Transfer pricing and transactions in Finland

With the election of a new government and renewed focus on employment and productivity, Finland is hoping to continue the economic growth that has characterised the country over the past few years. The new transfer pricing legislation will place Finland directly in line with its European neighbours, whilst the passing of the Companies Act in 2006 enabled greater flexibility in financing and cross border transactions. Despite the credit crunch, the number of transactions in Finland was at a record high in 2007, with the number of deals exceeding the previous record set in 2000. With forecasts of slowing economic growth and employment concerns due to ageing populations, the new government is streamlining bureaucracy and focussing on innovation to spur Finland’s economic growth.

Continued foreign direct investment activity
The transaction market was active in 2007 with industrial buyers reentering the market and private equity continuing to sell to private equity. The number of transactions was at a record high, with 768 deals exceeding the previous record set in 2000, and a 17 percent increase in deals over 2006. Finnish companies purchased 105 companies abroad, whilst non-Finnish buyers purchased 101 companies from Finnish sellers. Finnish entities sold businesses covering turnover of €5bln both in Finland and abroad. In total, Finnish companies purchased turnover worth €2.8bn, a decrease from €3.2bn in 2006.

In 2007 majority stake transactions, 110 000 employees were transferred under new shareholder control. As the Finns made the largest transactions abroad, about 38 percent of the group, some 41 000 persons, work outside of Finland. Standout deals include Nokia purchasing Navteq for €5.7bn: the purchase price exceeding 14 times the target’s 2006 turnover; Atria, Finnish food product corporation acquiring Swedish Sardus and Finnish Pouttu and Cargotec did 13 acquisitions in 2007.

The State of Finland sold a 30 percent stake of Kemira Growhow, fertilising business, to the Norwegian Yara. M-real, pulp and paper company, divested Map Merchant in the Netherlands, Zanders plant in Germany,

Petöfi plant in Hungary, Tako in Finland and Meulemans in Belgium.

There were two new listings in the OMX Nordic Exchange: SRV Group in June 2007 and Suomen Terveystalo in April 2007. A rather new phenomenon in 2007 was an IPO through a merger: Tiimari merged with listed Leo Longlife, John Nurminen with listed Kasola, and Trainers’ House with listed Satama Interactive. OMX also organised a new market place, First North, for small growth companies.

Impact of the credit crunch
The credit crunch meant that there was a period in the autumn of 2007 in which transactions were delayed and negotiations between parties took longer. It is likely that some transactions did not take place but overall, the effect was not dramatic. Market value of companies listed in the local Stock Exchange decreased some €24bn within a month according to Talouselämä in February 2008. When comparing the October 2007 peak with the current situation, the market values have decreased some €45bn of which Nokia counts only for €10bn. According to the same source, exits by non-Finnish institutional investors and large private investors have played a big role in this development.

Merger of the Financial Supervision and Insurance Supervisory Authority
The merger of the Financial Supervision and Insurance Authority will essentially cover the same duties as the two existing supervisory authorities. The objective would be to enable companies and organisations in financial markets to operate in a balanced business environment, maintain public confidence in financial markets, foster compliance with good practice and disseminate general knowledge about the financial markets. The centralisation will make it possible to supervise more effectively and take into consideration special characteristics of different industries in the financial sector.

Activities within the financial market, including: Icelandic Glittnir acquiring FIM, investment bank, Danish Danske Bank acquiring Sampo Bank, and offers on the OMX Stock Exchange, will have an effect on the roles and responsibilities of the new authority.

Implications of new government
The new government’s approach to taxation has been a movement toward trying to attract business angels to the country, with the Ministry of Employment and Economy and the Ministry of Finance currently drafting a proposal to offer direct tax incentives. This would take the form of exemption on capital gains after a holding period of three years. The incentive would not be targeted to institutional private equity, and although the details have yet to be released, the purpose is to prepare the package by the end of the year.

Despite this, there is also a draft proposal, prepared by the Ministry of Finance, on a new asset classification, which would limit the scope of participation exemption on capital gains. The government recently terminated plans to design a new tax depreciation regime for investments to maintain productive investment activity in Finland. There is also a Real Estate Investment Trust (REIT) discussion pending, as there is currently no tax element included in the REIT legislation.

The Ministry of Employment and the Economy was established on 1st January and its mandate prescribe duties assigned to the current Ministry of Trade and Industry (excluding matters related to immigration and integration), and functions of the Interior Department for Development of Regions and Public Administration (excluding the Regional and Local Administration Unit). The Ministry’s focus will be on innovation, the employment of labour, reforms to meet the challenges of climate change through energy policies and a focus on developing regional co-operation.

2007 transfer pricing legislation
According to Finnish tax law, associated companies are required to comply with the arm’s length principle in their intra-group transactions. The principle may be applied to adjust the profits of a Finnish company in relation to both domestic and cross-border transactions. An adjustment is possible if the taxpayer has agreed to the transaction on conditions differing from those that would have been agreed to between independent parties. Any profits that would have accrued to the company but for the non-arm’s length terms have not, may be included in the company’s profits.

All companies are obligated to comply with the arm’s length principle in their intra-group tradings, even though the transactions would be exempted from documentation requirements. Documentation must be provided separately for each tax year. Satisfactory documentation is to be prepared in accordance with the model set forth in the EU Code of Conduct (COM (2005) 543 Final), taking into account the OECD Transfer Pricing Guidelines.

Under the new regulations, a taxpayer is obliged to provide the documentation within 60 days from the date of request by the tax authorities. The revenue may not request documentation before six months from the end of the company’s accounting period under scrutiny. The tax authorities are also entitled to require additional information regarding the documentation, which is to be provided within 90 days from the date of the request. It should be noted that companies are not obliged to file transfer pricing documentation in connection with the corporate income tax return.

An exemption from documentation requirements applies to small and medium-sized enterprises. However, as the independency criteria set by the EU Commission 2003/361 EC Recommendation apply; Finnish companies that are small and medium-sized on stand-alone basis are required to fulfill the documentation requirements if they are controlled by large non-Finnish corporations. A company is not regarded as an SME if, in accordance with the Commissions Recommendation, the company employs more than 250 persons and has an annual turnover exceeding €50m and/or an annual balance sheet total exceeding €43m.

Transfer pricing has been a subject of increasing interest of the Finnish tax administration during the past decade. In the lack of specific documentation requirements and resources, the Finnish revenue has, in terms of numbers, mostly targeted simple issues, e.g. management fees. During the last ten years or so, especially after the establishment of the Tax Office for Major Corporations in late 90’s, the revenue has placed a certain amount of effort in more complex transfer pricing issues on Finnish based large multinational companies.

Legal issues arising from cross border transactions
Cross-border transactions are subject to documentation requirements and the expectation is that the Finnish revenue will actively monitor the Finnish tax base and there will be more inquiries and disputes in this area of practice. Recent discussions in Finnish tax journals and published case law indicate the revenue’s growing interest in business model conversions as well as issues on intellectual property. Finland actively follows the international tax discussion and it may well be that some of the international developments will be adopted in some form in Finland.

With regard to other legal issues arising from cross border transactions, the amendment of The Companies Act in 2006 allowed greater flexibility in financing and these measures are available for transactions where there is a Finnish acquisition vehicle. There are still some pending tax debates on tax treatment, especially in the area of repatriation.

The documentation should include items listed below:

A description of the taxpayer’s business activities


A description of the connection between the associated companies, including the associated companies names, and a clarification of what the association is based on, as well as a description of the group structureInformation on transactions undertaken with associated companies and information on agreements concerning the transactions between the associated companies

A functional analysis of the transactions undertaken with associated companies, providing information on functions performed, property used and risks assumed

A comparability analysis, including information on comparable transactions or companies, validating the arm’s length level of the applied transfer pricing

A description of the selected pricing method and its application and an explanation of the choice of the selected method

There is less documentation required if the total amount of the intra-group transactions entered into by the taxpayer does not exceed 500,000 euros. According to the section on penalties, a maximum penalty of 25,000 euros may be imposed if the taxpayer has not prepared sufficient documentation in accordance with the regulations. Standard tax penalties may be levied if income is adjusted

For further information:
Tel: +358 20 755 5314

Unlimited opportunities

This plethora of deals in Russia represent a rise of 11 percent in the volume and 57 percent in the value of deals from the previous year, which saw $75bn transacted across some 759 deals.

Looking at these deals in a little more detail, it is clear that just as Russian businesses are becoming increasingly acquisitive on the international stage, so too are foreign companies taking more of an interest in Russian assets. Of the deals in 2007, 300 were domestic transactions, 56 saw Russian companies embarking upon international expansion and 489 were deals led by non-Russian firms.

Driving factors
In terms of outbound investment, Russia is home to a number of large corporations that have developed as a result of the abundance of Russia’s large reserves of natural resources, principally gas and mining. In recent years Gazprom has made some significant international acquisitions, including including Natural Gas Shipping Services Ltd in the UK and WINGAS GmbH in Germany.

So far in 2008 Gazprom has concluded two deals outside Russia, acquiring Serbian investment company Naftna Industrija Srbije for $730m and Austria-based Central European Gas Hub GmbH for a undisclosed figure.

But it is not just these traditional sectors that are enjoying popularity. Russia as a nation is rapidly coming up to speed with its Western counterparts, and as such there is considerable investment in sectors that contribute to this development.

Infrastructure-related industries such as real estate, telecommunications, technology and public services have received a boost from private investors, and in the near future government initiatives look set to spur further development.

Western countries have launched a number of Public Private Partnerships (PPPs), designed to revitalise weary public services. And although in Russia, investment in infrastructure is hotly debated, as in other fields, Russia is likely to develop its own unique approach and solution.

Interest in infrastructure development is expected to be big. Investment bank Merrill Lynch estimates that investment in the infrastructure sector could reach as much as £90bn over the next three years. Add to this the downward pressure on the $US, and Russian assets are looking increasingly attractive price-wise.

The fact that international private equity firms are taking a keen interest confirms this. Big names including Texas Pacific, Lion Capital, Mid-Europa, Morgan Stanley, Barclays and Deutsche Bank have all taken significant shareholdings in Russian companies. In 2007 alone there were 60 private equity-backed transactions in Russia, totalling more than £11.3bn in value.

Business framework
With investors queuing at the door, it is just as well that Russia’s business framework is conducive to doing deals. Russian businesses are served by a strong network of advisors, well-equipped to handle the needs of the acquisitive business.

PwC has 2400 professionals on the ground in Russia, offering a range of services including pre and post transaction services.

With 450 employees, one of the largest departments – reflective of the size and importance of the task – is the tax and legal practice. PwC’s tax and legal services provide assistance to businesses involved n M & A, helping them structure the transaction to ensure it is built in the most efficient way, put together as quickly as possible, is focused on value creation and the strategic priorities of the business.

Tax planning at an early stage can add significant value to a transaction, and is essential to reduce both the actual transaction tax costs and the long-term sustainable effective tax rate following the transaction.

Common issues faced on M & A deals in Russia include the tax philosophy or tax culture of the target, which by western standards may be considered either overly aggressive or overly conservative. Tax savings opportunities and strategies employed by the target may not be acceptable to a western buyer. Other tax issues include the complexity of the group structure, underlying transaction flow, related party transactions, transfer pricing practices, unrecorded transactions, and transparency of the target including ownership and control.

Overcoming issues
Russia is a vast country with many different tax jurisdictions, and as such the way certain aspects of tax is handled by one tax authority may differ from that of a neighbouring tax authority.

Bill Henry is a partner and tax specialist, based at PwC’s Moscow office. ‘The authorities are still developing and they are having to adapt quickly to a rapidly-growing business environment. Tax authority risk includes resource constraints, lack of experience and sophistication relative to market developments, harsh and indiscriminate actions of some tax authorities. In some cases, authorities have been viewed as biased against taxpayers and have said to serve as an instrument of pressure.

But it is heading in the right direction. ‘The tax legislation is actually in pretty good shape, and it is possible to get some good letters of clarity. However, the problem is one of scale – the ministry of finance is working hard to bring about better organisation and consistency, but this can’t happen overnight. It is a huge logistical challenge.’

Since the judicial system does not have the expertise to handle the modern business climate, with particular reference to M & A transactions, more time is spent by the advisors in managing tax risks. This provides lots of work for the advisors, but it is such great news if you want to get your deal done quickly and efficiently.

Aside from administration, there are other issues facing a high-growth business community.

Indigenous talent
The main issue is that there is a shortage of people with the correct level of experience and expertise to manage within the business community. This is a result of the speed at which the country has developed – there is just not enough indigenous talent to cope with the amount of work.

Furthermore, the businesses that do employ good Russian staff are finding it increasingly hard to retain them. It is all too common for internationally-trained professionals to quickly change employers for increasing opportunity and reward afforded by the booming economy.

But these problems are just teething troubles – the sign and the stigma of a developing market – and there is no doubt that they will soon be addressed. On balance, the pros of investing in Russia easily outweigh the cons.

One of the biggest attractions of doing business in the Russian market is the way it has fared in the wake of the credit crisis. At a time when billions of dollars has been wiped off the balance sheets of some of the world largest businesses and large corporate acquisitions due to the lack of availability of debt to fund the transactions, Russia has remained relatively unscathed by the turmoil that has hit the West.

Bill Henry comments, ‘The credit crunch has not yet had an impact on Russian transactions – in fact I can only think of one enterprise that has collapsed, and that was more down to the quality of the balance sheet, not the availability of funding.’

One reason for Russia’s near unique position amidst all the credit issues is simple: until recently the country was isolated from the trends of Western banking. As such there is no great levels of consumer debt as is found in the US and the UK, for instance. So when the crisis came, there was much less of a credit crunch in Russia. However, Russian companies will have to refinance short term borrowings. While the expect volume of refinancing is not expected to bring about a crisis, defaults are possible among those who lack credit worthiness in the tighter credit environment.

On the public markets, too, the issues in the credit market are not as pronounced as in some Western markets. Whereas, as expected, there has been a slight slowdown in IPO activity, it does not mirror the near total shutdown in institutional interest for listings.

