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T A X R E F E R E N C E L I B R A R Y N O 9 0

Financial Services 1st edition

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04 Automatic exchange of informationAutomatic exchange of information:Adapting to new global tax reportingstandardsAs things gather pace in the move towardsautomatic exchange becoming the globallycoordinated standard for tax information shar-ing, KPMG’s Hans-Jürgen Feyerabend, VictorMendoza and Jennifer Sponzilli explore theintricacies of implementing a new global norm,as well as how it will sit alongside other initia-tives including the US FATCA.

08 Bank leviesBank levies: A step toward harmonisationLegislators have recently reacted to popularthinking that banks and their investors shouldbe the ones paying for losses from banking riskmaterialising. Hans-Ulrich Lauermann andKathryn Struve of PwC discuss bank levies inrespect of European and US legislators.

13 BelgiumBelgium publishes new guidelines onbusiness restructuringsThe Ruling Committee of the Belgian Ministryof Finance has recently published an “Advice”which includes new guidelines for the applica-tion of anti-abuse rules on various types ofbusiness restructuring, such as a (partial)demerger and the contribution of a branch ofactivities. Geert De Neef of Lydian explainshow these guidelines will impact taxpayers.

18 GermanyFATCA 2.0: The introduction of a globalstandard on automatic exchange of taxinformationGlobalisation has meant that items are increas-ingly being sent around the world. Thisincludes an increasing amount of money beingsent abroad, which may go untaxed if taxpayers,negligently or willingly, do not comply withtheir tax obligations. Karl Kuepper of PwClooks at the new standard for ensuring compli-ance, and explains the strategic and flexibleapproach taxpayers will be required to take.

23 IndiaTax issues for foreign banks in an everchanging landscapeSunil Gidwani, Nehal Sampat and Dipesh Jainof PwC discuss some of the key taxation issuesaffecting foreign banks in India.

28 IndiaTax issues for offshore asset managers in anever changing landscapeGautam Mehra, Nehal Sampat and Neha Shahof PwC discuss the key Indian income taxissues relevant for foreign investors and assetmanagers investing into India.

32 MexicoMexico 2014 income tax reform:Considerations for the financial sectorKarina Pérez and Alejandro Ortega of PwCanalyse Mexico’s recently reformed tax codeand related administrative regulations, focusingon those provisions that taxpayers in the finan-cial sector need to be acutely aware of.

37 The NetherlandsThe impact of BEPS on private equityOn March 14 2014, the OECD released a dis-cussion draft on treaty abuse under its ActionPlan on Base Erosion and Profit Shifting(BEPS). Marc Sanders of Taxand providesguidance on the BEPS project’s impact on theprivate equity sector.

41 NorwayFinancial services in Norway: Navigating thetax issuesNorway is participating in the EuropeanEconomic Area which includes the 28 EU mem-ber states and the three European Free TradeAgreement (EFTA) states. The EEA treaty islargely founded on the same principles as the EUtreaty and most EU regulations apply in Norwaywithin the financial services sector, including tax-ation. PwC’s Dag Saltnes, Stian Roska Revheimand Liv Lundqvist explain.

Financial Services

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45 SwitzerlandSwiss fund management structure taxconsiderationsIn light of new EU legislation on collectiveinvestments, Alberto Lissi and MonikaGammeter Utzinger of Tax Partner – Taxandexplain the tax considerations relating to Swissfund management structures.

50 SwitzerlandSwiss withholding tax and pending refundclaims: A €2 billion question Financial institutions filing withholding taxrefund claims on Swiss dividends over the pastseven years have generally received informationrequests rather than the refund expected as theSwiss tax authorities challenge refund claimstied to dividend trades. This has led to uncer-tainties that have reduced the market value ofdividends on Swiss stocks. KPMGSwitzerland’s Charles Hermann explains.

53 USUS tax developments affecting financialinstitutions and productsWilliam Skinner and Julia Ushakova-Stein ofFenwick & West discuss the newest regulationsunder FATCA and section 871(m) alongsiderecent case law developments.

E D I T O R I A L


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I n anticipation of the launch of International Tax Review’s FinancialServices Tax website, the annual publication on Capital Markets tax devel-opments has been repositioned to also cover banking, asset and wealth

management, private equity and fund management from a tax perspective. In Europe, discussion around the financial transaction tax being taken

forward by 10 EU member states continues to top the list of concerns forfinancial services taxpayers, but there is activity on other fronts, too.

The Alternative Investment Fund Managers Directive takes full effectfrom July 22 and final administrative preparations are being performed.AIFMD compliance is required to obtain a licence to manage or market EUAIFs from 2015, so fine-tuning processes to ensure compliance with italongside related requirements at national level remains a priority. You willalso find out within these pages why uncertainty is reducing the marketvalue of dividends on Swiss stocks.

In the US, there is a continued focus on the Foreign Account TaxCompliance Act (FATCA). A list of participating foreign financial institu-tions has been published, and intergovernmental agreements continue to besigned, while in the Asia-Pacific region India is unsurprisingly fertile groundon which to find tax controversy. Specific issues are cropping up for foreignbanks in the country, as well as for foreign investors.

Bank levies are seen as the favoured tool for legislators seeking to appeasethe populist view that financial institutions should bear the cost of losses stem-ming from banking risk, and the fact 16 European countries have implement-ed one bears this out. Even the business-friendly UK tax regime has seen itsbank levy raised successively in recent years. The levy provides great variety andflexibility in scope, so do not be surprised if this trend takes hold elsewhere, too.

For private equity fund investors, the impact of the OECD’s multilateralBEPS project is a critical issue. Despite the OECD acknowledging that theposition of collective investment vehicles must be addressed, greater elabo-ration on the specific challenges is required.

Whether it is information regarding worldwide initiatives such as BEPSor FATCA 2.0 – the term being used to describe the global standard ofautomatic tax information exchange – or domestically-focused updates onBelgian business restructuring or the implications of Mexican tax reform forthe financial sector, this publication takes a practical approach to providingeverything you need to effectively manage your financial services tax issues.

Matthew GilleardCorporate tax editor, International Tax Review

Editorial

A U T OM AT I C E X C H A N G E O F I N F O R M AT I O N


Automatic exchange ofinformation: Adapting to newglobal tax reporting standardsAs things gather pace inthe move towardsautomatic exchangebecoming the globallycoordinated standardfor tax informationsharing, KPMG’sHans-JürgenFeyerabend, VictorMendoza and JenniferSponzilli explore theintricacies ofimplementing a newglobal norm, as well ashow it will sit alongsideother initiativesincluding the USFATCA.

“Tax fraud and tax evasion are not victimless crimes: they deprivegovernments of revenues needed to restore growth and jeopardisecitizens’ trust in the fairness and integrity of the tax system.Today’s commitment by so many countries to implement the newglobal standard, and to do so quickly, is another major steptowards ensuring that tax cheats have nowhere left to hide.”

Angel Gurría, Secretary-General OECD, May 6 2014

T he OECD publication on February 13 2014 of a global standard forautomatic exchange of information (AEoI) on financial accounts is amajor step towards a globally coordinated approach to the disclosure

of income of individuals and organisations. As such, it is a key part of inter-national efforts to clamp down on tax evasion. The standard provides formutual exchange of information on account holders with foreign tax resi-dence, account balances, income and gross proceeds from certain financialtransactions. It has been developed in partnership between the OECD andthe G20 countries, and in close cooperation with the EU. The documentis in two parts: Part I contains the introduction to the standard; Part IIcontains the text of a Model Competent Authority Agreement (CAA) anda Common Reporting and Due Diligence Standard (CRS).The new standard was endorsed in May 2014 during the OECD’s

annual Ministerial Council Meeting in Paris and by the G20 FinanceMinisters and Central Bank Governors at their meeting in February 2014.More than 44 countries and jurisdictions have now committed to earlyadoption of the standard, and further countries are expected to do so dur-ing 2014. The OECD is working to develop information and guidance onthe technical measures necessary to implement the processes of actualinformation exchange, including compatible transmission systems andstandard formats, and to formulate a detailed commentary on the standardto help ensure its consistent application. These are due to be presented intime for the G20 meeting of finance ministers in September 2014, with theearly adopters implementing the new regime starting in 2016.AEoI is not new. The EU Savings Directive, introduced in 2005, pro-

vides for AEoI on interest income within the EU and certain non-EUcountries and territories, while changes due to take effect in 2017 willbroaden the Directive’s scope, primarily to remove perceived loopholes.More recently, AEoI has been adopted as the fundamental reportingregime under the US Foreign Account Tax Compliance Act (FATCA).What is new about the CRS is its scale and scope.



Building on FATCATo build on previous experience, the CRS has been built on asimilar approach to intergovernmental information exchange asFATCA. But it is misleading to view the CRS as simply FATCA2.0 or GATCA (global FATCA). Its scope is much broader;and in some respects solutions already being developed forFATCA may be inconsistent with those necessary for AEoI. The US statutory rules regarding FATCA do not require

information exchange between tax administrations. It is adomestic system aimed at US persons with offshore accountsand investments. Specified types of non-US entities, such asfinancial institutions, must disclose to the US InternalRevenue Service (IRS) information about their US accountholders, along with other similar information. There is a puni-tive 30% withholding tax on certain US source payments ifthe foreign entity does not comply with its registration andcompliance obligations. Intergovernmental exchange of information under FATCA

is governed by one of two forms of intergovernmental agree-ment (IGA). In a number of jurisdictions, for an institution topass information directly to the IRS would breach domesticprivacy and data protection legislation. To address this issue,under the Model 1 IGA, institutions first report informationto their local tax administration, which then passes it onto theIRS; by contrast, a handful of jurisdictions have agreed withthe US to allow their financial institutions to transfer USaccount information directly to the IRS under a Model 2IGA. At the time of writing, 34 countries have signed eitherModel 1 or Model 2 IGAs with the US and another 36 havebeen substantially agreed.

CRS: Much more than FATCATo capture all relevant taxpayers, CRS (consistent withFATCA) has been designed with a broad scope across threemain areas:• Reportable income, which includes all types of investmentincome (including interest, dividends, income from certaininsurance contracts, annuities and similar), as well as accountbalances and sales proceeds from financial assets;

• Financial institutions required to report under the CRSinclude banks, custodians, brokers, certain collectiveinvestment vehicles, trusts and certain insurance compa-nies; and

• Reportable accounts, which include accounts held by indi-viduals and entities (which includes trusts and foundations),and the requirement to look through passive entities to pro-vide information on reportable controlling persons.While each of these areas are those focused on in FATCA,

there are key definitional differences that will result in inconsis-tent entity and product classification, necessitating a full reviewof the differences and how they apply to your own entities, youraccounts and your customers. Moreover, certain decisionstaken in the CRS, such as elimination of account balance

thresholds for customer identification and the treatment ofinvestment entity interests traded on an exchange as financialaccounts, will greatly expand the scale of the information col-lected and reported as compared to that under FATCA.Reportable accounts are financial accounts held by tax res-

idents in relevant CRS reportable countries. A person is con-sidered to have a tax residence in a country if he or she, underthe laws of that country, is liable to tax due to domicile, resi-dence, place of management, or any other similar criterion.Where an account holder is a reportable person in respect ofmultiple participating countries, the entire account balance orvalue, as well as the entire amount of income or gross pro-ceeds, has to be reported to each participating country.Additional guidance is expected on understanding tax resi-dency and technical solutions for implementation.The financial information to be reported includes interest,

dividends, account balance, income from certain insuranceproducts, sales proceeds from financial assets, and otherincome generated from assets held in the account or paymentsmade with respect to the account. Reportable accountsinclude accounts held by individuals and entities (whichincludes trusts and foundations), and the standard includes arequirement to look through passive entities to report on therelevant controlling persons.The CRS covers:

• depository institutions – entities that accept deposits inthe ordinary course of a banking or similar business;

• custodial institutions – entities that hold, as a substantialportion of their business, financial assets for the account ofothers;

Hans-Jürgen FeyerabendKPMG

Tel: +49 69 9587 2348 [email protected]

Hans-Jürgen is a tax partner in Frankfurt and has more than 24years of experience in advising financial institutions on a fullrange of tax matters. He is specialised in banking and financeand asset management and leads KPMG’s Global FinancialServices Tax practice and also is the industry leader for ourGlobal Investment Management Tax practice. Hans-Jürgen advises credit institutions, financial services insti-

tutions, financial enterprises, clearing institutions, and asset man-agement companies on general tax law. His specialisationsinclude, in particular, the taxation aspects of financial instrumentsand investment funds as well as tax advice on M&A transactionsin the banking sector.



• investment entities – entities: (i) whose primary businessinvolves certain asset management or financial services foror on behalf of a customer; or (ii) whose gross income isprimarily attributable to investing, reinvesting, or tradingin financial assets, if the entity is managed by anotherfinancial institution; and

• specified insurance companies – insurance companiesthat issue or are obligated to make payments for cash valueinsurance contracts or annuity contracts.However, it impacts on a wider range of financial institu-

tions than FATCA, since a number of categories of financialinstitutions that are excluded from the FATCA Model 1 IGAmay not be excluded from the CRS:• Financial institutions with a local client base;• Local banks;• Certain treaty-qualified retirement funds;• Financial institutions with only low-value accounts;• Sponsored investment vehicles;• Some investment advisers and investment managers; and• Investment trusts.Hence the CRS will affect more financial institutions than

FATCA in any implementing country.

The reporting challengeFor those financial institutions with a significant customer orinvestor base outside their home country, AEoI means a bigincrease in the volume of data to be reported to the local taxauthority. In integrated regions such as the EU, the sheerscale of reporting will make manual or semi-manual solutionsimpractical. It is a similar story with due diligence and cus-tomer data monitoring, as financial institutions may have tostore more than one classification for a customer or investorwith multiple tax residences, and track all changes to cus-tomer status or residence, to keep up-to-date. Most financial institutions have dozens, if not hundreds, of

legacy systems to attempt to update and align, to capture andvalidate the required data for annual reporting. They areunlikely to have allocated budget for such work in 2014 and,even if the commitment and funds exist, there is still consid-erable uncertainty over the scope and timing of the CRS. It isunclear how many countries will formalise the agreements bythe end of 2014, or whether 2016 will remain the big bangdate for introducing the CRS due diligence requirements.Institutions also have to find ways to deal with any nationallegal restrictions on collecting additional AEoI data, such asas data protection and confidentiality restrictions. Systems and programmes built for FATCA cannot simply be

extended to comply with the CRS. New fields will be requiredto capture information to be reported where the reportingschemes are similar but not identical, and there may be differ-ent processes for the two regimes. The range of productsexempt from documenting or reporting also vary, and institu-tions may have to reassess whether each product offered createsa reportable account. Finally, some financial institutions havetaken steps to limit their burden under FATCA, including clos-ing accounts of US individuals to reduce reporting, or central-ising all US investments in one entity. These strategies will notwork for the CRS when there will ultimately be many morecountries with which to exchange information. Although thetools and analysis developed for FATCA can inform an AEoIprogramme, the differences are so profound that new process-es, systems and controls will undoubtedly be needed.It is clear, then, that AEoI requires a wholesale review, and

a potentially substantial reconstruction, of solutions devel-oped so far to respond to FATCA. In particular, processes forcustomer acceptance, know-your-customer (KYC) and anti-money laundering (AML) will need to be reviewed andextended, and new systems for reporting relevant data to thetax authorities created. Efficient and effective processes andIT solutions need to be built: these solutions must be sustain-able and scalable as more countries enter into the AEoIregime over the months and years ahead. Governancerequirements for AEoI processes will be significantly greaterthan under FATCA, and need to be designed accordingly. All of this has to be undertaken while institutions are still

working to achieve FATCA compliance: the consequence willbe the inevitable disruption of systems and processes that havejust been established for FATCA. In addition, to the extentthat operating models have been defined in part to avoid orminimise operational burdens from such tax reportingrequirements, these decisions will need to be re-evaluated inthe light of the global scale of AEoI.

Action now?Once again, the pace of regulatory change threatens to over-whelm the ability of financial services companies to developthe necessary systems and processes to respond. And whilethe deadlines are short, the detail cannot be specified until the

Victor MendozaKPMG

Tel: +34 91 456 3488 [email protected]

Víctor is a tax partner in Madrid and has been advising onFinancial Services taxation for more than 24 years. He is head ofthe Financial Services Tax practice at KPMG in Spain and thechairman of the KPMG’s Global Banking Tax practice.Víctor advises major domestic and foreign financial institutions

in Spain on tax matters relevant to the financial industry. He hasalso a strong experience advising and implementing cross-borderstructured finance transactions and M&A.



CRS is fully defined towards the end of the year. In addition,there are in many cases legal limits to what can be pursued onan early timetable: in many jurisdictions, data protection lawsprevent companies from collecting the necessary informationon account holders in advance of the passage of domesticenabling legislation.Nevertheless, there are a number of housekeeping actions

which can be mounted now, and which should yield benefitsin any event. In this regard, businesses should:• review and overhaul existing customer onboarding sys-tems, KYC and AML processes, documentation standards;

• review and streamline separate systems, and rationaliseinconsistent policies and definitions;

• review and overhaul governance arrangements to ensureclear lines of authority and responsibility for compliance;and

• ensure that policies and procedures to manage operationaland reputational risk are geared up to capture AEoI issues.

These and similar actions should also feed into the final keypriority of ensuring that where business imperatives substan-tially favour one AEoI implementation methodology overanother, the argument is effectively captured in representa-tions to governments. Financial institutions can still influencehow AEoI will operate. But the window of opportunity isclosing rapidly.Hans-Jürgen Feyerabend is head of Global Financial Services Tax (KPMGGermany)Victor Mendoza is head of Global Banking Tax (KPMG Spain)Jennifer Sponzilli is office managing partner of the US tax practice (KPMGUK)The information contained herein is of a general nature and based onauthorities that are subject to change. Applicability of the information tospecific situations should be determined through consultation with your taxadviser. This article represents the views of the authors only, and do notnecessarily represent the views or professional advice of KPMG LLP.

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Bank levies: A step towardharmonisation

Legislators haverecently reacted topopular thinking thatbanks and theirinvestors should be theones paying for lossesfrom banking riskmaterialising.Hans-Ulrich Lauermannand Kathryn Struve ofPwC discuss banklevies in respect ofEuropean and USlegislators.

M any legislators have focused on the supervision and financial stabil-ity of the banking sector which has included the desire to set asidefunds to bail out banks finding themselves in financial difficulty. To

raise the required funds, European legislators have mostly introduced banklevies. The financial stability levy once considered in the US never foundsufficient political support.

