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March 4, 2019 |
Supreme Court Holds That Payments For Lost Wages Are Taxable “Compensation” Under The Railroad Retirement Tax Act

Click for PDF Decided March 4, 2019 BNSF Railway Co. v. Loos, No. 17-1042 Today, the Supreme Court held 7-2 that payments for lost wages due to on-the-job injuries are a form of taxable “compensation” under the Railroad Retirement Tax Act (“RRTA”). Background: A railroad employee sued the railroad for work-related injuries and won a jury award that included $30,000 for lost wages.  The railroad moved to withhold from that amount $3,765 to cover the employee’s share of taxes under the RRTA, which taxes railroad employee “compensation” in order to fund retirement benefits for railroad employees.  26 U.S.C. § 3231(e)(1).  The district court denied the railroad’s motion and the Eighth Circuit affirmed, reasoning that an award for lost wages does not qualify as taxable “compensation” under the statute because “compensation” means “any form of money remuneration paid . . . for services rendered,” id., which does not include payments for services the employee would have rendered but for the injury. Issue:  Whether payments to railroad employees for lost wages due to on-the-job injuries are taxable “compensation” under the RRTA. Court’s Holding: Yes.  The term “compensation” under the RRTA includes not only payments for active service, but also payments for a period of absence from active service that stems from the “employer-employee relationship.”  Social Sec. Bd. v. Nierotko, 327 U.S. 358, 366 (1946). “[W]e hold that ‘compensation’ for RRTA purposes includes an employer’s payments to an employee for active service and for periods of absence from active service. It is immaterial whether the employer chooses to make the payment or is legally required to do so.” Justice Ginsburg, writing for the majority What It Means: The Court’s decision allows railroads to withhold RRTA taxes from payments they make to injured employees for lost wages. As a result of this required withholding of taxes, injured railroad employees will not receive more money from payments for lost wages than they would have received from payments for actual services rendered. The Court harmonized two statutes governing railroad employee retirement benefits:  (1) the Railroad Retirement Act, which determines benefits payable to railroad employees; and (2) the RRTA, which taxes employee “compensation” to pay for those benefits.  The Railroad Retirement Act defines “compensation” to include payment “for time lost as an employee,” 45 U.S.C. § 231(h)(1), and that same term in the RRTA now also encompass lost wages. The decision is the second time in the last two Terms that the Court construed the RRTA.  In Wisconsin Central Ltd. v. United States, 585 U.S. __ (2018), Gibson Dunn successfully argued that stock options were not “compensation” under the RRTA because they are not “money remuneration” within the meaning of the statute. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding developments at the Supreme Court.  Please feel free to contact the following practice leaders: Appellate and Constitutional Law Practice Caitlin J. Halligan +1 212.351.3909 challigan@gibsondunn.com Mark A. Perry +1 202.887.3667 mperry@gibsondunn.com Related Practice: Tax Benjamin H. Rippeon +1 202.955.8265 brippeon@gibsondunn.com

January 28, 2019 |
Staking Out New Territory: Taxation of Proof-of-Stake Protocols

New York associate Brian Hamano is the author of “Staking Out New Territory: Taxation of Proof-of-Stake Protocols” [PDF] published by Tax Notes on the January 28, 2019.