In 2007, 55 Russian companies achieved a listing, just four fewer than the previous year. Putting this into perspective, in the UK the total number of IPOs fell from 433 to 339 over the same period. What is most interesting is the amounts of money achieved by such listings. The total value of listings by UK companies in 2007 was $16.3bn, as compared with $15bn by Russian companies.

Business landscape
From the huge difference in the number of listings it is clear that many more large cap Russian businesses made it to market that year. Indeed the Russian business landscape is largely characterised by a small number of very large companies.

And there are other plusses that Russia has on its side. There is an affluent middle class in Russia with strong spending power, and this is likely to appeal to retail investors.

Furthermore, although some catching-up is needed, especially in terms of the tax administration, certain aspects of Russia’s business legislation has been more flexible than in many Western nations. One of the most significant is connected with anti-avoidance laws.

Most countries have in place legislation that dictates that if a company enters into a domestic or cross border arrangement primarily for the purpose of reducing their tax burden, the resulting tax advantage can be removed. Therefore, any arrangement that confers a tax advantage should also have a commercial purpose, and should be set up, at least in part, for reasons other than tax planning.

The historical absence of any real anti-avoidance restrictions has been a real advantage for Russian businesses. However, recently there has been an emergence of anti-avoidance practices on a substantive approach including guidance issued by the Supreme Arbitration Court and proposed tax policy instruments including controlled foreign corporation legislation, tax residency based upon the place of management and control, and proposed amendment to transfer pricing rules.

Looking to 2008, it seems that the Russian market is in for another prosperous year. In the first two months alone the total value of M & A deals involving Russian companies tipped 100, with a combined deal value of just over $8bn.

But figures only tell half the tale. It is those on the ground involved in business that count. What does Bill Henry think the future will hold for Russian business? ‘Simply put, the opportunities are unlimited.’

For further information:
Tel: +7 (495) 967 6023

Doing it the right way

As the effects of the sub-prime crisis in the US continue to reverberate around the world, investors are understandably adopting a more cautious approach. Yet some regions and countries are weathering the current financial storm better than others. Sweden for example, in the Nordic countries, is still relatively unaffected by the credit squeeze, says Gunnar Thuresson, a senior tax partner at Ernst & Young Sweden, and although the government’s current privatisations may be scaled back slightly,  some recent tax court decisions have only served to reinforce the country’s continued attractiveness for investors.

Despite its relatively small size –it has a population of about nine million – Sweden has an impressive roster of economic and business related achievements. In a recent OECD ranking of prosperous nations, for example, Sweden placed no.9, above the UK, Germany and Japan. The country also placed no.1 in the European Union’s European Innovation Scoreboard (EIS) 2007 and no.4 in the World Economic Forum’s Global Competitiveness Report 2007-2008 (from over 130 countries), up from no.9 previously.

Overall other economic fundamentals are relatively sound.  Growth expectations have been cut back in recent months, with growth forecasts of 2.3 percent in 2008 and 2.2 percent in 2009. However, in 2007 Sweden enjoyed considerable success on the employment front with 111,000 Swedes entering the labour force in 2007, reducing full-year unemployment by one percent from 2006 figures, to 6.1 percent, and the number of hours worked increased by 3.1 percent, up to 138.6 million hours per week.

In addition, consumer confidence remains buoyant with January 2008 retail figures up 4.8 percent on the previous year. Plus the Swedish government is sitting on a record budget surplus.

Real estate
One area that should be of interest to investors is the real estate sector.  Sweden has one of the most liquid real estate markets in Europe; so even a very large property investment will remain a liquid investment.

Sweden is the fourth largest real estate investment market in Europe with more than SEK 140 billion (€15.6bn) in total real estate transactions in 2007. By the end of 2007, foreign investors owned real estate assets amounting to more than SEK 210 billion (€23.1bn) by acquisition value, a 300 percent increase over five years. Office and retail property remained the most popular targets for foreign investment.

The outlook for 2008 in the commercial property market remains favourable, says Thuresson. “Real estate rentals are expected to increase, and vacancies are expected to fall further, and while the trend in transaction volume is down slightly over the last three years, the volume is still large relative to the size of Sweden, and we are not expecting volumes to fall dramatically,” he says.  “For the immediate future at least, the story is likely to be rents rising, lower vacancies, coupled with a more selective approach by investors on what to buy, when to buy, and at what price.”

Sweden does not yet offer the equivalent of the Real Estate Investment Trust (which has a special tax status), found in the US and some other EU jurisdictions. Entry into the real estate market is likely to be via a holding company – a limited liability company (AB), or non-resident company – and the taxation regime is a favourable one in this regard.

“From a tax perspective the benefits are that a property sale is very easy to structure as a tax exempt sale,” says Antoine van Horen, Transaction Tax partner at Ernst & Young Sweden. “That is because most property deals done here are in the form of corporate deals –you don’t buy the property, but the shares in the company that owns the property,” says Mr van Horen. “That means it is a tax exempt transaction for the seller, and also, when it comes to the sale, an exempt exit for the buyer. Plus there is a very generous approach to interest deductions. It all adds up to an extremely low effective rate of tax.”

At the moment the rate of return for commercial property investors is somewhere between five and seven percent depending on the type of property (that reflects the yield in the form of rent, rather than any increase in the capital value). Yield expectation in the surrounding countries appear to be 100 basis points or so lower at present.

Another note of interest for real estate investors is the Swedish government’s forthcoming privatisation programme, a key pledge of the government upon its election in 2006.

As part of the programme the government is hoping to sell its 100 percent stake in the property company Vasakronan.  But the sale of Vasakronan is only part of a wider privatisation, where the government has approved or indicated that it will privatise a number of wholly or partly owned government companies. There are six on the list at present which should attract interest from a wide range of potential investors.

The government is still evaluating the timings involved, especially in the wake of current financial market turmoil.  Mats Odell, the minister for financial markets, who is overseeing the privatisation process, recently acknowledged that some reshaping of the original plans may have to take place, including some of the prospective sales being delayed.

So far $2.97bn has been raised from the sale of eight percent of the government’s 45 percent stake in TeliaSonera, the telecommunications company, as well as $363m, from the sale of its 6.6 percent stake in OMX, the Swedish stock market company, to Borse Dubai and Nasdaq.

Forthcoming deals include the sale of Vin & Sprit, the makers of Absolut vodka, as well as banking group Nordea, and mortgage lender SBAB. Although, when referring to SBAB recently, Odell did note, “mortgage lenders are not exactly the top of everyone’s list,” – and the same could be said of banks. Whether or not there are delays in the short term, the intention is for the government to complete the sale of the six organisations by 2010.

Impact of the credit crunch
While the financial markets are going through a period of upheaval, and it is difficult to predict the future with a high degree of certainty, to date there is not much credit crunch related suffering in Sweden.

The credit crunch has had an impact worldwide. All the major international banks have become very careful about counterparty risk and lending, and at the time of writing one major bank, Bear Stearns, had had to be rescued. The effect of this change in attitude towards risk in Sweden and the Nordic countries is that it has reduced activity on very large deals. So deals above $1bn are more difficult to manage because the large foreign banks are more cautious.

“What we have seen both in real estate and in the commercial sector is that where a lot of those deals in the past would have been funded by large foreign banks – Swiss, German, UK and US – we now see less of that,” says Mr van Horen.

“At the same time, however, a more important development at the local level is that local banks do not seem to have suffered from any balance sheet impact, and do not appear to have invested in the problematic US led derivative products. Consequently these banks are less risk averse and are stepping in and grabbing market share. So we are seeing more deals funded by local banks and by equity.”

One reason that the Nordic and Swedish banks may be holding up well is that they learnt some tough lessons at the beginning of the 1990s. In the early 1990s there was a financial crisis in Sweden largely as a result of extensive bank lending to speculative investments. Real estate prices slumped and the Swedish banks suffered very badly. It would be fair to say that without government assistance (a general guarantee of bank obligations) many would have gone under. So the Swedish banks may have been a bit more risk averse this time around.

While a general perception exists that Sweden is a country with a high tax regime, on the commercial side nothing could be further from the truth. In fact Sweden has a very favourable tax regime for investors.

At 28 percent, the corporate tax rate is competitive with corporate tax rates across Europe. Factor in the ability to defer – companies can defer a quarter of their taxes every year, for a maximum period of six years – and you end up with an effective annual corporate tax rate of about 21 or 22 percent.

“From a corporate tax perspective, any gains from buying and subsequent sale, for almost all of the parties involved, are tax-free,” says Mr van Horen.  “Capital gains on sale for corporations are almost always exempt, as are capital gains for institutional investors. Transaction costs from the tax point of view are virtually zero. There is no stamp duty on the transfer of shares, for example, as in some jurisdictions, such as the UK.”

The so-called participation exemption for both capital gains and dividends received also means that Sweden is an attractive location as an intermediate holding company, particularly for wider investment into Europe.

Historically, the rules relating to deductibility of interest have also been fairly liberal compared to many other countries in Europe, or elsewhere in the world.

Whereas in many jurisdictions the total debts of the acquisition vehicle, or the consolidated group, can only be a certain percentage of the total balance sheet, (so-called ‘thin capitalisation’ rules), in Sweden there is no limitation at present. This means it is possible to use more debt to fund a transaction, and to obtain greater interest deductions than under most tax regimes.

There have, however, been strong signals from the tax authorities that changes are likely on interest deduction regulations. This stems from a recent tax case in the Supreme Administrative Court, which related to interest deductions.

“The case at hand concerned interest deductions on inter-company loans in connection with a tax driven internal reorganisation. The result of the planning measures was that the tax cost for the group was substantially reduced.  Consequently, the tax authorities challenged that transaction,” says Mr Thuresson.

Initially, the tax authorities obtained a favourable decision from the courts and, as a result, developed a policy to challenge a number of taxpayers on what the authorities perceived as aggressive interest deductions. This caused a lot of concern on the part of tax advisers and big corporations.

“At the end of 2007, the Supreme Court gave its judgment in that case and, in line with the expectations of most tax professionals, gave judgment against the tax authorities, and in favour of the taxpayer,” says Mr van Horen. “The tax authorities then changed their approach, dropped all cases against the taxpayers, and instead have entered into a lobbying process to persuade the government to think about adopting anti-abuse rules around these types of structures.”

Understandably, the tax community is somewhat concerned about the outcome of the lobbying process and how far the government will pursue the interest deduction issue. Will they, for example, look for broader restrictions such as thin capitalisation rules? Mr Thuresson remains optimistic.

“It is not easy to see how the current Swedish government would be persuaded to introduce more general limitations on interest deductions, as we have seen in a lot of other countries, as that would not fit with the government’s liberal thinking with respect to the business climate in Sweden. Based on the current standing of the law, there are very few limits to obtaining interest deductions in connection with investments in Sweden.”

Specialist advice needed
It is clear from developments like the recent decisions on interest deductions by the Swedish courts that it is essential for prospective and existing investors in Sweden to obtain specialist advice. Such as that provided by EY Sweden.

“Our goal is to ensure, whatever the type of activity we are engaged in, that we support clients throughout the whole process – planning, implementation, financing, and finalising the activity,” says Helena Norén, Business Tax Services leader at EY Sweden.

“We try to offer clients a service that goes through the entire lifecycle of the process, which starts with thinking about the investment, supporting them in the financial modelling and tax structuring, supporting them in the due diligence and completion of the transaction, in the integration of the business with the rest of their business, and in the compliance and reporting aspects.”

Because, as Helena Norén notes, a good service for the investor is about more than just the transactional aspects. “We are there for our clients whenever they need us. We take an interest in our clients and invest time with them to understand their business and be able to service them better and in a practical and pragmatic way; to do the right things in the right way.”

For further information
Tel: +46 8 520 590 00

Working through the tax lifecycle

The development of Polish capital markets, demonstrated by the capitalisation of the Warsaw Stock Exchange in March 2007, for 700 billion PLN, and corporate restructuring, deregulation and further privatisation has made the country an increasingly attractive location for FDI. With the country being the beneficiary of €90bn in EU funds for development, infrastructure and human capital it would seem that the country’s transformation is set to continue. Poland is offering beneficial tax rates to foreign investors and offers an environment with low inflation and an excellent strategic geographical location for both Western and Eastern Europe.

According to Ernst & Young’s attractiveness survey, Poland holds 7th position worldwide among countries with the greatest potential of attracting new FDI. The country’s growth has been driven by export growth, industrial production, and investments. It also has a highly skilled and educated workforce with strong language skills, as well as a large consumer market.

However, with the liberalisation of the economy and rapid growth, have come difficulties, namely a need for the regulatory environment to keep up with economic progress. Essential to Poland’s continued growth will also be the presence of a strong tax advisory market, with the expertise and actionable insights to help potential investors best capitalise on this developing business environment. Jacek Kedzior, Managing Partner at leading tax advisory firm Ernst & Young spoke to World Finance about his company and its capabilities, the innovative training schemes his company offers, and the tax environment in Poland.

Ernst & Young’s roots in Poland go back to 1933-1939 when Whinney Murray & Co, Ernst & Young’s predecessor, provided advisory services in Warsaw. The company has operated in Poland under the name of Ernst & Young since 1990. Thanks to the combination with Andersen, Ernst & Young in Poland has become the biggest auditing and advisory firm in the Polish market. The company’s total workforce now tops 1,000 professional advisors and auditors, and the company has recently launched the Ernst & Young University.

Standing apart from competitors
Ernst & Young is the biggest tax advisory and a market leader in Poland. We provide our clients with comprehensive services, including tax advice supporting international tax planning needs, mergers and acquisitions, transfer pricing support and defense, indirect tax services including both VAT and excise related to supply chain and new investment planning.

Our Corporate tax services are accompanied by a very strong Human Capital advisory practice. In Poland we are leaders in tax litigation and regulatory advice services. We help our clients to receive public support through our grants and incentives service offering.