Current state of bank leviesThough bank levies have been around for decades, only in recent yearssince the financial crisis has there been a significant increase in the numberof bank levies being implemented. Bank levies are currently being imposedat the national level, with 16 countries in Europe having introduced a banklevy.This has led to a fragmented landscape of bank levies being imposed at

the national level, leaving global banks to cope with varying requirementsaround the world, though mainly in Europe. Some levies, for example in the UK, have been introduced as taxes fund-

ing the general budget, others (such as Germany) as regulatory levies feed-ing a fund separate from the general budget. There is also a great variety in the scope of the national levies, includ-

ing:• Base for the levy: the base varies with respect to being based on bankdeposits, capital assets, risk-weighted assets, and other calculations withrespect to a bank’s balance sheet.

• Tax deductible contributions (whether a particular bank levy resultsin a tax deduction) are decided on a national level and so differs byjurisdiction.

• The implementation date: many bank levies have implementation datesfrom 2011 through to 2014 and beyond, some with phased-in timeperiods for different components.

• Branch application: application to branches and subsidiaries of the head-quarter/parent bank may differ by levy.These variations have given rise to multiple bank levy charges for

multinational banks with generally no relief being available under tradi-tional double taxation conventions. Only recently have bilateral treatiesbeen introduced aiming specifically at granting credit or exemption reliefmitigating multiple charges. Banks normally use multi-disciplinary teamsto handle the levy, which may be led out of the regulatory or the taxdepartment.

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There is only limited transparency of how much fundinghas been raised through bank levies against the targets set bylegislators. In the case of Germany, though the target size ofthe restructuring fund is €70 billion ($95 billion), in the firsttwo years of being implemented, only about €1.28 billion intotal has been collected.As far as repercussions of the bank levy on taxable income

for corporate income tax purposes are concerned, there is noharmonised picture. Some jurisdictions allow for tax deductibility of the levy,

while others do not. Transfer pricing charges of national banklevies to jurisdictions outside the respective banks’ homecountries are very complex and seldom successful under thenational legislations governing the branch or subsidiaryreceiving the charge. As a consequence, implementing bank levies solely at the

national level has the potential of creating competitive distor-tions and tensions between legislative bodies over how toresolve failing multinational banks.

Proposal for single resolution fundOn April 15 2014, three key legislative acts were adopted bythe European Parliament to complete the banking union:• The Bank Recovery and Resolution Directive (BRRD), • The Single Resolution Mechanism (SRM), and • The Directive on Deposit Guarantee Schemes. According to the European Commission, the SRM, which

will govern the efficient resolution of an institution, in con-junction with a Single Resolution Fund (SRF or Fund), man-aged by a central authority will, among others, “restore theorderly functioning of EU banking markets”.The BRRD is an EU-level single rulebook for the resolution

of banks in EU member states, one component of whichrequires member states to establish national resolution fundswith a minimum target of 1% of covered deposits. Under theSRM, a Single Resolution Fund will be established to ensureconsistent application of resolution funding for all institutionscovered under the Single Supervisory Mechanism (SSM), whichaims at harmonised banking supervision in the Eurozone. Contributions should begin under the BRRD in 2015. For

the Euro Area, they will be transferred to the SRF in 2016once the IGA has been ratified by all participating countries;the Eurozone plus other member states opting to participate. However, the UK, for example, has stated it does not plan

to opt-in for purposes of the SSM, and consequently, will notbe covered under the SRF, which may lead to further distor-tion in the markets between the Eurozone and states outsidethe Eurozone. The UK will have to set up a resolution fundunder the BRRD, but the contributions will not be trans-ferred to the SRF.The Fund is not meant to replace private investors absorb-

ing losses but rather to provide temporary financial aid to ail-ing banks to ensure that the functions which are critical to

financial stability and the overall economy are resolved with aminimal impact on the real economy.

Financing the FundThe SRF will be financed by levies on banks covered underthe SSM. To meet the financing goals of the Fund, institu-tions covered will need to collectively contribute roughly12.5% of the target fund level annually for an eight-yearimplementation period. The Fund will initially consist ofnational compartments to be mutualised over a phased-inperiod, but accelerated with 60% over the first two years, fol-lowed by 6.7% in each of the remaining six years.The funds will be used in a waterfall method consisting

first of the use of a bank’s national compartment up to a pre-scribed threshold, followed by the use of the mutualised por-tion of other national compartments, and finally by the use ofany remaining funds in a bank’s national compartment.Furthermore, if the previous funds are not sufficient, addi-tional funds can be raised in the form of ex post contributions,loans from the member state, or borrowing from othernational compartments.An intergovernmental agreement (IGA) has been signed

that covers the transfer of contributions raised by nationalauthorities and the mutualisation of the funds available in thenational compartments.

Hans-Ulrich LauermannPwC

Direct: +49 69 9585 6174 [email protected] www.pwc.de

Hans is a partner with PwC and based in Frankfurt. Since 2007he has led the German tax financial services practice. He is amember of the German financial services and tax leadershipteam. In May 2014 he was announced as co-leader global FStax.Hans overseas tax and regulatory advice to banks, insurance

companies and asset managers. His broad range of experienceincludes international structuring, coordination of transactions,and compliance projects for financial services companies.Before joining PwC Frankfurt, Hans worked for several years as

a director in the London-based global financial services tax teamof PwC. He is a regular speaker at conferences on financial serv-ices matters.Hans-Ulrich Lauermann is a German attorney and certified tax

adviser. He holds a PhD in securities law.

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The level of contributions of an individual bank will bebased on two factors:1) A flat contribution calculated pro-rata based on theamount of each institution’s liabilities, excluding ownfunds and covered deposits compared to the total liabili-ties, excluding own funds and covered deposits of all cov-ered institutions; and

2) A risk-adjusted contribution based on criteria set out in theBRRD.Thus, riskier banks will generally make higher contribu-

tions than those institutions exposed to a smaller degree ofrisk. However, given that the regulatory environment aims tomake banks less risky, through maintaining more capital,increasing liquidity, and reducing leverage, the burden of thecontributions may shift throughout the funding period alongwith the risk profiles of banks.Contributions are expected to begin in 2016 to the Fund,

with a target size of 1% of covered deposits, or roughly €55billion, based on 2011 balance sheet data. There are someconcerns that a €55 billion Fund is not sufficient to ensurefinancial stability. The 1%, however, is the minimum set by theBRRD, and thus, participating states may require higher con-tributions or a higher base if they choose.

Further fragmentationConsequently, though the SRF may appear to be a har-monised bank levy for participating states, banks may still befacing a fragmented landscape.Most notably, though, the minimum requirements for the

Fund are set, participating states have the flexibility to choose to

raise the minimum requirements or even the relevant base, aslong as the minimum amount is met. Thus, even with a singlefund, the way the charge is levied may still differ by jurisdiction.In addition to the SRF, banks may also be subject to addi-

tional levies. First, the SRM Board (board that prepares theresolution of a bank) will be financed by a separate, independ-ent levy than that for the Fund. Additionally, if the funds inthe SRF are not sufficient to cover a bank resolution, ex postcontributions can be raised, imposing an additional levy oncovered banks. The ex post contributions will be allocated inthe same manner as the annual contributions to the fund,however, the total amount of ex post contributions per yearshould not exceed three times the amount of annual contri-butions. Finally, national deposit guarantee schemes must still be

financed, since, in case of a bank failure, the deposit guaran-tee schemes will still be liable up to the amount they wouldhave been if a bank was wound down under normal insolven-cy proceedings.

Considerations from a tax perspectiveMost global banks have, based on publicly available figures,an effective tax rate (ETR) approximating 30%. There areexceptions to the rule, especially where banks have incurredsignificant tax losses. This does not greatly differ fromETRs in the real economy.While bank levies are an above-the-line charge and, hence

no component of the ETR of a bank, it is worthwhileincluding them hypothetically to measure their impact. Forexample, the UK has raised more than £5 billion from itsbank levy since it was introduced in 2011 with some of thelargest banks in the UK paying an effective tax rate of 40%,including the bank levy. Taking into account some extraor-dinary effects hitting one of the banks, the hypotheticaleffective tax rate of the five biggest banks in the UK wasmore than 71% in 2013.Measures introduced under Basel III/CRD IV aiming at

enhancing capital and liquidity while reducing leverage have,beyond the goals set by the Basel Committee, contributed tomaking banks less tax efficient. The same holds true for cer-tain restrictions on the tax deductibility of hybrid debt undernational legislation, and the situation will be exacerbatedunder the OECD BEPS (base erosion and profit shifting)concept.While the harmonisation of the bank levy is generally a

welcome step to simplify cross-border banking business, it isclear from initial estimates that the new levy will add to thefinancial burden of banks under existing national levies. Thisburden is running counter to the regulators’ goal to strength-en banks’ capital bases, as it will limit each bank’s ability to setaside retained earnings to build capital. This will adverselyimpact the Eurozone (plus opting member states) banks’competitiveness from at least two perspectives:

Kathryn StruvePwC

Direct: +49 69 9585 [email protected]

Kathryn Struve is a manager with PwC in the financial servicestax team in Frankfurt, Germany. Before moving to Germany inMarch 2012, Kathryn worked in the PwC New York office whereshe worked in the asset management team focusing on advis-ing hedge funds and private equity funds. Since moving toFrankfurt, Kathryn has focused on FATCA and has supported mul-tiple engagements in both banking and asset management.Kathryn is a certified public accountant (CPA) in New York and

is a member of the American Institute of Certified PublicAccountants.

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• Their main competitors in the US are not subject to a sim-ilar levy and are unlikely to become so any time soon.

• Given that banks have less ability to build capital fromretained earnings, they will have to tap capital markets forfurther capital. Bank levy costs will add to banks offeringless attractive earning per shares and other KPIs making itmore expensive for them to raise capital than for theirEuropean peers in the real economy.The degree of a banks’ suffering from the levy will also

depend on its tax treatment. Based on the bank levies in placenow, more than half are tax deductible. Should national gov-ernments make different decisions regarding the taxdeductibility of the levy, this could lead to competitive distor-tion among the markets.

Additionally, transfer pricing of the new levy continues to bea complicated topic because of the potential deviation of actualimplementation approaches from country to country, especiallywith respect to tax deductibility and the use of calculation basis.Banking institutions may need to implement a transfer pricingstrategy to deal with the new levy, which could be linked to thestrategy for any existing levies. Furthermore, since the bank levyis a balance sheet driven and regulatory driven cost, a bankgroup might want to review how efficiently it has deployed itsbalance sheet, for example in terms of debt and equity mix.Thus, while a harmonised bank levy is a step toward sim-

plifying cross-border banking, banks may still be subject to afragmented landscape and left addressing various regulationswith different objectives.

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W W W . I N T E R N A T I O N A L T A X R E V I E W . C O M 1 3

Belgium publishes newguidelines on businessrestructuringsThe Ruling Committeeof the Belgian Ministryof Finance has recentlypublished an “Advice”which includes newguidelines for theapplication of anti-abuse rules on varioustypes of businessrestructuring, such as a(partial) demerger andthe contribution of abranch of activities.Geert De Neef ofLydian explains howthese guidelines willimpact taxpayers.

T he Advice of the Ruling Committee provides further clarification oncertain criteria which will be of particular importance in decidingwhether or not the Ruling Committee is prepared (or not) to issue a

positive ruling decision.In general, Belgian tax law provides for the possibility to carry out a tax

free demerger, a partial demerger or a contribution of a branch of activitiesif certain conditions are fulfilled (article 46 and article 211 Income TaxCode (ITC)). One of these conditions is that the transaction should com-ply with article 183bis ITC, which states that the transaction should nothave as its main motive, or as one of its main motives, tax fraud or tax eva-sion. Article 183bis ITC further states that, if the transaction is not moti-vated by business considerations, such as the restructuring orrationalisation of the activities of the corporate taxpayers involved in thetransaction, it can be presumed that tax fraud or tax evasion is the mainmotive or one of the main motives for the transaction. However, the tax-payer remains entitled to deliver proof that the transaction is not motivat-ed by tax fraud or tax evasion.The above business motive in practice is the most challenging element

of proof to deliver by the taxpayer to enjoy a tax free (partial) demerger ora contribution of a branch of activities. The other two conditions applyingon tax free (de)mergers and contributions are of a more formal nature andtherefore much easier to comply with or at least to validate: (a) the acquir-ing company needs to be a Belgian company or an intra-EU company; and(b) the transaction needs to comply with the Belgian Code of Companiesor with similar corporate legislation in the EU member state that applieson the contributing or acquiring intra-EU company (article 46 – article211 ITC).To obtain legal certainty on the tax consequences of any such transac-

tions, and obviously also to avoid unexpected or unwanted surprises at theoccasion of a tax inspection post-transaction, a significant percentage ofrulings applied for specifically consider the question of whether the (par-tial) demerger or the contribution of a branch of activities complies withthe various conditions of articles 46 and 211 ITC and, more specifically,does it pass the business motive test of article 183bis ITC?It should be noted that it is not compulsory to request for a preliminary

ruling. Also, a positive ruling only commits the Ministry of Finance withregard to a specific taxpayer for a specific transaction. At the same time how-ever, and even though rulings have no binding power towards all, the deci-sions of the Ruling Committee are generally considered as important

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guidelines by taxpayers who are expecting to execute a (par-tial) demerger or a contribution of a branch of activities.Often, taxpayers not requesting an individual ruling, imposethe conditions generally set forth by the Ruling Committee insimilar transactions on themselves, and by doing so they expectthat such compliance will avoid adverse consequences resultingfrom later tax inspections. As a result, the tax communityattributes a specific interest to an Advice published by theRuling Committee, since such Advice is considered to includefuture guidelines in judging ruling requests introduced, but atthe same time is by many considered as a kind of “beacon” intax planning for mergers, contributions, and so on.

New guidelines The guidelines published by the Ruling Committee specifical-ly consider the importance of certain anti-abuse rules theRuling Committee may consider in dealing with future rulingrequests.

I. Demerger, partial demerger or contribution of a branch ofactivities accompanied by an immediate or later transfer ofsharesIn the first instance, the Ruling Committee will examine, ofcourse, the business motives underlying the transaction. For

the purposes of this analysis, the taxpayer needs to indicate ifhe intends to transfer in a later stage the shares received as aresult of the (partial) demerger or contribution of a branch ofactivities. It is not necessary to indicate any specific period oftime during which the taxpayer commits to remain owner ofthe concerned shares. This level of flexibility is a new elementcompared to earlier rulings where the Ruling Committeeoften imposed a three year ‘lock-up’ of shares received out ofthe demerger or contribution. In case the taxpayer indicates in his ruling request that

such a transfer of shares is not intended, but neverthelesstransfers the shares post-transaction, the Advice indicates thatthe “legal validity of the ruling can be challenged”, whichseems to indicate that the Ministry of Finance may still refusethe tax free nature of the transaction since the initial descrip-tion of the operation has not been entirely respected by thetaxpayer, because of the effective transfer of shares. TheAdvice indicates that in such a case both the general anti-abuse rule (GAAR, article 344, section 1 ITC) as well as thespecific anti-abuse rule applying on (de)mergers, contribu-tions of a branch, and so on (article 183bis ITC) could beapplied and may allow the tax authorities to tax the profits orcapital gains deemed realised during, or as a result of, thetransaction. Although such review of the earlier granted taxneutrality does not seem to be limited to a specific period oftime (such as for instance the earlier applied lock-up of threeyears), effective taxation of the transaction may, however, nolonger be possible if the prescription period has alreadyelapsed (the prescription period in general is three years, whilein the case of tax fraud a prescription period of seven yearsapplies – article 354 ITC). In case the taxpayer indicates in his ruling request that a

transfer of shares will take place, the Advice indicates that thebusiness motives of the transaction (immediately) must beanalysed to acknowledge or refuse the tax free regime of thetransaction.

II. Related transactionsAs related transactions to the (partial) demerger or the con-tribution of a branch are considered, certain transactions oracts which take place before or after the (partial) demerger orthe contribution, and which may have an influence on the taxconsequences of the main transaction itself. As an example ofsuch a related activity, the Advice refers to the increase of theequity of a company involved in a merger transaction in orderto optimise the pro-rata transfer of deductible losses. TheAdvice indicates that the GAAR of article 344, section 1 ITCcan be applied on the related transaction, if all other condi-tions are fulfilled for doing so.

III. Inclusion of a “warning” in ruling decisionsThe Advice indicates that the Ruling Committee will includein its future ruling decisions a clause stating that: “The present

Geert De NeefPartnerLydian

Tel: +32 (0)2 787 91 [email protected]

Geert is a partner at Lydian where he heads the Tax practice.Geert specialises in all tax aspects of M&A, real estate, inter-

national tax law and restructuring of companies. He is alsoinvolved in tax litigation. His expertise is mainly dedicated tomultinational companies, investment funds, banks and realestate investors on a Belgian and international level.Geert advises clients both on the structuring of their business

and real estate assets, and on the structuring of private assets.His advice is based on a broad experience in corporate law,transfer of enterprises to the next generation or to third parties.His clients include investment funds, banks and real estateinvestors, as well as high-net-worth individuals. Geert graduated with a degree in law in 1988 from the

Catholic University of Leuven (KUL). In 2007, he obtained a diplo-ma in financial management at the Brussels Business School.Geert was admitted to the Brussels bar in 1996.

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ruling decision is exclusively based on the elements and factswhich were indicated in the ruling request. The RulingCommittee does not deliver any opinion or approval in the pres-ent ruling decision on any potential application of anti-abuserules (article 183bis ITC or article 334, § 1 ITC, article 18, §2 Registration Duties Code) as a result of transactions whichhave not been described in the present ruling decision”.

