itsupport | World Finance

The roots of America’s financial crisis

Posted on September 2, 2008February 9, 2012 by itsupport

The US Federal Reserve’s desperate attempts to keep America’s economy from sinking are remarkable for at least two reasons. First, until just a few months ago, the conventional wisdom was that the US would avoid recession. Now recession looks certain. Second, the Fed’s actions do not seem to be effective. Although interest rates have been slashed and the Fed has lavished liquidity on cash-strapped banks, the crisis is deepening.

To a large extent, the US crisis was actually made by the Fed, helped by the wishful thinking of the Bush administration. One main culprit was none other than Alan Greenspan, who left the current Fed Chairman, Ben Bernanke, with a terrible situation. But Bernanke was a Fed governor in the Greenspan years, and he, too, failed to diagnose correctly the growing problems with its policies.

Today’s financial crisis has its immediate roots in 2001, amid the end of the Internet boom and the shock of the September 11 terrorist attacks. It was at that point that the Fed turned on the monetary spigots to try to combat an economic slowdown. The Fed pumped money into the US economy and slashed its main interest rate – the Federal Funds rate – from 3.5% in August 2001 to a mere 1% by mid-2003. The Fed held this rate too low for too long.

Monetary expansion generally makes it easier to borrow, and lowers the costs of doing so, throughout the economy. It also tends to weaken the currency and increase inflation. All of this began to happen in the US.

What was distinctive this time was that the new borrowing was concentrated in housing. It is generally true that lower interest rates spur home buying, but this time, as is now well known, commercial and investment banks created new financial mechanisms to expand housing credit to borrowers with little creditworthiness. The Fed declined to regulate these dubious practices. Virtually anyone could borrow to buy a house, with little or even no down payment, and with interest charges pushed years into the future.

As the home-lending boom took hold, it became self-reinforcing. Greater home buying pushed up housing prices, which made banks feel that it was safe to lend money to non-creditworthy borrowers. After all, if they defaulted on their loans, the banks would repossess the house at a higher value. Or so the theory went. Of course, it works only as long as housing prices rise. Once they peak and begin to decline, lending conditions tighten, and banks find themselves repossessing houses whose value does not cover the value of the debt.

What was stunning was how the Fed, under Greenspan’s leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash. There were a few naysayers, but not many in the financial sector itself. Banks were too busy collecting fees on new loans, and paying their managers outlandish bonuses.

At a crucial moment in 2005, while he was a governor but not yet Fed Chairman, Bernanke described the housing boom as reflecting a prudent and well-regulated financial system, not a dangerous bubble. He argued that vast amounts of foreign capital flowed through US banks to the housing sector because international investors appreciated “the depth and sophistication of the country’s financial markets (which among other things have allowed households easy access to housing wealth).”

In the course of 2006 and 2007, the financial bubble that is now bringing down once-mighty financial institutions peaked. Banks’ balance sheets were by then filled with vast amounts of risky mortgages, packaged in complicated forms that made the risks hard to evaluate. Banks began to slow their new lending, and defaults on mortgages began to rise. Housing prices peaked as lending slowed, and prices then started to decline. The housing bubble was bursting by last fall, and banks with large mortgage holdings started reporting huge losses, sometimes big enough to destroy the bank itself, as in the case of Bear Stearns.

With the housing collapse lowering spending, the Fed, in an effort to ward off recession and help banks with fragile balance sheets, has been cutting interest rates since the fall of 2007. But this time, credit expansion is not flowing into housing construction, but rather into commodity speculation and foreign currency.

The Fed’s easy money policy is now stoking US inflation rather than a recovery. Oil, food, and gold prices have jumped to historic highs, and the dollar has depreciated to historic lows. A Euro now costs around $1.60, up from $0.90 in January 2002. Yet the Fed, in its desperation to avoid a US recession, keeps pouring more money into the system, intensifying the inflationary pressures.

Having stoked a boom, now the Fed can’t prevent at least a short-term decline in the US economy, and maybe worse. If it pushes too hard on continued monetary expansion, it won’t prevent a bust but instead could create stagflation – inflation and economic contraction. The Fed should take care to prevent any breakdown of liquidity while keeping inflation under control and avoiding an unjustified taxpayer-financed bailout of risky bank loans.

Throughout the world, there may be some similar effects, to the extent that foreign banks also hold bad US mortgages on their balance sheets, or in the worst case, if a general financial crisis takes hold. There is still a good chance, however, that the US downturn will be limited mainly to America, where the housing boom and bust is concentrated. The damage to the rest of the world economy, I believe, can remain limited.

The specter of global stagflation

Posted on September 2, 2008February 9, 2012 by itsupport

Inflation is already rising in many advanced economies and emerging markets, and there are signs of likely economic contraction in many advanced economies (the United States, the United Kingdom, Spain, Ireland, Italy, Portugal, and Japan). In emerging markets, inflation has – so far – been associated with growth, even economic overheating. But economic contraction in the US and other advanced economies may lead to a growth recoupling – rather than decoupling – in emerging markets, as the US contraction slows growth and rising inflation forces monetary authorities to tighten monetary and credit policies. They may then face “stagflation lite” – rising inflation tied to sharply slowing growth.

Stagflation requires a negative supply-side shock that increases prices while simultaneously reducing output. Stagflationary shocks led to global recession three times in the last 35 years: in 1973-1975, when oil prices spiked following the Yom Kippur War and OPEC embargo; in 1979-1980, following the Iranian Revolution; and in 1990-91, following the Iraqi invasion of Kuwait. Even the 2001 recession – mostly triggered by the bursting high-tech bubble – was accompanied by a doubling of oil prices, following the start of the second Palestinian intifada against Israel.

The ‘r’ word
Today, a stagflationary shock may result from an Israeli attack against Iran’s nuclear facilities. This geopolitical risk mounted in recent weeks as Israel has grown alarmed about Iran’s intentions. Such an attack would trigger sharp increases in oil prices – to well above €130 a barrel. The consequences of such a spike would be a major global recession, such as those of 1973, 1979, and 1990. Indeed, the most recent rise in oil prices is partly due to the increase in this fear premium.

But short of such a negative supply-side shock, is global stagflation possible? Between 2004-2006 global growth was robust while inflation was low, owing to a positive global supply shock – the increase in productivity and productive capacity of China, India and emerging markets.

This positive supply-side shock was followed – starting in 2006 – by a positive global demand shock: fast growth in “Chindia” and other emerging markets started to put pressure on the prices of a variety of commodities. Strong global growth in 2007 marked the beginning of a rise in global inflation, a phenomenon that, with some caveats (the sharp slowdown in the US and some advanced economies), continued into 2008.

An unlikely scenerio?
Barring a true negative supply-side shock, global stagflation is thus unlikely. Recent rises in oil, energy and other commodity prices reflect a variety of factors:

High growth in demand for oil and other commodities among fast-growing and urbanising emerging-market economies is occurring at a time when capacity constraints and political instability in some producing countries is limiting their supply.
The weakening US dollar is pushing the dollar price of oil higher as oil exporters’ purchasing power in non-dollar regions declines.
Investors’ discovery of commodities as an asset class is fueling both speculative and long-term demand.
The diversion of land to bio-fuels production has reduced the land available to produce agricultural commodities.
Easy US monetary policy, followed by monetary easing in countries that formally pegged their exchange rates to the US dollar (as in the Gulf) or that maintain undervalued currencies to achieve export-led growth (China and other informal members of the so-called Bretton Woods 2 dollar zone) has fueled a new asset bubble in commodities and overheating of their economies.

Most of these factors are akin to positive global aggregate demand shocks, which should lead to economic overheating and a rise in global inflation.

Exchange rate policies are key. Large current-account surpluses and/or rising terms of trade imply that the equilibrium real exchange rate (the relative price of foreign to domestic goods) has appreciated in countries like China and Russia. Thus, over time the actual real exchange rate needs to converge – via real appreciation – with the stronger equilibrium rate. If the nominal exchange rate is not permitted to appreciate, real appreciation can occur only through an increase in domestic inflation.

So the most important way to control inflation – while regaining the monetary and credit policy autonomy needed to control inflation – is to allow currencies in these economies to appreciate significantly. Unfortunately, the need for currency appreciation and monetary tightening in overheated emerging markets comes at a time when the housing bust, credit crunch, and high oil prices are leading to a sharp slowdown in advanced economies – and outright recession in some of them.

The world has come full circle. Following a benign period of a positive global supply shock, a positive global demand shock has led to global overheating and rising inflationary pressures. Now the worries are about a stagflationary supply shock – say, a war with Iran – coupled with a deflationary demand shock as housing bubbles go bust. Deflationary pressure could take hold in economies that are contracting, while inflationary pressures increase in economies that are still growing fast.

