Political and economic factors continue to rock the transaction boat

Transactional work varies from jurisdiction-to-jurisdiction with the ebb and flow of various economic cycles, but a prevailing theme across the EMEA region has been that more and more advisory firms are urging taxpayers to prepare for the impact of the OECD’s base erosion and profit shifting (BEPS) action plan. Joe Stanley-Smith investigates how this is impacting key jurisdictions across the region.

The BEPS project is dominating the minds of taxpayers and while the initiative will continue to breed uncertainty until final solutions are delivered, one thing taxpayers can be sure of is that it will lead to more disputes, heightened exposure of transactions, financial instruments, and structures, and the potential for reputational damage in the future – a reality which the world is now waking up to and beginning to prepare for.

Germany

Real estate is a key growth sector in the German market, which is becoming increasingly attractive to sellers – a trend which is expected to continue.

“A seller-friendly environment, particularly in the real estate market, definitely results in seller-friendly negotiation positions, also with regard to taxes,” says Hardy Fischer, partner at P+P Pollath + Partners. “For example, we often see absolute statute of limitation periods lately, for instance for tax indemnities. A few years ago such clauses were quite difficult to achieve.”

The OECD’s BEPS project has had a marked effect on the environment in Europe’s most populous nation, which is representative of many western European countries in that tax transparency is rapidly rising up the agenda.

Structures and vehicles which, in the past, were routinely accepted without question, such as hybrid instruments and entities, debt push-downs and interest deductions, are now scrutinised by the public, the media and politicians.

“Due to legislative changes and the political environment – that is, BEPS – tax compliance and tax transparency for businesses have become increasingly important issues,” says Fischer.

“The German tax legislator follows the political pressure and there will be further legislative changes that will affect structures used in the past. For example, in Germany, the tax legislator will most likely propose rules to avoid double-dip partnership structures with domestic partnerships having its partners abroad.”

Structures that provide tax benefits to share swaps combined with an additional payment are also likely to be examined by the tax authorities, using the reorganisation tax law, as the push towards a more transparent tax system – and Germany’s desire to be ready for the implementation of the BEPS action plan – continues.

In addition to this, Fischer says that “the unequal treatment of taxable dividends and tax-free disposal gains from minority shareholdings in the context of corporate taxation has been on the agenda for quite some time”.

Taxpayers should be aware of the reputational implications of their structures in today’s (and what is likely to be tomorrow’s) political environment. With that in mind, taxpayers need to raise their awareness of the negative reputational damage that may be sustained down the line, even if the structure in question is legally permissible at the point of entering into a transaction.

“Tax disputes to be aware of relate to the use of hybrid entities and instruments and the ongoing discussion (including pending cases) about the constitutionality of the German interest deduction barrier rules and change of ownership rules,” says Fischer.

As far as property transactions are concerned, taxpayers should carefully observe the race to the top of the different German federal states regarding the real estate transfer rates.

Italy

The BEPS action plan has also had a noticeable effect in Italy. Advisers and taxpayers are wisely preparing for the programme’s impact by insulating their structures to best avoid future conflicts.

“Within the new BEPS framework, our advice nowadays goes beyond providing our clients with the most tax-efficient structure that meets both their business and tax needs,” says Filipa Correira, attorney at Valente GEB Partners.

“It now involves the structuring and the design of the operation taking into account the expected BEPS changes – anticipating long-term effects of a specific structure or transaction so as to minimise any potential source of conflict in the years to come.”

The need to take such steps is particularly pronounced in Italy due to its adversarial tax authorities. Some advisers are even looking forward to the implementation of BEPS, believing that it will bring in more concrete guidelines for the tax police to work with.

The authorities remain under pressure to garner more income from multinationals to combat the country’s budget deficit. Planned rises in VAT up to 25.5% by 2018 will only be avoided if the country hits its own debt reduction targets.

The notoriously complex Italian tax system is another hurdle for companies in Italy to contend with, and this is not helped by changes in tax law coming from Brussels.

“There is an increase in tax complexity and on tax regulatory requirements worldwide. In Europe, for example, there have been several legislative changes recently,” says Correira.

