Permanent establishment

Question 1 - Permanent Establishment

To determine the position of (i) Gullit BV in this country and (ii) Houllier Sarl in the Netherlands and this country is arguably founded upon the concept of permanent establishment that is fundamental to international double tax treaty law. With this in mind, almost all modern tax treaties use permanent enterprise as the main instrument for then establishing taxing jurisdiction over a foreigner's unincorporated business activities. In this case it is to be assumed double taxation conventions are in place that are similar to the Organisation for Economic Co-operation & Development (OECD) Model Tax Treaty. On this basis, the foreign enterprise's profits are taxable in the country where the activity takes place if the enterprise is deemed to constitute a permanent enterprise. Moreover, it has also been recognised that Article 5 of the OECD Model Tax Treaty established the general definition of a permanent enterprise as being as follows so that - (a) “'permanent establishment' means a fixed place of business through which the business of an enterprise is wholly or partly carried on”; (b) “The term includes a place of management, a branch, an office and a factory”; and (c) “It does not include some activities which carried out by foreign enterprise if they continue for a period of less than certain months, say half year”.

Therefore, a firm is considered to have a permanent establishment in a country where it employs an agent (other than an independent agent) to act regularly for it and conclude contractual agreements there. In addition, it was also recognised under Article 5 of the OECD Model Tax Treaty that, with regards to 'business that is carried on', “persons who, in one way or another, are dependent on the

enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated”. Moreover, the business is carried on to this effect “by the entrepreneur or persons who are in a paid-employment relationship with the enterprise (personnel). This personnel includes…other persons receiving instructions from the enterprise (e.g. dependent agents)”. This is because it has long been recognised that, in an agency relationship, a principal like Houllier Sarl is directly bound by the activities of its agent (in this case, Gullit BV) through a process of direct representation (i.e. a contract concluded in the name of the principal) - although it is to be appreciated that indirect representation (i.e. a contract established between the agent and the third party with the principal not legally involved) may cause some problems where a third party is unaware that the agent is still acting on the principal's behalf in seeking to establish relations because they are considered to be undisclosed.

Furthermore, with a view to establishing Houllier Sarl's tax liability, Article 5(5) of the OECD Model Tax Treaty recognised that where someone, “other than an agent of an independent status, is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise”. In addition, generally, a permanent establishment is created when an entity like Houllier Sarl or Gullit BV - (a) has a fixed place of business in the relevant country through which the business is wholly or partly carried on (including a place of management, a branch or an office); or (b) has someone acting on its behalf in the relevant country (other than an agent of independent status) like Gullit BV through Mr Beckham who has, and habitually exercises, an authority to conclude contracts in the name of the home country entity. At the same time, however, in some countries, a permanent enterprise is also created when services are provided through employees or other personnel in that other country which exceeds a set period of time, whilst patterns of travel, especially to the same customer, can create permanent argument for host tax authorities. In addition, the concept of a 'permanent establishment' does not include - (a) using facilities solely for storage, display or delivery of goods or merchandise belonging to the enterprise; (b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for storage, display, or delivery; and (c) the maintenance of stock of goods or merchandise belonging to the enterprise solely for processing by another enterprise.

If it is assumed that the activities of (iii) Gullit BV created a permanent establishment for Houllier Sarl, the profits of Houllier Sarl's permanent establishment and the profits of BV would be calculated on the basis of the fact that it was recognised permanent establishment refers to a 'taxable presence' that allows a country to tax the local operations of a company, branch, individual, or, under some treaties, a partnership, in that country. Then, under Article 7(2) of the OECD Model Tax Treaty, “there shall in each Contributing State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities, under the same and similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment”. With this in mind, this includes revenue from Houllier Sarl's activities as a permanent enterprise principally based upon the measure of their sales and distribution activities. At the same time, however, revenue in this context is attributable to an employee - (a) of the home country entity that participates in the everyday management of a host country entity; (b) who serves as a director of a host country entity whilst continuing in the employment of the home country entity; (c) who provides for 'overall account management' directly to local customers in the name, or on behalf, of an affiliate; (d) authorised to negotiate and conclude contracts on behalf of the home country employer and regularly exercises that authority; (e) of the home country entity who draws, accepts or endorses any negotiable instrument on behalf of the host country entity; (f) of the home country entity pledges the credit of the host country entity; or (g) with no subcontract, who performs any contract or fills any order on behalf of a different entity other than the specific entity they are assigned to.