Thus, central banks in many advanced and emerging economies are facing a nightmare scenario, in which they simultaneously must tighten monetary policy (to fight inflation) and ease it (to reduce the downside risks to growth). As inflation and growth risks combine in varied and complex ways in different economies, it will be very difficult for central bankers to juggle these contradictory imperatives.

Nouriel Roubini is Professor of Economics at the Stern School of Business, New York University, and Chairman of RGE Monitor

Captain’s knock

Posted on August 19, 2008February 3, 2012 by itsupport

Editor’s note
This is an archived article. For the cover story concerning Sir Allen Stanford please click here.

Sir Allen’s new and innovative cricketing enterprise is merely the latest innings in a business empire that spans financial services to upmarket real estate development, hospitality and professional sports. We talked to the Sir Allen about his ability to keep investments on track, whether there’s a formula for making financing work, and his interest in cricket.

Wise investment decisions
Tireless research, meticulous planning and hard work have been the core principles of Stanford Financial Group’s success since the first Stanford enterprise was begun by Sir Allen’s grandfather in 1932. Like other investment firms Stanford Financial offers its clients diversified portfolios fine tuned to meet their financial objectives; near, mid and long-term. Where the firm differs, however, is in the way it measures performance.

“Certainly global diversification across asset classes, economic sectors and currencies is critical to the Stanford Investment Model (SIM) strategy, but we do not measure our performance against current market indices,” says Sir Allen. “Instead of benchmarking as most firms do, we set our own Return on Investment goals. Our SIM strategies are a fluid, therefore constantly evolving process guided by the parameters set by our investment committees. Our investment strategies have always been one of long-term consistency. The current market conditions we find ourselves in today are no exception.”

“We do not invest in anything that we do not fully understand, and often we don’t follow current trends when making investment decisions,” emphasises Sir Allen. “For example, the reason we had no exposure to the securitised debt meltdown was that after doing our own internal research and risk analysis we simply could not get our arms around the underlying assets and their associated risk, therefore any perceived profits became irrelevant.”

Sir Allen also points to the quality of the people working for Stanford Financial as instrumental in the firm’s performance. “A financial advisor who delivers true world class wealth management service to his clients must also be supported internally and externally by world class talent,” says Sir Allen. “At Stanford, that external support is provided by advisors and money managers with whom we have had, in some cases, relationships going back three decades. Internally over the years we have continuously invested considerable sums of money to grow our policy research, financial analyst, equity research and fixed income teams, in spite of current trends to outsource these disciplines.”

The internal Stanford team includes over 100 people constantly searching for opportunities across the globe in order to meet the firm’s ROI goals with palatable risk. As Sir Allen notes, the fact that the housing market in the United States is in distress, yet in Brazil new home construction is booming, shows how important it is to take a global approach to investment strategy, and to thoroughly understand the economies in each country that support the industries being invested in.

“The bottom line is this, there is no short cut to quality investing, or magic formula for making money, it is a process of discipline and hard work.” says Sir Allen.

Identifying opportunities
You do not become a billionaire entrepreneur without having a good understanding of the global economy, and Sir Allen’s opinions on the regional economic prospects and possible investment opportunities for the future are well worth noting.

On the US economy, Sir Allen has concerns. “With a sluggish economic base, dependency on imported oil, tight credit, inability to substantially grow exports with a weak dollar and now commodity prices that are certain to bring on inflationary pressures, and a €0.6bn a day cost to fight the Iraq and Afghanistan wars; any economist will tell you that this scenario points towards stagflation,” he warns. “I hope that I am wrong and the US economy can weather these current storms, but the challenges are in a number of sectors that have been hit hard, and it will take some time for them to recover.”

In the emerging markets, however, Sir Allen sees a number of opportunities, although not necessarily where you might imagine. China, on its way to becoming an economic superpower, is perhaps overexposed, he says. “I am lukewarm for investing in China right now, if for no other reason than everyone else is already in China, the cost of living and wages are guaranteed to rise, and they have some serious environmental issues, which they will soon have to deal with.”

“India has created pockets of great wealth and great investment opportunities, but it is a volatile place for investing that will eat the ill-informed alive.” Says Sir Allen

He sees the Middle East and Africa as the last true emerging market with this observation. “This part of the world is definitely one where relationships determine your success and there is almost no correlation to the rest of the global economy from these oil exporting, enormously wealthy countries.”

Sir Allen is bullish on Russia, currently undergoing a transition from communist society to capitalism, (but with the added caveat that you need to do your homework), just as he is on Latin America, and Brazil in particular.

“Capital inflows have increased significantly in most Latin American countries over the past few years indicating a confidence and enthusiasm for a part of the world with enormous untapped natural resources and a burning desire to move up the economic and social ladder. Most governments are committed to investing in their countries’ infrastructure and the political risk of investing, at least in most countries, is acceptable,” says Sir Allen.

“Just look what a success story Brazil has become, for example. Back in the 1970’s no one took Brazil seriously, except in soccer. Today Brazil is South America’s largest economy, it is a true global player, and produces all of its energy needs internally. If the government can keep inflation in check and give as much attention to the environment and ecology of the country as it has to its economy, then Brazil has an incredibly bright future.”

There is a bright future ahead for the Stanford Financial Group too, according to Sir Allen. “In these turbulent and uncertain times, I see great opportunities for Stanford. I certainly wish that the current chaos and confusion in the markets could have been avoided, but there are great buying opportunities and huge opportunities to grow our business now,” he says. “We had no sub-prime exposure, were extremely conservative in our use of leverage, and our business model has proven highly efficient in the current market conditions.”

A new game
Despite his considerable business success, restless entrepreneur Sir Allen, shows no signs of letting up the pace, with a number of new enterprises on the go, or at the planning stage.

One well publicised venture is Sir Allen’s foray into the world of cricket, shaking up the sport with the relentless vigour of a man not used to failure. While Sir Allen’s commitment to the 20/20 form of the game, and the €12m prize for the winner of the England versus Stanford’s All Stars game on November 1, 2008, may have diehard traditionalists choking on their Pimms, there is no denying Sir Allen loves the game and wants to secure a successful future for it – regardless of format. He is also keen to revive the flagging fortunes of the West Indies national side.

“I looked very carefully at how we could take a sport that was dying in the Caribbean, bring it back to life and give it a future. In the process, we needed to change the entire cricket fan demographic from being male dominated to one that was family oriented and particularly exciting for young kids. The 20/20 format, no doubt about it, is the future of the sport,” says Sir Allen.

“As a point of reference the TV rights for the recently completed Indian Premier League were sold for €0.6bn. Our business model goal for the Stanford 20/20 is for our costs to be covered within three years through TV, sponsorship and other direct revenue streams. With the Stanford 20/20 Tournament, we firmly believe we have created something that will capture a huge global audience and promote the Stanford brand to new and exciting markets.”

On another front Sir Allen is planning something even more ambitious. “I am presently working on a series of projects within a project that is unequalled in the world. I have been working on this for over nine years with some of the world’s top architectural, engineering and design firms,” he says.

“Hopefully we are in the last phases of negotiations with government officials and I am optimistic it will all come to a positive conclusion very soon. This mega project will transform one island nation into a model for sustainable, ecologically correct development, while providing a foundation for future economic and social improvement for an entire population for generations to come.”

The sustainability focus is very apt. For there is one considerable cloud on the horizon, says Sir Allen.

“Poor global leadership, nuclear or biological war, man’s inhumanity to man, greed, religious intolerance, exponential growth of human enterprise… they are all overshadowed by global climate change,” he says. “I am not talking about saving planet earth. I’m talking about saving civilisation. For the next generation to have a future, we as nearly seven billion people living on a planet with finite resources, must immediately begin the process of restructuring the global economy before we reach the tipping point of massive market failure and the collapse of social, economic and government structure.”

And given his track record, there is little doubt that Sir Allen will play a significant role in tackling the challenge of global climate change, applying the same meticulous preparation, dynamic energy, and appetite for sheer hard work, that has made him such a successful businessman, to help knock this global threat for six.

For further information www.stanfordeagle.com

Transfer pricing and over-regulation

Posted on August 18, 2008February 9, 2012 by itsupport

What is transfer pricing?
It embodies the fundamental pricing calculation when services, tangible property and intangible property are bought and sold across international borders between related parties. The arm’s-length principle is formally defined in Article 9 of the OECD’s model tax convention as following:

“Where conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.”

As the IRS’s section 482 puts it more plainly, transfer pricing regulations are necessary to prevent related taxpayers in differing taxing jurisdictions from easily and artificially shifting items of income and expense between these different tax jurisdictions (with differing rates of tax). The intent of the law is to ensure that an arm’s-length price is charged in all related-party multi-jurisdictional transactions.

Under the umbrella of “best method”, the most important factors to be taken into account for each inter-company transaction is “the degree of comparability between the controlled transaction (or taxpayer) and any uncontrolled comparable, and the quality of the data and assumptions used in the analysis”.