Despite the wide range of services that we offer, the main strength of our practice is built around client-centricity. Our client’s needs are at the top of our agenda and drive our service offering. Rather than sell and idea or a scheme, we listen to our clients, understand their business imperatives and wrap our planning advice into this process.

This combination of high technical expertise and ability to help compliment our clients in order for them to achieve their business goals makes Ernst & Young the most reputable firm in the Polish market.

Global footprint and strong personnel key drivers to leadership
The firm’s reputation comes on the back of the high esteem in which its tax advisors are held in professional circles in Poland. For me, in order to be the best tax advisory firm, we need to recruit and develop the best people, provide the best quality of services and serve the best clients.

We have and continue to be successful in attracting and retaining the highest caliber of professionals with long-term aspirations to succeed. Our advisors combine sound expertise with the skills and abilities to deliver value to clients aligned with their business objectives. Quality in a developing environment like Poland means for us not only technical knowledge and accumulated experience, but the on-going development of knowledge, as Poland is still a country going through significant changes. What’s more, quality is also access to the world’s thought leadership of the Ernst & Young organisation. We are proud when looking at our client list. We share clients with EY Global and win new business from inbound investors. Thanks to our local reputation we work for the biggest Polish enterprises. Our Clients Satisfaction Surveys prove that in all categories our services are highly regarded by clients.

Ernst & Young University: Developing tax advisors of the future
The wide range of services we offer gives our employees an opportunity to gain experience in all areas of tax advisory services. For many years we have been investing in the training and development of our people, both locally and internationally.

At the same time we are constantly challenging ourselves and asking, ‘What is our value proposition for newcomers?’ The most recent response to employees’ needs is the just launched Ernst & Young University. It is also a response to our clients’ current needs. Nowadays clients expect their advisors to be experts in the given field, but with a broad understanding of other areas. Ernst & Young University is the first such comprehensive program for professional development in Poland. It has already been introduced by Ernst & Young in countries like the USA, Switzerland or the Czech Republic. It is a unique structured approach that was designed to help participants gain diversified technical and non-technical experience. Getting experience is combined with a counseling structure and learning curriculum. Those three pillars: experience, learning and counseling will give young people an opportunity to acquire a set of skills necessary to operate as genuine business advisors.

Our approach to professional development is a response to the expectations of the young generation (generation Y), which is very demanding, has clear and ambitious professional plans, and a variety of opportunities to make their dreams come true. The program will ensure that talented people are not pigeon-holed early in their careers and will provide the opportunity to “find the right home” in the firm. In this context EYU is also important from the perspective of our firm’s values – it promotes an atmosphere of appreciation of achievements of people from different competency groups rather than internal competition.

Tax environment increasingly compatible with the EU
The foundations of the current tax system in Poland were laid in the early 90’s. At that time, tax authority decisions were viewed by many as arbitrary. The regulations were changing constantly. The unpredictability of both the regulations and the tax authorities were a serious problem for most organizations, especially when one looked at the relatively harsh penalties that could be imposed on companies or criminal sanctions on those responsible for the filing of the returns.

In time the Polish tax system began to settle down and the regulatory agencies introduced programs to further stabilize it by providing binding tax rulings and advanced pricing arrangements for related party transactions.

Polish courts also have played an important role in stabilizing the practice of tax law. Prior to Poland’s EU accession Poland introduced a number of changes into its tax system in line with the EU regulations. However, the European regulations and the jurisprudence of the European Court of Justice remain an important point of reference for tax law practitioners in Poland.

Growing tax advisory market
As Polish businesses have grown and new investors have invested in Poland the demand for tax advice has grown. So too have the advisors of such services.

Companies growing and expanding or needing access to larger sources of capital, including from public capital markets have fueled the growth of the larger accounting firms that include Ernst & Young, KPMG, Deloitte & Touche and PricewaterhouseCoopers.

Serving smaller companies are a number of advisory firms, many times consisting of former advisors from the Big 4. These firms provide advice to companies not needing the resource and broader service offering of the larger firms.

We see also law firms that have established in house tax capabilities to support their corporate practices focusing tax matters that might be applicable on transactions they represent their clients on.

Smaller advisors in our marketplace face a similar challenge in making sure that continue to develop and improve our ability to attract the best graduates from Polish universities and offer appealing career opportunities.

As the Polish economy continues to become more global, Polish investors and their businesses will require advisors which offer comprehensive tax advisory services and the support of an international network that is there to greet them where they go.

Evolving tax advisory market
Historically, due to the developing framework around tax policy and rules, there was a lack of a clear understanding of the law, regulations and in some instances the decisions of the Polish Courts.

This combination led to a lack of clarity around the application of the tax rules to actions of companies that tax advice was sought from lawyers to provide opinions that their treatment was correct.

These services have been and will continue to be needed even as the laws, regulations and judicial decisions become clearer. The Polish economy is becoming more integrated with the global economy, this brings an element of constant change which fuels the need for advice.

What we are seeing today is a growing need for tax professionals focused on the operational aspects of tax departments. Tax compliance and reporting has become more complex. This is taking corporate resources away from integrated and timely tax planning in their organisation.

The skills now needed in tax practices today are quickly broadening. Clients need and expect not only tax advice and opinions addressing their risks but also demand value driven solutions having a positive impact on their financial statements.

Tax advisors should be capable of providing services throughout the tax lifecycle including the planning stages, compliance, reporting and defending such positions in front of the regulators.

Regulatory and tax processes improvement advice, including gaining the support from corporate IT departments is increasingly more important. I also believe that reputable tax advisory firms will become more and more important partners working with the tax administration to develop proper tax practices.

For further information:
Tel: +48 (0) 22 557 7263

Decisive developments

The funds, or SIFs, are part of a wider portfolio of instruments approved by the Luxembourg parliament over the last few years. Bounded by Belgium, France and Germany, the world’s only remaining Grand Duchy is developing a niche within the EU as a modern investment capital with highly sophisticated financial services. The sector, whose contribution to the economy is growing as a percentage of GDP, is a key factor in the Luxembourg having the highest GDP per capita in the world.

Specialised investment funds, or SIFs, have proved extremely popular with investors since they were authorised in February last year.  In the end of 2007, 581 files had been authorised by the Commission for the Surveillance of the Financial Sector, Luxembourg’s regulatory authority. According to Luxembourg-based corporate and tax law firm Loyens & Loeff, the take-off in these specialised investment funds is unprecedented. As such, they have added another string to the financial sector’s bow. The wave of interest in SIFs has also thrown a broader spotlight on the Grand Duchy’s long-held but still-developing appeal as a stable, on-shore location for the increasingly sophisticated needs of international investment capital. The relatively small size of the country encourages a close dialogue between the financial sector community and the law-makers – a partnership that helps Luxembourg adjust rapidly to international investment trends. Considered a safe haven for such capital, Luxembourg has for instance proved largely immune so far to the turmoil of the international credit crisis.

An instrument for a fast-changing investment environment
SIFs are the result of a new law that creates an umbrella structure that in some ways reflects long-standing Anglo-Saxon structures in collective investment. The purpose of the legislation, which required a rewrite of legal, regulatory and fiscal provisions, was to deliver a multi-purpose product that dove-tails with the contemporary investment environment. Lightly regulated, flexible and fiscally efficient, SIFs have demonstrated over the last year they have more than met their designed purpose.

A key element of SIFs is that they are highly inclusive rather than rigidly prescriptive. The law allows any institutional, professional or “well-informed” investor, according to the definition, to access an SIF. Also, the entry threshold is relatively low.

Designed for accessibility
Based on Luxembourg’s previous experience with instruments such as the SICAV regime (an investment company with variable capital), the new definition of a well-informed investor has considerably broadened the attraction of SIFs by admitting non-institutional capital. A well-informed investor is classified as one with a minimum of 125,000 euros [£95,000] to invest, and lesser sums may qualify in certain circumstances. In this way the SIF law admits investors other than those able to prove the existence of “deep pockets”. So far, the level set for minimum capitalisation rules have proved to be about right. Under the law, at least 1.25m euros must be invested within a year of the fund being approved.

Investors also cite the relative simplicity of establishing an SIF, particularly the absence of excessive red tape, as an important factor in their appeal. For instance, an SIF does not require the prior approval of the regulatory authority before it becomes operational. Indeed many of the SIFs awaiting official registration are already in business and investing. The CSSF only requires that all the essential complying documentation be delivered to the regulatory authority within one month of the fund becoming operational. Once the authority confirms the SIF fully satisfies the law, it is admitted to the official list as a bona fide, approved investment instrument.

An additional attraction to investors has been the flexibility of SIFs. For instance, it does not prescribe rules that might inhibit investment strategy, whether in quantitative or qualitative terms. The only specific instruction is that the fund observes certain parameters in the spreading of risk. Thus the law has created a versatile fund regime that gives the initiators of SIFs the freedom to determine investment policy according to the prevailing environment and their own requirements. Thus they are able to diversify the fund according to need in terms of geography, sector and product.

Importance of high-quality management
However in a lightly-regulated environment, the regulatory authority sets considerable store on the quality of the fund’s management. The supervisory regime requires directors to establish their suitability and qualifications to guide the fund and, although the law encourages flexibility, it also requires transparency in the form of correct documentation. For instance, directors are now preparing the first generation of annual reports for the first generation of SIFs. These documents require directors to follow established templates. They must be delivered to investors and the authority within six months of the specific period.
Fiscal efficiency

The tax regime applying to SIFs builds on Luxembourg’s more than a quarter of a century’s experience with broadly similar investment funds.  It provides for a fixed one-off duty of 1,250 euros [£950] on capital contributions and, with certain exceptions, an annual subscription tax rated at 0.01 per cent on value of total net assets.

Financial sector continues to develop
Luxembourg’s financial sector is in a constant state of evolution. For instance, modifications are about to be introduced to the highly successful, four year-old SICAR regime relating to investment companies in risk capital. Reacting to feedback from investors and the financial sector, the regulations will be fine-tuned to make these funds even more flexible than at present. Under the changes, investors will be able to create compartments within existing structures — extra portfolios of investment that allow the development of a wider range of investments under the same umbrella.
Private equity short-circuits traditional banks

Similarly, Luxembourg has moved to meet the global requirement to establish holding companies in secure, on-shore locations. The grand duchy recently replaced the Netherlands as the prime location for the registration of these entities. The rapid growth of Luxembourg-based holding companies is in part a result of the development of private equity in the country, which has helped boost the entire financial sector in the last five years. Official records show that private equity companies is increasingly attracted to Luxembourg as a suitable location for a long-term base, with its fully EU-compliant tax and fiscal regime. The short lines of communication between the financial community and the government are considered to be a particular advantage, particularly compared with much larger legislatures. “Authorities here understand the real world,” as one source put it. A result is that laws and regulations can be quickly streamlined to meet prevailing conditions.

The pace of development in private equity is so marked that many practitioners in Luxembourg believe that it may threaten the long-term future of established banking channels. Investors are increasingly by-passing the major banks, traditionally the first port of call for investment-hungry funds, and placing them with private equity. In this way they are able to access new ventures more directly, eliminating one stage in the investment process.

Luxembourg has not however proved to be entirely immune from the credit crunch. As elsewhere, there has been a slowing of activity in the more highly-leveraged M&A transactions but little change in the appetite for deals at more normal ratios of debt to equity.
A good citizen of the EU

Article 41 of the Luxembourg law on the financial sector – the law that preserves Luxembourg’s bank secrecy laws – has given the state an historic reputation for confidentiality in banking arrangements. That is unlikely to change, given that Luxembourg, a founding member of the EU, fully complies with its financial regime and is in constant dialogue over savings directives and other developments in investment law. The purpose is to widen its appeal as a reputable home for a wide range of investment purposes. For instance, the nation has become a fully compliant channel for investment in the wider EU real estate market. Investors typically use Luxembourg-based funds and financing vehicles, in particular special-purpose vehicles such as tax-efficient real estate investment funds known as REIFs, to purchase properties in one or more jurisdictions. Others may prefer to set up their own portfolio.

In tandem with its widening portfolio of instruments, over the last few years Luxembourg has moved decisively to develop its reputation as a location of integrity for long-term investment funds. In the process it has deliberately distanced itself from regimes that are chosen primarily for their confidentiality. As one practitioner put it, “people don’t come to Luxembourg to hide.” One result is that Luxembourg has become the preferred on-shore location for the registration of investment funds. More than 10 percent of UCITS in the world are located in Luxembourg, which makes of it the second haven for investment funds after the USA.

The strategy of full compliance has proved highly effective, helping the financial sector grow rapidly as it develops a broader array of investment instruments and opportunities. Established practitioners such as Loyens & Loeff report that clients increasingly demand matched solutions that employ a full package of fiscal and legal services that meet best practice in every area.

A result of the demand for the financial sector’s service is the rapid recruitment of highly qualified staff. Indeed the sector’s biggest current problem is attracting professionals of a suitable calibre in law, tax and other areas of expertise. However, compared with other financial-sector hubs around the world that are shedding staff in the wake of the credit turmoil, that can safely be regarded as a desirable state of affairs.

For further information:
Tel: +352 466 230 222 or +352 466 230 233
Email: or  

Heart of Europe

The survey said Flanders was attractive for foreign direct investment based on seven key areas: economic potential, business friendliness, quality of life, human resources, costs, infrastructure and foreign direct investment.

The magazine pointed to Flanders’ central location in Europe, its world-class seaports, its rapid connections to neighbouring countries and its multilingual and productive workforce.

It success in attracting investment has led to Flanders sometimes being referred to as SME country, a region where enterprises with fewer than 50 employees make up about 96 percent of the total number of companies. This doesn’t mean large enterprises are hard to find. In fact, the number is growing quickly. And in 2006, about two thirds of the largest enterprises in the region were controlled by foreign shareholders.

One of the reasons for the increase in FDI in Flanders is that it offers some of the most carefully structured tax incentives in Europe: the kind of incentives designed to bring inn companies in key growth areas such as services, logistics, nanotechnology, pharmaceuticals and communications.

