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April 8, 2021 |
New York Adopts LIBOR Legislation

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On April 6, 2021, New York Governor Andrew Cuomo signed into law Senate Bill 297B/Assembly Bill 164B (the “New York LIBOR Legislation”), the long anticipated New York State legislation addressing the cessation of U.S. Dollar (“USD”) LIBOR.[1]  The New York LIBOR Legislation generally tracks the legislation proposed by the Alternative Reference Rates Committee (“ARRC”).[2] It provides a statutory remedy for so-called “tough legacy contracts,” i.e., contracts that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions in the event USD LIBOR is no longer published or is no longer representative, and that will remain in existence beyond June 30, 2023 in the case of the overnight, 1 month, 3 month, 6 month and 12 month tenors, or beyond December 31, 2021 in the case of the 1 week and 2 month tenors.[3]

Under the new law, if a contract governed by New York law (1) references USD LIBOR as a benchmark interest rate and (2) does not contain benchmark fallback provisions, or contains benchmark fallback provisions that would cause the benchmark rate to fall back to a rate that would continue to be based on USD LIBOR, then on the date USD LIBOR permanently ceases to be published, or is announced to no longer be representative, USD LIBOR will be deemed by operation of law to be replaced by the “recommended benchmark replacement.” The New York LIBOR Legislation provides that the “recommended benchmark replacement” shall be based on the Secured Overnight Financing Rate (“SOFR”) and shall have been selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC for the applicable type of contract, security or instrument. The recommended benchmark replacement will include any applicable spread adjustment[4] and any conforming changes selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC.

The New York LIBOR Legislation also establishes a safe harbor from liability for the selection and use of a recommended benchmark replacement and further provides that a party to a contract shall be prohibited from declaring a breach or refusing to perform as a result of another party’s selection or use of a recommended benchmark replacement.

It should be noted that the New York LIBOR Legislation does not affect contracts governed by jurisdictions other than New York, and that the parties to a contract governed by New York law remain free to agree to a fallback rate that is not based on USD LIBOR or SOFR; the new law does not override a fallback to a non-USD LIBOR based rate (e.g., the Prime rate) agreed to by the parties to a contract. Although this legislation provides crucial safeguards, it should not be viewed as a substitute for amending legacy USD LIBOR contracts where possible. Rather, it should be viewed as a backstop in the event that counterparties are unwilling or unable to agree to adequate fallback language prior to the cessation date or date of non-representativeness.

The ARRC, the Federal Reserve Board and several industry associations and groups have expressed their strong support for the new law.[5]

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   [1]   See https://www.nysenate.gov/legislation/bills/2021/S297.

   [2]   See https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/libor-legislation-with-technical-amendments.

   [3]   We note that certain contracts, such as derivatives entered into under International Swaps and Derivatives Association (ISDA) standard documentation, provide for linear interpolation of the 1 week and 2 month USD LIBOR tenors until USD LIBOR ceases to exist for all tenors on June 30, 2023. The New York LIBOR Legislation provides that if the first fallback in a contract is linear interpolation, then, for the 1 week or 2 month tenor USD LIBOR contracts, the parties to the contract would continue to use linear interpolation for the period between December 31, 2021 and June 30, 2023. See the definition of “LIBOR Discontinuance Event” and “LIBOR Replacement Date” in the New York LIBOR Legislation.

   [4]   Note that the ICE Benchmark Administration Limited and the UK Financial Conduct Authority formally announced LIBOR cessation and non-representative dates for USD LIBOR on March 5, 2021. These announcements fixed the spread adjustment contemplated under certain industry-standard documents. See Gibson Dunn’s Client Alert: The End Is Near: LIBOR Cessation Dates Formally Announced, available at https://www.gibsondunn.com/the-end-is-near-libor-cessation-dates-formally-announced/.

   [5]   See “ARRC Welcomes Passage of LIBOR Legislation by the New York State Legislature,” ARRC (March 24, 2021, available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/20210324-arrc-press-release-passage-of-libor-legislation; see also, Randall Quarles, Keynote Address at the “The SOFR Symposium: The Final Year,” an event hosted by the Alternative Reference Rates Committee, New York, New York (March 22, 2021), available at https://www.federalreserve.gov/newsevents/speech/quarles20210322a.htm.


Gibson Dunn's lawyers are available to answer questions about the LIBOR transition in general and these developments in particular. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Capital Markets, Derivatives, Financial Institutions, Global Finance or Tax practice groups, or the following authors of this client alert:

Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) John J. McDonnell – New York (+1 212-351-4004, jmcdonnell@gibsondunn.com)

Please also feel free to contact the following practice leaders and members:

Capital Markets Group: Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com)

Derivatives Group: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Darius Mehraban – New York (+1 212-351-2428, dmehraban@gibsondunn.com) Erica N. Cushing – Denver (+1 303-298-5711, ecushing@gibsondunn.com)

Financial Institutions Group: Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Michelle M. Kirschner – London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com)

Global Finance Group: Aaron F. Adams – New York (+1 212 351 2494, afadams@gibsondunn.com) Linda L. Curtis – Los Angeles (+1 213 229 7582, lcurtis@gibsondunn.com) Ben Myers – London (+44 (0) 20 7071 4277, bmyers@gibsondunn.com) Michael Nicklin – Hong Kong (+852 2214 3809, mnicklin@gibsondunn.com) Jamie Thomas – Singapore (+65 6507 3609, jthomas@gibsondunn.com)

Tax Group: Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com) Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com) Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224/+1 212-351-2344), jtrinklein@gibsondunn.com) Bridget English – London (+44 (0) 20 7071 4228, benglish@gibsondunn.com) Alex Marcellesi - New York (+1 212-351-6222, amarcellesi@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 9, 2021 |
The End Is Near: LIBOR Cessation Dates Formally Announced

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On March 5, 2021, regulators and industry groups provided market participants with much anticipated clarity by announcing the dates for the cessation of publication of, and non-representativeness of, various settings of the London Interbank Offered Rate (“LIBOR”)[1] which will allow market participants to identify the date that their financial instruments and commercial agreements that reference LIBOR will transition to an alternative reference rate (e.g., a risk free rate).

The March 5th announcement is not only critical in providing certainty for the financial markets regarding timing for the replacement of LIBOR, but the announcement will also fix the spread adjustment contemplated under certain industry-standard documents as of March 5, 2021—thereby providing greater clarity around the economic impact of the transition from LIBOR to a risk free rate, like the Standard Overnight Financing Rate (“SOFR”) or the Sterling Overnight Index Average (“SONIA”).

LIBOR Announcement

The ICE Benchmark Administration Limited (“IBA”), the authorized administrator of LIBOR, published on March 5, 2021 a feedback statement on its consultation regarding its intention to cease the publication of LIBOR (the “IBA Feedback Statement”).[2]  The IBA Feedback Statement comes in response to the consultation published by IBA on December 4, 2020 (the “Consultation”)[3] and confirmed IBA’s intention to cease the publication of:

  • EUR, CHF, JPY and GBP LIBOR for all tenors after December 31, 2021;
  • one week and two month USD LIBOR after December 31, 2021; and
  • all other USD LIBOR tenors (e.g., overnight, one month, three month, six month and twelve month) after June 30, 2023.

Concurrent with the publication of the IBA Feedback Statement, the UK Financial Conduct Authority (the “FCA”) announced the future cessation or loss of representativeness of the 35 LIBOR settings published in five currencies (the “FCA Announcement”) from the above mentioned dates.[4]

Summary of FCA Announcement and IBA Feedback Statement:

Last Date of Publication or Representativeness is December 31, 2021:

Currency

Tenors

Spread Adjustment Fixing Date

Result

EUR LIBOR

All Tenors (Overnight, 1 Week, 1, 2, 3, 6 and 12 Months)

March 5, 2021

Permanent Cessation.

CHF LIBOR

All Tenors (Spot Next, 1 Week, 1, 2, 3, 6 and 12 Months)

March 5, 2021

Permanent Cessation.

JPY LIBOR

Spot Next, 1 Week, 2 Month and 12 Month

March 5, 2021

Permanent Cessation.

JPY LIBOR

1 Month, 3 Month and 6 Month

March 5, 2021

Non-Representative.  “Synthetic” rate possible for one additional year.

GBP LIBOR

Overnight, 1 Week, 2 Month and 12 Month

March 5, 2021

Permanent Cessation.

GBP LIBOR

1 Month, 3 Month and 6 Month

March 5, 2021

Non-Representative.  “Synthetic” rate possible for a “further period” after end-2021.

USD LIBOR

1 Week and 2 Month

March 5, 2021

Permanent Cessation

Last Date of Publication or Representativeness is June 30, 2023:

Currency

Tenors

Spread Adjustment Fixing Date

Result

USD LIBOR

Overnight and 12 Month

March 5, 2021

Permanent Cessation.

USD LIBOR

1 Month, 3 Month and 6 Month

March 5, 2021

Non-Representative.  “Synthetic” rate possible for a “further period” after end-June 2023.

The FCA Announcement and the IBA Feedback Statement are critical as they make clear the dates on which certain LIBOR settings will cease to exist or become non-representative (as described in more detail above), and they will serve as a “trigger event” for the fallback provisions in industry standard or recommended documentation, including those fallback provisions recommended by the Alternative Reference Rates Committee (“ARRC”) with respect to USD LIBOR and the fallback provisions in the International Swaps and Derivatives Association (“ISDA”) documentation.[5]

The FCA Announcement drew attention in markets around the globe.  For example, the Asia Pacific Loan Market Association (“APLMA”) issued a statement on March 8, 2021 in which it clarified the APLMA’s understanding of the FCA Announcement: The APLMA stated that the FCA Announcement indicates that the most widely used USD LIBOR settings in Asia, such as 1, 3 and 6 Month USD LIBOR, will continue to be published until June 30, 2023 and will continue to be representative until that date.  The APLMA also confirmed that based on undertakings received from the panel banks, the FCA does not expect that any LIBOR settings will become unrepresentative before the relevant dates set out above.

ISDA Index Cessation Event Announcement

Relatedly, shortly after the publication of the IBA Feedback Statement and the FCA Announcement, ISDA announced that these statements constitute an “Index Cessation Event” under the IBOR Fallbacks Supplement (Supplement Number 70 to the 2006 ISDA Definitions) and the ISDA 2020 IBOR Fallbacks Protocol, which in turn triggers a “Spread Adjustment Fixing Date” under the Bloomberg IBOR Fallback Rate Adjustments Rule Book for all LIBOR settings on March 5, 2021.[6]  The ARRC has stated[7] that its recommended spread adjustments for fallback language in non-consumer cash products referencing USD LIBOR (e.g., business loans, floating rate notes, securitizations) will be the same as the spread adjustments applicable to fallbacks in ISDA’s documentation for USD LIBOR.[8]  For further information on why a spread adjustment is necessary, see our previous alert from May 2020.[9]

This ISDA announcement provides market participants holding legacy contracts with greater clarity regarding the economic impact of the transition from LIBOR to risk free rates; however, even though the spread adjustment is now fixed, a value transfer is nonetheless expected to occur as a result of transition.  This is because the spread adjustment looks backwards to the median difference between the risk free rate and LIBOR over the previous five years, which is unlikely to be equivalent to what the net present value of the relevant instrument would have been at the time of transition, had LIBOR not been discontinued / ceased to be representative.  For example, in the case of USD LIBOR, when all tenors cease to be published or are deemed non-representative (at the end of December 2021 or June 2023, as the case may be) fallbacks for swaps will shift to SOFR, plus the spread adjustment that has now been fixed as of March 5, 2021. The fallback replacement rate of SOFR plus the spread adjustment that was fixed over two years prior is unlikely to match what would, absent transition, have been the net present value of such swap on the applicable LIBOR end date, thereby ultimately resulting in a value transfer to one party. However, the extent to which such value transfer will impact a particular financial instrument on the relevant LIBOR end date is unclear, as markets have been pricing in, and will continue to price in, the expected transition when valuing legacy instruments referencing LIBOR.

Potential “Synthetic” LIBOR for Limited Use

The IBA Feedback Statement explains that in the absence of sufficient bank panel support and without the intervention of the FCA to compel continued panel bank contributions to LIBOR, IBA is required to cease publication of the various LIBORs after the dates described above.[10]  Importantly, the IBA Feedback Statement and the FCA Announcement note that the UK government has published draft legislation (in proposed amendments to the UK Benchmarks Regulation set out in the Financial Services Bill 2019-21)[11] proposing to grant the FCA the power to require IBA to continue publishing certain LIBOR settings for certain limited (yet to be finalized) purposes, using a changed methodology known as a “synthetic” basis.

Specifically, the FCA has advised IBA that “it has no intention of using its proposed new powers to require IBA to continue publication of any EUR or CHF LIBOR settings, or the Overnight/Spot Next, 1 Week, 2 Month and 12 Month LIBOR settings in any other currency beyond the intended cessation dates for such settings.”  However, for the nine remaining LIBOR benchmark settings, the FCA has advised IBA that it will consult on using its proposed new powers to require IBA to continue publishing, on a synthetic basis, 1 Month, 3 Month and 6 Month GBP and JPY LIBOR (for certain limited periods of time) and will continue to consider the case for the “synthetic” publication of 1 Month, 3 Month and 6 Month USD LIBOR.  On March 5, 2021, the FCA also published statements of policy regarding some of the proposed new powers that the UK government is considering granting to the FCA.  These statements of policy include more detail on why the FCA is making these distinctions (e.g., to reduce disruption and resolve recognized issues around certain “tough legacy” contracts) and explain the intended methodology for the publication of the identified LIBORs on a synthetic basis (i.e., a forward looking term rate version of the relevant risk free rate, plus a fixed spread adjustment calculated over the same period, and in the same way as the spread adjustment implemented in the IBOR Fallbacks Supplement and the 2020 IBOR Fallbacks Protocol published by ISDA).[12]

If the FCA is granted the power to, and decides to require IBA to continue the publication of any LIBOR setting on a “synthetic” basis, the FCA Announcement makes clear that the synthetic LIBOR settings will no longer be deemed “representative of the underlying market and economic reality the setting is intended to measure”[13] (notwithstanding that the FCA may be able to compel the publication of a “synthetic” LIBOR rate for one or more of the 1 Month, 3 Month or 6 Month tenors for JPY LIBOR, GBP LIBOR and/or USD LIBOR beyond the set cessation date).

Notably, if the UK government decides to grant the FCA the power to, and the FCA decides to compel IBA to publish “synthetic” LIBOR for certain settings, the intent would be to assist only holders of certain categories of legacy contracts that have no or inappropriate alternatives and cannot practically be renegotiated or amended (so called “tough legacy” contracts, such as notes which may require up to 90% or 100% noteholder consent to amend the relevant terms of the note).[14]  As such, the powers are intended to be of limited use, and regulators have consistently stressed the need for market participants to actively transaction their legacy contracts.  For example, under the proposals in the UK Financial Services Bill, UK regulated firms would be prohibited from using such “synthetic” LIBOR settings in regulated financial instruments.  The FCA plans to consult on the “tough legacy” contracts that will be permitted to use “synthetic” LIBOR in the second quarter of this year.

Conclusion

The announcements on March 5th bring us one step closer to the cessation of LIBOR. The announcements are likely to offer market participants much needed clarity regarding the timing, and economics, of the transition of LIBOR to alternative reference rates. They also provide a reminder to, and increase pressure on, market participants to actively transition their financial instruments and commercial agreements that reference LIBOR to risk free rates.

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   [1]   LIBOR is the index interest rate for tens of millions of contracts worth hundreds of trillions of dollars, ranging from complex derivatives to residential mortgages to bilateral and syndicated business loans to commercial agreements.

   [2]   ICE LIBOR® Feedback Statement on Consultation on Potential Cessation (March 5, 2021), available here.

   [3]   ICE LIBOR® Consultation on Potential Cessation (December 2020), available here.

   [4]   “FCA announcement on future cessation and loss of representativeness of the LIBOR benchmarks,” Financial Conduct Authority (March 5, 2021), available here.

   [5]   We note that although the FCA Announcement and IBA Feedback Statement would constitute ”trigger events” under ARRC standard fallback language (e.g., a “Benchmark Transition Event”) and under ISDA standard fallback language (e.g., an “Index Cessation Event”), such financial instruments would continue to reference LIBOR until the date that LIBOR ceases to be published or is deemed non-representative (i.e., after December 31, 2021 or after June 30, 2023).  In other words, the date on which LIBOR changes to a risk free rate and the “trigger event” will likely be two distinct events as a result of the announcement.

   [6]   See Future Cessation and Non-Representativeness Guidance on FCA announcement on future cessation and loss of representativeness of the LIBOR benchmarks, ISDA (March 5, 2021), available here; see also IBOR Fallbacks, Technical Notice – Spread Fixing Event for LIBOR, Bloomberg, available here.

   [7]   See “ARRC Commends Decisions Outlining the Definitive Endgame for LIBOR,” Alternative Reference Rates Committee (March 5, 2021), available here; “ARRC Announces Further Details Regarding Its Recommendation of Spread Adjustments for Cash Products,” Alternative Reference Rates Committee (June 30, 2020), available here.

   [8]   The ARRC followed ISDA’s announcement stating that the IBA Feedback Statement and the FCA Announcement constitute a “Benchmark Transition Event” with respect to all USD LIBOR settings pursuant to the ARRC’s recommended fallbacks for new issuances of LIBOR floating rate notes, securitizations, syndicated business loans and bilateral business loans.  See “ARRC Confirms a “Benchmark Transition Event” has occurred under ARRC Fallback Language,” ARRC (March 8, 2021), available here.

   [9]   See Tax implications of benchmark reform: UK tax authority weighs in, Gibson Dunn (May 2020) available here.

  [10]   IBA received 55 responses to the Consultation which are summarized in the IBA Feedback Statement.  IBA notes that it shared and discussed the feedback received on the Consultation with the FCA.

  [11]   The text and status of the Financial Services Bill 2019-21 are available here.

  [12]   See “Proposed amendments to the Benchmarks Regulation,” Policy Statement, FCA (March 5, 2021) available here.

  [13]   FCA Announcement at footnote 3.

  [14]   See “Paper on the identification of Tough Legacy issues,” The Working Group on Sterling Risk-Free Reference Rates (May 2020), available here.


The following Gibson Dunn lawyers assisted in preparing this client update: Linda Curtis, Arthur Long, Jeffrey Steiner, Jamie Thomas, Bridget English, and Erica Cushing.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following practice group leaders and members:

Capital Markets Group: Andrew L. Fabens – New York (+1 212-351-4034, afabens@gibsondunn.com) Hillary H. Holmes – Houston (+1 346-718-6602, hholmes@gibsondunn.com) Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Peter W. Wardle – Los Angeles (+1 213-229-7242, pwardle@gibsondunn.com)

Derivatives Group: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Darius Mehraban – New York (+1 212-351-2428, dmehraban@gibsondunn.com) Erica N. Cushing – Denver (+1 303-298-5711, ecushing@gibsondunn.com)

Financial Institutions Group: Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Michelle M. Kirschner – London (+44 (0) 20 7071 4212, mkirschner@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com)

Global Finance Group: Aaron F. Adams – New York (+1 212 351 2494, afadams@gibsondunn.com) Linda L. Curtis – Los Angeles (+1 213 229 7582, lcurtis@gibsondunn.com) Ben Myers – London (+44 (0) 20 7071 4277, bmyers@gibsondunn.com) Michael Nicklin – Hong Kong (+852 2214 3809, mnicklin@gibsondunn.com) Jamie Thomas – Singapore (+65 6507 3609, jthomas@gibsondunn.com)

Tax Group: Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com) Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com) Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224/+1 212-351-2344), jtrinklein@gibsondunn.com) Bridget English – London (+44 (0) 20 7071 4228, benglish@gibsondunn.com) Alex Marcellesi - New York (+1 212-351-6222, amarcellesi@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 14, 2021 |
2020 Year-End German Law Update

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In 2020, the COVID-19 pandemic taught the world another lesson about the unpredictability of life. Each country responded to the challenges posed by the pandemic in its own way. The German Government in its familiar technocratic and sober approach quickly unlocked massive financial resources to mitigate any immediate economic damage. It supported a further relaxation of the purse strings at EU level and put legislative acts in place that helped manage the uncertainty in the most affected industries for now. Hit by a second wave of the pandemic in an unexpectedly hard way, Germany is now left wondering whether the country really was smart in the spring or just lucky. The new year 2021 will provide the answer to this question.

The disruption caused by the pandemic is not over; it has just started. On a positive note, we have seen an unprecedented move towards more efficient means of communication through the use of new media and the leveraging of technology in general. For example, long overdue changes to the handling of annual shareholder meetings of German joint stock corporations were implemented within weeks to facilitate the annual reporting season under lock-down conditions. By providing short term work allowances to compensate for losses in remuneration resulting from temporary cuts in working hours, the German system helped employers to hold onto their highly-skilled work force in the hope of a quick recovery thereby avoiding immediate hardship for those hit hard by the imposed restrictions. A speedy process to amend legislation addressing topics from suspending rent payments and interest payments to the temporary relaxation of insolvency filing obligations flanked by a coherent communication strategy added to the sentiment of most Germans of having been governed well, so far.

2021 will be different and bigger challenges certainly lie in wait. Instead of throwing hundreds of billions of Euros at the problem, German politicians will now have to explain to the public who is going to pick up the bill for all the important measures taken. The inadequate accords reached with the twenty-seven European Union members states that remain after Brexit designed to stabilize the weakest member state economies will require rigorous implementation and oversight. To date, hope rests on what has been a series of blink-decisions taken in face of an imminent European crisis coupled with the expectation that this will all result in a more aligned and more integrated European Union. A very optimistic scenario, indeed.

Apart from the emergency measures triggered by the COVID-19 pandemic, the EU and Germany have set and started to implement an ambitious agenda with regard to the regulation of international trade (by the introduction of tightened rules on foreign direct investments), antitrust laws (responding to the topics of market dominance in the digital age), consumer protection (with the introduction of collective redress within the EU), increased corporate responsibility in the white collar area (with the long-discussed introduction in Germany of criminal corporate liability), and the fight against money laundering and tax evasion.

And, finally, Angela Merkel’s term ends in the fall of 2021. She will have been the longest serving Chancellor in German history. This brings a 16-year era to an end that served Germany well and also helped Europe to navigate through difficult waters. She is expected to leave a temporary vacuum in German and European leadership that comes at the wrong time and is difficult to be filled in the short term.

Is this a dramatic crisis? No. Should we be concerned? Maybe. Should we act? Yes.

There are many things that each of us can do to turn the many challenges ahead into something new and potentially better. Here is our favorite list: First, stay healthy, look after yourself and your loved ones. Second, take informed and careful decisions each day to tackle the problems ahead, instead of rushing to beat “long-term-trends” with blurry visionary steps or short-sighted activism. Third, stay connected with the world, avoid narrow-minded thinking and a further fragmentation of the world, while staying connected to your local community. Learn where you can, challenge where you can, and help where you can. We are all in this together and only when we join forces, will we navigate the challenging times ahead of us.

At Gibson Dunn, we are proud and honored to be at your side to help solve your most complex legal questions and to continue our partnership with you in the coming year in Germany, in Europe and the world. We trust you will find this German Law Year-End Update insightful and instructive for the best possible start in 2021.

_______________________

Table of Contents

  1. Corporate, M&A
  2. Tax
  3. Financing and Restructuring
  4. Labor and Employment
  5. Real Estate
  6. Compliance / White Collar
  7. Data Privacy - Regulatory Activity and Private Enforcement on the Rise
  8. Technology
  9. Antitrust and Merger Control
  10. International Trade, Sanctions and Export Control
  11. Litigation
  12. Update on COVID-19 Measures in Germany
________________________ 

1.         Corporate, M&A

1.1       Next Round - Virtual-only Shareholder’s Meetings of Stock Corporations in 2021

The temporary COVID-19-related legislation of March 2020 allowing to hold virtual-only shareholders’ meetings of stock corporations in 2020[1] has been extended until the end of 2021 by means of an executive order of the German Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz) issued in October 2020. While the legal framework of the temporary regime for virtual-only meetings remained unchanged, the regulator strongly appealed to the management of the relevant corporations to use the emergency instrument of a virtual-only meeting in a responsible manner, taking into account the specific individual circumstances due to the pandemic situation.

In addition to this mere moral appeal by the executive branch, just before year-end and somewhat surprisingly, the parliamentary legislator modified the March 2020 legislation with regard to the shareholders’ right to information in virtual-only meetings as a concession to the widespread criticism in the aftermath of the March 2020 legislation. The March 2020 legislation had reduced the shareholders’ right to information to a mere possibility to submit questions in electronic form prior to the meeting, leaving it up to management in its sole discretion as to whether and in which manner to answer such questions. Additionally, it allowed management to set a submission deadline of up to two days prior to the meeting.

The October legislation, addressing widespread criticism raised not only by shareholder activists and institutional investors but also by legal scholars, restored the shareholder’s right to ask questions in the 2021 season for shareholders’ meetings taking place after February 28, 2021: It will again constitute a genuine information right requiring management to duly answer all shareholders’ questions submitted in time prior to the meeting. In addition, the cut-off deadline for the submission of shareholders’ questions may not exceed one day.

Furthermore, the parliamentary legislator also clarified in its last minute amendments that counter-motions by shareholders that are submitted for publication with the company at least 14 days prior to the shareholders’ meeting must be dealt with in the virtual-only shareholders’ meeting if the submitting shareholder has duly registered for the virtual shareholders meeting.

The virtual-only format is available to shareholders’ meetings of stock corporations which are held by December 31, 2021. In light of the current pandemic, the extensive use of the virtual-only format and the frequently observed extraordinary high participation-rate of shareholders in 2020, it can be expected that most stock corporations will again hold their shareholders’ meetings in a virtual-only format in 2021.

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1.2       Legislative Initiative to Strengthen Market Integrity after the Wirecard Scandal

In the aftermath of the spectacular collapse of German payment solutions provider Wirecard last summer, the German Government on December 16, 2020 presented a draft bill (Regierungsentwurf) for an Act on the Strengthening of the Financial Market Integrity (Finanzmarktintegritätsstärkungsgesetz - FISG) which aims to restore and strengthen trust in the German financial market.

The draft bill provides for new rules designed to bolster both the internal (in particular, via the supervisory board) and external (e.g. by strengthening the independence of external auditors and their supervision) corporate governance of companies of public interest, including listed companies.

This includes, in particular, the explicit obligation for the management board of a listed stock corporation to implement an adequate and effective internal control and risk management system. Furthermore, the draft bill also aims to strengthen the accounting and audit expertise present in the supervisory board of listed companies: Whereas the law currently only requires that, at least, one supervisory board member shall have expertise in the fields of accounting and auditing, the draft bill requires that, at least, one board member has expertise in the fields of accounting and, at least, one other board member has expertise in the fields of auditing, thus increasing the minimum number of experts to, at least, two board members. In addition, the establishment of an audit committee by the supervisory board shall no longer be discretionary but becomes compulsory for companies of public interest, including all listed companies.

In order to strengthen the independence of the auditor as part of a company’s external safeguards, the draft bill suggests the tightening of the mandatory external rotation. The external rotation of the auditor shall occur no later than after ten years for all companies of public interest, including listed companies, thus eliminating national exemptions from the EU audit regime, which currently allow for a maximum term of 24 years, and introduces further restrictions on non-audit services that can be provided by the auditor.

In reaction to the widespread criticism leveled at the response of Germany’s Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) to the events that led to Wirecard’s collapse and the perceived failure of the supervisory and enforcement procedures and mechanisms in financial reporting, the draft bill also proposes revisions to the current supervisory and enforcement procedures, including further-reaching competences for the financial regulator BaFin itself.

Last but not least, the draft bill provides for increased civil liability for damages caused by auditors as well as a tightening of criminal and administrative penalties for misrepresentations made by company representatives and statutory auditors in connection with the preparation and audit of company accounts.

The Government’s draft bill essentially corresponds to a joint ministerial draft of October 26, 2020 by the Federal Ministry of Finance (Bundesministerium für Finanzen) and the Federal Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz), which had been met with widespread criticism arguing that the proposals were not going far enough and failed to address the shortcomings of the current system which were also identified by the EU’s securities market regulator, the European Securities and Markets Authority (ESMA), in its special report on the Wirecard collapse published in November 2020. It remains to be seen whether and to which extent this criticism will be taken up by the lawmaker in the upcoming parliamentary process by providing for more fundamental changes and reforms.

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1.3       German Foreign Direct Investment Control – Rule-Tightening in Light of COVID-19 and the EU Screening Regulation

In December 2020, for the very first time, the German Federal government officially prohibited the indirect acquisition of a German company with specific expertise in satellite/radar communications and 5G millimeter wave technology by a Chinese state-owned defense group. The decision is the culmination of an eventful year which has seen various changes to the rules on foreign direct investments (the “FDIs”) in light of, inter alia, COVID-19 and the application of the EU Screening Regulation[2].

Below is an overview of the five key changes that have become effective over the course of 2020:

    1. Extension of the catalog of select industries triggering a mandatory filing with the German Ministry of Economy and Energy (Bundesministerium für Wirtschaft und Energie, BMWi) upon acquisition of 10% or more of the voting rights in a German company by a non-EU/non-EFTA acquirer to include (i) personal protective equipment, (ii) pharmaceuticals that are essential for safeguarding the provision of healthcare to the population as well as (iii) medical products and in-vitro-diagnostics used in connection with life-threatening and highly contagious diseases.
    2. No more gun-jumping: All transactions falling under the cross-sector review that require a mandatory notification (i.e., FDIs of 10% or more of the voting rights by a non-EU/non-EFTA investor in companies active in one or more of the conclusively listed select industries) may only be consummated upon conclusion of the screening process (condition precedent).
    3. Introduction of penalties (up to five years imprisonment or criminal fine (in case of willful infringements and attempted infringements) or an administrative fine of up to EUR 500,000 (in case of negligence)) for certain actions pending (deemed) clearance by the BMWi, namely: (i) enabling the investor to, directly or indirectly, exercise voting rights, (ii) granting the investor dividends or any economic equivalent, (iii) providing or otherwise disclosing to the investor certain security-relevant information on the German target company, and (iv) the non-compliance with enforceable restrictive measures (vollziehbare Anordnungen) imposed by the BMWi.
    4. Implementation of the EU-wide cooperation mechanism as required under the EU Screening Regulation.
    5. Expansion of the grounds for screening under German FDI rules to include public order or security (öffentliche Ordnung oder Sicherheit) of a fellow EU member state as well as effects on projects or programs of EU interest, and tightening of the standard under which an FDI may be prohibited or restrictive measures may be imposed from “endangering” (Gefährdung) to “likely to affect” (voraussichtliche Beeinträchtigung) the public order or security, so as to reflect the EU Screening Regulation.

For additional details on these and other changes in 2020 to foreign investment control and an overview on the overall screening process in Germany, please refer to our respective client alerts published in May 2020[3] and November 2020[4].

Further changes to the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung, AWV) are announced for 2021. In particular, the catalog of critical industries are to be extended further. Based on earlier announcements by the BMWi, artificial intelligence, robotics, semiconductors, biotechnology and quantum technology will likely be added to the catalog of critical industries.

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1.4       Gender Quota for (Certain) Management Boards on the Horizon

Five years after the (first) Management Position Act (Führungspositionen-Gesetz) for the first time implemented a mandatory female quota for the composition of supervisory boards of certain German companies in 2016,[5] the German government coalition parties now support a mandatory quota also for management boards. In the future, under the contemplated Second Management Position Act (Zweites Führungspositionen-Gesetz) (i) listed companies, (ii) which are subject to the 50% employee co-determination under the Co-Determination Act (Mitbestimmungsgesetz) and (ii) whose management board consists of more than three members, must appoint at least one female management board member whenever a position becomes vacant.

The new management board quota will only apply with regard to the rather limited number of companies who meet all of the above criteria. However, it is nevertheless a strong signal by the German coalition parties to a German business community in which voluntary commitments to increase gender equality have failed to gain significant momentum in the past. Under the 2015 Management Position Act which had introduced the mandatory gender quota for supervisory boards, companies were, in addition, requested to set themselves gender targets for the composition of their management boards. Rather than taking the opportunity to consider voluntary targets in line with the specific circumstances of a company, a large number of affected companies simply set the target at “zero” year after year. By contrast, the mandatory 30% gender quota for the composition of supervisory boards has not just been met but even exceeded and is currently polling at approximately 37%.

For all companies in which governmental authorities hold a majority, the contemplated Second Management Position Act will also (i) provide for a mandatory 30% female quota for the composition of supervisory boards and (ii) introduce a minimum number of mandatory female management board members. In addition, public law corporations (Körperschaften des öffentlichen Rechts) primarily active in the health and insurance sectors which typically employ a large number of female staff, will be required to appoint at least one female board member if the board is composed of two or more members.

The draft legislation was approved by the cabinet in early January 2021 and will now be submitted to the German Parliament. The new gender quota should in any event come into force prior to the German federal elections in autumn 2021.

While a number of corporations welcome the move towards more gender equality as Germany is lagging behind in comparison to, in particular, Scandinavian and UK companies, others oppose the quota law arguing undue interference with the right of the supervisory board to appoint the best available candidate. It will be interesting to see if and how investors position themselves.

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1.5       New Developments on Taxation of Remuneration for Supervisory Board Members

As a consequence of a ruling by the German Federal Fiscal Court (Bundesfinanzhof, BFH) late in 2019, the tax classification of compensation paid to supervisory board members has been modified in terms of value-added tax (VAT). In order to avoid potential adverse tax effects based on the incorrect tax treatment of supervisory board compensation, both individual supervisory board members and the companies they serve should be familiar with the ruling.

Previously, the tax authorities presumed without further differentiation between fixed or variable supervisory board compensation that members of supervisory boards were engaged in independent entrepreneurial activity and their remuneration was to be charged with VAT. It was irrelevant whether the respective member of the supervisory board was an elected member, served on the board as a shareholder delegate or in a capacity as an employee representative. At least in those cases where supervisory board members receive a fixed compensation for their service, future invoices will no longer be permitted to charge a VAT component.