Analysis and commentIt is clear that the Advice attributes high importance towhether or not the shares received as a result of the (partial)demerger or the contribution, will be transferred or not afterthe transaction. This is motivated by the fact that taxpayershave often used, and still use, a (partial) demerger or a contri-bution as a tax planning technique for the tax free transferringof assets from one company to another, followed by a tax freetransfer of the shares received as a result or in exchange forthe demerger or the contribution. The Belgian capital gainsexemption in principle still provides for a 100% exemption ofqualifying capital gains on shares (article 192 ITC – pleasenote, however, that a separate tax of 0.40 % may apply on cap-ital gains realised by certain categories of taxpayers – article217, 3° ITC), although the capital gains exemption sincerecently only applies to shares which have been held in fullproperty by the seller or transferor for a non-interrupted peri-od of one year. If this one year holding period is not fulfilledat the moment of realisation of the capital gain, this capitalgain will be taxed at a separate corporate tax rate of 25% (arti-cle 217, 2° ITC). Still, the tax free carrying out of any of the above transac-

tions still offers interesting tax planning opportunities, cer-tainly in situations where the one year holding period onshares is fulfilled (and obviously also all the other conditionsfor applying the capital gains exemption on shares are com-plied with). Moreover, the transfer of shares of a real estatecompany (a company essentially owning real estate) is in prin-ciple not subject to the levying of registration duties, whilethe sale or transfer of the real estate asset itself will be subjectto registration duties (10% registration duties if the real estateis located in the Flemish Region, 12.5% registration duties ifthe real estate is located in Brussels or in the Walloon Region.Please note that the transferring of “new” buildings and relat-ed land may be subject to the levying of VAT). The conclusion would only be different – that is, the sale

of the shares of the real estate company would be subject toregistration duties (or VAT) – if the tax authorities would beable to demonstrate that the sale of shares essentially needs tobe qualified as a form of “fiscal abuse” in accordance witharticle 18, section 2 Registration Duties Code (or article 1,section 10 VAT-Code). As a result, taxpayers are often interested in structuring a

transfer of real estate by means of a partial demerger, whichcan be carried out on a tax free basis (if all conditions are ful-

filled) instead of directly selling the real estate asset which willtrigger registration duties (or VAT) on the asset itself, as wellas corporate income taxes on any profits or capital gainsrealised. In case of a partial demerger, the real estate is con-tributed by a contributing company into an acquiring compa-ny and, in exchange, shares in the acquiring company areattributed to the shareholders of the contributing company. Avery effective technique which, if supported by genuine busi-ness motives and carried out by Belgian or intra-EU compa-nies in accordance with Belgian corporate law rules (or similarforeign rules), can enjoy a full tax exemption from a corporatetax and registration duties point of view.The Ruling Committee has been quite active recently in

analysing and judging ruling requests for partial demergeroperations, and has granted various favourable decisions. For example, in a specific case the Ruling Committee decid-

ed that the centralisation of real estate owned by various groupcompanies into one single real estate (group) company, couldbe considered to facilitate a more dedicated management of thereal estate activities, also strengthened the credit and lendingpotential of the real estate company, and finally allowed a bet-ter focus by the operational companies on their specific com-mercial activities. For these reasons, the Ruling Committeeconcluded that the transaction did not violate the specific anti-abuse rule of article 183bis ITC, and in the same ruling deci-sion confirmed the exemption for registration duties purposeson the transfer of the real estate involved (Ruling 2013.437 ofNovember 12 2013). In this specific case, the individual taxpay-ers involved in the transaction committed themselves towardsthe Ruling Committee not to transfer any shares obtained as aresult of the partial demerger during a period of three years. Itshould be noted that in other, similar rulings, the RulingCommittee imposed a holding period of three years as a condi-tion to obtain a favourable ruling. The Ruling Committeeclearly wanted to avoid that taxpayers were able to combine –within a relatively short period of time – the carrying out of atax free partial demerger followed soon after by a tax exemptsale of shares received as a result of the demerger. In a similar case, the Ruling Committee decided that the

transfer of real estate by means of a partial demerger could beconsidered to qualify as a legitimate business motive, in a casewhereby the operational headquarters of a group of compa-nies was changed to a new location. The Committee consid-ered that the envisaged transaction increased the flexibility ofthe companies involved and at the same time allowed thesecompanies to improve the organisation and execution of aspecific development project. At the same time, the RulingCommittee confirmed the application of the exemptionapplying for registration duties purposes (Ruling 2013.514 ofDecember 24 2013). Also in this ruling request and decision,the taxpayers concerned committed themselves not to trans-fer any shares obtained from the partial demerger during aperiod of three years.

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Based on the Advice of the Ruling Committee the transfer(or not) of shares obtained as a result of a (partial) demergeror a contribution of a branch will become a very relevant fac-tor in judging the presence or absence of fiscal abuse. Also,even if the main transaction itself passes the fiscal abuse test,any related transactions may still be subject to the fiscal abusetest of article 344, section 1 ITC.The Ruling Committee in fact confirms that any events or

acts which occur in a later stage, or which occurred before butwere not included in the ruling request, may still have a sub-stantial impact on the question of whether or not fiscal abusecan be deemed present and may therefore challenge the taxfree character of the main transaction (assuming the tax pre-scription period has not yet elapsed). The Ruling Committee however no longer indicates a spe-

cific time period during which the shares obtained from thedemerger or contribution can not be transferred by the tax-payer benefitting from a positive ruling decision. At the sametime, the Ruling Committee considers such transfer of shares,regardless of the timing of the transfer, as an important (neg-ative) element in considering the presence of fiscal abuse, ifsuch transfer can be directly linked to the main transaction,and as such constitutes an act covered by a single purpose oftax avoidance or tax evasion.However, the Advice does not change the basic rule apply-

ing on all mergers, demergers, partial demergers or contribu-tions of branches: the transaction should not have as its mainmotive or one of its main motives tax fraud or tax evasion(article 183bis ITC). At the same time, the Advice states thatalso the general anti-abuse rule of article 344, section 1 ITCcould apply on the transaction, which would be the case if thetransaction qualifies as fiscal abuse. The definition of “fiscalabuse” is very broad, but in fact applies on any transaction

seeking to obtain a tax advantage or to avoid the applicationof a tax rule without a legitimate justification for such behav-iour. The taxpayer can prove the absence of fiscal abuse bydemonstrating that the choice for a specific transaction orstructuring is based on other motives than purely tax motives(though the taxpayer still has the right to tax optimise opera-tions or transactions he is involved in, as long as his tax con-duct is also based on genuine business motives and notexclusively on tax motives).As a result, the fact whether or not the shares obtained as

a result of the (partial) demerger or contribution of a branchare transferred after the transaction, will be considered infuture rulings as a very important element or circumstance,without however automatically leading to a negative ruling incase of such a transfer of shares, provided the taxpayer canalso demonstrate that genuine business motives have been rel-evant reasons for the way in which the transaction has beenstructured.Finally, it should be noted that the Advice refers to various

anti-abuse rules which may apply (article 344, section 1 ITC,article 18, section 2 Registration Duties Code), and not onlyto the specific anti-abuse rule applying on (partial) demergersand contributions of a branch of activities (article 183bis ITC).This position of the Ruling Committee seems to take into

account jurisprudence of the EU Court of Justice inZwijnenburg (C-352/08), as a result of which the anti-abuseclause of the Merger Directive should not be applied in a sit-uation whereby the taxpayer seeks to avoid other taxes thanthose envisaged by the Merger Directive. As a result, theRuling Committee specifically states in its Advice that also fis-cal abuse with respect to other taxes, such as for example indi-rect taxes or registration duties will be taken into account bythe Ruling Committee in its future decisions.

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FATCA 2.0: The introduction of aglobal standard on automaticexchange of tax informationGlobalisation has meantthat items areincreasingly being sentaround the world. Thisincludes an increasingamount of moneybeing sent abroad,which may go untaxedif taxpayers, negligentlyor willingly, do notcomply with their taxobligations. KarlKuepper of PwC looksat the new standard forensuring compliance,and explains thestrategic and flexibleapproach taxpayers willbe required to take.

A ccording to recent estimates, tax evasion significantly decreases pub-lic revenues, and may potentially lead to a serious disruption of thecompetitive market functions. Combatting international tax evasion

is, however, complex despite sitting high on the political agenda.Conceptual approaches to tackling tax evasion include (flat) taxation atsource on the one hand and increasing tax transparency on the other hand,enabling the competent tax authorities to ensure appropriate taxation inthe taxpayer’s (tax) residence country. While just a few years ago Europeangovernments were still negotiating tax treaties, for example withSwitzerland aiming at taxation at source and avoiding disclosure of assetsand income generated offshore, the political mindset has changed and isnow leading towards a new standard of multilaterally exchanging tax infor-mation between governments around the globe: the Common ReportingStandard (CRS).

Political agenda and timeline Information exchange between governments is not new. Article 26 of theOECD Model Tax Convention already includes a provision on exchangeof tax information, but information is generally obtained upon request.What is new now is that exchange of tax information becomes automatic,on a multilateral and comprehensive basis, focusing on information main-tained by financial institutions with respect to financial accounts.Triggered by the experience with offshore investments in the Swiss mar-

ket in 2010, the US government enacted a law addressing the disclosure ofhidden assets in non-US countries by having financial institutions disclosecorresponding information to the US tax authorities. This initiative is theForeign Account Tax Compliance Act (FATCA). In subsequent yearsFATCA was the accelerator and catalyst for enhanced discussions amonggovernments on how to address FATCA outside the US, particularly byway of negotiating intergovernmental agreements (IGAs) and implement-ing FATCA into local laws. Such negotiations led to additional and corre-sponding initiatives in the market, including the CRS. In April 2013, for example, the finance ministers of France, Germany,

Italy, Spain, and the UK outlined an initiative to develop and pilot a mul-tilateral automatic information exchange programme towards the EUCommission. On July 20 2013, G20 leaders endorsed the OECD propos-als for a global model of automatic information exchange as the expectednew standard on information exchange. On February 13 2014, (so only afew months later) the OECD released the CRS and model Competent

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Authority Agreement (CAA). The OECD is further expectedto deliver a detailed commentary on the new standard, as wellas technical solutions to implement the actual informationexchange, during the G20 meeting in September 2014.More than 60 countries and jurisdictions have committed

to an early adoption of the CRS, and additional GlobalForum members are expected to join this group in the com-ing months. The early adopters of the CRS will need to com-ply with a planned effective date of January 1 2016 for newaccount opening procedures. The initial exchange of informa-tion, with a limited scope under the CRS, is planned to startin 2017, while the full scope exchange of information shallbegin in 2018. The CAA can be executed within existing legal frameworks

such as article 26 of the OECD Model Tax Convention, orarticle 6 of the Convention on Mutual AdministrativeAssistance in Tax Matters. The question of having in place alegal framework and administrative capacities before enteringinto reciprocal agreements on information exchange is an openissue for a number of countries participating in the initiative. Within the EU, the current expectation is that the CRS

will be implemented through a further enhancement of theEU Savings Directive (EUSD). The advantage over an imple-mentation through the Directive on AdministrativeCooperation would be that certain non-EU member stateswould already be participants under the EUSD.Corresponding press releases by EU governments show thata revised directive is intended to be available already in Q42014. EU member countries will need to transfer the EUDirective on the Automatic Exchange of Information intonational law, which leaves a very challenging timeline for bothfinancial institutions and governments to implement the newstandard on information exchange.

The context of CRS CRS is not the first initiative for enhancing tax compliancewhich focuses on transparency of tax information rather thanon taxation at source, but it nevertheless could also serve forand support future taxation at source regimes (for example,TRACE). CRS clearly is based on the FATCA IGAs but facesa market with both information reporting and taxation atsource regimes. With respect to taxation at source regimes, the market

knows particularly the US Qualified Intermediary (QI) pro-gram which became effective on January 1 2001. The QI pro-gramme allows the US government to collect taxes on USsourced income and certain tax related information throughforeign financial institutions (FFIs) and foreign branches ofUS financial institutions. The IRS announced that withhold-ing obligations under QI and FATCA will be merged andaddressed in a revised QI agreement this summer and thatcertain reporting obligations under FATCA also fulfil certainreporting obligations under QI.

In the European market the EUSD provides for a (limited)automatic exchange of information on savings income sinceJuly 1 2005. Unlike the US QI programme, the EUSD con-stitutes a mutual exchange of information aiming at the effec-tive taxation of cross-border interest income and revenuesapplied by EU member states. While generally entitled toreceive information from the other member states,Luxembourg and Austria were, however, entitled during atransitional period to levy a withholding tax instead of provid-ing information; 75% of the revenue of such withholding taxis being transferred to the investor’s state of residence. In2004 a similar EUSD status was agreed for Switzerland,Andorra, Liechtenstein, Monaco and San Marino. EU mem-ber states’ dependent or associated territories have beenincluded since 2005 with a similar treatment. In January2013, the new Administrative Cooperation Directive enteredinto force providing for a further automatic exchange of avail-able information as of January 1 2015 on income fromemployment, director's fees, life insurance products, pen-sions, and immovable property. In addition to these Europeandirectives the UK has introduced further initiatives for auto-matic information exchange with its crown dependencies andoverseas territories (cf. UK-FATCA / CDOT Agreements).The current political momentum around the CRS is driv-

en by the implementation of FATCA. With FATCA the USgovernment enacted a comprehensive exchange of tax infor-mation regime with respect to which a number of countriesaround the globe declared the intention to take an intergov-ernmental approach to compliance. Most of these countrieswill pass local legislation intended to meet the objectives of

Karl KuepperPwC

Tel: +49 69 9585 5708 Fax: +49 69 9585 1894 [email protected] www.pwc.de

Karl is a partner with PwC in the financial services tax team inFrankfurt, Germany, where he leads the Tax Operations Groupand PwC initiatives around FATCA and CRS. He has more than 14years of working experience in international tax and regulatoryfund structuring, transactions, private banking and legal advice(corporate, commercial, M&A transactions, arbitration proceed-ings). Projects include large scale structuring projects, transactionsparticularly with respect to US investments as well as ICC arbitra-tion proceedings. Karl is a qualified German tax attorney andholds a PhD in investment tax laws.

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FATCA (Model I Agreement). Certain other countriesincluding Switzerland, Japan, Bermuda, Austria and Chileintend to take an intergovernmental approach to the legisla-tion under different terms (Model II Agreement). FATCAimplementation now involves the interaction of both the reg-ulations in the US and the IGAs with related local legislationproviding a complex framework of rules for globally operat-ing financial institutions to comply with. By the end of April2014, 27 jurisdictions had signed Model I IGAs and five juris-dictions signed Model II IGAs. In addition, 34 jurisdictionshad reached agreements in substance and are therefore treat-ed as having IGAs in effect. The CRS introduces its requirements on top of these glob-

al and local implementation programmes aiming at a uniformglobal standard of information exchange. As the CRS is com-ing, however, only now that other programmes have alreadystarted, it remains to be seen to what extent CRS can functionas a framework for a single and globally unified informationexchange standard. In particular, the US is currently notamong the early adopters and it will be interesting to see howthe US positions FATCA within the global approach towardsCRS.

CRS requirements in detail The CRS and the CAA establish a new global standard whichwill require financial institutions to play a central role in pro-viding the tax authorities with greater access and insight intofinancial account data maintained by financial institutions. Itsets out the financial account information to be exchanged,the financial institutions that need to report, the differenttypes of accounts and taxpayers covered, as well as commondue diligence procedures to be followed by financial institu-tions. The overall structure and a fair amount of detailed require-

ments are similar compared with FATCA. However, the CRShas its own specifications and overall will require higher ITand operational efforts for implementation and continuingcompliance. The standard consists of complex rules and requirements

which can be grouped into three areas: 1) scope and gover-nance: defining which financial institutions should be subjectto the CRS rules and how compliance should be governed; 2)due diligence: detailing the procedures and documentationrequirements that financial institutions should follow in orderto classify financial accounts and corresponding account hold-ers; and 3) reporting: specifying the (data) elements and time-lines for performing CRS reporting. With respect to the scope, financial institutions under the

CRS include depository institutions, custodial institutions,investment entities and specified insurance companies.According to this broad definition, banks and custodians areclearly within the scope of the CRS. In addition, other finan-cial institutions such as brokers, certain collective investment

vehicles (CIVs) and certain insurance companies should alsocomply with the CRS. From a general point of view, the CRSdefinition is almost identical to the definition under FATCA.Differences include, for example, certain investment entitieswhich qualify as financial institutions under FATCA but arenot located in partner countries and should be classified aspassive non-financial entities under the CRS. Other differ-ences include the provision of certain exempt statuses and cer-tain non-reporting financial institutions. Once classified as afinancial institution under FATCA, such institutions are gen-erally required to register with the IRS to obtain a GlobalIntermediary Identification Number (GIIN). Such registra-tion is, however, not required under CRS.The due diligence procedure is likely to be the most bur-

densome obligation for financial institutions. The CRS hasadopted similar due diligence procedures and requirements tothose under FATCA. However, since the focus is no longerlimited to US account holders and non-participating foreignfinancial institutions (NPFFIs), but is expanded to identifythe tax residents of any partner jurisdiction, the number ofimpacted clients is significantly higher than under FATCA.Moreover, while under FATCA certain funds or smaller banksescaped implementation by saying they did not maintain rela-tionships with US investors or customers, such institutionswould now be brought into scope for the first time. According to the current timeline agreed by the early

adopters, the accounts opened on or after January 1 2016 willbe new accounts and should go through the enhanced newaccount opening procedures which require a self-certificationas mandatory documentation. Furthermore, new accounts ofpre-existing clients will not be treated as pre-existing accountsfor CRS purposes. The accounts outstanding on December31 2015 are treated as pre-existing accounts and should bereviewed according to the applicable procedures. As FATCAdid already, CRS also takes a risk-based approach: high valueaccounts will be subject to the enhanced review proceduresand should be reviewed by December 31 2016, while theremaining pre-existing accounts, if not eligible for any exemp-tion, should be reviewed by December 31 2017. De minimisrules are provided only for certain pre-existing entity accountsbut are not available for any individual accounts as underFATCA.

Reporting is the core component given that exchanging taxinformation is the ultimate goal of the CRS. Similar to FATCA,CRS reporting takes a phased-in approach: the first reportingwill be required in 2017 on new accounts and high value pre-existing accounts covering only basic account and accountholder information as well as certain income payments. Startingin 2018, full reporting will be required on all reportableaccounts, also including information on gross proceeds.Reporting is likely to be performed based on a similar dataschema as under FATCA and to be provided to the local taxauthorities. The data elements to be reported per country are,

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however, subject to the individual CAA concluded between therelevant partner jurisdictions specifying the information to beprovided or obtained within such automatic informationexchange. Deviating information to be provided or exchangedwill lead to a higher complexity within implementation.Unlike FATCA, the CRS does not contain a concept of

“non-compliant financial institutions” and does not levypunitive taxation. The enforcement of the CRS lies withineach partner jurisdiction and corresponding local laws; imple-mentation of the CRS is likely to be subject to local penalties.The OECD CRS requirements are understood to constituteminimum requirements and partner jurisdictions may expandsuch requirements as deemed necessary or appropriate.

Strategic and flexible approachAlthough the CRS contains similar requirements as underFATCA, there are remarkable differences which will requireadditional amendments of IT systems and processes andresult in higher implementation and continuing complianceefforts. Particularly considering that a number of furthercountries will follow the early adopters, the CRS is expectedto be a key compliance requirement over the next five years.

In addressing the CRS, a flexible and strategic approach istherefore recommended. The implementation of FATCA, CDOT agreements, the

revised QI-agreement and CRS will further raise questions onhow to best and most efficiently address the new tax trans-parency landscape. Within such a new environment furtherquestions around data quality, data security and focus of busi-ness and compliance functions on their individual and corepurposes will be raised. Other regulatory initiatives alsoaddressing customer or investor due diligence and reportingshould be considered jointly.To the extent it has been under FATCA, limiting business

to non-US investors and customers is not a viable solutionunder the CRS anymore. Going forward tax information willbe made transparent and will be shared among governmentsglobally. Banking secrecy will not survive, at least not withrespect to tax information to be provided to the tax authori-ties. As a result, compliance requirements will increase andmarkets will also change. Market participants will have to beprepared: the Common Reporting Standard is coming, itrequires a strategic and flexible approach, but there is a lot toleverage from FATCA.