Tax treatment
Swiss food giant Nestlé was one of the latest multinationals to make the most of the incentives offered by Flanders. Nestlé is transferring its pension funds to Flanders because of the region’s favorable tax treatment of pan-European funds. The company has said it intends to centralise all its pension funds from the different EU countries in Belgium because it is more economical and efficient.

In practical terms, what Nestlé is doing is establishing an Organisation for Financing Pensions, or OFP, a special purpose vehicle specifically designed for pension institutions. An OFP gives companies beneficial tax rates including the ability to credit interest and dividend withholding tax against corporate tax still to be paid.

The OFP is just one area of growth. Flanders’ fast-growing knowledge-based economy has resulted from far-sighted government policies that place emphasis on research and development in growing areas. One of the specific policies that has proved hugely successful is to form business clusters – geographic concentrations of companies that are active in the same value chain or that use the same technologies.

Spending on R&D in Belgium as a whole is growing as a percentage of GDP, reaching 2.33 percent last year. In specific areas such as the information and communications technology (ICT) cluster close to Leuven University about 30 kilometres east of Brussels, R&D spending is among the highest in Europe at US$7,011 per employee. Pharmaceutical companies are well-represented in Flanders, as are medical device and medical imaging companies.

Other clusters have been established. The Flanders Graphics Valley has a concentration of leaders in digital graphical communication and a wide application base in printing and editing. Flanders Multi Media Valley is a regional cluster that began with the strong R&D department of Philips. The cluster is steadily growing and now services more than 100 companies.

Major sectors such as the automotive industry also have strong research bases in the region. Much of the automotive industry’s R&D is in-house, but universities and specialist research institutes all play a role, ensuring a continuous stream of high-level research and a regular crop of skilled workers to carry it out. The Scientist magazine ranked Leuven and Ghent universities in the 10 best research centres in the world, while the independent research centre IMEC, also at Leuven, is Europe’s leading independent research centre in micro- and nanoelectronics, nanotechnology.

To stimulate economic growth, both the Belgian and Flemish Government have implemented other incentives for businesses with operations in Flanders. These range from investment incentives through tax-related schemes to employment, training and R&D advantages.

Cash grants are available to incoming companies that meet certain criteria, with the government limiting its participation to 25 percent. Companies applying for cash grants are evaluated on business-economic criteria, and also on their level of relevance to Flemish government policy priorities. The level of financial support is dependent on the size of the company and the location of the investment.

Tax incentives include notional interest deduction, which allows a company to reduce its taxable base when making investments from its own resources.

Flanders is also an attractive holding company location because it allows exemption from domestic dividend withholding tax. This means companies using Flanders as a holding location for investments in Europe can repatriate European profits without paying dividend withholding tax and without a limitation on benefits.

An incentive known as VAT grouping is another tax break that has made multinationals choose Flanders as a base, especially those that handle invoicing, accounting and credit management.

VAT grouping allows all taxpaying entities that are part of a larger corporation to be regarded by the Belgian VAT administration as a single fiscal entity. Consequently, different companies within the same group will not have to invoice one another VAT, resulting in cost savings (because companies belonging to the same group can save the 21 percent VAT when they invoice one another) and flexibility, because foreign companies can choose which parts of their group will fall under the system.

Technology transfer
The Flemish government institution, IWT-Flanders (Institute for the Promotion of Innovation by Science and Technology) is behind many of the incentives on offer to companies involved in industrial research and technology transfer. Any company with activities in Flanders can ask IWT-Flanders for financial support with technological projects. Three types of projects qualify for support:

·         Basic industrial research such as scientific-technological research focused on the generation of new knowledge;

·         Prototype or development activities;

·         Mixed research – essential research that combines basic industrial research as well as prototype or development activities.

In addition to financial support, IWT-Flanders offers technological advice, provides partner search services and provides information concerning international programmes for technological innovation.

Flanders even offers tax allowances for R&D personnel, with a one-time tax exemption for companies hiring additional research or quality assurance personnel. In practice this works by Flanders granting a deduction from taxable income for scientific researchers, staff in charge of developing a company’s technological potential, and the heads of quality assurance departments and export departments. Higher exemptions are on offer for what the Flemish government defines as “highly qualified researchers employed in the company in Belgium for scientific research”.

But tax breaks and incentives amount to very little if the infrastructure isn’t there to back them up. Flanders’ infrastructure is second to none, with freight channelled through four major ports (Antwerp, Ghent, Ostend and Zeebrugge) and two airports: Brussels and Ostend. All these ports and airports are close to the region’s motorway system, which links Flanders directly with France, Germany, the Netherlands and, across the Channel through the Channel Tunnel, the UK. Geopolitically, Flanders is also in a prime location, at the centre of the wealthiest and most populated areas of Europe.

Language skills
The workforce is another of the region’s assets. It’s among the world’s most educated and productive, as well as having a high level of language skills. In GDP per hour worked, the region scores 113 with the US at a base rate of 100 and the G7 average at 92. Per capita GDP has consistently been more than 20% above the EU average. The workforce, says the Flemish government, is a byword for the economy as a whole: dynamic, flexible and internationally orientated.

Vincent Vanden Bossche, a consultant and specialist based in Belgium, believes that Flanders holds a whole range of trump cards when it comes to hosting multinational organisations.

“You have a level of multilingualism that you don’t find in many other regions in Europe,” he says. “And there’s a tradition of all these European institutions being based here that creates a pool of multilingual personnel. The people are also well educated and well trained, they’re productive, and they’re ready to work and work hard. On top of this, Belgium has a central location at the heart of Europe.”

Tax reform seeks to attract more investment to germany

Transferring money abroad became a tradition for Germans after World War II. Political instability forced many to divert their assets toward more secure holdings. The post-war revival that followed saw Germany climb the ranks of the world’s strongest economies, but it failed to stem the outflow of cash altogether. The reason: tax rates – among the highest in Europe. But things have just got better for Germany.

Large-scale tax reforms came into force on January 1, 2008. The German Parliament’s decision – criticised in many quarters as not going far enough to enhance economic development – could have a major impact. Domestic businesses and foreign investment should benefit, but there are doubts over whether the reforms have gone far enough.

The 2008 Company Tax Reform Act was essential for many reasons – not least to make Germany more internationally competitive. In the broadest sense, most believe this is where the government has succeeded. The decision to reduce the corporate tax rate from 25 percent to 15 percent is the key. RP RICHTER&PARTNER – one of Germany’s leading tax, audit, accounting and legal service consultants – provides tailor-made solutions to clients with an international approach.

Managing partner Wolfgang Richter, a former senior partner in and head of the tax department at Ernst&Young Munich, welcomes the positive change, but has mixed feelings about other aspects of the reform. “In our opinion the Company Tax Reform Act 2008 is an important step towards a more internationally competitive tax environment in Germany,” he says.

“However, a simplification of the German tax system, which had been planned, did not become reality.”

Complex legal system
If reducing the corporate tax burden was seen as crucial to Germany’s competitiveness, tackling the complex legal system was one of the several requirements that failed to materialise. But it was not all bad. Some simplification was realised following many months of consultation and talks between experts on all sides.

The non-deductibility of the trade tax as business expense, from the trade tax basis and the corporate-income tax basis, was one such benefit. This non-deductibility had no significant impact on the trade tax burden, because the general multiplier to calculate the taxable amount was decreased from 5 to 3.5 (the abolishment of the progressive tariff of the general multiplier for partnerships and sole proprietorships could have an impact on the trade tax burden, but this change will only affect small businesses).

The improvement of this method was that deductibility of the trade tax was such a complex calculation issue. But German tax reform 2008 has been as much about missed opportunities as improvements.

The failure to abolish trade tax – seen as major step towards simplification – is generally perceived as a serious flaw. There is little doubt the predominance of the municipalities, and the anticipated loss of local tax revenue, forced legislators to think again. Numerous transition rules between the old and new also conspired to undermine the anticipated move from old to new, according to experts such as Richter.

His firm operates fully integrated tax, audit, accounting and legal services.

Recognised as one of the leading consultancies in Germany, especially in the tax business (see rankings of JUVE, Legal 500, Tax Directors Handbook and World Tax by International Tax Review), the company has a unique insight of the challenges facing the business sector.

“After much deliberation, the German tax authorities, including the Ministry of Finance, became anxious because they could not calculate the impact of tax revenue loss from the transition rules,” he explains. “Fearing significant losses could have resulted in tax base, simplification failed to materialise.”

Draft publication
Many had feared the worse during the long months leading up to publication of a final draft and the Act being formally adopted by the Bundestag and Bundesrat. Concerns were not just limited to matters of trade tax. Worries surrounded the thin capitalisation rules (so called interest-barrier rule,) which apply not only to shareholder loans but also to any bank loan. The new rules are seen as a significant limitation for high leverage buy outs/investments.

“The tax legislators listened, but made only few changes,” says Frank Schönherr, tax law expert and another founding partner of RP RICHTER&PARTNER. “New rules for shifting of functions and transfer pricing brought quite some disturbances, especially the question of whether the doubling of functions is a taxable shifting of functions.” But while changes to the final draft were small, some amendments were a surprise.

One example was the interest barrier rule. Many businesses successfully raised concerns about the rule, leading to a change. The draft had been tied to the EBIT, but by the latter stages of the legislation process it was aligned to the EBITDA. This led to a higher amount of deductible interest expenses (30 percent of EBITDA is deductible interest expense).

Winners and losers
So who were the major winners and losers from reform? There are two groups of taxpayers that are expected to benefit most:

Low debt financed domestic corporations;
Foreign corporate entities.

The first, benefits most from the reduction of corporate tax rate, which was lowered from 25 percent to 15 percent. Taking the trade tax burden into account, the average corporate tax rate was reduced from about 40 percent to 30 percent varying from 23 percent to 33 percent depending on the municipal rate fixed by the municipality (´Hebesatz der Gemeinde´).

Foreign corporations could do even better. Non-resident corporations for example, holding German real estate (PropCos), could under some circumstances be free of trade tax. They will have to calculate with an aggregate tax burden of 15 percent instead of 25 percent. And the losers: highly debt financed companies with low income. This is primarily due to the interest-barrier rule.

“The so called German ‘Mittelstand’ could also be loser of the reform if they do not adjust their structure to the new rules,” says Schönherr. “The Mittelstand is organised generally as the partnerships. “The partnership is liable to trade tax, the individuals holding an interest in the partnerships are liable to income tax. The progressive tax tariff had been increased from 42 percent to 45 percent (so called Rich Tax).” No compensation has been introduced for this increase despite earlier reassurances by the government. To equalise the tax burden of partnerships and corporations, the tax reform introduced a special tax rate for retained earnings of partnerships.

However, if these monies are distributed, the aggregate tax rate on the income derived from the partnership is higher than the taxation of income derived from the partnership at the new top tax rate of 45 percent (plus solidarity surcharge, plus church tax, if any).
Estimates over whether the reforms will result in an aggregate rise in total tax revenues remain in the balance.

“It cannot be excluded that the counter financing of the tax rate reduction through broadening the tax base (new thin capitalisation rules, new add-backs for trade tax purposes) could lead to a higher aggregate tax revenues in total,” explains Schönherr. “But the government is of the (official) opinion that the broadening of the tax base equals the lowering of the tax revenue, resulting from the reduction of the corporate tax rate finally.”

Although Schönherr agrees the impact of reform is likely to be positive, he warns it is impossible to rule out the possibility that broadening might have a negative impact on key sectors of the economy. Real estate investors and real estate leasing companies in particular could suffer from the new interest-barrier rule and the new add-backs for trade tax purposes, he says. Highly leveraged investments are likely to be affected negatively too.

Thin capitalisation rules
There is less doubt about the ‘negative impact’ of the new thin capitalisation rules. When European courts issued a ruling in 2002 declaring German thin capitalisation rules contrary to law, change became inevitable. The first solution of the tax legislators after the Lankhorst-Hohorst case in 2002 was to broaden the scope of application by including loans from domestic shareholders. Due to problems with these early amendments, the Company Tax Reform Act 2008 introduced additional changes to thin capitalisation rules.

The new system applies to any loan irrespective of the status of the lender, as a shareholder or not, and irrespective of whether the lender is a domestic or a foreign one. The effect is that general loans could lead to the non deductibility of interest expenses, according to Claus Lemaitre, international tax partner at RP RICHTER&PARTNER.

“In our opinion many of the unsolved application problems of the old thin capitalisation rules will still arise by the application of the new thin capitalisation rules,” says Lemaitre. “The new rules have a negative impact on the economy in Germany in our opinion because a tax burden could arise even in cases where no positive income is earned by the company.”

The application of the new thin capitalisation rules, flawed or otherwise, meant the legislators did make a significant step towards preventing a shift of interest to foreign countries. But alongside the changes of the add-backs on trade tax, thin cap’ rules will have the most affect on how companies operate in future.

Worrying changes
Changes of the rules regarding the loss of loss carry-forwards have proven a worry too. “This new rule will lead to many unexpected tax issues in the M&A and restructuring context,” Mr Lemaitre says. The write-offs of shareholder loans were ruled by changes of the Tax Act 2008 ‘Jahressteuergesetz 2008’.

In many cases shareholder loans can no longer be written-off. The German tax authorities’ description of this ‘change’ as a ‘clarification’ has not been universally accepted.

“In our opinion and in the opinion of many other tax practitioners the change is not a clarification but the implementation of an unfavourable new rule,” Mr Lemaitre explains. The legislators will perhaps demur, arguing their reforms have certainly made Germany more attractive to overseas companies looking to invest. As for the domestic market – despite the reform set backs, 2008 could be the year that sees the Germany economy out perform some of its rivals.

For further information:
Phone: +49 (0)89 55 0 66 – 310

Current M & A and private equity practice in Switzerland

The number of M & A deals for the year 2007, according to one deal count, soared from an average for 2006 below 300 deals to almost 400 deals. It is interesting to note that the aggregate value of deals is however at similar levels compared to previous years. This may be explained by the fact that strategic as well as private equity buyers have proceeded to numerous smaller acquisitions by purchasing Swiss high added value entities in order to optimise their portfolio of investments. Moreover, a certain number of deals can be accounted for as secondary buy-outs with private equity funds selling their stakes to other private equity funds, in most cases keeping the management in place. A notable transaction of that nature was the sale of the cable machinery group Maillefer by Argos Soditic (advised by Lenz&Staehelin) to Groupe Alpha. If these secondary buy-outs were made with the firm intention of going public on short or mid-term, it remains to be seen whether such plans can still be implemented in the current economic context.