With regards to the worldwide tax system a resident of a country is taxed on all income regardless of the source of income (whether it is inside or outside the country). But, conversely, non-residents are taxed only on income sourced in a country like the United Kingdom (UK). At the same time, however, the combined operation of the residence and source principles may lead to international double taxation in relation to cross-border income flows (i.e. income that has been derived through economic activity carried on in one country by a resident of another) with the income being taxed in the country of source and then again in that of residence. Therefore, there are three main methods available for providing relief from international double taxation - (a) the Exemption Method (i.e. residents are exempted from tax on foreign income) that is favoured by those who believe that residents should be encouraged to invest abroad; (b) Credit Method (i.e. residents are taxed on foreign income (gross of foreign tax) at domestic tax rate subject to a credit for any foreign taxes that have been paid) is favoured by those who take an international view of the equity and efficiency goals; and (c) the Deduction method (i.e. residents are allowed a deduction for foreign taxes paid) is favoured by those who take a national view of the equity and efficiency goals. In addition, it is also to be appreciated that double taxation conventions are in place that are similar to the OECD Model Tax Treaty. As a result, with a company like Houllier Sarl that is being considered on the facts here, the foreign enterprise's profits are taxable in the country where the activity takes place if the enterprise is deemed to constitute a permanent enterprise on the facts as they stand.

Question 2 - Controlled Foreign Corporations (Cfcs)

In seeking to describe the tax consequences, on the level of AG, in the tax year 2004 (when also taking into account income from its operations as well as interest income), it is to be appreciated that, generally, a taxpayer in one country is not subject to domestic tax on the profits of a foreign subsidiary until these profits are received in the home country as, for example, dividends or interest. The reason for this is that it serves to offer the opportunity for tax deferral and avoidance by establishing entities in low-tax jurisdictions and diverting income to them. This is because it has been recognised that most CFC rules aim to stop companies reducing their tax liabilities by diverting profits to foreign companies they control situated in countries with low tax regimes by apportioning the CFC's income to the parent company so, although the parent company may not have received the income, its taxable profits are calculated with this in mind.

At the same time, however, more specifically it has been recognised through the information provided as part of this case study that under German domestic tax law the income of a foreign corporation is commonly deferred until such income is distributed to the German resident shareholder. But there are two sets of different anti-deferral rules that may be applied currently to tax the income of a foreign corporation owned by German-resident shareholders. The first (CFCs) served to establish rules through which ‘normal' passive income can be attributed to German residents controlling shareholders, whilst the second (the passive foreign investment income rule) means certain types of passive income can be attributed to the German resident shareholder without the need for a controlling German interest. In addition, it has also been recognised that if the income of a controlled foreign corporation (like Hong Kong Ltd) includes income with capital investment character - and such income exceeds 10% of the total passive income of the foreign corporation or €62,000 - the rules for income with capital investment character prevail over the general attribution rules applicable to controlled foreign corporations.

Rules regarding CFCs were introduced into German domestic law under sections 7-14 of the Foreign Transactions Tax Act 1972 with some significant changes enacted in the form of the German Tax Reform Act 2001 with further changes coming between 2002 and 2004. But the term CFC was defined under section 7 of the Foreign Transactions Tax Act 1972 as being a corporation incorporated abroad with neither its principal place of management nor its seat in Germany. In addition, it was recognised that, by the end of the corporation's accounting period, more than 50% of a company's shares or the total voting power of all the shares is owned by German resident taxpayers alone or together with people subject to the extended limited tax liability under section 2 of the Foreign Transactions Tax Act 1972. Finally, it has also long been understood under the terms of the Foreign Transactions Tax Act 1972 that a foreign corporation like Hong Kong Ltd is subject to a total tax burden in the jurisdiction where it maintains its actual principal place of management (i.e. AG in Germany) or its statutory seat and in other countries with less than 25%.