For tax authorities, the pricing calculation is vital because it fixes the profits of the business that are subject to tax in particular jurisdictions. Increasingly these authorities are prepared to re-calculate inter-company pricing if they consider the agreed price would be different from that agreed between two unrelated – or arm’s-length – parties. In short, they are on the look-out for transactions they regard as manipulated in order to obtain a tax advantage. When that happens tax charges can be expected to increase, especially when extra interest and even penalties are applied.

There are important inconsistencies and disagreements between different tax authorities over the interpretation of the arms-length standard. But the OECD’s methodologies have become the gold standard in transfer pricing calculations. Thus the use of arm’s-length provides a measure of certainty and, if properly observed, is likely to keep any adjustments to a minimum. Essentially, it is based on a transfer price being reached that would have been arrived at by unrelated parties for the same transaction.

Regulations Versus Principle
The dominance of the internationally accepted arm’s-length standard in all issues of transfer pricing has tended to blunt the effect of the multiplicity of regulatory changes introduced over the last twenty years. This is because the principle of arm’s-length requires that the prices employed in related-party transactions must make commercial sense. Thus, unlike most other areas of tax law, the measure is not based on explicit rules but a principle grounded firmly in issues of economic substance. As a result it hardly matters what new set of regulations is issued by a taxing authority or even by the OECD because the analytical process required to justify the prices reached in a particular related-party transaction remains the same. Namely, the arm’s-length standard. Therefore arm’s-length, essentially an economic issue, remains pre-eminent as the cornerstone of transfer pricing methodologies.

For example, many countries specify a hierarchy of transfer pricing methodologies to be used (e.g., direct price comparisons are first in the hierarchy and gross margin comparisons are second and third). Before the mid-1990s, the US too specified such a hierarchy in its 1969 regulations. Then the US abolished the hierarchy. Did the change in the US alter real practice? No. “Under the old 1969 rules I never saw a situation in which both parties agreed that method B was better than method A, but nonetheless method A was used because it was higher up in the regulatory hierarchy” Greg Ballentine, of The Ballentine Barbera Group, a CRA International company, explains. “If one party preferred method A and the other method B, they had to debate the issue on the basis of the accuracy of the method employed.”

The introduction in the US in the early 1990s of the best method-rule, replacing the hierarchy, has hardly changed things at all. “We are still seeing the same debate we had until the changes were made,” Mr Ballentine adds. “But it now occurs in the context of the best-method rule.”

It would be overstating the case to claim that all the modifications of the past 20 years have had no effect. Some have manifestly served to clarify issues around the edges. However there is a strong argument that in summary those changes have tended to confuse the issue. In particular they give the impression that, as long as one reads the local taxing authority’s regulations and follow them step by step, the prices reached must therefore be acceptable regardless of the degree to which those prices may clash with commercial reality. In fact this is deceiving because the nub of the arm’s-length standard is that it essentially requires commercial commonsense, whatever the local rules may say.

An international issue
The most important issues in transfer pricing over the last twenty years relate to the heightened scrutiny by taxing authorities around the world. Transfer pricing long seemed like a purely US issue but it is now very much a multinational one. The authorities in many countries are rapidly training up auditors to cast a cold eye on transfer prices, even in those jurisdictions with relatively low tax rates and/or tax holidays where they would not be expected to take much interest. It increasingly seems there is no escape as taxing authorities catch up with the international dynamics of the commercial world.

The implications for taxpayers are obvious – they must take every care to fulfil compliance obligations under the relevant jurisdiction’s tax laws. According to UK-based accountancy firms, documentation should cover sales prices, purchase prices, management fees, interest paid on any loans, and even the price paid for general use of facilities such as office space and computer systems. After amending its own regulations in 2004 [see below], Her Majesty’s Revenue and Customs allowed a documentation holiday of two years but the requirements are now fully in force. In the absence of complete records, jurisdictions may feel free to construct the facts as they see fit, which is not generally in taxpayers’ interests.

However in the existing system the taxpayer risks falling between two stools. On the one hand there is a need for local documentation or some well-supported form of defence under the particular jurisdiction’s specific rules. On the other there is the need for a worldwide consistency. The latter becomes especially important as local taxing authorities increasingly seek pricing information in jurisdictions other than their own. For instance, BBG/CRAI regularly finds that, despite a client’s documentation declaring sufficiently high local, taxable profits to satisfy the relevant authority, the IRS also wants to sight the documentation under its own set of transfer pricing rules.

State of flux
The entire transfer pricing issue is highly dynamic, with constant modifications occurring in many arenas. For example, in late 2007 US Treasury urgently recommended measures to combat what it termed transfer pricing abuses. Arguing that the original regulations had remained in force essentially unchanged for almost 40 years, it added: “These regulations have proven to be inadequate to handle the increased volume and complexity of multinational operations and transactions that have occurred since that time.”

US Treasury singled out in particular the absence of updated regulations for the transfer of services which “has led to discontinuities between transfer pricing for services and transfer pricing for tangible and intangible property”. Just one area ripe for attention, US Treasury said, was global dealing rooms.

And in 2004 the UK government amended its rules so they encompassed for the first time transactions between connected UK companies. This was because Her Majesty’s Revenue and Customs feared it could be successfully challenged in the European Court of Justice on the grounds it discriminated against companies from other EU countries because the rules did not apply to transactions between UK companies. Other countries have also been busily updating their regulations in their determination to maximise tax revenue.

Even the OECD, which has made the international pace on transfer pricing, is in the middle of a review of its approach. As of this moment it is weighing up responses to its proposals to modify its application of transactional profit methods, specifically on the issues of profit split and net margin. It is considered highly likely that modifications will result. Indeed the OECD sees the harmonisation of transfer pricing rules as a significant element in fostering world trade.

Economists in demand
As further proof of the economic nature of the arm’s-length principle, BBG has seen a marked swing recently towards the use of economic expertise as clients and governments alike struggle to settle transfer pricing issues. Until relatively recently, BBG/CRA’s economic expertise was in demand by US-based clients because that is what US Treasury-devised laws require whereas, outside the US, clients believed they needed accountants. “I am convinced that a major reason for this is that the IRS relied on economists while foreign tax authorities did not”, adds Mr Ballentine.

However like much else in transfer pricing, this is changing. The Canadian Revenue Authority, which has for years employed economists on transfer pricing audits, has called them in as expert witnesses in transfer pricing trials there. The Australian Tax Authority, another entity that employs economists, has enquired whether BBG’s economists would serve as expert witnesses on several cases heading towards trial. And in New Zealand, clients have tapped BBG/CRA’s expertise and that of other US economists in cases taken by the New Zealand authorities. Similarly in Britain where HMRC has sounded out BBG/CRA’s US-based economists about supplying expert testimony in possible trials there.
Taken together, these examples support the case that arm’s-length is less a tax regulation-based issue than one grounded on economic substance.

For further information tel 202.662-7831; email gballentine@crai.com; www.crai.com

The top ten great financial crises

Posted on June 19, 2008February 14, 2012 by itsupport

The Dutch tulip crisis (1630s)
Perhaps it is possible to understand why investors abandoned all economic logic, and ignored historical evidence, during the dot com bubble. After all, the internet is an astonishing phenomenon, as is the personal computer. But tulip bulbs? What sane person would ruin their family’s fortunes over tulip bulbs? A large proportion of the Dutch well-to-do in the early 17th century, as it turns out.

It was the 1630s when tulipmania took hold, and as with most bubbles, the great and the good, in this case the local mayors, were investing heavily when the market began to wilt. Not wishing their investments to rot, the mayors initiated some neat financial engineering. They agreed to convert their contracts with the-planters from a contract to buy bulbs at a fixed price, to an option to do so if a higher price was reached. If not they paid a fraction of the contract price to the planters.

And so, in the winter of 1637, it was in everyone’s interests for the market to go up. By February 1637 the contract price was 20 times greater than the previous year. One person supposedly paid over 6,500 guilders for a single bulb, the equivalent of an Amsterdam townhouse. But, in the spring of 1637, as all bubbles do eventually, the tulip bulb market burst.

The South Sea Bubble
In February 1720, shares in the South Sea Company, based in England, were trading at £130; by June the price was an astonishing £1050. Adam Anderson, a clerk with the company, described events of the time as an “unaccountable frenzy”. By November 1720, however, the share price was back to £170. The frenzy had subdued. The South Sea bubble, as it is famously known, had burst.

While the South Sea Company may conjure up images of oceanic trading, it was actually established in 1711 as a rival to the Bank of England. Backed by the Lord Treasurer, Robert Harley, it was promised a monopoly of all trade to the Spanish colonies in South America (then the South Seas) in return for taking over and consolidating the national debt incurred as a result of the War of Spanish Succession.