“We also assist clients in relation to an increase on audit controls in Italy, as well as on an increase on the focus devoted to transparency and exchange of information related issues, such as rulings. These changes also affect our clients’ choices and structures.”

The role of the tax adviser will also come under scrutiny in the coming years across Europe and beyond â⒬“ highlighted by the UK parliament’s Public Accounts Committee calling for a tax advisers’ code of conduct.

“We, as tax advisers, expect that we will be requested to focus also on tax compliance besides tax optimisation,” says Correira. “Many tax administrations in different jurisdictions are seeking a wider commitment from tax advisers in terms of responsibilities undertaken by tax advisers in carrying out their functions. Our role as tax advisers is definitely changing.”

Regardless of this, advisers still expect to be kept busy with transaction tax work throughout the year.

“Notwithstanding the latter, we continue to expect growth in transactions in 2015.”

Russia

Russia has undergone significant changes to the way transactions are carried out due to its wide-ranging ‘de-offshorisation’ package. Many transactional structures which have been used in Russia for years are now less useful, more risky, or completely redundant. Coupled with economic difficulties and a slump in the rouble, this makes the transactional outlook fairly bleak.

As a result of the de-offshorisation package, many M&A vehicles used in share deals are now classified as controlled foreign companies (CFCs), which means that ultimate beneficiary owners face being taxed on them, and heightened disclosure requirements, unless they are relocated outside of Russia.

The package also includes noteworthy anti-avoidance rules for real estate transactions made via offshore share deals. “Many old structures would simply not work now, or expose selling shareholders to significant risks,” says Artem Toropov, a senior associate in Goltsblat’s international tax practice.

It is also important to ensure proper corporate governance when selling offshore vehicles or state treaty vehicles with participation exemption, to avoid corporate tax residency claims being raised on the grounds of their place of effective management, which can lead to Russian corporate income tax of 20% being applied.

“Taxpayers should clearly reconsider their risk appetite and acknowledge that the degree of risk has changed significantly since 2015,” says Toropov.

“One of the trends in the market is to go for less aggressive transactional structures or avoid the offshore element completely. Many taxpayers prefer paying Russian tax in full on income from M&A transactions as opposed to accumulating risks of subsequent challenge of such transactions,” he adds.

Transactional and structuring advice now involves more work around compliance due to tax and securities legislation, currency control regulations and the more rigorous disclosure requirements brought about by the de-offshorisation package.

Other troubles

“There is a dramatic downturn in the number of transactions – both in M&A and in closer areas, such as project finance and real estate,” says Ilya Bolotnov, partner at Pepeliaev Group.

He does not, however, attribute this solely to the de-offshorisation changes.

“The main reasons are lack of financing from foreign banks, which was traditionally a significant source of financing of transactions in Russia. Local financing is also very limited.”

Investors are in no rush to spend money because of the turbulence de-offshorisation has brought, as well as the fact that it is difficult to accurately predict how well potential target companies will perform due to economic uncertainty in Russia.

“In many situations, deals are affected by the drop of the Russian rouble,” says Bolotnov. “The parties do not close transactions nominated in roubles.”

Even when prices are agreed in euros or US dollars, parties can still be reluctant or unwilling to close deals because the value of the Russian assets has gone down due to revenues being lower because most businesses carry out their operations in roubles.

“Certain areas in transaction documentation need to be assessed in negotiations with greater care, both from the seller’s and the buyer’s perspective,” says Bolotnov. “[These include] material adverse change conditions, rights to walk away from the deal, guarantees on availability and sufficiency of financing for the deal and liability caps and earn-out or adjustment mechanisms.”

“It becomes more and more important to assess potential targets and the business parties from the perspective of financial standing and solvency,” Bolotnov says.

“Dealing with or buying something from the bankrupt or potentially bankrupt accelerates the risks that are totally different from ordinary transaction risks; mainly that the transaction could be invalidated due to being classified as a wrongful disposal made by a bankrupt party.”

South Africa

The transaction market in South Africa in 2014 was a busy and prosperous one, a trend which looks set to carry on into 2015 and beyond. South Africa continues to position itself as the investment hub of Africa. It has strong banking, legal and accounting infrastructure, helping it to fend off competition from other countries such as Mauritius, which is seen to be more attractive from a pure tax and exchange control perspective.