The respective ruling by the BFH applied an earlier decision of the European Court of Justice (ECJ) taken on June 13, 2019 at the national level and confirmed the ECJ’s view that supervisory board members who receive fixed remuneration are not qualified as independent. The ECJ held in its decision that supervisory board members, who act on behalf of and in the sphere of responsibility of the supervisory board, do not bear any economic risk for their activities and therefore do not perform entrepreneurial activities due to a lack of independence. The BFH followed the argumentation of the ECJ and agreed that supervisory board members who receive a fixed remuneration which is neither dependent on their attendance at meetings nor on the services actually performed, cannot be classified as entrepreneurs. The BFH left it open whether independent entrepreneurial activities can be deemed to exist in cases where a variable remuneration is agreed with the individual member of the supervisory board.

For the individual supervisory board member, such classification as a dependent activity means, at least, in the case of fixed remuneration, that he or she may no longer add a VAT element to the remuneration in invoices issued to the company. Otherwise the supervisory board member would owe such tax, while the company would not be able to deduct such an incorrectly added tax component as an input tax deductible. Likewise, input tax amounts incurred in connection with the activity as a supervisory board member (e.g. VAT on travel expenses or office supplies) would no longer be recoverable due to the lack of independence of the supervisory board member.

If the supervised company is entitled to an unrestricted input tax deduction, this new jurisprudence should not have any adverse economic impact on the company, provided correct invoices are issued. Industries which are not entitled to deduct input tax or only entitled to deduct it to a limited extent - such as banks, insurance companies or non-profit organizations – actually benefit if the supervisory board member issues invoices without VAT.

The tax authorities have so far not yet published any guidelines in response to the new case law. It therefore remains to be seen whether the tax authorities will draw a distinction between fixed and variable compensation when qualifying the activities of a supervisory board member for VAT purposes. It would also be conceivable that the tax authorities would now generally assume that a supervisory board member's services are deemed to be a dependent activity which is generally not subject to VAT.

However, since a short-term response to the case in the administrative guidelines is to be expected in the near future, the ruling should be applied to fixed compensation and VAT should not be included in any future invoice. In the case of variable compensation and in view of the previous administrative practice, the invoicing of a separate VAT component would continue to be required until the tax authorities have communicated their new position on the matter or - if variable compensation is also to be accounted for without VAT - legal action may become necessary. It also remains to be seen whether the tax authorities will apply the new case law retrospectively and whether and how it would take into account considerations of the protection of legitimate expectations (Vertrauensschutz).

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2.         Tax

2.1       Taxation of Transactions involving German Registered IP

In a decree issued on November 6, 2020, the German tax authorities expressed their opinion that transactions between non-German parties, which relate to IP registered in a German register, are subject to tax in Germany. The tax provision the German tax authorities are referring to has been in existence for almost 100 years but in practice this provision has not been applied to transactions where both contracting parties reside outside of Germany. The German tax authorities now deviate from past practice and take the view that such extraterritorial transactions with German registered IP are taxable in Germany. In essence, such interpretation of the German tax authorities creates a taxable nexus in Germany only by virtue of the German registration of IP. As a consequence, royalties paid by a non-German licensee to a non-German licensor for German registered IP are subject to German withholding tax at a flat rate of 15.8%. A potential upfront tax relief under European directives or applicable double tax treaties may be applicable but requires a formal application by the licensor and a certification by the German tax authorities prior to payment of the royalties. If the withholding tax was not withheld, which is the typical case for German registered IP, the licensee as well as the licensor may be held liable for the payment of the withholding tax.

Only two weeks after the issuance of the decree, the German government released a draft tax bill on November 20, 2020 recognizing the far reaching interpretation of the tax authorities. Under the draft tax bill German tax for registered IP in Germany would only apply if the IP is exploited through a German permanent establishment or facility of the licensee; the pure registration of IP in a German register would not be sufficient anymore to become taxable in Germany. It is still unclear if and to what extent the draft tax bill becomes effective and, therefore, the November 6 decree remains for now the only currently valid administrative guidance on the taxation of IP registered in Germany.

Affected tax payers are well advised to closely monitor the further legislative process.

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2.2       Anti-Tax-Avoidance Directive

In 2016, the EU enacted the Anti-Tax-Avoidance Directive (ATAD) containing a package of legally binding measures to combat tax avoidance to be implemented into national law by all EU member states by 2018/2019. Germany has so far delayed implementation, exposing itself to EU infringement proceedings for failure to implement ATAD into national law in time. Almost one year after publication of the first draft bill, Germany is now considering implementing ATAD requirements in early 2021. Implementation has been delayed because Germany wanted to introduce several measures beyond a one-to-one implementation of the Directive, such as new rules on cross-border intercompany financing or exit taxation for individuals.

As part of the most relevant gap between existing German tax rules and ATAD requirements, Germany will introduce rules which limit the deduction of operating expenses for certain hybrid arrangements between related parties. Significant changes under ATAD regarding the current controlled foreign corporation (CFC) rules (Außensteuergesetz) will be a new control criterion and introduction of a shareholder-based approach. Control shall be deemed to exist if a German-resident shareholder, alone or jointly with related persons, holds a majority stake in the foreign company. The current concept of domestic control by adding up the participations of all German taxpayers will be abandoned. The current CFC rules, according to which a foreign company is considered as lowly taxed if the income tax is below 25%, shall, however, be retained.

This has evoked strong criticism by commentators since even in many developed countries the income tax rate is below 25% and CFC regulations in Germany can therefore be triggered too easily.

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2.3       New Anti-Treaty Shopping Rule

The European Court of Justice (ECJ) has consistently declared Germany’s attempts at creating a treaty-overriding anti-abuse provision to be a violation of EU fundamental freedoms. On November 20, 2020, the German government released a draft tax bill and launched another attempt at making the anti-abuse provision compatible with EU law. The draft law takes into account recent ECJ case law and provisions under the ATAD. Under the new wording of the anti-abuse provision a foreign company has no claim for relief from withholding tax to the extent that it is owned by persons, which would not be entitled for such relief, had they been the direct recipients of the income, and as far as the source of income is not materially linked to economic activity of this foreign company. Receiving the income and its onward transfer to investors or beneficiaries as well as any activity that is not carried out using business substance commensurate with the business purpose cannot be regarded as an economic activity. Withholding tax relief shall be given in so far as the foreign company proves that none of the main purposes of its interposition is obtaining a tax advantage or if the shares in the foreign company are materially and regularly traded on a recognized stock exchange.

If the new rule becomes law, it could in the future be harmful for a holding company to be interposed between its parent and a German income source even if the holding company and the parent are in different countries and both German tax treaties applicable to the holding and the parent company provide for the same withholding tax benefits. In such case it may be required to create a sufficient economic link between the German income source and the economic activity of the holding company in order to avoid the application of the anti-treaty shopping rule. An active management holding company should be regarded as a sufficient economic activity and such holding company should not to fall under the new rules. Further clarifications in that respect by the German tax authorities are expected in the first half of 2021.

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3.         Financing and Restructuring

With the COVID-19 pandemic hitting the German economy hard, the areas of financing and restructuring saw some of the most significant changes and sustained reform in 2020. The initial legislative response focused, in particular, on providing new sources of emergency funding and a temporary relaxation of the traditionally strict German insolvency filing obligations for companies perceived to be in financial disarray through no fault of their own due to the effects of the pandemic.[6]

On December 17, 2020, the German Parliament then adopted the Act on the Continued Development of Restructuring and Insolvency Law (Sanierungs- und Insolvenzfortentwick­lungsgesetz – SanInsFoG) to address (i) the fear of a large-scale “insolvency wave” upon the originally scheduled expiry of the COVID-19 pandemic triggered partial suspension of the insolvency filing requirement due to over-indebtedness on December 31, 2020,[7] and (ii) the implementation of the European Union Directive (EU) 2019/1029 of June 23, 2019 on preventive restructuring frameworks, the discharge of debt and measures to increase the efficiency of restructuring and insolvency proceedings (the “Restructuring Framework Directive”) into German law which would have been due by July 2021.

This reform of German restructuring and insolvency law, which was pushed through the parliamentary process in a very short period of time, has been labeled by many commentators as potentially the most significant reform of the German restructuring landscape since the introduction of the German Insolvency Code (Insolvenzordnng, InsO) in 2001.

A selection of key changes introduced by the SanInsFoG reform which came into effect on January 1, 2021 are highlighted in the below sections:

3.1       Reform of the German Insolvency Code (InsO) by the SanInsFoG

  • The insolvency reason of over-indebtedness (Überschuldung) was modified in such a way that the period for the necessary continuation prognosis (Fortführungsprognose), during which a mathematically over-indebted company must be able to meet its obligations when they fall due, was shortened to twelve months only. Before the reform, the relevant period was the current and the following business year.
  • If certain special requirements during the period of the pandemic are met, the prognostication period is shortened further to only four months in order to deal with the economic effects of the pandemic which makes reliable long term planning difficult if not impossible. This provision is designed further to soften the effects of the pandemic and applies only from January 1, 2021 to December 31, 2021.
  • The suspension of the insolvency filing obligation under the COVInsAG was further extended for all of January 31, 2021. The suspension applies to all over-indebted and/or illiquid companies (i) who filed an application for public support under the “November and December COVID-relief funds” (November- und Dezemberhilfen) but the respective funds were not yet paid out or (ii) such application was not possible for technical or legal reasons even though a business was entitled to apply. The extension does not apply if the receipt of such funds would not be sufficient to cure the existence of the insolvency reason or such application would clearly be unsuccessful.
  • For the insolvency reason of over-indebtedness only, the previous maximum period for mandatory insolvency filing of three weeks was extended to a maximum of six weeks.
  • The prognostication period for the determination of impending illiquidity (drohende Zahungsunfähigkeit) is now as a general rule twenty-four months.
  • Certain provisions relevant for the liability of the managing directors in times of distress were removed from various corporate statutes and concentrated in modified form in a new provision of the Insolvency Code (§ 15b InsO). The legislator, in particular, clarified and extended the payments permitted by the management of a debtor company after the time an insolvency reason has already occurred if a timely filing is later made.
  • The provisions on future access to own administration by management (Eigenverwaltung) and so-called protective umbrella proceedings (Schutzschirmverfahren) in the Insolvency Code were modified and partly restricted to address past undesirable developments. However, exceptions apply for entities who became insolvent due to the pandemic: (i) Illiquid entities may rely on the protective umbrella proceedings which otherwise are only available in case of impending illiquidity, and (ii) companies may under certain specific circumstances continue to avail themselves of the less restrictive pre-reform rules on own administration by management if such proceedings are applied for during the year 2021.

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3.2       Introduction of a New Pre-Insolvency Restructuring Tool Kit

The core piece of the SanInsFoG is the new, stand-alone act called the Business Stabilization and Restructuring Act (Unternehmensstabilisierungs- und -restrukturierungsgesetzStaRUG, the “Restructuring Act”). This Restructuring Act contains the German rules to transpose the requirements of the Restructuring Framework Directive into local German law, but partly goes beyond such minimum requirements.

Without any claims to be complete, clients and their management ought to be aware of the following key items in the Restructuring Act:

  • The Restructuring Act introduces a general obligation for management to install continuous supervision and early warning systems that enable management to detect any developments endangering their company’s existence or financial wellbeing.
  • Once a company is faced with impending illiquidity, and has opted for voluntary pre-insolvency restructuring proceedings, management of the debtor has to conduct the business with the care of prudent business person in restructuring and thus, in particular, has to safeguard the interests of the community of creditors. Conflicting shareholder instructions may not be complied with.
  • In voluntary pre-insolvency restructuring proceedings, management of the company must draw up a detailed, descriptive (darstellend) and executive (gestaltend) restructuring plan in order to restructure the company’s business or individual types of liabilities or contractual obligations. Measures may, for example, include haircuts and amendments of the rights of secured or unsecured creditors, but a comparative calculation/analysis needs to be attached which outlines the effects of the restructuring on individual creditors compared to a regular insolvency situation. It should be noted that claims of employees (including pension claims) may not be restructured or changed as part of the restructuring plan.
  • Approval of the restructuring plan requires a majority of 75% of the voting rights per creditor group. Subject to additional requirements, non-consenting creditors can be overruled via a court approved cross-class cram-down.
  • The court may upon request of the restructuring company further impose a temporary three-month moratorium on individual enforcement measures. Such moratorium may under certain circumstances be extended to a maximum period of eight months.
  • The handling of the entire pre-insolvency restructuring can be assisted or facilitated by the involvement of two newly-created functional experts appointed by the competent court, the so-called restructuring agent (Restrukturierungsbeauftragter) and the restructuring moderator (Sanierungsmoderator). In addition, the competent court may appoint a so-called creditor’s advisory committee (Gläubigerbeirat) ad officium if the proposed restructuring plan affects all creditors (except for creditors of exempt claims such as claims of employees) and, thus, is of such general application to all groups of creditors that the proceedings are akin to universal proceedings (gesamtverfahrensartige Züge). Such creditor advisory committee may also include members that are unaffected by the restructuring plan like e.g. employee representatives or others.
  • If illiquidity or over-indebtedness occurs during the restructuring proceedings, management is obliged to immediately inform the restructuring court, but the formal duty to file for insolvency is suspended. Such insolvency filings do remain possible, though, and the restructuring court may close the restructuring matter to allow for formal insolvency proceedings. Failure to inform the restructuring court duly or timely may incur personal liability for management.
  • The tools, procedures and restructuring measures contained in the Restructuring Act are mostly new and untested. It can thus be expected that the need for specialist advice for distressed companies will generally increase.

The need for additional expert assistance and the relatively heavy load of technical and procedural safeguards may pose a challenge in particular for small and medium-sized distressed businesses who suffer heavily from the pandemic and who may not have the financial and other resources to benefit from the Restructuring Act. It therefore remains to be seen whether and how the new Restructuring Act will stand the test of time in this regard. It can be expected, though, that the Restructuring Act will offer interesting options and restructuring potential, at least, for bigger and more sophisticated players in the German or international business arena. We would thus recommend that interested circles, i.e. German managing directors and board members but also investors or shareholders, familiarize themselves with the fundamentals of the Restructuring Act.

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4.         Labor and Employment

4.1       Employers’ Options during the COVID-19 Pandemic

The German lawmaker has enacted several support measures and subsidies for companies to cope with the ongoing COVID-19 pandemic, especially enhancing short-time work options. In a nutshell, short-time work means that working hours are reduced (even down to zero) and that the state pays between 60% and 87% of the net income lost by the affected employees. Currently, such a scheme can be extended to 24 months with the government even covering the social security costs.

Companies that make use of this generous scheme are not barred from carrying out redundancy measures. However, the narrative for such lay-offs is different: A termination for business reasons requires a permanent, not only a temporary loss of work. Regardless of these strict requirements, we have seen an uptick of redundancies during the pandemic.

For a more detailed insight we would refer to our client alert on the topic.[8]

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4.2       Reclassification Risk of Crowd-Workers into De-Facto Employees

The German Federal Labor Court (Bundesarbeitsgericht, BAG) has recently held that crowd-workers, i.e. freelancers hired over an online platform, can be classified as employees of the platform (9 AZR 102/20). This would entitle them to certain employee-protection rights, such as protection against dismissal, continued payment of remuneration and vacation claims.

In this particular case, the crowd-worker was considered an employee because the platform controlled the details of the work (place, date and contents) and featured a rating system that incentivized him to continuously perform activities for the platform operator. In the opinion of the court that sufficed to show that the crowd-worker was integrated in the platform operator’s business, making him an employee.

While the ruling will not render the business model of crowd-working platforms entirely impossible, especially platform operators using incentive systems should have these arrangements double-checked to mitigate the risk of costly reclassification of their crowd-workers.

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4.3       Pension Claims in Insolvency (Distressed M&A)

The European Court of Justice (ECJ) has issued an important ruling concerning the liability of acquirers of insolvent companies for occupational pensions. According to German case law, such acquirers have not been liable for their new employees’ rights with regard to occupational pension schemes as far as these rights had been accrued prior to insolvency. Instead, such claims are covered by the German Insolvency Protection Fund (Pensionssicherungsverein, PSV), which secures them to a certain extent, but not always entirely.

The plaintiffs in the underlying German court proceedings sued the acquirer for acknowledgement of their full pension claims disregarding reductions due to the insolvency. The ECJ now ruled on September 9, 2020 that the limited liability of the acquirer regarding occupational pension claims was only in line with European Union law if national law provided a certain minimum protection regarding the part not covered by the acquirer (C-674/18 and C-675/18). Regrettably, the ruling does not make it entirely clear who would be liable for a possible difference in benefits – the acquirer or the PSV. According to the few publications available so far, it appears more convincing that the PSV would have to cover said deficit. However, due to the lack of certainty, investors ought to take this potential risk into account when acquiring insolvent businesses.

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5.         Real Estate

5.1       Conveyance requires Domestic German Notary

The transfer of title to German real estate requires (i) the agreement in rem between the transferor and the acquiror on the transfer (conveyance) and (ii) the subsequent registration of the transfer in the competent land register. To be effective, the conveyance needs to be declared in the presence of both parties before a competent agency. While a notary appointed in Germany fulfills this criterium, it is disputed among German scholars whether the conveyance may also be effectively declared before a notary public abroad.

In its decision of February 13, 2020, the German Federal Supreme Court (BundesgerichtshofBGH) held that the conveyance may not be effectively declared before a notary who has been appointed outside of Germany. Engaging a notary abroad for the conveyance to get the benefit of (often considerably) lower notarial fees abroad, is thus not a viable option. In case of a sale of real estate under German law, additional notarial fees for the conveyance, however, may be avoided if the conveyance is included in the notarial real estate sale agreement recorded by a German notary.

The feasibility of a notarization before a notary public abroad is still disputed with respect to the notarization of the sale and transfer or the pledging of shares in a German limited liability company (GmbH). It remains to be seen whether this decision on real estate conveyance may also impact the dispute and arguments on the permissibility of foreign notarization of share sales and transfers or pledges.

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5.2       Update regarding Commercial Lease Agreements

Further developments of potential relevance for the real estate world, which were triggered by the COVID-19 pandemic, are discussed in the context of the continuing legal impact of the pandemic in sections 12.3 and 12.4 below.

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6.         Compliance / White Collar

6.1       Corporate Sanctions Act: Extended Liability for Criminal Misconduct

The German Federal Government is still pursuing its plan to implement a corporate criminal law into German law. After the Federal Council (Bundesrat) had demanded some changes to the previous draft bill, the Federal Government introduced its draft to Parliament on October 21, 2020. Unlike many other countries, German criminal law does not currently provide for corporate criminal liability. Corporations may only be fined for an administrative offense. Based on the draft bill, corporations will be responsible for business-related criminal offenses committed by their leading personnel and will be liable for fines of up to 10% of the annual – worldwide and group-wide – turnover. In addition to this fine, profits can be disgorged and the corporation will be named in a sanctions register as a convicted party for up to 15 years.

Furthermore, if implemented, public prosecutors would be legally obliged to open investigations against the corporation on the basis of a reasonable suspicion (currently, it is in their discretion), and a written legal framework for internal investigations will be established. A corporation will benefit from considerable mitigation of the sanction if it carries out an internal investigation that meets certain criteria (such as a cooperation with the authorities in an uninterrupted and unlimited manner, organizational separation between investigation and criminal defense, and adherence to fair trial standards).

In view of these developments, corporations should not only revise existing compliance systems to prevent corporate criminal misconduct, but also set up an action plan to be prepared for criminal investigations under the planned Corporate Sanctions Act. Considering that the current legislative period will end in the autumn of 2021, it is expected that a final resolution on the Corporate Sanctions Act will soon be reached by the legislator.

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6.2       Money Laundering: The German Government’s Intensified Fight for AML Compliance

In the past, the FATF (Financial Action Task Force) and others have often portrayed Germany as being too lenient in its efforts to combat money laundering, and the German regulatory framework was branded as containing too many loopholes. Recent developments surrounding the collapse of German pay service provider Wirecard have done little to assuage such views.

In response to such criticism, Germany has recently increased its efforts towards introducing a more forceful AML framework. A prime example of Germany’s new-found vigor in this regard is the fact that the German government opted not only to implement the 5th EU Money Laundering Directive, but to go above and beyond the minimum requirements set by the EU. As already discussed in sections 1.4, 5.2 and 6.2 of last year’s client alert, a number of legislative changes came into effect.[9]

In addition, the German government issued two distinct resolutions, namely the eleven points “National Strategy Package” and – in direct conjunction with the Wirecard collapse – the “16-Points Action Plan”. The corresponding changes are not limited to the German Criminal Code and the Anti Money Laundering Act (Geldwäschegesetz, GwG), but extend to establishing an improved organization of the German AML authorities.

The provision on money laundering in the German Criminal Code (section 261) will, according to the current Ministry of Justice draft bill, undergo a fundamental change. Pursuant to the intended legislation, the scope of section 261 of the German Criminal Code will be significantly broadened as any criminal wrongdoing may in the future constitute a predicate offense for money laundering.

Under the current state of the law, only a limited set of criminal offenses may give rise to money laundering. Importantly, criminal acts committed abroad may serve as predicate offenses for money laundering as well. The new legislation extends the scope of relevant prior offenses to certain acts which under EU law is required to be rendered punishable under the respective local criminal laws of the member states, irrespective of whether such act is in fact punishable in the jurisdiction at the place it is committed. Moreover, the offense of grossly-negligent money laundering has been re-introduced into the draft after a heated debate in this regard.

As supporting measures to the amended Anti Money Laundering Act, the German government decided to subject numerous economic players to (new or partially enhanced) AML requirements, including private financial institutions, crypto currency traders, real estate agencies and notaries who would be burdened with extended new obligations to disclose AML-related concerns regarding their customers and clients. These measures are mainly reflected in this year’s draft of a regulation on obligations to report certain facts surrounding real estate (Verordnung zu den nach dem Geldwäschegesetz meldepflichtigen Sachverhalten im Immobilienbereich).

Key German AML institutions were – as a direct result of the aforementioned government’s resolutions – significantly strengthened:

  • The Financial Intelligence Unit’s (FIU) personnel was more than doubled, and its data access rights were significantly expanded. In addition, a high level government body was established between German federal and local state authorities.
  • The German Federal financial supervisory authority BaFin was requested to ensure that companies and persons under its supervision implement any statutory obligations, and BaFin’s related supervisory competences were broadened.
  • The transparency registry which may be accessed by members of the public was established, collecting key relevant data including the UBO. Registration in the transparency register is mandatory for all companies with business activities in or related to Germany.

The German business community and relevant AML specialists should, at least, inform themselves or gain an in depth understanding of the new and extended regulatory framework. New monitoring systems need to be put in place to follow up on future predicate offenses. Therefore, relevant risk factors including those arising from new business models such as crypto currency trading have to be evaluated as a first step prior to implementing the new provisions.

While Germany has failed to implement new European AML requirements by December 3, 2020, the corresponding draft bill is expected to come into force soon.

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6.3       Cross-Border European Investigations: The European Public Prosecutor’s Office

To fight crimes against the fiscal interests of the European Union, the European Public Prosecutor’s Office (“EPPO”) is expected to become operative in 2021. The EPPO will act both on a centralized level with European Prosecutors based in Luxembourg having a supervisory and coordinating function and on a decentralized level with European Delegated Public Prosecutors situated in the participating EU member states having the same powers as national prosecutors to investigate specific cases. Its activities will focus on the prosecution of offenses to the detriment of the EU such as subsidy fraud, bribery and cross-border VAT evasion.

After the originally intended start of the new authority was delayed at the end of 2020, it is anticipated that investigation activities will start in 2021. In addition to the existing national criminal prosecution authorities and European institutions such as OLAF, Europol and Eurojust, a genuine European criminal prosecution authority will enter the stage and possibly bring about a shift in European enforcement trends. It is to be hoped that crimes affecting the EU’s financial interests will be pursued in a more robust manner and that international coordination of investigations will be significantly improved.

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7.         Data Privacy - Regulatory Activity and Private Enforcement on the Rise

The German Data Protection Authorities (“DPAs”) have certainly had a busy year. While, the trend towards higher fine levels for GDPR violations continues, the German DPAs have also initiated a number of investigations and issued guidance on a variety of issues, such as COVID-19 related data privacy concerns, the consequences of the “Schrems II” ruling of the Court of Justice of the European Union (judgment of July 16, 2020, case C-311/18)[10] and the use of video conferencing services and other technological tools in the context of working from home.

With regard to fines, in 2020 the German DPAs issued fines in the total amount of EUR 36.6 million (approx. USD 44.8 million). In October 2020, the Hamburg Data Protection Authority imposed a record-breaking fine in the amount of EUR 35.3 million (approx. USD 43.2 million) on a retail company for comprehensively and extensively collecting sensitive personal data from its employees, including health data and data about the employees’ personal lives, without having a sufficient legal basis to do so. This was the highest fine ever issued by a German DPA.

However, for companies it may well pay off to push back against such fines: The District Court (Landgericht) of Bonn largely overturned a fining decision issued by the German Federal Commissioner for Data Protection and Freedom of Information against a German telecommunications service provider in December 2019. While the court confirmed a violation of the GDPR, the court significantly reduced the fine in the amount of EUR 9.5 million (approx. USD 11.6 million) to EUR 900,000 (approx. USD 1.1 million).

Another important trend is the increasing number of private enforcements in the context of data protection violations. In particular, consumers are seeking judicial help to enforce information and access requests as well as compensation claims for material or non-material damages suffered as a result of GDPR violations, especially in the employment context. But German courts are apparently not (yet) prepared to award larger amounts to plaintiffs for this kind of GDPR violations. For example, in a case where an employee requested damages in the amount of EUR 143,500 (approx. USD 175,800) the Labor Court of Düsseldorf has awarded damages in the amount of only EUR 5,000 (approx. USD 6,000). Nevertheless, companies are well advised to keep an eye on future developments as courts may raise the amount of damages awarded if an increasing number of cases were to show that current levels of damages awarded are not sufficient to have a deterrent effect.

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8.         Technology

8.1       Committee Report on Artificial Intelligence

In November 2020, the German AI inquiry committee (Enquete-Kommission Künstliche Intelligenz des Deutschen Bundestages, hereafter the “Committee”) presented its final report, which provides broad recommendations on how society can benefit from the opportunities inherent in AI technologies while acknowledging the risks they pose. The Committee was set up in late 2018 and comprises 19 members of the German Parliament and 19 external experts.

The Committee’s work placed a focus on legal and ethical aspects of AI and its impact on the economy, public administration, cybersecurity, health, work, mobility, and the media. The Committee advocates for a “human-centric” approach to AI, a harmonious Europe-wide strategy, a focus on interdisciplinary dialog in policy-making, setting technical standards, legal clarity on testing of products and research, and the adequacy of digital infrastructure.

At a high level, the Committee’s specific recommendations relate to (1) data-sharing and data standards; (2) support and funding for research and development; (3) a focus on “sustainable” and efficient use of AI; (4) incentives for the technology sector and industry to improve scalability of projects and innovation; (5) education and diversity; (6) the impact of AI on society, including the media, mobility, politics, discrimination and bias; and (7) regulation, liability and trustworthy AI.

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8.2       Proposed German Legislation on Autonomous Driving

The German government announced plans to pass a law on autonomous vehicles by mid-2021. The new law is intended to regulate the deployment of connected and automated vehicles (“CAV”) in specific operational areas by the year 2022 (including Level 5 “fully automated vehicles”), and will define the obligations of CAV operators, technical standards and testing, data handling, and liability for operators. The proposed law is described as a temporary legal instrument pending agreement on harmonized international regulations and standards.

Moreover, the German government also plans to create, by the end of 2021, a “mobility data room”, described as a cloud storage space for pooling mobility data coming from the car industry, rail and local transport companies, and private mobility providers such as car sharers or bike rental companies. The idea is for these industries to share their data for the common purpose of creating more efficient passenger and freight traffic routes, and support the development of autonomous driving initiatives in Germany.

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9.         Antitrust and Merger Control

9.1       Enforcement Overview 2020

The German Federal Cartel Office (Bundeskartellamt), Germany’s main antitrust watchdog, has had another very active year in the areas of cartel prosecution, merger control, consumer protection and its focus on the digital economy.

On the cartel prosecution side, the Bundeskartellamt concluded several investigations in 2020 and imposed fines totaling approximately EUR 358 million against 19 companies and 24 individuals from various industries including wholesalers of plant protection products, vehicle license plates, and aluminum forging. It is of note that the fining level decreased by more than 50 % compared to 2019. While the Bundeskartellamt received 13 notifications under its leniency program, the increasing risks associated with private follow-on damage claims clearly reflect on companies’ willingness to cooperate with the Bundeskartellamt under its leniency regime. The authority stressed that it is continuing to explore alternative means to detect illegitimate cartel conduct, including through investigation methods like market screening and the expansion of its anonymous whistle-blower system.

In 2020, the Bundeskartellamt also reviewed approximately 1,200 merger control filings (i.e., approximately 14 % less than in 2019). As in previous years, more than 99 % of these filings were concluded during the one-month phase one review. Only seven merger filings required an in-depth phase-two examination. Of those, five were cleared in phase-two (subject to conditions in two of these cases), and two phase-two proceedings are still pending.

Looking ahead to the year 2021, the Bundeskartellamt will likely continue to focus on the digital economy and conclude its sector inquiry into online advertising. The agency also announced to go live with its competition register in Q1 of 2021 for public procurement purposes. This database will list companies that were involved in competition law infringements and other serious economic offenses.

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9.2       Paving the Way for Private Enforcement of Damages

In its Otis decision (C-435/18 of December 12, 2019), the European Court of Justice (ECJ) paved the way for private enforcement in cases concerning antitrust damages. The ECJ held that even a party not active on the market related to the one affected by the cartel may seek damages if there is a causal link between the damages incurred and the violation of Article 101 of the Treaty on the Functioning of the European Union (TFEU). The ECJ also reaffirmed that the scope of the right to compensation under Article 101 TFEU, i.e. the “who,” “what” and “why”, is governed by EU law while the national laws of the member states determine how to enforce the right.

Private enforcement of cartel damages is gaining momentum. Since the Otis decision, German courts, in particular the German Federal Supreme Court (Bundesgerichtshof, BGH), have further explored the course set by the ECJ in several antitrust damages cases concerning the so-called rail cartel.

The BGH held that Article 101 TFEU and, therefore, also the right to damages under German law, does not require the claimant to prove that a certain business transaction has directly been affected by the cartel at issue. Instead, it is sufficient if the claimant establishes that the cartel infringement is abstractly capable of causing damages to the claimant. As a result, courts only need to evaluate one long-lasting cartel infringement instead of individual breaches. The BGH further clarified in its decisions that the extent of an impairment by a cartel is a question of “how” a claimant would be compensated and, therefore, subject to German procedural law. As a consequence, the BGH encouraged courts to exercise judicial discretion when weighing the parties’ factual submissions and assessing cartel damages.

The BGH also ruled that the passing-on defense could apply if the claimant had received public grants which otherwise would not or not in such an amount have been paid to the claimant if the cartel had not existed. The court explained, however, that the defense may be barred when the damage is scattered to the downstream market level. In this case, it is inappropriate for the initiator of the cartel to walk free only because the individual damages were too minor to prompt claims for damages.

In the future, businesses will do well to monitor these ongoing developments as private enforcement actions of damages further gather pace and may develop into a sharp sword to police anti-competitive practices of other market players.

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9.3       Adoption of the “GWB Digitalization Act” expected for 2021

The draft bill for the 10th Amendment of the German Competition Act, also known as “GWB Digitalization Act” endorsed by the German Federal Government on September 9, 2020 is currently undergoing the legislative procedure in the German Parliament. The adoption of the bill is expected for early 2021. Having said that, the final discussions of the bill originally scheduled for December 17, 2020 were postponed until January 14, 2021.

As reported in our Year-End Alert 2019,[11] the draft bill addresses topics such as market dominance in the digital age and introduces a number of new procedural simplifications. For example, the bill currently foresees that companies, which depend on data sets of market-dominating undertakings or platforms, would have a legal claim to data access against such undertakings or platforms. Further, the draft bill introduces a rebuttable presumption whereby it is presumed that direct suppliers and customers of a cartel are affected by the cartel in case of transactions during the duration of the cartel with companies participating in the cartel.

Compared to the draft bill discussed in our Year-End Alert 2019, the governmental revision contains certain changes, in particular in the area of merger control. Thus, the draft bill currently features an increase of the two domestic turnover thresholds by EUR 5 million (approx. USD 6 million), i.e. from EUR 25 million to EUR 30 million (from approx. USD 30.6 million to approx. USD 36.8 million), and from EUR 5 million to EUR 10 million (from approx. USD 6.1 million to approx. USD 12.3 million), respectively. Additionally, a new provision was introduced in the legislative procedure, whereby the German Federal Cartel Office (Bundeskartellamt,) may require companies, which are deemed to reduce competition through a series of small company acquisitions in markets in which the Bundeskartellamt conducted sector inquiries, to notify every transaction in one or more specific sectors provided that certain thresholds are met. This notification obligation can be imposed on a company, if (i) the company has generated global turnover of more than EUR 500 million in the last business year, (ii) there are reasonable grounds for the presumption that future mergers could significantly impede effective domestic competition in the sectors for which the obligation has been imposed and (iii) the company has a market share of at least 15% in Germany in the sectors for which the obligation has been imposed. However, a notification will only be required if the target company has (i) generated turnover of more than EUR 2 million in the last business year and (ii) has generated more than two-thirds of its turnover in Germany. The notification obligation lasts for three years.

In light of the recent publication of the draft regulation on an EU Digital Markets Act by the European Commission, it remains to be seen how the German legislator will react to the proposals put forward by the Commission and how the national legislative procedure will evolve.

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10.       International Trade, Sanctions and Export Control

10.1     The New Chinese Export Control Law and its Impact on German Companies

The challenges, which German companies, specifically those with a U.S. parent or another U.S. nexus, face in light of the EU Blocking Statute’s prohibition to comply with certain U.S. sanctions on Iran and on Cuba, are well documented.[12] While 2021 might see calmer waters in the West due to the expected (yet far from certain) return to a more multilateral focus of the incoming Biden Administration, further complications await the German export business community in the East.