Ultimately, the trading proved to be a diversion, the main money making enterprise being converting government debt into South Sea Company shares and then talking up the trade prospects to inflate the share price.

In a masterstroke of financial innovation four share subscription offers were made to the public using a credit payment system where investors made an upfront payment, paying the balance in instalments over a fixed period. Each issue involved a different down payment and instalment period.

Despite it being effectively the same product – the original shares and four different subscription contracts, the receipts of which quickly became tradeable – the prices of the four assets deviated from each other, and arbitraging failed to bring about price convergence.

The aberrant investor behaviour, described by one lawyer for a Dutch investor as “nothing so much as if all the lunatics had escaped out of the madhouse at once”, has been put down to factors such as complexity and excitement. It certainly must have been both to confuse one of the world’s greatest thinkers. “I can calculate the motions of the heavenly bodies but not the madness of people,” observed Sir Isaac Newton, who lost money amid the feverish speculation.

The Wall Street Crash
Ask the average person in the street to name a financial crisis or stock market crash and the chances are they will name the Wall Street Crash of 1929. Not a single steep one day fall, but rather a long protracted affair, the Crash involved not one but three “black” days – Thursday, Monday and Tuesday (October 24, 28 and 29)– in quick succession.

In August 1921, the Dow Jones Industrial Average was at 63.9. There followed a period of economic boom, through the Roaring Twenties, fuelled by the optimism of a new technological age – radio, cinema, the car, telephone, and aviation. Stock prices reached new records, driving the Dow to a peak of 381.17 in September 1929.

In October 1929, however, the market turned, it fell and continued to fall, (38 points on Black Monday). Mass selling overloaded the telephone and telegraph system. After a brief recovery, the Dow headed southwards once more, and by July 1932 had reached 41.22, it would take over 20 years to recover. At the same time the mass withdrawal of savings precipitated a banking crisis, with the number of banks declining from 25,568 in 1929, to 14,771 in 1933.

Apart from its severity the Wall Street Crash is notable for the great names that it reduced from riches to rags. William Crapo Durant, the founder of General Motors, King Camp Gillette of shaving razor fame, Charles Schwab, one of America’s greatest industrialists; these and many more great businessman (and ordinary investors) were ruined by the Crash of 29.

The Weimar Republic – a banking and currency crisis
A large bank gets into severe difficulties. It reacts by cutting back lending to other banks and to businesses, which in turn has a knock-on effect inducing turmoil in the financial markets. Sound familiar? But on this occasion it is not North America in 2007, but Germany in 1931.

In July 1931, the Weimar republic suffered a major economic blow. The Reichsbank, Germany’s central bank, found itself in difficulty because of a combination of factors, including the collapse of international trade and Germany’s debt burden, and reacted by reining back credit facilities. The result was a panic in the banking sector that led to the nationalisation of two of Germany’s biggest banks, the rescheduling of short-term foreign debt, and the introduction of capital controls.

More significant, however, were the long term effects. Germany ceased World War One reparation payments in 1932 and defaulted on is foreign debt in 1933, both events were important precursors to the rise of the NSDAP party in Germany and the eventual outbreak of the next world war.

Oil crisis 1973
Although not strictly a financial crisis, the oil crisis of 1973 merits inclusion in this list, if only because of the far reaching effects it had on western economies. The catalyst for the oil crisis was the Yom Kippur War, between Syria and Egypt on one side, and Israel on the other, which began on October 6, 1973. The conflict triggered a cascading sequence of events that caused chaos, inflation and recession in the West.

The Organisation of Arab Petroleum Exporting Countries (the Arab members of OPEC plus Egypt and Syria) announced an oil embargo, affecting the US and other nations that supported Israel. In the US, oil imports from the Arab nations plummeted from some 1.2 million barrels daily to around 20,000 barrels. Oil prices rose rapidly and the US suffered its first fuel shortage since the Second World War.

Across Europe the effects of the embargo were patchy. The Netherlands, which supplied arms to the Israelis, was badly hit, whilst France was relatively untroubled. After the embargo was announced on October 17, 1973, the NYSE lost nearly $100bn in just a few weeks. The embargo was lifted in March 1974, although the effects rumbled on, manifest most noticeably in an increased drive for energy security among western nations, as well a radical reshaping of the automobile industry and the rise of the hatchback.

Black Monday
Black Monday, or, if you are Australian, Black Tuesday, is the popular name for Monday, October 19, 1987, the most spectacular of global stock market crashes to date. Not the steepest one day market fall though, that honour lies with the Dow Jones’ 24.39 percent collapse on December 12, 1914.

The significance of Black Monday, when the Dow Jones fell by 22.6 percent, is severalfold. It was a substantial fall, the second largest in the Dow’s history in percentage terms. It was a global event, starting in Hong Kong and rippling across international time zones. By the end of the month markets had declined by 45 percent in Hong Kong, 41 percent in Australia, and 26 percent in the UK.

Perhaps the most interesting thing about Black Monday, however, is that it was not predicted, and has yet to be explained satisfactorily. Not that there is any shortage of suggested causes. Some attribute the crash to automated programme trading, derivative trades, and portfolio insurance, others to recession fears, others still to overvaluation of stocks.

Certainly the supposed “rational investor” of economic theory, capable of absorbing changes in events and making sensible well-informed, if self centred decisions, appeared to have vanished, replaced by irrational, excitable, exuberant investors, who blindly followed the crowd.

But, just as soon as the panic started, it was over. Historic blip behind it, the Dow Jones carried on climbing as normal service was resumed.

Black Wednesday
Another black day in the world of finance, at least from the UK’s perspective, Wednesday the 16th September 1992, was the day that the UK government was forced to withdraw from the European Exchange Rate Mechanism (ERM). The decision came on a day during which the UK treasury spent some $27bn of foreign currency reserves in an attempt to shore up the value of sterling (although the total cost weighing other factors is said to be £3.3bn). At the same time, currency speculators and investors, most notably George Soros, made a small fortune betting against the UK government’s ability to beat the markets.

The UK’s plight demonstrated the perils of fixed exchange rates. With UK sterling entering the ERM in 1990 tied to the deutschmark at DM 2.95, it soon became clear that keeping sterling within its exchange rate limits was at odds with the needs of the domestic economy. Germany was reining back inflation as result of a post unification boom, while the UK needed to promote growth on the back of the recession. When Germany’s interest rates went up, the UK found it painful to follow. A strong pound was damaging exports and prolonging recession.

Currency speculators figured it was a only a matter of time before the UK allowed sterling to devalue, beyond its narrow ERM bands, and that there was not the political will on behalf of the other EU countries to defend the pound. Consequently, they began to short sterling, confident they would be able to buy it back more cheaply in the near future.

Initially, the UK government resisted devaluation, mounting a concerted campaign to shore up sterling both through trading and by hiking interest rates. Matters came to a head on Black Wednesday, as the Chancellor of the Exchequer announced a series of interest rate rises in quick succession, from 10 percent to 15 percent (although the last was never implemented), it was clear to everyone that the game was up, however, and the UK withdrew from the ERM.

The Asian financial crisis
Whether you prefer to call it the Asian financial crisis, East Asian financial crisis, or IMF crisis, the fact remains that the financial crisis that gripped Asia from the summer of 1997 onwards was one of the most significant and long running financial events of the latter half of the 20th century.

Like many other crises, the Asian financial crisis follows an all too familiar pattern. First the boom. During the mid-1990s, foreign investment flooded into Asia and the emerging economies, resulting in high interest rates, high asset prices, and rapid growth rates. Countries like Thailand, Malaysia, Indonesia, the Philippines, Singapore, and South Korea were growing at average rates of over eight percent. Much of the investment was highly leveraged.

Then the bust. The US, emerging from its recession during the early 1990s, began to focus on keeping inflation down, and raised interest rates. Investors switched attention to the US; the US dollar increased in value. At the same time, many of the Asian nations had pegged their currencies to the US dollar and in an effort to remain an attractive investment destination were forced to raise interest rates and expend reserves defending their currencies to avoid devaluation.

You just know that there is going to be trouble when a Prime Minister makes a public announcement that they will not devalue their currency. And so it proved when, in June 1997, Prime Minister Chavalit Yongchaiyudh of Thailand refused to countenance devaluation of the baht, leaving the way clear for currency speculators. Inevitably the baht was eventually floated, and the currency slumped.

And so, temporarily, the “Asian economic miracle” shuddered to a halt, as panic spread throughout the region, badly affecting Indonesia, South Korea, Hong Kong, Malaysia, Laos and the Philippines, with the IMF pumping in $40 billion in an effort to stabilise currencies in South Korea, Thailand, and Indonesia.

On a wider scale the Asian crisis knocked confidence in lending to developed countries, which has a negative impact on oil prices, contributing in part to the Russian financial crisis.