January 11, 2019 |
2018 Year-End German Law Update

Click for PDF Looking back at the past year’s cacophony of voices in a world trying to negotiate a new balance of powers, it appeared that Germany was disturbingly silent, on both the global and European stage. Instead of helping shape the new global agenda that is in the making, German politics focused on sorting out the vacuum created by a Federal election result which left no clear winner other than a newly formed right wing nationalist populist party mostly comprised of so called Wutbürger (the new prong for “citizens in anger”) that managed to attract 12.6 % of the vote to become the third strongest party in the German Federal Parliament. The relaunching of the Grand-Coalition in March after months of agonizing coalition talks was followed by a bumpy start leading into another session of federal state elections in Bavaria and Hesse that created more distraction. When normal business was finally resumed in November, a year had passed by with few meaningful initiatives formed or significant business accomplished. In short, while the world was spinning, Germany allowed itself a year’s time-out from international affairs. The result is reflected in this year’s update, where the most meaningful legal developments were either triggered by European initiatives, such as the General Data Protection Regulation (“GDPR”) (see below section 4.1) or the New Transparency Rules for Listed German Companies (see below section 1.2), or as a result of landmark rulings of German or international higher and supreme courts (see below Corporate M&A sections 1.1 and 1.4; Tax – sections 2.1 and 2.2 and Labor and Employment – section 4.2). In fairness, shortly before the winter break at least a few other legal statutes have been rushed through parliament that are also covered by this update. Of the changes that are likely to have the most profound impact on the corporate world, as well as on the individual lives of the currently more than 500 million inhabitants of the EU-28, the GDPR, in our view, walks away with the first prize. The GDPR has created a unified legal system with bold concepts and strong mechanisms to protect individual rights to one’s personal data, combined with hefty fines in case of the violation of its rules. As such, the GDPR stands out as a glowing example for the EU’s aspiration to protect the civic rights of its citizens, but also has the potential to create a major exposure for EU-based companies processing and handling data globally, as well as for non EU-based companies doing business in Europe. On a more strategic scale, the GDPR also creates a challenge for Europe in the global race for supremacy in a AI-driven world fueled by unrestricted access to data – the gold of the digital age. The German government could not resist infection with the virus called protectionism, this time around coming in the form of greater scrutiny imposed on foreign direct investments into German companies being considered as “strategic” or “sensitive” (see below section 1.3 – Germany Tightens Rules on Foreign Takeovers Even Further). Protecting sensitive industries from “unwanted” foreign investors, at first glance, sounds like a laudable cause. However, for a country like Germany that derives most of its wealth and success from exporting its ideas, products and services, a more liberal approach to foreign investments would seem to be more appropriate, and it remains to be seen how the new rules will be enforced in practice going forward. The remarkable success of the German economy over the last twenty five years had its foundation in the abandoning of protectionism, the creation of an almost global market place for German products, and an increasing global adoption of the rule of law. All these building blocks of the recent German economic success have been under severe attack in the last year. This is definitely not the time for Germany to let another year go by idly. We use this opportunity to thank you for your trust and confidence in our ability to support you in your most complicated and important business decisions and to help you form your views and strategies to deal with sophisticated German legal issues. Without our daily interaction with your real-world questions and tasks, our expertise would be missing the focus and color to draw an accurate picture of the multifaceted world we are living in. In this respect, we thank you for making us better lawyers – every day. ________________________ TABLE OF CONTENTS 1.      Corporate, M&A 2.      Tax 3.      Financing and Restructuring 4.      Labor and Employment 5.      Real Estate 6.      Compliance 7.      Antitrust and Merger Control 8.      Litigation 9.      IP & Technology 10.    International Trade, Sanctions and Export Controls ________________________ 1.       