If, in the aggregate, German resident shareholders hold more than 50% of the shares or voting rights it can constitute a controlled foreign corporation irrespective of whether they are related or know each other. Additionally, it has been recognised that a foreign corporation is a controlled foreign corporation if its income is subject to low-level taxation in the state where its principal place of management or its statutory seat is located and this low-level taxation is defined as a tax burden less than 25% calculated under German tax rules. At the same time, however, not all the income of a CFC is attributable to German shareholders since the rules of attribution are restricted to certain types of passive income comprising all items not expressly defined as active income under section 8(1) of the Foreign Transactions Tax Act 1972 with the following active activities listed regarding income from - (a) agriculture and forestry; (b) manufacturing; and (c) the operation of a bank or insurance business maintaining commercially equipped office facilities to transact its business and performs services predominantly with third parties.

In addition, income from trading activities may be included unless it is generated through supply transactions between the CFC and the controlling domestic taxpayer or an affiliated person taxable in Germany. At the same time, however, it is still to be appreciated that a tainted trading activity with the CFC may still qualify as active if the taxpayer can establish the foreign corporation maintains adequate office facilities to transact its sales activities in the preparation, execution and follow-up of the sales without the assistance of a controlling domestic taxpayer or of an affiliated person as well as where it engages in trading activities with the public. Moreover, income from the provision of services will be included unless they are performed by a foreign controlled corporation like Hong Kong Ltd with the assistance of either a resident controlling shareholder or someone considered affiliated with such a taxpayer and the income generated by the assistance is subject to German taxation. Furthermore, there is also a need to recognise that, in the case of this exception, the income is passive since no counter exception applies. The income also qualifies as passive if the services are provided to the resident shareholder or related party - although the service income may still qualify as active if the taxpayer can establish the CFC maintains fully-equipped office facilities for the performance of the services concerned, no assistance by the resident shareholder or a related party took place, and it engages in trading activities with the general public.

Rental and royalty income may also be included subject to the very strict limitations that are contained in section 8(1) of the Foreign Transactions Tax Act 1972. Allied to this, the borrowing and lending of money may be included if the taxpayer can prove the funds are borrowed exclusively on foreign capital markets and are lent on a permanent basis to business or permanent establishments located outside of Germany that virtually derive all of their earnings from active activities or German permanent establishments or businesses. In addition, dividend income may also be recognised as an important consideration even if it is distributed from companies in low tax countries that virtually only generate passive investment income. Finally, capital gains may also be included in any calculation regarding the disposal of shares in corporations where such gain economically does not relate to the disposal of assets generating passive investment income.

At the same time, however, under sections 10-14 of the Foreign Transactions Tax Act 1972 it has been recognised that passive income generated by the CFC is allocated to the shareholder on the basis of the following rules - (a) the (net) income from a certain business year will be attributed to the German taxpayer immediately after the tax year of the CFC; (b) the income is treated as dividend income for individuals (although not entitled to the 50% tax exemption) and trading income for corporations (not entitled to the participation exemption, but subject to corporation income tax and local trade tax) with the same rule also applying if investment in the CFC is a business asset of an individual's trade or that of a partnership; (c) it is possible to offset this special type of income against losses resulting from other sources such as business or rental income; and (d) actual dividends of the CFC received by a German corporation like AG are, under the German Corporate Income Tax Act 1988 (as amended), tax exempt. In addition, for individuals it has also been recognised that a 50% tax exemption usually applies - although individuals also benefit from a special provision in the German Income Tax Act (as amended) that grants a full tax exemption for dividends if the underlying profits of such dividend income have already been subject to CFC taxation in the previous seven years.

