CROSS-BORDER FINANCING The Hidden Cost of Capital. Ka Sen Wong Allen & Overy

Transcription

1 CROSS-BORDER FINANCING The Hidden Cost of Capital Ka Sen Wong Allen & Overy

2 Overview The current environment Anti-hybrid rules Diverted profits tax Chevron Suggested actions

3 Tax is front page news Senate enquiry High profile boycotts Lux Leaks Panama Papers Tax reform BEPS

4 Tax directors are feeling the pressure A&O survey of 350 senior executives at MNEs in 2015 Majority of tax directors still charged with reducing the effective tax rate Tax increasingly a board level issue Key skill now is strategically minded Change to tax outcomes requires change to business outcomes

5 ATO is increasingly sophisticated Technology is extending the ATO s reach Globalisation and information exchange Information reporting obligations are becoming wider: FATCA, CRS Country by country Third party reporting Uncertain tax positions The ATO s highest echelons are populated by a number of private sector appointments Anti-Avoidance Taskforce: ATO will be recruiting further expertise

6 ATO increasingly helpful Transparency with the ATO typically having significant benefits Less pressure Proper independent review Less risk of tangential issues

7 Assume the ATO will find out Accounting standards require you to. They probably will anyway!

8 Lots of announcements Large number of announced legislative changes Legislative changes take a long time to process Grandfathering typically not offered Many legislative changes get cancelled (trust rewrite, the Hockey press release) Many legislative changes are highly politicised Quasi-law announcements (FIRB conditions)

9 Overview The current environment Anti-hybrid rules Diverted profits tax Chevron Suggested actions

10 Anti-hybrid rules Board of tax has reported Very limited consultation time, and only a few submissions (especially considering the size of the topic) Implementation by later of 1 January 2018 or six months following enactment UK has drafted rules already No requirement for base erosion Grandfathering is unlikely though many submissions have suggested this is necessary

11 Situations covered 1. Debt/equity mismatches 2. Capital/revenue mismatches 3. Timing mismatches 4. Payment commuted into tax-preferred form on assignment 5. Payment assigned to a tax-advantaged recipient 6. Loan/sale mismatches 7. Payments by disregarded entities to their parents 8. Payments by disregarded entities to third parties 9. Payments by dual residents to third parties 10. Payments to disregarded entities by other parties 11. Imported mismatches

12 Design of the rules Structured arrangements: widely held exception? tax disclosures marketing to jurisdiction tax calls Related parties (25%) vs control group Restructures subject to Part IVA Limited exemptions, e.g. securitisation vehicles, MITs

13 Example 1.1 Debt/equity mismatch Loan A Co B Co Interest / Dividend Recommendation 1 and 2.1 The loan carries a market rate of interest, but is subordinated to ordinary creditors and can be suspended to meet solvency requirements. Country B treats the loan as a debt instrument, and interest is deductible. Country A treats the loan as an equity instrument (i.e. a share) and interest is exempt. Recommendations 1 and 2.1 apply (circular application). Related parties (25%) or structured.

14 Example 1.27 capital/revenue mismatch Recommendation 1 Purchase price + interest B Co buys share from A Co for market value plus interest. A Co Transfer B Co Country A treats the interest as part of purchase price. Country B treats the interest as deductible. Shares Rules apply in Country B (even if A Co is taxable on trading gain) (but they don t prevent a trading loss deduction for B Co).

15 Example 1.21 timing mismatch Loan A Co Contingent interest Recommendation 1 A Co 1 lends to A Co 2 under long-dated (50-year) loan with deferrable interest. Country A allows A Co 2 to deduct the interest. Country A treats A Co 1 is taxable only on maturity. Rules apply. 3-year deferral permitted, plus clawback B Co

16 Example 1.30 commutation into tax-preferred form Recommendation 1 substitute payment Purchase price + earnings adjustment B Co buys share from A Co for market value plus earnout. A Co Share transfer B Co Country A treats the earnout as part of purchase price. Country B treats the earnout as deductible. Rules apply in Country B. C Co

17 Example 1.36 commutation into tax-preferred form A Co Purchase price + premium B Co Loan transfer 50% 50% Recommendation 1 substitute payment B Co transfers bonds with accrued interest to A Co. B Co is not taxable on the premium representing the accrued interest. A Co can deduct the premium. Rules apply to deny deduction for premium. Interest Loan C Co

18 Example 1.32 loan/sale mismatch (stock loan) Recommendation 1 hybrid transfer A Co transfers shares to B Co under a stock loan. B Co makes a manufactured dividend payment. A Co Share transfer B Co Dividend (70) B Co can deduct the manufactured dividend payment (not merely as a trading loss). Manufactured dividend (70) Repo A Co is exempt on the manufactured dividend payment. Rules apply to deny deduction for MDF. Shares SP rule may apply in Country A to include MDF in income.