On December 1, 2020, a comprehensive new Chinese export control law went into effect. Generally speaking, the Chinese export control law reflects key elements of U.S. and EU/German export control related law. Particularly, licensing requirements for the export of controlled Chinese goods (including technologies) are determined on the basis of lists of goods and a catch-all clause.

As early as December 4, 2020, China's Ministry of Commerce along with other authorities already published the first such lists of goods in the area of “commercial cryptography”, i.e. regarding goods and technologies which can be used for encryption, inter alia, in telecommunication applications, VPN equipment or quantum cryptographic devices.

It is likely that any significant restrictions on, inter alia, exports of certain U.S. origin items and technology to China will eventually be mirrored in the respective Chinese lists to also impose significant restrictions on the export of certain Chinese origin items and technology to the U.S. For many German-based companies with a diversified supply chain this raises the unenviable prospect that they may use suppliers whose sourced goods originate in the U.S. and in China, respectively, which feature on each of the respective lists. This conflict may eventually limit the number of counterparties the German company can export the final product to without jeopardizing either supply chain. It may also limit the possibility of cooperation (e.g. technology transfer) with U.S. and/or Chinese suppliers and customers alike.

Further, China's new Export Control Law contains regulation comparable to the (U.S.) concept of “deemed export” via the definition of “exports”, which applies when a Chinese person transfers listed goods to a foreign person. Depending on how extensively this is interpreted by the Chinese authorities, this could, for example, result in Chinese export control law also applying to transfers by Chinese individuals located in Germany to a German person. Therefore, the details of this potential extraterritorial effect of Chinese export control law, as well as a vague reference to an extension of Chinese export control law to re-exports of listed goods and technologies or goods and technologies covered by the catch-all regime, raises numerous questions that will presumably only be clarified in time by the publication of specific regulations or guidance by the Chinese authorities.

Additionally, the EU is also taking initial steps to further strengthen its defense mechanisms against perceived and potential interference with its sovereignty by the extraterritorial effects of U.S. and Chinese export control laws. Specifically, the EU Parliament requested a study[13] on extraterritorial sanctions on trade and investments and European responses, that, inter alia, suggests the establishment of an EU agency of Foreign Assets Control (EU-AFAC) with the aim of more efficient and effective enforcement of, inter alia, the EU Blocking Statute, which might also come to include parts of the Chinese export control law.

In any case, any German export control compliance department would be well-advised to update its Internal Compliance Program to be able to identify conflicting compliance obligations early and establish a process to swiftly resolve them - without breaching applicable anti-boycott regulations – in order to avoid the supply-chain-management of the company being negatively impacted.

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10.2     Update on the German Rules regarding Foreign Direct Investment Control

For a summary of the recent reforms of German foreign investment control laws, reference is made to section 1.3 above.

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11.       Litigation

11.1     Establishment of Commercial Courts in Germany - An Emerging Forum for International Commercial Disputes?

Over the past few years, Germany has taken several efforts to become a more attractive forum venue for international disputes. In 2010, three District Courts (Landgerichte) in Cologne, Bonn and Aachen had established English-speaking divisions for civil disputes. Since January 2018, the Frankfurt district court has allowed oral hearings in international commercial disputes to be conducted in English, provided the parties agree. The same now applies for the district courts in Mannheim and Stuttgart where two civil and two commercial divisions specially established for this purpose have started their work in November 2020. The civil divisions consist of three professional judges, respectively. The commercial divisions offer a combination of legal and industry-specific expertise and are led by one professional judge and two honorary judges from the local business community. All divisions have been equipped with state-of-the-art technical equipment, allowing for video-conferences and video testimonies of witnesses and experts.

Provided that the district court in Mannheim or in Stuttgart has jurisdiction (or the parties agree), the Commercial Courts in Mannheim or Stuttgart may hear corporate disputes, post-M&A disputes as well as disputes concerning mutual commercial transactions. Additionally, the court in Mannheim is available for disputes resulting from banking and financial transactions. While the Commercial Court in Stuttgart does not limit its jurisdiction to a certain litigation value, the court in Mannheim (its patent division enjoys global recognition) requires an amount in dispute of at least EUR 2 million. To ensure an effective review at the appellate level, the Higher District Courts (Oberlandesgerichte) in Stuttgart and Karlsruhe have also established specialized appeal panels responsible for dealing with appeals and complaints against the decisions of the new Stuttgart and Mannheim Commercial Courts.

The new Commercial Courts are supposed to let international litigants benefit from the high quality of the German court system and the advantages of its procedural rules. Overall, the duration of court proceedings in Germany is fairly short. There is no “American-style” discovery process. Costs are moderate by international standards, and must be borne by the losing party. Hearings are usually held in public, but the public can be excluded when business secrets are discussed. Additionally, parties may decide whether or not to allow for an appeal.

Despite these benefits, it remains to be seen whether the Commercial Courts in practice will measure up to these high expectations: Even though oral hearings may be conducted in English and a translation of English appendices is no longer required, every written submission must still be filed in German, and the decisions the court renders are in German as well. In any case, the new Commercial Courts seem to be a further step into the right direction towards a more international business-friendly approach.

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11.2     Directive for Collective Redress – Class Action at EU-Level

On December 4, 2020, following an agreement between the EU-institutions in June 2020, the EU-Parliament has approved the “Directive on representative actions for the protection of the collective interests of Consumers” (the “Directive”)[14], introducing the possibility of collective redress across the borders within the EU. The Directive aims to strengthen the protection of EU-consumer rights in case of mass damages, covering both domestic and cross-border infringements, especially with regard to data protection, energy, telecoms, travel and tourism, environment and health, airline rights and financial services. The EU Member States need to implement the Directive into their national laws within two years and six months, i.e. by mid-2023.

Under the Directive, collective legal actions may only be taken by “qualified entities” on behalf of consumers against traders, seeking injunction and/or redress measures. For the purpose of cross-border representative actions, the qualified entities may only be designated (by the Member State) if they comply with EU-wide criteria (i.e. non-profit, independent, transparent and ensure a legitimate interest in consumer protection). To prevent abusive litigation, the defeated party has to bear the costs of the proceedings (“loser pays”) and courts or administrative authorities may dismiss manifestly unfounded cases. Consumers can join the action by either opt-in or opt-out mechanisms, depending on the decision regarding procedure which each Member State takes.

Even though the legal orders of many Member States already provide for the possibility of collective redress, the Directive assures (i) a harmonized approach to collective redress and (ii) mandatory redress measures in every Member State such as compensation, repair or price reduction without the need to bring a separate action. Therefore, the Directive goes beyond some existing regulations, which only allow declaratory actions or injunctive relief. At the same time, individual actions by plaintiffs remain possible and unregulated at the EU level. As the diesel emissions lawsuits in Germany demonstrate, this can lead to waves of mass actions and a massive clogging of court dockets.

Even though the deadline for the implementation of the Directive is still sometime down the road, the adoption of laws and regulations in the Member States to implement the Directive will need to be closely monitored by companies and law firms, in particular with regard to the various Member States’ chosen path on such issues as opt-in vs. opt-out and discovery or disclosure of documents.

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11.3     German Courts and the COVID-19 Pandemic

COVID-19 has affected all areas of life, including the court system. Over the year 2020, German courts had to learn how to litigate despite the pandemic and conduct oral hearings, as well as litigation in general, as safe as possible for everyone involved.

During the first wave of the pandemic in spring 2020, non-urgent matters were mostly postponed. Some courts in areas particularly troubled by the virus were forced to close their buildings to the public. However, the German administration of justice was never completely suspended or paused.

During the summer of 2020, with fewer COVID-19 cases, court proceedings started to normalize and courts developed concepts to continue with litigation despite the pandemic. In appropriate cases, courts tried to avoid oral hearings and, with the parties’ consent, conducted the proceedings in writing only. Courts also slowly started to hold oral hearings using video conferencing tools. While the German Rules of Civil Procedure (Zivilprozessordnung, ZPO) allow this method since 2001, German Courts were reluctant to use it before the pandemic. However, in the vast majority of cases, German Courts still conduct oral hearings despite the COVID-19 situation. Most courts adhere to hygiene concepts for these hearings, such as wearing face masks, keep sufficient distance between the individuals and ventilate the court room frequently.

For the year 2021, we expect that more and more courts elect to conduct the proceedings in writing or by videoconference. If an oral hearing is necessary nevertheless, the courts now have hygienic routines in place. Thus, unless we see a dramatic change in the COVID-19 infection rates, we do not expect that German courts will need to reduce their working speed in 2021.

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12.       Update on COVID-19 Measures in Germany

As in other jurisdictions, the COVID-19 pandemic has led to a large variety of legislative measures in Germany, which were aimed at mitigating the impact of the pandemic on the economy. These measures included in particular a moratorium for continuing obligations (temporary right to refuse performance under certain contracts), a temporary deferral of payment for consumer loans, the Special Program 2020 set up by the Kreditanstalt für Wiederaufbau (KfW) and the introduction of the Economic Stabilization Fund (Wirtschaftsstabilisierungsfonds). While many of these state measures and programs are still in place unchanged, others have been amended and adapted in time and some have lapsed without replacement. The following summary therefore gives a short overview on the current status of the COVID-19-induced state measures and programs in Germany. Most of the measures mentioned in this alert have already been covered in more detail in previous alerts published throughout 2020, that can be found here.[15]

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12.1     Economic Stabilization Fund (Wirtschaftsstabilisierungsfonds)

The Act on the Introduction of an Economic Stabilization Fund (Gesetz zur Errichtung eines Wirtschaftsstabilisierungsfonds - WStFG) entered into force on March 28, 2020. This act provides the statutory framework for state stabilizing measures, in particular, guarantees and recapitalization measures, like the acquisition of subordinated debt instruments, profit-sharing rights (Genussrechte), silent partnerships, convertible bonds and the acquisition of shares. After the introduction of the Economic Stabilization Fund was approved under state aid law by the EU Commission in July 2020 and the legal regulations for its implementation were published in the Federal Law Gazette in October 2020, the Economic Stabilization Fund has become fully operational.

Moreover, in July 2020 the new Economic Stabilization Acceleration Act (Wirtschaftsstabilisierungsbeschleunigungsgesetz – WStBG) came into force, which provides for temporary modifications of German corporate law in order to implement the state aid measures by the Economic Stabilization Fund more efficiently. These changes include, inter alia, facilitations for capital measures and transactions (capital increases, capital reductions, etc.) in connection with stabilization measures, which significantly relax minority protection.

Since the introduction of the Economic Stabilization Fund, there have been several high profile cases, in which those measures have been effectively put into action: Deutsche Lufthansa (silent participation in the amount of EUR 5,7 billion and subscription of shares by way of a capital increase amounting to 20% of the share capital), TUI (convertible bond and various other emergency support measures in the amount of EUR 1.3 billion), FTI Touristik (subordinated loan in the amount of EUR 235 million), MV Werften Holding (subordinated loan in the amount of EUR 193 million) and German Naval Yards Kiel (subordinated loan in the amount of EUR 35 million).

Originally, (i) guarantees under the Economic Stabilization Fund could only be granted until December 31, 2020 and (ii) the application period for recapitalization measures was set to run until June 30, 2021. These deadlines have now been extended and (i) guarantees can now be granted until June 30, 2021 and (ii) recapitalizations can be granted until September 30, 2021, respectively.

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12.2     Corporate Law Modifications pursuant to the COVID-19 Pandemic Mitigation Act

The COVID-19 Pandemic Mitigation Act (Gesetz zur Abmilderung der Folgen der COVID-19-Pandemie im Zivil-, Insolvenz- und Strafverfahrensrecht) provided for, inter alia, (i) a modification of the Limited Liability Company Act (GmbHG), which facilitates shareholder resolutions in text form or by written vote (circulation procedure) without requiring the consent of all shareholders to such procedure, and (ii) a modification of the Conversion Act (UmwG) with regard to measures requiring the submission of a closing balance sheet, where the balance sheet reference date (Bilanzstichtag) used in such filings can now be up to twelve months old at the time of the register filing instead of a maximum of eight months as under the regular statutory rules.

Both of these COVID-19-induced rules were extended by legislative decree dated October 20, 2020 (Verordnung zur Verlängerung von Maßnahmen im Gesellschafts-, Genossenschafts-, Vereins- und Stiftungsrecht zur Bekämpfung der Bekämpfung der Auswirkungen der COVID-19-Pandemie) and are effective until December 31, 2021.

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12.3     Moratorium for Continuing Obligations and Consumer Loans, Restriction of Lease Terminations

The COVID-19 Pandemic Mitigation Act also introduced a moratorium for substantial continuing obligations (i.e. those which serve to provide goods or services of general interest, such as the supply of energy and water), which allowed obligors to refuse to fulfill their obligations if they were no longer able to meet their obligations as a result of the COVID-19 pandemic. This moratorium was limited to June 30, 2020. It could theoretically have been extended thereafter by legislative decree until September 30, 2020, but the government decided not to make use of the option to extend the moratorium. The moratorium therefore expired on June 30, 2020.

Likewise, the payment deferral for consumer loan agreements, which stipulated that claims of lenders for payment of principal or interest due between April 1 and June 30, 2020 were deferred by three months, was not extended by the government, either. As a result, debtors can no longer defer payment, and in order to avoid a double burden for the debtor, the period of the loan agreement will be extended by three months, unless the lender under such a consumer loan and the debtor have reached another arrangement.

Furthermore, the COVID-19 Pandemic Mitigation Act restricts the landlords’ termination right concerning German real estate lease agreements. Until June 30, 2022, a landlord is not entitled to terminate such a lease agreement solely based on the argument that the tenant is in default with payment of the rent for the period April 1, 2020 through June 30, 2020 if the tenant provides credible evidence that the payment default is based on the impact of the COVID-19 pandemic. The landlord’s other contractual and statutory termination rights as well as its rental payment claims for such period, however, remained unaffected by the COVID-19 Pandemic Mitigation Act. Likewise, the government did not make use of the option to extend the termination restrictions to backlogs in tenants’ payments for the period July 1, 2020 through September 30, 2020.

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12.4     Request for Adjustment of Commercial Lease Agreements

The German Parliament (Bundestag) passed a bill on December 17, 2020 that is supposed to increase the chances of tenants of German commercial property or room leases to successfully request an adjustment of the contractual lease terms or even termination of the lease pursuant to Section 313 German Civil Code (Bürgerliches Gesetzbuch – BGB) due to the COVID-19 pandemic. A request pursuant to Section 313 BGB requires that (i) circumstances that are the mutually accepted basis of the contract have significantly changed since the conclusion of the contract, (ii) the parties would not have entered into the contract or only with different content if they had foreseen this change, and (iii) the party making such a request cannot reasonably be expected to be held to the terms of the contract without adjustments or even at all taking into account all circumstances of the specific case, in particular, the contractual or statutory distribution of risk between the parties.

According to this bill, circumstances that are the mutual basis of the contract are refutably deemed to have significantly changed if the use of such leased premises is significantly restricted due to public measure for the purpose of combating the COVID-19 pandemic. As the tenant still needs to show that the other conditions are fulfilled, in particular, that the balancing of interest under (iii) above is in its favor, it remains to be seen whether this bill has the desired effect. Attempting to find an amicable solution may still be the better option for both the landlord and the tenant.

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12.5     Miscellaneous

In addition to the legislative measures mentioned above, Germany has introduced a varied array of additional programs to stabilize and support the German economy. Particularly noteworthy is the KfW’s Special Program 2020 (“KfW Sonderprogramm 2020 für Investitions- und Betriebsmittelfinanzierung”), which includes the KfW Entrepreneur Loan (“KfW Unternehmerkredit”), the ERP Start-Up Loan – Universal (“EPR Gründerkredit – Universell”) and the KfW Special Program Syndicated Lending (KfW Sonderprogramm “Direktbeteiligung für Konsortialfinanzierung“). The Special Program 2020 was originally set to run until December 31, 2020 and has in the meantime been extended until June 30, 2021. The European Commission has not yet approved the program under state aid law, but this is expected to take place in the near future.

The Immediate Corona Support Program for small(est) enterprises and sole entrepreneurs (Corona Soforthilfe für Kleinstunternehmen und Soloselbstständige) was a one-off payment for three months during the first lockdown in the spring of 2020, that has not been relaunched by the government in connection with the second lockdown in Germany in the fall of 2020. However, similar support has been provided to companies which are particularly affected by the lockdown (most notably restaurants and hotels) through the so-called “November and December COVID-relief” program (November- und Dezemberhilfen).

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12.6     Conclusion

The COVID-19 pandemic is obviously not over yet and it is difficult to predict how things will develop going forward. It is important for companies to keep an eye on the current status of the COVID-19 support measures and programs and how they will be amended or evolve over time. Otherwise, there is the risk that new support programs will be overlooked or deadlines for existing programs will be missed.

The following webpage provides a good overview of the current support measures for businesses in Germany: https://www.bmwi.de/Redaktion/DE/Coronavirus/coronahilfe.html.

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____________________

   [1]   Also see our alerts dated March 27, 2020, section III., published under https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/ and dated September 24, 2020, published under https://www.gibsondunn.com/covid-19-german-rules-on-possibility-to-hold-virtual-shareholders-meetings-likely-to-be-extended-until-end-of-2021/.

   [2]   EU Regulation (EU) 2019/452 of March 19, 2019 establishing a framework for screening of foreign direct investments into the EU, available in the English language version under: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32019R0452&from=EN.

   [3]   “German Foreign Investment Control Tightens Further”, available under https://www.gibsondunn.com/german-foreign-investment-control-tightens-further/.

   [4]   “Update on German Foreign Investment Control: New EU Cooperation Mechanism & Overview of Recent Changes”, available under https://www.gibsondunn.com/update-on-german-foreign-investment-control-new-eu-cooperation-mechanism-and-overview-of-recent-changes/.

   [5]      In this context, see section 1.6 of 2015 Year End Alert available under https://www.gibsondunn.com/2015-year-end-german-law-update/.

   [6]   We refer you to our earlier alerts in this regard available at: https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/ and at https://www.gibsondunn.com/european-and-german-programs-counteracting-liquidity-shortfalls-and-relaxations-in-german-insolvency-law/, as well as more specifically on insolvency filing obligations https://www.gibsondunn.com/temporary-german-covid-19-insolvency-regime-extended-in-modified-form/.

   [7]   Again see our alert at https://www.gibsondunn.com/temporary-german-covid-19-insolvency-regime-extended-in-modified-form/.

   [8]   Available under https://www.gibsondunn.com/covid-19-short-term-reduction-of-personnel-costs-under-german-labor-law/.

   [9]   Available under https://www.gibsondunn.com/2019-year-end-german-law-update/.

[10]   See https://www.gibsondunn.com/the-court-of-justice-of-the-european-union-strikes-down-the-privacy-shield-but-upholds-the-standard-contractual-clauses-under-conditions/.

[11]   Section 7.2 in the Year-End Alert published under https://www.gibsondunn.com/2019-year-end-german-law-update/.

[12]   Available under https://www.gibsondunn.com/new-iran-e-o-and-new-eu-blocking-statute-navigating-the-divide-for-international-business/.

[13]   This study is available under: https://www.europarl.europa.eu/RegData/etudes/STUD/2020/653618/EXPO_STU(2020)653618_EN.pdf.

[14]   See at https://eur-lex.europa.eu/legal-content/en/TXT/PDF/?uri=CELEX:32020L1828&from=DE.

[15]   These earlier alerts are available under https://www.gibsondunn.com/european-and-german-programs-counteracting-liquidity-shortfalls-and-relaxations-in-german-insolvency-law/, under https://www.gibsondunn.com/whatever-it-takes-german-parliament-passes-far-reaching-legal-measures-in-response-to-the-covid-19-pandemic/ and under https://www.gibsondunn.com/corporate-ma-in-times-of-the-corona-crisis-current-legal-developments-for-german-business/.


The following Gibson Dunn lawyers assisted in preparing this client update:  Birgit Friedl, Marcus Geiss, Carla Baum, Silke Beiter, Andreas Dürr, Lutz Englisch, Ferdinand Fromholzer, Daniel Gebauer, Kai Gesing, Franziska Gruber, Selina Grün, Johanna Hauser, Alexander Horn, Markus Nauheim, Patricia Labussek, Wilhelm Reinhardt, Markus Rieder, Richard Roeder, Sonja Ruttmann, Martin Schmid, Annekatrin Schmoll, Benno Schwarz, Ralf van Ermingen-Marbach, Linda Vögele, Friedrich Wagner, Frances Waldmann, Michael Walther, Georg Weidenbach, Finn Zeidler, Mark Zimmer, Stefanie Zirkel and Caroline Ziser Smith.

Gibson Dunn's lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. The two German offices of Gibson Dunn in Munich and Frankfurt bring together lawyers with extensive knowledge of corporate, M&A, finance and restructuring, tax, labor, real estate, antitrust, intellectual property law and extensive compliance / white collar crime experience. The German offices are comprised of seasoned lawyers with a breadth of experience who have assisted clients in various industries and in jurisdictions around the world. Our German lawyers work closely with the firm's practice groups in other jurisdictions to provide cutting-edge legal advice and guidance in the most complex transactions and legal matters. For further information, please contact the Gibson Dunn lawyer with whom you work or any of the following members of the German offices:

General Corporate, Corporate Transactions and Capital Markets Lutz Englisch (+49 89 189 33 150), lenglisch@gibsondunn.com) Markus Nauheim (+49 89 189 33 122, mnauheim@gibsondunn.com) Ferdinand Fromholzer (+49 89 189 33 170, ffromholzer@gibsondunn.com) Dirk Oberbracht (+49 69 247 411 510, doberbracht@gibsondunn.com) Wilhelm Reinhardt (+49 69 247 411 520, wreinhardt@gibsondunn.com) Birgit Friedl (+49 89 189 33 122, bfriedl@gibsondunn.com) Silke Beiter (+49 89 189 33 170, sbeiter@gibsondunn.com) Annekatrin Pelster (+49 69 247 411 521, apelster@gibsondunn.com) Marcus Geiss (+49 89 189 33 115, mgeiss@gibsondunn.com)

Finance, Restructuring and Insolvency Sebastian Schoon (+49 69 247 411 540, sschoon@gibsondunn.com) Birgit Friedl (+49 89 189 33 122, bfriedl@gibsondunn.com) Alexander Klein (+49 69 247 411 518, aklein@gibsondunn.com) Marcus Geiss (+49 89 189 33 115, mgeiss@gibsondunn.com)

Tax Hans Martin Schmid (+49 89 189 33 110, mschmid@gibsondunn.com)

Labor Law Mark Zimmer (+49 89 189 33 130, mzimmer@gibsondunn.com)

Real Estate Hans Martin Schmid (+49 89 189 33 110, mschmid@gibsondunn.com) Daniel Gebauer (+49 89 189 33 115, dgebauer@gibsondunn.com)

Technology Transactions / Intellectual Property / Data Privacy Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)

Corporate Compliance / White Collar Matters Benno Schwarz (+49 89 189 33 110, bschwarz@gibsondunn.com) Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Mark Zimmer (+49 89 189 33 130, mzimmer@gibsondunn.com) Finn Zeidler (+49 69 247 411 530, fzeidler@gibsondunn.com) Ralf van Ermingen-Marbach (+49 89 189 33 161, rvanermingenmarbach@gibsondunn.com)

Antitrust Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com) Georg Weidenbach (+69 247 411 550, gweidenbach@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)

Litigation Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Markus Rieder (+49 89 189 33 160, mrieder@gibsondunn.com) Mark Zimmer (+49 89 189 33 130, mzimmer@gibsondunn.com) Finn Zeidler (+49 69 247 411 530, fzeidler@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com)

International Trade, Sanctions and Export Control Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Richard Roeder (+49 89 189 33 122, rroeder@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 14, 2021 |
Who’s Who Legal 2021 Recognizes Gibson Dunn Partners in Arbitration, Tax and Competition

Four Gibson Dunn partners were featured in Who’s Who Legal Arbitration 2021 guide:  London partners Cyrus Benson, Penny Madden and Jeffrey Sullivan were recognized and New York partner Rahim Moloo was named as a Future Leader.  London partner Sandy Bhogal was recognized as a Corporate Tax 2020 Thought Leader in the UK.  London partner Ali Nikpay, Los Angeles partner Daniel Swanson, San Francisco partner Rachel Brass and Washington, D.C. partners Scott Hammond and Richard Parker were recognized in WWL: Thought Leaders – Competition 2021. The lists were published in December 2020 and January 2021. 

January 4, 2021 |
DAC 6 Update: UK Narrows Scope of Mandatory Tax Reporting

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In a surprise u-turn, on 31 December 2020, the UK government took steps to narrow the scope of mandatory reporting under DAC 6. In the UK, only cross-border arrangements falling under the Category D hallmark (broadly, those that (a) have the effect of circumventing the OECD’s Common Reporting Standard or (b) obscure beneficial ownership) will be reportable. The change will apply to both historic, and future, cross-border arrangements.

The amendment to the existing legislation is intended as a temporary step. In the coming year, the UK intends to introduce, and consult on, legislation to implement mandatory reporting under the OECD Mandatory Disclosure Rules (the “MDR”).

These actions will significantly reduce the number of arrangements that need to be reported to HMRC. Nevertheless, reporting under DAC 6 is already required in some EU member states (such as Germany), and will be required elsewhere in Europe in the coming months. Accordingly, it needs to be considered whether arrangements that would previously have been reportable to HMRC under DAC 6 now need to be reported to other tax authorities.

EU Council Directive 2011/16 (as amended) (known as DAC 6) requires UK intermediaries (or failing which, taxpayers) to report, and HMRC to exchange, information regarding cross-border arrangements which meet one or more specified characteristics (hallmarks) and which concern at least one EU country. Regulations implementing DAC 6 reporting obligations into UK law (the “Regulations”) came into force on 1 July 2020.

At the end of the Brexit transition period at 11pm on 31 December 2020, obligations requiring the UK to implement DAC 6 fell away. During the course of last year, the UK government had indicated that DAC 6’s UK implementation would be unaffected by, and that the Regulations would remain in force following, the end of the Brexit transition period. However, under the Free Trade Agreement agreed between the UK and the EU on 24 December 2020, the UK is only required to ensure any legislation it implements at the end of the transition period relating to the exchange of information concerning potential cross-border tax planning arrangements offers the level of protection provided for by the “standards and rules which have been agreed in the OECD…”.

Accordingly, on 31 December 2020, the UK government published legislation (taking effect at the end of the transition period) to narrow the scope of the Regulations in line with the MDR. As a result, only cross-border arrangements (i.e. those concerning the UK or an EU member state) that fall within Category D of Part II of DAC 6 will fall within the scope of UK reporting obligations.[1] Broadly, an arrangement will be reportable under Category D if the arrangement either: (i) has the effect of undermining reporting obligations under agreements for the automatic exchange of information (e.g. the EU Common Reporting System, or the OECD’s Common Reporting Standards); or (ii) involves non-transparent legal or beneficial ownership chains that:

  • do not carry on a substantive economic activity;
  • are incorporated, managed, resident, controlled or established in any jurisdiction other than the jurisdiction of residence of one or more of the beneficial owners of the assets held by such persons, legal arrangements or structures; and
  • have unidentifiable beneficial owners.

Historic arrangements

For reportable transactions after 30 June 2020, the first UK DAC 6 reporting deadline is 30 January 2021, and for transactions on or before 30 June 2020 where the first step in implementation was taken on or after 25 June 2018, it is 28 February 2021.

The effect of the amending Regulations (which has been confirmed by HMRC) is that the narrower reporting obligation will not only apply to future arrangements, but will also apply to historic arrangements for the period prior to 31 December 2020. Accordingly, only those arrangements which fall within a hallmark under Category D would need to be reported to HMRC.

Practical impact

The amendments to the Regulations have reduced the scope of disclosures to HMRC under DAC 6. Nevertheless, a full DAC 6 assessment and hallmark analysis will still be required in respect of EU jurisdictions involved in a transaction, in order to determine whether a DAC 6 filing obligation arises in those member states. Cross-border transactions that would otherwise have been reportable to HMRC may need to be reported to EU tax authorities. It is expected that the exception would be cross-border transactions that were reportable under hallmarks A, B, C and E of DAC 6 solely as a result of a UK nexus. However, it remains to be seen whether EU member states will update their domestic legislation implementing DAC 6 to require reporting of arrangements that concern only the UK and a non-EU jurisdiction. Such amendments would likely raise a number of practical issues, including, for example, questions as to who should bear the reporting obligation where intermediaries in the relevant EU jurisdiction have limited knowledge of the wider arrangements.

From a practical perspective, the UK’s divergence from the DAC 6 standard may create additional administrative burdens for those intermediaries and taxpayers with pan-European operations that had planned to coordinate and submit DAC 6 reports in the UK. As the UK’s actions were not trailed, these businesses may, at short notice, need to shift the coordination and submission of reports to an EU member state involved in the reportable arrangement. For those businesses that had already begun preparing data for submission using HMRC’s XML schema, additional administrative work may be needed to ensure this data can be submitted to other relevant EU member states’ databases. It remains to be seen whether (to lessen such burdens) HMRC may be willing to accept submissions on a voluntary basis or whether (if HMRC was so willing) this would be permissible under the laws of relevant EU member states.

Going forward

OECD Mandatory Disclosure Rules

We understand that the UK government will consult on draft legislation to implement the MDR in due course. The MDR were first published in March 2018, and form part of the OECD’s recommendations set out in the “Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures”.[2] They are designed for jurisdictions wanting to implement disclosure obligations on certain intermediaries involved in arrangements intended to circumvent disclosure obligations under the OECD’s Common Reporting Standard.[3]

It is unclear whether such legislation would, in the immediate term, substantively alter the scope of mandatory reporting obligations provided for under the Regulations (as amended). Looking forward, however, enhanced reporting is fast becoming a popular measure, internationally, for tackling tax avoidance, evasion and non-compliance. Countries outside the EU have introduced disclosure requirements that go beyond the MDR (with Mexico being the latest country to implement a disclosure regime modelled on DAC 6). Given this trend, it is expected that the OECD will further expand the scope of the MDR in the future. Accordingly, despite the reduced scope of the UK’s current reporting regime, wider mandatory disclosure obligations may well become standard practice for taxpayers party to, and intermediaries advising on, cross-border arrangements.

Exchange of tax information

Before the end of the transition period, the UK was required to exchange tax information (including information relating to tax rulings and advance transfer pricing agreements, EU Common Reporting Standards, country-by-country reporting and beneficial ownership) with EU member states under the various provisions of Directive 2011/16/EU (the “DAC”). However, it is not yet clear: (i) how reports relating to Category D cross-border arrangements will be shared between HMRC and other tax authorities under the current DAC 6 exchange framework; (ii) whether HMRC will have access to information relating to cross-border arrangements falling within hallmarks A, B, C or E; and (iii) whether HMRC will retain access to other information currently shared under the DAC, given that the UK is no longer part of the EU. The FTA, for example, is silent on such matters.[4]

Outside of the DAC, there are existing international frameworks that allow for the exchange of tax information between tax authorities. In particular, (a) the OECD provides a platform for the spontaneous exchange of tax rulings and advance transfer pricing agreements and (b) most double tax treaties between the UK and EU member states allow for the exchange of information between the treaty parties on request, in each case where the information is foreseeably relevant to the recipient tax authority. Furthermore, the OECD provides an information sharing platform for jurisdictions that have entered into bilateral agreements to exchange information, should the UK seek to enter into such agreements with EU member states. For the moment, however, it remains to be seen whether existing frameworks will provide sufficient information sharing rights for HMRC.

_____________________

   [1]   The Category D hallmarks are contained in Annex IV Part II of the EU Council Directive 2018/822 of 25 May 2018 amending Directive 2011/16/EU at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex:32018L0822

   [2]   OECD (2018), Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures, OECD, Paris. https://www.oecd.org/tax/exchange-of-tax-information/model-mandatory-disclosure-rules-for-crs-avoidance-arrangements-and-opaque-offshore-structures.htm

   [3]   The CRS was introduced in 2014 as a global reporting standard for the cross-border exchange of financial information.

   [4]   https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:22020A1231(01)&from=EN


Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax Practice Group or the authors:

Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com) Benjamin Fryer – London (+44 (0) 20 7071 4232, bfryer@gibsondunn.com) Bridget English – London (+44 (0) 20 7071 4228, benglish@gibsondunn.com) Fareed Muhammed – London (+44 (0) 20 7071 4230, fmuhammed@gibsondunn.com) Barbara Onuonga – London (+44 (0) 20 7071 4139,bonuonga@gibsondunn.com) Aoibhin O' Hare – London (+44 (0) 20 7071 4170, aohare@gibsondunn.com) Avi Kaye – London (+44 (0) 20 7071 4210, akaye@gibsondunn.com)

© 2021 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

December 22, 2020 |
UK Tax Quarterly Update – December 2020

Click for PDF The UK, and the international economy, have faced momentous challenges in the past year. The UK economy shrank 11 per cent - the largest drop in over 300 years - and, according to last month’s figures from the UK’s Office for Budget Responsibility, its debt level is set to balloon to £394 billion in 2020 - the highest recorded level of borrowing in the UK since 1944 and equivalent to 19% of GDP. Conversely, however, interest rates on government debt are at a historic low and are expected to remain so for some time. The Chancellor vowed in October to make “hard choices” that are needed to “balance the books” and to address the high levels of national debt incurred during the COVID-19 coronavirus pandemic.  However, the International Monetary Fund warned the Chancellor that now is not the appropriate time to balance the books. The economic outlook for the UK remains highly uncertain and its success depends upon a multitude of factors, including the effectiveness and timing of vaccines, the outcome of the Brexit negotiations and the response of businesses and households to these events. Whilst the UK Government does expect relatively rapid economic recovery in the UK, the costs of COVID-19 combined with the head wind pressures from a post-Brexit world undoubtedly will put pressure on the UK economy, at least in the near term. Another tension is the desire to attract investment (by way of illustration, see the two consultations mentioned below). It is inevitable that revenues will need to be raised, though not necessarily as soon as 2021. As the Autumn Statement was cancelled this year, it remains to be seen how UK tax policy may change in response. In the meantime, however, there have been plenty of incremental proposed (and actual) changes to the UK, and the international, tax landscape.  Following a positive reception to an initial consultation on the UK asset holding company (“AHC”) regime, the UK government recently launched a second stage consultation on more detailed design features of a new AHC regime (including targeted changes to the UK real estate investment trust regime). The government is also currently consulting on new legislation relating to “UK property rich” collective investment vehicles and their investors for UK capital gains tax purposes, broadly designed to address administrative burdens borne by specified investors under existing rules. We will cover these topics and address any published outcomes of these consultations in our next Quarterly Alert (together with the recent OECD publications on transfer pricing and the impact of COVID-19).