Most recently, the US subprime crisis and its consequences on the international capital markets have certainly made it more difficult to obtain reasonable financing for contemplated deals. This situation is particularly felt by private equity investors, although small and medium size transactions, which form the bulk of the M & A work, will not be greatly affected in all likelihood. Conversely, this situation could benefit strategic investors with a full war chest who now can contemplate acquisitions of Swiss companies at prices that are not so highly driven by competing private equity investors.

One of the biggest private acquisitions of the year 2007 was Medi-Clinic’s acquisition of the hospital group Hirslanden from the private equity fund BC Partners Ltd for an amount of almost $3bn. Lenz&Staehelin advised the purchaser.

It should be remembered that for each Swiss company acquired by a foreign purchaser, a Swiss company bought two foreign companies. In 2007, this would include transactions such as Swisscom’s purchase of the Italian broadband telecommunications company Fastweb SpA for an amount of $6.35bn or Hoffmann-La Roche’s acquisition of the US manufacturer of medical diagnostic instruments Ventana Medical for an amount of $3.4bn.

New draft bill regarding the law of corporations
In the very last few weeks of 2007 the Department of Justice published a new draft bill regarding amendments to the law of corporations (Aktiengesellschaft, société anonyme). However, it does not include any spectacular changes and it appears that doing business in Switzerland will benefit from the usual stable legal environment for more years to come. Yet, there are some intersting features of the draft legislation, particulraly those which will enhance counsels’ tool box when it comes to structuring private equity deals. First and foremost the new concept of the ‘capital band’ must be mentioned. This concept will replace the well-known concept of the authorised capital and will be completed by its corrollary, an authorized capital reduction which up until now has not been possible under Swiss law. Once this becomes law, the board of directors will have the power, for a period of a maximum of three years, to increase or decrease the corporation’s capital (within some global limits provided by the law) depending on the corporation’s needs. This concept has been widely welcomed by the legal community.

There has been, from the outset, more criticism in respect of some surprising proposals, such as the possibility for the shareholders to impose a duty on the board of directors to submit certain business decisions to the approval of the general assembly. This mechanism is at odds with the basic structure of the corporation. The design of the corporation aims at a clear separation of ownership and control and the shareholders are supposed to have no duties other than making their capital contribution to the corporation and should not have any management or monitoring duties. Put in a broader context, by borrowing heavily from the regime actually applicable to the LLC (GmbH in German / Sarl in French) the Bill blurrs the distinction between the two company forms.

Another proposal which appears to violate basic principles of the capitalistic corporation is the possibility of creating non-voting stock without limitation (the law currently provides for a limitation of a maximum of twice the company capital). This would imply that a corporation could be controlled by a shareholder holding just one voting share whereas all the other capital providers would have no saying in the governance of the corporation (but still bear same risks of a shareholder with respect to their investment).

Further amendments deal with issues such as the flexibility of the general assembly (electronic general assembly), proxy voting and the election of the board members. As at today, it is too early to predict how the parliamentary debates will impact the bill and when it could enter into force.

Amendments to law of LLCs
The long awaited amendments to the law concerning LLCs (GmbH ? Sarl) eventually came  into force on January 1, 2008. At the same time, various amendments to the laws relating to corporations, the commercial registry and corporate names have come into force.

The main features of the amendments to the law concerning LLCs is that (i) LLCs of a certain importance must appoint auditors to carry out either an ordinary audit or a restricted review, (ii)  transfer of LLC shares has become easier as a written form is now sufficient (as opposed to the notarized form which was required under the old law), and (iii) the LLCs’ share capital is no longer capped at CHF 2 million.

The LLC has hence become an appopriate legal form for firms having significant need for equity and it may well become the predominant legal form for companies in Switzerland belonging to a group. Opting for the LLC has the advantage of allowing multinational groups to draft the subsidary’s articles of incorporation to maximize the power of the parent company to take the management decisions for the LLC.

Certain amendments to the law concerning corporations are of interest from an international view point, in particular the amendment to the provision relating to the composition of the board of directors. Previously, the majority of the members of the board of directors of a Swiss corporation had to be domiciled in Switzerland and be Swiss, EU or EFTA nationals. The new provision now provides that only one person authorised to represent the corporation must be domiciled in Switzerland such authorised representative being a board member or an officer of the corporation.

The amendment to the law concerning LLCs did not include any changes to Swiss tax laws. As in the past, LLCs will be taxed as a corporation as regards direct taxes, withholding taxes, stamp duty and VAT. From an American law perspective, one can speculate as to whether the amendments to the law concerning LLCs may have consequences for the American tax classification of Swiss LLCs held by American groups as a partnership of persons or as companies with capital (check-the-box regulations). The choice offered by American tax laws between a partnership of persons and a company with its own capital is excluded only for companies known as “per se corporations”. Only Swiss corporations are considered to be such per se corporations. We anticipate that with respect to the choice of American companies to classify a Swiss subsidiary that is an LLC as a transparent partnership of persons or a non transparent company with its own capital, nothing will change as a result of the new law on LLCs.

For further information:
Tel: +41 22 318 7000

Financial services sector grows with the EU

The global credit crunch could prove a long-term blessing for Switzerland’s investment environment. The currency of choice for many years, the Swiss franc lost favour between 2003 and mid-2007 after an uncharacteristic period of instability. But as liquidity dried up and currencies became more volatile, the franc has rapidly strengthened after its four-year decline. Since mid-2007 it has gained against the euro and the dollar among other currencies, and many economists see the franc regaining its former role as an international haven in times of volatility. The consensus forecast is for the franc to find a ‘fair value’ against the euro of around SFr1.40-1.45 and SFr1.10 against the dollar.

The recovery of the franc is considered likely to cement Switzerland’s growing popularity with foreign business and with wealthy investors attracted by its stable political and social climate, low corporation tax and high standard of living. Although the credit crisis has inevitably slowed activity in the financial sector, all the signs are that it will quickly rebound on the back of the economy’s gold-plated official rating of AAA Stable.

M&A business expected to rebound
The financial sector expects the M&A market, which was extremely active over 2006 and the early part of 2007, to recover as soon as the credit crisis settles and the price of debt reverts to more normal levels. Like all cross-border financial sectors, the industry has been affected by the drying-up of acquisition finance as banks hoard capital to strengthen balance sheets. Although the caution is mainly down to the crisis, the introduction of Basle II with its higher standards for regulatory capital has also affected the availability of credit.

At the same time domestic institutions have responded to the global tightening of standards by requiring more demanding loan covenants. As elsewhere, lenders seek lower-risk debt: equity ratios in a general reversion to more sustainable standards.

However there appears to be no shortage of appetite among acquirers when conditions improve in the capital markets. Several of Switzerland’s biggest companies in the pharmaceutical, food and tourism industries are reportedly waiting in the wings with substantial investment war chests. Cash-rich with robust profits and strong balance sheets, they have only temporarily frozen acquisition strategies as they wait for a more favourable investment climate to emerge.

Meantime analysts point out that the fundamentals of Switzerland’s corporate sector, which is dominated by SMEs, are extremely healthy with excellent forward order books, assured markets and stable cashflows.
Fiscal reform drives M&A markets

A host of reforms including laws on limited liability, mergers and corporate tax has continued to stimulate activity in the last two years. One of these is the clarification of tax law in what is known as the indirect partial liquidation regime involved in the sale of shares. Under the previous regime, the issue of the taxation of capital gains on the sale of shares in a business was typically argued case by case in the absence of clear rules. By making the regime more transparent, the clarification has made it easier for private investors and family-owned businesses to cash out their assets.
Real estate

In spite of the credit crisis, there is no shortage of funds for more normally leveraged investments in both residential real estate and smaller-scale commercial property transactions. There is a marked trend for wealthy investors to develop portfolios of prime properties through investment funds under recent changes to the law that have enabled more flexible participation in CBD, industrial and other property opportunities. There has been a healthy diversification of the M&A transactions market into retail, hotels and hospitals and other sectors in the last few years.

Although non-Swiss residents cannot in general own residential real estate, there are exceptions. For example, certain cantons apply a kind of quota for foreigners that has proved attractive to the new wave of wealthy private investors. Typically, these exceptions apply in the most desirable locations such as ski resorts like Verbiers and Gstaad. However there is no law preventing high net worth individuals from renting prime properties and the growing attraction of Switzerland has driven up rentals and helped fuel the residential market.

Meantime the large-scale, headline deals that typified early 2007 are temporarily off the agenda, mainly  because banks face difficulty in syndicating loans. A repeat of the headline deals of the last two years are considered unlikely for 2008.

Swiss-style private equity continues to thrive
The domestic private-equity industry has generally defied the turmoil in financial markets. As before, it continues to concentrate on SME buy-outs in the Sf10m-Sf30m [£4.8m-£14.4m] range often overlooked by the biggest private-equity operators. Debt is readily available for these mid-market transactions, but at levels of leverage several notches lower than those available at the peak of the boom during 2004-mid-2007 as lenders return to more normal debt ratios. Mid-market private-equity firms continue to target family-owned SMEs with robust profits and largely unencumbered assets.

The family-run investment offices that are an integral part of private equity sector remain focused on the long term, as they have always done. They continue to seek long-term deals characterised by low volatility rather than ones featuring quick exits and high returns. The biggest deals, most of which were headed by foreign firms, are however off the agenda for the present.

Equities market matures
Despite the introduction of rules that have made the equities market more transparent, its relatively small size has long proved a deterrent to public listings by foreign companies. However observers hope that the influx of foreign-owned companies and wealthy individual investors to Switzerland will in time boost the equities market.
Integration with the EU

Switzerland’s participation with the EU continues to deepen through bilateral agreements that facilitate the financial sector’s growth outside its own borders. It continues to work towards a profitable integration with the single market that absorbs 62 per cent of all Swiss exports. These agreements include the rule on the free movement of persons, which among other things helps Swiss banks locate staff in EU-based branches.

It is also considered important that the sector does not miss out on the advantages of access to the EU’s single market in financial services. “We need innovative Swiss banks to enhance EU competitiveness,” as Brussels’ commissioner Charlie McCreevy told the association recently. For instance, although Switzerland is outside the Single Euro Payments Area [SIPA], Swiss banks have pledged to fully uphold all their obligations under it. Officially, the Swiss Bankers Association “wholeheartedly supports” these and similar arrangements that help bind the domestic and EU financial sectors.  “Good relations between the EU and Switzerland matter a good deal to Swiss banks,” remains the official view.

For further information:
Tel: +41 44 498 98 98

Optimistic financial market

It would be wrong to say that other countries outside the Anglo-Saxon circle are feeling smug at the credit-crunch crisis, fuelled in large part by what may seem, in hindsight, an unwise rush into sub-prime home loans, that has already claimed banking victims in the UK and the United States. But there is certainly a sense of relief in places such as Italy that local bankers have been considerably more cautious than those in New York or Newcastle upon Tyne.

At Simmons&Simmons Italy, one of the country’s leading legal firms, which has 120 to 130 lawyers in Rome, Milan and Padua and which specialises in work for clients in the financial sector, senior partner Filippo Pingue says: “We do not have doubts that the Italian banking system is really solid. The sub-prime issue has not involved Italian banks.”

The Italian banking sector has seen a fair degree of consolidation in the past three or four years, leaving two giants, Intesa Sanpaolo, and Unicredito, and a good handful of smaller operators, including Banca Monte dei Paschi di Siena, the oldest bank in the world, dating back to the 15th century, which recently acquired Banca Antonveneta in the north-east of Italy. “None of these banks had sub-prime loans among their assets,” Mr Pingue says. “But although the situation for Italian banks is very good, now, after what’s been happening, they are very cautious about where they invest their money. However, if we did not have a situation like Northern Rock, or Bear Stearns, I’m sure the Italian government would persuade another bank to take over the bank in difficulties.”

Simmons&Simmons Italy is certainly in a position to comment on the state of the Italian financial sector: its client list is a blue-chip line-up of names both domestic and international, including Intesa Sanpaolo, the biggest domestic banking group in Italy, with approximately 5,500 branches serving 12 million customers, UniCredit, now the second-largest bank in Europe after HSBC, and Cassa di Risparmio di Firenze, all from Italy, as well as JP Morgan, Nomura, West LB, Morgan Stanley and Deutsche Bank.

Substantial deals
The company has been involved in some substantial deals over the past couple of years, including advising Mediobanca, another Italian investment bank, and Nomura on the €1.8bn securitisation of healthcare receivables in the Lazio region and advising Capitalia, the former Banca di Roma, which merged with UniCredit last year, on updating its €20bn medium-term note (EMTN) programme.

In the past year, Mr Pingue says, the Italian bond market has been comparatively quiet, and “we have been more involved in restructuring of bond issues than the issuing of corporate bonds.” Among the operations Simmons&Simmons has been involved in are the continuing saga of the Italian food group Cirio, which collapsed in 2002 with more than €1bn of debt – the firm represent Law Debenture, trustee of the group’s bond issues, and Pingue sits on the creditors’ committee of Cirio, having been appointed by the Minister of Production Activities to supervise the activities of the group’s receivers. Other rescue missions of Simmons&Simmons and the distressed debt team lead by partner Nino Lombardo include restructuring the bond issues of a couple of middle-cap companies, one a port equipment manufacturer, Fantuzzi Reggiane, and the other being Italtractor. “They had bond issues of respectively €125 and €100m and we organised under a legal point of view a postponement in payments agreed by a bondholders’ meeting,” Mr Pingue says. As a result, “essentially Italtractor didn’t go bust and they have been able to reimburse the bondholders entirely. The same is going on for Fantuzzi Reggiane.”