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Tax issues for foreign banks inan ever changing landscape

Sunil Gidwani,Nehal Sampat andDipesh Jain of PwCdiscuss some of the keytaxation issues affectingforeign banks in India.

A lbert Einstein once said that “the hardest thing in the world to under-stand is the income tax”. More than half a century later, it may stillbe the case, especially in the Indian context. Ambiguities in the taxa-

tion regime are often compounded with an ever changing regulatory land-scape, especially for foreign banks operating in India.

Subsidiarisation of foreign banksAfter the global financial crisis, the Reserve Bank of India (RBI) indicatedits preference for foreign banks to operate in India as subsidiaries asopposed to branches. It announced a framework for foreign banks to setup their presence in India as wholly owned subsidiaries (WOS). Similarly,the Regulator intends to encourage existing foreign banks to convert theirbranches into subsidiaries.

The decision to operate as a branch or as a subsidiary has income-taxramifications too. Illustratively, a branch is taxable at a higher rate of 40%as compared to tax at 30% applicable to residents. However, on the flipside, any distribution of profits by a subsidiary to its parent is subject todividend distribution tax at 15% (as dividends) or 20% (as buyback).Further, there are surcharges and cesses levied on the tax rates that differfor branches and subsidiaries. The effective tax rate for branch and sub-sidiary may only be marginally different where entire profits are distrib-uted. However, where profits are not fully distributed, a subsidiary form ofpresence could lead to a tax rate arbitrage over a branch.

Further, the following pros and cons merit attention:-

Pros• Lower rate of tax considering that many of the foreign banks have not

been repatriating their entire profits and hence the dividend distributiontax would not arise;

• Income from offshore loans need not be consolidated with profits fromonshore business (this could be a con in case of certain tax deductionsbased on aggregate income);

• The head office need not file its annual tax return if the only source ofincome is interest income from offshore loans;

• Often the head office or overseas branches invest in Indian stock mar-kets as portfolio investors. The issues around consolidation of incomeand attribution to Indian branch may not arise on subsidiarisation;

• Higher allowance for deduction of provision for bad and doubtful debtsfor a subsidiary; and

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• The cap on deduction for head office expenses in a branchscenario (discussed subsequently) not applicable to a sub-sidiary.

Cons• Receipt of interest income from foreign parent taxable in

the hands of subsidiary; in case of a branch, arguably, suchreceipt may not be taxable.

Some of the leading global banks have been present in Indiafor decades and have a significant presence. A change in theirform of presence could have, among others, the followingramifications from taxation perspective:-

Tax costs on conversionTo facilitate tax neutral conversion of foreign bank branchesinto subsidiaries, a special set of provisions (ChapterXII-BBand Section 115JG of the Indian Income-tax Act, 1961) wereincorporated in the domestic income-tax law with effect fromApril 1 2013. The provisions seek to exempt capital gains aris-ing from the conversion of a bank branch into subsidiarywhere such conversion is in accordance with a scheme framedby the RBI. The provisions also discuss the central governmentnotifying conditions for carry forward of tax losses, computa-tion of income and certain other tax aspects. However, nonotification has been issued by the central government to date.

With the above backdrop, the following issue merits con-sideration: If a foreign bank were to convert its branch into asubsidiary, would such conversion be taxable in the hands ofthe transferor foreign bank?

At the outset, the term conversion may be regarded asvague and may not be the most appropriate term as theprocess does not involve conversion from a legal perspective.The process involves, among others, the foreign bank setting-up a subsidiary in India followed by amalgamation of theIndian bank branch into the subsidiary upon receipt of neces-sary regulatory approvals.

Though the intent of the law appears to provide for anexemption for transfers in the context of bank branch sub-sidiarisation, could the provisions leave room for anotherinterpretation?

Indian law provides for tax neutrality for various forms ofmergers and acquisitions and in the relevant provisions theterm amalgamation, which has a specific meaning, is frequent-ly used. In the context of bank subsidiarisation, ideally toavoid ambiguities, the term conversion should have beendefined to include any manner of succession of banking busi-ness from a branch to a subsidiary so long as it is in accor-dance within the regulatory framework.

In addition, the following points merit consideration:• Could transfer pricing provisions apply given that the

transaction would be between a resident (subsidiary) and anon-resident (its parent)?

• Could deeming provisions seeking to impute the fair mar-ket value in the context of transfer of immovable proper-ty apply?Given the above, an interesting alternative argument that

foreign banks can explore is whether the transfer can beregarded as a transfer from a company to its WOS.

To provide for tax neutrality in intra-group transfers,there is a general provision in the income-tax law (section47(iv)) which stipulates that transfers from a company to itsWOS will not be regarded as taxable transfers for income-taxpurposes.

Considering the significant nature and impact of bankbranch subsidiarisation transactions, it would only be fair fortaxpayers to seek more clarity on some of the above issuesbefore implementing the same.

Deductibility of head office expenditureIt is common for foreign bank branches to claim deductionfor expenses incurred by the head office (HO). From an

Sunil GidwaniExecutive directorPwC

[email protected]

Sunil Gidwani is an executive director with PwC in tax and regu-latory services with a focus on financial services sector. Sunil specialises in tax and regulatory matters affecting banks,

non-banking financial companies, stock brokers, investmentbanks, asset management companies, mutual funds, sovereignfunds and other institutional investors. He has advised clients onstructuring investments into India, setting up Indian businesspresence and obtaining relevant regulatory approvals andadvised on several transactions and financial service productsfrom tax and regulatory perspective.Sunil has delivered talks on the subject of domestic and inter-

national taxation at various forums and has contributed articlesin various financial papers. He has authored a book on tax andregulatory issues affecting the entertainment industry publishedby the Bombay Chartered Accountants Society. He was recentlyawarded the Trivedi Prize by the Bombay Chartered Accountants’Society for his paper on taxation of BPO units. He is a chartered accountant, company secretary and a law

graduate, and has been in the profession for over 18 years. Hepassed CS examinations with a rank, and topped MumbaiUniversity in the subject of taxation during LLB examinations.

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income tax law perspective, the deduction for ‘executive andgeneral administrative expenses’ (HO expenses, in short) isrestricted to 5% of the adjusted total income (section 44C).The intent behind capping the deduction was to resolve dif-ficulties in scrutinising and verifying the claims in respect ofsuch expenses. The claim for deduction of HO expenses hasbeen the subject matter of litigation between the taxpayersand the tax authorities.

Some of the key aspects to be considered in this regard are:

General v specific expenditureThe disallowance provision refers to “so much of the expen-diture in the nature of head office expenditure as is attribut-able to the business in India”. In other words, anexpenditure claimed by the branch could fall within theambit of the disallowance provisions only if part of theexpenditure pertains to business carried outside of India.Where expenditure incurred pertains wholly and exclusivelyto Indian operations of the branch, such expenses should,arguably, fall outside the ambit of HO expenses’ disal-lowance. This position is supported by several court rulings.

Illustratively, bank branches have expenses such as salariespaid to expatriates deputed to India and technology relatedexpenses, and so on, incurred by the HO for the Indianbranch. Where such expenses are exclusively for Indian pur-poses and there is no element of allocation, one could con-tend that such expenses, being specific expenses, are notsubject to the rigours of the disallowance of HO expenses.

If the HO is in a jurisdiction that has a Double TaxationAvoidance Agreement (DTAA) with India, the provisions ofarticle 7 need to be examined. Where the DTAA provisionsprovide specific relief in this regard, they could prevail overthe domestic law.

Is charge to profit and loss (P&L) necessary?Tax treaties often provide that tax deduction of expenditurewherever incurred would be allowed to determine taxableincome attributable to Indian branch/permanent establish-ment. Hence, clearly in the context of treaties, the place ofincurring expenditure and charge to local profit and lossaccount is not necessary or relevant.

Some revenue officers challenge the tax deduction onaccount of absence of payment by, or charge to, localaccounts of Indian branch. Courts have allowed deductionfor HO expenses even where such expenses have not beendebited to the P&L account of the branch.

Transfer pricingAlso, as per the Indian transfer pricing regulations, the crosscharge of HO expenses would be regarded as an internation-al transaction and would have to be at arm’s-length. Few tax-payers have contended that as the provisions incorporatespecific restrictions, transfer pricing provisions do not apply.

Interest on loans extended by HO /overseas branches toIndian borrowersIt is common for HO/other overseas branches of foreignbanks to give foreign currency loans to Indian borrowers.Such loans are recorded in the books of the HO/overseasbranches and the Indian bank branch may or may not beinvolved in the origination process.

When the borrowers pay interest on such loans, they typ-ically withhold tax at applicable rates. Given that HO/otherbranches are not separate entities, tax on all such interestpayouts is withheld using the permanent account number ortax ID of the overseas HO. With increasing computerisation,the data on taxes withheld is captured in the tax office’srecords. Interestingly, such interest income, although beingsubject to tax withholding was at times not disclosed in theincome-tax returns in the past for sheer want of availability ofinformation. With such data now available from the recordsof the tax office, taxpayers may be expected to compile andreport such income. The revenue officers in certain caseshave adjusted the bank’s income where such interest incomeis not originally disclosed in their filings. This may not haveany financial implications if the tax payable has been withheldby the Indian borrower. Also, banks that have exhausted thelimit of 5% of adjusted total income for claiming deductionfor HO expenses can explore claiming deduction on theenhanced adjusted total income after considering such inter-est income.

An interesting issue arises where the Indian bank branch isinvolved in the loan origination process. From the interestearned by the HO/overseas branches, following transfer pric-ing rules, the Indian bank branch is required to be compen-sated on an arm’s-length basis for its origination effort. Giventhat such interest would be typically taxable on gross basis,offering the compensation allocated to the Indian branch totax may effectively result in the same income being taxedtwice. An aggressive taxpayer could, after adequate safe-guards, challenge such an approach though the industry prac-tice is to follow a conservative view.

Interest payments/receipts between HO/ overseasbranches and Indian branchWhere there are borrowing and lending activities betweenHO/overseas branches and the Indian branch, resulting inreceipts/payments of interest (for want of a better word), aquestion arises whether such interest receipt by the HO/overseas branch is taxable in India and, vice versa, interestpayout is tax deductible. Judicial precedents on this issue sug-gest interesting conclusions:

In ABN AMRO Bank NV vs. CIT [2012] 343 ITR 31(Calcutta High Court), in the context of the India NetherlandsDTAA, the court held that interest payment to the HO is anallowable deduction because the profits of the branch need tobe computed as if it were a distinct and separate enterprise.

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However, in the context of taxability of such interest and with-holding of tax thereon, in the case of Sumitomo Mitsui BankingCorporation vs. DDIT [2013] 56 SOT 390 (MumbaiTribunal), it has been held that such interest cannot be taxedunder the domestic law as it is a payment to self.

Transfer pricingA discussion on Indian taxation is usually incomplete with-out a discussion on transfer pricing. In recent times, taxauthorities have challenged the attribution made to theIndian bank branches in respect of their role in the offshoreloan booking business. The Mumbai Tribunal has also adju-dicated on the attribution to be made to the Indian bankbranches for their role in such transactions. Besides theabove, the tax authorities have also sought to make transferpricing adjustments with respect to back-to-back derivativetransactions entered into by the Indian bank branches withits HO / overseas branches and inter-branch lending andborrowings.

While taxpayers deal with their transfer pricing in theseareas, they must plan to review their transfer pricing policieson a regular basis to ensure that they align with evolving mar-ket practices / business dynamics. Further, changing businessstructures such as subsidiary models (versus branch struc-tures) will have a bearing where, for example, aspects such asthe approach to allocate a return to capital deployed may playa role in the arm's-length pricing framework.

As a final point, in view of the introduction of stringentpenalty provisions (of 2% of transaction values) on failure toreport transactions, Indian bank branches may need to evaluatetheir existing reporting framework for voluminous transactionssuch as foreign exchange contracts, derivative trading, etcetera.

Post faceThese are interesting times in India with a recent change inthe government at the helm. While issues in taxation cannotbe wished away, one can hope for a more taxpayer friendly taxadministration.

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Tax issues for offshore assetmanagers in an ever changinglandscapeGautam Mehra, NehalSampat and Neha Shahof PwC discuss the keyIndian income taxissues relevant forforeign investors andasset managersinvesting into India.

“T he trouble with our times is that the future is not what it used tobe”, as suggested by Paul Valery, may reflect the ever changinglandscape of the asset management industry in India, especially the

taxation regime for foreign investors.

General anti-avoidance rule (GAAR)The first topical issue in any discussion with an offshore asset manager onIndian taxation is, invariably, the GAAR. Over the past couple of years, GAAR has been the subject matter of so

many debates, articles, representations, and so on, that a search on “IndiaGAAR” on a popular search engine suggests more than 400,000 results. Hence, without delving into the chronology of GAAR, the key take-

aways for offshore asset managers have been summarised below:• There are no specific provisions for the asset management industry inthe GAAR provisions, though specific representations have been filed byindustry associations and by PwC to consider and review the impact onthe asset management industry differently, given its unique characteris-tics.

• Based on the provisions, offshore funds making use of treaty benefits,especially under the India-Mauritius tax treaty, which do not have eitherpooling vehicles in Mauritius or substance in the form of an asset man-ager with operations in Mauritius, may face a significant challenge in theform of GAAR after April 1 2015.

• Singapore is fast emerging as an alternative to Mauritius, given that it isan asset management hub. Asset management groups, which have exist-ing operations in Singapore, may be in a position to leverage off that forestablishing India structures. The capital gains protection under theIndia-Singapore tax treaty, which is contingent upon continuation of asimilar protection under the India-Mauritius tax treaty. Additionally, theIndia-Singapore tax treaty has the specific anti-avoidance rule (SAAR)in the form of the limitation of benefits clause, which requires demon-stration that the Singapore structure is not set up primarily to takeadvantage of the treaty provisions.

• An important aspect to be considered in evaluating Singapore as a juris-diction is the form of an entity and the ease of repatriation of exit pro-ceeds from a local regulatory perspective. Where the entity is set up asa company, there are conditions relating to solvency and proceduralaspects that need to be factored in, especially if proceeds are required tobe repatriated regularly.

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• New funds are actively considering the potential impact ofGAAR, including evaluating more appropriate jurisdictionsto domicile the fund/fund manager in light of the com-mercial considerations.From a potential impact perspective, the following merits

attention:• An impact analysis for a hedge fund may generally not becritical for a long-term only fund investing in Indian listedsecurities with a holding period of more than a year, unlessthe fund wants flexibility to exit from Indian investmentswith a shorter holding period or there is an aspersion onthe continuation of the exemption for long-term capitalgains on sale of listed equities on the stock exchange.

• For an existing PE/VC fund, an impact analysis is notrequired for (i) investments that were made before August30 2010 or (ii) investments where exit is probable beforeApril 1 2015 or (iii) investments where the likely mode ofexit is an IPO or (iv) investments in listed securities wherethe exit is on the stock exchange and within the price bandusually allowed for trading on the exchange. All otherinvestments could potentially be affected by GAAR. Iftreaty benefits were to be denied, an exit tax of 20% couldbe applicable, unless the investments were in “securities” asdefined under the relevant securities law, in which case, theconcessional exit tax rate of 10% could apply. There isambiguity on whether shares in a private company qualifyas “securities”, and a relatively simple solution to thedebate, subject to other considerations, could be to con-vert a private company into a public company.Where a fund, especially a hedge fund, for commercial

considerations, decides to migrate from one jurisdiction toanother, for example from Mauritius to Singapore, therewould be regulatory considerations such as approvals fromthe local securities regulator and transaction taxes that needto be considered. Furthermore, if the migration were to resetthe holding period, and thus risk long-term capital gainsbeing regarded as short-term, it may not be an optimal solu-tion and so evaluation of alternative strategies may berequired.

Offshore transfersLike GAAR, the provisions relating to taxation of “offshoretransfers” have been the subject matter of extensive debateand deliberations. The key takeaways for offshore asset man-agers have been summarised below:• The provisions are primarily relevant for India-focussedfunds or global funds that invest into India through SPVstructures.

• There is significant ambiguity with respect to:-(i) Threshold for the provisions to be triggered, in the

context of value of shares or interest in an offshoreentity, and the meaning of the phrase “substantiallyderived from Indian assets”. A threshold of 50% may

be reasonable though there are strong grounds to sup-port an even lower threshold.

(ii) The mode of valuation of Indian assets to which thethreshold of “substantially derived” has to be applied(book value, fair market value, whether it includesintangible assets, and so on).

(iii)Manner of computation of gains including both thesale consideration and the cost.

• Recently, the Andhra Pradesh High Court in the case ofSanofi Pasteur Holding SA [2013] 354 ITR 316 (AP) heldthat the retrospective amendment on offshore transfersshould not have an impact on any benefit otherwise avail-able under the applicable tax treaty. Therefore, tax arisingon account of offshore transfers should continue to be eli-gible for exemption, if any, under the applicable tax treaty.However, the case is now pending before the Apex courtfor final adjudication.

• These provisions may be particularly relevant in the con-text of cross-border restructurings such as merger ofFunds, etcetera because there are no carve-outs for anysuch exercise.

Gautam MehraExecutive directorPricewaterhouseCoopers

[email protected]

Gautam is sector leader in asset management for PwC in Indiaand leads the PwC financial services tax and regulatory team.

He has a varied experience of more than 28 years. Beforejoining PwC in September 2003, he had stints with two leadingaccounting and tax consultancy firms, which was followed by along association with an independent practice founded by him.In the past few years, he has been focused on working withplayers in the financial services space with a particular emphasison the asset management sector, and also in providing strategictax inputs to large multinational as well as domestic Indian play-ers.

Gautam is a regular speaker at seminars, both in India andoverseas and a contributor to the media. He has been a mem-ber of the National Direct Tax Committee of The Confederation ofIndian Industry (CII) and the American Chamber of Commerceand a member of the Expert Advisory Committee of the Instituteof Chartered Accountants of India.

Gautam is a Chartered Accountant, has post-graduated in lawand holds a degree in financial management.

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• Additionally, while it may not have been the legislativeintent, these changes require careful consideration at thetime when funds are repatriating proceeds above the SPVor fund levels.

Transfer pricingContinuing with the momentum on tax controversies, trans-fer pricing is fast emerging as the biggest tax issue on theIndian tax landscape. A significant tax controversy that has been raging for the

past few months is the applicability of transfer pricing prin-ciples in the context of a transaction involving the issue ofshares by an Indian company to its non-resident parent, atan alleged discount to the fair market value. The transferpricing officers are of the view that such an alleged discountconstitutes income (strangely, in the hands of the issuingcompany). Also, there is a contention of a deemed loan by the

Indian company to its parent when shares are issued at adiscount that merits attribution of notional interest in thehands of the Indian company. It appears that the transferpricing officers are now also looping the foreign parent intothe debate. Particularly relevant in the context of follow-oninvestments by non-resident parents, a question arises as towhether the non-resident parent is required to report thesubscription of shares and the valuation basis to the Indiantax authorities. In addition to a litigation risk with respectto valuation, there is a significant risk of imposition ofpenalties (that extends up to 2% of transaction value) forfailure to report. Also, Indian subsidiaries of asset managers that operate on

a cost plus basis have been visited with litigation by the trans-fer pricing officers, enhancing the mark-up from 20% to sig-nificantly higher levels in some cases. Advance pricingagreements (APAs) are fast emerging as a solution, especiallywhere the Indian operations are sizeable.