Corporate, M&A 1.1       Further Development regarding D&O Liability of the Supervisory Board in a German Stock Corporation In its famous “ARAG/Garmenbeck”-decision in 1997, the German Federal Supreme Court (Bundesgerichtshof – BGH) first established the obligation of the supervisory board of a German Stock Corporation (Aktiengesellschaft) to pursue the company’s D&O liability claims in the name of the company against its own management board after having examined the existence and enforceability of such claims. Given the very limited discretion the court has granted to the supervisory board not to bring such a claim and the supervisory board’s own liability arising from inactivity, the number of claims brought by companies against their (former) management board members has risen significantly since this decision. In its recent decision dated September 18, 2018, the BGH ruled on the related follow-up question about when the statute of limitations should start to run with respect to compensation claims brought by the company against a supervisory board member who has failed to pursue the company’s D&O liability claims against the board of management within the statutory limitation period. The BGH clarified that the statute of limitation applicable to the company’s compensation claims against the inactive supervisory board member (namely ten years in case of a publicly listed company, otherwise five years) should not begin to run until the company’s compensation claims against the management board member have become time-barred themselves. With that decision, the court adopts the view that in cases of inactivity, the period of limitations should not start to run until the last chance for the filing of an underlying claim has passed. In addition, the BGH in its decision confirmed the supervisory board’s obligation to also pursue the company’s claims against the board of management in cases where the management board member’s misconduct is linked to the supervisory board’s own misconduct (e.g. through a violation of supervisory duties). Even in cases where the pursuit of claims against the board of management would force the supervisory board to disclose its own misconduct, such “self-incrimination” does not release the supervisory board from its duty to pursue the claims given the preponderance of the company’s interests in an effective supervisory board, the court reasoned. In practice, the recent decision will result in a significant extension of the D&O liability of supervisory board members. Against that backdrop, supervisory board members are well advised to examine the existence of the company’s compensation claims against the board of management in a timely fashion and to pursue the filing of such claims, if any, as soon as possible. If the board of management’s misconduct is linked to parallel misconduct of the supervisory board itself, the relevant supervisory board member – if not exceptionally released from pursuing such claim and depending on the relevant facts and circumstances – often finds her- or himself in a conflict of interest arising from such self-incrimination in connection with the pursuit of the claims. In such a situation, the supervisory board member might consider resigning from office in order to avoid a conflict of interest arising from such self-incrimination in connection with the pursuit of the claims. Back to Top 1.2       Upcoming New Transparency Rules for Listed German Companies as well as Institutional Investors, Asset Managers and Proxy Advisors In mid-October 2018, the German Federal Ministry of Justice finally presented the long-awaited draft for an act implementing the revised European Shareholders’ Rights Directive (Directive (EU) 2017/828). The Directive aims to encourage long-term shareholder engagement by facilitating the communication between shareholders and companies, in particular across borders, and will need to be implemented into German law by June 10, 2019 at the latest. The new rules primarily target listed German companies and provide some major changes with respect to the “say on pay” provisions, as well as additional approval and disclosure requirements for related party transactions, the transmission of information between a stock corporation and its shareholders and additional transparency and reporting requirements for institutional investors, asset managers and proxy advisors. “Say on pay” on directors’ remuneration: remuneration policy and remuneration report Under the current law, the shareholders determine the remuneration of the supervisory board members at a shareholder meeting, whereas the remuneration of the management board members is decided by the supervisory board. The law only provides for the possibility of an additional shareholder vote on the management board members’ remuneration if such vote is put on the agenda by the management and supervisory boards in their sole discretion. Even then, such vote has no legal effects whatsoever (“voluntary say on pay”). In the future, shareholders of German listed companies will have two options. First, the supervisory board will have to prepare a detailed remuneration policy for the management board, which must be submitted to the shareholders if there are major changes to the remuneration, and in any event at least once every four years (“mandatory say on pay”). That said, the result of the vote on the policy will continue to remain only advisory. However, if the supervisory board adopts a remuneration policy that has been rejected by the shareholders, it will then be required to submit a reviewed (not necessarily