Overall, Pingue says, “corporate bonds have not been historically a large market in Italy”. After the Cirio and Parmalat scandals earlier this decade, “Italian corporations have been a bit reluctant to issue corporate bonds.” The average issue size is around €50m – small stuff, Filippo Pingue says. The bonds are issued for specific reasons, such as acquisitions, refurbishment of production processes, or to support investments, and generally what happens, he says, is that a bank itself, looking to have a bit more of its portfolio in bonds rather than loans, “goes to the company and says. ‘Would you like to issue a bond, I will subscribe to the bonds’ – it’s not a public placement, more a relationship between the bank and its client. They are institutional deals.” Bond issues are also used by unlisted companies “just to put a toe into the international capital markets before an IPO.” Mr Pingue says.

For Simmons&Simmons, banking and corporate bond issues “are not really a profitable segment of the market, but since we want our top financial institutions clients to consider us as a one stop shop, we have decided to invest in the segment,” Filippo Pingue says.

Raising cash
Once the credit crunch is over, Mr Pingue expects the bonds market to expand in Italy, across companies of all sizes looking for ways to raise cash: “The big companies have always suffered from a lack of capitalisation. In terms of medium companies, there’s a lot to do in terms of acquisition financing, leverage finance, which will continue to be a solid and substantial market. And in relation to premium small-cap companies, they are very active, and the financial markets can support their growth.”

On the securitisation side, “the main assets in Italy for securitisation have been residential mortgages,” Mr Pingue says. “The law regarding securitisations was enacted in 1999, and as soon as it was passed the banks securitised their non-performing loans. After that they started securitising the residential performing loans and eventually it came the time of personal loans.”

The notorious slowness of Italian bureaucracy, particularly its slowness in paying money due, has also meant that VAT credits are another area where securitisation has been taking place, where “a bank buys the VAT receivables and put them on its own balance sheet, or using a credit default swap to reallocate risk,” Filippo Pingue says.

But the dominant area for securitisation, at least from 2003 to 2007, has been the securitisation of health care receivables. These are the receivables due to the suppliers of medical goods from the Italian regional health care system. Up to 60 or 70 percent of an Italian region’s budget is made of health care expenses, and the global health care expenses market in Italy is around €100bn. “But Health Care Units in Italy do not pay on time, and so suppliers sell on these debts to specialist vehicles,” Mr Pingue says. “You can understand that it is a big market. We at Simmons&Simmons as a firm have been the most active in this sector – we were the first, we opened up the market with our banking partners, both Italian and foreign banks,– Intesa San Paolo, UBS, Nomura, Mediobanca, JP Morgan, The deals were as big as €1.8bn, €600m, etc.”

After a change in the law in 2007, however, “this kind of securitisation has been made more difficult to structure,” Mr Pingue says. “But, of course, the market finds other ways, alternative ways and we continue to work in the health care field.”

More cautious
Even though Italian banks do not have the sub-prime loans problems hitting the financial markets in the United States, the current situation has still made securitising property assets a little more difficult, Mr Pingue says, as institutions become even more cautious: “We have been involved in three residential mortgage-backed securities (RMBS) transactions in the past four months, which is quite a good result, but the RMBS market now is going rather slowly.”

Commercial mortgage-backed securities, on the other hand, have never taken off in Italy, largely because the Bank of Italy, as regulator for the banking sector, has remained sceptical about the safety of such deals, Mr Pingue says. “You have a bank or a number of banks that make loans to a property company to buy something, then the banks would like to securitise their loans. But usually the commercial rent fees do not ensure the same stability for the repayment of the bonds.”

All the same, he says: “I believe that securitisation will continue to be a very good funding source for banks. From time to time the securitisation market is able to find new eligible assets – healthcare has been one, from 2003 to 2007, then it disappeared, but I believe we can have other assets that will be discovered by the market.  We advise a number of banks on the investment side – they call us, they ask our opinions, we work closely to find new assets out in the market. We are considered a point of reference for banks, especially foreign banks.”

One brand new vehicle for financial institutions in Italy is covered bonds, bonds backed by mortgage loans, or receivables from the public sector, which were made legal in Italy only last year, despite being popular in countries such as Germany. Covered bonds, which are issued by eligible banks, come with a double guarantee that is likely to make them more attractive to both institutional and retail investors, Mr Pingue says. As yet, however, despite comments from big banks such as UniCredit that they are likely to move into the covered bonds market this year, no Italian financial institution has yet issued such a bond. The banks, Mr Pingue says, “are studying the situation. I don’t expect covered bonds on the market before the end of the year.” When they do start to come on to the market, however, Mr Pingue expects that they will eventually be “quite a plain vanilla transaction, as they are in Germany for instance, or in other countries. People will come to see them as just another investment they ought to have in their portfolios.”

Sharing risk
Overall there is no one fund-raising structure that is most popular in Italy, Mr Pingue says, although the mezzanine structure for corporations is an increasing way of raising funds, mixing debt and shares. The reason for this is simple, he says: “The banks must accept the fact that they must share the risk with the entrepreneurs. We are involved in a number of mezzanine structure deals.”

Meanwhile, despite the turmoil across the Atlantic, Filippo Pingue remains optimistic about the future for the Italian financial markets, although he says: “We still don’t know if we are in a baby fall or a big-sized one. I felt at the end of last year we were in for a crash. Now I am a bit more optimistic. But in my opinion we have not touched the floor yet and we need to wait for this to happen overseas – and overseas means the US.”

For further information
Tel: +39 06 809 551 

The tax and accounting relationship

The regime introduces a whole new method of measuring the amount of interest that can be deducted in the case of leveraged acquisitions. The new benchmark for deductions and related expenses is now firmly tied to pre-tax income. The high ground is fixed at 30 percent of adjusted EBITDAR in any given year. Inspired by similar legislation introduced as part of Germany’s crackdown on the claims based on carrying costs, the main objective is to simplify the tax system by establishing an easily understood and recognisable yardstick from which all parties can work.

However practitioners in general agree that the overall effect of the new regime is considered to significantly limit the options of Italian corporates in the deduction of interest expenses, especially when involved in large-scale acquisitions.

A carry-forward mechanism has been introduced, but it is likely to prove ineffective for businesses with a relatively steady turnover and financing structure. Thus the new rules will impact significantly on the way businesses finance themselves in the future.

Not all taxpayers come under the regime’s umbrella. For instance, the banking and insurance sectors are excluded. And at least temporarily, so is in part the real estate market which is still free to claim for interest incurred through mortgage loans on rentable property.

Comparisons with the previous regime

The old regime relied on an entirely different method of assessing liabilities in acquisition finance. In this, the main constraint in the design of financing structures was the rules applying to thin capitalisation. The main principle was that they limited the deduction of interest on related party debt in cases where it exceeded adjusted equity by four times.

Importantly however, the regime applied only to related party debt. In turn, this had a direct effect on the way shareholders structured their financing in order to comply with the rules, as well as on the design of guaranteed third-party debt. For example, if such debt was guaranteed by a related party, it was treated for tax purposes as debt held by the latter.

However relatively generous debt to equity ratios softened the blow. Under the rules of thin capitalisation, the maximum permissible debt-to-equity ratio was 4:1. Additionally, the rules had applied for four years and were well understood by all practitioners involved in designing tax-efficient acquisition financing. The result was that, provided deals were underpinned by soundly leveraged structures, arrangements were generally green-lighted by the authorities.

Similarly, the rules limiting deductions in the case of eligible participations could generally be overcoming by opting into tax consolidation. Thus overall, the limitations did not really constitute an insurmountable hurdle.

All in all, the old regime required careful attention to the structure of the financing architecture. But provided that was the case, the authorities could hardly ever disallow claims for substantial portions of interest expenses. In short, expert practitioners could generally manage the regime in ways that delivered highly efficient solutions for clients.
Implications for leveraged acquisitions

Although all parties are still feeling their way through the new arrangements, it is clear there has been an important sea change. It is more difficult than before to obtain tax advantages, even in structures that employ levels of leverage that were once perfectly acceptable. This is because the regime now applies to all kinds of interest costs including that anchored on third parties. Thus the umbrella extends across the whole spectrum of leverage, not just intra-group financing established for tax-planning purposes.

Also, since EBITDAR has become the starting point for the measurement of what is deductible and what is not rather than the overall financing structure of the relevant company, the previous yardstick of capitalisation no longer applies. Thus it is no longer possible to secure or even predict the amount of deductible amounts by capitalising the company.

At this stage practitioners are still learning how to navigate the regime. Uncertainty about the exact scope may induce creativity in the use of alternative forms of finance as practitioners work their way towards what is or is not an acceptable form of financing. As yet, no firm conclusion can be reached and in the long run uncertainty may prove detrimental rather than not.

Temporary reprieve for commercial property
Rationally, interest expenses incurred in mortgages incurred on rental property are temporarily exempt. This is probably for the obvious reason that otherwise the regime would have blocked the legitimate deduction of expenses on purely business-driven financial structures as distinct from tax-driven ones. While the property sector is still waiting for clarification on these details, its is likely the new regime will prove to be of benefit to it.
Tighter interpretations

All parties are in the middle of a steep learning curve as they learn how to work within the new boundaries. However it is already clear that the concept of what is deemed “legitimate” tax planning in financial structures has shrunk considerably, especially in the light of rulings by the tax authorities. The nub of these rulings is how the tax authorities determine what constitutes an abusive structure.

So far, any structure has been deemed abusive if it produces a tax advantage without generating an overwhelming non-tax advantage that could not be achieved through an alternative structure. In practice that means the reason behind the option adopted for the financial structure must reflect a significant — and fully corroborated — business motivation. Also, they make no distinction between onshore and offshore financing, applying equally all kinds of debt including bank borrowings.

Cross-border structures
In the meantime cross-border structures have come in for special attention. As we have seen, on the one hand foreign-based structures are challenged if they cannot show a specific, non-tax advantage that could not otherwise be achieved in a domestically-based structure. This is why the use of foreign holding companies often faces objections on the grounds that the structure could just as easily take the form of a domestic entity.

Normally, the line of challenge is based on the place of effective management of the relevant foreign company. Thus the final decision comes down to where the executive team is located. If the entity is an offshore structure but the management is clearly based locally, the structure can be expected to come under scrutiny.

Applying similar principles, tax authorities are also challenging foreign tax structures if in their view they reveal a lack of substance and are thus designed for tax-planning purposes rather than for commercial gain. In fairness however, several of the entities that have come under scrutiny so far have most of the executive team centred within Italy. It could therefore be argued that so far it has been the less legitimate structures have been affected by these stricter interpretations.
Anti-abuse principles invoked

The marked and growing tendency by the authorities to dispute previously acceptable structures has been growing over recent years. It suggests a concerted strategy by the tax authorities. However the position taken by the tax authorities in the growing volume of challenged structures seems motivated by a desire to boost tax revenue rather than by an interest in making impartial judgements on the different circumstances that may lie behind a particular structure.

Although this may be understandable in the case of the tax authorities, many practitioners believe the weight of judicial decisions has been less helpful. The Supreme Court in particular has consistently issued judgements on tax matters that appear to rely on a blanket, anti-abuse principle embedded in the code. This provides the courts with a reason to challenge transactions even in cases where there is no obvious anti-avoidance element.

However practitioners believe the reference to a vague principle rather than more or less specific provisions only serves to increase uncertainty in the interpretation of what is considered abusive and what is not.

However in principle, the new emphasis on genuinely commercially-based structures is seen as helpful and more balanced than in the past. It is clear that the prime inspiration behind the architecture of acquisition finance must be business-driven rather than tax-driven.

Verdict still out on IAS accounting
As part of the general reform, new legislation allows IAS adopters to use the international system for computing taxable income. The laws are not yet complete and follow-up work still has to be done. However it looks as though IAS-adopters will benefit from greater simplicity and clarity because there are likely to be fewer deviations from existing law under the code.

Similarly, it is probably too soon to make a decision about the effect that IAS will have on the assessment of levels of taxable profits. Secondary legislation will also complete the picture in this case.

Under present Italian standards, not all companies are permitted to adopt the international accounting standards. The exceptions are banks, insurance companies and listed companies. However, the authorities may decide to widen the scope of IAS accounting and bring more companies into the net. We believe IAS will become more widespread and eventually provide the foundation for assessing taxable income in an increasing number of companies.

Meantime the government has promised to introduce laws that harmonise local accounting principles more closely with international standards. This move will lead to an important simplification of the relationship between tax and accounting.

For further information:
Tel: +39 02 776 931

Adding attraction

Since its inception, the Firm has been advising clients with an international focus, on tax, legal, and accounting matters and whilst the firm has grown considerably since its formation, many of its people have been with the firm since its early years. Umberto Belluzzo comments: “Foreign investors in Italy face with the particularities and complexity of the Italian business framework together with the dominant ‘family business’ structure of Italian Industry. We work alongside these investors to bridge and facilitate their understanding of Italian industry.”

“The various issues that our clients face and the multi-faceted nature of our own service offering, led the business to evolve into the functional structure that it is today, with eight departments each of which, is led by an associate.” says Luigi Belluzzo, managing partner of the Firm.

Overseas office
The Firm has strong experience in assisting Italian companies with the process of internationalisation. The Firm soon identified a need for an overseas office an opened an office in London’s St James’ headed by Alessandro Belluzzo. From this base in London, Alessandro Belluzzo consults on Internationalisation and, on Foreign Investments in Italy, commenting: “From London we coordinate an international network of 100 correspondents in major markets and business centres around the world and work with European and Asian Private Equity , looking to invest into Italy and the Italian brand.”

The Firm maintains a classic tax&legal approach which enables the international investor to achieve results in the Italian market, also advising on legal matters such as contracts, company law, tax law and M&A operations.

“Our understanding of the Italian market, the family businesses that preside over much of it, and our strong relationships in Italy are of relevance to foreign investors who upon entering the Italian market, need to consider cultural factors and the existing driving forces in place as much as the pure logistics.” Francesco Lombardo who leads Corporate Law Counselling department says.

