Key Tax Questions to Be Addressed in a Downturn

Aprilie 2009

MIHAELA MITROI - Tax Partner PRICEWATERHOUSECOOPERS in ROMANIA

„It is better to know some of the questions than all of the answers” – James Thurber

Following decrease in aggregate demand, rising financing costs and accelerated depreciation of the local currency, minimizing costs has become an issue of major concern for companies in all business sectors. Among these costs, taxes also require special scrutiny, in order to effectively manage the impact of the market factors above on the tax position of your company.

 

How does increasing the cost of financing affect my business from a tax perspective?

What are the tax consequences of an increase in the cost of funds and what tax issues could arise if lenders need to renegotiate loan terms?

• One tax problem is the likely impact on thin capitalisation requirements which increases the nondeductibility of related expenses. Companies should analyse ways to mitigate the tax impact of the increase in interest rates on thin cap and safe harbour limits, by for example blending rates through a special purposes vehicle. This will result in averaging out of interest rate charges below and above the deductibility threshold, so that the average rates fall under the safe harbour ceiling for deductibility.

• Companies may also identify whether variations in loan period may lead to reclassification of existing loans for taxation purposes and assess whether this may have positive consequences for the application of the debt and equity rules and hence for the deductibility of interest and foreign exchange differences. The period of the loan are easier to control and modify when the SPV is interposed. However, the setting up of the new financing vehicle requires a cost benefit analysis.

• In addition, whether cross-border intra-group finance arrangements should be reconsidered or whether the intra-group rates or guarantee charges should be reset, in this tough transfer pricing compliance environment, the analysis must be done now with priority, because of the corporate income tax consequences.

 

How can I manage my liquidity?

With financing becoming more and more difficult to obtain from banks these days, what solutions can companies implement?

• A tool which is becoming more tax efficient is the cash pooling or other country specific cash management systems, especially since the issue of authorisation as nonbanking financial institution (NBFI) has been clarified by the National Bank of Romania.

• Another alternative solution to the financing crisis which becomes more utilised in the current market conditions is barter. Attention should be paid, however, to the tax treatment of the settlements between companies. According to tax rules, the transactions are to be treated separately and not netted off for profit tax and VAT purposes.

• Times of crisis bring creative ideas. The current scarcity of financing may trigger additional solutions for settling liabilities. For example, companies in a VAT refundable position can settle their current commercial liabilities by assigning their VAT receivables against the state budget, possibly at a discounted price. Companies in a VAT refundable position may also cash their outstanding VAT receivables by using factoring specialised NBFIs. These companies may assign their receivables to the NBFIs at a discounted price and the NBFIs may assign them to companies that have tax payables. This solution may partially improve the current blockage of the tax settlement administration.

Another question to be answered is how cash trapped in the group structure can be released?

• For good measure, the first step required in answering this question should be a diagnosis of the group structure to identify the “weak points”, from a tax perspective. For example, the structure may not allow tax efficient movement of cash in the group because of withholding taxes on dividends, thin cap restrictions are not taken into account and dealt with, non-matching interest rates between external and internal loans might raise issues with the tax authorities. Once the issues are identified, the group can proceed to streamline the structure by: reducing the number of entities, centralising sales/purchases/support functions (including using commissionaire structures, or centralised back office); optimising the ownership structure (e.g. by contributing subsidiaries).

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