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Ireland – trends and transactions

11 July 2017

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Ireland is in a position that allows it to adapt well to external issues. Fintan Clancy and Ciara Fagan of Arthur Cox highlight global and European trends and discuss how they impact transactions carried out in Ireland, sometimes with unexpected and curious side effects.

The levying of tax is a fundamental feature of any well organised state. Tax and other governmental regulation and charges do not operate in a vacuum from politics or law but instead are an integral part of both. It is unsurprising, therefore, that political or legal changes influence commercial transactions which in turn influence politics and law. As a small, open trading economy, Ireland is exposed to the threats that such changes bring, but is also well located to benefit from opportunities due to its capability as a small state to adapt quickly.

Raising equity in the US

With Brexit on the horizon, Ireland is now more attractive for listed holding companies.

Ireland's experience

Ireland is a very suitable location for establishing US and/or EU-listed holding companies. The main competitor has historically been the UK, which offers similar advantages to Ireland, particularly in the past few years with the decline in its corporate tax rate.

Over the years, a number of high-profile companies have migrated to Ireland through M&A deals or reconstructions.

More recently, the Irish market has seen a number of NASDAQ listed companies move within the EU to Ireland. Such transactions include Flamel Technologies moving from France to Ireland via an EU cross-border merger to become Avadel Pharmaceuticals, Innocoll Holdings moving from Germany to Ireland again through an EU cross-border merger, and Strongbridge moving from Sweden to Ireland through a tender offer.

In June, it was publicly announced that the new holding company that will be formed from the agreed $73 billion merger of two industrial giants, Linde (Germany) and Praxair (US), will be Irish.

Why is Ireland attractive as a holding company jurisdiction?

Ireland is considered to be a neutral place for global groups to locate their holding companies and has a number of valued attributes including a common law legal system, a sensible and efficient tax regime, an excellent corporate governance system which protects shareholders' rights, fair regulation of takeovers, ease with which funds can be returned to shareholders and practical rules around the liability of directors.

In particular, Ireland is very attractive to companies looking to raise funds through initial public offerings (IPOs) or listing on the stock exchanges in the US. A primary reason for this is that the manner in which Ireland's corporate governance regime and share dealing and settlement is consistent with SEC listing rules and DTC rules and procedures, meaning no depositary receipts are needed. Post-Brexit, for these transactions there will be only one common law, English-speaking jurisdiction that benefits from EU law protections – Ireland.

Onshoring IP

With a global focus on aligning taxing rights with real economic substance, technology groups are restructuring their operations. This goes beyond mere IP restructuring to realigning whole segments of their businesses. Transactions involving the onshoring of IP are extremely prevalent in the market, and the adoption of a centralised IP and substance model is the emerging trend.

Background

Historically, multinational technology groups typically developed intellectual property (IP) in one country and transferred it to a company in a low tax country which often simply passively held the IP. The group could allocate significant royalties based on IP ownership to the low-tax country, which had the effect of reducing the overall tax burden.

The OECD has recognised the need to update transfer pricing guidelines so that the country in which the value-driving functions are carried on will derive the profits. Under Action 8 of the BEPS Action Plan, the key functions that a company would need to perform to justify returns flowing to the IP are develop, enhance, maintain, protect and exploit (DEMPE). This means that companies which merely own IP will not be able to justify significant royalty flows as they had in the past.

It seems that the OECD member states' objective in introducing this measure is to increase the corporate tax take, particularly in the larger economies. This is a curious objective when the overall OECD corporate tax take as a percentage of GDP is increasing anyway and corporate tax is the most economically damaging way of raising a unit of tax revenue. Perhaps the OECD member states should more effectively promote property and consumption taxes. Then again, corporations do not vote but consumers and property owners do.

Onshoring IP

Corporates do not passively accept change. To deliver on their objective of enhancing shareholder value, many are uniting their IP with DEMPE functions in either a single location or a small number of locations.

To the extent technology groups decide to onshore their IP to more than one location, issues are likely to arise in determining how revenue should be allocated between the countries. Double tax treaties are bilateral, and, because there is no legal basis for mutual agreement on a tripartite (or more) basis, double taxation may arise. Furthermore, from a legal and corporate governance perspective it is easier for multinational groups to place DEMPE functions in one country rather than many. Accordingly, a centralised model appears to be emerging as the preferred choice for most large technology groups.