There were significant movements in several key industries, with retail being the busiest and private equity, mining and real estate also seeing strong activity.

“My sense is that there was significantly more transactional-based work in 2014 than in previous years,” says Peter Dachs of ENSafrica. “Towards the end of the year, Steinhoff announced that it was acquiring Pepkor for R60 billion ($5.2 billion). This is the largest corporate deal in South Africa’s history.”

High inflation and unemployment to the tune of more than one in four means that spending by consumers is waning, and retailers seeking to expand must look to acquisitions out of necessity.

“The Steinhoff deal, Woolworths’ Australian acquisition of David Jones and the Foschini group’s UK acquisition were all in the retail space,” says Dachs.

Legislation

In 2014, South Africa tabled legislation which recharacterised interest as dividends in certain circumstances.

“The new interest withholding tax comes into force in March 2015 and cross-border transactions have therefore taken account of the higher tax cost in respect of certain cross-border debt,” says Dachs.

Another change to affect transactional work has been the introduction of real estate investment trust (REIT) regulations for property companies.

“A new type of work-stream has emerged in terms of which property groups are consolidating and listing under this REIT regime,” says Dachs. “The REIT regime, from a tax perspective, allows for flow-through treatment of income to the ultimate investors.”

“In addition, share buy-backs have been utilised as a tax efficient mechanism for, for example, exiting shareholders.”

Taxpayers in South Africa, along with the rest of the world, are also keeping a close eye on the BEPS debate. The Davis Committee, which looks at South Africa’s tax policy framework, released a report in December which looked at several of the action points discussed in the OECD’s BEPS action plan and is now open for public comment.

One of the areas addressed was hybrid instruments, which Dachs believes may lead to a lower risk appetite on cross-border transactions for complex hybrid instruments.

Taxpayers should be cautious when engaging in debt pushdown transactions, which have been targeted by the South African Revenue Service (SARS) recently. These transactions have also been made more difficult by legislative changes.

Overall, the outlook for transactional work in South Africa is positive. The changing advisory landscape means that South African law firms are being afforded more chances to work on pan-African deals.

This is proven by the fact that more international law firms are opening offices there – Allen & Overy, for example, opened in Johannesburg in October. The firm’s global managing partner Wim Dejonghe said at the time: “Johannesburg has become a key hub for local and international banks, development institutions, institutional investors and funds looking at investment and finance opportunities in sub-Saharan Africa.”

Dachs is also optimistic, and says: “In 2015 we expect the advisory work in respect of pan-African transactions to be done from South Africa as opposed to, London, Paris and other non-African locations.”

UK

As well as the tax concerns surrounding BEPS, which are common throughout the world, taxpayers operating in the UK have a more immediate legislative challenge: the diverted profits tax (DPT).

The proposed tax, which was announced in December’s Autumn Statement pre-Budget speech (released in draft form a week later) could come into effect as soon as April. It has the potential to affect non-UK resident companies, such as special purpose vehicles used in transactions which involve shifting profits from the UK to low-tax jurisdictions, or transactions which involve UK real estate.

“Unfortunately the draft legislation is not very well drafted so it is not at all clear at present whether it will apply to real estate transactions,” says John Christian, tax expert at Pinsent Masons.

Companies which have activity relating to the provision of goods or services to consumers in the UK will be liable to pay the DPT if the tax authorities believe that any activities are in place for the purpose of avoiding carrying on a trade through a permanent establishment.

The DPT would only apply to multinationals whose annual sales exceed £10 million ($16 million) but that threshold is low enough to be causing substantial concern for corporate taxpayers.

The proposal may have popular support from a public which is starved of the real facts by political rhetoric and misreporting in the mainstream media, but the uncertainty it could cause as to how companies’ operations should be taxed is a huge worry for companies looking for a certain environment in which to carry out transactional work.

While many across Europe and beyond might expect governments to adopt a wait-and-see attitude towards the BEPS project, proposals such as the UK DPT indicate that this is not the case, with unilateral action being enacted or considered in plenty of other jurisdictions, too. Given that governments are taking a proactive approach, taxpayers should too. Those that bury their heads in the sand will find that it is much more difficult to structure deals appropriately in the post-BEPS world.