CONTENTS

A. INTERNATIONAL AND UK DEVELOPMENTS

I. BEPS 2.0 - OECD Blueprints

II. OECD consultation on dispute resolution mechanics

III. Updates to the Directive on Administrative Cooperation (DAC)

IV. UK developments

V. UK and EU VAT updates

B. NOTABLE CASES

I. Blackrock HoldCo 5 LLC v HMRC [2020] UKFTT 443 (TC)

II. Dunsby v HMRC [2020] UKFTT 0271 (TC) and Bostan Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

III. Bluejay Mining plc [2020] UKFTT 473 (TC)


A.   International and UK developments

I.       BEPS 2.0 - OECD Blueprints

In October, the OECD’s Inclusive Framework (the “IF”) released blue-prints for its Pillar I and Pillar II initiatives - addressing respectively, (a) new nexus rules for the digital economy and (b) “top-up tax” mechanics to secure an international minimum tax rate. The blueprints focus on technical aspects of the proposals and illustrate that the proposals are becoming increasingly complex. They also acknowledge that there are many points on which political agreement has yet to be reached. It remains to be seen whether the IF’s aim of reaching consensus on both Pillar I and II by mid-2021 remains achievable.
Pillar I[1] Pillar I focuses on the allocation of taxing rights (rather than the tax base itself) and seeks to redistribute taxing rights to so-called “market jurisdictions” (i.e. jurisdictions into which a group’s “in scope” services and products are supplied and/or its users are located). The blueprint does not seek to fit this new “nexus” rule into the existing international tax framework, but rather, layers it over the framework. Though much remains to be agreed politically, the blueprint sets out the direction of travel for many technical aspects of the proposals:
  • Scope: The proposals will apply to: (a) “automated digital services” businesses, including social media platforms, online search engines and cloud computing businesses and (b) “consumer facing businesses” (i.e. retail businesses). Some IF members favour a staggered introduction of the rules, with delayed implementation for consumer facing businesses.
  • Thresholds: It is proposed that the new nexus rules would only apply to global businesses with revenue from “in-scope” activities above certain (yet to be politically agreed) thresholds both: (a) globally and (b) in jurisdictions that don’t currently tax the relevant income (on existing residence / permanent establishment principles). The former threshold is expected to be set at c.€750 million.
  • Exclusions: Blanket carve-outs are proposed for the financial industry (asset managers, insurers, pension funds, and banks), the extractives and natural resources industries, and international airlines and shipping.
  • Calculation of tax base: The amount of income available to be allocated to market jurisdictions (so called “Amount A”) is not determined on the basis of principles. Rather, (once a political decision is reached on the various thresholds) its calculation is intended to be a highly mechanical exercise. In high level terms:
    • Amount A is intended to represent the group’s global “excess profit” from in-scope activities - i.e. income exceeding an agreed level of profitability, which would be calculated using agreed formulae (that would vary by industry). Determining the level at which “excess profit” is set is likely to be highly contentious.
    • The starting point for the calculation would be the group’s consolidated accounts, with the various formulae (to calculate the tax base, and the allocations) being applied to figures set out therein. Where a group has both in-scope and out-of-scope activities, it is proposed that taxpayers prepare additional “segmented” accounts (but that losses from out-of-scope activities could not be set against profits from in-scope activities). This raises the prospect that businesses could be subject to additional tax in multiple jurisdictions, even if they are loss-making overall.
  • Nexus: It is proposed that Amount A would only be shared between market jurisdictions in which the group has an “active and sustained participation”. This would be tested by reference to revenue generated in that jurisdiction over a certain number of (yet to be decided) years. It is contemplated that, for consumer facing businesses, market jurisdictions may need to meet higher thresholds (of revenue and/or other qualitative factors) to meet this test.
  • Novel “dispute prevention” mechanisms: In expanding the pool of jurisdictions to which taxing rights are awarded, the proposals materially increase the scope for double taxation. The blueprint recognises this - and that existing dispute resolution processes (such as mutual agreement procedures, discussed further below) may be ill-equipped to resolve disputes between tax authorities regarding their rights to tax “in scope” income. The blueprint therefore focuses on novel “dispute prevention processes”. In particular, the blueprint contemplates that many aspects of the proposals (including the amount of income to be allocated to market jurisdictions generally, and to specific jurisdictions in particular) would, for each in-scope taxpayer, be subject to advance review both by (a) the tax authorities of interested jurisdictions and (b) if there is disagreement, panel(s) of representatives from tax administrations in IF member states. Such innovation is to be welcomed. Nevertheless, concerns have been raised about the practicality of such measures. In the absence of willingness and (perhaps more significantly) means on the part of tax authorities to allocate resources to the proposals, demand for pre-agreement is likely to outstrip capacity, with taxpayers potentially suffering the cost of double taxation whilst they wait.
  • Implementation: The blueprint contemplates that the proposals would be implemented via a multi-lateral instrument (an “MLI”). Past experience with 2018’s MLI (giving effect to BEPS 1.0 initiatives) illustrates that, in practice, implementation of MLIs is highly staggered. To prevent businesses facing significant double taxation risks during such a transitional period, it is hoped that streamlined implementation can be achieved.
  • Matters for political decision: In addition to the points raised above, swathes of the proposal remain subject to political agreement - not least: (a) whether Pillar A will be introduced on a mandatory or (as the US proposes) optional basis (as to which, see our July Tax Quarterly Alert) and (b) the various thresholds and percentages inherent in the proposed calculations.
The complexity of the new rules is apparent, even at this relatively early stage of the process. With such an ambitious project, some degree of complexity (and additional compliance burden) was unavoidable. Nevertheless, it seems likely that this has been exacerbated by the early choice not to fit Pillar I proposals within existing tax frameworks (e.g. by expanding the traditional concept of a physical “permanent establishment” to accommodate digital presences). Moreover, the significant risk of double taxation inherent in the project’s aims has led the IF to favour a model based on formulae (offering certainty) over principles (offering flexibility). While such certainty may be welcome in the short term, it is not without challenges. Though not acknowledged by the blueprint, it seems likely, for example, that the various thresholds and percentages intrinsic to the rules would need to be refreshed every 5-10 years in response to inflation, the changing fortunes of particular industries, and human ingenuity as to the various means by which value can be created. As such, even if consensus can be reached next year, it is unlikely to be the end of the multinational political decision making on which the rules rely. Pillar II[2] In contrast to Pillar I, Pillar II expressly aims to increase the amount of tax paid by certain multinational groups. It would do so by introducing an international minimum effective tax rate. The level at which this would be set has yet to be agreed between IF members. The blueprint gives significant shape to the proposal:
  • Scope: The blueprint contemplates that Pillar II would, in any given year, only apply to groups with a consolidated gross revenue in excess of €750 million (in the immediately preceding fiscal year).
  • Exclusions: In good news for the investment management industry, it is proposed that certain types of entities heading multinational groups (such as investment entities, sovereign wealth funds and pension funds) would be exempt - although the proposals could apply to entities lower down the ownership chain. However, (in contrast to Pillar I) it appears that there is limited political will for including a broader carve out.
  • The blueprint largely focuses on two proposed “top-up” tools:
    • The income inclusion rule (the “IIR”): The IIR gives the jurisdiction in which the group’s parent is resident the power to levy a “top-up” income tax, on the parent, in respect of the difference between the group’s effective tax rate and the (yet to be agreed) minimum rate. The proposal is supported by a “switch-over rule” which would effectively disapply obstacles to such taxing rights in double tax treaties.
    • The “undertaxed payments rule” (the “UTPR”): Broadly, the UTPR empowers source jurisdictions to apply withholding tax to, or deny a deduction for, related party payments which are not taxed (or are subject to low tax) on receipt. This proposal is supported by the “subject to tax rule”, which would amend treaties to give effect to source countries’ new taxing rights.
  • A key element of both proposals is the manner in which the group’s effective tax rate (the “ETR”) is calculated:
    • Blending: The IF appears to have rejected an approach based on “global blending”, which would have calculated the ETR at group level. Instead, the IIR favours “jurisdictional blending” – which requires groups to calculate the ETR for each jurisdiction in which they have a taxable presence. While the blueprint moots the possibility of certain simplification processes (such as a safe harbour where the ETR (calculated for county-by-country reporting purposes) is a certain level above the minimum tax rate) it acknowledges that such proposals are in their infancy. Indeed, even with simplification methods, a jurisdiction-focused approach is likely to result in a significant compliance burden (particularly when compared to the simplicity offered by global blending).
    • Financial accounts as a starting point: Interestingly, notwithstanding the preference for jurisdictional blending, the blueprint proposes that the ETR be calculated using the parent’s consolidated accounts. Many taxpayers had favoured simpler alternatives, including: (a) a “proxy” ETR calculation, based on consolidated accounts only (which, while divorced from the tax actually paid, would minimise the compliance burden) or (b) an ETR calculation based on the tax actually paid in each jurisdiction (which would align the proposals with the economic reality, and use information that taxpayers are already required to prepare at a local level). The proposed approach creates particular difficulties for many businesses in the financial industry, for whom there are often material mismatches between the consolidated accounting, and tax, position. Examples include insurers (who are often taxed on a fundamentally different basis than ordinary corporate income taxpayers) and issuers of additional tier 1 capital instruments and other hybrid instruments. Under the proposals, such businesses could be subject to additional tax in circumstances where their actual ETR is above the minimum level.
    • Measures to address tax volatility: The IF recognise “the principle that Pillar II proposals should not seek to impose additional tax where a low ETR is merely a product of timing differences in the recognition of income or the imposition of taxes”. The blueprint therefore proposes certain mechanics to address these points, such as the right to carry forward “excess” ETR (over the minimum rate) and off-set it against a low ETR in subsequent years. However, it is contemplated that this carry-forward right may be limited to seven years.
    • IIR substance carve outs: Similar to another notable erosion rule, the US’ “global intangible low-taxed income rule (“GILTI”), the blueprint contemplates that certain types of income would be carved out of the ETR calculation. These include payroll taxes, and (a fixed amount of) income from fixed assets. This is, the blueprint notes, because Pillar II “focuses on excess income, such as intangible-related income, which is most susceptible to base erosion”. Nevertheless, the narrow scope of the exclusion omits many additional sources of income which are not “mobile”, including income from traditional non-digital businesses which rely on a fixed establishment and a local consumer base.
  • Other matters addressed in the blueprint include:
    • Interaction between IIR and UTPR: The blueprint notes the IF’s intention that the UTPR operate as a “backstop” to the IIR, applying only where the parent’s jurisdiction of residence has not implemented the IIR. However, the blueprint’s proposals do not quite achieve this stated aim. In particular, the blueprint contemplates that the UTPR could apply to payments made to a parent entity that is subject to the IIR, if the ETR in its jurisdiction of residence is below the minimum rate. This raises the prospect that parent entities could be subject to both the IIR and the UTPR, creating the potential for multiple layers of tax, and a heavy compliance burden.
    • Implementation: The blueprint proposes that treaty changes needed to implement the switch-over-rule and the subject-to-tax rule would be implemented via an MLI signed and ratified by IF members. As regards the IIR and the UTPR, it is contemplated that the OECD would produce draft legislation for implementation by IF member states. While the latter approach is designed to limit the difficulties that would be created by mismatches in implementation (such as increased compliance costs and an enhanced risk of double taxation) such differences are likely unavoidable. As regards the risk of double tax in particular, (in contrast to Pillar I) the blueprint signals an intent to rely solely on existing dispute resolution procedures. The weaknesses in these processes (discussed further below) have raised concerns as to whether this goes far enough.
    • Matters for political decision: Key elements, however, remain subject to political agreement. These include (a) the rate at which the minimum tax will be set and (b) the interaction between Pillar II proposals and (broadly equivalent) base erosion taxes (such as the US’ GILTI and the base erosion anti-abuse tax). On the latter point in particular, it is hoped that a sensible agreement can be reached to minimise double tax risk.
The IF has been subject to intense pressure to reach a consensus on the proposals - not least from the EU, who have threatened to introduce equivalent measures if the IF cannot reach agreement - and possibly even if they do (see further our July Tax Quarterly Alert). Nevertheless, given the significant, once-in a-generation, changes contemplated by the blueprints, the short period of public consultation (which ran for two months to 14 December) is notable. It is hoped that the IF can resist pressure to hurry these significant projects, increase taxpayer engagement and take the time needed to develop proposals that best achieve the aims of: (a) imposing tax only where there is economic under-taxation and (b) minimising the compliance burden on taxpayers.

II.   OECD consultation on dispute resolution mechanics

In November, the OECD published a consultation document on mechanisms to make double tax treaty dispute resolution procedures more effective. Proposals include implementing a requirement for tax authorities to submit to binding arbitration where they cannot otherwise reach agreement within two years (so called “MAP arbitration”). The effectiveness of treaty dispute resolution mechanisms is set to take on increased significance for certain UK taxpayers. Earlier this month, the UK government announced the repeal of two EU directives which provide for MAP arbitration where tax authorities from EU member states cannot reach agreement on tax treaty disputes. The process will therefore no longer apply to disputes under the UK’s treaties with 11 EU jurisdictions (including Italy, Denmark, Poland and Romania).
Double tax treaty disputes arise where a taxpayer has been taxed by two states, each of whom believes that the treaty between them entitles them to do so. Such disputes are currently resolved through “mutual agreement procedures” (so called “MAP”) - a process by which the relevant tax authorities, through discussion, attempt to resolve disagreements about the effect of the relevant treaty. Though the outcome of the dispute will determine the amount of tax the taxpayer must pay, and to whom, the taxpayer is not party to the discussions. MAP’s weaknesses are well known. For example:
  • It relies on tax authorities reaching agreement: The process can be inherently uncertain. Though treaty provisions require tax authorities to “endeavour to resolve” the dispute, the taxpayer bears the risk that they will not, and that the relevant double tax will not be relieved.
  • It is time consuming: Recent figures from the OECD indicate that on average, transfer pricing cases take 30.5 months to resolve via MAP, while other cases take 22 months[3]. Interestingly, in 2019, the UK was the jurisdiction with the fastest resolution of cases via MAP (taking an average of 21 months for transfer pricing cases and 6 months for other cases). These figures are likely to increase going forward, with taxpayer requests for MAP having doubled since 2016.
The Consultation The consultation asks stakeholders to “share any general comments on their experiences with, and views on, the status of dispute resolution and suggestions for improvement”.  However, in contrast to the approach to Pillar I dispute resolution processes (described above), it does not seek to challenge the primacy of MAP, or to address its weaknesses with significant reforms. Some key issues with MAP, such as the above-mentioned delays, are not addressed at all. Rather, narrow changes to existing systems and procedures are proposed. These centre around possible steps to strengthen the minimum standards that IF members have (since 2016) committed to adhere to on the subject (the “Minimum Standards”), and include mandatory:
  1. Programmes for bilateral advance transfer pricing agreements, pursuant to which taxpayers seek advance clearance from tax authorities that their arrangements will be treated as arm’s length. Interestingly, the consultation acknowledges that many jurisdictions already have such programmes in place. Moreover, those that do not would be exempt if they have only a minimal number of transfer pricing MAP cases.
  2. Training on international tax issues for tax authorities’ auditors and examination personnel (with a view to preventing excessive adjustments likely to give rise to disputes).
  3. Suspension of tax collection while MAP is on-going (if/to the extent that such measures apply to domestic challenges).
  4. Rules enabling MAP agreements to be implemented, notwithstanding domestic time limits (where the matter is not addressed in the terms of the treaty itself).
  5. MAP arbitration.
Importantly, the proposals put forward in the consultation do not represent IF consensus, and therefore function as mere discussion points. Some proposals are, accordingly, disappointingly modest in their aims (e.g. (a) and (b) above). Others (such as those at (c) and (d) above) do not seek to fix dispute resolution mechanisms themselves, but instead seek to accommodate MAP’s weaknesses (perhaps recognising that support for an effective alternative remains quite a way off). While this is helpful in the short-term, it does not represent a long term solution. In particular, the consultation strikes a pessimistic note on the likelihood of achieving consensus on mandatory MAP arbitration, noting that “a number of [IF members] have clearly indicated that MAP arbitration raises several issues around constitutional and sovereignty concerns, [and] practical issues including cost, capacity and resource constraints, which is why they do not support its inclusion into the Minimum Standard and consider it very difficult to move away from such position”. The statement is informed, no doubt, by the less than enthusiastic response to such provisions in the 2018 MLI, with all but 33 of the signatories opting out. Nevertheless, as tax laws become ever more complicated, the scope for disagreement grows. Tax treaties will increasingly fail in their objective of preventing double tax if tax authorities have the option of merely “agreeing to disagree”. Indeed, this problem will be amplified if/ when Pillar I and II proposals take effect. It is therefore hoped that, once BEPS 2.0 processes wind down, the OECD will refocus its attention (and its resources) on this fundamental issue. Brexit Unfortunately, global reluctance to embrace MAP arbitration is likely to gain increasing significance for certain UK taxpayers. Earlier this month, the UK government announced that it would repeal UK laws that give effect to two EU directives that provide for MAP arbitration in disputes between EU tax authorities[4]. From 1 January 2021, applications for MAP thereunder will not be accepted. Many EU jurisdictions have, like the UK, opted into the MLI’s MAP arbitration provisions, or otherwise have bilateral treaties with the UK that include such provisions. The repeal will not impact taxpayers’ positions under those double tax treaties.  However the UK’s treaties with Italy, Poland, Denmark, Romania, Czech Republic, Croatia, Slovakia, Bulgaria, Estonia, Latvia and Lithuania do not provide for MAP arbitration, and these jurisdictions have not opted into the MLI’s arbitration provisions. If a taxpayer is subject to double tax in the UK and any one of these jurisdictions, they will face an increased risk that any MAP proceedings, if initiated, will not be resolved. It remains to be seen whether the UK will seek to renegotiate the relevant bilateral treaties.

III.   Updates to the Directive on Administrative Cooperation (DAC)

(i)                 DAC 6 update

See our Gibson Dunn presentation on DAC 6 here.

The first UK DAC 6 reporting deadline, on 30 January 2021, is fast approaching. As a result, parties to cross border arrangements are increasingly focusing their thinking on the practical implications of mandatory reporting obligations, with DAC 6 provisions starting to feature in contractual arrangements. Other recent developments include the publication of further guidance from HMRC on the application of the DAC 6 in the UK, and the removal of the Cayman Islands from the EU’s non-cooperative tax jurisdictions list (though unanswered questions remain with respect to whether certain payments to the Cayman Islands will be subject to DAC 6 reporting obligations in the UK).

The EU Council Directive 2011/16 (as amended), known as DAC 6, requires intermediaries (or failing which, taxpayers) to report, and tax authorities to exchange, information regarding certain cross-border tax arrangements with an EU nexus. Due to the COVID-19 coronavirus pandemic, the implementation of DAC 6 was deferred (on an optional basis). Certain jurisdictions, such as Germany and Finland, chose to proceed as planned, with mandatory reporting beginning in July. The UK opted to defer, and the first UK reporting deadlines, beginning on 30 January 2021, are now fast approaching (for further detail, see our July 2020 Quarterly Update here). (It’s worth noting in particular that DAC 6 obligations will be unaffected by, and will remain in force following, the end of the Brexit transition period). In the meantime, DAC 6 developments continue. Of particular note has been the recent (widely anticipated) removal of the Cayman Islands from the EU list of non-cooperative jurisdictions, which might be short-lived as its removal provoked further discussions and even calls for it to be re-added to the list (primarily on the basis of the secrecy laws of the jurisdiction and the scale of offshore financial activities taking place there). One of the many adverse tax implications of being on the list is that a DAC 6 reporting obligation can be triggered if the recipient of a deductible cross-border payment, between associated enterprises, is resident in a jurisdiction on the list. Unfortunately, it is not yet clear how this development interacts with the deferral of reporting in the UK – in particular whether such payments to a Cayman recipient while Cayman was on the list (between 18 February 2020 and 6 October 2020) are required to be reported to HMRC. The point will be particularly relevant to those sectors which regularly use Cayman vehicles in investment structuring and it is hoped that HMRC will clarify the point before the reporting deadline for transactions in the period (being 30 January 2021 for reportable transactions after 30 June 2020, and 28 February 2021, for transactions on or before 30 June 2020 where the first step in implementation was taken on or after 25 June 2018). HMRC has, however, published updated guidance on other aspects of the rules. The revised guidance:
  • Confirms that an arrangement that otherwise concerns only one jurisdiction will not be considered “cross-border” solely because an intermediary involved in that arrangement is located in a different jurisdiction.
  • Confirms that a non-UK, non-EU branch of a UK resident company, that provides aid, assistance or advice in respect of a reportable arrangement, will be subject to UK reporting obligations. However, HMRC would therefore not usually expect a DAC 6 report to be made where local data laws would restrict the ability to report, unless transactions were being actively routed through a branch in order to avoid DAC 6 reporting obligations.
  • Addresses, in particular, the triggers for reporting (the so called “hallmarks”) which incorporate transfer pricing concepts. For example, as regards the hallmark for arrangements involving:
    • the use of unilateral safe harbour rules, HMRC has confirmed that (a) safe harbour rules agreed by jurisdictions on a bilateral or multilateral basis (such as OECD agreements) and (b) arrangements that have been properly priced on an arm’s length basis (even if they also happen to fall within a safe harbour rule) should not be in scope;
    • the transfer, between associated enterprises, of “hard-to-value intangibles” (i.e. those for which no reliable comparables exist and projections of future cash flows or income therefrom are “highly uncertain”), HMRC has confirmed that the degree of uncertainty must be higher than a normal level of uncertainty. While helpful, unfortunately, the subjective nature of the clarification leaves residual uncertainties as to how this is to be applied in practice; and
    • intragroup cross-border transfers of functions, risks or assets (where the earnings before interest and taxes (“EBIT”) of the transferor, are decreased by 50%), HMRC has provided additional guidance on the calculation of EBIT.
Given the impending reporting deadline, attention is now being focused toward the more practical aspects of mandatory reporting obligations. For example, trends are developing toward addressing reporting obligations in relevant contractual arrangements (including fund investor side letters and tax deeds in an M&A context). In addition, there continue to be substantive differences in how key aspects of DAC 6 have been implemented in different jurisdictions, including the applicability of hallmarks and the operation of legal professional privilege.

(ii)              DAC 7 update

Consensus has been reached on DAC 7, paving the way for the bolstering of information-gathering powers of tax administrations regarding income generated via the digital platform economy. The main aim is to provide better cooperation across tax administrations, whilst keeping business compliance costs to a minimum through providing a common EU reporting standard.
EU member states recently “reached consensus” on the proposed amendment (published on 15 July 2020) to Council directive 2011/16/EU (“DAC 7”) which requires the automatic exchange of information on revenues generated by sellers on digital platforms. In a departure from previous iterations, which focused on direct taxes, DAC 7 will also cover VAT. (For further information on its scope, see our April Tax Quarterly Alert. This update was tweeted by Benjamin Angel, Director of Direct Taxation at the European Commission’s Directorate-General for Taxation and Customs Union: “Consensus reached on DAC 7…DAC 7 will ensure that tax administrations get information from platforms on transactions done by users in Member States, be the platforms located within the EU or outside.[5] It is unclear when DAC 7 will become law, but it is expected in the very near term, as work has already begun on the next amendments to Council Directive 2011/16/EU - DAC 8 (see below).

(iii)            DAC 8: proposal for the automatic exchange of information relating to crypto-assets

Work has begun on “DAC 8” - the next version of the European Council Directive on Administrative Cooperation in the Field of Taxation (Council Directive 2011/16/EU). The proposals form part of EU efforts to create a framework for the (regulatory and tax) automatic exchange of information mechanics of crypto-assets. Feedback on the EU’s proposals is requested by 21 December 2020. Following a public consultation period (anticipated in the first quarter of 2021), the European Commission expects to publish legislation in the third quarter of 2021.
Last year, European Commission President, Ursula von der Leyen, emphasized the need for “a common approach with Member States on cryptocurrencies to ensure we understand how to make the most of the opportunities they create and address the new risks they may pose.”[6] The European Commission elaborated on that plan in mid-November, publishing a roadmap for bringing crypto-assets and e-money within the scope of existing automatic exchange of information mechanics. It is proposed that this would be achieved via a further amendment to the Directive on Administrative Cooperation in the field of taxation (a proposed “DAC 8”). If implemented, current information reporting and exchange regimes (such as the exchange of information on financial accounts reported by financial institutions) would extend to crypto-assets (as well as intermediaries for these assets, such as crypto-exchanges and brokers). Crypto assets are digital assets based on distributed ledger technology (“DLT”) and cryptography. DLT is a decentralised database used to record, share and synchronise the transaction of assets. The European Commission roadmap acknowledges that income derived from crypto-assets could be subject to taxation - a view widely held by tax authorities internationally. HMRC, for example, first published (non-binding) guidance on how it considers UK tax law applies to arrangements involving crypto-assets back in 2014. This guidance was subsequently updated, and supplemented, with guidance for businesses on the taxation of crypto-assets in 2019. Indeed last month, HMRC announced (at the OECD’s virtual Global Blockchain Policy Forum) its plans to soon release an entire manual of guidance on the subject. However, the ability of tax authorities to ensure the appropriate application, and proper enforcement, of tax legislation to (and to transactions in) crypto-assets is hindered by two key issues which DAC 8 aims to tackle:
  • First, the lack of information at national tax authority levels about the use of crypto-assets and e-money: As crypto-assets and e-money (and relevant intermediaries such as crypto-exchanges and brokers) are not fully covered by the existing provisions of DAC, tax authorities: (a) have to rely on taxpayers’ ordinary course self-assessment obligations and (b) (notwithstanding the international reach of crypto-asset technology) have limited tools to exchange any information which is reported between them. Moreover, there are inherent difficulties in identifying and taxing these new assets in the same way as more traditional assets, including (as identified by the Commission) “[t]he lack of centralised control for crypto assets, its pseudo-anonymity, valuation difficulties, hybrid characteristics and the rapid evolution of the underlying technology as well as their form…” [7]
  • Second, the exclusion of crypto-assets and e-money from the scope of existing EU legislation, resulting in ‘disparity in sanctions applied’ thereunder to crypto-assets and e-money on one hand, and more traditional assets and currencies on the other.
The above concerns reflect that lack of information on crypto-assets and e-money is a major stumbling block for tax authorities and that, unless addressed, this will likely undermine the integrity of other information exchange initiatives in place to tackle tax evasion, such as the exchange of information from financial institutions on financial accounts set up by DAC 2 in 2014. Among other measures, the proposals would address this gap by extending DAC2 obligations to crypto-assets, and those who facilitate the holding of, and transactions in, them (e.g. exchanges and brokers). Feedback on the proposals was sought by 21 December 2020, to be followed by a public consultation in the first quarter of 2021, and the publication of an amending Directive in the third quarter.

IV.   UK developments

(i)          Fundamental changes to UK capital gains tax proposed in report published by Office of Tax Simplification
In November 2020, the Office of Tax Simplification (“OTS”) published the first of two reports on their review of the UK capital gains tax (“CGT”) regime, recommending significant changes. If implemented, the changes could potentially result in material changes to liabilities for UK taxpayers. Any recommendations adopted could be implemented as early as March 2021, when the Spring Budget is expected.
The OTS is the independent adviser to the government on simplifying the UK tax system. In response to a request from the Chancellor in July 2020, the OTS carried out a review of UK CGT, with the aim of identifying the policy design of, and the principals underpinning, CGT and then exploring opportunities to address any areas where the present rules distort behavior or do not meet their policy intent. The first report addressing the policy design and principles underpinning CGT was published in November (the "Report") and a second, technical report, is expected in early 2021. Whilst there has been a lot of media coverage of certain aspects of the OTS review (and certain areas that it highlights for review), it is important to note that the objective of the OTS is to set out a framework of policy choice about the design of tax. The OTS formulated their Report by reference to four policy areas: (1) rates and boundaries; (2) the Annual Exempt Amount; (3) capital transfers, and (4) business reliefs. The proposals focus on the liabilities of individuals, but cover neither the attribution of offshore gains to UK resident individuals, nor the CGT implications of an individual’s arrival or departure from the UK. The CGT treatment of trusts was also not addressed. Eleven recommendations were made, with the most fundamental proposals related to addressing the disparity between the current rates of CGT (generally 20%) and income tax (from 20% to 45% for higher income earners). This discrepancy is correctly highlighted as one of the main sources of complexity in the area of individual taxation. Given that CGT rates are lower, individuals can be incentivised to arrange their affairs so as to re-characterise income as capital gains. There is, accordingly, a raft of complex UK anti-avoidance legislation targeting such re-characterisation techniques, such as the “transactions in securities rules” (which operate to tax a profit as income, rather than as a chargeable gain subject to CGT) and the “transactions in UK land” provisions (which seek, broadly, to ensure that profit arising in the context of trading transactions involving certain disposals of interests in UK real estate will be taxed as income, rather than chargeable gains). The areas that the Report indicates would most notably benefit from a greater convergence of the income tax and CGT rates are: (a) share-based remuneration, and (b) the accumulation of retained earnings in smaller owner-managed companies. The Report does, however, also highlight the many arguments against raising CGT - in particular: (i) the inappropriateness of taxing an increase in value that is due simply to inflation, and (ii) a CGT rate increase may incentivise taxpayers to hold assets or otherwise alter commercial strategies in relation to in-scope assets. The Report notes that, if the government did increase CGT rates, further knock-on amendments would be required in other aspects of the relevant tax legislation, including the anti-avoidance provisions referred to above, and there would be a case for considering a greater degree of flexibility in the use of capital losses. Other proposals of interest in the OTS report include:
  • a lowering of the annual exempt amount (£12,300 in tax year 2020-21) to a de minimis amount (on the basis that it is an ineffective means to achieve its stated objective of compensating for inflation, because it does not take holding periods or asset values into account). Instead, the OTS propose a broader exemption for personal effects (with only specific categories of assets being taxable).
  • the replacement of Business Asset Disposal Relief (formerly Entrepreneurs’ Relief - which, by way of reminder, reduces the CGT rate to 10% on the disposal of assets and shares meeting certain conditions) with a relief more focused on retirement.
It is not clear whether (and if so, to what extent) the UK government will adopt the recommendations from this Report or the OTS.