When considering an appropriate location in which to centralise IP, technology groups will focus on a country that has robust and internationally recognised IP and data protection rules, a stable regulatory and governmental environment and a sensible tax system.

Ireland as a centralised IP location

Ireland has an excellent track record for attracting and retaining inward investment from large multinational organisations. Ireland's tax rate, at 12.5%, is the lowest in the OECD and, now that the location of substance is critical to the location of taxation, Ireland is a prime location for multinational technology groups to transfer or create additional substance to in order to reduce their overall tax liability. Within the EU, this is simply an exercise of the fundamental freedom of establishment within the single market so should not be subject to anti-avoidance legislation if implemented properly.

The main beneficiaries of additional corporate tax revenue will likely be low-tax onshore countries where multinational groups can place substance – perhaps not what the large economies had in mind!

Changes to the tax treatment of Irish property funds

Recent changes to Irish tax legislation affect non-Irish investors in Irish regulated property funds. There are tax efficient ways of structuring transactions such that Ireland retains a competitive advantage over other countries.

Background

Ireland is a leading global domicile for regulated funds. Historically, the tax regime relating to an Irish regulated property fund with non-Irish resident investors was very simple – there was typically no Irish tax in the structure.

As an increasing amount of Ireland's real estate became held by Irish investment funds, the Irish government perceived an erosion of the Irish tax base and introduced changes to tax non-Irish resident investors in these funds.

The new rules

The new rules affect Irish regulated investment funds that hold at least 25% of their net asset value (NAV) in Irish property assets. Such funds are called Irish real estate funds (IREFs).

The changes introduce a 20% withholding tax on distributions or payments to non-Irish resident investors by an IREF out of retained profits that relate to its Irish property business. A refund of IREF withholding tax may be available under the terms of a double taxation treaty.

This isn't the end of tax-efficient Irish property structures

The proposed changes materially alter the tax treatment of Irish property funds. However, there are opportunities for investors to restructure their Irish real estate holdings into corporate structures or REITs. Furthermore, there are many different ways of structuring an IREF such that the tax payable in the structure is minimised.

The changes in this area represent a policy decision on the part of the Irish government to increase taxation in the area that the OECD concluded would least affect economic growth – property taxes – and continue to keep corporate taxation low. This is an economically sensible decision and one which other OECD member states should consider.

EU cross-border securitisations

The environment for cross-border securitisation structures is changing and the OECD's BEPS project brings with it fresh challenges, potentially conflicting with the objectives of the EU Capital Market Union (CMU). The Irish market is well placed to navigate the changes.

The creation of a CMU

In May 2017, the European Parliament, the European Council and the European Commission agreed on a package of regulatory reforms for securitisations as part of the European Commission's initiative to build a CMU. The intention behind the CMU is to mobilise capital in Europe.

The package will establish, among other things, a common framework for simple, transparent and standardised securitisation (STS), which will be a cornerstone of the CMU. The intention behind the STS is to create an EU-wide regulatory infrastructure under which new entrants will be encouraged to enter the EU capital markets and additional sources of funding will be unlocked.

It is fundamental to the CMU that cross-border securitisations within the EU can access double tax treaties as, without double tax relief, withholding taxes may apply to the income streams earned.

The Multilateral Convention and availability of treaty relief

In June, 68 countries and jurisdictions signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) that will transpose treaty related items from the BEPS project into 1,100 double tax treaties worldwide.

Most countries will not adopt the limitation on benefit (LoB) test but will instead adopt the principal purpose test (PPT), including all EU countries. In order for securitisation vehicles to continue to obtain treaty relief in the future, they will need to satisfy the PPT as incorporated in the relevant intra-EU treaty.

The PPT denies treaty relief if it is reasonable to conclude that obtaining a treaty benefit was one of the principal purposes of the arrangement or transaction, unless it is established that granting the benefit would be in accordance with the object and purpose of the MLI.

Positively for Ireland, the securitisation example included in the OECD's recent discussion draft on non-CIV examples, which satisfy the PPT, mirrored a typical EU cross-border securitisation structure effected using an Irish section 110 company, i.e. the Irish securitisation regime. The OECD approach was strongly influenced by the information provided by the Irish Debt Securities Association's (IDSA) submission on a previous OECD consultation document.

The future for cross-border securitisations

The CMU and BEPS will bring regulatory and tax changes to cross-border securitisation structures. Securitisation structures in countries within the EU and the OECD will need to be able to navigate the new environment for those counties to retain their position in the market.