The Russian financial crisis
The bank’s motto may have been, “We are for real, we are here to stay,” however Inkombank had not reckoned with the ferocity of Russia’s 1998 currency crisis, which reached a peak on August 13 1998.

Like many banking crises, the Russian banking crisis was caused by a combination of factors. In 1997 and 1998, the effects of a declining economy were exacerbated by the Asian financial crisis and the decline in demand and price of oil and other commodities that Russia produced.

In the background, amidst the impending crisis, the government were issuing short term bonds, known as GKOs, to help finance the budget deficit. However their issuance resembled something of a pyramid or Ponzi scheme, with the interest on matured obligations met using the proceeds of newly issued obligations.

Internal debt obligations became difficult to fulfil. By August 1, 1998 there was over $10 billion in unpaid wages owed to Russian workers. Various workers were on strike –including the coal miners. And as with the UK and the ERM crisis, Russia’s problems were compounded by its policy of linking the rouble, to another country’s currency, in this case the US dollar. Throughout 1997 and 1998 the Russian government expended billions of its US dollar reserves, supporting the rouble.

Finally, on August 13, 1998, the Russian financial system went into meltdown. Stock, bond, and currency markets collapsed, as investors scrambled to get their money back. The stock market was temporarily closed because of the steep falls. In the fallout, several banks closed, including the not so permanent Inkombank. Russia’s recovery, however, was surprisingly swift, driven in part by a rapid rise in the price of oil and other commodities.

The Great Credit Crunch (2007-08/09?)
In contrast to the short sharp shock of most stock market crashes, the present credit crunch crisis is more like death by a thousand cuts.

The origins of the crunch are well rehearsed. Speculative unsound mortgage lending, the repackaging and reselling of sub-prime mortgage debt as supposedly attractive financial products, the gradual realisation that those products were not quite as attractive as their credit ratings might suggest, the consequent unwinding of positions, recalling of funds, and reluctance of banks to lend money to each other.

If it feels as if the current crisis is interminable, that’s probably because it has been rumbling along since the beginning of 2007 when it became clear that a number of sub-prime lenders in the US were in trouble. Ever since, it has been an endless procession of write downs, financial losses, CEO resignations and now rights issues.

Along the way Wall Street investment bank Bear Stearns has been acquired by JP Morgan Chase, and the UK bank Northern Rock taken into public ownership. The response of the central banks wavered initially between wanting to avoid a banking catastrophe, and not wishing to encourage moral hazard and reward poor lending practices. In the end, the former won out, with concerted action pumping hundreds of billions of dollars into the system in an effort to lubricate interbank lending and bring down the LIBOR rate.

Has it worked? Who knows. Everyone has an opinion, but it is early days still. The only certain thing is that it will happen again, and that one quick read through the following shows that we should all, banks, investors, regulators and governments, know better. Forget neoclassical economics and efficient market theory; fear and greed, that is where it’s at.

Financial crises that shook the world…

Posted on June 9, 2008October 11, 2012 by itsupport

SEPA – simpler, faster, safer

Posted on May 27, 2008February 14, 2012 by itsupport

At the end of last month, January 28, the European banking industry implemented a process that will make it simpler, faster and cheaper to transfer money across national borders. This is the first visible outcome of an ambitious project to harmonise and modernise the retail payments market in the European Union. More practical steps will follow, bringing benefits to bank customers across Europe, and opening up new opportunities for the banks themselves.

Single Euro Payments Area (SEPA) is the name of the project that harmonises rules for euro payments. It will enable bank customers to make more efficient payments in euro, irrespective of their location. The European Central Bank (ECB) and the national central banks of the Euro system have a keen interest in the efficient functioning of the financial system. We are fully committed to help making SEPA a success.

Opportunities for Europe
The SEPA project is an important step towards more financial integration in Europe. It removes the fragmentation in the retail payments markets by introducing a single set of payment instruments or services for euro payments. SEPA is also introducing equal access conditions to payment services or products, thereby ensuring that market players are treated equally across Europe.

With its harmonisation and restructuring efforts, SEPA is a crucial driver for opening up the different national retail payments markets, encouraging European-wide competition and fostering innovation. Banks and other payment service providers are able to offer their services in different European countries, which will intensify competition to the benefit of European citizens. SEPA is also increasing the possibilities for economies of scale and scope, for example in the processing platforms, and is thus stimulating investment opportunities. Indeed, SEPA allows for more rationalisation, consolidation and expansion, all of which we already see happening now.

SEPA will also bring opportunities for corporates and customers as it will simplify their euro payments and allow for cost savings. From one single account it will be possible to reach all other accounts in Europe. Merchants and corporates will also benefit from more efficient processes and common standards for their payments. And payment cards will be used more widely, which will ultimately reduce the costs of cash handling. The introduction of chip and pin for every card will further improve customer safety and convenience.

SEPA will initiate a modernisation process in Europe, which will bring new and innovative products. The SEPA instruments, which have been designed for credit transfers and direct debits, are the basis on which further developments will be made. Several future-oriented initiatives, such as e-invoicing, online payments (web-retail) and mobile payments, permit efficiency gains for customers. For banks, SEPA is an opportunity to reach wider audiences and new sources of revenue.

Challenges of SEPA
SEPA has already led to many changes in the banking industry and will continue to bring new challenges in the years to come. The banking industry is facing in particular three main challenges, which are of a technical, commercial and legal nature respectively. The industry must address these challenges together by removing the barriers that exist between the current national payments markets.

A first challenge is of a technical nature. So far, the banking industry has been very successful in developing common technical standards that enable the smooth connection of systems and the transfer of messages between different banks in Europe. Technical standards are the basis for payment systems, ensuring the transfer of funds. In the years to come the industry should further deepen and widen its standardisation efforts, which could lead to new challenges. National fragmentation through different standards, e.g. in the customer-to-bank space, should soon belong to the past and common standards should be in place. The Euro system fully supports the work of the industry in this field and encourages the adoption of international best practices and standards, such as those developed by the International Standards Organisation (ISO).

A second challenge is of a commercial nature. With SEPA, the banking industry has developed new rules and business practices for euro payments. These are referred to as the ‘rulebooks’ that ensure common treatment for transferring funds in Europe. In particular, the banking industry has agreed on the common rulebooks for credit transfers and direct debits, and two frameworks, one for card payments and the other for clearing and settlement mechanisms. The Euro system fully supports the banks’ work in this field. The challenge for the industry is to develop common rules that will allow different entities to provide more innovative services throughout Europe. The younger generation of bank customers in particular increasingly prefer online and mobile transactions, and a solid common framework for Europe must be developed.

A third challenge is of a legal nature. For a long time the national regulatory differences in Europe hindered the provision of efficient and automated services across borders. The Payment Services Directive will remove these legal barriers. The Directive will create a clear and homogenous framework for making payments in euro, and should be transposed by November 2009 at the latest. The Euro system strongly supports the work on the Directive as it will provide the legal certainty that is necessary for operations across Member States. A coherent and early adoption of the Directive is imperative for the banking industry, as it will facilitate the implementation of SEPA. The European Commission and the ECB are therefore closely monitoring the implementation of the Directive into national legislation.

A bright future
The ECB’s outlook for SEPA is a truly integrated market where all euro payments are treated as domestic payments and the level of safety and efficiency meets customers’ needs. To realise the SEPA vision, strong commitment from all the stakeholders is required.

The banking industry has showed its commitment to the project and has laid the foundation for a new payments landscape in Europe. In January 2008, with the launch of the new SEPA credit transfers, the future begins in Europe. The SEPA direct debit will be launched in a second wave, during 2008-2009.

The success of the single euro payments market, however, does not only depend on the alignment of national practices or on banks developing new services; it also requires economic actors in all countries to change their habits. The banking industry, therefore, must continue its work and engage customers in the further development of SEPA. The modern, informed and demanding European customer wants an attractive offer and future-oriented products and services.

The ECB and the national central banks of the euro area are supporting the developments of SEPA, and will pay particular attention to ensure that the new landscape has all the characteristics of an integrated market which benefits customers. The ECB is acting as a helping hand or ‘catalyst’ for private sector initiatives and is monitoring the progress of SEPA. As a catalyst, the ECB is making special efforts to foster collective action that facilitates financial integration and provides better services for customers. In this respect, the ECB is paying particular attention to providing clarity on all features of direct debits, addressing the need for at least one additional European debit card scheme and ensuring the reach ability of banks.

SEPA has initiated the necessary developments that will bring Europe closer to enjoying an integrated and sophisticated retail payments market. It is now up to banking industry to not lose momentum and to maintain its efforts to develop further ‘state of the art’ products and services.