revised) remuneration policy to the shareholders at the next shareholders’ meeting. With respect to the remuneration of supervisory board members, the new rules require a shareholders vote at least once every four years. Second, at the annual shareholders’ meeting the shareholders will vote ex post on the remuneration report (which is also reviewed by the statutory auditor) which contains the remuneration granted to the present and former members of the management board and the supervisory board in the past financial year. Again, the shareholders’ vote, however, will only be advisory. Both the remuneration report including the audit report, as well as the remuneration policy will have to be made public on the company’s website for at least ten years. Related party transactions German stock corporation law already provides for various safeguard mechanisms to protect minority shareholders in cases of transactions with major shareholders or other related parties (e.g. the capital maintenance rules and the laws relating to groups of companies). In the future, in the case of listed companies, these mechanisms will be supplemented by a detailed set of approval and transparency requirements for transactions between the company and related parties. Material transactions exceeding certain thresholds will require prior supervisory board approval. A rejection by the supervisory board can be overcome by shareholder vote. Furthermore, a listed company must publicly disclose any such material related party transaction, without undue delay over media providing for a Europe-wide distribution. Identification of shareholders and facilitation of the exercise of shareholders’ rights Listed companies will have the right to request information on the identity of their shareholders, including the name and both a postal and electronic address, from depositary banks, thus allowing for a direct communication line, also with respect to bearer shares (“know-your-shareholder”). Furthermore, depositary banks and other intermediaries will be required to pass on important information from the company to the shareholders and vice versa, e.g. with respect to voting in shareholders’ meetings and the exercise of subscription rights. Where there is more than one intermediary in a chain, the intermediaries are required to pass on the respective information within the chain. In addition, companies will be required to confirm the votes cast at the request of the shareholders thus enabling them to be certain that their votes have been effectively cast, including in particular across borders. Transparency requirements for institutional investors, asset managers and proxy advisors German domestic institutional investors and asset managers with Germany as their home member state (as defined in the applicable sector-specific EU law) will be required (i) to disclose their engagement policy, including how they monitor, influence and communicate with the investee companies, exercise shareholders’ rights and manage actual and potential conflicts of interests, and (ii) to report annually on the implementation of their engagement policy and disclose how they have cast their votes in the general meetings of material investee companies. Institutional investors will further have to disclose (iii) consistency between the key elements of their investment strategy with the profile and duration of their liabilities and how they contribute to the medium to long-term performance of their assets, and, (iv) if asset managers are involved, to disclose the main aspects of their arrangement with the asset manager. The new disclosure and reporting requirements, however, only apply on a “comply or explain” basis. Thus, investors and asset managers may choose not to make the above disclosures, provided they give an explanation as to why this is the case. Proxy advisors will have to publicly disclose on an annual basis (i) whether and how they have applied their code of conduct based again on the “comply or explain” principle, and (ii) information on the essential features, methodologies and models they apply, their main information sources, the qualification of their staff, their voting policies for the different markets they operate in, their interaction with the companies and the stakeholders as well as how they manage conflicts of interests. These rules, however, do not apply to proxy advisors operating from a non-EEA state with no establishment in Germany. The present legislative draft is still under discussion and it is to be expected that there will still be some changes with respect to details before the act becomes effective in mid-2019. Due to transitional provisions, the new rules on “say on pay” will have no effect for the majority of listed companies in this year’s meeting season. Whether the new rules will actually promote a long-term engagement of shareholders and have the desired effect on the directors’ remuneration of listed companies will have to be seen. In any event, both listed companies as well as the other addressees of the new transparency rules should make sure that they are prepared for the new reporting and disclosure requirements. Back to Top 1.3       Germany Tightens Rules on Foreign Takeovers Even