(ii)              Finance Bill 2021 – updates following consultation responses

The UK government has published draft legislation for the Finance Bill 2021, alongside explanatory notes, responses to consultations and other supporting documents (see our previous July 2020 Quarterly Update for list of tax policy consultations). Certain draft provisions for the Finance Bill 2021 were published in July 2020, at which point there was intended to be an Autumn Budget later in 2020. This was however cancelled as a result of the COVID-19 pandemic, and on 12 November, the government instead published further draft legislation, (without a budget). Consultation on the draft legislation will close on 7 January 2021, with the Finance Bill 2021 expected to be introduced to Parliament in spring 2021 and to receive royal assent in summer 2021. Notably, the publication of further legislation in spring 2021 raises the possibility that further new legislation will be introduced in 2021 with a very short consultation window. (a) LIBOR withdrawal
Following its consultation, over the summer, on the potential tax implications of the withdrawal of the London Interbank Offered Rate (“LIBOR”), HMRC has published its response, together with updated guidance for businesses and new draft guidance for individuals. The guidance, which should provide UK taxpayers with a path to circumvent potential adverse tax impacts of the withdrawal, will be welcomed by affected parties.
The publication of LIBOR is expected to cease after the end of 2021, such that parties to financial instruments, with a term beyond 2021, that reference LIBOR (so called “legacy contracts) will need to be amended to refer to (or replaced with contracts that refer to) one of several alternate reference rates. The consultation aimed: (i) to seek views on how the several UK statutory references to LIBOR should be amended as a result of the LIBOR withdrawal and (ii) to identify the tax impacts that could arise from the reform of LIBOR (and other benchmark rates). With only a few references to LIBOR in the tax legislation (dealing with treatment of certain leases), on 12 November 2020, HMRC published draft legislation for inclusion in the Finance Bill 2020/21 to ensure the leasing provisions continue to function as intended. Helpfully, the draft legislation also introduces a power to allow any unintended tax consequences arising from the transition away from LIBOR (and other benchmark rates) to be addressed separately in secondary legislation. HMRC has also produced guidance (updated on 12 November 2020 following responses to the consultation) that explains its view on the tax implications of amending financial instruments to respond to the benchmark reform. As discussed in our previous Alert, the guidance (published in draft form in March):
  • confirms that any amounts recognised in taxpayers’ profit and loss statements as a result of such amendments will generally be taxed / relieved in the usual way; and
  • addresses other potential tax implications, confirming, among other things that (a) amendments to legacy contracts would not generally be treated as giving rise to a new contract - provided amendments are on (broadly) economically equivalent terms, and (b) in such circumstances, provisions requiring taxpayers to test the economic reasonableness of the contracts’ terms (such as transfer pricing, distributions and stamp duty relief, provisions) would not generally need to be revisited.
The guidance has now additionally been updated to:
  • provide comfort that HMRC would generally treat amendments to financial contracts pursuant to (or on terms which mirror) market standard documentation (such as ISDA’s IBOR Fallbacks Protocol) as constituting amendments on economically equivalent terms, (and hence as not generally giving rise to a new contract) - irrespective of whether amendments were booked as a new trade in internal systems;
  • confirm that amendments to financial contracts via (or on terms which mirror) such market standard documents should generally be considered arm’s length for transfer pricing purposes;
  • confirm that the VAT treatment of one-off additional payments, made in connection with transition-related amendments, will follow the treatment of the underlying supply (and hence will generally be exempt for most financial transactions); and
  • confirm that relief can be sought, under existing provisions of the hybrid mismatch rules, if differences in the tax treatment of the transition across relevant jurisdictions gives rise to timing mismatches.
In addition, HMRC published guidance for individuals, mirroring the position set out in the business guidance and additionally confirming that amendments to financial instruments would not generally give rise to a disposal for capital gains tax purposes. It is worth noting that the tax treatment described above, and in the guidance, would not generally apply where taxpayers respond to LIBOR’s withdrawal by replacing, rather than amending, legacy contracts. Nevertheless, for those taxpayers that opt to amend legacy contracts (on economically equivalent terms), the guidance should provide a path to minimising the tax implications of transition, and will be welcome relief for affected parties. (b) Amendments to the hybrid and other mismatches regime
On 12 November 2020, HMRC published its response to its consultation on certain aspects of the UK hybrid and other mismatches regime, together with some draft legislation to amend the rules, explanatory notes and a policy paper summarising other proposed legislative changes to be included in the Finance Bill 2021. The majority of measures will be welcomed by businesses. However, certain aspects of the regime continue to represent a missed opportunity to address certain instances where tax deductions are disallowed even in the absence of an economic mismatch.
The UK hybrid and other mismatches regime was introduced in 2017 to counter arrangements that give rise to hybrid mismatch outcomes and generate a tax mismatch. As mentioned in our previous April and July Tax Quarterly Alerts, HMRC consulted on certain aspects of the regime over the summer, particularly:
  • the rules applying to “double deductions”, and the application of section 259ID income (a provision introduced in 2018 which broadly takes account of certain taxable income where there is no corresponding deduction);
  • the definition of “acting together” (for the purposes of rules which broadly, aggregate the interests of persons acting together when testing whether parties to arrangements are under sufficient “commonality of ownership” to fall within the scope of the regime); and
  • the application of the regime to certain categories of exempt investors in hybrid entities.
On 12 November 2020, HMRC published its response to the consultation, draft legislation and a policy paper summarising proposed new legislation to be included in the Finance Bill 2021.  As the consultation process welcomed broader views on the UK hybrid regime, the scope of the policy paper details wider reforms and further draft legislation can be expected at some point in the future. Certain measures (noted with an asterisk* below) are proposed to take effect retrospectively from 1 January 2017. Whilst the majority of measures are intended to be helpful, some aspects continue to represent a missed opportunity to address certain instances where tax deductions are disallowed in the absence of an economic mismatch. A non-exhaustive list of key proposed measures is set out below:
  • Changes will be made to provide reliefs to certain categories of taxpayer:
    • The definition of “acting together” will be amended to exclude cases where: (i) a party has a direct or indirect equity stake in a paying entity no greater than 5%, including votes and economic entitlements*, and (ii) any investor holds less than 10% of a partnership that is a collective investment scheme (not dissimilar to Luxembourg’s implementation of anti-hybrid mismatch rules), which will take effect from the date of Royal Assent of the Finance Bill 2021. The changes, will be welcome news to investment managers, and funds, focusing on portfolio interests.
    • Counteractions will be prevented under certain parts of the rules where the recipient of a relevant payment is a tax exempt investor (akin to a qualifying institutional investor within the UK substantial shareholding exemption rules). It is intended that this will apply from the date of Royal Assent of the Finance Bill 2021.
    • Counteractions will be prevented where payments are made to and from entities taxed as securitisation vehicles under the UK securitisation regulations*.
  • Amendments will be made to address the application of reliefs where there is dual inclusion income (broadly a single amount of ordinary income that is recognised twice for tax purposes where the relevant entities and jurisdictions involved correspond to those that benefit from a double deduction)
    • Section 259ID will be repealed*. Instead, the definition of dual inclusion income will be widened to include income that is brought into account for tax purposes in the UK without generating a tax deduction in any other jurisdiction (e.g. payments from a US parent to a UK subsidiary that is disregarded for US federal income tax purposes). This treatment will only apply where that outcome would not have arisen but for the hybridity of the UK recipient which gives rise to a counteraction under the UK hybrid rules*.
    • A new surrender mechanism for “surplus” dual inclusion income is to be introduced. This will allow entities within a group relief group to surrender dual inclusion income, for set-off against doubly deductible amounts elsewhere in the group. It is intended that this will apply from 1 January 2021.
    • In our April Tax Quarterly Alert, we discussed potential issues with the current application of the double deduction mismatch rules (where section 259ID does not obviously apply). In particular, we considered a scenario where an intra-group payment by a US parent company to a UK subsidiary (that is disregarded for US federal income tax purposes) may give rise to a disallowance, under the UK hybrid rules, for an otherwise deductible expense incurred by the UK subsidiary - resulting in taxation on profits it does not economically possess. The example highlighted a broader issue with HMRC’s previous “fix” introduced in 2018 by section 259ID, which is highly narrow in its application. The above changes address the issues raised in the example, albeit with one caveat – that this treatment will only be available where the inclusion/no deduction treatment was created by the same element of hybridity as the double deduction under consideration. So, where a US parent makes a payment to its disregarded UK subsidiary, the new treatment will be available (i.e. it would have been the disregarded status of the UK subsidiary which gives rise to the inclusion/no deduction mismatch). Whilst the widened definition of dual inclusion income will be helpful for certain taxpayers, for others it will not. Common structures where UK subsidiaries that have been checked open incur costs from third parties, whilst only receiving reimbursement from another subsidiary or sister company that is also checked open, but resident in neither the US nor the UK, continue to face economic double taxation. That is unfortunate, particularly given that other countries (such as Ireland) have adopted a more pragmatic approach to the implementation of their hybrid regimes to prevent such an outcome occurring for taxpayers (and consistent with the OECD principle that double taxation should be avoided).
  • More generally:
    • The carry forward treatment of illegitimate overseas deductions (amounts for which it is reasonable to suppose that (part of) a hybrid entity’s double deduction amount is deducted under non-UK law for a taxable period from the income of any person, excluding the investor) under the hybrid rules is to be amended, so that where a relief is used by a multinational or dual resident company to set against its own single inclusion income, the relief will not be permanently denied in the subsidiary or branch. The amendments will take effect from the date of Royal Assent of the Finance Bill 2021.
    • Acknowledging that the interaction of the US Dual Consolidated Loss rules with Part 6A of the hybrid rules should not operate to deny loss relief in both jurisdictions, HMRC in its response to the consultation has indicated that the new surrender mechanism and changes to the definition of illegitimate overseas deductions above should simplify the economic effects of the US rules. HMRC guidance is also expected to be published in the future to clarify the interaction. The imported mismatch rule, will be amended so that: (i) condition E (which previously required the overseas regime to apply similar provisions to the relevant part of the UK rules) will instead test whether an overseas regime seen as a whole is equivalent to the UK hybrid rules and prevents any counteraction if it is (to apply from the date of Royal Assent of the Finance Bill 2021); and (ii) condition F (which provided taxpayers with a degree of protection against a counteraction by allowing consideration of UK tax attributes to mitigate against a foreign mismatch payment) will be repealed*.
The draft legislation published to date only relates to the double deduction rules, and the application of section 259ID income. Although a timeline was not provided by HMRC, further draft legislation can be expected at some point in the future to address the remaining measures in the policy paper. HMRC has also indicated it will provide further clarification of certain points in forthcoming updates of its guidance on the hybrid regime. Despite the many proposed changes, certain requests from consultation respondents have been explicitly rejected. These include the addition of a tax avoidance motive to the regime, an exclusion for small and medium-sized enterprises and the treatment of the US global intangible low-taxed income (GILTI) rules as an equivalent regime (so as to prevent a UK counteraction where a GILTI charge applies). Given the scale of the hybrid and other mismatches rules and respective HMRC guidance, there has understandably been criticism of the UK’s overly mechanical approach (as opposed to a more principles based approach taken by certain other EU jurisdictions). (c)  Delay in the implementation - uncertain tax treatment rules
A proposed new obligation for businesses to notify HMRC of uncertain tax positions taken in their tax returns has been delayed until April 2022.
HMRC consulted, over the summer, on a proposed new requirement for large businesses to notify HMRC where they have adopted an uncertain tax treatment (an uncertain tax treatment being one where the business believes that HMRC may not agree with their interpretation of the legislation, case law or guidance). The proposals are designed to improve HMRC’s ability to identify tax treatments adopted by large businesses that do not stand up to legal scrutiny.  In part, this is intended to aid HMRC’s efforts to open an inquiry into relevant tax positions before the statutory deadlines have passed. The consultation concluded on 27 August 2020, and attracted strong criticism from respondents for the level of ambiguity inherent in the proposed reporting requirement (in effect requiring a judgement as to what action HMRC might take in relation to any tax position – across the full range of UK taxes). The proposals were originally due to apply to tax returns filed after April 2021, but have now been delayed until April 2022. Helpfully, HMRC appears to have now accepted the original proposal was perhaps too subjective and difficult for businesses to assess.  Consequently, it is looking at ways to make the definition more objective and straightforward to comply with, whilst minimising the administrative impact on businesses. Businesses will understandably be relieved that HMRC is revisiting the proposals in light of critical responses to the consultation. In addition, the delay provides respite from a potentially costly administrative burden at an uncertain time for many businesses. (d) Extension of the annual investment allowance The UK government has announced an extension, until 1 January 2022, to the £1 million annual investment allowance for capital allowances purposes. The allowance gives relief for 100% of expenditure qualifying for capital allowances, up to the threshold, in the tax year the expenditure is incurred. The allowance was previously increased to a maximum of £1 million (from £200,000) for a 2-year period, but was due to expire at the end of 2020. The announcement will be welcome news for businesses, who may be incentivised to increase capital investment at a time where managing short-term liabilities may have otherwise been more in focus.

V.   UK and EU VAT updates

(i)           UK VAT grouping – Establishment, Eligibility and Registration Call for Evidence

In August, HM Treasury published a call for evidence (“CfE”) to gather stakeholders’ views on certain elements of the UK VAT grouping rules. Feedback has been sought, in particular, on (a) the interaction of the UK’s establishment rules with other EU Member States’ and the application of the rules to overseas branches; (b) possible compulsory VAT grouping; and (c) grouping eligibility criteria for limited partnerships and Scottish limited partnerships.
VAT Grouping Broadly, VAT grouping rules enable “eligible entities”[8] under common control to register for VAT as a group, and be treated as a single taxable entity for VAT purposes. A VAT group files one VAT return through the group’s representative member and supplies made between VAT group members are disregarded for UK VAT purposes. The purpose of VAT grouping is to allow administrative efficiency and while the purpose of the mechanism is not  to achieve VAT savings, in practice, in some circumstances, VAT grouping supports this result. Establishment provisions The UK applies a “whole establishment” approach to VAT grouping. This means that “fixed establishments” (broadly akin to branches) of eligible persons, whether in the UK or abroad, are treated as part of the UK VAT group. This contrasts with other EU countries’ “establishment only” provisions, which the UK does not utilise. The “establishment only” rules provide that where an entity has “fixed establishments”[9] (or “branches”) in multiple jurisdictions, it is only the establishment in the country in which the VAT group is based that can be included in that VAT group. Differences in VAT grouping rules have led to additional administrative and operational complexities for businesses. The document therefore calls for feedback on the benefits of adopting the “establishment only” provisions. If the UK adopted the “establishment only” approach, only UK fixed establishments of foreign companies could be within a UK VAT group. This means that overseas branches of that foreign company could not join the UK VAT group – with the effect that supplies from foreign headquarters to a UK branch or a UK branch to foreign headquarters would be subject to VAT. For entities/groups making exempt or partially exempt supplies, any input VAT incurred in connection with supplies from non-UK branches of the head-office (or other members of the group) would be irrecoverable (or partially irrecoverable), representing an actual cost for these groups. For those making solely taxable supplies, any input VAT incurred in connection with those supplies will be recoverable - albeit, that there may be a cash flow impact if periods of account are not aligned. The CfE notes that an “establishment only” approach may reduce the administrative burden as groups will only then have to account for a reverse charge for VAT, and would not have to engage with anti-avoidance provisions introduced to prevent abuse of the existing rules (which the CfE contemplates would be repealed if the UK moved toward an “establishment only” approach).  It is arguable whether the benefit of removing the anti-avoidance provisions will outweigh the additional administrative requirements that will come from adopting an “establishment only” approach - particularly for groups heavily reliant on internal supplies. Under the latter approach, compliance burdens may equally arise from the requirement to charge and account for VAT on certain recharges of staff costs, and any other supplies made between branches that are currently part of a UK VAT group. Implications of Skandia[10] As a result of the Court of Justice of the European Union’s (“CJEU’s”) judgment in Skandia, the UK introduced an exception to the “whole establishment” approach, effective 1 January 2016. Under this exception, if the overseas branch is a member of a VAT group in its local jurisdiction (which applies an “establishment only” approach to VAT grouping), then the UK head office and the overseas branch cannot be treated as the same taxable person, and VAT is applied to supplies made between them. The call for evidence seeks feedback on the potential reversal of the UK’s changes to the VAT grouping rules following Skandia, acknowledging that the application of Skandia is administratively onerous for businesses. While this reversal would alleviate some VAT costs and compliance burdens for taxpayers, these benefits would be significantly outweighed by the costs associated with the introduction of any of the other proposals suggested in the CfE. Compulsory VAT grouping VAT grouping in the UK is currently optional for entities that meet the relevant control and establishment conditions. In particular, corporate groups can choose: (a) whether or not to form a VAT group and (b) which eligible entities in a corporate group should be a part of that VAT group. In certain jurisdictions, however, VAT is compulsory for specific sectors. The government states that compulsory VAT grouping can offer administrative benefits, and level the playing field for businesses who would then all operate under the same VAT treatment.[11] The CfE seeks feedback on the introduction of compulsory VAT grouping into the UK. Concerns have been raised, in particular, that compulsory VAT grouping is an “inflexible” approach, which will have significant adverse commercial consequences because of enforced joint and several liability that attaches to membership. It is notable that the recent introduction of compulsory grouping in Luxembourg is widely considered to have been unsuccessful, as a result of inflexibilities and resultant commercial difficulties. Eligibility criteria For VAT purposes, in a UK fund context (where the fund vehicle is typically either a limited partner (“LP”) or a Scottish limited partnership (“SLP”)):
    1. The activities of the general partner (the “GP”) of the LP / SLP are treated as the activities of the fund vehicle (i.e. the LP / SLP, as applicable). The fund vehicle is therefore generally able to form a VAT group with the investment manager for the fund (as the GP will usually be part of the same investment management group as, and eligible to be grouped for VAT purposes with, the investment manager) allowing investment management supplies to be made to the fund free from VAT.
    2. Since last year, LPs and SLPs have been entitled (but not required) to join a VAT group if the LP / SLP controls all the entities in the VAT group. “Control”, in this context, is tested by reference to whether the LP / SLP would, if it was a body corporate, be the holding company of the entities - a test which is itself determined by reference to voting rights / ability to appoint directors. Generally, this enables the fund LP / SLP (acting through the GP) and accordingly, the investment manager, to also be part of a VAT group with the fund’s portfolio companies.
The CfE acknowledges the position described in paragraph (a) above, noting that the current VAT grouping rules enable LPs / SLPs to receive supplies from entities other than the GP free of VAT - notwithstanding that the GP typically has limited rights to the profits / assets of the funds - which are held, by fund investors, outside of the VAT group. The CfE therefore: (a) contemplates limiting LPs’ / SLPs’ ability to join VAT groups, by imposing a requirement for common beneficial ownership and control, and (b) asks for stakeholders’ views on the impact of such changes. It was the combination of the rules in (a) and (b) above that led to the decision in Melford[12] (discussed in our April Tax Quarterly Alert). By way of recap, in Melford: (a) the fund’s investment manager was grouped with the fund vehicle but (b) the parties had chosen not to include the underlying portfolio entities in the VAT group. As a result, (a) the investment manager was able to provide taxable supplies to the portfolio companies (thereby improving its recovery position) but (b) the fund was able to receive investment management services from the investment manager free from VAT (as those supplies were between members of the same VAT group, and hence disregarded). It is therefore possible that the result in Melford may have been the trigger for the CfE - with HMRC possibly seeking to (a) gauge whether/how to change existing rules to prevent the outcome achieved by the taxpayers in Melford, and (b) collect information regarding the collateral damage of the alternative approaches. If this is indeed the case, it seems likely that restricting current fund grouping arrangements would cause material harm. In a funds context (or where an LP / SLP otherwise serves as a collective investment vehicle), if the proposals in the CfE were implemented, the fund vehicle LP / SLP would no longer be eligible to join a VAT group with:
  • its GP and investment manager, with the effect that VAT would be payable by the LP / SLP on investment management services received from the investment manager; or
  • the fund’s portfolio companies, with the effect that VAT would be payable by the portfolio companies on any investment management services received from the LP / SLP.
This would increase compliance costs, and it’s possible that at least some of the VAT payable by the fund LP / SLP, and/or the portfolio entities, may be irrecoverable. The proposals would, therefore, increase the cost of using UK fund structures. For existing funds in particular, these costs would not have been assumed at the time the fund was set up, or reflected in economic modelling (and accordingly, may distort results). Next steps It is expected that the proposals mooted in the CfE would, if implemented, give rise to an increase in VAT costs for many UK taxpayers, in particular, for fund structures and financial services groups. UK VAT groups should continue to monitor this consultation process. We would expect further dialogue from HMRC in respect of this CfE over the coming months. (iii) Input VAT recovery for financial services provided to customers outside the UK
The Chancellor has announced that from 1 January 2021 (following the end of the Brexit- transition period), the VAT recovery position of UK financial and insurance service providers will not be restricted as a result of their making supplies to persons belonging outside the UK. Legislation to give effect to the proposals has not yet been published.
The Chancellor has announced that from 1 January 2021 (following the end of the Brexit- transition period), the VAT recovery position of UK financial and insurance service providers will not be restricted as a result of their making supplies to persons belonging outside the UK. Legislation to give effect to the proposals has not yet been published. In order to obtain full recovery of input VAT incurred on costs, either: (a) the relevant costs must be directly related to the provision of taxable supplies or (b) the costs must form part of general overheads (and may be only partially recoverable to the extent the taxpayer makes exempt supplies). Financial services are generally exempt for UK VAT purposes. Accordingly, input VAT incurred in connection with the provision of financial services is currently generally irrecoverable. In November, HMRC announced proposals which, broadly (if implemented), would mean that UK providers of financial services and insurance (including intermediary) services would be able to recover input VAT incurred on: (i) financial and insurance services supplied to customers belonging outside the UK (including to persons belonging in the EU) or directly related to an export of goods; or (ii) the making of arrangements for these supplies. Supplies to UK customers will remain exempt for UK VAT purposes. Accordingly, UK financial and insurance businesses that make supplies to both UK and non-UK customers will need to calculate input VAT recovery in accordance with the partial exemption method. As a result of the announcement, financial and insurance groups may wish to reconsider their intragroup VAT planning, particularly where the UK VAT group includes entities with EU branches (to whom the UK VAT group currently makes non-taxable supplies). Depending on their particular circumstances, it may be the case that the UK VAT group’s recovery position could be improved by de-grouping such UK entities, with a view to recognising the supplies made to its EU branch for VAT purposes. From a documentation perspective, it is important that suppliers maintain evidence to support the input VAT claimed, including invoices and any relevant correspondence establishing the connection between the input VAT claimed and supplies made to EU. Given the potential benefits of the proposed changes (if they are implemented), maintaining documentation and monitoring internal processes will become increasingly important. (iv)  VAT treatment of termination fees – HMRC issues revised guidance
HMRC has changed its position on the VAT treatment of termination charges and compensation payments, following the CJEU’s judgements in Meo and Vodafone Portugal. HMRC’s new position, set out in HMRC’s Revenue and Customs Brief 12/20 , states that charges arising from early contract termination will generally be subject to VAT. Notably, this includes payments described as compensation or liquidated damages.
HMRC has changed its position on the VAT treatment of termination charges and compensation payments, following the CJEU’s judgements in Meo and Vodafone Portugal. HMRC’s new position, set out in HMRC’s Revenue and Customs Brief 12/20[13], states that charges arising from early contract termination will generally be subject to VAT. Notably, this includes payments described as compensation or liquidated damages. Prior to Brief 12/20, which was published in September, payments arising out of early contract termination were generally treated as outside the scope of VAT. In particular, payments would only be outside the scope of VAT to the extent that the termination payment, or the payment of liquidated damages, was contemplated in the relevant contract between the parties. Following the CJEU’s decision in Meo[14] and Vodafone Portugal,[15], HMRC has revised this position, now concluding that payments by a customer for early termination or cancellation of a contract in fact constitutes consideration for the original supply that the customer had contracted for. The new position applies to cases where the original contract contemplates such a payment, as well as cases where a separate agreement (outside of the original contract) is reached. In Meo, the CJEU held that early termination charges (in the case at issue, under a telecom contract) reflect consideration for the supply of the original services, regardless of whether the customer uses that supply or not. More recently, in Vodafone Portugal, the CJEU confirmed that this would be the case even where the payment is not calculated by reference to the value of the services that would have been provided under the contract (but for the termination). HMRC’s guidance confirms that, for the payment to be subject to VAT, there just needs to be a "direct link" between the termination payment and a taxable supply. Rate of VAT While we would expect the VAT treatment of termination payments to match the VAT treatment of the underlying supplies, it is not entirely clear whether this will be the case or whether such payments will be standard-rated. Further clarification is expected on this point. Retrospective effect Brief 12/20 states that any taxable person that has failed to account for VAT to HMRC on such termination payments should correct the error. This implies that HMRC intends the guidance to apply retrospectively. While it is not mentioned, we would expect the general VAT time limits for correcting past errors to apply. Consequently, termination payments received in accounting periods that ended within the past four years should be reviewed. If an adjustment is required, the supplier will need to pay the VAT due to HMRC and amend their VAT returns. (HMRC has not stated whether it intends to charge interest and/or penalties on any late-paid VAT where an adjustment is required. However, we would expect further clarification from HMRC on this point). Suppliers should, in such circumstances, consider whether the contractual terms underlying the supply would enable them to pass the VAT cost on to their counterparty. However, even if counterparties are required, under such contracts, to bear the cost of such VAT, given the passage of time, there may be practical difficulties in recovering these amounts, particularly given the current economic climate. Looking forward, early termination and compensation clauses should be drafted to account for VAT costs and potential VAT adjustments. Particular applications Property-related transactions The revised guidance will likely have a significant impact on property-related contracts. The VAT position of landlords, property managers and developers should be reviewed where termination payments have been charged. Past and future payments for breaking a commercial lease will likely be subject to UK VAT, where the landlord has opted to tax the property. Similarly, for residential developers, termination payments incurred in connection with certain construction-related services (e.g. architect fees, surveyor costs, supervisory services), where these services do not constitute a single “design and build” contract, may attract UK VAT at the standard rate. It is expected that payments for breach of contract, such as dilapidation payments, will remain outside the scope of VAT. M&A break-up fees There is a question as to whether the guidance extends to “break-fees”  - a common compensatory clause in an M&A context, which requires one party to compensate the other if the agreement does not complete. This so-called “break-fee” is typically calculated as a percentage of the consideration that would have been payable had completion occurred. We consider it likely that:
  • Where the contract provides for the seller (or the target) to pay the break-fee, the fee should not be subject to VAT. This is on the basis that the payment is disconnected from the consideration for the supply (that would otherwise have been made) under the contract - as that consideration would have come from the buyer, rather than the seller.
  • If the break-fee is payable by the buyer, it is possible that the payment may be subject to VAT. However, the circumstances do differ from those contemplated in HMRC’s updated guidance - which describes the early termination of a supply that has (to some extent at least) taken place. A break fee, in contrast, is payable in circumstances where completion never occurred, and no supply was ever made from the seller to the buyer. On that basis, HMRC may take the view that break fees are outside the scope of VAT, even if payable by the buyer. In any event, if the contract was for the sale of shares, that supply would have been exempt from VAT, and the same treatment should extend to the break-fee.
Brexit
On 31 December 2020, the Brexit transition period will come to an end and the legal consequences of the UK’s decision to leave the EU will take effect. This will have implications from a tax perspective - irrespective of whether a no-deal Brexit can be avoided. While the UK direct tax, and transfer tax, consequences are expected to be minimal, there will be some changes to national insurance contribution and VAT rules. Most significantly, customs duties may apply on the importation of a range of goods into the UK from the EU customs market (and vice versa). Indeed, the consequences are not limited to UK tax: leakage may be suffered on investment structures involving the UK and any of Germany, Italy and / or Portugal and certain EU resident subsidiaries of UK resident companies may face obstacles in accessing US double tax treaties.
Although the UK left the EU on 31 January 2020, from a tax perspective at least, the effect will not be felt until the end of the transition period, at 11pm on 31 December 2020. A non-exhaustive list of the key changes that will then take effect are set out below. UK direct tax The legal effects of Brexit will be minimised by the European Union Withdrawal Act 2018 (the “Withdrawal Act”). Broadly, the Withdrawal Act provides: (a) for EU law to be retained as a part of UK domestic law (except to the extent specifically repealed by the UK parliament) and (b) for EU case law, handed down prior to the end of the transition period, to remain binding for UK legal (and tax) purposes - to the extent not overruled by a decision of the UK Supreme Court or (as is proposed) High Court[16]. As a result, significant changes to UK direct taxes are not expected on 31 December.[17] Nevertheless, there will be changes (and practical difficulties too). While it seems likely that the UK parliament may be keen to exercise these new powers, the enthusiasm of the UK courts remains to be seen. In the recent Volkerrail[18] case, the First Tier Tribunal opted to disapply certain UK tax provisions (restricting the surrender of losses between UK resident, and UK branches of EU resident, taxpayers) on grounds of incompatibility with EU law. Should HMRC appeal, it may present one of the first opportunities to test the High Court’s interest in exercising their freedom to depart from the CJEU. Moreover, following the end of the transition period, UK courts will no longer be able to refer questions about the application of EU law to the CJEU. Last week’s referral from the Upper Tribunal to the CJEU in Gallagher[19] (regarding the compatibility with EU law of territorial limitations on UK relief for intra-group transfers) is likely to be the last of its kind. Thus, even if retained EU laws remain on UK statute books, there is scope for conflicting applications in the EU and the UK– bringing an inherent risk of double taxation and enhanced compliance costs. UK transfer taxes Certain provisions of EU law prevent a 1.5% stamp duty / stamp duty reserve tax charge applying: (a) on issuances of securities into a clearing system or depositary receipt system in connection with the raising of capital or (b) on transfers of securities into such systems which are integral to such capital raising. The UK government has confirmed that these reliefs, which are frequently relied upon in capital markets transactions, will be retained. Social security contributions EU regulations[20], which prevent internationally mobile workers from paying social security contributions in more than one EU member state, will cease to apply from 31 December. (For existing arrangements, a slight extension has been provided for “so long as the [arrangements] continue without interruption”). The UK has introduced legislation which (broadly) attempts to replicate the positon under the regulations. However, as (most) EU member states have not reciprocated, the risk of double tax continues. The UK has, however, secured a bilateral agreement with Ireland, and intends to pursue similar agreements with other member states. VAT Under current rules, goods imported into the UK from the EU (and vice versa) are generally subject to acquisition VAT - which the importer accounts for by way of reverse charge (if registered for VAT purposes). From the end of the transition period, such imports will instead be subject to import VAT (which under current rules, must be accounted for immediately). The UK government has introduced legislation, to take effect from 31 December, to ensure that this change does not accelerate the time at which importers must account for VAT. Equivalent treatment will be extended to imports from non-EU jurisdictions as well. Customs duties The cost of the UK’s departure from the EU is likely to be most apparent in the context of customs duties. From 31 December 2020, (except to the extent otherwise agreed) customs duties, at rates determined by applicable World Trade Organisation (“WTO”) trading terms, will apply on goods imported into the UK from the EU (and vice versa). The UK published its WTO trading terms (the so-called “UK Global Tariff”) in May[21]. That contemplates that approximately 60% of items will be tariff-free, with the remaining 40% attracting duties at an average rate of approximately 6%. The EU, meanwhile, will apply its “Common External Tariff” (which imposes duties at an average rate of approximately 7%) to imports from the UK. Even if a “no-deal Brexit” can be avoided, any agreement under consideration at the moment is unlikely to be sufficiently expansive to materially improve this position. As the EU is the UK’s largest global trading partner, the economic impact is expected to be significant. European tax The UK’s departure from the EU may also impact taxpayers’ position under the laws of EU member states. In particular, taxpayers will need to consider whether they can continue to access reliefs available under (a) the EU Interest and Royalties Directive[22] (the “IRD”), which generally prevents withholding tax arising on intra-group payments of interest and royalties and (b) the EU Parent / Subsidiary Directive[23], which generally prevents withholding tax and direct tax applying on dividend payments (in each case, between EU-resident companies). Interestingly, the UK Withdrawal Act operates to preserve the benefit of these EU tax reliefs for EU taxpayers transacting with UK taxpayers. Unfortunately, this position has not been reciprocated by EU member states. As a result, even if treaty relief is available, (a) dividends paid from German entities to UK entities will now be subject to German withholding tax of at least 5%, (b) intra-group interest and royalties paid between UK- and Italian- resident companies will generally be subject to withholding tax of at least 10% and 8%, respectively and (ii) intra-group interest and royalties paid between UK- and Portuguese- resident companies will generally be subject to withholding tax of at least 10% and 5%, respectively (in each case subject to any domestic reliefs). Finally, for EU-resident subsidiaries of UK-resident companies, access to treaty relief under their residence jurisdiction’s treaty with the US may be impeded. This is because their parent would no longer be a resident of an EC / EEA member state for the purposes of the “derivative benefits” exemption to the limitation of benefits article in the treaty. For further information, see our Client Alert on the subject. Going forward The Withdrawal Agreement’s retention of EU retained law will, to some extent, smooth the end of the transition period. However, significant portions of retained EU law cannot fully maintain the status quo, because this would require reciprocity from EU member states. It is therefore hoped that the UK government will continue to engage with EU member states (bilaterally if necessary) to remove (or at least reduce) leakage on EU/UK transactions. More generally, from the end of the transition period, it can be expected that EU and UK tax law will begin to diverge. The extent of this divergence, and the substantive areas in which UK policy and legislation will depart from the EU, remain to be seen. Nevertheless, (particularly in the administratively-heavy field of VAT) it seems likely that the mere fact of such divergence will generate increased compliance costs for pan-European businesses.

B.   Notable Cases

I.       Blackrock HoldCo 5 LLC v HMRC [2020] UKFTT 443 (TC)

HMRC sought to disallow UK tax deductions for all of the interest payable on $4 billion worth of loans pursuant to UK and international transfer pricing rules and the unallowable purpose rule contained in the Corporation Tax Act 2009. The First-tier Tribunal rejected HMRC’s arguments and found for the taxpayer in respect of both issues. However, it is likely that HMRC will appeal the decision.
This case arose following HMRC’s decision to disallow the deduction by BlackRock Holdco 5 LLC (“LLC5”) of loan relationship debits in respect of interest payable on $4 billion worth of loan notes issued by LLC5 to its parent company, Blackrock Holdco 4 LLC (“LLC4”), under each of the unallowable purpose and transfer pricing rules. Background LLC5 appealed HMRC’s decision in the First-tier Tribunal (“FTT”) and the following issues were identified in the appeal:
  1. Was a / one of the main purpose[s] of LLC5 being a party to the loan relationships with LLC4 to secure a tax advantage for LLC5 or any other person?
  2. What amount of any debit is attributable to the main purpose of securing a tax advantage (if any) on a just and reasonable apportionment? (issues 1 and 2 being the “Unallowable Purpose Issue”)
  3. Do the loans between the LLC5 and LLC4 differ from those which would have been made between independent enterprises? (the “Transfer Pricing Issue”)
The dispute with HMRC arose from the acquisition structure of the US part of Barclays Global Investors business (“BGI US”) in December 2009. Blackrock Holdco 6 LLC,  (“LLC6”), LLC4 and LLC5 were incorporated on 16 September 2009 and LLC 4 elected to be a disregarded entity for US tax purposes and as such interest accruing to it from the acquisition would not be taxed in the US. On 31 March 2012, LLC5 entered into a loan agreement with LLC6, pursuant to which LLC6 loaned $92,640,000 to LLC5. . LLC5 used these funds to make the interest payments due on certain tranches of the loan notes. On 30 September 2012, LLC5 entered into a loan agreement with LLC6, pursuant to which LLC6 loaned $92,728,008 to LLC5. LLC5 used these funds to make the interest payments due to LLC4 in September 2012 on certain tranches of the loan notes. LLC5 filed company tax returns for accounting periods ending 30 November 2010 to 31 December 2015 and claimed deductions on its interest expenses under the loan notes for the relevant accounting periods. For each of the returns, HMRC concluded that “no amount of the interest payable or the finance charges/or the payment to vary the terms of loan notes/or the other finance costs [by LLC5 in respect of the Loan Notes in the return period] is deductible for UK tax purposes and no amount may be included within the non-trade deficits arising on loan relationships as recorded on the company tax return for the period.” Unallowable Purpose Issue The relevant provisions of the Corporation Taxes Act 2009 as applicable at the time of the transaction provided are contained in sections 441 and 442. In summary, Section 441 provided that a company may not bring into account any debits which on a “just and reasonable apportionment” is attributable to an unallowable purpose. Section 442 provided that a loan relationship of a company has an unallowable purpose if a party to the relevant loan relationship entered into a transaction which included a purpose (“the unallowable purpose”) which is not amongst the business or other commercial purposes of the company. Section 442 further provided that a tax avoidance purpose is only regarded as a business or other commercial purpose of the company if it is not “(a) the main purpose for which the company is a party to the loan relationship or, as the case may be, enters into the related transaction, or (b) one of the main purposes for which it is or does so”. References to a tax avoidance purpose are references to any purpose which consists of securing a tax advantage for the company or any other person. Tax advantage is construed widely under the Corporation Tax Act 2010 asa relief from tax or increased relief from tax…” The FTT quoted a number of cases in relation to the identification of the “purpose” of a company.[24] The FTT went on to state that it was common ground that the deduction of loan relationship debits in respect of interest is a tax advantage and that it is the subjective purpose of LLC5 that is to be considered in order to determine whether securing a tax advantage was the main purpose or one of the main purposes of its loan relationship with LLC4. The FTT considered the evidence of a board member of LLC5 who stated that he had not taken account of any UK tax advantage in the decision to proceed with the relevant transaction. The FTT adopted the reasoning of the House of Lords in Mallalieu v Drummond, and stated that it was necessary to look beyond the conscious motives of LLC5 and take into account the inevitable consequences of entering into the loan relationship with LLC4 – one of which was the securing of a tax advantage. The FTT concluded that there was both a commercial and tax purpose in entering into the relevant loans and as such it was necessary to consider a “just and reasonable apportionment”. The FTT followed the obiter comments of Judge Beare in Oxford Instruments UK 2013 Limited v HMRC and concluded that as the tax advantage purpose had not increased the debits, on a “just and reasonable basis”, all of the relevant debits arising in respect of the relevant loans should be apportioned to the commercial main purpose rather than the tax advantage main purpose. The Transfer Pricing Issue The FTT considered whether the terms of the loans entered into between LLC5 and LLC4 differ from those which would have been made between independent enterprises, taking account of all relevant information, including: (a) Would the parties have entered into the loans on the same terms and in the same amounts if they had been independent enterprises? (b) If the answer to question (a) is negative, would they, as independent enterprises, have entered into the loans at all, and if so, in what amounts, at what rate(s) of interest, and on what other terms? The FTT took into account the analysis of expert witnesses on behalf of LLC5 (the “Joint Statement”)  and HMRC (the “Gaysford Statement”)  relating to transfer pricing. Both the Joint Statement and the Gaysford Statement agreed that it would have been possible for LLC5 to execute a $4 billion debt transaction in December 2009 with an independent enterprise at similar interest rates to the actual transaction that took place between LLC5 and LLC4, but subject to different terms and conditions that independent lenders would have required to manage the credit risks appropriately. The FTT stated that although paragraph 1.42 of the Organisation for Economic Co-operation and Development (OECD) Guidelines[25] recognises that, “it may be helpful to understand the structure and organisation of the group and how they influence the context in which the taxpayer operates”, it is clear from the OECD Guidelines that a separate entity approach should be adopted. This approach is outlined in paragraph 1.6 of the OECD Guidelines as follows:  By seeking to adjust profits by reference to the conditions which would have obtained between independent enterprises in comparable transactions and comparable circumstances (i.e. in comparable uncontrolled transactions), the arm's length principle follows the approach of treating the members of an MNE [multinational enterprise] group as operating as separate entities rather than as inseparable parts of a single unified business. The FTT noted that such an approach is also consistent with the UK tax legislation, namely section 147(1)(a) Taxation (International and Other Provisions) Act 2010, which concerns the transaction or series of transactions made or imposed between “any two persons”. Accordingly, the FTT stated that the transactions to be compared are the actual transaction, a $4 billion loan by LLC4 to LLC5 and the hypothetical transaction, a $4 billion loan by an independent lender to LLC5 having regard to the covenants which such an independent lender would have required. The FTT concluded that, given the expert evidence, even though an independent enterprise would not have entered into the relevant loan on the same terms as the actual transaction it would, subject to various covenants, have entered into the relevant loans on the same terms as the parties in the actual transaction.