There is, however, also a passive foreign investment income rule that is found in section 7 of the Foreign Transactions Tax Act 1972 (as amended) that was introduced in 1992 that deals with the attribution of income with capital investment character. In effect this rule serves to reduce the conditions where CFC rules apply. Additionally, it has been recognised that a foreign corporation like Hong Kong Ltd does not need to be controlled by German resident shareholders since it is sufficient for them to merely hold a share interest of at least 1% in such a corporation instead of more than 50% with a CFC earning 'normal' passive income. Then where such a corporation generates virtually all passive investment income, no minimum participation rule exists unless the taxpayer proves the corporations shares are listed on a stock exchange and are traded in sufficient volume. At the same time, however, a foreign corporation like Hong Kong Ltd still has to be subject to low-level taxation in the same way as a normal controlled foreign corporation. But it is also to be appreciated that this special rule only applies to income with a capital investment character defined under section 7 of the Foreign Transactions Tax Act 1972 (as amended) as income resulting from the holding or management, or from transactions that serve to maintain or enhance the value of means of payment, accounts receivable, securities, participations or other similar assets. Such income with capital investment character, however, needs to either be in excess of 10% of the total gross income of the foreign corporation or €62,000 in aggregate.

With this in mind, to conclude, it has been recognised that German CFC rules are considered to override treaty law so that the application of these rules serves to negate the participation privilege that exempts dividend income from taxation based on a given tax treaty. But a concluded treaty with another country is established in German national law by means of a statute which is German domestic law. At the same time, however, there is a need to appreciate that the application of this statute for German taxpayers can be overridden by special rules, as is the case under section 20(1) of the Foreign Transactions Tax Act 1972 which states that, for the purposes of CFC income, the tax treaties concluded by Germany are not applicable. As a result, it has come to be understood that the problem of compatibility of CFC rules with treaty law does not arise since it is actually really a question of domestic legislation when determining the tax consequences for a company like AG.

Question 3 - Hybrid Debt: Convertible Preferred Equity Certificates Case Study

Using the technical information provided in relation to the US & Luxembourg's tax treatment of hybrid instruments, it is necessary to analyse the tax advantages of the preferred equity certificates implemented by Luxco 1 by focussing upon the general tax advantage to be obtained by utilising hybrid financing structures and tax issues resulting from the structure that is presented. Therefore, in Luxembourg substance rather than form is the foundation for determining whether a financing arrangement is a debt or equity for tax purposes. On this basis, it was recognised through the information provided as part of this case study that a financing arrangement concluded in the form of a loan may be recharacterised into equity through old German case law and not explicitly defined by the Luxembourg doctrine - although the basic characteristics implying a potential recharacterisation of a loan into equity are that the loan is granted to a company where the lender has a direct substantial shareholding (i.e. representing at least 10% of the borrower's capital or the acquisition price of at least €1.2 million) or it is granted under special conditions.

The criteria that may lead to a loan's recharacterisation into a hidden capital contribution are founded on the loan in Luxembourg - (a) not being repayable until the winding up or liquidation of the borrower or is solely repayable after a significant period of time; (b) being subordinated; (c) having no preference regarding the paid-up share capital; (d) having no guarantee as to the repayment being given; (e) having interest payments dependent upon the annual profit of the borrower; (f) investor participating fully in the surplus profits of the borrower in the event of winding up or liquidation; (g) having voting or other similar rights in the borrower attached to it; and (h) having a condition that can solely be issued to existing shareholders to be incorporated in the borrower's articles of association. But just because one of the above criteria is met in a particular case does not automatically serve to imply that the loan's recharacterisation into a hidden capital contribution by the parent company to its subsidiary.