Having worked on numerous deals with foreign investors, private equity funds and Italian investors, Luigi Belluzzo says “Our policy is to maintain strict privacy; we seek to ensure where possible, that deals emerge when clients wish them to” adding further: “Perhaps today more than for many years, the way a Firm behaves in Italy and the trust it is able to command, is of fundamental importance. We pride ourselves on the high standing that we have built over time with our colleagues, banks and financial institutions as well as other professionals and entrepreneurs within industry.”

The Firm’s professionals are highly trained and have strong capabilities and qualities that they bring to the firm. We encourage involvement in the wider community through publishing of opinion and articles and teaching activities. Many of the firm’s associates are linked with Universities and professional bodies (eg IFA, STEP) and regularly publish articles in the key trade and industry journals on tax&legal matters, M&A, Estate Planning and more.

The Italian Budget 2008
The following measures announced in the recent Italian Budget can be seen as having created a more favourable tax environment in Italy:

Corporate taxation: For tax periods starting from 1st January 2008 onwards, the corporate tax rate (IRES) is reduced to 27.5 percent (previously, 33 percent), and the regional income tax rate (IRAP) is reduced from 4.25 percent to 3.9 percent

PEX Regime: From 2008, the exempt portion of capital gains on shares realized on years starting from 1st January 2008 onwards is increased to 95 percent (previously 84 percent). The holding period requirement is reduced from 18 months to 12 months.

Extraordinary transactions: The proposed rule, relating to the applicability of a substitute tax of 18 percent payable on goodwill derived from extraordinary transactions, has been amended as follows; in the case of contribution of going concern, the receiving company may elect to apply a substitute tax in order to obtain the step-up of the fiscal value of the assets received. The step-up is available also on the assets received by way of merger or de-merger. The substitute tax applies at the rate of 12 percent, 14 percent and 16 percent depending on the amount of the revaluation: up to €5m, from €5m to €10m, more than €10m, respectively.

The revaluation is disregarded if the stepped-up assets are disposed before the end of the subsequent four years. The new provision applies for tax periods starting from 1st January 2008 onwards.

Application of IAS: The 2008 Budget introduced a new provision, applicable to companies drafting their financial statements under the IAS, stating that the criteria set forth by International Accounting Standard (IAS) are relevant for IRES purposes. In particular, the qualification, timing of accrual and classification of items pursuant to IAS is valid also for IRES.

Stefano Barone, head of Accountancy, Tax and Compliance Advisory, comments: “This measure can be regarded as a positive move for foreign investors into Italy and I am optimistic that we may see further such enhancements in the future”.

Emanuele Lo Presti who leads the M&A, Governance and Corporate Reorganization team comments further on the Budget 2008: “Systematic (fiscal) changes aside, there are still some challenges for the domestic Italian market namely, in opening up to a more international and global environment. This is where we seek to assist clients both Italian and overseas clients by both making the ‘unknown’ more familiar in both a cultural and practical sense, and crucially providing the tax, legal and accounting framework to facilitate cross border deals.”

Investments and trusts
During the last year new rules have been introduced which have modified the Italian stance on the taxation of trusts. The most important of these, was the new legislation regarding the residence of some international trusts that are administered in countries ‘blacklisted’ under Italian tax law (e.g. Guernsey, Jersey etc.), with Italian resident settlors and beneficiaries.

What this means is that where an Italian resident is asked to prove that the trust’s main activities are indeed managed in the country where that trust is resident, there is a potential loss of confidentiality. Where the residence status of the trust is not sufficiently proven, the trust would be treated as ‘Italian resident’ with Italian tax rules therefore applicable.

Alessandro Belluzzo comments: “This change is significant not least because the Trust is commonly used to hold real estate property or Italian companies. We have advised several clients on the impact of these new rules some of whom, have taken the option of moving the trust’s residence to a ‘white-listed’ country in order to avoid the potential requirement for exchange of information and loss of privacy.”

Even given this change though, Italy is by no means a hostile environment for trusts. Indeed, another very notable recent statement on the taxation of trusts was the clarification of the direct tax-exempt status of distribution capital received from a trust, by an Italian resident beneficiary. This was the first time that this had been explicitly clarified and this move, together with a low (between 4-8 percent) indirect rate of tax on distributions by a trust, represents a favourable tax environment for trusts in Italy.

Luigi Belluzzo comments; “There have been considerable moves to take up Italian residence in recent times. The above development in the taxation of trusts, together with the generally low taxation (12.5 percent in some cases) on financial income for Italian residents represents a welcome environment. Any less than positive changes in other tax regimes in Europe – the recently proposed taxation changes for non-domicile in the United Kingdom being one example – may add further to Italy’s attractiveness in this respect.”

New rules for Italian covered bonds – worth the wait?

The new covered bonds regulation provides for an exceptionally safe regime according to procedures set out in articles 69-70 of Royal Decree 2440 of November 18 1923. These ensure they effectively grant a transfer against the assigned debtor/public entity. This is done through:

1) Notification to the assigned debtor/public entity of the transfer agreement through a Court Bailiff

2) Acceptance by the assigned debtor/public entity of such transfer agreement) that would not be applied unless the agreement from which the receivables originate expressly sets out that, notwithstanding the new legislation, the procedure of Royal Decree 2440 still needs to be complied with to consider any assignment valid

Assets purchased by the SPV represent a segregated portfolio, which may be used by the originating bank as a guarantee for the originating bank’s issued bonds, or in connection with their funding when the SPV is remote from an insolvency.

The guarantee from the SPV must be irrevocable, payable on first demand, unconditional and independent from the obligations of the bank issuing the covered bonds. It will be also enforceable on the issuing bank’s failure to pay or on insolvency, within the limits of the assigned assets, on the basis of the bankruptcy remoteness of the SPV.

Receivables fall into several categories, such as:

Residential mortgage loans provided that the ratio of the value of the mortgages issued by the originating bank and any other mortgage on the same property to the value of the property (LTV) is less than 80 percent of the value of the property, if the assets are in the EU or Switzerland and the terms of any applicable claw-back periods have expired in the relevant jurisdiction.


Commercial mortgage loans provided that the LTV is less than 60 percent (if the assets are in the EU or Switzerland and the terms of any applicable claw-back periods have expired in the relevant jurisdiction).


Loans to all public administrations including ministries, public territorial entities and any other public entity or body – both national and local – of any member state of the EU or Switzerland, provided the risk weighting of exposures to that entity under the standardised approach credit risk capital requirements under Basel II is no higher than 20 percent.


Loans to public administrations of any non-member State provided that they must have a zero risk weighting in the case of central governments or 20 percent risk weighting in the case of public territorial entities and other non-economic public entities, both national and local.


Asset backed securities that represent no less than 95 percent of the value of the segregated portfolio and have risk weightings no higher than 20 percent, whose repayment is not subordinated to the issue of other assets in the same transaction.

New changes, new limits
Under the original 2006 provisions, in order to issue covered bonds the originator/issuer needed consolidated regulatory capital (CRC) of € 500 m, a CRC ratio of at least 10 percent and a consolidated Tier 1 capital ratio of at least 6 percent. These parameters were much criticized by the Italian Banking community as being too restrictive. But the final version of the Bank of Italy Regulation of May 2007 imposes a lower minimum CRC Ratio of 9 percent and accordingly it opens the market to the most significant national players.

These limits are defined as:

Banks with a CRC Ratio of at least 11 percent and the Tier 1 Ratio of at least seven percent face no limits to the amount of assets that can be transferred to the SPV

Those with CRC Ratio between 10 percent and 11 percent and a Tier 1 Ratio of at least 6.5 percent can transfer 60 percent of their assets to the SPV


Banks with a CRC Ratio between nine percent and 10 percent and a Tier 1 Ratio of at least six percent can transfer only 25 percent of assets to the SPV. The thresholds of capital position (CRC Ratio and Tier 1 Ratio) for each range must be met together. In case only one of the two ratios above is met, the lower range must be applied

Rating agency criteria risk

Most importantly, the new Italian legislation appears to be in line with the criteria envisaged by rating agencies. Fitch has identified four key areas that need to be considered (and the relative weights to be given to each) when measuring the risk that payments owed to investors might be interrupted in the event of an insolvency of the issuer. They are as follows:

1) Segregation of cover assets backing the issues of covered bonds from the bankruptcy estate of the issuing financial institution (50 percent weight) – under the new Italian legislation, asset segregation is achieved by the transfer of the assets to a bankruptcy remote special purpose vehicle acting as a guarantor of the issued covered bonds

2) Alternative management of the cover assets and the covered bonds (15 percent weight) – the legislation provides that in the event of the issuer’s mandatory winding up (liquidazione coatta amministrativa) the SPV shall represent bondholders vis-à-vis the issuer

3) Liquidity gaps between the respective amortisation profiles of the cover pool and the covered bonds (30 percent weight) – the Bank of Italy’s prescriptions provide that the net value of the segregated assets must be at least equal to the net value of the covered bonds and that interests and other revenues generated by the cover pool must match all the costs due on the covered bonds; also, the supervisory legislation introduces specific strategies of asset and liability management for banks to follow in order to bridge potential maturity mismatches

4) Dedicated covered bonds oversight (5 percent weight) – the Bank of Italy imposes specific transaction guidelines and will supervise banks implementation as part of its overall mission to safeguard the stability of the domestic banking environment.

Strict asset segregation satisifies Fitch
Fitch expressed a favorable evaluation on the Italian covered bond regulation in its last research report, published at the end of last January 2008. In particular, Fitch expressed satisfaction for the assets segregation mechanism provided by Italian regulation. Given such strict asset segregation mechanism, Fitch states, “a high degree of credit is given to the ‘true sale’ transfer of the assets to the SPV. In fact, in the case of issuer insolvency, this segregation mechanism will allow,” continues Fitch, “to grant the repayment of the covered bonds holders through the covering assets and the cash flows deriving from them.”

A favorable opinion is expressed also with reference to the supervision role assumed by the Bank of Italy (BoI) in respect of the covered bond issuance. On this point however, Fitch points out that while BoI is the first regulation authority on covered bonds which imposed specific insolvency limits for prospective originators, the Italian framework is less detailed and prescriptive than in some other European jurisdictions, in particular with respect to the ongoing surveillance of asset and liability management. In fact, although there is a generic requirement that issuers have to report to BoI on the proposed management of maturity mismatches and on the system in place to control specific risks, there is no specific provision for a regular audit by BoI to take place, nor is any reference made to stress testing under different scenarios.
Positive feedback sets the tone

The general evaluation made by rating agencies on the Italian covered bond regulations certainly seems positive. The new regime appears to be characterized by a high level of innovation, both legally and commercially. It has introduced liquidity safeguards and robust strategies of asset and liability management designed to maintain a balance between protecting the interests of creditors and the creation of a potentially large covered bond market.

So, when can we expect to see the first Italian covered bond issuance? Due to the recent news in the financial markets – Banca OPI has officially announced its plans to launch a public sector backed deal while UBI Bank recently communicated to have mandated Barclays Capital to arrange its program – maybe by the end of 2008. Meanwhile the foundations for growth have been laid and the future of the Italian covered bond market seems much brighter.

For further information:
Tel: +39 06 362 271

Taking the pro-active approach

For a change of administration, says Giuseppe Pirola, Founder and Senior Partner at Studio Pirola Pennuto Zei & Associati, the Italian headquartered tax and legal advisory firm, is often accompanied by a change in the taxation and legal provisions, something that the country’s professional services advisers have become only too accustomed to in recent years.

Shifting sands of taxation
A good example of the shifting uncertainties of investing in Italy is the tax treatment of goodwill. Over the past few years, what was a particularly favourable tax regime for acquisitions, in terms of the provisions relating to tax relief for goodwill, has grown much less attractive.

“Twenty five years ago, tax relief for goodwill was as high as 52 percent, and more recently 36 percent,” says Pirola. “It was possible to make an acquisition, do a merger, step up the value of the assets, the liabilities in the company acquired, and get tax relief for that goodwill, write it off against taxes over a period five years.”

Successive Finance Acts have extended the goodwill write off period – the time taken to get the tax relief – first to 10 and now 18 years. And tax relief was only available if there was a clear business case, so when investors had to reorganise after an acquisition, they would only get tax relief if there was a bona fide commercial reason for the reorganisation, and it was not just being done to crystallise the tax relief.

Then tax relief on goodwill was removed entirely, other than in some limited cases when taxes are paid upfront. Substitute tax provisions have been introduced in various Finance Acts over the past few years usually as “one off” provisions. With the substitute tax, the taxpayer paid a reduced rate of tax typically between 10 percent and 18 percent in advance, on a revaluation of assets, to get the tax back over a 10 or 18 year period at the standard rates.

“Now, the Finance Act 2008 has reintroduced the concept, with the option of paying 12 to 16 percent in advance to get the tax back over 18 years,” says Pirola. “For many taxpayers, however, the reality is that an 18 year recovery period means that, paying tax up front, albeit at 16 to 18 percent, is not worth it.”

Although it is worth noting, that for an asset with a shorter amortisation or depreciation period, such as a patent, where depreciation is over the life of the patent, but there are only three or four years left for the patent to run, then there will be some benefit, as you will get tax relief in shorter period of time. So opportunities do exist to take advantage of the substitute tax.

The recent Finance Act has, unsurprisingly, introduced more than one change to the tax regime. The corporate income tax rate (IRES), for example, has been reduced from 33 percent to 27.5 percent.

This move makes Italy very competitive with respect to corporation tax. Although, in terms of tax relief, with the tax rate reducing from 52 percent, to 36 percent, 33 percent and now 27.5 percent, payback on the substitute tax is reduced.

There is also a regional production tax (IRAP) to contend with. This tax has been contested in the European Courts, but the Italian authorities won the case, and the tax seems to be here to stay. In the 2008 Act the standard rate was reduced by from 4.25 percent to 3.9 percent, and rules simplifying the computation of the taxable base have been introduced. Labour costs are not deductible in computing the taxable base which is based on the gross margin shown in the statutory profit and loss account. Successive governments have met the criticism that IRAP is a tax on jobs with a series of measures providing IRAP relief for businesses taking on new employees.

