Richard Cornelisse

Indirect Tax Considerations: Migration To New Jurisdictions

In Benchmark, Business Strategy, Indirect Tax Strategic Plan, US VAT introduction, VAT planning on 30/05/2012 at 8:41 am

By Richard Cornelisse

Are More Relocations Expected Soon?

Eaton Expects $160 Million Tax Savings From Ireland Move By Richard Rubin

Eaton Corp. (ETN)’s decision to buy Cooper Industries Plc (CBE) and place the combined company’s headquarters in Cooper’s Ireland instead of Eaton’s Cleveland home will save $160 million a year in taxes by 2016, the companies said.

The move, announced today, underscores the tax disincentives for multinational companies organized in the U.S., said Gary Clyde Hufbauer, a senior fellow at the Peterson Institute for International Economics in Washington.

“The U.S. tax system just invites this,” said Hufbauer, a former deputy assistant secretary at the Treasury Department. “Any tax adviser in his right mind for this kind of thing would suggest: Locate the new company abroad.”

The U.S. has the industrialized world’s highest statutory corporate tax rate at 35 percent. U.S.-based companies must pay taxes when they repatriate profits earned outside the country. Ireland has a top corporate tax rate of 12.5 percent.

President Barack Obama and Republican lawmakers in Congress want to lower the statutory corporate tax rate by removing many breaks that allow companies to have effective tax rates lower than 35 percent.

Eaton is a maker of industrial equipment with $16 billion in revenue in 2011. Eaton shareholders will own 73 percent of the combined company, which may be known as Eaton Global Corporation Plc although the name may change, said the companies’ announcement.

‘Cash Management Flexibility’

“Incorporating as an Irish company provides significant global cash management flexibility and associated financial benefits,” the companies said in announcing the $11.8 billion transaction, which is expected to close in the second half of 2012.

Eaton’s effective tax rate for 2011 was 12.9 percent and its rate for 2010 was 9.5 percent, according to company filings. In 2011, lower taxes on its non-U.S. operations made up more than half of the difference between the company’s effective tax rate and the 35 percent top U.S. rate.

The company also benefited from the research and development tax credit and the foreign tax credit. As of the end of 2011, Eaton had $6.4 billion in profits it earned outside the U.S. that haven’t been taxed because they remain invested overseas, according to the filings.

Cooper, which makes electrical-distribution equipment, was a U.S. company before a 2002 transaction moved the headquarters to Bermuda. In 2009, the company moved from Bermuda to Ireland.

Shift from Direct to Indirect Tax

Methods of governments to balance their budgets are a shift from direct to indirect taxation, increase of VAT rates and tax authority scrutiny. Governments can via VAT revenue lower corporate tax rates and internationally better compete for tax revenues.

“The global spread of Value Added Taxes (sometimes referred to as Goods and Services Taxes) has been the most remarkable development in taxation over the last 50 years. Operated in less than 10 countries in the late 1960s, VAT now raises one fifth of the world’s tax revenue and still more countries are adopting it. The increasing importance of VAT as a source of government revenue is likely to continue as countries deal with fiscal consolidation pressures in the wake of the economic crisis while seeking to restore growth.” Jeffrey Owens Director, Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development

From a competion over tax revenues perspective the US does not have (yet) an European based VAT system. I refer to my article: About US Tax Reform – Larry Lindsey, Former Fed Governor: “a Value Added Tax Should Be on the Table”.

Irish VAT Revenue To Support Fiscal Stimulus

Ireland 2% VAT increase to 23% in 2012

  • Standard Rate 23% (since Jan 2012)
  • Reduced Rates 13.5%, 9%, 4.8%

Ireland VAT Recovery Time: 3-4 months
Ireland VAT Registration Threshold Non-Resident: Nil (Source TMF)

Migration And Indirect Tax

Migration to a new jurisdiction will inevitably involve dealing with VAT. For some migrating corporations it may mean having to deal with VAT for the first time although probably for most, VAT will be a familiar concept albeit with variations from the ‘old’ jurisdiction.

Assessing the VAT treatment of the migration itself and the subsequent activities in the new jurisdiction is a necessary work stream that should run parallel other disciplines/work streams, primary because VAT is a transaction tax affecting both costs and revenue, and there will invariably be many transactions happening to achieve the migration and the on-going activities.

Misunderstanding or not recognizing the VAT implications of the migration and subsequent activities in the new jurisdiction could result in an unwelcome and unexpected cost.

In the next paragraphs a number of issues are addressed that should be considered for VAT purposes in order to ensure that the migration will take place in the most effective manner from a VAT perspective.