Exit by PE/VC funds – other considerationsMany PE/VC funds with an early vintage that have investedinto India are in exit mode with respect to some of their initial

investments. Some of the tax issues that get featured in exitdiscussions include:

Obligation to withhold tax Extensive tax litigation in India has generally made investorswary when it comes to acquiring shares from non-residentswho are entitled to treaty benefits. While a buyer may preferthe non-resident seller to seek a confirmation from the Indiantax authorities for the amount of tax to be deducted, or a rul-ing from the Authority for Advance Rulings, it may be a chal-lenge given the time involved and other constraints. Toachieve the twin objectives of concluding transactions and mit-igating tax risks, the parties may agree on other modes ofobtaining tax protection from any tax litigation, including fur-nishing of tax indemnities to be provided by the non-residentseller to the buyer. Indemnity caps, period and credit risk onthe entity providing the indemnity are subject to negotiations.This could be a challenge, where the life of the selling

Fund is coming to an end, when tax insurance may be anoth-er option to explore.

Pending tax proceedings/demandsBuyers also tend to seek appropriate representations from theseller to the effect that there are no pending tax proceedingsas, in certain situations, the sale could become void wherethere are pending tax proceedings against the seller.For a seller, it is imperative to maintain up-to-date docu-

mentation in the form of a tax residency certificate and decla-ration in the Form 10F to make use of tax treaty relief.

The silver liningWhile the above may paint a grim picture, there is a silver lin-ing. India has witnessed historic results in the recently con-cluded general elections. A new government has been electedwhich is perceived by investors to be more business andinvestor friendly. Although tax uncertainties may have actedas a deterrent for foreign investors and fund managers, it isanticipated that the new government may change the tax nar-rative in India. India tax, hopefully then, will not be a matterof concern for asset managers.

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Mexico 2014 income taxreform: Considerations for thefinancial sectorKarina Pérez andAlejandro Ortega ofPwC analyse Mexico’srecently reformed taxcode and relatedadministrativeregulations, focusing onthose provisions thattaxpayers in thefinancial sector need tobe acutely aware of.

T hough income tax regulations are expected to be issued shortly andadministrative regulations have just been issued on June 6 2014, the2014 Income Tax Law means there is already plenty for financial sec-

tor taxpayers to contend with.

Income TaxCorporate tax and tax on distributionsThe new Income Tax Law which repealed the 2013 Income Tax Lawmaintains the 30% corporate income tax rate, eliminating the scheduledreductions to 29% and 28% for 2014 and 2015, respectively. The withhold-ing tax applicable to non-residents that refers to the maximum rate appli-cable to individuals of 30% was replaced by a 35% rate. An additional 10%withholding tax on dividends paid to individuals resident in Mexico andnon-resident shareholders was introduced. This additional withholding taxis equally applicable to distributions made by branches to their headoffices.

Withholding tax on interest paid abroadThere is no change in the 4.9% income tax withholding rate applicable tointerest paid to foreign banks resident in countries that have signed a taxtreaty with Mexico. Tax residency certification is required for Mexicaninterest payers to apply this reduced rate.

Treaty applicationTreaty relief for non-resident taxpayers is available provided domesticand treaty requirements are met. One relevant aspect of the reforms isthat for treaty relief the tax administration may require certain docu-mentation to prove that double taxation arises with respect to transac-tions between related parties (that is, a declaration under oath).Administrative regulations contain some exceptions to this rule.Considering that this provision is not intended to override tax treaties,it would be desirable that tax authorities issue additional regulations inthis regard to clarify that this rule would be enforceable only if a treatycontains a similar rule. However, tax authorities would still have thepower to request this information.It should be noted that some Mexican treaties contain specific exclusion

clauses that have an impact on the financial sector that should be taken intoaccount when applying a treaty. These features are common in the Mexicantreaty network and particularly in the most recently signed treaties.

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Limitations for deductionsLimitations for deductions concerning technical assistance,interest and royalty payments between related parties when aMexican resident controls or is controlled by a related partywere introduced. This limitation applies in the followingcases: a) when and to the extent that the recipient is a trans-parent entity whose owner or owners are not subject to tax inits jurisdiction; b) the recipient country of tax residence con-siders the payment to be disregarded; or c) the recipient doesnot include the payment as part of its taxable income underits jurisdiction’s rules.The deduction of payments is not allowed when made to

tax haven jurisdictions (as defined in the Income Tax Law),unless supported by transfer pricing documentation. Further,the law does not allow the deduction of expenses that are alsodeducted by another related party, unless the correspondingincome is included in the related entity’s taxable income inthe same or in a subsequent tax year.These measures are intended to limit undue tax erosion of

the Mexican tax base pursuant to the OECD initiative on baseerosion and profit shifting (BEPS).Other limitations for deductions were introduced which

have important impact, such as limitations (at 53%) for taxexempt salaries and benefits, as well as for contributions topension and retirement plans. If the employer reduces theemployee’s benefit package, then the deduction for taxexempt salaries and benefits will be limited to 47%.Some taxpayers have considered that some of these limita-

tions go against constitutional provisions and therefore havefiled injunctions before the Mexican courts.

DepreciationThe reform eliminates the option to depreciate certain assetson an accelerated basis. The 100% rate deduction remains forinvestments on certain machinery and equipment for limitedcases.

Installment salesThe new law repeals the provision that allows companies todefer income recognition on installment sales.

Real estate investment companiesThe tax reform eliminates the special tax treatment for realestate investment companies (REICs or SIBRAS for itsacronym in Spanish) and increases from one to four years theminimum leasing period to apply the exemption applicable topension funds on the sale of real estate or shares representingsuch real estate.

Registry for foreign financial institutions and fundsThe Tax Administration Service will no longer hold a registerfor foreign financial institutions (FFIs, such as banks, pensionand retirement funds, investment banks and non-bank banks),

a former requirement to apply income tax exemption or a lowwithholding rate for interest.

Karina Pérez PwC

Tel: +52 55 52 63 57 34Email:[email protected]/mx/

Karina Pérez is the leading partner for Mexico of the tax financialservices practice. She joined PricewaterhouseCoopers in February2008. Karina was the former leading partner for Mexico andLatin America for the Tax Controversy and Dispute Resolutionpractice. In this capacity she successfully resolved disputes in dif-ferent industries, such as in the financial, consumer products,pharmaceutical, telecommunications, and energy sectors, amongothers. She has practised in the area of international taxation formore than 25 years.

Before working at the firm she worked at the Mexican CentralBank. After that she occupied for 17 years different relevant posi-tions at the Mexican Treasury Department and Tax AdministrationService. In that capacity she was engaged in important projectsrelated to the banking and capital markets area, as well as inasset management, real estate and other matters related to thefinancial sector. She negotiated 44 of the treaties and protocolsentered into by Mexico with its major commercial partners (forexample, US, Canada, UK, Spain, France, Italy, Germany,Switzerland, Belgium, Luxembourg, Netherlands, Russia, India,China, Singapore, Malaysia, Netherlands, Brazil, Chile, andVenezuela). She also was involved in the negotiation and imple-mentation of exchange of information agreements and has beenin involved in FATCA projects in Mexico and its regulation.

As a tax official she worked on proposed tax legislation,administrative rules and regulations. She was also responsiblefor issuing private rulings for international transactions and wasthe competent authority in several mutual agreement proceduresfor treaty interpretation. As part of her functions she issued tech-nical and operational guidelines applicable to the LargeTaxpayers Division of the Tax Administration Service, includingthose applicable to the financial sector. In this role she was alsoresponsible for the registry of foreign banks, pension funds andexempt organisations and placement of bond reporting obliga-tions. Being a tax official she served for many years as a dele-gate for Mexico in different working groups at the OECD (forexample, the Committee of Fiscal Affairs, Working Group No.1,Treaties and Related Issues, Harmful Tax Competition).

She graduated as a lawyer from the Escuela Libre de Derecho.

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Although this was meant to simplify tax obligations, thismeasure may give rise to uncertainty regarding documenta-tion that is needed to apply such exemption or rate that maybe required under a tax review. In some instances a writtenconfirmation from the tax authorities may be desirable toavoid controversies. Further, the elimination of this registrymay give rise to an increase in the administrative burdenregarding the documentation to be provided to each of thewithholding agents by financial institutions. As a resultadministrative regulations to minimise these burdens wouldbe desirable.

Deduction of contingency reservesThe option to deduct contingency reserves for banking insti-tutions has been eliminated and currently banks are allowedto deduct bad debts once they are not collectable from a legalstandpoint pursuant to the Income Tax Law to the extent thatthese bad debts were not previously deducted under the rulesapplicable to the deduction of contingency reserves. From alegal standpoint, bad debts would be considered uncollec-table when such debts are considered as such pursuant to theNational Banking and Securities Commission rules.Transitory provisions are included in the law in this regard.

These rules provide that banks will continue to recognise taxableincome from the decrease of the balance of contingency reservesas of December 31 2013. Such transitory provisions also providethat where the deduction for bad debt in the corresponding yearis lower than 2.5% of the contingency reserve average balance ofthat year and limited to the amount of such difference, thededuction would be allowed for the remaining balance of thecontingency reserves as of December 31 2013. In cases wherethe remaining balance of the contingency reserves as of

December 31 2013 has been fully deducted, banks have theright to deduct write-offs, rebates, waivers and discounts on loanportfolios and losses from the sale of such portfolios, as well aslosses arising from foreclosure. Administrative regulations estab-lish another procedure applicable to this deduction.This item of the reform applicable to banks was under the

review of the tax authorities and as a result of this review newregulations were issued in this regard.In accordance with such new regulations, beginning 2014,

an option is available for the banking institutions as a transi-tion rule to deduct bad debts generated in 2014 in lieu ofapplying the transitory provisions mentioned above. For thesepurposes, such regulations provide that the deduction of loss-es of bad debts arising in 2014, including writ-offs, rebates,waivers, discounts of loan portfolios and losses from the saleof such portfolios, as well as losses arising from foreclosure,may be deducted within certain limits and considerations,provided that the amount of these items is equal to theremaining accounting balance of the contingency reserve as ofDecember 31 2013 considering the annual limit of 2.5% ofthe annual average balance of the loan portfolio.While the above procedure is completed, banking institu-

tions are allowed to deduct every year the excess of contin-gency reserves that has not been deducted as of December 312013, considering for this purpose the limitation of 2.5%mentioned above.Additionally, banking institutions would have to compare

the balances of the contingency reserves of December 312013 and 2012 against the balance of such reserves of the fol-lowing years to determine a potential taxable income whenthe final balance is lower than the previous balance; the refer-ence to 2012 is unclear.For insurance and bonding companies the reserves deduc-

tion was maintained.

Withholding tax on publicly traded sharesThe new law imposes on individuals (both those resident inMexico and also non-residents) a 10% tax on capital gainsderived from the sale of shares issued by Mexican residents, ofshares issued by foreign companies or of instruments that rep-resent such shares, or share indexes, to the extent that theyare publicly offered on the Mexican recognised stockexchanges. The income tax is calculated on each transaction,applying the 10% rate on the gain and the intermediary shalldetermine the profit and respective tax, without deductinglosses.Income tax withheld is considered a definitive payment

pursuant to the law. The gain shall be the difference betweenthe purchase price (closing quote on the day of the transfer)and the average acquisition price during the holding period.An exemption is available for treaty residents and the inter-

mediary will not be obliged to withhold the tax as long as thetaxpayer provides a sworn statement that he is a resident in a

Alejandro Ortega QuintanarPwC

Tel: +52 55 52 63 61 [email protected]/mx/

Alejandro Ortega is acting partner of the Financial Services Taxpractice in Mexico. He has practised in the area of financial sec-tor international taxation for more than 20 years. Before joiningPwC he worked in BBVA Bancomer, S.A., GE Capital Bank, S.A.and also at other Big 4 firms. He graduated as an accountantfrom Instituto P0litécnico Nacional and he has a master infinance from Universidad Nacional Autónoma de México. He isalso a member of Colegio de Contadores Públicos de México.

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treaty country, as well as his tax registration number issued bythe competent authorities. If the taxpayer does not providethis information to the intermediary, the intermediary wouldbe obliged to withhold the 10% tax. Administrative regula-tions provide an optional waiver for the intermediaries tomake the 10% withholding, provided that the account holderdelivers a sworn statement to the intermediaries that he is atreaty resident.It is uncertain whether such sworn statements would relieve

the taxpayer from meeting treaty application requirements tobe entitled to the exemption. In this regard, it would be desir-able that tax authorities issue some guidance stating that thetaxpayer is relieved from meeting treaty benefit requirementsto facilitate the application of this exemption.The 10% rate is not applicable where shares are not consid-

ered as publicly placed or where the shares are purchased out-side the authorised stock exchanges or when the securities arenot considered as publicly traded. Also, this rate would notapply if, in a period of 24 months, a person or group of per-sons sells 10% or more of the fully paid shares of the legal issu-ing entity, through one transaction or more than onesimultaneous or successive transaction. This exclusion alsoapplies to transactions on such securities markets conductedas listing operations or protected cross trades, regardless ofhow such operations are labelled, which prevent sellers fromaccepting more competitive bids than those they receivebefore and during the period in which the shares are offeredfor sale, even if the National Banking and SecuritiesCommission has classified such transactions as agreed in astock exchange. In these cases the maximum rate of 35%would apply on the gain derived and no deduction of losses isapplicable.The recently issued administrative regulations that deal

with the application of this new capital gains tax clarify thetreatment of American Depository Receipts (ADRs) withunderlying Mexican shares.

Pursuant to these new regulations, the exemption provid-ed for publicly traded Mexican shares is extended to ADRs.Further, pursuant to such regulations taxpayers are no longerobliged to file the declaration under oath or their tax identi-fication number to the Mexican intermediaries to obtain suchexemption provided that some requirements are met. Thewording of this new rule can be interpreted in the sense thatthis benefit only applies to taxpayers that are treaty residents,although this may not be the intention of this rule and leavesopen other questions regarding its application. In the case of over-the-counter transactions the applicable

withholding rates are 35% on the gain if certain requirementsare met or 25% on a gross basis.The new regulations also introduce the procedure to

determine the cost of acquisition of shares or securities whereits custody and administration corresponds to a differentintermediary than that who participated in its alienation. Tax treaty relief is available where relevant conditions are

met. Very few Mexican treaties exempt gains from the sale ofshares; most of the Mexican treaties exempt gains derivedfrom the sale of shares that represent a participation of lessthan 25% of the capital of a Mexican company.

VATThe value added tax law maintains the exemption applicableto mortgage interest.

Flat tax and tax on cash depositsThe tax reform package repeals the flat tax and tax on cashdeposits.These changes in force from the beginning of 2014 have a

significant impact on the industry, especially on companieswith affiliates or other investments in Mexico. As mentionedabove, there are some administrative regulations and incometax regulations that are expected to be issued shortly whichwill provide positive clarifications in some relevant areas.

T H E N E T H E R L A N D S


The impact of BEPS onprivate equity

On March 14 2014,the OECD released adiscussion draft ontreaty abuse under itsAction Plan on BaseErosion and ProfitShifting (BEPS).Marc Sanders ofTaxand providesguidance on the BEPSproject’s impact on theprivate equity sector.

B EPS is a reaction to the discussion in politics and the press on per-ceived treaty abuse by multinationals. The intention is that inSeptember 2014 final proposals will be published on the various

BEPS actions.The document contains proposed tax treaty provisions and related com-

mentary together with proposed domestic law provisions to address poten-tial treaty abuse. The recommendations include incorporating in taxtreaties both a specific anti-abuse rule limitations on benefits (LOB) simi-larly found in US tax treaties and a general anti-abuse rule similar to themain purpose test found in UK tax treaties.

The tax profile of private equityInvestors into private equity funds are typically pension funds, familyoffices, insurance companies, banks, sovereign wealth funds, not-for-profitorganisations, educational endowment funds, charities, and other invest-ment funds in a broad range of jurisdictions. Many of these investors can,in general, benefit from tax treaties in their jurisdictions of residence. Froma tax perspective, it is therefore important that the structure of the fund istax neutral for the investors. The pooling of the investments through thefund entity should not trigger additional tax for investors when comparedwith a situation in which the investors would have invested directly.Private equity funds typically invest in companies in multiple jurisdic-

tions, to diversify risk and maximise investment opportunities. It is there-fore critical to private equity funds that they can operate effectivelycross-border and tax is not a barrier to invest into another country. Thefunds use holding companies to avoid any double taxation.Holding companies are also necessary for private equity funds for rea-

sons other than tax such as being able to structure the acquisition of a tar-get through an appropriate legal system, obtaining financing for theacquisition and implementing a suitable management structure. BEPS is largely focused on multinationals. However, private equity

operates very differently from multinationals. Many of the issues the pri-vate equity industry faces with the proposed changes are because thedocument does not (yet) consider the position of collective investmentvehicles (CIVs). It is clear from previous OECD publications that theOECD is aware of the particular challenges faced by CIVs in relation totreaties. During a webcast by the OECD on May 26 it was stated that thetax position of CIVs should be taken into account but no details wereprovided.