Conversely, it has been recognised in the US that, whilst the Treasury has the authority under the Internal Revenue Code to issue regulations to determine whether an interest in a corporation is treated as stock or indebtedness, the last attempt by the Treasury was abandoned in 1983. One of the Treasury's proposals contained a safe harbour debt-equity ratio of 3:1 still generally considered an acceptable level to withstand challenge regarding thin capitalisation. But when analysing hybrid securities it is to be appreciated that thin capitalisation is just one of several factors considered necessary for resolving disputes between taxpayers and the Internal Revenue Service. With this in mind, 'classic debt' is generally described as an unconditional obligation to pay a certain sum at a reasonably close fixed maturity date along with a fixed percentage of interest payable regardless of the debtor's income - any other obligations may be subject to attack.

There is also a need, however, to consider the - (a) fixed maturity date - US case law indicates a fixed or ascertainable maturity date is virtually essential for debt classification; (b) remedies for default - creditors ordinarily have the right under applicable local law to sue for amounts owing and, if necessary, to force the debtor into bankruptcy; (c) subordination - to the claims of general creditors is an adverse factor, especially regarding related party debt because it clearly pushes the creditor closer into a holder of equity; (d) certainty of return - the right to receive dividends is generally conditional upon the ability of the company to make a distribution out of earnings or surplus; and (e) label chosen by the parties - the intent of the parties with respect to a security has been cited by the US courts as a significant factor especially regarding related party debt since there is uncertainty whether a taxpayer is free to disregard the label chosen and undertake a reclassification from debt to equity (or vice versa) or whether an instrument's reclassification is left to the Internal Revenue Service.

In addition, it has also been recognised that the interest paid by a Luxembourg company is principally deductible from its taxable basis without limit regardless of the creditor and its tax status. But, whilst legislation still also offers some restrictions regarding the unlimited tax deductibility of interest expenses, profit distributions are not deductible for corporate income tax purposes. To this effect Article 164(2) of the Luxembourg Income Tax Law 1967 (as amended) defines distributions of profit as being not only direct to shareholders, but also in respect of other securities including founder's shares and any similar securities along with bonds bearing a variable interest giving right to a share in the annual profit or the issuer's liquidation profit. Moreover, interest expenses derived from profit participating bonds are considered to be profit distributions to the lender. Therefore, the yield that has been derived from purchase exemption certificates should not be considered as distributions of profits for Luxco since the yield is independent of its profits so that the yield should be deductible in the hands of the Luxembourg issuers.

Since the purchase exemption certificates holders will be Luxco shareholders, there is a risk Luxco's yield paid to the purchase exemption certificate holders may be recharacterised into a hidden profit. As a result, Article 164(3) of the Luxembourg Income Tax Law 1967 (as amended) - an anti-abuse provision - specified a hidden profit distribution includes all cases where a shareholder receives any advantages from a company he would not normally have received without this relationship. Any part of the yield payment that is excessive or abnormal would be considered a distribution of profit and not deductible from Luxco's taxable basis. Therefore, to guarantee Luxco's tax position there is a need for a prior clearance from the Luxembourg tax authorities to ensure the interest paid will be considered at 'arm's length'. But, whilst Luxembourg tax law does not provide for any maximum debt-equity ratio, the authorities recommended a ratio of 85:15 otherwise the deduction of the part of the yield arising from the excessive debt may be refused - although the debt-equity ratio applies only to activities other than those of financing performed by Luxco and the authorities usually grant clearance as a result. It is also to be appreciated, however, that any dividend distributions to the non-treaty protected investors will be subject to 20% Luxembourg withholding tax and also applies to 'interest' on profit participation bonds requalified into dividends. With this in mind, the purchase exemption certificates in this context are not profit participating so interest paid will not be subject to withholding tax, whilst their redemption should be considered as a repayment of the principal of a loan and not be subject to withholding tax in Luxembourg.