II.       Dunsby v HMRC [2020] UKFTT 0271 (TC) and Bostan Khan v HMRC [2020] UKUT 168 (TCC) (2 June)

The First Tier Tribunal and the Upper Tribunal (“UT”) recently considered and applied the Ramsay principle of statutory interpretation in two separate cases: Dunsby v Revenue and Customs Commissioners [2020] UKFTT 271 (TC) and B Khan v HMRC [2020] UKUT 168 (TCC) (2 June), respectively. Its application in these cases sheds some light on limitations of the principle, including that the UK courts will not recharacterise a composite transaction if the purposive interpretation of relevant tax legislation does not require it.
Briefly, the facts in Dunsby were as follows: the appellant (“D”) was the sole original shareholder and director of a company (the “Company”). D and the Company implemented a tax avoidance scheme (sold to them by a promoter) that was, in the words of the FTT, designed to allow shareholders in trading companies with distributable profits to receive those profits free of income tax. Broadly, the scheme involved the Company issuing a single share in a new class (the “S share”) to a non-UK resident, unconnected recipient (“G”). In exchange for a small subscription amount (£100), the holder of the S share had the right to receive income profits and distributions, but had no voting rights. The return of capital of the S share was limited to its nominal value. G created a Jersey trust (the “Trust”) and transferred the S share to the trustee. The terms of the trust essentially provided a de minimis hurdle payment for a charity; a de minimis hurdle payment for G and the majority of any further income (98%) would be received on trust for the benefit of D (0.5.% and 1.5% of the further income would go to a charity and G, respectively). The Company declared a single dividend payment in respect of the S Share.  D did not pay income tax on the amount received.  HMRC (by way of a closure notice) amended D’s self-assessment tax return - D appealed. The FTT dismissed the appeal, finding that the payment from the Company would be treated as income (and therefore taxable as income) received by D (either under the settlements anti-avoidance legislation, or - if that was the incorrect basis - under the transfer of assets abroad legislation).  HMRC successfully argued that the receipt was to be treated as income to D under the settlements legislation. What is particularly interesting about the judgment, however, is the FTT’s application of Ramsay to arguments proposed by HMRC. The FTT (in dismissing one of HMRC’s arguments) set out that it would be an incorrect interpretation of the Ramsay principle to, when applying tax legislation to a factual scenario, simply disregard transactions or elements of transactions which had no commercial purpose. Such an approach was dismissed by the FTT as “going too far”.  In Dunsby, HMRC had tried to argue an interpretation that ignored the true facts of the arrangement. The payments from the Company were in accordance with company law treatment of the transactions. When applying tax legislation to a set of facts, two steps are required: (i) determine on a purposive basis the precise transaction the provisions are to apply to; and (ii) apply that tax legislation to the transaction identified. The Ramsay principle was whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically (Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 at [35]). Whilst the taxpayer was unsuccessful in this case, Dunsby serves as a reminder as to some of the limits of the Ramsay principle, frequently used by HMRC in defending its position. The UT in B Khan[26] considered - and dismissed - arguments put forward by HMRC based on the Ramsay principle. The case concerned the tax treatment of the sale of a target company (the “Company”) to an individual (“K”) and of subsequent payments made from the Company. K acquired 100% of the Company for £1.95 million plus the net asset value of the Company. Immediately following the acquisition, the Company bought back 98 of the total 99 shares for consideration of £1.95 million. HMRC issued a closure notice, amending K’s tax return by increasing the income tax due (on the basis that the buy-back of the 98 shares was a taxable distribution and subject to income tax). K’s (unsuccessful) appeal to the UT was based on the grounds that the FTT erred in failing to recognise the “true substance” of the transaction, which K asserted was that it was a composite transaction pursuant to which K, in return for entering into the various transactions, received the remaining share in the Company without £1.95 million distributable reserves. On this basis K (unsuccessfully) asserted that his income tax liability should have been calculated on his net receipt of the single share (rather than the single share, plus £1.95 million). Of note with respect to the Ramsay principle, the FTT considered whether the construction of a tax statute, using a purposive statutory interpretation, required the court to consider solely one element of a composition transaction or, on the other hand, the whole of the transactions viewed together as a composite. The UT considered a line of case law that sets out what it considers to be the modern approach to the interpretation of taxing statutes (Barclays Mercantile Business Finance Ltd v Mawson [2005] STC 1; UBS AG and DB Group Services v HMRC [2016] UKSC 13; Inland Revenue Commissioners v Wesleyan and General Assurance Society (1946) 30 TC 11). The UT found that, whilst the process of statutory construction may reveal the relevance or otherwise of the economic effect of transactions, it should not be assumed that economically equivalent transactions should be taxed in the same way. The UK courts will not re-characterise a composite transaction if the purposive interpretation of relevant tax legislation does not require it.

III.       Bluejay Mining plc [2020] UKFTT 473 (TC)

HMRC denied Bluejay Mining plc (“Bluejay”) credit for input VAT incurred for the relevant VAT accounting period on the basis that Bluejay, a holding company, was not making taxable supplies to its subsidiaries for consideration and/or that there was no economic activity being carried on by Bluejay. The FTT instead found that Bluejay was carrying on an economic activity and allowed the appeal.
Bluejay is a UK incorporated holding company which is listed on the Alternative Investment Market. It operates in the mineral exploration and mining industry. Bluejay’s business model broadly consisted of Bluejay identifying a possible mining project following which the necessary exploration licence would be acquired by a locally resident subsidiary. Bluejay would provide technical services to the local subsidiary and would loans the funds to pay for such services to the local subsidiary. If and when the project is successful or the licences and relevant assets are sold to another company which is willing and able to take the project to exploitation, the intracompany debt is repaid. As explained by the FTT, HMRC’s position was that Bluejay's central activity is to make a return through investing by buying shares in foreign mining companies. It also supplies technical services to its foreign subsidiaries. HMRC contended that in order to be able to claim input tax in relation to supplies of the services to the subsidiaries, Bluejay needed to be able to show that those services are supplied in return for a consideration. It also needed to show that those services are provided for the purpose of generating income on a continuing basis from the provision of those services, i.e., that it is carrying on an economic activity. Accordingly, HMRC’s position was that the purpose of the provision of the services was not to generate income on a continuing basis but to enhance the value of Bluejay’s investment in the subsidiary, and, as such, the services did not amount to an economic activity. The FTT noted that HMRC’s position required a re-characterisation of the contracts between Bluejay and its subsidiaries as HMRC were arguing that the “contracts as drafted do not represent the economic and commercial reality of the situation”. The FTT concluded that the contracts do reflect the underlying economic and commercial reality of the transactions. The FTT stated that it was important that “the contract for services provides that invoices are to be settled within 30 days of the invoice being submitted and I cannot see this as anything other than consideration for the services rendered”. In relation to the question as to whether Bluejay was carrying on an economic activity, the FTT considered the case of Polysar Investments Netherlands v Inspecteur der Invoerrechten en Accijnzen C-60/90[27] in the Court of Justice of the European Union (“CJEU”) and concluded that it is necessary to examine the actual services provided to a subsidiary in order to establish if the holding company is carrying on an economic activity. The FTT concluded that Bluejay was carrying on an activity when supplying technical services to its subsidiaries. It remains to be seen whether HMRC will appeal the decision. ____________    [1]   The Pillar 1 blueprint is available here: https://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillar-one-blueprint.pdf    [2]   The Pillar II blueprint is available here: https://www.oecd.org/tax/beps/tax-challenges-arising-from-digitalisation-report-on-pillar-two-blueprint.pdf    [3]   https://www.oecd.org/tax/dispute/mutual-agreement-procedure-statistics.htm and https://www.oecd.org/tax/dispute/mutual-agreement-procedure-2019-awards.htm    [4]   Directive (EEC) 90/463 on the elimination of double taxation in connection with the adjustment of associated enterprises (the so-called “Union Arbitration Convention”) and Directive (EU) 2017/1852 on tax dispute mechanisms in the EU (the so-called “Arbitration Directive”)    [5]   https://twitter.com/benjaminangelEU/status/1330223479300497410    [6]   Mission letter of President-elect Von der Leyen to Vice-President Dombrovskis, 10 September 2019. https://ec.europa.eu/commission/sites/beta-political/files/mission-letter-valdis-dombrovskis-2019_en.pdf    [7]  European Commission Inception Impact Assessment. Ref. Ares(2020)7030524 - 23/11/2020 https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12632-Tax-fraud-evasion-strengthening-rules-on-administrative-cooperation-and-expanding-the-exchange-of-information    [8]   “Eligible entities” are generally bodies corporate, but can also include individuals, partnerships and Scottish partnerships, in certain circumstances.    [9]   For UK VAT purposes, a “fixed establishment” is an ‘establishment other than the business establishment, which has the human and technical resources necessary for providing or receiving services permanently present’ (HMRC VAT Notice 741A). [10]   Skandia America Incorporation (USA), filial Sverige v Skatteverket (Case C-7/13) EU:C:2014:2225 (17 September 2004) (Advocate General: M. Wathelet).   [11]   https://www.gov.uk/government/publications/vat-grouping-establishment-eligibility-and-registration-call-for-evidence [12]   Melford Capital General Partner v Revenue and Customs Commissions [2020] UKFTT 6 (TC) [13]   https://www.gov.uk/government/publications/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments [14]   MEO - Serviços de Comunicações e Multimédia SA v Autoridade Tributária e Aduaneira (Case C-295/17) EU:C:2018:942 (22 November 2018) (Advocate General: J. Kokott). [15]   Vodafone Portugal – Comunicações Pessoais, SA v Autoridade Tributária e Aduaneira (Case C-43/19)EU:C:2020:465 (11 June 2020) (Advocate General: G. Pitruzzella) [16]   Although the UK government has announced that it intends for the UK High Court to also have such power, legislation is not yet in place. Cases decided by the CJEU after 31 December 2020 will be merely persuasive authorities in UK proceedings. [17]   Following the end of the transition period, UK courts will no longer be able to refer questions about the application of EU law to the CJEU. In what may well be the last such referral for UK tax purposes, the UK’s Upper Tribunal this week referred questions to the CJEU about the compatibility of certain UK tax provisions (relating to reliefs for intra-group transfers) with EU law. The responses of the CJEU will only be relevant for transfers taking place prior to 31 December 2020. [18]   Volkerrail Plant Ltd and others v HMRC [2020] UKFTT 476 (TC) [19]   Gallaher Ltd v HMRC [2020] UKUT 354 (TCC). The responses of the CJEU will only be relevant for transfers taking place prior to 31 December 2020. [20]   Regulations (EC) No. 883/2004 and 987/2009 [21]   For further information see https://www.gov.uk/guidance/uk-tariffs-from-1-january-2021 [22]   Council Directive 2003/49/EC [23]   Council Directive 2011/96/EU [24]   House of Lords case of Inland Revenue Commissioners v Brebner 1967 2 AC 18 as authority that it is the company’s subjective purposes that mattered. The case of Mallalieu v Drummond (Inspector of Taxes) 1983 2 AC 861 as authority that when identifying a “subjective purpose”, such purpose can be wider than the conscious motive of the person concerned. In the case of Oxford Instruments UK 2013 Limited v HMRC 2019 UKFTT 254 (TC), Judge Beare considered the extent to which on a “just and reasonable apportionment” how much of any debit is attributable to an unallowable purpose whereby there are one or more commercial main purposes. Judge Beare stated that “as long as the company can show that it had one or more commercial main purposes unrelated to any tax advantage in entering into, and remaining party to, that loan relationship, and that the relevant debits would have been incurred in any event, even in the absence of the company's tax advantage main purpose in so doing, then none of the relevant debits should be apportioned to the tax advantage main purpose”. Judge Beare’s comments on this issue did not form part of the court’s conclusion on the facts of that particular case but provides a helpful analysis. [25]   Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations approved by the OECD on 22 July 2010 [26]   B Khan v HMRC [2020] UKUT 168 (TCC) (2 June) [27]   In Polysar, the CJEU stated as follows: “It does not follow from that judgment, however, that the mere acquisition and holding of shares in a company is to be regarded as an economic activity, within the meaning of the Sixth Directive, conferring on the holder the status of a taxable person… It is otherwise where the holding is accompanied by direct or indirect involvement in the management of the companies in which the holding has been acquired, without prejudice to the rights held by the holding company as shareholder”.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax Practice Group or the authors: Sandy Bhogal – London (+44 (0)20 7071 4266, sbhogal@gibsondunn.com) Benjamin Fryer – London (+44 (0)20 7071 4232, bfryer@gibsondunn.com) Bridget English – London (+44 (0)20 7071 4228, benglish@gibsondunn.com) Fareed Muhammed – London (+44(0)20 7071 4230, fmuhammed@gibsondunn.com) Barbara Onuonga – London (+44 (0)20 7071 4139,bonuonga@gibsondunn.com) Aoibhin O' Hare – London (+44 (0)20 7071 4170, aohare@gibsondunn.com) Avi Kaye – London (+44 (0)20 7071 4210, akaye@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 5, 2020 |
Gibson Dunn Ranked in the 2021 UK Legal 500

Gibson Dunn earned 13 practice area rankings in the 2021 edition of The Legal 500 UK. Four partners were named to Legal 500’s Hall of Fame, recognizing individuals who receive consistent feedback from their clients for continued excellence, and four other partners were named Leading Lawyers in their respective practices. The firm was recognized in the following categories:

  • Corporate and Commercial: Corporate Tax
  • Corporate and Commercial: Equity Capital Markets – Mid-High Cap
  • Corporate and Commercial: EU and Competition
  • Corporate and Commercial: M&A: upper mid-market and premium deals, £500m+
  • Dispute Resolution: Commercial Litigation: Premium
  • Dispute Resolution: International Arbitration
  • Dispute Resolution: Public International Law
  • Human Resources: Employment – Employers
  • Projects, Energy and Natural Resources: Oil and Gas
  • Public Sector: Administrative and Public Law
  • Real Estate: Commercial Property – Investment
  • Real Estate: Property Finance
  • Risk Advisory: Regulatory Investigations and Corporate Crime (advice to corporates)
Legal 500’s Hall of Fame for 2021 consists of: Steve Thierbach – Corporate and Commercial: Equity Capital Markets; Philip Rocher – Dispute Resolution: Commercial Litigation; Cyrus Benson – Dispute Resolution: International Arbitration; and Alan Samson – Real Estate: Commercial Property – Investment and Real Estate: Property Finance. The partners named as Leading Lawyers are Sandy Bhogal – Corporate and Commercial: Corporate Tax; Ali Nikpay – Corporate and Commercial: EU and Competition; Jeffrey Sullivan – Dispute Resolution: International Arbitration; and Anna Howell – Projects, Energy and Natural Resources: Oil and Gas. Benjamin Fryer has been named a Next Generation Partner for Corporate and Commercial: Corporate Tax. Additionally, Claibourne Harrison has been named a Rising Star for Real Estate: Commercial Property – Investment, and Mitasha Chandok has been named a Rising Star for Projects, Energy and Natural Resources: Oil and Gas. The guide was published on September 30, 2020. Gibson Dunn’s London office offers full-service English and U.S. law capability, including corporate, finance, dispute resolution, competition/antitrust, real estate, labor and employment, and tax.  Our lawyers advise international corporations, financial institutions, private equity funds and governments on complex and challenging transactions and disputes.

September 29, 2020 |
Gibson Dunn Ranked in World Tax 2021

World Tax, in association with the International Tax Review, has recognized Gibson Dunn in two categories in its 2021 edition. The firm was recognized in the UK General Corporate Tax and Transactional Tax categories. World Tax is International Tax Review’s annual guide to the world's leading tax advisory practices. The 2021 edition was published September 28, 2020. The Tax Practice Group provides large multinational corporations, publicly traded and private companies, sovereign wealth funds, investment funds, partnerships, joint ventures and startups with state-of-the-art tax advice. The Tax Practice Group’s transactional practice provides tax advice to clients in connection with a broad range of business transactions and investments, including taxable and tax-free mergers, acquisitions, reorganizations and dispositions (including spin-offs and split-offs), insolvency restructurings, business combinations, capital markets offerings, investment fund formation, infrastructure investments, real estate acquisition and disposition, and specialized investment vehicles, including master limited partnerships and real estate investment trusts.

September 24, 2020 |
UK Government Announces Its ‘Winter Economy Plan’

Click for PDF Today, the UK Government announced its “Winter Economy Plan” – a series of employment and business support and tax measures intended to support the UK economy as the COVID-19 pandemic continues to impact economic output. These latest support measures mark a shift in focus to keeping the UK economy open whilst providing support to businesses as reduced demand continues to impact many businesses during the winter months and through to Q1 2021. It remains to be seen whether further support measures are announced as the UK grapples both with economic recession and the impact of COVID-19 on public health. The Jobs Support Scheme The UK Government has announced the Jobs Support Scheme (“JSS”) as the successor to the Coronavirus Job Retention Scheme (“CJRS”), starting 1 November 2020 for a period of 6 months. Unlike the CJRS, which was designed to support employees unable to work as a result of the requirement to stay at home, the aim of the JSS is to protect viable jobs by supporting the wages of those in work, providing employers with the option to retain employees on shorter hours rather than making them redundant. Whilst employers participate in the JSS, they are not able to issue redundancy notices to employees on the JSS scheme. To be eligible for the JSS, employees must be working at least 33% of their usual hours and be paid for those hours by their employer as normal. For the remaining hours not worked, the employer and the UK Government will each pay one third of the employee’s wages, resulting in the employee receiving at least 77% of their total wages (the employer paying 55% and the UK Government paying 22%). The level of the grant will be calculated based on an employee’s usual salary, capped at £697.92 per month. The JSS is open to employers with a UK bank account and UK PAYE scheme and is not limited to those employers who made use of the CJRS; all small and medium sized businesses may apply and larger businesses may apply if their turnover has been reduced as a result of the pandemic. Employers may also claim for JSS in addition to claiming the job retention bonus announced earlier in the year. The UK Government has stated that it expects that large employers using the JSS will not be making capital distributions, such as dividend payments or share buybacks, whilst accessing the JSS.  Further guidance on the JSS is expected to be issued in due course and we will update our clients once this has been announced. Self-Employed Support The UK Government has also announced the extension of the Self Employment Income Scheme Grant (“SEISS”). An initial taxable grant will be provided to those who are currently eligible for SEISS and are continuing to actively trade but face reduced demand due to the Coronavirus pandemic. The initial lump sum will cover three months’ worth of profits for the period from November to the end of January next year, capped at £1,875. An additional second grant, which may be adjusted to respond to changing circumstances, will be available for self-employed individuals to cover the period from February 2021 to the end of April 2021. UK Government Funding Schemes Bounce Back Loans – the UK Government announced the Pay As You Grow Scheme, which will allow businesses to pay back government Bounce Back Loans over a period of 10 years. This is an extension on the original 6-year term of these loans, together with the UK Government’s 100% guarantee of these loans. In addition, firms in financial difficulty will be permitted to suspend their repayments for up to 6 months and also elect to make interest only payments for the same period, without impacting a firm’s credit rating. The deadline for applications for Bounce Back Loans has also been extended to 31 December 2020. Coronavirus Business Interruption Loan Scheme – the Coronavirus Business Interruption Loan Scheme will also be extended to 31 December 2020 for applications and the UK Government has announced its intention to provide lenders with the ability to extend the term of a loan from 6 years to 10 years. This also has the effect of extending the UK Government’s 80% guarantee of these loans. Coronavirus Large Business Interruption Loan Scheme - the deadline for applications for Coronavirus Large Business Interruption Loans has been extended to 31 December 2020. Future Fund - the deadline for applications for funding under the Future Fund scheme has been extended to 31 December 2020. Tax Measures The temporary cut in VAT from 20% to 5% for the tourism and hospitality sectors that was due to expire in January 2021 has been extended through to 31 March 2021. In addition, businesses that deferred their VAT payments due in March to June 2020 will be given the option to pay their VAT in smaller instalments. Instead of paying a lump sum in full at the end March 2021, these businesses will be able to make 11 equal instalments over 2021-2022.  It has been announced that businesses will need to opt into this VAT deferral mechanism and that HM Revenue & Customs will put in place an opt-in process in “early 2021”. A further tax deferral has been introduced for self-assessment income tax payers (building on the deferral provided in July 2020): details are still be provided at the time of writing, but it has been announced that taxpayers with up to £30,000 of self-assessment income tax liabilities will be able to use the “Time to Pay” facility to secure a further 12 months to pay those liabilities due in January 2021, meaning that payments may now not need to be made until January 2022.


This client update was prepared by James Cox, Sandy Bhogal, Benjamin Fryer, Amar Madhani, and Georgia Derbyshire. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding developments related to the COVID-19 outbreak.  For additional information, please contact your usual contacts or any member of the Firm’s Coronavirus (COVID-19) Response Team. In the UK, the contact details of the authors and other key practice group lawyers are as follows: James A. Cox – London, Employment (+44 (0)20 7071 4250, jcox@gibsondunn.com) Sandy Bhogal  – London, Tax (+44 (0)20 7071 4266, sbhogal@gibsondunn.com) Benjamin Fryer – London, Tax (+44 (0)20 7071 4232, bfryer@gibsondunn.com) Amar Madhani – London, Private Equity and Real Estate (+44 (0)20 7071 4229, amadhani@gibsondunn.com) Georgia Derbyshire – London, Employment (+44 (0)20 7071 4013, GDerbyshire@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 24, 2020 |
World Tax Recognizes Sandy Bhogal and Elaine Chen

World Tax, in association with the International Tax Review, has named London partner Sandy Bhogal and Hong Kong partner Elaine Chen among its 2021 Tax Leaders. Sandy Bhogal was ranked Highly Regarded for the United Kingdom in World Tax’s Tax Controversy Leaders guide, and Elaine Chen was ranked Highly Regarded for Hong Kong in the Women in Tax Leaders guide. World Tax’s Tax Controversy Leaders guide was published on September 1, 2020, and the Women in Tax Leaders guide was published on September 17, 2020. Sandy Bhogal’s experience ranges from general corporate tax advice to transactional advice on matters involving corporate finance & capital markets, structured and asset finance, insurance and real estate. He also has significant experience with corporate tax planning and transfer pricing, as well as with advising on the development of domestic and cross border tax efficient structures. He also assists clients with tax authority enquiries, wider tax risk management and multi-lateral tax controversies. Elaine Chen represents companies and high-net-worth individuals in civil and commercial litigation and disputes, including a full range of banking, contractual, tort, companies, trust and tax matters. She has particular experience in tax, contentious probate and estate administration, mental health, private wealth, and boardroom and shareholders disputes. She has acted as legal adviser to many Hong Kong and overseas-listed corporations and financial institutions, and ultra-high net worth individuals and trusts and has wide-ranging experience in challenging big ticket litigation.

August 31, 2020 |
Murphy Oil’s $2.127 billion Divestment of its Malaysian Operations to PTTEP Named Impact Deal of the Year by ITR

International Tax Review has named Murphy Oil's $2.127 billion divestment of its entire Malaysian operations to PTT Exploration and Production Company Limited (PTTEP), the publicly listed subsidiary of Thailand's national oil company, PTT, as one of its Impact Deals of the Year at the ITR Asia Tax Awards 2020. Gibson Dunn represented Murphy Oil on this deal. The awards were held on August 26, 2020. The Tax Practice Group provides large multinational corporations, publicly traded and private companies, sovereign wealth funds, investment funds, partnerships, joint ventures and startups with state-of-the-art tax advice. The Tax Practice Group’s transactional practice provides tax advice to clients in connection with a broad range of business transactions and investments, including taxable and tax-free mergers, acquisitions, reorganizations and dispositions (including spin-offs and split-offs), insolvency restructurings, business combinations, capital markets offerings, investment fund formation, infrastructure investments, real estate acquisition and disposition, and specialized investment vehicles, including master limited partnerships and real estate investment trusts.

August 4, 2020 |
Corporate Tax 2020 – United Kingdom

London partner Sandy Bhogal and associate Barbara Onuonga are the authors of "United Kingdom," [PDF] published in Global Legal Insights - Corporate Tax 2020, Eighth Edition in August 2020.

August 4, 2020 |
Tax Partner Pamela Lawrence Endreny Joins Gibson Dunn in New York

Gibson, Dunn & Crutcher LLP is pleased to announce that Pamela Lawrence Endreny has joined the firm’s New York office.  Endreny, formerly a partner at Skadden, Arps, Slate, Meagher & Flom LLP, will continue to focus on advising clients in a broad range of U.S. and international tax matters. “We’re thrilled to welcome Pamela to Gibson Dunn,” said Ken Doran, Chairman and Managing Partner of Gibson Dunn.  “Pamela is a respected senior tax advisor with deep expertise across a broad range of U.S. and international tax matters.  The breadth of her experience will be an invaluable asset for our clients as they work to navigate today’s increasingly complex tax challenges, both in the U.S. and abroad.” “Pamela is a terrific addition to the firm,” said Andrew Lance, Co-Partner in Charge of the New York office.  “She is a highly regarded lawyer in the New York market who will further deepen our strong bench of New York-based transactional tax lawyers.” “I’m excited to join Gibson Dunn.  The firm has a wonderful reputation in the market – for both its solid transactional platform and its collaborative culture,” said Endreny.  “I am very much looking forward to continuing my practice at Gibson Dunn.” About Pamela Lawrence Endreny Endreny regularly advises clients on a broad range of tax matters, including public and private M&A, spin-offs, joint ventures, restructurings, financings and capital markets transactions, as well as on all types of matters involving asset managers and private equity funds.  She is also experienced in obtaining private letter rulings from the IRS on spin-offs and other corporate transactions and in assisting in audits and tax controversies. Endreny currently serves as chair of the Financial Transactions & Products Committee of the ABA Tax Section and as Co-Chair, Investment Funds of the Tax Section Executive Committee of the New York State Bar Association.  She frequently writes and speaks on emerging tax topics. Before joining Gibson Dunn, Endreny served as a partner at Skadden, Arps, Slate, Meagher & Flom LLP.  She received her J.D. from Columbia Law School in 1994.  She received her B.A. from Brown University in 1986, magna cum laude.

July 17, 2020 |
Jeff Trinklein and Sandy Bhogal Recognized in Tax Expert Guide 2020

Legal Media Group’s Expert Guides has named London partners Jeff Trinklein and Sandy Bhogal to its 2020 edition of the Tax Expert Guide, which recognizes the top legal practitioners in the industry. The guide was published on June 23, 2020. Jeff Trinklein serves as Co-Chair of Gibson Dunn’s Tax Practice Group. Jeff has extensive experience in U.S. and international taxation, with special emphasis on advice to foreign clients with investments in the United States and advice to U.S. clients with foreign operations. His areas of practice include advice to U.S. individuals and companies establishing investments outside the U.S., planning advice on worldwide investment structures and acquisition financing and general U.S. corporate and partnership tax planning. Sandy Bhogal’s experience ranges from general corporate tax advice to transactional advice on matters involving corporate finance & capital markets, structured and asset finance, insurance and real estate. He also has significant experience with corporate tax planning and transfer pricing, as well as with advising on the development of domestic and cross border tax efficient structures. He also assists clients with tax authority enquiries, wider tax risk management and multi-lateral tax controversies.

July 16, 2020 |
UK Tax Quarterly Update – July 2020

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In this Tax Quarterly Update, we have outlined various UK and international tax developments which we consider to be of greatest significance since our April Tax Quarterly Update.

It will not have escaped the attention of readers that we find ourselves in very interesting times from a tax policy perspective. We are facing a confluence of factors - including the fall-out from the COVID-19 coronavirus pandemic, and continuing efforts to formulate a workable set of principles to tax the digital economy and counteract base erosion and profit shifting - which will reshape the domestic and international tax landscape for many.

Against the backdrop of economic recession, tax policy is and will continue to be at the forefront of measures to both stimulate growth and generate additional tax revenue.

On 8 July 2020, Chancellor Rishi Sunak delivered his Summer Economic Update with the primary aim of securing the UK’s economic recovery from  the COVID-19 coronavirus pandemic. The tax announcements included:

  • a reduction in the rate of VAT from 20% to 5% from 15 July 2020 to 12 January 2021 for certain supplies in the hospitality and tourism sectors (notably supplies of food and non-alcoholic beverages sold for on-premises consumption, hot takeaway food and hot takeaway non-alcoholic beverages, and sleeping accommodation in hotels or similar establishments); and
  • a stamp duty land tax (“SDLT”) ‘holiday’ from 8 July 2020 until 31 March 2021, implemented by increasing the 0% threshold for ‘standard’ purchases of residential property by individuals from £125,000 to £500,000 (meaning that the first £500,000 of the price paid for such purchases will be free from SDLT). There are then corresponding changes to the additional residential rates for individuals buying additional dwellings and companies buying dwellings: here, the first £500,000 will now be subject to SDLT at 3%.

At the same time, we expect to see a continued focus in the UK and elsewhere on international tax measures, in particular BEPS 2.0 including the Organization for Economic Co-operation and Development’s Pillar One and Pillar Two proposals.  This promises to be particularly interesting in the wider context of political and global trade implications (as to which, please see further below).

From a UK perspective, we also look forward to seeing draft legislation for inclusion in Finance Bill 2021, which the Government has now confirmed for publication on Tuesday 21 July 2020.

We hope that you find this alert useful. Please do not hesitate to contact us with any questions or requests for further information.

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Table of Contents

A. Delay to DAC 6 reporting deadlines B. International update C. UK digital services tax update D. Key COVID-19 coronavirus tax update E. Recent notable cases _________________________

A.   Delay to DAC 6 reporting deadlines 

As a result of the COVID-19 coronavirus pandemic, the EU has provided member states with the option to postpone the deadlines for reporting and exchanging information under DAC 6 for up to six months. Depending on the evolution of the pandemic, the possibility exists (subject to strict conditions) for the Council to extend the deferral period once, for a maximum of a further three months. The UK government has announced it will amend its own regulations to give effect to the deferral on the full six month basis.

The EU Council Directive 2011/16 (as amended), known as DAC 6, requires intermediaries (or failing which, taxpayers) to report, and tax authorities to exchange, information regarding cross-border tax arrangements, which meet one or more specified characteristics (hallmarks), and which concern at least one EU country.

The EU Commission had, as a result of the COVID-19 coronavirus pandemic, initially proposed to defer the reporting deadlines under DAC 6 by three months, whilst affirming that the initial date of application of the rules will remain 1 July 2020. However, political agreement has now been reached by member states to postpone the filing deadlines on an optional basis by up to six months, as follows:

  • for reporting “historical” cross-border arrangements (i.e. arrangements in relation to which the first step was implemented in the period from 25 June 2018 to 30 June 2020), the filing deadline would be 28 February 2021;

the operation of “30 day” reporting deadlines will be postponed from 1 July 2020 to 1 January 2021, with the effect that:

    • arrangements that become reportable in the period between 1 July 2020 and 31 December 2020 will need to be reported by 31 January 2021;
    • arrangements that become reportable after 31 December 2020 will need to be reported within 30 days;
  • for marketable arrangements, the first periodic report would need to be reported by the intermediary by 30 April 2021; and
  • the automatic exchange of information reported between member states will be postponed from 31 October 2020 to 30 April 2021.