Unlimited opportunities

Posted on May 23, 2008June 12, 2013 by itsupport

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
Email: bill.henry@ru.pwc.com
Website: www.ru.pwc.com

Transfer pricing and transactions in Finland

Posted on May 23, 2008February 9, 2012 by itsupport

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
Email: outi.ukkola@deloitte.fi
Website: www.deloitte.fi

India’s tax situation

Posted on May 23, 2008February 9, 2012 by itsupport

There is a growing concern in the international business community about the lack of certainty and transparency in the application of income taxes to their business operations in India.

The general impression is that the administration of tax laws in India is often arbitrary and deviates from well-accepted international norms and interpretations. Executives also are concerned about the time- consuming nature of litigation and dispute resolution in the country.

In order to improve the situation, Ernst and Young regularly participates in discussions with the policy-makers in the Indian Ministry of Finance to communicate the concerns of the international business community, says Gaurav Taneja, national tax director and partner of Ernst & Young in India.

The objective of the discussions is to make the authorities aware of several factors, he said, namely that:

* A gap exists between Indian and international income tax practices

* There is an economic cost from the current practices in the form of lost investment and employment opportunities;

* Simpler and clearer tax policies and interpretations and simplification of the dispute resolution process would facilitate an investor-friendly environment, yield more revenues, and reduce administration and compliance costs.

“The ultimate objective is to assist in the development of credible positions which are seen to be in the overall interest of the Indian government and the non-domestic corporate tax- payers,” said Mr. Taneja, whose firm states that it has the largest integrated tax advisory team in India of more than 1,000 dedicated professionals.

Changes to the tax policies were announced on February 29 in the nation’s Budget and incorporated into the Finance Bill, 2008.

However, says Mr Taneja, “the future of India’s tax policies cannot be foreseen based on the provisions of the Finance Bill alone. Over the years, the corporate tax rate has stabilised with the basic corporate tax rate being 30 percent. Perhaps for the first time, the direct tax collections have surpassed those from indirect tax such as excise, the hallmark of any tax-developed regime. Thus, Indian tax policies do need to take into account the changing environment.”

Indian Finance Bill 2008
The Economic Times in India believed that the Indian Finance Minister’s Budget was “crafted with an eye on the upcoming general elections, rather than giving impetus to the growth story.” The news journal noted that there were some “positives” for certain sectors such as auto and education, but was “rather disappointing” for information technology and banking.

Ernst & Young’s Mr. Taneja, meanwhile, pointed out some of the new taxation issues that are proposed in the Finance Bill 2008 as announced during the Budget.

For example, there has been no change on the corporate tax rate, but one of the most significant proposed changes has been in the manner of computing the book profits for the “minimum alternative tax” levy (MAT).

Presently under the MAT provisions, if the tax payable on total income computed under the normal provisions of the Income Tax Act 1961 (Act) is less than 10 percent of the book profits of the company, then MAT is levied at 11.33 percent on such book profits. (Book profits are the net profits shown in a profit and loss account prepared as per the Companies Act, 1956 as increased or reduced by certain adjustments provided for in the Act.)

However, says Mr. Taneja, the Finance Bill proposes to add back any deferred taxes and provisions to arrive at the adjust book profits. “Moreover, this amendment is proposed to be retrospective from April 1, 2001,” Mr. Taneja added. “By doing so, the Bill has sought to overturn a few judicial decisions and may lead to reopening of tax cases in several instances.”

However, the Finance Bill gives some respite from dividend distribution tax (DDT), says Mr. Taneja. Shareholders have been exempt from paying tax on dividends paid by Indian resident companies, but the companies have had to pay a “dividend distribution tax” of 16.99 percent. “This has lead to a cascading impact in the case of multi-tier group entities,” says Mr. Taneja. “The effective tax burden is high since DDT is a sunk cost and is not allowed as a deduction while computing taxable business profits.”

The Finance Bill provides some respite by proposing that the amounts of dividend paid by an Indian resident company (provided it is not a subsidiary of any other company) will be reduced by the amount of dividend received by it from its Indian subsidiary in the same financial year. This provision, however, does not benefit a subsidiary in India of a foreign company or more than a two-tiered company structure.

Also in the Finance Bill are certain proposed amendments regarding administrative and procedural provisions which may give the tax authorities further leeway on the issue of notices at the summary (initial) assessment level and the initiation of penal proceedings without giving any reasons. “One proposal which has come in for much criticism is that where a taxpayer has appeared in any proceeding or cooperated in any inquiry relating to an assessment, it shall be “deemed” that the notice from the tax department was duly serviced on him and was not invalid,” said Mr. Taneja. “In other words, he cannot cooperate without prejudice to the right to object subsequently as regards the invalid status of the tax notice.

I.T. industry taxation
Meanwhile, the Budget proposals were not favourable to the I.T. industry, according to Mr. Taneja. Under the present taxation scheme, the I.T. sector operating through undertakings set up under various government schemes such as the Software Technology Park, Electronic Hardware Technology Park Schemes –enjoy a complete direct tax exemption or tax holiday on earned export profits. Such undertakings are also eligible for certain indirect tax benefits such as exemption from payment of customs duty on imports. However, while the indirect tax benefits are slated to continue for companies operating out of such undertakings -. the tax holiday has a sunset clause of March 31, 2009 when it would be due to expire. Perhaps owing to India’s World Trade Organization commitment, this tax holiday period has not been extended in the 2008 Budget, even though the depreciating dollar against the rupee has hit hard the IT exporters.

“The Budget proposals have also been largely unfavourable to the IT Industry on the indirect tax front as well,” said Mr. Taneja. The excise duty on packaged computer software has increased from 8 percent to 12 percent. There is also a proposal to withdraw the service tax protection available to the IT industry by bringing ‘information technology software services’ within the service tax net (taxable at 12.36 percent). “This proposal may actually be beneficial to exporters who will now be able to claim a refund of service tax/excise duty paid on input services/inputs,” he added.

There could have been a more focused set of incentives provided to the IT industry targeted at the continued growth of the IT sector, Mr Taneja adds. “In our view, the Budget could have provided an extension of the tax holiday benefits for at least one year for the smaller players if not for everyone in the industry,” he said.

News reports claim that India may face stiff competition from other countries such as Vietnam for the “Business Process Outsourcing (BPO)” sector which sets up outsourcing companies in nations which offer tax holidays, free space, and reimbursement for salaries and training costs.

However, it is too early to say how the impending sunset clause on India’s tax holiday will affect the growth in India’s BPO sector, says Mr. Taneja.

“Over the years, India has transformed from being a pure outsourcing destination to an innovation or knowledge hub,” he said. “Unlike BPO which is regarded as procedure driven, Knowledge Process Outsourcing (KPO) is more knowledge-driven. Nasscom, an IT industry association, estimates that this sector is poised for a 45 percent per annum growth till 2010 and may touch $17bn by that date. According to Nasscom, engineering, design, biotech and pharmaceuticals are some key areas in the KPO sector. Thus, while it may be possible that other countries may attract investments into BPO operations, by reinventing the wheel India appears to be still capable of attracting investments.” It is also interesting that some large Indian resident companies are migrating their low-value operations to cheaper jurisdictions, Mr Taneja added.

Offshore jurisdictions
Meanwhile, prior to the Budget, there was talk of India’s finance minister introducing anti abuse provisions in the Finance Bill, primarily to take care of treaty abuse, especially as regards the tax treaty with Mauritius,

In the recent past, the practice of routing investments into India through jurisdictions like Mauritius and Cyprus, which contain favourable capital gains tax clause in the treaties, has been a much debated topic,” said Mr Taneja. “In these cases, the sale of shares of Indian companies do not attract capital gains tax in India. Further Mauritius and Cyprus also do not levy any tax on such capital gains.”

However, the Finance Bill, 2008, has not introduced any unilateral amendment which could impact foreign investments. “Fortunately, there has been no knee jerk reaction,” said Mr Taneja. “While interpretation of tax treaties may continue to result in litigation at the lower judicial levels, by and large, India is committed to honouring its treaty commitments.”

Media reports have highlighted efforts at renegotiation of these tax treaties – those with Mauritius and Cyprus, but the outcome of such negotiation is still unclear, as renegotiation is a bilateral act based on consensus, Mr. Taneja said. “The Indian Government may completely want to do away with the favourable capital gains tax clause in these tax treaties similar to the recently amended UAE tax treaty. Alternatively, they may want to introduce specific Limitation of Benefits clause to avoid misuse of tax treaties similar to the one introduced in the Singapore tax treaty,” he said.

Permanent establishments
On another matter, Mr. Taneja has concerns about the treatment of “permanent establishments (PE)” under Indian law. “Despite various judicial precedents, there is a lack of clarity and consistency at the tax assessment stage, especially by lower level tax officers, as regards creation of a PE in India upon deputation of expatriate employees, limited presence in India such as through a representative office, or performance of activities in India by agents,” said Mr. Taneja. “The attribution of appropriate profits to PE of the foreign enterprise in India has also suffered arbitrariness.”