Where, however, as in this case, a US shareholder supplies funds to a foreign related party under what is recognised as being a hybrid arrangement, the US tax consequences of treating a hybrid arrangement as a debt or equity must be considered with regards to both the income for the US shareholder and the expense that has been recognised for the foreign related party in the circumstances. On this basis, it is understood that the deductibility of 'interest' payments serves to affect the amount of foreign earnings and profits under US tax accounting principles for the purposes of making determinations under 'Subpart F' and for foreign tax credit purposes. At the same time, however, it is also to be appreciated that, on the income side, treatment of the payments as interest income or as dividends can serve to affect both the timing of income recognition and the foreign tax credit in the circumstances of a given case. With this in mind, accrued interest in such cases may be subject to immediate recognition, whilst it is also to be appreciated that company dividends are generally not realised until they are paid and carry with them creditable foreign taxes for purposes of the US indirect foreign tax credit - although no indirect credit is available with respect to interest payments in the circumstances.

Q4 - Holding Companies - Big Apple Case

In seeking to examine the opportunity for establishing an acquisition company it is also necessary to look to determine a shortlist of suitable locations for such an acquisition company based on both business and tax considerations. With this in mind, it is to be appreciated that there are a number of specific tax motivations for establishing an acquisition company - (a) capital gains/losses planning; (b) withholding tax planning; (c) consolidation of earnings/losses; (d) repatriation of earnings; (e) acquisition by indebtedness; and (f) blending/mixer companies for parents in tax credit regimes. At the same time, however, there are also several significant non-tax considerations involved with establishing an acquisition company that includes the fact that - (a) there would be greater alignment of legal and organisational structures; (b) it would be easy to acquire and to disinvest subsidiaries; (c) it would be possible to adhere to publication rules in accordance with disclosure requirements/anonymity; (d) this would serve to attract investors/minority shareholders/floatation;

And (e) this would also allow for the implementation of a greater control mechanism.

There is also a need to look to consider the tax parameters involved with selecting a holding company location including as to whether there is - (a) no tax on any dividend that is received; (b) no tax on any capital gains that are received; (c) either no or reduced withholding tax on the dividends that are paid out; (d) a good and extensive tax treaty network in place for conducting the business' affairs; (e) a recognised deductibility of liquidation losses or provisions against loss in value; (f) no capital tax; (g) any other activities are permitted; (h) a level of deductibility of finance expenses; (i) either no, or lenient, thin-capitalisation rules; (j) easy access to the holding company's regime; (k) an absence of anti-avoidance provisions including CFCs; (l) either stable legislation or rulings in place; (m) any substance requirements or management and control; (n) any cost of entry into the structure; (o) any cost of exit in place for leaving the structure; and (p) a parent company in a CFC position. This is because it has been recognised that Big Apple LLP's main objectives are to serve to push down a maximum of acquisition debt and utilise the interest expense, avoid all withholding taxes and also avoid the remit of any capital duty.

In addition, it is also necessary to seek to take into account the non-tax parameters involved with selecting a holding company location in view of the need for companies to advance their businesses and achieve significant economic growth including as to whether there is - (a) an effective infrastructure in place regarding transport, finance, communications and other service providers; (b) sufficient understanding of the language to conduct business in the proposed location; (c) an appropriate time-zone in place for the purposes of conducting business; (d) sufficient scope for third parties and shareholders activities; (e) a low level of administration costs; (f) a sufficient mix of

permitted activities in place; (g) sufficient accounting standards in place to meet the desired accounting result; (h) regulatory authority in place; and (i) it is sufficiently close to the subsidiaries of the company to maintain a viable working relationship for the purpose of maintaining and advancing economic growth. Moreover, there is also a need to look to consider specific company law requirements in whatever location is chosen for the purposes of advancing Big Apple LLP's business with regards to the - (a) flexibility of return of capital as well as the ability to actually pay dividends; (b) currency of capital denomination; (c) flexibility that is needed to structure rights that are recognised as being attached to share classes; (d) corporate governance framework that is in place in terms of the nature and scope of the supervisory board, board of directors, advisory board and local directors in terms of their number, nationality and remuneration for their services; (e) level of workers representation; and (f) publication of financial statements.