Further After the German government had imposed stricter rules on foreign direct investment in 2017 (see 2017 Year-End German Law Update under 1.5), it has now even further tightened its rules with respect to takeovers of German companies by foreign investors. The latest amendment of the rules under the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung, “AWV“) enacted in 2018 was triggered, among other things, by the German government’s first-ever veto in August 2018 regarding the proposed acquisition of Leifeld Metal Spinning, a German manufacturer of metal forming machines used in the automotive, aerospace and nuclear industries, by Yantai Taihai Corporation, a privately-owned industry group from China, on the grounds of national security. Ultimately, Yantai withdrew its bid shortly after the German government had signaled that it would block the takeover. On December 29, 2018, the latest amendment of the Foreign Trade and Payments Ordinance came into force. The new rules provide for greater scrutiny of foreign direct investments by lowering the threshold for review of takeovers of German companies by foreign investors from the acquisition of 25% of the voting rights down to 10% in circumstances where the target operates a critical infrastructure or in sensitive security areas (defense and IT security industry). In addition, the amendment also expands the scope of the Foreign Trade and Payments Ordinance to also apply to certain media companies that contribute to shaping the public opinion by way of broadcasting, teleservices or printed materials and stand out due to their special relevance and broad impact. While the lowering of the review threshold as such will lead to an expansion of the existing reporting requirements, the broader scope is also aimed at preventing German mass media from being manipulated with disinformation by foreign investors or governments. There are no specific guidelines published by the German government as it wants the relevant parties to contact, and enter into a dialog with, the authorities about these matters. While the German government used to be rather liberal when it came to foreign investments in the past, the recent veto in the case of Leifeld as well as the new rules show that in certain circumstances, it will become more cumbersome for dealmakers to get a deal done. Finally, it is likely that the rules on foreign investment control will be tightened even further going forward in light of the contemplated EU legislative framework for screening foreign direct investment on a pan-European level. Back to Top 1.4       US Landmark Decision on MAE Clauses – Consequences for German M&A Deals Fresenius wrote legal history in the US with potential consequences also for German M&A deals in which “material adverse effect” (MAE) clauses are used. In December 2018, for the first time ever, the Supreme Court of Delaware allowed a purchaser to invoke the occurrence of an MAE and to terminate the affected merger agreement. The agreement included an MAE clause, which allocated certain business risks concerning the target (Akorn) for the time period between signing and closing to Akorn. Against the resistance of Akorn, Fresenius terminated the merger agreement based on the alleged MAE, arguing that the target’s EBITDA declined by 86%. The decision includes a very detailed analysis of an MAE clause by the Delaware courts and reaffirms that under Delaware law there is a very high bar to establishing an MAE. Such bar is based both on quantitative and qualitative parameters. The effects of any material adverse event need to be substantial as well as lasting. In most German deals, the parties agree to arbitrate. For this reason, there have been no German court rulings published on MAE clauses so far. Hence, all parties to an M&A deal face uncertainty about how German courts or arbitration tribunals would define “materiality” in the context of an MAE clause. In potential M&A litigation, sellers may use this ruling to support the argument that the bar for the exercise of the MAE right is in fact very high in line with the Delaware standard. It remains to be seen whether German judges will adopt the Delaware decision to interpret MAE clauses in German deals. Purchasers, who seek more certainty, may consider defining materiality in the MAE clause more concretely (e.g., by reference to the estimated impact of the event on the EBITDA of the company or any other financial parameter). Back to Top 1.5       Equivalence of Swiss Notarizations? The question whether the notarization of various German corporate matters may only be validly performed by German notaries or whether some or all of these measures may also be notarized validly by Swiss notaries has long since been the topic of legal debate. Since the last major reform of the German Limited Liability Companies Act (Gesetz betreffend Gesellschaften mit beschränkter Haftung – GmbHG) in 2008 the number of Swiss notarizations of German corporate measures has significantly decreased. A number of the newly introduced changes and provisions seemed to cast doubt on the equivalence and capacity of Swiss notaries to validly perform the duties of a German notary public who are not legally