Spain Hybrid debt instruments Profit sharing loans. Debt for Spanish borrower: tax deductible interest. Foreign lender will obtain a variable interest determined on net profit, turnover, net worth, etc, of Spanish borrower Co. Additionally, parties may agree a fixed interest. Non stapled to shareholder status. Benefit from the exemption on interests paid to EU lenders. Silent partnership (Cuentas en participación). Partnership agreement, based on the Commercial Code where a General Managing Partner is financed by a non-related investor. Payments to the investor treated as tax deducible interests. Benefit from the exemption on interests paid to EU lenders. 62

32 Spain: Investment in Spain Hybrid debt instruments (cont d) Preferred stock. Equity for Spanish corporate law purpose. Debt for Spanish accounting purposes. Tax deductible financial expense in Spain. Benefit from the exemption on interest paid to EU lenders. 63 Spain: Investment in Spain Debt financing Loans Tax group Investor Spanish SPV 75% Spanish Target Spanish SPV raises debt to fund the leveraged purchase of Spanish Target (share deal). Spanish SPV acquires at least 75% of the share capital of Spanish Target (70% if the Spanish Target is a listed company). Spanish SPV becomes head of a tax consolidated group together with Spanish Target. Interests accrued at the level of Spanish SPV are offset against operating profits made by Spanish Target. 64

33 Spain: Investment in Spain Debt financing (cont d) Loans Upstream Merger Investor Spanish SPV Spanish Target Alternatively, Spanish Target is merged into Spanish SPV under the Spanish corporate income tax neutrality regime. Tax neutrality regime applies if the merger is carried out for valid business reasons, such as the restructuring or rationalization of the activities of the companies involved, and not with the sole objective of achieving a tax advantage. Interest borne by Spanish SPV is offset against Spanish Target s operating income. 65 Spain: Investment in Spain Financial goodwill depreciation Upstream Merger Foreign Company Spanish Holding Target Company 5% Financial goodwill recognized in the merger can be depreciated for tax purposes under certain conditions: Minimum participation of 5% in Target Company. The stake in target must not have been acquired from Spanish non-residents (unless taxed in Spain or another EU Member State) or Spanish resident individuals (unless gain is taxed). Difference between the purchase price of shares in Target and the Target s net asset value must be allocated to its assets and rights (step-up in basis). Any excess is regarded as financial goodwill and may be depreciated for tax purposes in 20 years at an annual rate of 5%. Sound business reasons required to apply the special tax regime (e.g. restructuring or rationalization of the activities of the companies involved in the merger). 66

34 Spain: Spanish investment abroad - Financing structures SPE Sociedad de Promoción de empresas Profit sharing loan Non resident SPE / ETVE Non resident 0 % DWT 0 % tax on dividends / interests. Regular companies subject to a special tax regime in the Basque region of Spain that can perform the following activities: Own shares in Spanish / Foreign subsidiaries. Grant profit sharing loans for at least a 5- year term. Exemption on interests if: SPE s paid in capital of at least 3MM. Direct participation in the borrower. Interests received in profit sharing loans or shares. Compatible with ETVE regime. 67 Spain: Spanish investment abroad - Financing structures Swiss financing branch Non resident 1-2% taxation on interests at the level of the Swiss branch. 0 % Branch profits exempt in Spain. 0 % tax on profit ETVE 0 % Spanish tax on dividends and capital gains Position of the tax authorities (tax ruling V ): dividends distributed to the shareholders of the Spanish Holding deriving from income of a foreign branch Swiss Branch can apply all benefits of ETVE (0% Interest withholding tax). 68