With such considerations borne in mind it is to be appreciated there is a Asia-Pacific Holding Company Structure in place with - (i) Regional HQ incentives (i.e. Singapore, Malaysia, Thailand, Philippines, and China); (ii) Pan-Asian holding company candidates (i.e. the Netherlands that is one of the most extensive treaty network with Asian countries, Singapore that has HQ incentives and participation exemption and use of investor country entity as the direct holding company); and (iii) pure SPV holding companies (i.e. Mauritius and Labuan). But there is no one single Pan-Asian holding company - although the following are commonly used for various countries - (a) Mauritius/Barbados/Switzerland - China; (b) Singapore - Australia/Malaysia/Taiwan branch/Vietnam/Hong Kong/Thailand/India/China; (c) USA - Japan/Philippines; and (d) Netherlands - Taiwan, Korea, Indonesia. At the same time, however, there is a need to appreciate that Australia is likely to become an increasingly attractive location for holding companies in this

region in view of proposed tax changes whilst it has also been recognised that Australia can hold Singapore, Hong Kong, India, Taiwan branch, and Vietnam.

One significant option for Big Apple LLP is likely to be that of the Netherlands that has a 100% dividend/capital gains exemption with no holding period and an exit rate at 0% via Malta, Cyprus or other European Union countries for this purpose. In addition, there is also a good treaty network in place with other Asian-Pacific nations along with a new US-Netherlands treaty protocol at the 0% Dewhurst share price. Moreover, the Netherlands may also be a useful location for the acquisition company since Big Apple LLP is preparing a bid for the shares in Foods Industries Overseas BV that is the Dutch intermediary holding company of Foods Industries NV (the global market leader in the fast moving consumer goods industry) and the company is already successfully running 100% owned subsidiaries in Taiwan (fair value estimated at €80 million), Thailand (€120 million) and Singapore (€75 million) as well as a 30% minority interest in a contractual joint-venture with a Chinese state owned company (€175 million).

2. In seeking to examine what opportunity there is to have part of the acquisition debt at the level of the separate subsidiaries it is also necessary to determine if, and under what conditions, the resulting interest charges can be deducted from the local subsidiary's future profits. With this in mind, several economic issues must be considered in terms of the debt policy trade-off between tax advantages and risk of borrowing along with the company's repatriation objectives. Moreover, there is also a need to consider as to whether it is easier to pay down debt than equity along with the return on debt and equity. Furthermore, it is also important to appreciate the remit of tax law in this

regard in relation to thin capitalisation rules in terms of debt to equity requirements along with the taxation of interest at recipient level allied to the need to balance local and investor tax rates. Additionally, it is arguable that there may be a withholding of tax on interest allied to the rules of deductibility rules regarding matters of accrual amongst other issues as well as the availability of funds and national debt/equity repatriation objectives. Finally, there is also a need to look to consider legal exchange controls, solvency requirements along with limits put in place upon interest rates.

With regards to if, and under what conditions, the resulting interest charges can be deducted from the local subsidiary's future profits it is to be appreciated that, from one country to another, there is a difference of treatment of interest. In this context, the recognition of issues in this regard are likely to be focussed upon - (a) the deductibility of remuneration; (b) variations in interest rates; (c) levels of inflation; (d) differences in exchange gains or losses; (e) rate differences; (f) the withholding of tax; (g) timing differences in terms of accruals and payments; (h) the level of taxation to investors or lenders allied to tax relief differences; and (i) issues of capital gains. More specifically, however, the general rule for the paying company is that interest payments are tax deductible, whilst the general rule for the receiving company is that interest income is generally taxable. But, whilst in the country of source it has been recognised both interest and dividend payments are generally/often subjected to a withholding tax, in the country of the recipient interest is generally founded on an accrual basis even if it is not paid. Additionally, the foreign tax credit regarding interest is generally limited to the withholding tax that is charged on the interest.