bound by the mandatory, non-negotiable German fee regime on notarial fees. As a consequence and a matter of prudence, German companies mostly stopped using Swiss notaries despite the potential for freely negotiated fee arrangements and the resulting significant costs savings in particular in high value matters. However, since 2008 there has been an increasing number of test cases that reach the higher German courts in which the permissibility of a Swiss notarization is the decisive issue. While the German Federal Supreme Court (Bundesgerichtshof – BGH) still has not had the opportunity to decide this question, in 2018 two such cases were decided by the Kammergericht (Higher District Court) in Berlin. In those cases, the court held that both the incorporation of a German limited liability company in the Swiss Canton of Berne (KG Berlin, 22 W 25/16 – January 24, 2018 = ZIP 2018, 323) and the notarization of a merger between two German GmbHs before a notary in the Swiss Canton of Basle (KG Berlin, 22 W 2/18 – July 26, 2018 = ZIP 2018, 1878) were valid notarizations under German law, because Swiss notaries were deemed to be generally equivalent to the qualifications and professional standards of German-based notaries. The reasons given in these decisions are reminiscent of the case law that existed prior to the 2008 corporate law reform and can be interpreted as indicative of a certain tendency by the courts to look favorably on Swiss notarizations as an alternative to German-based notarizations. Having said that and absent a determinative decision by the BGH, using German-based notaries remains the cautious default approach for German companies to take. This is definitely the case in any context where financing banks are involved (e.g. either where share pledges as loan security are concerned or in an acquisition financing context of GmbH share sales and transfers). On the other hand, in regions where such court precedents exist, the use of Swiss notaries for straightforward intercompany share transfers, mergers or conversions might be considered as an alternative on a case by case basis. Back to Top 1.6       Re-Enactment of the DCGK: Focus on Relevance, Function, Management Board’s Remuneration and Independence of Supervisory Board Members Sixteen years after it has first been enacted, the German Corporate Governance Code (Deutscher Corporate Governance Kodex, DCGK), which contains standards for good and responsible governance for German listed companies, is facing a major makeover. In November 2018, the competent German government commission published a first draft for a radically revised DCGK. While vast parts of the proposed changes are merely editorial and technical in nature, the draft contains a number of new recommendations, in particular with respect to the topics of management remuneration and independence of supervisory board members. With respect to the latter, the draft now provides a catalogue of criteria that shall act as guidance for the supervisory board as to when a shareholder representative shall no longer be regarded as independent. Furthermore, the draft also provides for more detailed specifications aiming for an increased transparency of the supervisory board’s work, including the recommendation to individually disclose the members’ attendance of meetings, and further tightens the recommendations regarding the maximum number of simultaneous mandates for supervisory board members. Moreover, in addition to the previous concept of “comply or explain”, the draft DCGK introduces a new “apply and explain” concept, recommending that listed companies also explain how they apply certain fundamental principles set forth in the DCGK as a new third category in addition to the previous two categories of recommendations and suggestions. The draft DCGK is currently under consultation and the interested public is invited to comment upon the proposed amendments until the end of January 2019. Since some of the proposed amendments provide for a rather fundamentally new approach to the current regime and would introduce additional administrative burdens, it remains to be seen whether all of the proposed amendments will actually come into force. According to the current plan, following a final consultancy of the Government Commission, the revised version of the DCGK shall be submitted for publication in April 2019 and would take effect shortly thereafter. Back to Top 2.         Tax On November 23, 2018, the German Federal Council (Bundesrat) approved the German Tax Reform Act 2018 (Jahressteuergesetz 2018, the “Act”), which had passed the German Federal Parliament (Bundestag) on November 8, 2018. Highlights of the Act are (i) the exemption of restructuring gains from German income tax, (ii) the partial abolition of and a restructuring exemption from the loss forfeiture rules in share transactions and (iii) the extension of the scope of taxation for non-German real estate investors investing in Germany. 