35 Spain: Spanish investment abroad Hybrid debt instruments Juros sobre capital (Interest as return on capital) US SpanishCo Brazil 10% WHT 0% Spanish Corporate Tax 15% WHT on juros Juros: Tax deductible Return on equity paid to the shareholders according to their stake in the Brazilian Company. Juros are a tax deductible expense at the level of the Brazilian company limited to the rate applicable to long-term loans to its net equity. Brazilian company must have either sufficient profits (before the deduction of the interest) or retained earnings for, at least, twice the interest to be paid. Juros paid to Spanish Co subject to 15% withholding tax. In Spain, Juros will be treated as exempt dividends (Tax treaty Spain-Brazil). 69 Spain: Fraus legis doctrine Spanish general anti-abuse rule: Conflicto en la aplicación de la norma tributaria (i.e., abuse of tax law doctrine). The Fraus legis doctrine would apply if the taxable event is partially or totally avoided or the taxable base or the tax due reduced through acts or transactions: that individually or jointly considered are artificial or improper for the result achieved; and from which no relevant legal or economic effects other than tax savings are generated as compared with cases where the usual or proper acts have been performed; The mere attainment of tax advantages is not enough to characterize a transaction as abusive. 70

36 Spain: Case Study I Equity contributions to SpanishCo are exempt from Capital tax. Taxable profits derived by SpanishCo are subject to a 30% tax rate. Taxation of dividend distributions: Spanish holding regime: If the SpanishCo benefits from the Spanish holding regime, dividend distributions to the US parent (related to dividends and capital gains qualifying for the participation exemption) would not be subject to withholding tax in Spain on the dividends. Tax treaty rate: 10% withholding tax. 71 Spain: Case Study I (cont d) Shareholder loan: Interest must be arm s length. Interest payments are tax deductible in Spain. Interest payments are subject to 10% (treaty rate). No thin capitalization. US Spain Tax Treaty: non discrimination clause. Financing hybrid instruments may be used: Profit sharing loan. Silent partnership. Preferred stock. 72

37 Spain: Case Study II Interest paid to a third party lender are fully deductible. Debt push down structures may be used for the investment in a Spanish target company under (i) the tax consolidation group or (ii) an upstream merger. Use of a financing branch (e.g. Switzerland) would allow for a tax efficient treatment of financing transactions. Dividends / branch profits received by SpanishCo: Exemption under participation exemption. Otherwise: Foreign tax credit on dividends if participation of at least 5% and one-year holding period (or commitment), including corporation tax paid by the subsidiaries up to the limit of the Spanish tax that would have been applicable to those profits. 73 Spain: Case Study II (cont d) Financial income received from foreign subsidiaries is subject to Spanish Corporation Tax at a 30% rate. Taxation of dividend distributions: Spanish holding regime: If the SpanishCo benefits from the Spanish holding regime, dividend distributions to the US parent (related to dividends and capital gains qualifying for the participation exemption) would not be subject to withholding tax in Spain on the dividends. Tax treaty rate: 10% withholding tax under the US Spain tax treaty. 74

38 Switzerland 75 Switzerland: Overview of Relevant Rules -- Swiss Company as Investing Entity General: 8.5% federal income tax plus 12-20% cantonal/communal income tax; effective combined rates on pre-tax net profit are 12-24% depending on location. Tax relief for dividends received Federal tax: "participation deduction" --> tax rebate for dividends from equity investments of at least 10% or CHF 1 million market value. Cantonal/communal tax: Same as federal tax; full income tax exemption for "holding companies"; dividend and gains exemption for "mixed" / "administrative" / "auxiliary companies" (companies with mainly foreign activities). Tax relief for capital gains Federal tax: "participation deduction" on gains of investments of at least 10%, held for at least 1 year. Cantonal/communal tax: same as federal tax; full exemption of gains under "holding company" and "mixed" / administrative" / "auxiliary" company tax regimes. No CFC rules; dividends and gains tax relief is not subject to "subject to local tax" requirements. 76