It is very much a question of assessing the VAT position of the entities affected by the migration as it is currently and determining whether the future position will be better, neutral or negative. If it is the latter, determine whether and how the VAT cost may be mitigated.

VAT Status Of The Entity(ies) Migrating

Assessing the VAT status of the entity or entities migrating to the new jurisdiction is the starting point as that will give us a good indication as to whether the migration itself and the subsequent activity in the new location will be VAT neutral, beneficial to the current position or result in a VAT cost.

The process to assess the VAT status of the migrating entity or entities is to review the current treatment of its activities from a VAT perspective.

If it is a pure holding company i.e, its activities are purely passive, its activities (certainly from a European VAT perspective) will be outside the scope of VAT with the result that it will not on its own account be able to register for VAT.

Thus, VAT that it incurs on its costs will be an additional cost as it will not be able to deduct that VAT.

In practice, depending on the company’s flexibility (establish VAT entrepreneurship) or local tax possibilities (e.g. VAT grouping) such a VAT burden could be limited or even avoided.  This is, however, often only possible if VAT planning is considered at the right time  (see paragraph ‘Related Topics’ and ‘Indirect Tax Checklist below).

One area for particular attention is to plan how external fees are purchased i.e. which legal entity should enter into the engagement with the different external vendors/ consultants.

This can be an area of contention with the VAT authorities over the deduction of VAT on these costs.

Mechanism Of Migration

The method of migration can be undertaken in a variety of ways.

Thus, from a VAT perspective,  the VAT consequences of the method of migration need to be determined to assess whether or not VAT incurred on the costs associated with the migration will be real cost or just a cash flow cost.

This will mean looking at the micro legal step plan  to ensure that such steps are carried out in the most VAT effective manner, subject to commercial and other factors. Certain means of achieving the migration may enable advantage to be taken of particular VAT reliefs e.g. many countries allow a VAT relief of the transfer of a business as a going concern.

Related Topics

From Merger and Acquisition – Integration And Indirect Tax: Managing the Moving Parts Before, During, And After a Transaction

An Indirect Tax And Acquisition Checklist:

Indirect tax risks are prevalent throughout the entire M&A and integration process. Here are some of the leading practices, lessons learned, and perspectives to keep in mind so that they do not become stumbling blocks:

  • Set up a project charter that will take effect as of the very first due diligence activities.
  • Validate due diligence findings and define priorities.
  • Make an indirect tax integration plan and ensure that the right sponsors provide buy-in.
  • Map out the current state upon acquisition and identify key risk areas, opportunities, and people in the organization acquired.
  • Jointly validate and refine the integration plan and develop a road map to success.
  • A relevant indirect tax strategy—correctly implemented—will allow the new business to function effectively from go-live, from both a tax and commercial perspective, so that it can move inventory, generate sales and invoices, face fewer disputes with non-paying customers, remain tax compliant, and integrate the business on time and on budget.

From: VAT Rate Increase Results In Extra Saving:

It might still be interesting – especially as VAT rates are increasing – to move the B2C e-business to countries with low VAT rate(s). Luxembourg has a 15% standard VAT rate and for certain supplies reduced rates of 3%, 6% or 12%.

Calculation Of The Saving

Assume that France – as mentioned in the newsletter – has already increased its VAT rate to 21.2% (planned for October 2012). The standard VAT rate in Luxembourg is still 15%. That means at least a VAT saving of 6.2% per transaction. “At least” as lower reduced VAT rates might be applicable (e.g. 3%).  The total saving will be 6.2% times net “French allocated” turnover from moment of implementation until January 1, 2015 minus of course any implementation costs. That could be substantial and even higher if you also operate in Denmark (standard rate 25% since 1992: 10% saving) or Hungary (standard VAT rate of 27% per January 2012: 12% saving) etc. What is the companies current profit margin in relation to these savings? Do your  competitors supply from low rate countries? For companies that already moved to Luxembourg such an increase in France would result in an extra “saving” of  1.6% if you compare positions with local operating companies.

From: Systems: ‘Indirect Tax Automation’ And ‘Plug And Play’:

There are all kinds of business reasons for centralizing supply chains and set up models like “Limited Risk Distributor” or “Commissionaire”. The challenge from an implementation perspective is indirect tax.

Richard Cornelisse is CEO of the KEY Group and worked previously as Big4 Partner in the Tax Performance Advisory and Indirect Tax Practice and blogs on Tax Function Effectiveness and Tax Control Framework developments.

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