2.1       Exemption of Restructuring Gains The Act puts an end to a long period of uncertainty – which has significantly impaired restructuring efforts – with respect to the tax implications resulting from debt waivers in restructuring scenarios (please see in this regard our 2017 Year-End German Law Update under 3.2). Under German tax law, the waiver of worthless creditor claims creates a balance sheet profit for the debtor in the amount of the nominal value of the payable. Such balance sheet profit is taxable and would – without any tax privileges for such profit – often outweigh the restructuring effect of the waiver. The Act now reinstates the tax exemption of debt waivers with retroactive effect for debt waivers after February 8, 2017; upon application debt waivers prior to February 8, 2017 can also be covered. Prior to this legislative change, a tax exemption of restructuring gains was based on a restructuring decree of the Federal Ministry of Finance, which has been applied by the tax authorities since 2003. In 2016, the German Federal Fiscal Court (Bundesfinanzgerichtshof) held that the restructuring decree by the Federal Ministry of Finance violates constitutional law since a tax exemption must be legislated by statute and cannot be based on an administrative decree. Legislation was then on hold pending confirmation from the EU Commission that a legislative tax exemption does not constitute illegal state aid under EU law. The EU Commission finally gave such confirmation by way of a comfort letter in August 2018. The Act is largely based on the conditions imposed by a restructuring decree issued by the Federal Ministry of Finance on the tax exemption of a restructuring gain. Under the Act, gains at the level of the debtor resulting from a full or partial debt relief are exempt from German income tax if the relief is granted to recapitalize and restructure an ailing business. The tax exemption only applies if at the time of the debt waiver (i) the business is in need of restructuring and (ii) capable of being restructured, (iii) the waiver results in a going-concern of the restructured business and (iv) the creditor waives the debt with the intention to restructure the business. The rules apply to German corporate income and trade tax and benefit individuals, partnerships and corporations alike. Any gains from the relief must first be reduced by all existing loss-offsetting potentials before the taxpayer can benefit from tax exemptions on restructuring measures. Back to Top 2.2       Partial Abolition of Loss Forfeiture Rules/Restructuring Exception Under the current Loss Forfeiture Rules, losses of a German corporation will be forfeited on a pro rata basis if within a period of five years more than 25% but not more than 50% of the shares in the German loss-making corporation are transferred (directly or indirectly) to a new shareholder or group of shareholders with aligned interests. If more than 50% are transferred, losses will be forfeited in total. There are exceptions to this rule for certain intragroup restructurings, built-in gains and business continuations, especially in the venture capital industry. On March 29, 2017, the German Federal Constitutional Court (Bundesverfassungsgericht – BVerfG) ruled that the pro rata forfeiture of losses (a share transfer of more than 25% but not more than 50%) is incompatible with the constitution. The court has asked the German legislator to amend the Loss Forfeiture Rules retroactively for the period from January 1, 2008 until December 31, 2015 to bring them in line with the constitution. Somewhat surprisingly, the legislator has now decided to fully cancel the pro rata forfeiture of losses with retroactive effect and with no reference to a specific tax period. Currently pending before the German Federal Constitutional Court is the question whether the full forfeiture of losses is constitutional. A decision by the Federal Constitutional Court is expected for early 2019, which may then result in another legislative amendment of the Loss Forfeiture Rules. The Act has also reinstated a restructuring exception from the forfeiture rules – if the share transfer occurs in order to restructure the business of an ailing corporation. Similar to the exemption of restructuring gains, this legislation was on hold until the ECJ’s decision (European Court of Justice) on June 28, 2018 that the restructuring exception does not violate EU law. Existing losses will not cease to exist following a share transfer if the restructuring measures are appropriate to avoid or eliminate the illiquidity or the over-indebtedness of the corporation and to maintain its basic operational structure. The restructuring exception applies to share transfers after December 31, 2007. Back to Top 2.3       Investments in German Real Estate by Non-German Investors So far, capital gains from the disposal of shares in a non-German corporation holding German real estate were not subject to German tax. In a typical structure, in which German real estate is held via a Luxembourg or Dutch entity, a value appreciation in the asset could be realized by a share deal of the holding company without triggering German income taxes. Under the Act, the sale of shares in a non-German corporation is now taxable if, at some point within a period of one year prior to the sale of shares, 50 percent of the book value of the assets of the company consisted of German real estate and the seller held at least 1 