Limitation on benefits ruleOne of the proposed measures is that all tax treaties shouldinclude a LOB rule. The origin of this rule stems from taxtreaties concluded by the US. To benefit from a treaty, a qual-ifying person should meet one of several detailed tests underthe LOB rule such as the stock exchange test or the activetrade or business test. Experience shows that the LOB rule isoften a very complex and detailed rule that creates a signifi-cant burden on taxpayers. The specifics of the LOB rule aresuch that we could have filled this edition easily with furtherdetails. The fact is that the LOB test includes many subjectiveand complicated definitions which are left open for interpre-tation by tax administrations in each jurisdiction. This canonly lead to increased uncertainty for private equity funds.Furthermore many private equity investment funds, their

holding companies and even the companies they invest in maynot meet the LOB test because:• the fund, their holding companies and investee companieswill not be listed on a stock exchange and will thereforenot meet the stock exchange test;

• neither the fund nor the holding companies will in gener-al be treated as carrying on an active trade or businessunder the definition of the current LOB test; and

• the derivative benefits test proposed is very narrow. Giventhat many private equity funds raise funds from a broadrange of jurisdictions, it will rarely be the case that 50% ormore of the investors in the fund are resident in the samejurisdiction as the fund or holding company. From a prac-tical perspective it is also important to note that it will bevery difficult to establish the treaty status of the investorsin the fund. Even where the ultimate beneficiaries can beidentified, it will often not be possible for the fund toestablish their treaty status.Therefore there is a good chance that the fund and its

holding companies cannot benefit from treaty benefits if aLOB rule is included in tax treaties as now proposed by theOECD. It is likely that all investors would, however, qualifyfor treaty benefits if the investors in the private equity fundwould have invested directly. This demonstrates that the pro-posed LOB rule affects many CIVs and their holding compa-nies. Furthermore the LOB test will create a significantadditional administrative burden on the funds to reviewwhether they and their holding companies can qualify For a number of reasons, private equity funds frequently

use (holding) companies in locations such as Luxembourg orthe Netherlands. An analysis of the LOB provisions applied tothese types of structures shows that limiting access to a treatyprimarily by reference to the various LOB tests poses particu-lar challenges for businesses based in small open economies.Most private equity owned companies that operate in thesecountries, for example, have foreign owners and draw uponforeign sources of finance. This will make it more difficult toqualify under the LOB test.During the May 26 webcast the OECD said it will provide

some flexibility for countries to implement the LOB rule asthey see fit. No details are available at the moment, however.Although flexibility is welcome it may also create further com-plications if countries implement the LOB rule differently.

Main purpose testAlso included in the draft proposals is the inclusion of a gen-eral anti-abuse rule (main purpose test) designed to addressother forms of treaty abuse that would not be covered by theLOB provision. The test is whether it is “reasonable to con-clude” that obtaining a treaty benefit was one of the mainpurposes of the arrangement or transaction. The LOB test and the main purpose test are not presented

as being mutually exclusive. It is proposed that the LOBmeasures would have primary effect in limiting the potentialfor inappropriate use of the treaty but that the additionalmain purpose test could have effect even if a taxpayer met thetests for treaty entitlement set out in the LOB provisions. The challenge of the main purpose test is that it is subjec-

tive and that tax administrations in different jurisdictions canform a different view on the interpretation of the provisionsand the implemented structure. The potential to fail this test

Marc SandersTaxand

Tel: +31 20 435 [email protected]

Marc Sanders is a partner at Taxand Netherlands and specialisesin M&A transactions and international taxation. Clients include pri-vate equity funds and multinationals. Marc frequently works on(vendor) due diligence projects and tax structuring for M&A deals.Marc graduated in Tax Law from the University of Amsterdam

in 1999 and joined Deloitte on Aruba in the Caribbean. In 2000he joined the International Tax department of Arthur Andersen inAmsterdam where he worked in the Technology, Media &Telecom team with a focus on international corporate incometax planning.During 2002-2003 Marc was seconded to a major European

cable company, where he was the interim tax manager for thecontent division. Marc worked at the Dutch desk of Deloitte inNew York in 2006/2008 where he assisted US clients with taxplanning and M&A advice.As of 2009 Marc has been a partner at Taxand Netherlands,

the only independent Dutch tax firm with global coverage.



is relatively high because the test is very broad. For privateequity funds it is also more difficult to establish the aims andpurposes of all the investors in the fund. This will thereforealso lead to increased uncertainty for a private equity fund andits holding companies.

Conclusions on the proposed LOB and main purposetestThe inclusion of a LOB and main purpose test will createadditional uncertainty and administrative burden for multina-tional companies and especially private equity funds. At themoment it is not clear how the final proposals of the OECDwill look and whether these proposals will be implemented atall. The OECD does however seem to pursue the direction inthe draft document. Hopefully the OECD will reconsider thetax position of CIVs, take the significant criticism on the pro-posals into account and provide detailed commentary on thenew rules. This may eliminate some of the burden for the pri-vate equity industry.

Other developmentsA lot of companies and private equity funds are facing ques-tions from tax administrations on their tax structures and espe-cially the substance of their structures. The tax administrationsincreasingly demand economic rationale behind internationaltax planning structures. Recent high profile court cases in anumber of countries are a result of this increased scrutiny. Werefer, for example, to the recent court cases in Denmark onbeneficial ownership and the Vodafone case in India.The developments on the definition of beneficial owner-

ship are also important, as are the continuing discussions inthe EU on tax planning and potential changes to the EU par-ent-subsidiary directive. A number of countries have alreadyimplemented local anti-abuse rules which sometimes overridetax treaties. An example is the German rules on foreign hold-ing companies. Although the proposals by the OECD get themost attention, the proposals at EU level or local anti-abuserules may be implemented quicker and with more effect, par-ticularly if the OECD fails to achieve agreement on the vari-ous proposals.

Actions private equity firms can takeThese different developments in recent years have resulted ina new environment where private equity structures should beimplemented with sufficient substance and business purposes.Private equity funds therefore need to adapt to the new envi-ronment and reconsider their standard structures.

A cookie cutter approach should not (or no longer) betaken, especially considering the fast changing rules. The nec-essary substance in the structure should be tailored to thebusiness strategy and the tax requirements of the source juris-diction and the treaty. Fund managers should perform a cost/benefit analysis on establishing the necessary substance at aholding company. An empty letter box company in a taxhaven may seem a cost efficient solution but often provescostly in the long term. Setting up or maintaining holding or finance companies in

a jurisdiction without proper allocation of substance (func-tions, risks, employees, decision-making powers and assets)should be avoided. This should, however, not prevent com-panies from engaging in tax planning strategies. Tax planningwill remain possible as long as countries compete to attractinvestments through beneficial tax regimes. The tax planningstrategy should, however, be aligned with the business strat-egy of the company/fund and sufficient substance should bepresent.Actions that private equity funds are taking are, for exam-

ple, that they no longer use a separate acquisition/holdingcompany for each acquisition (often in different jurisdictions)but use a very limited number of holding companies in a sin-gle jurisdiction. These holding companies do have sufficientsubstance including relevant employees and resident man-agers/ directors.A number of private equity funds are also on-shoring their

funds from typical offshore locations such as Bermuda, BVIand Jersey to onshore locations such as Luxembourg and theNetherlands. The tax and legal benefits found in offshorelocations are often also available in onshore locations due tospecific tax and legal regimes. The main benefit of having thefund, management and holding companies in a single onshorelocation is that it is much easier to have sufficient substanceand business purposes for the structuring through that loca-tion. Centralising the location of the fund, management com-pany and/or holding companies will also create costefficiencies. Jurisdictions that can be considered in this regardshould have a proper infrastructure (workforce, transporta-tion, advisers and an attractive and cost efficient living envi-ronment), a stable economy and political climate, an attractivetax regime and a large treaty network.Overall private equity managers and their tax advisers

should take these developments into account when designingand evaluating their structures. Burying one's head in thesand and relying on structures that worked 10 years ago mayresult in unwelcome attention from the tax administrations.

N O R W A Y


Financial services in Norway:Navigating the tax issues

Norway is participatingin the EuropeanEconomic Area whichincludes the 28 EUmember states and thethree European FreeTrade Agreement(EFTA) states. The EEAtreaty is largely foundedon the same principlesas the EU treaty andmost EU regulationsapply in Norway withinthe financial servicessector, includingtaxation. PwC’s DagSaltnes, Stian RoskaRevheim and LivLundqvist explain.

General tax principles The Norwegian Corporate Income Tax (CIT) is based on a flat tax rate of27% on net profits. Tax losses can be forwarded against future profits foran indefinite period of time. The company’s worldwide income is taxablein Norway, usually with a credit for taxes paid in other jurisdictionsdepending on the various tax treaties. The tax exemption method (TEM) reduces the tax rate to zero or

0.81% depending on the circumstances for corporations on received divi-dends and capital gains on disposal of shares regardless of the level of par-ticipation and period of ownership. TEM is also applicable forshareholding in foreign companies with specific criteria for low tax jurisdic-tions and companies located outside the EU/European Economic Area(EEA).

The Norwegian tax exemption method (TEM)Under the tax exemption rules, corporate shareholders are generallyexempt from tax on dividends received and capital gains on qualifyingshares and on derivatives where the underlying object is qualifying shares.Correspondingly, losses on shares are, in general, non-deductible. All operational expenses related to exempt income from shares are fully

tax deductible. To limit the benefit of these deductions, the TEM is, withsome exemptions, limited to 97% for received dividends, and the remain-ing 3% is taxable for Norwegian corporate shareholders (at a 0.81% effec-tive tax rate). The 3% taxable income is calculated on dividends. Dividenddistributions within a tax group (where the ultimate parent companydirectly or indirectly owns more than 90% of the shares and voting rights)are fully tax exempt. There is no tax on capital gain on disposal of shares.In addition, the TEM also may apply for capital gains on qualifying

partnership units and, on certain conditions, to foreign-resident companieswith taxable activity in Norway (3% of the income taxable at 27% with aneffective tax rate of 0.81%). Distributions from partnerships are not recog-nised as taxable income for corporate partners, but will be included in thebases for calculating the 3% income. Participants of the partnership may, asthe subject for tax of the partnership's income, also utilise the TEM for itspart of the relevant share income received by the partnership.Note that an investment in a company resident in a low-tax country in

the EEA has to fulfil certain substance requirements to qualify for the taxexemption rules. These requirements are intended to be in line with thesubstance requirements of the European Court of Justice’s (ECJ’s) decision

N O R W A Y


in Cadbury Schweppes. A country is considered a low-taxcountry if the level of effective taxation is less than two-thirdsof the tax that would have been due if the foreign companyhad been resident in Norway. This is the same test used forthe controlled foreign company (CFC) regime. TheDirectorate of Taxes has published a non-exhaustive list oflow-tax jurisdictions (black list) and non-low-tax jurisdictions(white list).However, for investments outside the EEA, the exemption

applies only if a shareholder owns 10% or more of the sharecapital and the voting rights of the foreign company for a con-secutive period of two or more years. To be able to deductlosses on the realisation of shareholdings outside the EEA, theshareholder and/or a related party may not own 10% or moreof the share capital and the voting rights of the foreign com-pany in the two-year period before the realisation. For divi-dends, the holding period of two years does not have to bemet when dividends are distributed, but can also be met afterthe ex-dividend date.

Shareholdings in low-tax countries outside of the EEA donot qualify for the TEM.Acquisition and sales related costs (for example, broker

fees) must be added to the cost price of the shares for tax pur-poses. Costs incurred to manage acquired tax-exempt sharesare, however, tax deductible.Norway’s internal tax rules do not allow taxation of a non-

resident’s capital gain on the disposal of financial instruments,including shares in Norwegian companies, unless the non-res-ident has a permanent establishment (PE) to which the finan-cial instrument may be allocated.Investing in partnerships or transparent entities (such as

German KGs or Luxembourg FCPs) and investments madeby such entities must be considered on a case-by–case basis.The Norwegian Ministry of Finance has issued opinionsregarding hybrid entities. The Norwegian classification ofpartnerships and transparent entities is based on certain crite-ria which in many cases are different from classification local-ly. The tax authorities' opinion – which in our view may be

Dag SaltnesPartnerPwC

Tel: +47 [email protected]

Dag Saltnes is a Norwegian lawyer and has more than 25 yearsof experience as an adviser for clients in the financial servicessector, among others. His international and domestic clientsinclude insurance companies, pension funds, banks, asset man-agers, private equity funds, publicly-owned enterprises, quotedenterprises and private companies.Dag is the leader of the Financial Services group (Banking,

Finance and Insurance) with PwC Tax & Legal Norway. The FSservices include corporate tax, tax compliance and reporting, VAT,legal and regulatory requirements.He has headed up PwC teams on many restructuring projects

for insurance companies in recent years, including cross-bordermergers and transactions as well as cross-border marketing ofinsurance products. Dag has also been in charge of tax compli-ance and tax reporting engagements for Norwegian insurancecompanies.Dag is also a member of PwC Norway’s Tax and Legal

Service’s Management Committee managing more than 180 pro-fessionals working across nine offices.

Stian Roska RevheimDirectorPwC


Stian Roska Revheim is a Norwegian lawyer and director at PwC.Stian has 12 years' experience and has also spent time workingfor the tax authorities. Stian is a member of the financial sector group in PwC

Norway. Clients include international and domestic insurancecompanies, banks and other financial institutions as well as pri-vate and publicly owned companies. He works mainly with tax and regulatory questions related to

financial institutions, including those relating to:• the taxation of investments in financial instruments;• private equity investments; • withholding tax issues;• restructuring, including cross-border merger; and• EU Directives

N O R W A Y


challenged – is that all investors in a hybrid entity investing ina Norwegian company must qualify for the TEM in order tobe comprised by the rules. Additionally an investment madeby a Norwegian company in a hybrid entity requires that allincome received by the hybrid entity must derive from theEEA to qualify for the TEM.Life insurance companies and pension funds are excluded

by the TEM for the assets allocated to the policy holders. Thisapplies for the licenced entity and indirect investmentsthrough tax transparent entities, but not subsidiaries. The rea-soning is to avoid double deductibility as the income of suchassets will be tax deductible for the allocation to the technicalreserves.

Withholding taxAccording to internal rules there is no withholding tax paidon interest and royalties from a Norwegian entity.Withholding tax on dividends is, as a starting point, 25%,

but exemptions apply for shareholders within the EEA and

applicable tax treaties. For corporate shareholders located inthe EEA the withholding tax as a main rule is zero due to theTEM. This applies also for pension and in many cases alsoinvestment funds. Foreign life insurance companies and pension funds will in

our view be in position to obtain the most favourable with-holding tax position and be regarded as other corporate enti-ties regardless of the exclusion of the TEM as mentionedabove. This is because the foreign entities do not enjoy the taxdeductibility for allocation to the technical reserves. Theopinion of the tax authorities is not yet known.A list of the various rates in the tax treaties may be found

at www.taxsummaries.pwc.com.Withholding tax at the correct rate may be deducted from

the dividends by the dividend distributing company providedthat the shareholder has submitted documentation for its sta-tus. In case of incorrect deduction the shareholder can file arefund claim to the Norwegian tax authorities. The statute oflimitation is, according to the tax authorities' opinion, threeyears. The Norwegian tax authorities have accepted so-calledFokus Bank reclaims and refunded withholding tax and anumber of cases are still pending.

Limitation of interest deductibility for intra-group debtAs of 2014, limitations on the deductibility of interest expens-es between related parties have been adopted. In general,interest expenses to related parties that exceed 30% of aNorwegian company’s taxable income, with some adjust-ments, will not be tax deductible. The new regulations willonly apply to companies that have more than NOK 5 million($840,000) in total interest expenses and for the wholeamount if the threshold is exceeded.Two parties are related if one party directly or indirectly

owns or controls the other party by a stake of at least 50%.Related parties may be resident in Norway or abroad. Theinterest deductibility limitation is calculated for each entity inthe group. Disallowed interest deductions may be carried for-ward for 10 years.The limitation applies both to local and foreign companies

that have a taxable presence in Norway, as well as partner-ships, CFCs and so on. The new regulations will also apply tointerest costs on loans entered into before 2014.

Fund taxation Investment funds will for Norwegian tax purposes be classi-fied as either equity (share) funds or bond funds. Balanced orcombined funds will be defined as equity funds if the fundowns one share or more.Equity funds are taxed by a specific section in the General

Tax Act where capital gains on all disposals are tax exempt andlosses are not deductible. The fund may utilise the TEM onreceived dividends. Costs are deductible but income on debts(fixed income) and dividends not comprised by the TEM may

Liv Haneberg LundqvistDirectorPwC


Liv Haneberg Lundqvist is an associate lawyer and a director inAdvokatfirmaet PwC in Oslo. In addition to her law degree, sheholds the degree Executive Master of Management with speciali-sation in Taxation. This degree includes handling topics such ascorporate and business taxation, tax procedures, internationaltaxation, transactions and restructuring, transfer pricing andanalysis and methods. Liv is the leader for Advokatfirmaet PwC’s work with the finan-

cial services sector in Oslo. Her international and domesticclients include insurance companies and pension funds, banks,asset managers, private equity funds, publicly-owned enterprises,and private companies.She has more than 14 years of experience in the field of

domestic and international corporate taxation. She has extensiveexperience with providing advice and tax assessment to largeand listed multinational groups. Liv is a specialist in taxation ofNorwegian investors in private equity funds. Liv also has 12 years of experience from her time working at

the Norwegian tax administration. She has been in charge of theassessment of the largest and leading Norwegian groups in thefinancial services industry.

N O R W A Y


however become net taxable income for the fund and resultin a tax leakage if exceeding the costs.Bond funds are taxable entities for all income (and will not

have any equity instruments), but are allowed to deduct thedistributions to the investors.

Tax on asset management activities Asset managers may face some challenges with regard toNorwegian tax. A pending court case has temporarily resulted in carried

interest to be classified as operational income on the level ofthe management company and not – as argued by the taxauthorities – salary income for the partners of the manage-ment company. The decision from the Oslo City Court isappealed to the High Court and the final outcome may haveto wait until the Supreme Court has ruled on the dispute.Assets managers must also consider the Norwegian rules

on taxable residence and permanent establishment carefully.The regulatory process in the EU for passporting/cross-bor-der activities applies as a main rule in Norway as well, but thetax rules remain unchanged. The Norwegian corporate residence rules can be described

as follows. Companies that are registered and incorporated inNorway in accordance with Norwegian company law are, as ageneral rule, regarded as tax resident in Norway and taxablefor their worldwide income. If effective management at theboard or director level takes place outside Norway, residencyin Norway for tax purposes may cease, and the company maybe subject to exit taxation. Note that several factors should beconsidered to determine whether tax residency has moved(for example, other management functions and the overallconnection to Norway).Foreign corporations will be regarded as resident in

Norway if the place of effective management is in Norway.The place of effective management will be deemed to be inNorway if, for example, the board of directors makes its deci-sions in Norway.

The Norwegian PE rules are as follows. A foreign compa-ny is liable to tax in Norway when engaged in a business thatis either conducted in or managed from Norway. The tax lia-bility is limited to income that is derived from Norwegiansources. As a general rule, non-residents without a PE are notliable for tax on capital gains when selling Norwegian finan-cial instruments. However, when the property has been usedin a business that is conducted in or managed from Norway,the capital gain or loss has to be included.The legislation does not contain a reference to the treaty

concepts of "permanent establishment" or "permanent repre-sentative". The threshold for tax liability is normally lowerunder legislation than the taxing right afforded to sourcestates under tax treaties.With respect to double tax treaties (DTT), the Norwegian

tax authorities will, to a large extent, follow the OECDCommentaries when interpreting the relevant DTT, if thewording is similar to the OECD Model Tax Convention.