“The reduction in top line tax rate is consistent with a general trend among countries in Europe to reduce the top line tax rate, but increase the taxable basis,” says Pirola. “So at the same time as cutting the IRES rate, the Finance Act introduced a series of restrictions, such as a limitation on the possibility of claiming tax accelerated depreciation, for example, that increased the taxable base.”

The attitude of successive governments has been to simplify the system, and reduce the tax rate, in exchange for better and more accurate profit reporting by taxpayers. They have also targeted tax relief at enhancing growth in the economy. The recent introduction of 10 percent tax credit for research and development costs is a good example; the percentage is increased to 40 percent for costs incurred in connection with arrangements with universities and certain other public institutions.

Recent changes have also boosted the prospects of planning investments through the use of partnerships or tax transparent companies.

Capital gains and tax relief for interest
Another area where investors are faced with uncertainty and constant change in tax regulations, are the rules relating to participation exemption on capital gains deriving from disposals of shares, and other instruments that benefit from the participation exemption.

The rules, which were introduced in 2004, started with the exempted element at 100 percent, but in the space of three years that moved to 92 percent, 84 percent and now, after the 2008 Act, back up to 95 percent. On the other hand the minimum holding requirement in order to benefit from the participation exemption has reduced from 18 to 12 months.

Over recent years the government has also changed its approach towards the thin capitalisation rules that deal with the tax treatment of debt financed deals, and the deduction of interest. Thin capitalisation rules are designed to deny or restrict tax deductions for interest paid to related parties, and prevent companies from being artificially geared up with shareholder loans.

“Initially, a carrot approach saw an incentive to put funding into companies using equity capital, in the form of a reduced tax rate,” says Pirola. “Those rules were then replaced by more standard thin cap rules which denied deduction for interest in situations where a company exceeds a certain debt ratio; in this case four parts debt to one part capital. Exceed the debt ratio cap and you lose the tax deduction for the interest on the excess debt over and above the cap.”

 There were also some intricate rules deigned to stop an interest deduction on borrowings used to purchase shares.

These rules lasted for three years, from 2004 until 2008, and have now been replaced with yet another approach to the deduction of debt interest. “The government has introduced interest cover rules – a regime that focuses on net interest expenses – so the debt equity relationship is no longer important,” says Pirola. “Instead, you get a tax deduction for net interest expenses – interest expenses which exceed interest income – up to a limit of 30 percent of EBITDA as shown in the annual statutory profit and loss accounts.”

The impact of the new provision depends on the type of organisation or structure involved and the type of activity. “For private equity investors the new rules will have a significant impact,” notes Pirola. “Previously, acquisitions could be structured so as to get the debt to equity exactly right and maximise tax efficiency. Now, as it is not often possible to know the level of profits in advance, it is difficult for private equity to judge the most beneficial level of gearing.”

With MNCs, however, the effects of the new provisions are less clear cut. Many MNCs with manufacturing or sales operation in Italy, for example, have transfer pricing mechanisms in place designed to ensure a correct allocation of profits to the various countries in which they operate around the world. The profits and risk of the MNC’s global business may be the HQ of the business, and with good tax planning MNCs can structure their tax affairs to take advantage of the new provisions.

Real estate sector
The theme of uncertainty and opportunity continues with the real estate sector, in which there have been a number of interesting developments over the last few years,

Until recently the best way for foreign investors to make a real estate investment in Italy was to set up a company as a Special Purpose Vehicle (SPV) and then perform acquisitions through that SPV.

In 2000 the first SGR-managed vehicle, a speculative real estate investment fund, which currently has a minimum investment requirement of one million Euros, was launched. In 2003, a change in the law paved the way for open-ended ‘flexible’ real estate investment funds, in which at least two thirds of the overall value of the fund is represented by real estate, rights in property, or holdings in real estate companies – companies engaged in the building, purchase, sale, and management of real estate. (Closed-end real estate funds have been regulated in Italy since 1994).

Following on from the real estate fund, the Italian government proposed a new structure, the Italian version of Real Estate Investment Trusts (REITs). REITs and similar entities have existed in various countries such as the US and UK, for example, for some time, and were introduced in Italy for the first time by the 2007 Italian Financial Law, under the name of SIIQ (Società di Investimento Immobiliare Quotata).

SIIQs are qualified as a listed real estate investment company, explains Pirola. The qualifying features are: that shares of the company shall be listed on an Italian stock market; the company’s main business must be real estate lease; no shareholder can hold, directly or indirectly, more than 51 percent of the voting rights and a 51 percent share of the company’s profits; and at least 35 percent of shares must be held by shareholders, each of them holding, directly or indirectly, no more than one percent of the voting rights and a one percent share of the company’s profit.

Promising as the SIIQ is, implementation has proved slow. The law on SIIQs was approved at the end of 2006, and investors were expected to be able to use the new structure from the beginning of 2008. Early in 2008, however, the SIIQ still has to take-off.

“Today we don’t have SIIQ already up and running, we have a lot of announcements by real estate groups or listed companies that are planning to convert their companies into SIIQ,” says Pirola. “But it is a regime that probably has not confirmed its validity in full, and the market has no experience of SIIQs operating in investments.”

Moreover, a government commission is about to look at wholesale tax reform of the real estate sector, and is expected to submit proposals by June 2008.

The Finance Act 2008 states that the commission’s proposals may lead to the introduction and enactment of new rules that may apply retrospectively from January 2008. This means that a real estate business could look at an investment, make evaluations based on the current tax regime and find that after the proposals are announced in June, any business plan assumptions have been rendered incorrect, for the entire year.

Expert assistance
It is clear that the tax regime for investors is highly complex and picking your way through it requires the assistance of advisers with extensive local expertise.

“As you may appreciate when you speak with foreign investors approaching the Italian market, they can find the market confusing,” says Mr Pirola. “For example, with real estate, it is not easy to explain that a business looking to make an investment may perform valuations now, prepare a business plan, define prices and pay money, based on assumptions underlying the business plan, and then find that those assumptions will not be confirmed in six months time because of changes in the law.”

Studio Pirola Pennuto Zei & Associati is a firm with a very strong presence in Italy, with a total head count of 520, including 80 lawyers and 350 tax experts and accountants, located in 9 offices spread over the main Italian industrial areas. The firm also has an international presence, with offices in London and, in the near future, Paris and Brussels.

“We are a one stop shop, providing a full range of tax and legal services to our clients,” says Mr Pirola. “To do this we rely on the strength of our technical skills and knowledge, but also the close relationship we have with our clients. Because, in this business it is important to take pro-active approach, to provide solutions for our clients and point out the opportunities, not just answer their questions.”

For further information
Tel: +39 02 669 95203

More political opera to come?

Plus ça change? It’s all change in Italy – again. Despite the frequent regime changes it has endured in the last 30 years, Italy has enjoyed relative stability in the last nine years with just two changes of government. But with Prodi’s administration in disarray and Silvio Berlusconi showing every sign he would relish a return to power, international investors have every right – again – to feel a sense of apprehension. So what has been achieved by Prodi, and what could change again in the future?

In terms of employment issues, Franco Toffoletto, from Milan-based Toffoletto e Soci says employee stock option changes have definitely taken the shine off this usually effective reward tool, particularly for overseas investors. “Before they were widely used in Italy. But now it’s very difficult to use stock options – so difficult, in fact, that very few Italian companies will use them.”

The left wing faction of the Prodi administration emphatically pushed this change. Part of the problem thinks Franco Toffoletto was that the stock option change in the law was partly a problem of perception: stock options, thought many on the political left, were only for fat-cat managers and directors – not something ordinary employees could also benefit. Yet a wide range of employees did, and not just management top table.

“Previously stock options were very attractive to many because they were only taxed at 12.5 percent,” says Franco Toffoletto. “Companies and many people – not just managers – took advantage of them. Part of the problem too was that the rules changed so many times that it became very confusing to know how best to use them. Which, of course, made them less popular.”

Toffoletto E Soci areas of expertise:

Applications for disciplinary sanctions
All issues regarding employment contracts
Procedures for the management of confidentiality
Use of IT equipment and email
Trade union law
Transfers of undertaking, collective redundancies and lay offs
Stock options and immigration
International restructuring and occupational pensions
Collective bargaining agreements
EU disputes and discrimination issues

The devil is in the detail – always
Of course, despite the clamping down of stock options in Italy, Franco Toffoletto says stock options will continue to thrive in many other countries. And a change of government could see the rules relaxed again? At the moment the two big parties did not provide any details on that.

Meanwhile, international investors should know that the law around stock options must be watched very carefully, as the Romano Prodi legislation will regard the value of options as income – except if all the following conditions are met:

The amount paid by the employee is equal to or higher than the market value of the stock at time of the offer

The stock owned by the employee does not account for more than 10 percent of the authorised stock and does not entitle the employee to more than 10 percent of the voting rights in shareholders’ ordinary meetings

The option is not exercised for three years from the grant

The stock of the company is listed on a stock exchange market at the time the option is exercised

The employee keeps an investment in the stocks equal to the difference between the value of the stock at the time of the grant and the amount paid by the employee for at least five years’ following the exercise of the option.

Reduced employment flexibility
Between 2001 and 2003 considerable steps were made in Italy’s rigid labour market, with new laws introducing a lot more employment flexibility, supplying permanent contracts for agency workers and more flexibility regarding part time and fixed term contracts.

“One of the most important steps was the change regarding staff leasing (i.e. supplying workers on permanent contracts through authorised agencies)” says Toffoletto. “For employers who typically might hire agency workers to work within their own company, this option was important. It was limited only to certain jobs, but this has been abolished by the Prodi government. It’s a great pity because it was a very useful opportunity for many companies.” Now companies can only hire agency workers for a fixed period of time and only if there are economic, technical or production reasons for doing so.

However, this Milan legal expert adds that fixed term contracts remain highly used in Italy.

Other issues hang around which could unnerve the inexperienced investor warns Toffoletto. Currently there is no cap to compensation in the event of wrongful employment dismissal: reinstatement is the only remedy that can be awarded by the court.

The public sector still remains a highly unreformed sector of Italy’s economy. A more bolder, possibly younger politician might have had the energy and vision to reform Italy’s bloated public sector, stimulating investment. But that man was not Romano Prodi.

A Berlusconi return bringing increased flexibility?
It’s not easy to predict the future. No one knows if Silvio Berlusconi will end up back in power, replacing Prodi. Certainly what Italy needs more than ever is a genuinely new and innovative reformer – but is that man Mr Berlusconi? The evidences suggests not. Mr Prodi, although some of his changes were retrograde steps, did have some success with tax-collecting reforms, for example.

However, Franco Toffoletto says despite the Prodi changes, investor confidence has not been affected too deeply. Realistically, he says, many investors are ambivalent about investing in Italy – as many have always been. “It’s been that way for many years. Italy, in terms of employment legislation, is a nightmare. But it’s not quite as bad as many people make out. For example, I think Italy is certainly better in terms of employment law than France, even though it is more protective of issues like dismissals.”

Certainly Prodi’s replacement will have their work cut out. Like many EU countries feeling the effects of the global credit crisis, potential economic recession is on a knife edge. The high euro means there’s pressure on Italian exports and high oil and food prices are also taking their toll on the economy and people’s pockets.

Technology brings benefits – but also threats
Italy has the same IT problems that face companies everywhere: blogging, Internet gossip and chatrooms with disaffected employees writing, often very freely, about their employer. The issue of information sharing – sometimes with the wrong people – is of course a huge worry for many companies now. How do you keep control of your own reputation you’re your company’s confidential information when it becomes so easy to share with others?

“People use the Internet a lot in Italy,” says Toffoletto. “A lot of social life and business life can be interconnected. If you work for an IT company and you got on a business networking conference, you could well be inadvertently passing on very sensitive information. Look at the emergence of Facebook. You can see people’s friends, find out about their hobbies, even their religion. Who is making use of this information? Does the person concerned realise the consequences such disclosure could lead? So far, Italy has not had to deal with this in the courts. But it will at some point and companies have to face up to the reality of what this could bring.”

IT innovation milestones – Toffoletto e Soci
1986: the year of the first personal computer network in the firm and the first e-mail inbox. Over the years there has been a continuous improvement of the IT facilities.

1995: Easylex is invented by Franco Toffoletto and others and this remains the management software currently used in the firm. It became one of the best selling management software for law firms in Italy and winner of the SMAU award Macworld, 1999, as the best Italian management software suite.

2004: Extensive KM (Knowledge Management) knowledge sharing.

2006: The WebLex service online by which clients can look up information on EasyLex related to their files and download documents.

2007: The launch of Toffoletto e Soci’s new Knowledge Management web-based platform for clients.
The Toffoletto e Soci difference

We offer services at a national and international level. Among the Italian firms specialising in employment law we are the only one that is part of a structured international alliance

Quality of services: efficient, fast and punctual. We were among the first Italian firms to obtain the Quality Assurance Certificate UNI EN ISO 9001

Internal training quality: our training programme has been accredited for 2008 by the Italian Law Society. We have been running in-house English language courses for years, taught by teachers from the British Council, both for lawyers and support staff

Leaders in IT. For a number of years we have been using a Knowledge Management software developed internally ( We also set up an Intranet network 10 years ago. We are in the process of developing digital products to offer to clients and considering blog, podcast, video and audio options

Regularly in the media. We write a column (The expert replies) for newspaper Sole 24 Ore (the Italian equivalent of the Financial Times) as well as various law journals

Highly ranked. We are classified by all of international directories as a leading legal firm employing the best legal minds in Italian employment law. All partners regularly participate as speakers at Employment Law conferences both at a national and international level

More about Toffoletto e E Soci
The firm’s business is judicial, extrajudicial and consultancy (around 50/50 percent) and they act predominantly on behalf of companies. About 50 percent of clients are companies worldwide from all sectors including banking, IT, insurance, head hunting to publicity and marketing.

For further information:
Tel: +39 02 721441