19 Example 3.1 payment by disregarded entity to parent Loan A Co Interest (200) Recommendation 3 B Co pays interest to A Co. Country A treats B Co as disregarded, and ignores the interest payment. B Co can deduct the interest payment. Rules apply. B Co 1 Interest (300) Hybrid loan Operating income (400) B Co 2

20 Example 3.2 payment by disregarded PE A Co 1 A Co 2 Interest (300) Recommendation 3 PE pays interest to A Co 1. Country A ignores the interest payment (single entity). PE can deduct the interest payment. Rules apply. Can PEs make payments to head office? Loan PE Operating income (200) B Co Operating income (200)

21 Example 6.2 payment by disregarded entity to 3 rd party Recommendation 6 PE pays interest to a bank. A Co Country B allows a deduction for the interest, creating losses that might be transferred. Country A also allows a deduction for the interest payment. Country B PE Interest Bank Rules apply deduction denied except to the extent there is also double taxation of income. Loan Primarily a timing issue. Difficult tracking issues.

22 Example 7.1 payment by dual resident to 3 rd party A Co 1 A Co 2 Interest (150) Operating Income (300) Bank Recommendation 7 A Co 2 pays interest to a bank. Country B allows a deduction for the interest. Country A also allows a deduction for the interest. Rules apply deduction denied except to the extent there is also double taxation of income. Double taxation outcome with no solution other than tax structuring B Co Operating Income (350)

23 Example 4.1 payment to reverse hybrid A Co Interest Recommendation 4 Borrower pays interest to transparent entity. Country A ignores the interest payment (nothing has been received). Country B ignores the interest payment (sheeted home to A Co and exempt). Rules apply but should they, if the distribution will be taxable in Country A? B Co Borrower Co Loan

24 Example 8.5 imported mismatch Loan Payment (200) A Co C Co Interest (300) Hybrid financial instrument Loan Recommendation 8 C Co pays interest, which is a hybrid deduction. The deduction is imported into Country D because the deduction shelters interest receipts from D Co. The deduction is further imported into Country G because deductions on D Co interest payments shelter interest receipts from G Co. Loan B Co Interest (200) D Co Loan Loan Loan Rules apply in Country D or G to disallow deductions, if not neutralised earlier. Rule should yield to both primary and defensive rules in other countries E Co F Co G Co H Co

25 Overview The current environment Anti-hybrid rules Diverted profits tax Chevron Suggested actions

26 Diverted profits tax Companion to the Multi-national anti-avoidance law MAAL and DPT both based on UK DPT MAAL = avoidance of PE status DPT = profit-shifting to low tax jurisdictions Income years commencing on or after 1 July 2017 No grandfathering for existing transactions Financing transactions not excluded

27 Diverted profits tax 4 key requirements: 1. Organisation with $1 billion global turnover and $25 million Australian turnover. 2. Transaction between related parties : 25% common interest? Structured arrangements irrelevant. 3. Profit is shifted out of Australia and lowly taxed (<24% tax rate). 4. Insufficient economic substance: designed to secure tax reduction, unless: non-tax, financial benefits exceed tax benefit. Chevron: purpose of raising finance irrelevant

28 Diverted profits tax DPT: penalty tax rate of 40% on diverted profits amount based on provisional assessment assumed to be 30% of the gross expense UK rules: diverted profits determined using a counterfactual that ignores all taxes onus on taxpayers to demonstrate why the DPT is excessive pay tax upfront and wait 12 months to challenge!

29 Overview The current environment Anti-hybrid rules Diverted profits tax Chevron Suggested actions

30 Chevron Key outcomes: Reconstruction is available (even if it s not called that) Find a third party comparable any third party comparable Prep your experts as if there will be litigation Draft internal documents as if they are third party documents (?) External pricing can be passed on internally without margin (LCG 2015/15 in the context of MIT NALIR)

31 Overview The current environment Anti-hybrid rules Diverted profits tax Chevron Suggested actions

32 Kept Securitisation Vehicles Securitisation vehicle that is kept within tax consolidated group KSV requires: Insolvency remote SPV >50% debt-funded Established to manage risks

33 Kept Securitisation Vehicles Reduced cost of funding Access to new funding sources Advantages of KSVs Exempt from thin cap Exempt from anti-hybrid Recommendation 1 Possibly exempt from DPT Third party comparables for transfer pricing exist No tax event on transfers to vehicle No Part IVA

34 Dealing with uncertainty Assume the ATO will find out Direct ATO engagement (rulings, APAs) Use of experts (valuers, foreign tax specialists) Second opinions Contractual issues: Exit rights Information rights Sign-off that the documents and the tax advice match Budgeting for contested claims

35 Dealing with uncertainty Hofstadter s law: It always takes longer than you expect even when you take into account Hofstadter s law

36 Ka Sen Wong Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this presentation and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.