39 Switzerland: Overview of Relevant Rules -- Swiss Company as Investing Entity (cont d) Taxation of interest income Federal tax: Full inclusion of interest income in taxable net profit. Special regime for "finance branches" of foreign companies: Notional debt interest deduction on 10/11 of loan assets. CHF 100 million loan assets as minimum. Cantonal/communal tax: Same as federal tax; full income tax exemption for "holding companies"; partial exemption for "mixed" /"administrative" /"auxiliary companies" on foreign-source interest income; "Finance Branch" regime. Interest paid is generally deductible; limitations on interest paid to shareholders/affiliated parties: "thin-cap" rules and arm's length interest rate guidelines. 77 Switzerland: Overview of Relevant Rules -- Swiss Company as Investing Entity (cont d) Effective income tax rate on "mixed" and similar companies: about 9-11% on net profit. Effective tax rate on "Finance Branches": about 1.5-2%. Application of international tax treaties, subject to domestic antiabuse rules. Taxation of royalty income Federal tax: Full inclusion of royalty income in taxable net profit. Cantonal/communal tax: same as federal tax; partial exemption under "mixed" / administrative" / "auxiliary" company tax regimes; reduced tax rate (notional royalties paid deduction) under "licence box" regime of Canton Nidwalden (8.8% combined effective tax rate). Tax treaty application subject to domestic anti-abuse rules. 78

40 Switzerland: Overview of Relevant Rules -- Swiss Company as Investing Entity (cont d) Foreign branch exemption Income attributable to permanent establishments (PEs) located outside of Switzerland is exempt from taxable profit. Unilateral exemption, not dependent on tax treaties. Participation in active foreign partnership generally qualifies as PE. Income attribution generally based on OECD principles. Foreign tax credit Rather limited scope of FTC under Swiss law: Applies only to the extent that foreign income actually suffers Swiss tax (and generally limited to the foreign tax paid). FTC requires basis in applicable Swiss tax treaty. FTC only applies to foreign withholding taxes, not to underlying foreign profits taxes. Use of Swiss tax treaty network About 90 Swiss tax treaties Foreign-controlled Swiss companies are subject to domestic (or tax treatyintegrated) anti-treaty-shopping rules holding companies and "active" Swiss companies benefit of "lighter" anti-shopping rules. No application of Swiss rules where treaty includes an LOB provision (e.g. US). 79 Switzerland: Overview of Relevant Rules -- Swiss Company as Investee Entity Withholding tax on dividends paid 35% dividend WHT, applies to any distributions of profits and reserves including liquidation surplus, stock dividends paid from ordinary reserves. New exemption of distribution of contributed reserves (since 2011): Open shareholder contributions made after 1996, if separately accounted for in statutory accounts. Domestic shareholders/beneficiaries generally get full refund or credit of WHT, if dividend income is duly reported. Non-resident shareholders may be eligible for partial or full relief of WHT (generally via refund, exceptionally through at-source relief) based on Swiss double tax treaties or Switzerland/EU Savings Tax Treaty, art. 15(1). 80

41 Switzerland: Overview of Relevant Rules -- Swiss Company as Investee Entity (cont d) Taxation of interest paid In general: Deduction from taxable profit, subject to "thin-cap" rules and arm's length interest rate guidelines. In general: No withholding tax. However, 35% federal WHT applies if debt qualifies as a "bond" ("10/20 non-bank lender rule" or as a "customer deposit with Swiss bank" (more than 100 non-bank lenders). Furthermore, federal and cantonal/communal withholding taxes apply to interest on debt secured by Swiss immovable property. Foreign lenders may beenfit of Swiss tax treaties. Royalties paid: No Swiss withholding tax 81 Switzerland: Case Study I Loan funding to SwissCo: No stamp duty. Interest not subject to WHT (unless loan is secured on Swiss immovable property; US Parent would benefit of 0% tax treaty WHT rate). Interest generally deductible from SwissCo's taxable profit, subject to: Thin capitalization tax guidelines. Arm's length interest rate guidelines. Interest on "hidden equity" and "excessive" interest would be non-deductible and subject to dividend WHT ("constructive dividend"). Equity funding to SwissCo: 1% capital stamp duty (first CHF 1 million is exempt). Distributions on equity = dividends 35% dividend WHT; US Parent is principally eligible to 5% residual WHT rate. Dividends are not deductible from taxable profit. 82

