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Nexia International Tax Conference - Istanbul

“Loan Restructuring”

June 4, 2011

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• 3rd party financing more difficult to obtain• Trends• Self-finance within corporate group• Inter-corporate cross-border guarantees• External credit to related parties beyond normal trade

terms

Intra-Group Financing

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• Interest / income / deductibility• Guarantee fees• Withholding taxes• Transfer pricing• Consolidated group tax reporting• Hybrid entities - what if debtor’s country and

creditor’s country regard entities differently?

Intra-Group Financing – What should be considered?

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• After-tax profits distributed as returns of “paid-up capital” (PUC) or dividends

• Returns of PUC may not be subject to withholding tax• Dividends to non-resident shareholders are subject to

25% withholding tax, reduced to 5% under many treaties

• Participation exemption

Equity Financing

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• Debt could be re-characterized as equity (doctrine of substance over form)

• Debtor may be unable to fulfill its obligation to repay loan

• Trade debt gets re-characterized• Active income could be re-characterized as passive

Intra-Group Financing – What could go wrong?

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• Should interest be charged?• If so, at what rate?

• Does your local jurisdiction necessitate charging interest?

• Is the creditor borrowing to fund the loan and, if so, does the interest on the loan have to exceed the interest paid?

Interest – Creditor’s Perspective

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• Does it matter if the debtor is a subsidiary of the creditor?

• If interest rate is nil are there provisions to deem interest income?

• If interest rate is nil, are there filing provisions to deem interest income?

• Is the income taxable and, if so, as active or passive income?

Interest- Creditor’s Perspective (Cont’d)

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• Rate must be reasonable• Subject to transfer pricing rules• Does your jurisdiction have thin capitalization rules or

anti-earnings stripping rules?• Could excessive interest expense be re-characterized

as a dividend, subject to non-resident withholding tax?

Interest – Debtor’s Perspective

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• Denies interest deductibility on related-party cross- border debt

• Generally limits deductibility of interest based on a debt to equity ratio

• Ratios vary from country to country

Thin Capitalization

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• What is included in debt?• Is domestic 3rd party debt included in calculation?• Does it matter if debt is guaranteed by parent or

related party?• What is included in equity?• Paid up capital, contributed surplus and retained

earnings attributable to direct related non – resident shareholders on all equity?

• What about indirect loans to subsidiaries?

Thin Capitalization – (cont’d)

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• Is there withholding tax on payment of principal?• Paid or deemed paid?• If accrued but not capitalized, is it deductible (unpaid

amounts)?• What is the rate of withholding on interest? • In certain jurisdictions treaty rate is reduced to nil

Withholding Taxes

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• If trade debt is outstanding beyond normal terms, could it be reclassified as a loan or equity?

• If so, would transfer pricing rules apply and treat the debt as equity and thus cause deemed dividend?

• If terms are below market, would payer be deemed to have paid dividends (not deductible) and receiver to have received income that is taxable?

Re-characterization

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• In the event that a loan is not repaid, what are the implications?

• Creditor• Is there a loss?• Can the loss be used against ordinary income?• Is there a limitation as to the loss utilization?

• Debtor• Does the non-payment result in an income

inclusion?• If so, how is it applied?

Non-Payment of Debt

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• Hybrid Entities• Debt in one jurisdiction, equity in another• Double –dip on interest• Deductibility in two jurisdictions

• Utilization of partnerships• Consolidated filings in certain jurisdictions

Opportunities