Although, domestic tax laws (Rule 10) provide some guidance for the revenue authorities, these may not be objectively applicable in all situations where the PE would have performed limited role in the over-all business transaction, he said. Owing to the aggressive stand of the tax authorities, especially at the lower levels, it has now become very imperative for MNEs operating in India to review their existing business models to determine the extent of PE risk that they face and the risk associated with the subsequent income attribution to such PE by the tax office, he said.

For further information:
Tel: +91-124-464 4000
Email: gaurav.taneja@in.ey.com
Website: www.ey.com/india

The pole position – a blessing or a curse for FDI?

Posted on May 23, 2008February 14, 2012 by itsupport

Slovenia’s business makeover has not been a bumpy ride experienced by other economies in transition at the beginning of the 1990s. Slovenian companies were a target for foreign interest as early as in the late 1970s thanks to Slovenia’s manufacturers of household appliances, cars and commercial vehicles, furniture and garments. Conveniently nestled between Austria and Italy, Slovenia has traditionally served as a gateway for exports to the discerning markets of West Europe even in former Yugoslavia.

Much has been done to boost the country’s attractiveness as a place to do business between Slovenia’s independence and today. The call for political action was backed within the framework of effort to become a full EU Member State and awareness that the Slovenian internal market was not fully integrated, which in turn meant a lack of competition in some sectors and increased operating costs for foreign investors.

Following the political consensus, liberalisation of the internal market has been built continuously since 2000 as the Slovenian economy become fully integrated with the EU economies, joined the EU in 2004, qualified for Eurozone and adopted the euro on January 1, 2007, and entered the EU Schengen in December 2007.

Adding value
Despite the country’s good economic performance, the government is committed to continuing efforts to improve micro-economic conditions to enhance GDP growth. This includes measures to increase competition by liberalising previously sheltered industries such as electricity, energy, telecommunications, and to dismantle administrative hurdles. In response to the critics quoting Slovenia’s excessive red tape and the shortage of land for industrial use, the Slovenian authorities got down to the business of changing the country’s business landscape attractive to foreign investors. Since 2000, registering a company in Slovenia has been greatly facilitated in many ways including electronic access to practically all public administration services, and the number of locations for property development and redevelopment to technological parks and economic zones has jumped.

When foreign investors consider locations to relocate or expand operations, the attractive tax regime of the eastern Alpine country bordering the Adriatic Sea is a reason to shortlist it. The present government deserves much of the credit for Slovenia’s tax reforms: a gradual corporate tax rate reduction aimed at promoting a pro-growth economy, phasing out of pay-roll tax, a relief on personal income tax. Tax allowances are in place for investment in research, technology and development, while greenfield foreign investment projects in manufacturing and sectors with high value added are eligible for financial incentives when they create new jobs. With tax revenue accounting for some 40 percent of GDP in 2005, Slovenia’s tax rates are lower than in many other European countries and converge with the EU27 average.

While traditionally taxes have been one of the key reasons for locating and investing away from home, transparent and stable political, legislative and administrative environment, the ease of getting about: good transport to airports, good rail links, availability of schools and good quality accommodation, as well as quality of life in general, should tip the scale in favour of Slovenia. The government’s ambition is to make Slovenia the leading European choice of international companies for locating international/European headquarters, an R&D centre, or a centre for administration and/or accounting functions. The government reforms have helped Slovenia’s economy increase its competitive edge and appeal to foreign investors without overheating the economy. Thanks to a wide-spread use of the first common financial reporting standard – IFRS – investors can compare statements produced in one country with those produced in another and exploit the advantages of mobile technology and broadband penetration where Slovenians themselves are early adopters both for business and private purposes. Today investors can benefit also from lower transaction costs arising from the single currency and the implementation of the Single Euro Payments Area (SEPA) where the current differentiation between national and cross-border payments no longer exists. This means that customers within the SEPA are able to make payments throughout the whole euro area as efficiently and safely, and above all at the same price, as in the national context today.

More ingredients for a recipe to attract FDI
Many Slovenians speak English, German and Italian and the Slovenian economy has all the attributes of an open and dynamic system without high leverage. Its budget revenues and expenditures are balanced, services generated 64.4 percent of GDP (2007 estimate) leaving industry behind (33.5 percent), gross fixed investment accounted for over 27 percent of GDP (2007 estimate), value added grew most in construction (well over 18 percent) followed by manufacturing (slightly more than 8 percent). Financial intermediation, trade and transport enjoyed high growth rates, and the only figure to spoil the picture of prosperity was the fact that in 2007 consumer prices increased by 5.6 percent.

In other words, the level of external debt is sustainable leaving room for more private equity and M&A activity. The Resolution on National Development Projects for the Period 2007-2023 lists several national projects worth some €24bn of which some €15m in private equity through public-private partnership.

In conclusion, although foreign direct investment (FDI) is generally perceived a source of economic development and modernisation, income growth and employment, it should truly be a ‘win-win’ situation for both the investor and the recipient country. Over the past seven years, Slovenia has established a transparent and effective enabling policy environment for investment and has built the human and institutional capacities to attract foreign investors. If its FDI stock appears modest in comparison with other CEE countries, it has something to do with the proverbial prudency of its people and their system of values where diligence and loyalty go hand-in-hand with creativity and innovation that are often key to the success of a business. A good pole position seems to make people more prudent and more environment-concerned. In the long run, it should be good for the investor and the host country.

Why invest in Slovenia?

A strategic location as a bridge between Western Europe and the Balkan States boasting strong levels of efficiency and productivity.

A well developed transport infrastructure both on dry land and through the sea port at Koper to serve some of Europe’s major transit routes.

A proficient and skilled labour force boasting a high degree of IT and technological prowess, from electronics to financial services.

All attributes to become a location of choice of international companies for international or European headquarters, an R&D centre, or a centre for administration/accounting functions

Slovenian Ministry of the Economy identifies development priorities
The priorities of the Slovenian EU Presidency in the field of energy, telecommunications and industrial policy – sustainability, competitiveness and security of energy supply with focus on the internal gas and electricity markets, renewable energy sources, energy technology and external energy policy. Energy and waste management offer a host of opportunities for foreign investors (PPP).

The Resolution on National Development Projects for the Period 2007-2023 lists several national projects worth some €24bn of which some €15m in private equity through public-private partnership.

The areas of wholesale and retail trading such as in electronics and garments, as well as consultancy services remain investors’ favourites, but further opportunities exist in sectors such as IT, pharmaceuticals, banking, insurance and telecommunications. Niche sectors and boutique companies may not be high-profile but thanks to specialisation stand to fare better than large household names that often lack flexibility in meeting customers’ needs. From electronic components to sailing boats, from racing skis to roulettes, from ultra-light aircraft to motor exhaust systems – these are some of the products ‘Made in Slovenia’ that do not fear competitors.

Efforts to improve macro-economic conditions to boost GDP growth and attract FDI have delivered the following preliminary figures for 2007:

GDP growth                    6.1 percent
GDP (at current prices)      €33,542m
GDP per capita                     €16,616
Exports growth                 13 percent
Imports growth              14.1 percent
Employment growth         2.7 percent

Showcasing Caribbean investment opportunities

Posted on May 23, 2008October 10, 2012 by itsupport

The Ministry (MTI), Telecommunications Services of Trinidad and Tobago (TSTT) and RBTT Bank Limited have joined forces to sponsor the event, which is the flagship inward trade mission of the Trinidad and Tobago Manufacturers’ Association (TTMA

TIC 2008 takes place from April 30 to May 3, 2008. It is the Caribbean’s biggest business-to-business event, and includes a multi-sectoral 292-booth tradeshow, structured networking opportunities and a topical business education programme. A wide cross-section of companies from around the world will showcase goods and services to thousands of local, regional and international buyers – including specially organised trade missions and buyer delegations.

TIC is celebrating its ninth anniversary, and, says Minister Rowley, “has grown to become a critical nexus for business, trade and investment, providing opportunities for manufacturers and buyers, investors and financiers, suppliers, service providers, regulatory agencies, consultants and media operators to network, share ideas, and develop business partnerships. This productive, dynamic interaction is critical for our regional business sectors as we compete on the global stage.”

Spanning the sectors
TIC’s evolution in a very real way, reflects the growth, vibrancy and diversification of the economies of T&T and the Caribbean. What began as a small show, with about 30 exhibits devoted to manufacturing has grown into a massive display of regional business capabilities, spanning all sectors. For overseas exhibitors, buyers and investors, TIC offers a unique introduction to the warmth and culture of the peoples of the Caribbean and insights into the way business is done in the region. Central and South America are also major participants in the Convention, a direct result of the deepening of south-south ties.