Although approval to defer DAC 6 has been granted by the European Council, this will not automatically change the current reporting dates within member states. This will only occur if the relevant governments positively choose to implement the deferral (for example Germany has opted not to).

Depending on the evolution of the pandemic, the amended Directive also provides for the possibility, under strict conditions, for the Council to extend the deferral period once again, for a maximum of three further months.

The UK government for its part has implemented legislation to give effect to the above deferral on the full six month basis[1]. The amended regulations take effect from 30 July 2020 and HMRC has advised no action will be taken for non-reporting during the period between 1 July and the date the amended regulations come into force.

Taxpayers and intermediaries may also draw further comfort from updated HMRC guidance[2] in respect of late filing for DAC 6 purposes, which states that difficulties arising as a result of COVID-19 coronavirus may constitute a reasonable excuse to late filing of DAC 6 reports, provided that reports and filings are made without unreasonable delay after those difficulties are resolved.

It is worth clarifying that the proposals do not affect the substantive requirements of DAC 6, only the deadlines for reporting obligations. In particular, the date on which DAC 6 will start to apply will remain 1 July 2020. Nevertheless, in member states where the deferral is approved, it will be a welcome, albeit short, relief to both taxpayers and intermediaries who should have additional time to prepare reports and put reporting procedures and staff training in place.

It is somewhat regrettable that implementation of the deferral is optional, thereby creating a risk of divergence between member states. In particular, reportable cross-border arrangements that involve multiple member states, only some of which have adopted the deferral, may (subject to the relevant country-specific conditions being met) trigger a reporting obligation with a deadline that does not reflect the deferral period adopted by other relevant member state(s). As a result, the rejection of the deferral by one member state may operate to undermine the deferral offered by others. We understand that a number of stakeholders are encouraging the European Commission to make deferral mandatory and to provide more harmonised guidance.

B.   International update

I.   BEPS 2.0 update

In mid-June 2020, the US stepped back from negotiations relating to Pillar One of the  most recent Base Erosion & Profit Shifting project (“BEPS 2.0”) of the Organisation for Economic Co-operation and Development (“OECD”) . The OECD affirmed their commitment to seeking a consensus-based solution to Pillars One and Two by the end of 2020, with the next meeting scheduled for October 2020. The EU Commission president has made it clear that if the OECD fail to secure a global accord, the EU would pursue an EU digital tax, as well as a possible minimum tax on multi-national entities (“MNEs”).

In January 2020, 137 countries and jurisdictions (the OECD’s Inclusive Framework on BEPS 2.0, the “IF”) agreed to move ahead with a two-pillar negotiation to address the tax challenges of digitalisation and to continue working toward an agreement by the end of 2020. A detailed discussion on the various facets of the Pillar One and Pillar Two proposals is set out in our previous update on digital service tax proposals. However, for current purposes, broadly:

  • Pillar One proposes changes to traditional “nexus” rules for allocating taxing rights, enabling a portion of the revenue generated from digital services to be taxed in the jurisdiction in which they are used; and
  • Pillar Two (also referred to as the “Global Anti-Base Erosion” or “GloBE” proposal) relates to the possible introduction of a “global minimum tax rate”, by creating new taxing rights for jurisdictions whose taxpayers do business with low-tax jurisdictions (e.g. withholding tax rights in respect of payments to the latter).

At the January meeting, the members of IF (including the US) agreed to approach Pillar One on the basis of the broad architectural framework developed by the OECD Secretariat to facilitate progress towards consensus (the so-called “Unified Approach”). However, many outstanding issues are yet to be agreed, including the US’s controversial “safe harbour” proposal (suggesting that taxpayers could decide whether to “opt-in” to be taxed in accordance with Pillar One as currently envisaged or an alternative (as yet unspecified) basis for taxation). In respect of Pillar Two, the IF members acknowledged that significant progress had been made towards achieving the technical design of the proposal for a global minimum tax rate, but that more work needed to be done. The next OECD BEPS 2.0 meeting has been postponed by three months to October 2020. It is intended that, at this meeting, the key policy features of the solution to Pillars One and Two will be agreed.

However, in a significant twist, in June 2020, the United States stepped away from Pillar One negotiations. The US Trade Representative, Robert Lighthizer, informed the US House Ways and Means Committee that this was on the basis that the OECD “[was] not making headway” on a multilateral deal on digital services taxation. Steven Mnuchin, the US Treasury Secretary, confirmed this to a group of European finance ministers, stating that the US was taking a step back from the discussions, with talks to resume “later this year”. Regarding the GloBE proposal under Pillar Two, the Secretary noted that the US “fully supports bringing those negotiations to a successful conclusion this year.

The head of the OECD’s tax policy centre, Pascal Saint-Amans, said that the OECD and member countries would continue to collaborate on a workable draft deal, though he admitted that it was less likely that a deal would be achieved this year. Saint-Amans also floated the possibility that Pillar One and Pillar Two could be separated so that delays in agreeing Pillar One would not prevent the conclusion of the well advanced negotiations on Pillar Two.

In the absence of direct US involvement in the BEPS 2.0 process, it is difficult to see how meaningful progress could be made in respect of Pillar One at the October meeting (or more generally). For example, one of the thorniest Pillar One issues is the risk of double taxation; if the jurisdictions in which affected companies are currently taxed do not yield taxing rights, the result is likely to be double taxation. As the taxpayers most likely to be impacted by the reforms are US technology companies, US engagement is critical to finding a workable multilateral solution.

The lack of US direct involvement and the consequential low probability of a multilateral solution means that more countries are likely to adopt unilateral measures on digital taxation, thereby resulting in a fragmented and less effective international approach. The OECD Secretary-General noted that, in the absence of a multilateral solution, unilateral national measures would inevitably be implemented and these would result in increased tax disputes and heightened trade tensions.

Even though the Pillar Two negotiations are more advanced than the Pillar One talks, there are a number of pertinent issues that have yet to be agreed upon. For example, there are ongoing discussions on the proposed inclusion of some form of investment funds carve out from any GloBE tax. This is on the basis that most investment funds are structured as tax neutral investment pooling vehicles. The absence of a targeted exemption of this kind could result in potential double taxation of income received by the fund. Ultimately, the concern with such an outcome is that the differing (and adverse) tax treatment for indirect investment (over direct investment) would dissuade investors from using fund vehicles. Inherently, this would limit (and potentially eliminate) the economic benefits that funds can offer to investors via access to global markets and a diversified portfolio.

Should OECD discussions fail to produce consensus, the EU has made clear that it is willing to fill the void with its own proposals. The acting director-general of the Directorate-General for Taxation and Customs Union, Benjamin Angel, confirmed that any European solution to digital taxation will be based on the progress made in those discussions though, the European solution will not take the form of a digital services tax. In June 2020, the EU’s economy commissioner, Paolo Gentiloni, confirmed that (in the absence of Pillar Two progress) the EU could also propose its own minimum tax on MNEs in 2021.

However, the path to implementing measures at an EU level is not necessarily more straightforward:

  • Such measures would generally require the unanimous agreement of the EU Council under the special legislative procedure.
    • While many EU jurisdictions would, on balance, benefit from increased revenue following the introduction of a European solution to digital taxation, some jurisdictions (notably Ireland, Sweden and Denmark) opposed (and effectively blocked) the EU’s digital services tax proposal in 2019. In addition, the US has been robust in its position that states implementing such measures will suffer economic counter-measures. For example, the US has reiterated its intention to impose trade sanctions on French products in response to the proposed French digital services tax. The French tax was suspended at the beginning of this year in exchange for a postponement of the retaliatory tariffs threatened by the US, which have recently been delayed until 6 January 2021. Some member states may therefore feel that the potential economic risks outweigh the gains.
    • Given difficulties with the requirement for unanimous consent generally, there have been renewed calls for the decision-making process on taxation policy to be simplified. These have included calls (i) to move to “qualified majority voting” (“QMV”) which requires the approval of only a specified majority of the member states and EU population, and (ii) to move away from the special legislative procedure to the ordinary legislative procedure for tax law, under which the European Parliament has a decisive, rather than a consulting, role. However, any such changes would (ironically) require unanimous adoption by the Council and no opposition from any national Parliament. Whilst there is strong support for such changes in certain quarters, the reality is that they are unlikely to win the necessary unanimous support any time soon.
  • There are some (very limited) existing EU legislative mechanisms which enable tax provisions to be adopted in the absence of unanimity. These include the so-called “enhanced cooperation procedure” (which allows proposals to take effect in the absence of unanimous member state consent, provided they have the support of at least nine member states and only take effect in those member states) and limited use of QMV (which currently can only be used under the ordinary legislative procedure to eliminate distortions of competition due to different tax rules in member states). However, these have rarely been used in respect of tax legislation and not with much success. For instance, the enhanced cooperation procedure was proposed in 2013 for the planned EU financial transaction tax (discussed further below).

It would appear, therefore, that the best route to a coherent international solution is for the EU to put its weight behind the BEPS 2.0 process and attempt to draw the US back to the negotiating table. Given the potential double tax risks posed by the failure of the OECD project, they may find unlikely allies in the US technology companies whose interests are likely to be best served by such US re-engagement.

II.  EU proposal for new tax on large corporates

The EU appears keen to carve a more direct role for itself in the field of taxation. In May 2020, the EU’s multi-year budget contemplated the introduction of new taxes, the proceeds of which would be added to EU, rather than member state, coffers. Proposals (which have not yet been tabled for member state approval) include a new tax on large corporates “who benefit from the single market”.

In May 2020, the EU Commission published an outline of its next “multi-annual financial framework” for 2021-2027 (effectively, a budget for the EU for the relevant time period).[3] Typically, the framework garners attention for its proposed expenditure, with income predominately derived from member state contributions and a portion of the VAT collected by member states. On this occasion, however, the EU Commission projected that approximately 30% of its income for the period would come from new sources. In addition to income from the expansion of carbon trading, its seems that the EU intends to generate revenue from levying new taxes, the proceeds of which would be directed toward its own (rather than member states’) reserves.

One of the most significant revenue sources (estimated at €10 billion annually) was a proposed tax on companies operating in the single market with an annual revenue of €750 million or more, to be charged at a rate of 0.1% of annual revenue and to take effect around 2024. EU Commissioner Johannes Hahn noted that, due to their access to the single market, such firms have “a much bigger customer base, a seamless supply chain, in many countries the same currency and a uniform regulation. Companies save costs by simply using the single market, [such that] a modest levy for this access is…a fair deal”. However, subsequent statements from an EU spokesperson about the tax (which would be used to fund the EU’s COVID-19 coronavirus stimulus package) indicated that its form, and the rate at which it would be charged, are far from settled: “Depending on the design, whether a lump sum or a fee proportional to firms’ size, or a portion of a tax on profits, around 10 billion euros could be raised without excessively weighing on any individual firm. Ten billion euros is less than 0.2% of the turnover generated by the EU operations of those large companies.” Although the tax was discussed at the EU Council summit on 19 June 2020, no further statements have been made about its design, and no concrete proposals have been tabled for member state approval.

Despite the potential significance of the announcement, high level questions remain over the feasibility of the tax - or indeed any form of direct EU taxation – in the coming years. As discussed above, any EU-wide proposal would (based on current rules) require the unanimous backing of the member states, and the extent of member state support for the idea is not yet clear. They will be alive to the economic and fiscal difficulties to be faced at a national level in the wake of the COVID-19 coronavirus pandemic, and may be wary of additional taxes which risk impeding the recovery of national businesses, without the corresponding injection to national finances. Negotiations between member states are expected to continue over the summer.

III.   Possible resurrection of European financial transaction tax

Germany has announced that securing a pan-European financial transaction tax is one of its priorities during its current tenure as president of the EU Council.

In April 2020, the introduction of a European financial transaction tax was included on the German agenda for its six-month term as president of the EU Council (from July to December 2020).

Proposals for an EU-wide financial transaction tax were first mooted in 2011. The original proposal was for a tax levied on each party to certain dealings in financial instruments, such as transfers of debt and equity interests (at a rate of 0.1% of the consideration), and the entry into or modification of derivative contracts (at a rate of 0.01% of the notional amount). The tax was originally intended to apply in all member states, but only gained the support of 11 (Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain, although Estonia subsequently withdrew its support). In 2013, these states moved forward using the so-called “enhanced cooperation procedure” (described above). Nevertheless, the proposal stalled, and certain states (such as Italy and France) acted unilaterally to introduce national equivalents.

In December 2019, the proposal for an FTT was revived, when the German Finance Minister published draft legislation for its imposition by participating member states. Broadly, this iteration would apply (at a minimum rate of 0.2%) to the acquisition of shares in entities established in participating member states with a market capitalisation of €1 billion or more, if the shares were admitted to trading on a trading venue. The revised proposal included an exemption for (amongst other things) market-making activities, an optional exemption for pension funds and proposals for “mutualisation” (which guarantees participating member states a certain portion of the proceeds). Again, it did not proceed further.

It is understood that Germany’s vision for the form of an FTT is largely unchanged from last year’s proposals. However, it is unclear whether the other participating member states will agree with its scope and design, such that a consensus can be reached. In particular, statements following the EU Council meeting on 19 June suggested that the FTT was discussed as a possible means of funding the EU’s COVID-19 coronavirus recovery package (which may cut across proposed mutualisation mechanics).

Given fiscal pressures in the wake of the COVID-19 coronavirus pandemic, the proposal may perhaps receive a warmer airing on the third attempt – although member states may equally be conscious of the risk such a tax would pose to liquidity in the capital markets (at a time when it is very much needed). However the EU chooses to proceed, it is unlikely that any proposal would progress to implementation before the end of the Brexit transitional period (currently 1 January 2021). Given London’s role in European and global capital markets, the UK government is highly unlikely to have any appetite for equivalent measures.

IV.   DAC 7 update & OECD publication of the “Model Rules for Reporting by Platform Operators with respect to Sellers in the Sharing and Gig Economy”

After a short delay, the EU Commission published a proposal for a Directive amending Council Directive 2011/16/EU (referred to as “DAC 7”) on 15 July 2020. The proposal enhances the member states’ information gathering and sharing powers in respect of income generated via digital platforms.

Meanwhile, on 3 July 2020, the OECD published model rules which jurisdictions could adopt to facilitate greater transparency in the reporting of such income and the exchange of that information between jurisdictions.

The EU Commission published a proposal for a Directive amending the European Directive on Administrative Cooperation in the Field of Taxation, Council Directive 2011/16/EU (referred to as DAC 7) on 15 July 2020. This follows completion of the public consultation on DAC 7 in April 2020. The proposal was published along with a number of other tax policy initiatives that the EU Commission intends to implement between now and 2024.

By way of reminder, the aim of DAC 7 is the fair taxation of income generated via digital platforms and it will, unlike previous versions of DAC, address VAT (in addition to direct taxes). The main problems that DAC 7 is set to tackle are:

  • tax revenue losses due to some taxpayers failing to report what they earn via online platforms; and
  • the weaknesses in how national tax administrations cooperate to tackle tax evasion and the inefficiencies in data exploitation.

Specifically, DAC 7 is intended to bolster the information-gathering powers of tax administrations regarding income generated via the digital platform economy, to provide for better cooperation across tax administrations, and keep business compliance costs to a minimum by providing a common EU reporting standard.

Simultaneously, the OECD has been working on a global tax reporting framework as part of a wider strategy (a) to address the tax challenges arising from the digitalisation of the economy and (b) as a basis for increasing tax transparency to develop a stable environment for the growth of the digital economy. Following the publication of the OECD 2019 report on ‘The Sharing and Gig Economy: Effective Taxation of Platform Sellers’anda consultation process earlier this year, the OECD published, on 3 July 2020, Model Rules for Reporting by Platform Operators with respect to Sellers in the Sharing and Gig Economy (the “Model Rules”). The Model Rules seek to assist tax authorities collecting information on the income realised by those offering accommodation, transport and personal services through “platforms” (namely any software, including a website and phone applications) and to report that information to the tax authorities. In particular, (given the international nature of such platforms) the aim is to facilitate the standardisation of rules across jurisdictions.

C.   UK digital services tax update

At the time of writing, UK members of Parliament have, as part of amendment papers to the Finance Bill 2019-21, proposed additions to the UK digital services tax regime. These include:

  • requiring all corporate groups subject to the UK digital services tax to publish a group tax strategy, including a country-by-country report (which would include information about the group’s global activities, profits and taxes); and
  • requiring the UK government to report on the digital services tax annually (which would include an annual assessment of the effect of the regime on UK tax revenues).

The UK introduced its current “country-by-country” reporting regime in 2016, to implement Action 13 of the wider OECD BEPS project and to provide a more standardised approach towards consistent high-level transfer pricing assessments. Broadly the regime requires UK-headed MNEs, or UK sub-groups of MNEs, to make annual reports to HMRC in certain circumstances, showing revenues, profits, taxes paid and certain other measures of economic activity in the jurisdictions in which they operate.[4] The above proposals for a “country-by-country” report to be prepared by those within the scope of the UK digital services tax would subject such taxpayers to the same reporting obligations. This will likely increase the compliance burden for large MNEs within the scope of the UK digital services tax, but with an otherwise limited UK presence. It is also not clear at this stage what role each of the categories of information required under such reports will play in recovering UK digital services tax and the grounds under which those reports may be shared with other tax authorities or used in scrutinising wider transfer pricing arrangements of MNEs.

The UK digital services tax is still intended to be withdrawn once the OECD reaches consensus on a common approach to update the international corporate tax rules to tax the digital economy. The above proposals may (in part) have been in response to recent action by US Treasury Secretary, Steve Mnuchin, who in June 2020 reportedly wrote to the UK, France, Italy and Spain pulling the US back from wider discussions at the OECD level (see further Section B).

For our latest Client Alert on The UK Digital Services Tax click here.

D.   Key COVID-19 coronavirus tax update

I.   New timelines for tax policy consultations

HM Treasury and HMRC have set out revised timelines for the conclusion of open tax consultations, and the publication of other tax policy documents, in light of the COVID-19 coronavirus pandemic, in order to allow more time for stakeholders to provide feedback.

The UK government has extended deadlines in respect of ten consultations and calls for evidence currently underway by three months. Jesse Norman, Financial Secretary to the

HM Treasury, said that “[c]onsulting on tax policy is crucial to good tax law. And a good consultation makes sure everyone with an interest in the subject has an opportunity to have their say …. That is why [HMRC is] extending these deadlines”.

The table below sets out the revised deadlines for some of the most significant consultations:

Consultation

Revised deadline

Tax treatment of asset holding companies in alternative fund structures

19 August 2020

Notification of uncertain tax treatment by large businesses

27 August 2020

Consultation on the taxation impacts arising from the withdrawal of LIBOR

28 August 2020

Call for evidence: raising standards in the tax market

Tackling Construction Industry Scheme abuse

Preventing abuse of the R&D tax relief for SMEs: second consultation

Hybrid and other mismatches

29 August 2020

In light of the COVID-19 coronavirus, the UK government has also delayed the publication of a number of tax policy documents announced at Budget 2020, including the following:

Policy document

Revised publication date

A summary of responses to the call for evidence on the operation of insurance premium tax

Spring/summer

HMRC’s civil information powers

A summary of responses to the non-UK resident SDLT surcharge consultation

The call for evidence for the fundamental review of business rates

The consultation on the design of a carbon emissions tax

The response to the call for evidence on simplification of the VAT partial exemption and capital goods scheme

Autumn

The call for evidence on disguised remuneration schemes

Unspecified

The review of the UK funds regime

Details regarding the publication date of the UK government’s first review of VAT charged on fund management fees (which was announced at Budget 2020 as part of a wider review to ensure the ongoing competitiveness and sustainability of the UK regime as it applies to the financial services sector) are also yet to be provided.

It is unclear whether the delays noted above will impact the implementation date of some of the proposals. However, given the current environment, the extensions will be welcomed by many stakeholders who are facing disruption due to the COVID-19 coronavirus and who would like the opportunity to submit their views.

II.   OECD analysis of tax treaties and the impact of the COVID-19 coronavirus pandemic

The OECD has published an analysis (the “OECD Analysis”) of how the OECD Model Convention (the “OECD Model”) may be interpreted in the context of changing circumstances arising from the COVID-19 crisis, such as the dislocation of people and activities while travel restrictions remain in place. Issues addressed include: (i) the potential creation of permanent establishments; (ii) the residence status of a company (place of effective management); (iii) cross-border workers; and (iv) potential changes to the residence status of individuals.

 The COVID-19 coronavirus pandemic has forced governments to restrict travel and implement strict quarantine requirements and it is clear that such measures raise difficult tax issues. The OECD Analysis outlines the OECD’s view as to how the OECD Model can be interpreted and applied to certain tax treaty issues arising in the context of the pandemic.

  • Concerns related to the creation of permanent establishments: As a result of government restrictions, many cross-border workers are unable to physically perform their duties in their country of employment. The OECD Analysis addresses the concern that employees working from home in jurisdictions which differ from their usual place of work will create a permanent establishment (“PE”) for their employer in the former jurisdiction. According to the OECD Analysis, the temporary change of the location where employees exercise their employment because of the COVID-19 coronavirus pandemic, such as working from home, should not create new PEs for the employers pursuant to Article 5 of the OECD Model. The OECD Analysis states that a PE must have a “certain degree of permanency and be at the disposal of an enterprise in order for that place to be considered a fixed place of business through which the business of that enterprise is wholly or partly carried on”. Under Article 5(5) of the OECD Model, the activities of an individual temporarily working from home for a non-resident employer could also give rise to a dependent agent PE. The OECD Analysis states that an evaluation is required as to whether the employee performs these activities in a “habitual” way and concludes that an employee’s or agent’s activity in a particular country is unlikely to be regarded as habitual if he or she is only working at home in that country for a short period because of force majeure and/or government directives extraordinarily impacting his or her normal routine. HMRC published guidance in the International Tax Manual stating that the “existing legislation and guidance in relation to permanent establishments already provides flexibility to deal with changes in business activities necessitated by the response to the COVID-19 pandemic”.
  • Concerns related to the residence status of a company (place of effective management): The OECD Analysis notes that the COVID-19 coronavirus pandemic may raise concerns about a potential change in the “place of effective management” of a company as a result of a relocation, or inability to travel, of chief executive officers or other senior executives. The concern is that such a change may alter a company’s residence under relevant domestic laws and affect the country where a company is regarded as a resident for tax treaty purposes. In the UK for example (where, for non-UK incorporated entities, the domestic test looks to the location of central management and control), HMRC has noted that it would not consider that a company will necessarily become resident in the UK because a few board meetings are held in the UK, or because some decisions are taken in the UK over a short period of time. It is not clear what HMRC will consider a short period of time, particularly as the duration of the travel restrictions is unknown. In a treaty context (where the test typically looks to the place of effective management), according to the OECD Analysis, it is unlikely that the COVID-19 coronavirus pandemic will create any changes to a company’s residence status under a tax treaty. A temporary change in the location of the chief executive officers and other senior executives is an extraordinary circumstance because of the pandemic and such change of location should not trigger a change in residency. However, the OECD Analysis does note that if, due to domestic legislation, a dual residency issue appears, it would be resolved under tie-breaker rules set out in the relevant double tax treaty.
  • Concerns related to cross border workers: Article 15 of the OECD Model governs the taxation of employment income, allocating the right to tax between the employee’s state of residence and the place where their employment is performed. The OECD Analysis states that the starting point for the rule in Article 15 is that salaries, wages and other similar remuneration are taxable only in the person’s state of residence (the “resident state”) unless the “employment is exercised” in the other state (the “source state”).
    • The COVID-19 coronavirus pandemic has resulted in some governments subsidising the income of employees. The OECD Analysis notes that the income received by cross-border employees in these circumstances should be attributable to the country where the employee would otherwise have worked in the absence of the crisis. In most cases, this will be the place the employee used to work prior to the COVID-19 coronavirus pandemic. The OECD Analysis states that where the source state has a taxing right, the resident state must relieve double taxation under Article 23 of the OECD Model, either by exempting the income or by taxing it and giving a credit for the source state tax.
    • The OECD Analysis acknowledges that compliance difficulties may arise whereby the country where employment was formerly exercised loses its taxing right following the application of Article 15. For example, employers may have withholding obligations which are no longer underpinned by a substantive taxing right.In these circumstances, such obligations would have to be suspended and a way found to refund the tax to employees. Employees may also have new and enhanced liabilities in the other state.

HMRC has not yet indicated their approach to the above employment and source taxation issues as a result of the travel restrictions imposed in response to the COVID-19 coronavirus pandemic.

Concerns related to a change to the residence status of individuals: The final issue addressed by the OECD Analysis relates to the impact that unforeseen changes of location may have on the tax residency status of individuals. The UK statutory residence test, for example, considers the number of days an individual spends in the UK in determining their tax residency (amongst other factors). HMRC has confirmed that certain situations arising from the COVID-19 coronavirus pandemic would constitute “exceptional circumstances”, such that up to 60 days’ presence in the UK can be ignored for this purpose, while the government has also stated that in this context, special treatment will be afforded to those in the UK to assist with the response to the pandemic.[5]

  • The OECD Analysis states that “it is unlikely that the COVID-19 situation will affect the treaty residence position”. However, two scenarios are noted whereby an individual’s residence status may change as a result of the COVID-19 coronavirus pandemic:
    • A person is temporarily away from their home and gets stranded in the host country by reason of the COVID-19 coronavirus pandemic and attains domestic law residence there.
    • A person is working in a country (the “current home country”) and has acquired residence status there, but they temporarily return to their “previous home country” because of the COVID-19 coronavirus pandemic. They may either never have lost their status as resident of their previous home country under its domestic legislation, or they may regain residence status on their return.

The OECD Analysis provides that in both scenarios, if a tax treaty is available, the treaty tie-breaker rules should solve the issue and keep the person a resident of the country he/she was before the COVID-19 coronavirus pandemic.

The application of relevant domestic law requirements will, in the first instance, determine how these issues are addressed in practice. Although there are exceptions (e.g. Ireland, Australia), many jurisdictions have yet to (and indeed may not) provide guidance to taxpayers as to how they intend to deal with the above issues as a matter of domestic law.

Recourse to treaties may operate as a second line of defence for taxpayers, should such guidance/relief not be forthcoming at a domestic level. The OECD Analysis, which broadly favours interpretations which maintain the status quo regarding allocation of taxing rights, may therefore provide some comfort to taxpayers. However, the availability of treaty relief is, in any particular case, likely to depend on the specific terms of the relevant tax treaty. Unfortunately, uncertainties are unlikely to be resolved in the short term, as issues arising now are likely to take a number of years to play out. Indeed, the pandemic may well prove to be the first true test of the more robust treaty dispute resolution mechanics (such as mandatory arbitration) which have been adopted in recent years.

III.   Transfer pricing implications of COVID-19 coronavirus pandemic

Changing circumstances caused by the COVID-19 coronavirus pandemic may lead taxpayers to question whether their existing transfer pricing policies should be revisited (and if so, how). On 3 June 2020, the OECD issued a questionnaire to companies and trade associations, asking for their input on transfer pricing issues experienced in this context (the “OECD Questionnaire”). The OECD’s intention is to use the information provided in response to guide discussions on how to best respond to such issues. Nevertheless, the OECD has noted that its existing transfer pricing guidelines continue to represent internationally agreed principles for the application of the arm’s length principle. These will, accordingly, continue to be key reference points for taxpayers in the current circumstances.

Factors informing many MNEs’ transfer pricing policies are likely to have been impacted by the COVID-19 coronavirus pandemic. These include:

  • the possibility of significant people functions being located in unexpected jurisdictions;
  • possible changes to supply chains in response to shortages and travel restrictions;
  • possible changes in business strategies in response to changes in consumer demands;
  • the emergence of new commercial risks and changes to the significance of existing risks;
  • volatility in financial markets and potential liquidity shortages; and
  • a general economic downturn.

Such developments may raise questions as to whether (and if so, to what extent) these changes should be reflected in amendments to existing transfer pricing policies.

The OECD Questionnaire asked MNEs and trade associations to provide information on difficulties faced as a result of the COVID-19 coronavirus pandemic, including:

1. The issues (a) causing greatest concern, together with practical examples, (b) least clearly addressed in the existing OECD guidelines, and (c) most likely to give rise to disputes with tax administrations;
2. The types and sources of information that should be utilised as the basis for comparability analyses for 2020; and
3. Examples of supplementary transfer pricing guidance published by national tax administrations that address any of the identified issues.

While the OECD Questionnaire may result in the publication of additional guidance, given that transfer pricing must be assessed at the time arrangements are entered into, it may well be too late to assist MNEs in pricing arrangements being entered into presently. For the moment at least, taxpayers will have to be guided by the OECD’s existing transfer pricing guidelines - the 2017 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “2017 Guidelines”) and the 2020 OECD Transfer Pricing Guidelines on Financial Transactions (the “2020 Guidelines”). In this respect, the OECD has made clear that “irrespective of the underlying economic circumstances, [the 2017 Guidelines] provide guidance for the application of the arm’s length principle of which Article 9 [of the OECD Model Tax Convention] is the authoritative statement”.

The 2017 Guidelines address whether, and if so how transfer pricing analysis should take account of future events that were unpredictable at the time of the testing, stating that this question should be resolved by reference to “what independent enterprises would have done in comparable circumstances to take account of the valuation uncertainty in the pricing of the transaction”. One of the practical difficulties with such comparative analysis, however, is that the COVID-19 coronavirus pandemic presents a unique economic challenge, its impact has varied across industries and as between MNEs and there may be little (if any) comparative data on what independent enterprises would do (and are doing). The 2017 Guidelines accept that information on contemporaneous transactions may be limited, and state that in some cases taxpayers can demonstrate that they have made “reasonable efforts to comply with the arm’s length principle based on information that was reasonably available to them at that point”. It further clarifies that differences that materially affect the accuracy of the comparison will need to be adjusted to the extent that such adjustments are reasonable and improve comparability.[6] It will therefore be more important than ever for taxpayers to document all decisions taken in relation to their transfer pricing policies.

Moreover, MNEs will have to consider whether existing transactions should be reviewed to reflect the current circumstances. Given financial market volatility and the likelihood of fewer debt transactions, this is particularly true for financial transactions. The 2020 Guidelines provide that “a transfer pricing analysis with regard to the possibilities of the borrower or the lender to renegotiate the terms of the loan to benefit from better conditions will be informed by the options realistically available to both the borrower and the lender”. If MNEs consider that there is scope to renegotiate more favorable terms on intra-group loans or delay interest payments on a temporary basis, the decision should be contemporaneously documentedand reflect that the options realistically available to both parties have been considered.

Losses may also need to be considered. The 2017 Guidelines provides that “associated enterprises, like independent enterprises, can sustain genuine losses“ due to unfavorable economic conditions. However, an independent enterprise would not be able to “tolerate losses that continue indefinitely”.[7] The COVID-19 coronavirus pandemic would certainly constitute an unfavorable economic condition. However, that alone does not justify the legitimacy and allocation of intra-group losses - the relevant test would be the consideration of what unrelated parties in the same or similar circumstances would do. This would depend on the particular facts and circumstance and would require benchmarking support – which is not readily available in the context of the pandemic. In addition to analysing the allocation of losses, MNEs are required to perform impairment testing to ensure that an entity’s assets are not carried at more than their recoverable amount. COVID-19 coronavirus has resulted in a significant change in circumstances and as such MNEs may be subject to an unscheduled impairment test which may have a consequent impact on transfer pricing policies.

Broadly, within MNEs, employees who take on more important group functions are often required to relocate to locations where the entrepreneurial group companies or companies with the most important functions are based or where there is a more beneficial regulatory environment. Certain of these employees may have returned to their home jurisdictions as a result of the lockdown restrictions. A functional and factual analysis must be undertaken to determine whether key entrepreneurial risk taking (“KERT”) functions are performed by employees in their home jurisdiction and if any profits arising from such KERT functions should be attributable to the home jurisdiction. In such circumstances, it is unlikely that the relevant group company for which such employees perform KERT functions would change (i.e. that they would begin to perform such functions for a different group company in their home jurisdiction). If so, this should not change the functional profile of the group companies and the MNE’s transfer pricing model should not be impacted.

While the current circumstances are certainly novel, the existing OECD transfer pricing guidance is general in its nature, and was intended to be capable of application in a variety of different contexts. As such, the key message for MNEs when considering whether to make any changes to transfer pricing policies as a result of the COVID-19 coronavirus pandemic is to some extent familiar - MNEs should document all decisions and create a contemporaneous audit file and ensure that their transfer pricing policies align with business strategies. This will be helpful to support any review of transfer pricing policies by tax authorities in the future.

IV.   Tax status for EMI options granted to furloughed employees

There had been a concern that furloughing employees may result in the loss of Enterprise Management Incentive (“EMI”) tax benefits. The UK government has tabled amendments to Finance Bill 2020-21 which provide that an employee having been furloughed will not result in a “disqualifying event” for the purposes of obtaining tax relief under the EMI scheme.

Broadly, EMI options are special tax-efficient options which can be granted by certain qualifying companies without giving rise to income tax or National Insurance Contribution (“NICs”) charges on either grant or exercise (and only a charge to capital gains tax on the subsequent disposal of the shares acquired on exercise). However, to obtain these tax benefits, the relevant legislation under the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) provides that recipients of EMI options must spend:

  • at least 25 hours each week (the 25 hours requirement), or
  • if less, 75% of their working time (the 75% requirement),

working as an employee for the company granting the option (or one of its qualifying subsidiaries).

There was a concern that a furloughed employee may no longer satisfy the above working time requirement. Given that furloughed employees are expressly prohibited from working for their employer for the furlough period, any such employees holding EMI options would not be able to meet the 25 hours (or 75% of working time) test. Such failure is a “disqualifying event”, meaning that any EMI options held would have lost their tax advantaged status after 90 days.