42 Switzerland: Case Study II Loan funding to subsidiaries of SwissCo: Loans generate interest income, fully includible in taxable profit. Debt funding cost is deductible subject to thin-cap (85% debt gearing) and arm's length interest rates (interest spread, usually at least 25bps). Cantonal tax privileges (holding; mixed/admin/auxiliary regimes) may apply to SwissCo. Holding regime (full cantonal income tax exemption) requires compliance with "2/3rds assets or income test" Loans and interest are not eligible for that test. Mixed/admin/auxiliary regime applies to interest from non-swiss sources (partial exemption); may lead to effective combined tax rate of 9-11%. Limited foreign tax credit for any residual foreign withholding taxes pursuant to applicable tax treaties (no FTC without tax treaty). Impact of anti-treaty shopping rules (Swiss "1962 Decree" or treatyintegrated rules) may impose stricter thin-cap rules, anti-conduit, minimum distribution requirements. Use of Swiss Finance Branch (or a foreign company with an exemption system) rather than Swiss subsidiary may be attactive for lending to foreign group companies benefits of notional interest deductions, effective tax rate 1.4-2%. 83 Switzerland: Case Study II (cont d) Equity funding to subsidiaries of SwissCo: Substantial investments (10% equity stake or CHF 1m market value) qualify for "dividend tax relief" (rebate on tax, removes % of income tax burden on dividend, but is not an exemption! Hence, dividends absorb operating losses!) Capital gains relief on investments of 10%, held at least one year (also rebate on tax, not exemption). Funding cost (debt interest) is in principle deductible; however, may reduce effect of dividend and capital gains tax relief. Thin-cap rules apply (70% maximum gearing of investments with interest-bearing debt). Cantonal "holding company exemption" applies if qualifying investments represent at least 2/3rd of assets, or dividends represent at least 2/3rd of gross income. Also exemption of dividends and capital gains under cantonal "mixed" / "admin" / "auxiliary" company regimes. Anti-treaty shopping rules apply Swiss domestic or treaty-integrated rules. Holding companies benefit of "lighter" anti-treaty shopping rules (only minimum distribution requirement, 6% of equity). 84

43 Romania 85 Romania: Overview of Relevant Rules Corporate tax rate of 16%. No CFC rules. Dividends of foreign subsidiaries are taxable income for the Romanian company. FTC is available for tax paid by PEs or withholding tax; No FTC for underlying tax of foreign subsidiaries. Losses of subsidiaries cannot be offset with the RomanianCo s profits. Deduction of interest and foreign exchange net losses allowed if thin cap rules are met the loan is used for business purposes interest rate is at arm s length 86

44 Romania: Overview of Relevant Rules (cont d) No deduction in case of debt push-down arrangements. WHT of 16% on dividends, commissions, interest and royalties under the domestic taxation. Tax treaties concluded with 83 countries. Dividends can be distributed once a year, after submission of financial statements. Inbound investment via equity would not be tax efficient as compared to debt. No deduction in case of outbound investment financed via equity. There is no specific legislation for hybrid debt. Capital gains on disposal of foreign subsidiaries is taxable. 87 Romania: Case Study I Interest and net foreign currency losses will be deductible in Romania if at arm s length and thin cap rules are met. No deduction in case of acquisition of shares. Debt with reimbursement period less than 1 year is not subject to thin cap rules. Net foreign exchange gains will be taxable income. WHT of 10% on interest and dividends under Romania-US tax treaty; usage of intermediary jurisdictions (such as the Netherlands) can reduce the WHT to 0. Hybrid debt will be treated as debt if meeting the main features of the latter (e.g. there is a financing agreement providing for reasonable reimbursement period, payable interest, etc.). 88