In relation to the acquisition debt at the level of the separate subsidiaries it is also necessary to determine if, and under what conditions, the resulting interest charges can be deducted from the

local subsidiary's future profits. With this in mind, the losses recognised could be a valuable asset in tax planning because it may serve to reduce the effective tax rate and cash tax by sheltering taxable income and effective loss planning is influenced by accounting. Moreover, stranded losses can drive up a group's effective tax rate that needs to be looked at in the context of the key characteristics of the loss regime in the country where the loss is to be measured. Losses in this context can be measured in the context of - (a) intragroup disposals regarding the transference of assets within the group to realise loss in value and for liquidating companies to realise historic basis; (b) loss purchasing regarding the grouping with other companies to access their losses; and (c) 'Double Dip Financing' regarding the fact that, put simply, this is an arrangement whereby a multinational enterprise obtains two deductions for interest in respect of a single sum of borrowed money.

Generally, it will be for a company to look to use the losses in a cross-border context by looking to establish deductible expenses with regards to income in loss jurisdictions by generating relief for the same loss/expense in two countries - although it is also to be appreciated that whilst it may be possible to generate relief for expense in country A the income may not be taxed in country B. In addition, a country may also look to move its assets to a country that can 'amortise' (i.e. to be liquidated gradually) and put its financial receivables in low/nil tax countries or those with losses as well as moving its profits between countries through transfer pricing and the recognition of the value of effective Tax Efficient Supply Chain Management. At the same time, however, there is a need to appreciate that there are two primary systems in place in this regard - (a) the worldwide tax system that allows losses of foreign businesses to be offset against the local parent company's profits; and (b) an individual territorial system that does not do this.

Moreover, it is also to be understood that, in the worldwide system, generally countries do not permit the offsetting of losses of a foreign subsidiary - although they will permit the deduction of a foreign branch or a permanent establishment's losses. It is also to be appreciated, however, that

hybrid instruments may be utilised in this regard. This is because they serve to then create mismatched between two or more tax jurisdictions and accounting standards and tax rules. Additionally, there is also a need to increase credit/solvency ratings, improve the capital structure for bidding on contracts, and to mitigate capital duty in this regard. This is because a hybrid instrument is a form of financing treated differently by the tax system of the country receiving the finance and that of the country providing it. On this basis, in relation to issues of tax it has been recognised that the majority of countries apply domestic classification principles and pay very little attention to tax treatment of a hybrid instrument in any other country - although there are different rules for determining the timing and amount of deduction in the source country and the income in that of the country of receipt.

Bibliography

Text Books

A. Amatucci (Editor) 'International Tax Law' Kluwer Law International (2006)

L. Burns 'Controlled Foreign Companies: Taxation of Foreign Source Income' Longman Professional (1992)

'Halsbury's Laws of England' (2009) Lexis Nexis, Butterworths

R. Rawal 'Taxation of Permanent Establishments: An International Perspective' Spiramus (2006)

'2009 US Master Tax Guide' CCH A Wolter Kluwer Business (2005)

Journal Articles

D. Campbell (Editor) 'International Taxation of Low-Tax Transactions [2008] High-Tax Jurisdictions' Yorkhill Law Publishing (2008)

J. Dammann 'A New Approach to Corporate Choice of Law' (2005) 38(1) Vanderbilt Journal of Transnational Law 51

M. J. Graetz & A. C. Warren Jr 'Income Tax Discrimination & the Political & Economic Integration of Europe' (2006) 115(6) Yale Law Journal 1186

E. Rasmusen 'Agency Law & Contract Formation' (1st September 2004) 6 American Law & Economic Review 369

Websites

'Double Dip Financing' (2008)

(http://www.ctf.ca/PDF/BArnoldBook/tp111_09_1-20.pdf)

Table Of Cases

Scruttons Ltd v. Midland Silicones Ltd [1962] AC 446

Watteau v. Fenwick, (1892) 1 QB 346

Table Of Statutes

Foreign Transactions Tax Act 1972 (as amended)

German Corporate Income Tax Act 1988 (as amended)

German Income Tax Act (as amended)

German Tax Reform Act 2001

Luxembourg Income Tax Law 1967 (as amended)

‘Articles of the Model Convention with respect to Taxes on Income & on Capital' Organisation for Economic Cooperation & Development (OECD Model Tax Treaty) 2005