The UK government has announced that it will introduce a time limited exception for participants in EMI schemes who are not able to meet the relevant working time requirements as a result of the COVID-19 coronavirus pandemic. The proposed measure (to be included in Finance Bill 2020-21) will ensure that failure of furloughed employees to meet the current statutory working time requirement will not result in a “disqualifying event”, such that any EMI options held by furloughed employees will not lose their tax advantaged status. The proposed relief will apply from 19 March 2020 and will come to an end on 5 April 2021. If required, the relief may be extended by regulation for a further 12 months to 5 April 2022.

The proposals are welcome, and will ensure that furloughed employees holding EMI options will not be prejudiced by circumstances outside their control. It remains to be seen whether similar reliefs may be granted to other taxpayers at risk of having their tax status altered by reason of recent intervening circumstances (such as employees unexpectedly carrying out employment tasks in the UK by reason of travel restrictions, and their employees).

On 8 June, HMRC also issued a bulletin in respect of other tax advantaged share schemes:

  • Save as you Earn: Where participants are unable to contribute because they are furloughed, HMRC will extend the payment holiday terms. In addition, payments of Coronavirus Job Retention Scheme (“CJRS”) to employees furloughed during the coronavirus pandemic can constitute a salary and SAYE contributions can continue to be deducted from CJRS payments.
  • Share Incentive Plan: Payments of CJRS to employees furloughed during the COVID-19 coronavirus pandemic can constitute a salary and contributions can continue to be deducted from CJRS payments.
  • Company Share Option Plans: HMRC will accept that where employees and full-time directors, now furloughed because of the COVID-19 coronavirus pandemic, have been granted options before the pandemic, such options will continue to constitute qualifying options on the basis the recipients were full-time directors and qualifying employees at the time of grant.

V.   Crisis-driven changes to trading activities

HMRC has updated  its guidance on crisis-driven changes to trading activities for businesses. This includes guidance on temporary breaks in trading activity and the treatment of income and expenditure. The guidance confirms that a temporary pause in trading activity in response to the pandemic will not result in taxpayers being treated as having ceased to trade, provided an intention to trade remains.

In response to the COVID-19 coronavirus pandemic, many businesses have had to adapt their activities. For example, businesses may have had to change product lines in response to changing consumer demands and/ or production difficulties, or temporarily close altogether.

Changes in trading activities, or the cessation of a trade, can cause issues from a tax perspective. For example, a trading company that has incurred losses may not be able to carry such losses forward to offset against future profits if it is found to have ceased one trade and to have started a new trade. In this respect, case law establishes that the line between making changes to an existing trade, and beginning a new one, can be fine. In one case, a taxpayer who had incurred losses brewing and selling beer adapted its business model so that the beer was instead produced by a third party, but sold by the taxpayer in the same manner. To the customers there had been no change. However, the courts found that the taxpayer had ceased one trade, and began another.[8]

Case law over the years has shown that the intention of the taxpayer and the extent and length of period during which the trade was dormant (if relevant) are critical factors in determining whether a trade continued or ceased. In one instance, due to the economic conditions at the time, a taxpayer was unable to obtain new business, despite having made persistent attempts. After more than five years some new business was obtained and the business returned to profitability. The taxpayer successfully claimed that the trade had continued throughout the five years because of attempts to seek business throughout.[9]

In light of the limitations imposed by the COVID-19 coronavirus pandemic, taxpayers will welcome recently published guidance in HMRC’s Business Income Manual on the implications of crisis-driven changes to trading activities. The guidance sets out how HMRC will apply legislation and case law in situations where a crisis (such as the COVID-19 coronavirus) has resulted in changes to normal trading activities.

The guidance confirms the following:

  • A business that starts carrying on a new activity that is broadly similar to its existing trade should not be treated as commencing a separate trade. This of course will depend on the facts of each case. The guidance includes an example of a restaurant business starting to manufacture gowns and face masks, which should be treated as the commencement of a separate trade. This is compared to a business that already manufactures clothing articles starting to manufacture gowns and face masks using the same staff and premises, which should be treated as an extension of the same trade.
  • Temporary breaks in trading activity will not constitute a permanent cessation of a trade for tax purposes, provided the trading activities that resume are the same as, or similar to, those before the break. For example, if a business closed its doors to customers, or otherwise ceased trading during the COVID-19 coronavirus lockdown period, but intended to continue trading after restrictions were lifted, then the trade should not be treated as having ceased. Any income and expenses relating to the gap in trading will be taken account of in the calculation of trade profits or losses (subject to the usual tax rules and case law). Where, in the end, that business does not resume, there will be a cessation of trade.
  • If businesses have received donations of money to meet revenue expenditure or supplement trading income, these will be treated as trading receipts.
  • Some businesses may offer partial refunds to customers during the lockdown period (for example on gym memberships or other subscription-based services). Where these are included as trade expenses in the taxpayer’s GAAP-compliant accounts they should be deductible for tax purposes, assuming that the original receipt was included in the calculation of trade profits.

Clarifications in HMRC’s guidance are welcome at a time when many businesses are adapting to survive and have, consequently, had to consider whether there has been a change or cessation of trade for tax purposes. As always, however, each case will need to be considered on its own merits.

On a related note, HMRC has now acknowledged that, in exceptional circumstances, it will consider claims for repayments of corporation tax instalments paid earlier in the current accounting period, based on losses the taxpayer anticipates it will suffer later in the period.

However, HMRC’s guidance states that “it will be extremely difficult for a company to provide adequate evidence [to support such a claim for prepayment]. Even a drastic downturn in a company’s trading environment may reverse in the later part of the period, or its position could be mitigated by the recognition of an unexpected capital gain or revenue item. All claims for anticipated losses must be examined critically and in full. The evidence required to validate such a claim should be viewed strictly as there will often be considerable doubt about the company’s profit position in future months”. It is, therefore, recommended that companies keep a detailed record of the reasoning and assumptions behind any figures submitted (including, for example, board reports, any public statements and detailed management accounts).

***

For our client alerts on the legal and business implications of the COVID-19 coronavirus pandemic (including a high level summary of tax developments), please see here.

E.   Recent notable cases

I.   Fowler v. HMRC[10]

In Fowler, the Supreme Court examined the interaction between UK national law and the double tax treaty between the UK and South Africa. Specifically, the Supreme Court concluded that certain deeming provisions in UK domestic legislation, which recharacterised employment income as trading income, did not apply for the purposes of determining the allocation of taxing rights in respect of that income under the treaty. This was because the purpose of the deeming provisions was not to adjudicate between how the States regarded the interpretation of the treaty or to alter the meaning of its terms.

Fowler involved an analysis of where income earned by an individual should be taxed pursuant to the terms of a double tax treaty. The taxpayer was resident in South Africa for tax purposes, but worked as a professional diver in the waters off the UK. The relevant UK tax law included special deeming provisions, which provided that income earned by divers in the course of their employment was to be treated as trading income, rather than income from employment.[11]

The double taxation treaty between the UK and South Africa (the “Treaty”) provides for employment income to be taxed in the place where it is earned (i.e. here, in the UK) pursuant to article 14, but for the trading profits of individuals to be taxed only where they are resident under article 7. The taxpayer claimed that the income he earned from diving engagements was to be characterised as trading income for the purposes of the Treaty as well, and hence that the Treaty prevented HMRC from taxing the income.

The Supreme Court noted that (a) under article 3(2) of the Treaty, any terms which are not defined in the Treaty itself, are to be given the meaning which they have in the tax law of the state seeking to recover tax (i.e. the UK) (noting that there is no definition of employment in the Treaty) and (b) the relevant UK legislation provided for divers to be treated as if they were self-employed traders for income tax purposes.

Reversing the Court of Appeal’s decision, the Supreme Court held that the taxation of the taxpayer’s remuneration as trading income for UK income tax purposes did not affect its classification under the Treaty. The court concluded that nothing in the Treaty “requires articles 7 and 14 to be applied to the fictional, deemed world which may be created by UK income tax legislation. Rather they are to be applied to the real world, unless the effect of article 3(2) of the Treaty is that a deeming provision alters the meaning which relevant terms of the Treaty would otherwise have”. In this case, the relevant UK deeming provisions were of limited effect, and in their absence, there would be “no doubt that article 14, not article 7, would apply to [the taxpayer’s] diving activities, at least on the…assumption that he really was an employee.

This case highlights the potentially limited effect of domestic deeming provisions in an international context. Taxpayers who are taxed pursuant to deeming provisions and who are seeking to rely on double tax treaties will need to carefully analyse not only the terms of the relevant treaty, but also the intended ambit of the domestic deeming provisions, to determine whether the latter affects their position under the former.

II.   Investec Asset Finance Plc v. HMRC[12]

In Investec, the Court of Appeal found that capital contributions by taxpayers to leasing partnerships in which they held an interest were not deductible. This was because the contributions were made at least partly for the purposes of the leasing partnership’s trade, and accordingly not wholly and exclusively for taxpayers’ financial trades. The court also found that the “no double taxation principle” applied, so that profits of the trade which the taxpayers were deemed to carry on as partners in the leasing partnerships were not also brought into account as profits of their financial trades.

The two taxpayers in Investec each carried on a financial trade, which included investing in partnership interests. They invested in a number of partnerships (which were each carrying on a leasing trade) and shortly thereafter made capital contributions to the partnerships, to enable the partnerships to repay debt and purchase assets. The taxpayers intended to realise the value of partnerships’ businesses (and hence their investment) shortly after acquisition via the sale of the partnerships’ assets.

A partnership is not itself generally subject to UK corporation tax. Rather, its partners are treated as carrying on the same notional business as the partnership, and the profits of the partnership (calculated at partnership level) are attributed to its partners, in proportion to their partnership interests. Here, for example, the taxpayers were carrying on a financial trade, and a separate notional leasing trade.

Deductible expenses

Expenses can only be deducted in calculating the profits of a trade subject to UK corporation tax if they are incurred wholly and exclusively for the purposes of that trade. Case law on the subject distinguishes, in particular, between expenses incurred for the purpose of benefitting the taxpayer, and expenses incurred for the purpose of benefitting the taxpayer’s trade (with only the latter being deductible). The expenditure can benefit the taxpayer and still be deductible, but that must not have been the taxpayer’s subjective purpose in making the outlay.

In Investec, the court acknowledged that the taxpayer’s ultimate objective in making the capital contributions was “to make some money quickly” (i.e. to realise profits in their financial trades). However, “this could best be achieved” via a structure pursuant to which the taxpayers acquired interests in the partnerships rather than direct interests in the assets purchased by the partnerships, which was “vital to the [taxpayer’s] tax planning…however uninterested the banking people at [the taxpayer] may have been in that aspect of the transactions”. The partnerships’ trades were separate from the taxpayers’ financial trades. Accordingly, the court agreed with the lower courts’ conclusion that “the capital contributions were made…at least partly for the purposes of [the partnerships’] businesses, which…[were] distinct from those carried on by [the taxpayers]. This was not an incidental consequence, it was central to the way in which the … transactions were carried out.

The case highlights that taxpayers making material payments which are intended to be deductible should actively consider and record the purposes for which the payment is being made. In particular, an ultimate purpose of (indirectly) benefitting the taxpayer’s trade may not be sufficient if there is a parallel, more immediate, purpose. Care should particularly be taken in group structures, where payments made by a taxpayer to benefit its wider group are unlikely to meet the “wholly and exclusively” threshold unless such benefit is merely an incidental consequence of the taxpayer’s purpose of benefiting its own trade.

No double taxation principle

As a matter of UK law, the income of a partnership belongs to the partners as it arises (in proportion to profit-sharing arrangements agreed between the partners). However, for tax purposes, this basic principle is somewhat complicated by the “notional trade” fiction. Case law has, accordingly, produced the so-called “no double taxation” principle, to prevent income being taxed twice as both (a) income of the partner’s notional trade and (b) income from its own (actual) trade.

In Investec, the principle was applied to prevent the leasing profits taxed as part of the taxpayers’ notional trades from also being taxed as profits of the taxpayers’ financial trades arising from the holding of partnerships interests. The court found that it did not need to reach judgment on whether (as HMRC contended) the conclusion depended on whether the receipts of the taxpayers’ financial trade (deriving from the partnerships’ leasing activities) were income or repayments of capital. For present purposes, it was sufficient that the relevant profits had already been taxed as part of its notional trade.

Nevertheless, (although precluded from raising the argument on procedural grounds) it is clear that HMRC considers both (i) the nature of receipts from partnership interests in the hands of the partner and (ii) the manner in which partnership interests are accounted for by the partner, to be material to the application of the “no double taxation” principle. Specifically, HMRC seems to consider that the principle should not apply where (despite there being no difference in economics) the receipts take a different form in the hands of the partnership and the partner (e.g. where receipts are income for the partnership, but capital for the partners, or vice versa).

Investec shows the practical difficulties arising from the “notional trade” fiction. Indeed the court went so far as to note that HMRC’s application of these provisions was “still, to put it kindly, a work in progress”. However, on a practical level, the case also appears to highlight that partnerships will be subject to the same stumbling blocks encountered by companies. This means that, for UK tax purposes, the income or capital nature of a receipt will often be (or at least be taken by HMRC to be) significant. Therefore, the form in which funds are extracted from investments may well materially influence the tax outcome.

III.   Centrica Overseas Holdings Ltd v. HMRC[13]

In Centrica, the First-tier Tribunal (“FTT”) found that advisers’ fees incurred by the taxpayer investment company in relation to a potential disposal of the assets of a subsidiary were not deductible expenses of management for the taxpayer, because the decision to make the disposal was taken by the taxpayer’s parent, rather than the taxpayer.

The taxpayer was an intermediate holding company in the group headed by Centrica plc (“Centrica”). Centrica made a strategic decision to sell the business of the taxpayer’s Dutch subsidiary, and incurred expenses of £3.8 million over the period 2009–2011 in relation to the sale. The expenditure was recharged to the taxpayer, who claimed that £2.5 million of it constituted expenses of management deductible from its profits for UK corporation tax purposes.

The FTT held that the expenditure did not qualify as expenses of management of the taxpayer’s investment business because the taxpayer did not itself carry out any of the management activities in relation to which it was incurred. This is because, based on the facts, it was Centrica that had made all of the decisions. The group’s legal, tax and M&A teams who worked on the sale did so to give effect to Centrica’s decision to sell the subsidiary’s businesses. To the extent that the taxpayer’s directors participated in managing the process, they did so in their group capacities as Head of Tax and General Counsel. There was no evidence to show that they had taken any relevant decisions in their capacity as directors of the taxpayer or that any of the advice the taxpayer had paid for was used by them (in their capacity as the taxpayer’s directors).

This case emphasises the difficulties that can arise where the operational structure of a group does not correspond precisely to the legal structure and – once again – highlights the importance of contemporaneous and accurate record keeping.

IV.   Cape Industrial Services Limited & Robert Wiseman and Sons Limited v. HMRC[14]

In Cape, the FTT relied on the Ramsay doctrine to defeat a “double-dip leasing scheme”, intended to enable a taxpayer to claim capital allowances in respect of amounts which were more than double its expenditure. In particular, the FTT emphasised that the doctrine continues to enable courts to apply legislation by reference to the composite effect of transactions, and to ignore legal steps which lack commercial purpose.

In Cape, the taxpayer sought to claim capital allowance in excess of its actual expenditure. This involved a scheme pursuant to which (i) the taxpayer sold plant and machinery at market value to a bank, (ii) the bank granted the taxpayer a long funding finance lease in respect of those assets and (iii) the taxpayer granted the bank a put option pursuant to which the taxpayer could be required to purchase the assets at their predicted market value on termination of the lease. Four weeks after the lease was entered into, it was terminated and the put option was exercised. The taxpayer claimed capital allowances in respect of both (i) its entry into the lease (which was cancelled out by the disposal proceeds from the sale to the bank) and (ii) its purchase of the assets pursuant to the put option (which was not offset by any disposal proceeds, as the lease was terminated for nil consideration).

The FTT decided that, on a composite approach, the scheme did not involve any real disposal or acquisition of the assets by the taxpayer. Accordingly, the taxpayer was not entitled to allowances in respect of the purchase of the assets under the put option. The transactions comprised a set of steps specifically designed to operate as a composite whole and to give rise to the legal effects that would (usually) attract allowances but which lacked any enduring commercial consequences. Although the taxpayer had given up ownership of the assets, with all of the legal and commercial effects that entailed, it did so only to generate the desired allowances and for the bare minimum of time considered necessary to achieve that result.

The scheme in this case is of mainly historical interest because legislation was introduced in 2011 to counteract it. However, the case has wider value because of the insightful analysis of the current state of the Ramsay principle of statutory interpretation.

V.   Vermilion Holdings Ltd v. HMRC[15]

In Vermilion Holdings, the Upper Tribunal (“UT”) found that in considering whether an option was granted to a director “by reason of employment” for the purposes of UK employment-related securities rules, it was not necessary that the employment was the sole (or dominant) reason for granting the option; it was sufficient that employment was a condition of the option being granted.

In Vermilion, an individual (“X”) provided consultancy services to Vermilion Holdings Ltd (“Vermilion”). Instead of paying fees for those services, Vermilion granted an option over its shares to X’s consultancy company in 2006 (the “2006 option”). Vermilion subsequently fell into financial distress and X was appointed as a director of Vermilion as part of a broader rescue funding proposal that included an injection of new capital. During the restructuring, the now valueless 2006 option was replaced with a new option in 2007, on amended terms including a precondition that X would be the option holder instead of X’s own consultancy company (the “2007 option”).

HMRC argued that the 2007 option was an employment-related securities option as it was granted by Vermilion as X’s employer (the holding of a directorship being treated as an employment under the relevant rules). The question at issue was whether the option to acquire the shares was made available “by reason of employment” and would be treated as an “employment-related securities option”.[16] If it was, the profit on exercise of the 2007 option would be chargeable to income tax and NICs. If not, the exercise would not be taxable, with only the gain on a subsequent disposal of the shares chargeable to capital gains tax.

The FTT had previously ruled that the 2007 option was not an employment related securities option, on the basis that (as a matter of fact) the share option was granted solely as a replacement to the 2006 option. The FTT acknowledged however that the option was “made available” by Vermilion, so that a particular provision, which deems an option granted to a person by a corporate employer to be made available by reason of employment,[17] was in point. Nevertheless, the FTT considered that the deeming provision led to an anomalous and unjust result, so its application should be limited in this instance.

The UT reversed this decision finding that the 2007 option was granted by reason of employment. It was held that the 2007 option had been granted to X both:

  • to replace the 2006 option (which could no longer continue in existing form); and
  • as part of a package of measures conditional on the employment of X.

In applying existing case law,[18] the UT held it was not necessary that the employment was the sole (or dominant) reason for granting the option; it was sufficient that employment was a condition of the option being granted. Consequently, the 2007 option was an employment-related securities option.

Although the background facts of the case are unique, the FTT had found, perhaps surprisingly, that the 2007 option was not granted by reason of employment. Despite not considering the FTT’s approach to limiting the scope of the above-mentioned deeming provision, the UT, in reversing that decision, provides clear insight and greater certainty for taxpayers in how these provisions operate.

VI.   Blackrock Investment Management (UK) Limited v. United Kingdom[19]

The ECJ Blackrock judgment will be of interest to fund managers managing a mixture of special investment funds and other funds, as it confirmed that a single supply of management services to a fund manager (making such mixed supplies) will be subject to a single rate of VAT and will not benefit from the management exemption from VAT.

The ECJ judgment in Blackrock will be of relevance to fund managers providing mixed supplies when monitoring and planning their VAT position. The judgment confirmed the AG’s opinion (reported in our last Quarterly Client Alert) that a single supply of management services, provided by a third-party software platform for the benefit of a fund manager of both special investment funds (“SIFs”) and non-SIFs, cannot fall within the management exemption from VAT. The entire supply was subject to standard rate VAT in this case.

To briefly recap the facts of this case: the taxpayer (“Blackrock”) provided investment advisory services to both SIFs and non-SIFs. There is a specific VAT exemption for the management of SIFs whilst the management of non-SIFs is subject to standard rate VAT. A related US entity (“Blackrock US”) provided investment management services to Blackrock in the form of an AI platform known as “Aladdin”. As Blackrock US is not established in the UK, Blackrock had to account for VAT under the reverse charge mechanism. In doing so, Blackrock considered that the Aladdin services it used for the management of SIFs should be exempt from VAT under the fund management exemption. Blackrock therefore accounted only for the tax on services used in its management of non-SIFs, apportioning the value of those services in accordance with the value of the non-SIFs under management.

The ECJ ruled that the approach taken by Blackrock was incorrect on the basis that a uniform VAT rate applied to the Aladdin services. All parties agreed that the Aladdin services constituted a single supply and the ECJ considered that this supply could not be bifurcated.

The decision highlights three key points:

1. There are limited circumstances in which a single supply of services may be viewed as distinct and separate services. The Aladdin services comprised of multiple elements which were found to be equally necessary to allow investment transactions to be made under good conditions. These elements were so closely linked that they formed, objectively, a single indivisible economic supply and so they could not be artificially separated. Consequently, the Aladdin services could not be regarded as specifically for the management of SIFs.
2. The fact that Blackrock predominantly made VAT-able supplies to non-SIFs was not a determinative factor for identifying the applicable VAT rate. Had Blackrock predominantly made VAT exempt supplies to SIFs, for example, that would not have rendered the Aladdin services exempt from VAT.
3. The management exemption from VAT cannot be applied by apportioning consideration for a single supply of services which are used for different purposes. The exemption is defined by the nature of the services provided and not with respect to the person supplying or receiving the services.

The consequences for taxpayers will vary depending on their VAT position and the arrangements that they have in place with third party suppliers. The decision will be of particular interest to fund managers providing mixed supplies and receiving supplies used in the management of a variety of fund types. Practically, fund managers should consider if, from a VAT perspective, their third party supplier arrangements are accurately reflected in contractual arrangements. Any contractual separation that is not artificial could avoid inadvertently missing out on the management exemption.

VII.   HMRC v. Wellcome Trust Ltd (Case C-459/19)

The Advocate General in HMRC v Wellcome Trust has opined that services provided to a UK taxable person for the purposes of its non-economic activity were, for VAT purposes, provided in the place where the recipient belonged.

In HMRC v Wellcome Trust, the taxpayer was a legal company which was the trustee of a charitable trust. The trust (acting through the taxpayer) predominantly earned income from the holding of investments, but also made a small number of taxable supplies, which required the taxpayer (in its capacity as trustee) to be registered for VAT purposes. The AG was asked to consider the place of supply of investment management services procured by the taxpayer from investment managers based outside the EU in respect of the above-mentioned investments.

The taxpayer’s argument was a technical one, based on the wording of  Directive 2006/112/EC (the “VAT Directive”).

The Directive provides that VAT applies to “the supply of services for consideration within [an EU member state] by a taxable person acting as such”. A “taxable person” is, broadly, a person carrying on an economic activity. Although the taxpayer was (as a result of the few taxable supplies it made) a taxable person, the ECJ had previously specifically ruled that the taxpayer’s activity in holding investments was not an economic activity[20].

Generally, (subject to exceptions for specific supplies), the place of supply for a supply of services to:

  • a “taxable person acting as such” is the place where the recipient is established; and
  • a “non-taxable person” is the place where the supplier is established.

The Directive, however, also includes a deeming rule, which specifies that ‘[f]or the purpose of applying the rules concerning the place of supply of services (a) a taxable person who also carries out activities or transactions that are not considered to be taxable supplies….shall be regarded as a taxable person in respect of all services rendered to him and (b) a non-taxable legal person who is identified for VAT purposes shall be regarded as a taxable person”.

The taxpayer considered that, as the place of supply rule for supplies for taxable persons referred to a supply to the taxpayer “acting as such”, regard must be had to whether the taxpayer received the supply in its capacity as a taxable person or a non-taxable person (i.e. whether the supply received would be used in making taxable or non-taxable supplies). The above mentioned deeming provision did not deem a taxpayer carrying on mixed activities to always be “a taxpayer acting as a taxable person”, and so did not override this requirement.

The Advocate General (“AG”) disagreed, considering that the words “acting as such” could not be considered in isolation from the purpose of the place of supply rules. Ignoring express deviations, the rules were intended to set out exhaustive rules for determining the place of supply for supplies to a taxable person (except those intended for private use). The fact that the taxpayer was a non-taxable person in relation to supplies it made did not mean that, for this purpose, it was not a taxable person in relation to supplies it received. The reverse charge mechanism did, therefore, apply.

Looking at the wording of the place of supply rules in isolation, it is possible to have some sympathy with the taxpayer’s argument. However, the case highlights that purposive interpretation has as important a role to play in a VAT context as any other – particularly in the application and meaning of key legislation such as the VAT Directive. Ironically, it is VAT’s formulaic order which necessitates recourse to a purposive interpretation: in considering whether VAT applies to a supply, one of the first steps a taxpayer must take is to determine (by reference to the self-contained place of supply rules) where the supply is made.  To adopt the taxpayer’s argument would have undermined this process, by drawing a category of supplies outside the scope of VAT without even needing to consider where the supplies have been made.

VIII.   Sonaecom SGPS SA v. Autoridade Tributária e Aduaneira[21]

The AG in Sonaecom opined that the actual, rather than the intended, use of taxable supplies is determinative when considering whether input VAT is deductible.

The case concerned a holding company, Sonaecom SGPS SA (“Sonaecom”), that both passively held shares in certain companies and supplied taxable services to other companies, i.e. a “mixed holding company”. Sonaecom intended to acquire shares in a telecommunications provider and it incurred output VAT in relation to the proposed acquisition, namely (a) consultancy services in respect of a market study and (b) commission paid to an investment bank in respect of the issuance of bonds.

Sonaecom asserted that it planned to use the capital obtained from the bond issuance to acquire the target shares and following acquisition, to provide taxable technical support and management services to the target. However, the acquisition failed to materialise, and Sonaecom used the funds from the bond issuance to make a loan to the parent company of its group. The funds were subsequently repaid by the parent, and used by Sonaecom to purchase shares in other companies.

Generally, for a taxpayer to obtain full input VAT recovery in respect of costs it incurs, the costs must be directly attributable to the provision of taxable supplies by the taxpayer. In the case of a mixed holding company, a partial deduction may be available if the costs are not directly linked to the provision of services by the taxpayer, and are instead a part of its general overheads.

The question at issue here was whether the deductibility rules in the Sixth VAT Directive[22] permitted Sonaecom to deduct VAT paid in respect of the consultancy and bond placement services on the basis of the use to which the taxpayer intended (at the time of receipt) to put the supplies received (i.e. the provision of the taxable services to the target), rather than the subsequent actual use (i.e. the exempt supply of the loan to the parent). As regards the bond expenses, in the alternative, Sonaecom argued that the expenses were part of its general overheads and that the funds from the issuance had merely been “parked” with the parent, before being returned to enable Sonaecom to continue with its general activities.

Following previous judgments of the ECJ[23], the AG opined that (a) Sonaecom had the right to full input VAT deduction in respect of expenditure incurred for the acquisition of shares in a company to which it intended to supply taxable services and (b) that this right to deduct persists, even if the acquisition does not ultimately happen.

However, crucially, the AG also opined that, where the taxpayer’s intended use is superseded by a different actual use within the relevant tax period, the latter takes priority. There was a direct and immediate link between the bond expenses (the input transaction) and the exempt loan to the parent (the output transaction). The latter precluded Sonaecom from making an input VAT deduction in respect of the bond expenses incurred on the basis of the aborted intended use. Moreover, expenses can only be considered part of general overheads in the absence of a direct and immediate link with any supply; here, there was a direct and immediate link to the exempt supply of the loan.

The case illustrates that where costs are incurred for the purposes of making taxable supplies which do not materialise, taxable persons who want to maintain their right to deduct input VAT should carefully consider the VAT impact of any subsequent use to which the funds are put. A subsequent exempt output transaction (even if only intended to be temporary) may eliminate their right to deduct VAT.


  [3]See link here.

  [4]  Taxes (Base Erosion and Profit Shifting) (Country-by-Country Reporting) Regulations 2016

  [5] As to which, see the letter of 9 April from the Chancellor to the Chair of the Treasury Committee.

  [6] OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017, OECD

Publishing, Paris at paragraph 3.47

  [7] Ibid, at paragraph 1.129

  [8]  Gordon & Blair Ltd v IR Commrs (1962) 40 TC 358

  [9]  Kirk & Randall Ltd v Dunn (1924) 8 TC 663

[10]  Fowler v HMRC [2020] UKSC 22

[11] Specifically, section 6(5) ITEPA provides that “employment income is not charged to tax [as employment income] if it is within the charge to tax under Part 2 of the Income Tax (Trading and Other Income) Act 2005 (trading income) by virtue of section 15 of that Act (divers and diving supervisors)”. Section 15(2) provides that “the performance of the duties of employment is instead treated for income tax purposes as the carrying on of a trade in the United Kingdom”.

[12]  Investec Asset Finance Plc and another v HMRC [2020] EWCA Civ 579

[13]  Centrica Overseas Holdings Ltd v HMRC [2020] UKFTT 197 (TC)

[14]  Cape Industrial Services Limited & Robert Wiseman and Sons Limited v HMRC TC/2015/01817 TC/2015/01791

[15]  Vermilion Holdings Ltd v HMRC [2020] UKUT 162 (TCC)

[16]  Under section 471 ITEPA 2003

[17]  Under in section 471(3) ITEPA 2003

 [18]   Wicks v Firth 56 TC 318

[19]  Blackrock Investment Management (UK) Ltd v United Kingdom (C-231/19)

[20]  Wellcome Trust (C‑155/94)

[21]  Sonaecom SGPS SA v Autoridade Tributária e Aduaneira (Case C-42/19) EU:C:2020:378 (14 May 2020) (Advocate General Kokott).

[22]  Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonization of the laws of the Member States relating to turnover taxes. Specifically Articles 4(1) and (2) and 17(1), (2) and (5) of the Sixth VAT Directive were at issue.

[23]  Cibo Participations SA (Case C-16/00), Floridienne (Case C-142/99) and Ryanair (C-249/17).


Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax Practice Group or the authors:

Sandy Bhogal – London (+44 (0)20 7071 4266, sbhogal@gibsondunn.com) Benjamin Fryer – London (+44 (0)20 7071 4232, bfryer@gibsondunn.com) Panayiota Burquier – London (+44 (0)20 7071 4259, pburquier@gibsondunn.com) Bridget English – London (+44 (0)20 7071 4228, benglish@gibsondunn.com) Fareed Muhammed – London (+44(0)20 7071 4230, fmuhammed@gibsondunn.com) Barbara Onuonga – London (+44 (0)20 7071 4139,bonuonga@gibsondunn.com) Aoibhin O' Hare – London (+44 (0)20 7071 4170, aohare@gibsondunn.com) © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 26, 2020 |
Best Lawyers in Germany 2021 Recognizes 19 Gibson Dunn Attorneys

Best Lawyers in Germany 2021 has recognized 19 Gibson Dunn attorneys as leading lawyers in their respective practice areas. Frankfurt attorneys recognized include: Alexander Klein – Banking and Finance Law; Jens-Olrik Murach – Competition/Antitrust Law, and Litigation; Dirk Oberbracht – Corporate Law, Mergers and Acquisitions Law, and Private Equity Law; Wilhelm Reinhardt – Corporate Law, and Mergers and Acquisitions Law; Sebastian Schoon – Banking and Finance Law; and Finn Zeidler – Arbitration and Mediation, Criminal Defense, and Litigation. Munich attorneys recognized include: Silke Beiter – Corporate Governance and Compliance Practice; Peter Decker – Banking & Finance, Private Equity Law, and Real Estate Law; Lutz Englisch – Corporate Governance and Compliance Practice, Corporate Law, Mergers and Acquisitions Law, and Private Equity Law; Ralf van Ermingen-Marbach – Criminal Tax Practice; Birgit Friedl – Restructuring and Insolvency Law; Ferdinand Fromholzer – Corporate Law, Mergers and Acquisitions Law, and Private Equity Law; Kai Gesing – Litigation; Markus Nauheim – Arbitration and Mediation, Corporate Law, Litigation, and Mergers and Acquisitions Law; Markus Rieder – Arbitration and Mediation, Corporate Governance and Compliance Practice, International Arbitration, and Litigation; Hans Martin Schmid – Real Estate Law; Benno Schwarz – Corporate Governance and Compliance Practice, Corporate Law, Criminal Defense, and Mergers and Acquisitions Law; Michael Walther – Competition/Antitrust Law; and Mark Zimmer – Corporate Governance and Compliance Practice, Criminal Defense, Labor and Employment, and Litigation. The list was published on June 26, 2020.

June 25, 2020 |
Best Lawyers in France 2021 Recognizes 17 Gibson Dunn Attorneys

Best Lawyers in France 2021 recognized 17 Gibson Dunn attorneys and named Gibson Dunn the Insolvency and Reorganization Law “Law Firm of the Year.” The partners highlighted, with their respective practice areas, include: Nicolas Autet – Public Law, and Regulatory Practice; Ahmed Baladi – Information Technology Law, Intellectual Property Law, Privacy and Data Security Law, Technology Law, and Telecommunications Law; Nicolas Baverez – Administrative Law, Public Law, and Regulatory Practice; Maïwenn Béas – Administrative Law, and Public Law; Amanda Bevan-de Bernède – Banking and Finance Law, and Investment; Eric Bouffard – International Arbitration; Bertrand Delaunay – Mergers and Acquisitions Law, and Private Equity Law; Jérôme Delaurière – Tax Law; Jean-Pierre Farges – Arbitration and Mediation, Banking and Finance Law, Insolvency and Reorganization Law, and Litigation; Pierre-Emmanuel Fender – Insolvency and Reorganization Law, and Litigation; Benoît Fleury – Corporate Law, and Insolvency and Reorganization Law; Bernard Grinspan – Corporate Law, and Information Technology Law; Ariel Harroch – Corporate Law, Mergers and Acquisitions Law, Private Equity Law, and Tax Law; Patrick Ledoux – Corporate Law; Vera Lukic – Information Technology Law, Privacy and Data Security Law, and Technology Law; Judith Raoul-Bardy – Corporate Law; and Jean-Philippe Robé – Banking and Finance Law, and Corporate Law. The list was published on June 25, 2020.