Tax reform remains on the horizonThe Ministry of Finance has appointed a committee ("theScheel Committee") to assess the Norwegian corporate taxregime in comparison withforeign regimes. The committeewill provide a report with analysis and recommendations inOctober 2014. It remains to be seen whether the report willlead to a tax reform.Other relevant issues are, for instance, that there are no

specific signals that Norway will introduce a financial transac-tion tax (FTT). The previous social democratic governmentannounced that the EU development will be monitoredclosely but the right-wing government as of October 2013has not stated any opinion yet.Norway has entered into a FATCA agreement with the

US. Norway has entered into tax treaties or tax informationexchange agreements with 100 countries (67 double taxtreaties and 33 information exchange agreements) and thenumber is increasing.

S W I T Z E R L A N D


Swiss fund managementstructure tax considerations

In light of new EUlegislation on collectiveinvestments, AlbertoLissi and MonikaGammeter Utzinger ofTax Partner – Taxandexplain the taxconsiderations relatingto Swiss fundmanagement structures.

T he Alternative Investment Fund Managers Directive (AIFMD) – aproduct of the financial crisis – entered into force on July 21 2011.The goal of the AIFMD is to regulate the management and mar-

keting of alternative investment funds (AIFs) in the EU and thus, affectinga part of the financial industry that in the past was mostly unregulated oronly subject to light regulations.The Directive applies to alternative investment fund managers (AIFMs)

that manage AIFs in the EU, non-EU fund managers that manage AIFsestablished in the EU and non-EU fund managers that market units, orshares of EU or non-EU AIFs, in the EU (unless an exemption applies). EU member states had to implement the Directive in their local law by

July 22 2013. Due to transitional periods in many EU member states theDirective becomes fully effective only after July 22 2014. The benefit of the AIFM licence is that the licence will give the AIFM

the EU-wide “passport” that will permit the management of AIFs based inany EU member state and an EU-wide marketing passport to market AIFsto professional investors in the EU.

How are Swiss portfolio managers affected by the AIFMD?Swiss portfolio managers (or advisers) are affected by the AIFMD if (i)they manage and/or (ii) market an EU-AIF or (iii) market units or sharesof non-EU AIFs to professional investors in the EU (unless subject to de-minimis exemptions or grandfathering rules). Further, Swiss portfoliomanagers (or advisers) are affected by the AIFMD if the portfolio or riskmanagement is delegated to them by an EU-AIFM. According to theAIFMD EU member states may apply local regulations with regard to AIFmarketed to retail investors in their territory.Thus, if a Swiss portfolio manager or adviser intends to manage EU-AIFs

and/or market AIFs to professional investors in the EU, a licence from anEU member state of reference is required. A licence in an EU member stateof reference is also required if an EU or non-EU AIFM delegates the port-folio management or risk management tasks to the Swiss portfolio manager. To receive the licence the Swiss portfolio manager needs to be fully com-

pliant with the AIFMD. Thus, apart from being fully compliant with theSwiss Federal Act on Collective Investment Schemes (CISA) the Swiss port-folio manager needs to be fully compliant with AIFMD, to the extent thatthe AIFMD regulations are not in contradiction to the regulations in thehome country of the non-EU fund manager. On the other hand, not onlyhas the Swiss portfolio manager to fulfill the AIFMD requirements but there



are additional ‘home-country’ requirements that the country ofresidence of the non-EU AIFM needs to fulfill. First, it isrequired that Switzerland has concluded a comprehensive dou-ble tax treaty including the information exchange according toarticle 26 of the OECD model tax treaty with the country ofthe EU member state of reference. Second, it is required thatSwitzerland is not among the blacklisted non-cooperativecountries and territories on the list of the Financial Action TaskForce (FATF) and last but not least, the Swiss regulatorFINMA has concluded cooperation agreements regarding theregulation, cooperation and exchange of information withregard to the supervision of AIFM with all EU member states. However, even if all the requirements are fulfilled, Swiss

and other non-EU AIFM may only benefit from the manage-ment and marketing EU-passports after 2015. During theblocking period Swiss and other non-EU AIFM may stillmanage and market EU and non-EU AIFs to professionalinvestors in the EU if they comply with the national market-ing and private placement regimes of the respective EU mem-ber state in which marketing activities take place (subject tocertain AIFMD requirements). However, EU member statesmay impose stricter rules to non-EU AIFMs marketing EUand non-EU AIFs in their jurisdiction. According to AIFMD,national private placement regimes may be phased out in2018 and the EU-passport will become the standard require-ment.

Can the traditional offshore-fund structures still bemaintained under AIFMD?Investment managers are typically subject to regulation andtaxation in the country in which they are located.

Traditionally, the fund management of AIFs was based off-shore (for example, Bermuda, Bahamas, Cayman Islands,Guernsey, Jersey, etcetera) often delegating advisory andrisk management services to a Swiss entity. This set-up – inlight of international profit allocation and taxation –allowed for compensation of the formal offshore fund man-ager and the adviser service provider according to theirfunctions and liabilities under the fund management andadvisory agreement. If the offshore-manager did not havemuch substance (own personnel and infrastructure) mostSwiss cantonal tax authorities only allowed for limitedremuneration in accordance with the duties and liabilitiesperformed by the offshore manager. In general, the tradi-tional set-up allowed for a favourable overall taxation ofmanagement and performance fees. The traditional offshore-fund management structure can

still be maintained by non-EU AIFMs managing and market-ing non-EU AIFs in non-EU jurisdictions (see Diagram 1).For non-EU AIFMs with Swiss advisers managing tradi-

tional offshore AIFs and marketing them in the EU there arethe following options: (i) rely on reverse solicitation; (ii) relyon national private placement regimes as long as possible; (iii)rent-an-EU-AIFM (at least until 2015); (iv) make improve-ments to the offshore AIFM with the required substance toget compliant for the EU pass after 2015 and rely on nation-al private placement regimes in the meantime; (v) make theSwiss adviser compliant with CISA and AIFMD for the EUpassport after 2015 and rely on national private placementregimes in the meantime; and (vi) make the Swiss advisercompliant with CISA and set up a new EU-AIFM to get theEU-passport before 2015.

Service

Service

Fee

Fee

AIFM

(offshore)

Adviser

(Switzerland)

Custodian

(UK)

AIF

(offshore company or LP)

Administrator

(Ireland)

Investors

(Worldwide)

Investments

Diagram 1: Traditional offshore structure (example)



Structuring of new AIF with Swiss adviser or sub-managerSwiss portfolio managers or advisers anticipating the set-up ofa new fund structure with the intention to market to profes-sional investors in the EU before 2015 might consider theset-up of an EU-AIF with an EU-AIFM delegating the invest-ment advisory to a Swiss entity. To fulfill the requirements forthe delegation norm, the Swiss adviser (or sub-manager) willneed to be fully compliant with CISA.

Can the low-tax requirements from an investor’s pointof view be met by an EU-AIF?Traditionally AIFs have chosen offshore domiciles for variousreasons, among them: (i) favourable tax regimes; (ii) confi-dentiality; (iii) low levels of administrative burden; and (iv)the quality of fund infrastructure available in these locations.As offshore funds will only benefit from the EU-passport aftera transition period, AIFs domiciled in the EU will increase indemand. Among the major European onshore fund centresthat have established themselves for the set-up of AIFs areLuxembourg and Ireland and, more recently, Malta. From a tax point of view, the ideal fund structure should

meet the following requirements: (i) no taxation of the invest-ment fund; (ii) no withholding tax on distributions toinvestors; (iii) availability of double tax treaties and eligibilityto reclaim foreign source taxes; and (iv) no securities transferstamp duties on transactions.

With Malta offering one of the most competitive tax struc-tures in the EU, setting-up a Maltese SICAV and getting theEU-passport right away, might be considered as a veritableoption to an offshore AIF. If a self-managed Malta fund ischosen, the investment management and/or risk manage-ment functions can be delegated to a sub-manager licensed inanother EU member state or, for example, Switzerland. Toget a license as a self-managed fund in Malta the directors andinvestment committee members need to have the necessaryexpertise in the investments in which the AIF will invest.Further, active presence of at least two officers with sufficientmanagerial seniority is required in Malta.The Malta-registered SICAV is tax-exempt, provided it has

less than 85% assets situated in Malta (non-prescribed fund)and no income arising from immovable property or invest-ment income in Malta. Capital gains realised on transfers orredemptions by non-resident investors in the Malta-registeredSICAV are exempt from withholding tax in Malta.Distributions to non-resident investors are not subject towithholding tax in Malta. Malta has access to a broad double-tax treaty network (see Diagram 2).

Remuneration of sub-manager (former adviser) inSwitzerlandUnder the traditional offshore fund management set-up mostSwiss tax authorities would only accept compensation of the

Diagram 2: Potential onshore fund structure with EU passport

US-Feeder AIF

(Delaware)

Sub-Manager

(Switzerland)

Non-US-Feeder AIF

(Malta)

Administrator

(Ireland)

Investors

US (EU and non-EU)

Service

Fee

FeeService

Self-managedMaster AIF

(Malta)

Custodian

(UK)Investments



formal offshore manager according to the functions that werefactually carried out by the offshore manager and woulddemand that the Swiss adviser would receive an adequateshare of the management and performance fees (for exampleZurich cantonal tax authorities generally accepted remunera-tion of the offshore manager without adequate substance,resulting in a 20/80 profit split). In light of the AIFMD the formal fund manager has to be

adequately staffed to be fully compliant with AIFMD. Thus,Swiss tax authorities will have to accept that a larger part ofthe management and performance fees is used to remuneratethe functions of the formal fund manager that are required byAIFMD, or – in case of a self-managed Maltese SICAV –accept that a larger part of the profit will remain with the self-managed SICAV. The acceptance of the chosen remuneration of sub-manag-

er and formal AIFM by the Swiss tax authorities will likelydepend on the functions that are carried out by the formalAIFM (or – in case of the self-managed SICAV, by theemployees of the SICAV) and the functions that are delegat-ed to the Swiss sub-manager and whether the respective func-tions are considered routine or non-routine. The license ofthe Malta self-managed SICAV generally requires directorsand an investment committee with expertise and knowhow in

the investment management the fund will invest in, as well asthe active presence of at least two officers with sufficient man-agerial seniority. The function normally linked to such level ofsubstance should qualify from a Swiss tax perspective as non-routine in nature and therefore adequate remunerationshould be accepted by the Swiss tax authorities. If the equity shares in the Malta self-managed SICAV (or

in case of a Malta Feeder – the equity shares in the MaltaFeeder) are held by a Maltese private holding company(owned by a non-resident shareholder or shareholders) divi-dend distributions by the Malta SICAV (or the Malta Feeder)to the holding company are not subject to income tax. The net profit of the Maltese holding company deriving

from dividend distributions by the SICAV (or the Feeder) isallocated to the untaxed account of the holding company, anddistributions by the holding company will not be subject toincome tax in Malta. Other income of the holding companymay be subject to income tax at the tax rate of 35% (subjectto any double taxation relief including the Flat Rate ForeignTax Credit (FRFTC)) depending on the source of theincome. Distributions from the untaxed account of the hold-ing company to non-resident shareholders are gross of anytaxes as there will be no withholding tax on distributions tonon-resident shareholders.

Alberto LissiTax Partner – Taxand, Zurich


Alberto Lissi is one of 11 partners at Tax Partner – Taxand, theSwiss leading independent firm of tax advisers. He has a Ph.D. ininternational taxation and more than 15 years’ experience inlocal and international tax. Alberto’s activities are mainly focused on tax planning for

national and international corporations and entrepreneurs. Hehas wide experience in M&A and reorganisations of nationaland international corporations. Furthermore, he also advisesbanks and financial institutions. Tax Partner is one of the leading tax firms in Switzerland. With

32 professionals, the firm has been advising important multi-national and national corporate clients as well as individuals. TaxPartner co-founded Taxand in 2005 – the first global network ofmore than 2,000 tax advisers and 400 partners from independ-ent member firms in 50 countries.

Monika Gammeter UtzingerTax Partner – Taxand, Zurich


Monika is a senior manager of Tax Partner – Taxand, the leadingindependent Swiss firm of tax advisers. She has more than 18years’ experience in local and international tax law. Monika’sactivities are mainly focused on tax planning for national andinternational corporations and entrepreneurs, restructuring ofnational and international corporations and tax advice in thearea of banking, financial services and financial products. Beforejoining Tax Partner AG in 2003, Monika worked for several yearsfor the cantonal tax authorities in Zurich.Monika has studied business administration at the Zurich

University of Applied Sciences and later became a Swiss certifiedtax expert. She has published several articles in leading publica-tions. Monika is fluent in German, English and French.



Swiss withholding tax andpending refund claims:A €2 billion question Financial institutionsfiling withholding taxrefund claims on Swissdividends over the pastseven years havegenerally receivedinformation requestsrather than the refundexpected as the Swisstax authoritieschallenge refund claimstied to dividend trades.This has led touncertainties that havereduced the marketvalue of dividends onSwiss stocks. KPMGSwitzerland’s CharlesHermann explains.

I t all started in 2005 when a Swiss bank (Bank A) acquired some verylarge positions in Swiss shares from non-Swiss counterparties a couple ofdays before the dividend payment. At the same time the Swiss bank

entered into a synthetic forward (a call and put arrangement or a ‘call putcombo’) with those same counterparties. Shortly after the dividend pay-ment, the options were exercised and the Swiss bank returned the sharesto the non-Swiss counterparties. The transactions generated a withholdingtax (WHT) enhancement for the Swiss bank and the non-Swiss counter-parties, as the Swiss bank was in a position to obtain a full refund of the35% WHT on the dividends, whereas the non-Swiss counterparties wouldonly have been entitled to receive 65% or 85% of the gross dividend income(dependent on the treaty position). The Swiss tax authorities (STA) did not like these transactions consid-

ering them to be abusive ‘dividend stripping transactions’ and denied therefund of WHT on the dividends generated by the underlying Swiss shares.

Investigations on the refund of WHT associated with Swiss dividendsFurther to their discovery of these transactions, the STA began investigat-ing any large claims to WHT refund by Swiss and non-Swiss financial insti-tutions. Over the past six to seven years they have audited virtually all Swissbanks and equity traders and have enquired into virtually all non-Swissfinancial institutions with material claims to refund under a treaty. The STAinitially focussed on Danish entities but later started to look at entities res-ident in other jurisdictions that have a treaty with Switzerland. The reasonthe STA started their cross-border investigations with Danish banks andequity traders was that Danish entities were entitled to a full refund of theWHT on Swiss dividends up to the end of 2010, when the dividend arti-cle of the Swiss-Danish treaty was amended. Some non-Swiss entities have received up to four or five letters from the

STA. The first letter typically included the following questions: (1) Whendid the financial institution buy and sell the Swiss shares which generateda dividend? (2) Who are the counterparties to the trades? (3) Did the finan-cial institution use the shares as a hedge against derivatives? (4) What is theeconomic rationale of the transactions? and (5) Did the financial institu-tions forward the dividend income to another party? Sometimes the STAhave also raised questions in respect of securities lending and/or repotransactions with Swiss securities over the dividend season. Financial insti-tutions who have responded to these questions have almost never receivedtheir WHT refund. Instead they have been sent further, more specific



letters requesting additional (and sometimes repetitious)information including (1) the names and addresses of thecounterparties, (2) the timing and pricing of the transactionsin shares and derivatives, (3) details of the agreements relat-ing to the transactions, (4) a cash flow analysis of the transac-tions, (5) numerous additional information on the entity, theshareholders and the transaction including accounting infor-mation and, last but not least, (6) a confirmation that thetransactions are not “dividend stripping transactions”. Therequests can be longer, with the longest we have seen includ-ing a list of 21 questions.

How to obtain a Swiss WHT refund Switzerland applies a strict refund system on dividends fromportfolio investments. This means that the holder of Swissshares receives a cash payment representing 65% of the dividendand, upon filing a claim, a partial or full refund of the 35%WHT. A Swiss corporate shareholder is entitled to a full refundand generally receives a cash payment within a few months ofreceipt of the dividend if (as is usual) it applies for a refund oninstalment basis. A non-Swiss shareholder is normally not enti-tled to a full relief. Under most Swiss tax treaties the investorcan receive a refund of 20% (so that the final WHT is 15%). Anon-Swiss shareholder used to expect their money back withinnine months of filing the claim, but this is no longer the case. At the domestic level, the STA have denied WHT refund

claims relating to Swiss dividends made by numerous Swissbanks and traders holding long positions on Swiss shares overdividend date and having short exposures to single stockfutures and even, recently, SMI futures. They have denied theclaims to refund irrespective of whether the banks and thetraders entered into these transactions in the course of theirordinary business. The STA argue that Swiss banks andtraders holding Swiss stocks, receiving the real dividend andhaving a short exposure on these shares under a single stockfuture (including SMI future) or any other delta one (or closeto delta one) derivative(s) are not the beneficial owner of theshares and that these transactions are abusive from a domes-tic WHT perspective. At the cross-border level, the STA have challenged claims

to refund of WHT on Swiss dividends made, among others,by Danish, French, German, Italian, Luxembourg, UK, USfinancial institutions associated with swaps (irrespective ofwhether the swap is a price swap or a total return swap), secu-rities lending transactions and single stock forwards andfutures with Swiss stocks. As with the claims made at domes-tic level, the STA consider that the Danish, French, German,Italian, Luxembourg, UK and US entities are not the benefi-cial owner of the dividend and that the claims to refund areabusive from a Swiss treaty perspective. The STA believe that certain banks and brokers abused

their trust in the past and therefore view their actions regard-ing dividend stripping transactions as legitimate. It seems that

the US Senate report on dividend abuse and their enquiries sofar have further convinced them of this.

First Swiss court decisionsThe STA decided to take the dividend stripping transactionsto court. On March 12 2012, the Federal Administrative Court

(that is, the lower court) made its first decision in respect ofperceived dividend stripping transactions. The FederalAdministrative Court stated that a Danish bank, which heldSwiss shares as a hedge for a short swap referring to theshares, can obtain a refund of the WHT under the Swiss-Danish treaty even if the payments under the swap include alarge portion of the dividend amount. Specifically, the courtconfirmed that the Danish bank is the beneficial owner of thedividend income and the transaction (that is, the long posi-tion in Swiss shares and the swap) is not abusive within thecontext of the treaty. The Federal Administrative Court confirmed this approach

on July 23 2012 in the context of a Danish trader holding along position in Swiss shares as a hedge for a short singlestock future and index future referring to the shares. Thecourt emphasised that the Danish entity was the beneficialowner of the Swiss dividends even if the trades had a shortmaturity (no details have been published as to what is meantby a short maturity) and denied the application of anti-avoid-ance provisions because the Danish entity had staff and car-ried out its business in Denmark from its own premises.

Charles HermannPartnerKPMG AG

Tel: +41 58 249 29 82Fax: +41 58 249 44 [email protected]/ch

Charles leads the financial services tax group in Switzerland,which provides tax services exclusively to banks, broker-dealersand asset managers. He has extensive experience in advisingSwiss banks and asset managers on a wide range of tax issues.Charles is a frequent speaker at industry seminars on bankingand capital markets tax issues. Charles’ focus is on internationaland national corporate tax issues, transaction taxes, stamp taxesand Swiss value added tax issues in the financial service indus-try as well as addressing international questions relating toSwiss withholding tax, QI, FATCA, Swiss-UK and Swiss-AustrianRubik agreements and the Swiss-EU agreement regarding theEU-savings directive.