TIC takes place in the Caribbean’s most dynamic (and fastest growing) market. Energy has powered Trinidad and Tobago to success as Caribbean’s largest and strongest economy (GDP Growth 2006: 12 percent). Today, it is one of the world’s leading energy producers, the world’s fifth largest producer of Liquified Natural Gas (LNG) and the largest provider to North America (T&T also supplies the US with 56 percent of its ammonia and 77 percent of its methanol imports). Now, propelled by this wealth of energy and leveraging its natural, geographic and human resources, T&T has embarked on an ambitious programme of diversification, partnering with businesses across the globe.

Trinidad and Tobago’s open and increasingly diversified economy offers an investment and business friendly environment, characterised by a stable political system, strong legislative and regulatory framework and progressive investment policies encouraging fair competition. The prospects for investors are boundless and they’ll all be on show at TIC’s new Investment Portal.

The bottom line: $350m-plus in trade in just nine years makes TIC a force to be reckoned with. From small transactions, to orders for containers of goods, to massive construction deals – just about every type of deal is done on the TIC Tradeshow floor.

Significant contact
Mrs Katherine Kumar, Managing Director of RBTT Bank Limited, says TIC “has brought tremendous benefits to our clients and our bank in the domestic market — with unprecedented value added in regional and extra-regional markets,” noting that that “it was through the Trade and Investment Convention that RBTT was able to make that significant contact which led to a vibrant merchant banking and corporate banking business in Costa Rica… Joining the Convention will pay dividends. A chance visit to your booth or a chance conversation can lead to new horizons for your business, as RBTT discovered with our Costa Rican connections.”

TSTT’s Chief Executive Officer, Mr Roberto Peon adds: “Trinidad and Tobago may be a relatively small landmass at the tip of south America but TSTT has worked hard to ensure that the country is plugged into to every major hub around the world and vice versa. The TTMA has also worked extremely hard to plug Trinidad and Tobago into the rest of the world and the Trade and Investment Convention is an excellent example of how communications enables the creation of a global village. The TTMA has continued to successfully network to bring together a diverse group of buyers and sellers from the Caribbean, North America, Central America, South America, Europe, and Asia.”

Specialising in economic analysis

Posted on May 23, 2008February 9, 2012 by itsupport

It isn’t just corporate bombast. It’s a reality many US businesses have already witnessed. For many corporates, transfer pricing is the most important issue any large global business has to face up to during the next five years. Tax authorities – including Her Majesty’s Revenue & Customers (HMRC) – are getting tough with any company which may have pushed the envelope when it comes to clearly explaining their transfer pricing regime. But it’s also an environment where tough, intellectual rigour is increasingly valued says Dr Ted Keen of Ballentine Barbera, the US-based transfer pricing boutique specialist. “A lot of countries have already adopted the OECD Guidelines and the arm’s length principle into law, but though that gives countries the same basic rules, each country interprets the rules slightly differently. And you’ve got to remember that the OECD guidelines are just that – guidelines: there is no one correct transfer price! Producing economic evidence and analysis in support of your transfer pricing policy is critically important.”

Know your way in a changing landscape
The issue has certainly been underscored by Sir David Varney, former executive chairman of HM Revenue & Customs (HMRC). HMRC has taken a much tougher line with business, especially large operations. Varney repeatedly underlined that more resources were being ploughed into transfer pricing enquiries and would follow a clear action plan when not enough information is offered. “We’re expecting to see a lot more recourse to litigation generally,” says Keen, “especially in the UK. We’ve already seen a lot of action in the US, Canada and Australia. Certain types of companies, such as the largest drug companies, are being targeted. So the government isn’t wasting time on small fry. There’s a huge amount of money at stake.”

Litigation of transfer pricing matters is also quite a change in culture too. Tax authorities traditionally have had a close relationship with accounting firms – many tax partners in UK accounting firms got their start as tax inspectors. “So when taxpayers and their accountants go into negotiation with HMRC, they’re dealing with people who already know each other.” But with increasing prospects of litigation, lawyers are now starting to challenge the accounting firms’ dominance in the transfer pricing arena says Keen. ‘Law firms traditionally have been much more involved in the transfer pricing area in the US than in the UK. We’re now seeing law firms in the UK and Continental Europe getting more involved in transfer pricing. That has to give multinationals an advantage when it comes to litigation. Lawyers know the litigation process better. So the landscape is definitely changing.”

A more positive message
However, Ballentine Barbera’s Gerben Weistra says the EU is gradually developing a more consensual view on transfer pricing issues to prevent double taxation via the EUTP forum. In addition, “the OECD recently issued a paper suggesting changes to the 1995 guidelines. What they’ve done is incorporate some of the practices in the guidelines. You could say that there will likely still be differences in interpretation of transfer pricing regulations between countries, of course, but it’s becoming more about being less dissimilar than different, I’d say. In terms of transfer pricing, the EU has focused on the free flow of capital growth, taking away practical barriers to growth. . So it’s really about overcoming the differences at the theoretical side now.”

He says it’s useful to remember that many European countries are still working out their own transfer pricing initiatives. “Still, even if the now suggested changes are implemented some countries, of course, will interpret it to the letter, while others will be trying to find their own way with it.”

Weistra also says he is surprised some companies are still – within varying degrees – not aware of the huge financial ramifications as they should be. “Some companies still say things like ‘oh, our transfer pricing is audited out’, or they ‘don’t consider it a material issue’. Frankly, that surprises me.” He says some operations remain preoccupied with the process of transfer pricing issues, rather than the technical side and implementation of their policy. “Since Sarbanes Oxley, we see more people again who are interested about pricing procedures, and who is involved therein. They’re less interested in the technical side and implementation of a policy. But the process, actually, is not that different to what it was 10 years ago, although there are obviously new reporting rules for audit purposes. The key question however is about whether you have in fact a proper and consistent transfer pricing policy, how it is applied and communicated and what deviations might lie inside it. That is where possible transfer pricing corrections would arise.”

It’s also about getting a sense of where the legal argument really lies. For example, Greg Ballentine, a founder of Ballentine Barbera, has been involved in many landmark transfer pricing court cases helping build Ballentine Barbera’s reputation and invigorating debate on all the issues. Plainly it’s not about following tried-and-tested formulas that may have worked a few years ago. Something more demanding is now needed.

Imagining the future
So how will the role of transfer pricing develop? Dr Ted Keen thinks that Europe, including the UK, will need to get used to a great deal more transfer pricing litigation. “In the past, HMRC, for example, would have been quite reluctant to penalise tax payers and they would often give them the benefit of the doubt. But we’re seeing a lot more pressure from a variety of special interest groups who are interested in governance and how companies make their money. Just read the front page of The Guardian newspaper. You’ll see frequent challenges to multinationals’ transfer pricing practices to avoid paying UK taxes.”

Is there any way to avoid the expensive and lengthy litigation process? Some companies will certainly want to explore the use of advance pricing agreements (APAs) in greater detail. The advantages of APAs are simply certainty and consistency, especially useful for companies with less predictable audit cycles. Keen says the French government, for example, are increasingly looking hard at such arrangements. “There’s a lot of APA activity in France right now and certainly the French government seem quite eager to enter into APAs. The bigger you are, the easier it is to bear the fixed cost in terms of money and time. But others still prefer to handle transfer pricing issues if and when they arise under audit.” The Germans, on the other hand says Keen, have changed their transfer pricing rules slightly but significantly. “Germany is a very high tax country for business so many companies have attempted to scale back their operations there. The Germans don’t like this, of courses, so have implemented new rules on how they will look at supply chain reorganisation and disposals of business.”

Of course, it’s always quite a judgement call when considering your taxable footprint in one country compared to another. And a change your transfer pricing policy will inevitably upset at least one tax authority. But a rigorous examination of the facts and a thorough knowledge of your industry and market will help to support your case.

No right way
What are the key issues for transfer pricing going forward? Much of the real debate says Keen remains focused on intangible property and just where and how those after-tax profits are declared. “Much of the issue arises from licences to use intangible property, like patents or brands, to develop, manufacture and/or distribute goods or services. Where you incurred the costs and risks of developing your valuable intangible property will dictate where profits arising from those intangibles should be recorded. Multinationals who have a clear and well-documented strategy and policy for funding the development of their intangibles will be in much better shape than those who don’t. There is no one right way to do this, and what’s right for one might be completely wrong for another. It’s up to each multi-national to work with their economic and legal advisors to figure out the best strategy for them within the bounds of the OECD Guidelines. This will help them avoid costly litigation down the road.”

In other words, each case is different, and the OECD guidelines are just that – guidelines. “That’s why you need very tight economic analysis of your own operation and circumstances – that’s our specialty.”

Tax reform seeks to attract more investment to germany

Posted on May 22, 2008February 9, 2012 by itsupport

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:
RP RICHTER&PARTNER
Phone: +49 (0)89 55 0 66 – 310
Website: www.rp-richter.de

Adding attraction

Posted on May 22, 2008February 9, 2012 by itsupport

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.”