The OECD discussion draft on treaty access for non-CIV funds brings considerable certainty around the availability of treaty relief for Ireland's securitisation companies so Ireland seems to be in a good position to navigate the changes and benefit from the CMU. On the ground we are seeing increasing deal flows of CLOs.

Originator structures

Securitisation structures that comply with the EU and potentially the new US risk retention rules appeal to a much wider pool of investors.

The 'originate to distribute' model

Prior to the global financial crisis, an 'originate to distribute' model of lending had been developed. In this model, lenders originated new loans for the sole purpose of selling them into securitisation vehicles that funded the purchase by issuing asset backed securities. In an 'originate to distribute' model, lenders could immediately transfer their entire exposure to loans by selling the assets into a securitisation and there was less impetus on lenders to ensure that borrowers could repay their debts. In the year leading up to the financial crisis, the market for CLOs grew rapidly giving lenders an opportunity to distribute even larger portions of the loans they originated. Ultimately, the 'originate to distribute' model was thought by many to be one of the causes of the financial crisis.

The advent of the EU and US risk retention rules

In response, regulators across Europe introduced risk retention rules in an attempt to combat the risk associated with 'originate to distribute' securitisation structures. The intention of the rules was to remedy the potential for issuers or originators to be concerned with the volume of loans originated rather than the quality of those loans, by providing that an originator needs to retain part of the credit risk (typically 5%) in respect of the assets being securitised.

The CMU and the STS framework will introduce additional risk retention rules for EU securitisation structures, and the EU authorities recently reached provisional agreement on the text of the STS framework. One of the most controversial of the suggested changes to the risk retention rules was a requirement that at least one of the originator, sponsor or original lender be a regulated entity. This has now been omitted from the agreed text as it would adversely impact on the availability of non-bank finance in the EU. As a result, investors in "originator" structures will not, in effect, be obliged to invest in a regulated bank, MIFID firm, etc. but can invest in a more targeted way.

The US has also implemented risk retention rules, the latest regulations coming into force in January 2017, which have a similar policy objective to the EU equivalents but operate differently. Although the Trump administration has suggested it would repeal the Dodd-Frank Act (the US legislation that contains their risk retention rule), it remains to be seen whether this will come to pass.

Bridging the gap across both sets of rules

There are many Irish originator vehicles that comply with the EU risk retention rules. However, to make investment in a securitisation regulatory capital efficient for both EU and US investors, the structure must comply with both the EU and US rules. A dual-compliant structure is therefore the gold standard in terms of marketability, and will typically lead to a better price for the issuer.

There have been a number of dual-compliant structures launched globally since, and a number of existing EU compliant originators in Ireland are exploring the possibility of becoming dual compliant structures. With Ireland's leading position as a securitisation jurisdiction, and its many originator companies, we expect to continue to see increasing activity.

Final thoughts

Global and EU trends affect commercial activity and change leads to unintended consequences. As a small, open economy, Ireland's outward looking focus should see it adapt to change successfully.

Fintan Clancy

Partner and co-chair, tax group
Arthur Cox

10 Earlsfort Terrace, Dublin D02 T380
Tel: +353 1 920 1193
fintan.clancy@arthurcox.com

Fintan Clancy specialises in tax. He represents companies on the tax issues arising from transactions such as acquisitions, disposals, reorganisations, migrations, securitisations and financings. He advises multinationals, investment funds, banks and insurance companies in relation to insurance, financial and structured products. He navigates tax disputes and tax litigation with clients. Previously, Fintan worked in a London law firm and a New York headquartered law firm.

Fintan is recognised in band 1 by Chambers and Partners and as a "leading individual" by Legal 500. 


Ciara Fagan

Associate, tax group
Arthur Cox

10 Earlsfort Terrace, Dublin D02 T380
Tel: +353 1 920 1714
ciara.fagan@arthurcox.com

Ciara Fagan provides advice across all tax heads on a broad range of commercial matters. She regularly advises Irish companies and multinationals as well as banks and other financial institutions. Ciara has particular expertise in advising on structured finance transactions and the taxation of investment funds.

Ciara is a chartered tax adviser with the Irish Tax Institute and is admitted to practice in both Ireland and the UK. Ciara previously spent three years working with a Big 4 professional services firm in Australia.







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