However, on March 13 2013, the Federal AdministrativeCourt denied the refund of WHT on dividends to a Swiss bankwhich, shortly after the announcement of the dividend,acquired a large position in Swiss shares from UK brokers andon the same day entered into a single stock future with thesame counterparties (trade settled on Eurex). The FederalAdministrative Court concluded that the Swiss bank was notthe beneficial owner of the shares and the transactions wereconsidered abusive from a WHT perspective. The Swiss bankwas not considered the beneficial owner of the shares, accord-ing to domestic WHT legislation, because the counterpartiesto the futures were the same counterparties to the shares andthe transactions did not include any market and/or dividendrisk. The claim to refund of WHT was considered abusivebecause the transactions (1) did not make sense from an eco-nomic perspective (the margin on the trade was too small), (2)were unusual as a result of the size and the nature of the coun-terparties (same counterparties) and (3) appeared only to bemotivated by the WHT benefit (that is, 100% relief of WHTversus potentially 85% for the UK brokers, if entitled to).

Appeal to Federal Court pendingThe STA and the Swiss bank appealed these decisions to theFederal Court (the highest court in Switzerland). The FederalCourt should make its decision shortly as the first appeal hasbeen pending for two years and such a delay is extremelyunusual in Switzerland. These decisions (especially the deci-sion in respect of the Danish bank) are very significant infinancial terms. We estimate that the pending claims to refundof WHT associated with perceived dividend stripping transac-tions amount to more than €2 billion.The technical arguments of the STA to deny beneficial

ownership at domestic and cross-border level are weak. Swisstax regulations and the STA’s own guidelines explicitly con-firm that the holder of Swiss shares and the recipient of thereal dividend is the beneficial owner of the shares even if theyentered into a forward, a future or a securities lending (or

repo) arrangement in respect of the shares. In addition, theFederal Administrative Court positively concluded that afinancial institution is the beneficial owner of a Swiss dividendeven if it enters into a derivative instrument with anothercounterparty (and not the same counterparty having sold theshares) and the financial institution makes a payment repre-sentative of the dividend under the derivative. This approachis in line with the latest comments on the “OECD Model TaxConvention concerning the meaning of beneficial ownership”discussion draft articles 10, 11, and 12. The arguments of the STA to justify the application of the

anti-avoidance provisions at the domestic level and in connec-tion with Swiss treaty shopping at the cross-border level arealso weak. The STA do not distinguish between legitimatecommercial dividend transactions (including arbitrage) car-ried out during and outside the dividend season and perceiveddividend stripping transactions such as the 2005 transactionsof Bank A. In addition, the STA are seeking to apply the Swissdomestic anti-avoidance provisions in a treaty context wherethere is no technical basis to do so. Last but not least, theclaimants hope that the Swiss Federal Court will also criticisethe behaviour of the STA. Indeed, the STA do not have anyright to require information from a taxpayer which shows aclaim to refund of WHT is not related to perceived dividendstripping transactions. Indeed, the term ‘dividend strippingtransaction’ has never been defined in Swiss tax regulations,the STA have never been able to define it and the STA – andnot the taxpayer – have the burden of proof where they allegethat a transaction is abusive for Swiss tax purposes. In the meantime, it is unlikely that Swiss and foreign

financial institutions with pending WHT refund claims willreceive any refunds of WHT as the STA await the FederalCourt decision. Notwithstanding the large amount at risk, it is to be hoped

that the Swiss Federal Court will confirm the first decisions ofthe Federal Administrative Court and reinforce the reputationof Switzerland and its legal system.

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US tax developments affectingfinancial institutions andproductsWilliam Skinner andJulia Ushakova-Stein ofFenwick & Westdiscuss the newestregulations underFATCA and section871(m) alongsiderecent case lawdevelopments.

R ecent months have seen significant IRS and judicial developmentsaffecting financial institutions and market participants, including newFATCA changes and proposed regulations on dividend equivalent

payments under section 871(m). These new changes and their possibleimpact on affected taxpayers are discussed below.

FATCA updateThere have been a number of Foreign Account Tax Compliance Act(FATCA) related developments during the past year. As of June 2 2014,about 77,000 foreign financial institutions (FFIs) registered with the IRSto comply with FATCA and the list of FATCA-registered FFIs is expectedto continue to grow. The implementation deadline is July 1 2014 and, asit approached, foreign entities were scrambling to determine if they aresubject to FATCA and how to become FATCA compliant. Noteworthy are also the two voluminous sets of final and temporary

Treasury regulations issued on February 20 2014; IRS Notice 2014-33(May 2 2014) to implement a FATCA “transition period”; and IRSAnnouncement 2014-17 (April 2 2014) to allow for intergovernmentalagreements (IGAs) that are “entered into substance” between the US andvarious countries. Additionally, new lengthier versions of IRS Form W-8shave been released, with a new Form W-8BEN-E for entities.

Final and temporary Treasury regulationsThe first set of final and temporary regulations made important modifica-tions to the previous final FATCA regulations, while the second set coor-dinates the FATCA withholding regime with the pre-existing chapter 3withholding rules, that is, the long-standing cross-border withholding taxrules. Some of the key elements of the updated regulations include (i) theaccommodation of direct reporting to the IRS, rather than to withholdingagents, by certain non-financial foreign entities regarding their substantialUS owners; (ii) the treatment of debt securitisation vehicles; (iii) the treat-ment of disregarded entities as branches of foreign financial institutions;(iv) changes to the definition of the expanded affiliated group; and (v)transitional rules for collateral arrangements before 2017. The new temporary regulations expanded the scope of the special

exception for holding companies by including partnerships and other non-corporate entities in the holding company definition if substantially all oftheir activities consist of holding stock in one or more expanded affiliat-ed groups (EAGs) that are non-financial groups. For an EAG to be a

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non-financial group, (i) it must satisfy a three-year annualpassive income and asset test, and (ii) any members of theEAG that are FFIs must register with the IRS or establish adeemed-compliant FFI exemption.

Transition period for enforcement Notice 2014-33 announced a transition period during calen-dar years 2014 and 2015 for the purposes of IRS enforcementand administration of the due diligence, reporting and with-holding provisions of FATCA. Particularly, the IRS will takeinto account the extent to which certain foreign entities (typ-ically FFIs or foreign entities that are otherwise reportinginformation directly to the IRS) and withholding agents havemade good faith efforts to comply with FATCA require-ments. Additionally, a withholding agent that has a pre-exist-ing obligation falling under a new transitional rule will haveadditional time to determine whether the entity is a payeesubject to FATCA withholding. A pre-existing obligationincludes a contract, debt, or an equity interest maintained,executed, or issued by the withholding agent that is outstand-ing on June 30 2014. The Notice states that the IRS will beissuing amended regulations to allow a withholding agent orFFI to treat an obligation held by an entity that is issued,opened, or executed on or after July 1 2014 and beforeJanuary 1 2015, as a pre-existing obligation. This providessubstantial relief as any withholdable payment made beforeJuly 1 2016 with respect to a pre-existing obligation is notsubject to withholding, unless, generally, the payee is a primafacie FFI or a non-participating FFI.

IGAs in effect In Announcement 2014-17, the IRS provided important andneeded coordination between the FATCA regulations and theincreasing number of IGAs. As of June 2 2014, nearly 70jurisdictions have entered into IGAs with the US. For an entity to analyse whether it is an FFI, it must first

determine whether an IGA exists between the US and theentity’s country of formation and, if so, look to the definitionof an FFI under the IGA. Announcement 2014-17 statesthat, even though a number of countries and the US have notyet signed IGAs, certain jurisdictions reached agreements insubstance with the US on the terms of an IGA and have con-sented to be included on the Treasury and IRS IGA list.These jurisdictions will be treated as having an IGA in effect,but will need to sign an IGA by December 31 2014 to con-tinue to be included on this list. Even though the IGA FFI definitions are typically similar

to the FFI definition under the Treasury Regulations, if, forexample, an exception to FFI status is narrower under an IGAthan under the regulations, it is unclear which definition takesprecedence. The Tax Executives Institute (TEI) May 5 2014comments on the FATCA regulations discuss this very issuewith the example that an IGA FFI definition may not provide

for the treasury centre and holding company exclusions.Announcement 2014-17 further complicates a foreign enti-ty’s FATCA analysis. A foreign entity in a country with anIGA in effect must evaluate its status as an FFI under thatIGA. However, what if that IGA’s FFI definition is inconsis-tent with the treasury regulations and that country does notsign an IGA by December 31 2014 or signs an IGA that altersthe foreign entity’s status as an FFI? Which definition shouldthe foreign entity rely on in the interim? In short, even though the IRS has issued a great amount of

guidance and updates during 2014, many grey areas still exist.

New section 871(m) proposed regulationsSection 871(m) of the Code, enacted in 2010, sought to pre-vent certain abusive transactions involving notional principalcontracts (NPCs) that enabled foreign persons to avoid USwithholding tax on dividends. An offshore investor, typicallyin a non-treaty country, would substitute a derivative positionwith respect to US stock for direct ownership of the shares,

William R SkinnerFenwick & West

Tel: +1 650 335 7669Fax: +1 650 938 [email protected]

William Skinner is an associate in the tax group of Fenwick &West.Skinner focuses his practice on US corporate and international

taxation. He has significant experience in financial products taxissues, including foreign currency, hedging transactions, debt offer-ings and modifications, and offshore investment in US debt. Hiswork in the international tax area has included extensive work inthe areas of subpart F, sourcing and the foreign tax credit, repatria-tion planning, cross-border reorganisations and tax treaties. He serves on the adjunct faculty of San Jose State University’s

MST programme, teaching a course in international taxation, andspeaks and writes regularly on a variety of tax topics. He haspublished several articles on tax topics, including an articleselected for republication in PLI’s Corporate Tax Practice Series on tax issues in contingent

value rights (CVRs) transactions.Skinner graduated with a JD, with distinction, from Stanford

Law School, and received his undergraduate degree in historyfrom the University of California, Berkeley. Before moving into pri-vate practice, Skinner clerked for the Hon. Carlos T. Bea, USCircuit Court of Appeals for the Ninth Circuit.

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and treat dividend equivalent payments on the NPC as for-eign source and not subject to withholding. Section 871(m)overrides the normal foreign source rules and imposes with-holding tax on “specified” NPCs and other “substantiallysimilar” payments. Specified NPCs are those NPCs enteredinto under circumstances considered to be abusive: for exam-ple, where the long party sells the physical security to thecounterparty at the time the NPC was created (known as‘crossing in’) or receives the physical security back from theshort party on termination of the NPC (‘crossing out’).Beginning two years after enactment, section 871(m) alsoapplies to dividend equivalent payments on all NPCs, unlessregulations otherwise apply to narrow the rule to other spec-ified classes of equity-based NPCs. In December 2013, the IRS finalised earlier temporary

regulations under section 871(m) requiring withholding ondividend equivalent payments with respect to “specifiedNPCs”. The final regulations apply to payments with respectto NPCs accompanied by crossing in or crossing out, NPCs

on non-publicly traded securities, and NPCs where the shortparty posts the underlying security as collateral with the longparty.More significantly, at the same time, the IRS issued new

proposed regulations under section 871(m) that take a radi-cally different approach to taxing US equity derivatives heldby offshore investors. Previously, in regulations proposed in2012, the IRS would have required counterparties to analysewhether a NPC or other equity derivative met one of sevenfactors indicative of abuse. The new proposed regulations jet-tison this anti-abuse approach in favour of a bright-line rule:any US equity derivative would be subject to section 871(m)if the correlation of its expected price movements with theunderlying US shares reflects a delta of 0.70 or higher. Thesenew rules would take effect for all payments on NPCs madeon or after January 1 2016. For other equity-linked instru-ments (ELIs) besides NPCs, the proposed regulations wouldapply only to positions acquired on or after January 1 2016. As with the earlier IRS proposal, the proposed rules are

not limited to NPCs, but rather would apply to a broad arrayof equity derivatives, including options, forward contracts,futures contracts, exchange-traded notes and convertibledebt. The withholding tax would apply not only to actual div-idend equivalent payments (as in an NPC), but also any“implicit” dividends that factor into pricing of the contract.For example, if the parties to a forward contract agree to givethe long party credit for the expected quarterly dividendsbetween the contract date and the delivery date, the longparty will be treated as receiving dividend equivalent pay-ments subject to section 871(m). In such cases, section871(m) generally will apply to the extent of the dividendsactually paid on the underlying security. Alternatively, the par-ties may contemporaneously document and rely on a reason-able estimate of the dividends, in which case the lesser of theactual or estimated dividends will control taxation under sec-tion 871(m). Where the delta is less than 1.0, only a percent-age of the dividends equal to the delta times the dividends pershare will be taxable under section 871(m). The new rules would exempt from section 871(m) treat-

ment those derivatives that relate to qualified equity indexes.Thus, offshore investors would continue to be able to usederivatives to obtain tax-efficient exposure to the general USequity market or a sufficiently broad-based index. The IRS’sapproach here parallels its published guidance concerningNPCs that relate to US real property assets.Once the proposed regulations come into effect, parties to

US equity derivatives will have an affirmative obligation toanalyse application of section 871(m) and the amount of pay-ments subject to withholding. Generally, if the derivative isbetween a broker or dealer and its customer, the broker ordealer will be the reporting party required to have to analysesection 871(m). The reporting party must make a determina-tion as to whether section 871(m) applies, the tax to be

Julia Ushakova-SteinFenwick & West


Julia Ushakova-Stein is an associate in the tax group of Fenwick& West.Julia focuses her practice on US corporate tax planning and

controversy matters, with an emphasis on international tax plan-ning and restructurings, M&A (inbound and outbound), andtransfer pricing. She represents clients from a diverse set ofindustries and geographic areas of the US and a number of for-eign countries. Her clients range in size from high technologystart-ups to large Fortune 500 companies. She is licensed topractise in the state of California and is a member of the ABASection of Taxation, the International Fiscal Association andYoung IFA.Julia received her J.D. from the University of California, Berkeley,

School of Law (Boalt Hall) and her honours B.S.B.A., summa cumlaude, in accounting from the University of Arizona, Eller Collegeof Management.

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withheld, and certain supporting information. This informa-tion must be furnished to the counterparty on request, and aswith determinations of original issue discount, generally isbinding on both parties. The breadth of the proposed regulations has already drawn

significant commentary. For example, the application of sec-tion 871(m) to convertible debt has been questioned, as therealready exist comprehensive US tax rules to require dividendwithholding on convertible debt in appropriate cases. It hasalso been observed that the proposed regulations can be readto apply to employee compensation (such as RSUs) thattracks dividends on the parent’s stock. It remains to be seen how the proposed regulations will be

modified in the course of finalisation. However, barringanother policy about-face by the government, it appears thatthe days of derivatives providing offshore investors with a tax-advantaged vehicle to invest in a dividend-paying share maysoon be drawing to an end.

Case law developmentsRecent months have seen some significant new case law. Ifread broadly, these decisions could have impact on areas out-side the specific transactions at issue before these courts.

Pilgrim’s PrideThis decision of the US Tax Court concerns the proper scopeof IRC section 1234A, which treats gain or loss from theexpiration, lapse, cancellation or other termination of certaincontract rights and obligations as capital gain or loss. Beforesection 1234A, courts frequently held that a termination of acontract right (or obligation) produced ordinary income ordeduction, on the ground that there was no “sale orexchange” of a capital asset.The specific issue in the Pilgrim’s Pride case was a corpo-

rate taxpayer’s abandonment of shares in a minority-ownedsubsidiary. The taxpayer received no consideration (it simplywalked away from the shares), and thus argued that its deduc-tion was ordinary on the grounds that there was no “sale orexchange” of the stock necessary to produce a capital loss. In a potentially sweeping decision, the Tax Court held that

the taxpayer’s loss was capital under section 1234A. Rejectingthe taxpayer’s argument that section 1234A was limited tocontractual rights or obligations in the nature of a financialderivative, the Court read the words “right or obligation withrespect to an asset” to include direct ownership of the sharesthemselves. Accordingly, the abandonment of the stock pro-duced a capital loss because the taxpayer thereby terminatedits rights with respect to the stock.If the Court’s analysis is correct and taken seriously, it could

have interesting applications in other areas. For example, oneissue that has arisen is whether a taxpayer applying mark-to-market accounting under section 475 is permitted to treat unitsof foreign currency as a “security” that is marked-to-market.

The statute does not list currency itself as a “security”, butrather includes only “an evidence of an interest in, or a deriv-ative financial instrument in . . . any currency.” See section475(c)(2)(E). Under Pilgrim’s Pride, direct ownership of cur-rency would seem to also constitute “evidence of an interest”or possibly even a derivative financial instrument with respectto currency, and thus become subject to mark-to-marketaccounting. It is also possible to conjure up issues where the court’s

approach (which states that every asset is a right with respectto itself) could produce mischief for taxpayers or for theService.

Principal Life InsuranceHere, the Court of Claims explored the murky area ofincome stripping transactions: that is, where the rights toincome from an asset are separated from the residual or feeownership. Specifically, in one of the transactions at issue in Principal

Life, the taxpayer stripped out and retained the rights to div-idend income from money market mutual funds for manyyears, and while selling a third party the residual interest afterthe retained income term. The taxpayer sought to recover thefull amount of its tax basis on the sale of residual, producinga large loss.The Court of Claims rejected this claimed tax loss. It held

that the taxpayer was required to allocate a ratable portion ofits tax basis by fair market value to the income rights that hadbeen retained. While this ultimate conclusion is not surpris-ing, the court’s reasoning calls into question some of the lead-ing authorities involving the converse transaction: the sale ofan income stream by a taxpayer that retains the residual own-ership interest. Generally, taxpayers and the IRS have treated the true sale

of a right to future income as accelerating income to the yearof sale, with no recovery of the seller’s basis in the underlyingproperty. This was the result, for example, in Estate ofStranahan, where a father seeking to benefit from excessinvestment interest expense sold the rights to a stated amountof future dividends on shares to his son for cash. InStranahan, the court held that the sale shifted the dividendincome to the son and resulted in current income recognitionto the father. In Principal Life, the Court of Claims dismissedthe taxpayer’s reliance on Stranahan, and also suggested thatthe case was an “exception” and “isolated anomaly” ratherthan controlling authority. Does this mean that a taxpayer selling rights to future

income is not able to achieve the desired income acceleration?Does Principal Life have any impact on the purchaser? Giventhe limited authority in this area, taxpayers engaged in the saleor purchase of rights to future income stream would do wellto review Principal Life and analyse whether it creates anyrisks to the intended tax treatment of such transactions.

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