Cross Border Financing and Currency Hedging After Tax Reform

Transcription

1 Cross Border Financing and Currency Hedging After Tax Reform A Financial Executives Alliance Webinar By: Steven D. Bortnick, Partner Pepper Hamilton LLP John Frey, Managing Partner, Foreign Exchange, First Republic Bank August 21, 2018

2 Impact of CFC Pledges and Guarantees 2

3 CFC Pledges and Guarantees Pre 2018 USCo $100M Loan Bank USCo $100M Loan Bank Pledge of all assets including stock of CFC CFC Guarantee CFC Pledge or guarantee Deemed distribution of CFC E&P Like a deemed dividend E&P fills up amount of debt on which CFC provides guarantee or stock is pledged 3

4 Multiple Guarantors US Borrower $10M Loan Bank Guarantees CFC1 CFC2 CFC FSA Allocate among guarantors? 2015 Preamble Inclusions may exceed debt SIH Partners Case CFCs and non-cfcs guaranteed debt. Full inclusions w/respect to CFCs 4

5 956 Still the Law After 2017 Proposals to eliminate 956 inclusion for US corporations (not individual(s)) NOT adopted remains in tact 5

6 Broader Application of Subpart F (CFC Rules) Eliminated requirement that the foreign corporation be CFC for at least 30 days 10% shareholder determined by vote or value (used to be just vote) Attribution from foreign to US persons now required 6

7 Extra Diligence Required Unexpected CFCs US Co 100% Foreign Parent 10% loan 90% Foreign Sub Pre-2018 in determining CFC status no attribution from foreign to US person Post 2017 Attribution from foreign to US US Co deemed to own foreign sub Foreign sub = CFC Loan = Investment in US property so 956 applies Interest on loan taxable unless treaty applies (No portfolio interest because Foreign Sub now a CFC) Any different if US Co owned no stock? 7

8 Extra Diligence Required Foreign Parent Guarantee and pledge of stock 90% 10% US Co 100% loan Bank Foreign Sub is a CFC Foreign parent pledged 100% of stock of Foreign Sub 956 applies Any different if US Co owned no stock? Foreign Sub 8

9 CFC Holding Company Issue US Co Loan Bank Assets and Business US Sub (no assets except CFC) CFC 100% 100% Pledge All Assets Guarantee US sub s only asset is CFC Same as CFC guarantee or pledge? Market position? Pepper position. Is it relevant if US Sub is old and cold versus new? 9

10 CFC Holding DRE Issue Loan US Co Bank Assets and Business US LLC CFC 100% 100% Pledge All Assets Guarantee US LLC has operating business Different from CFC holding company issue - US LLC has business and asssets Treat as direct pledge / 100% of CFC stock since US LLC is disregarded? Consider partnership fix! 10

11 956 Still the Relevant After GILTI 956 picks up: - Pre-1986 E&P - Return on tangible property - High-tax kickout income 11

12 Hedging Currency Risk 12

13 Addressing FX risk: Identify, Quantify, Control Questions to ask: - What does the firm s exposure looks like? - How sensitive is the exposure to movement in exchange rates? - Do I fully understand the risk holistically? - What is the firm s policy towards reducing currency risk? 13

14 Strategy I: Forward Contract Provides full protection This strategy provides a simple way to eliminate risk by locking in a guaranteed exchange rates for converting one payment or a series of future payments. No up-front fee The exchange rate is determined on the day the trade is booked, it is a firm and binding commitment No money changes hands until the designated settlement dates The exchange rate will be no worse and no better than the agreed forward rate. Hence, you will forego the potential to do any better than the forward rate Forward exchange rates are a function of the spot rate and interest rate differentials between the two currencies A Foreign Exchange Guidance Line is required 14

15 Strategy II: Participating Forward Provides full protection and upside potential This strategy locks in a guaranteed worst-case rate while retaining upside potential No up-front fee Locks in a worst-case rate for the conversion of funds Allows you to participate in any subsequent strengthening of the CCY based upon the pre-agreed participation percentage (e.g., 25% 50% 75%) No money changes hands until the designated settlement dates Full hedge against underlying position Strike rate varies according to participation A Foreign Exchange Guidance Line is required but this product has a lower credit requirement than a Forward Contract 15

16 Strategy III: Vanilla Call Option Provides full protection and full participation This strategy can be viewed as an insurance policy where you are fully protected but you may walk away from it if you don t need it. There is an upfront premium paid on day of execution A call option provides the client with the right but not the obligation to buy a currency at expiry. If the currency moves in the clients favor the option can expire worthless and the currency can be bought on the spot market If the currency moves against the client the option would be exercised and the client would buy the currency at the strike. Options can be customized the strike, expiry, notional, and style are all chosen by the client. A Foreign Exchange Guidance Line is NOT required. 16

17 Hedging Decision Matrix Up Front Premium Binding Obligation Provides Protection Allows for Participation Credit Profile Forward No Yes 100% 0% 100% of the Credit Equivalent Exposure needs to be collateralized Participating Forward Not required Partial 100% Unlimited on floating piece of the structure 50% of the Credit Equivalent Exposure needs to be collateralized Vanilla Put Option Yes No 100% 100% None 17

18 Disclosure DISCLOSURE The material in this document is for informational purposes only and is of general market, economic, and political conditions or statistical summaries of financial data. This material should not be construed as legal, accounting, tax, investment, trading or other professional advice and should not to be relied upon in substitution for the exercise of independent judgment. This document does not constitute an offer, recommendation or solicitation to buy or sell a particular financial asset or a commitment to enter into any transaction. Although information in this document has been obtained from sources believed to be reliable at the time of publication, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. First Republic Bank and its affiliates do not assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Actual results will vary, and may be adversely affected by exchange rates, interest rates, or other factors. Recipients of this material should carefully consider any risks involved. This document may not be reproduced or circulated without our written authority. First Republic Foreign Exchange is a division of First Republic Bank. Foreign Exchange transactions are not FDIC insured, are not bank guaranteed, and may lose value. 18

19 Taxation of Hedging Transactions Currency exchange gain (loss) taxable as ordinary income (loss) In the case of a debt instrument denominated in a different currency: - FX gain/loss on difference in rates from time interest accrues until paid - FX gain/loss on difference in rates from time of loan until time of payment FX gain/loss also recognized on hedging transactions, such as forward contracts Potential to integrate hedge in order to avoid taxation on currency exchange gain - Creates a single synthetic debt instrument in currency of hedge 19

20 FRB Team John R. Frey is a Managing Director in the Foreign Exchange Division at First Republic Bank. As a currency advisor John is responsible for providing risk management solutions to alternative asset firms, life science, biotech, corporate clients and high net worth individuals throughout the banks footprint. John joined First Republic Bank in Prior to joining First Republic Bank, Mr. Frey worked at Morgan Stanley as a client service associate, where he managed business development and day-to-day client needs. Mr. Frey earned his Bachelor of Science degree in Business Administration & Small Business Management from Southern New Hampshire University. 20

21 Steven D. Bortnick Partner, Tax Steven D. Bortnick is a partner in the Tax Practice Group of Pepper Hamilton LLP, resident in the Princeton and New York offices. Mr. Bortnick focuses his practice on domestic and international tax and private equity matters. Mr. Bortnick handles a broad range of transactions, including asset, stock, cross-border and domestic acquisitions, recapitalizations and reorganizations. He is experienced in, and a significant portion of his practice is devoted to, the structuring of domestic and international private equity transactions. He advises business organizations on a variety of tax issues, and he is involved in the formation of private equity and hedge funds. An active speaker and author, Mr. Bortnick has written materials and spoken for several major private equity tax conferences. Topics of his presentations include private equity, venture capital, cross-border investing, venture capital operating company issues, and merger and acquisition tax issues. Before joining Pepper in 2007, he practiced in the New York office of Dechert LLP. 21