percent of the shares within the last five years prior to the sale. The Act is now in line with many double tax treaties concluded by Germany, which allow Germany to tax capital gains in these cases. The new law applies for share transfers after December 31, 2018. Capital gains are only subject to German tax to the extent the value has been increased after December 31, 2018. Until 2018, a change in the value of assets and liabilities, which are economically connected to German real estate, was not subject to German tax. Therefore, for example, profits from a waiver of debt that was used to finance German real estate was not taxable in Germany whereas the interest paid on the debt was deductible for German tax purposes. That law has now changed and allows Germany to tax such profit from a debt waiver if the loan was used to finance German real estate. However, only the change in value that occurred after December 31, 2018 is taxable. Back to Top 3.         Financing and Restructuring – Test for Liquidity Status Tightened On December 19, 2017, the German Federal Supreme Court (Bundesgerichtshof – BGH) handed down an important ruling which clarifies the debt and payable items that should be taken into account when determining the “liquidity” status of companies. According to the Court, the liquidity test now requires managing directors and (executive) board members to determine whether a liquidity gap exceeding 10% can be overcome by incoming liquidity within a period of three weeks taking into account all payables which will become due in those three weeks. Prior to the ruling, managing directors had often argued successfully that only those payables that were due at the time when the test is applied needed be taken into account while expected incoming payments within a three week term could be considered. This mismatch in favor of the managing directors has now been rectified by the Court to the disadvantage of the managing directors. If, for example, on June 1 the company liquidity status shows due payables amounting to EUR 100 and plausible incoming receivables in the three weeks thereafter amounting to EUR 101, no illiquidity existed under the old test. Under the new test confirmed by the Court, payables of EUR 50 becoming due in the three week period now also have to be taken into account and the company would be considered illiquid. For companies and their managing directors following a cautious approach, the implications of this ruling are minor. Going forward, however, even those willing to take higher risks will need to follow the court determined principles. Otherwise, delayed insolvency filings could ensue. This not only involves a managing directors and executive board members’ personal liability for payments made on behalf of the company while illiquid but also potential criminal liability for a delayed insolvency filing. Managing directors are thus well advised to properly undertake and also document the required test in order to avoid liability issues. Back to Top 4.         Labor and Employment 4.1       GDPR Has Tightened Workplace Privacy Rules The EU General Data Protection Regulation (“GDPR”) started to apply on May 25, 2018. It has introduced a number of stricter rules for EU countries with regard to data protection which also apply to employee personal data and employment relationships. In addition to higher sanctions, the regulation provides for extensive information, notification, deletion, and documentation obligations. While many of these data privacy rules had already been part of the previous German workplace privacy regime under the German Federal Data Protection Act (Bundesdatenschutzgesetz – BDSG), the latter has also been amended and provides for specific rules applicable to employee data protection in Germany (e.g. in the context of internal investigations or with respect to employee co-determination). However, the most salient novelty is the enormous increase in potential sanctions under the GDPR. Fines for GDPR violations can reach up to the higher of EUR 20 million or 4% of the group’s worldwide turnover. Against this backdrop, employers are well-advised to handle employee personnel data particularly careful. This is also particularly noteworthy as the employer is under an obligation to prove compliance with the GDPR – which may result in a reversal of the burden of proof e.g. in employment-related litigation matters involving alleged GDPR violations. Back to Top 4.2       Job Adverts with Third Gender Following a landmark decision by the German Federal Constitutional Court in 2017, employers are gradually inserting a third gender into their job advertisements. The Federal Constitutional Court (Bundesverfassungsgericht – BVerfG) decided on October 10, 2017 that citizens who do not identify as either male or female were to be registered as “diverse” in the birth register (1 BvR 2019/16). As a consequence of this court decision, many employers in Germany have broadened gender notations in job advertisements from previously “m/f” to “m/f/d”. While there is no compelling legal obligation to do so, employers tend to signal their open-mindedness by this step, but also mitigate the potential risk of liability for a discrimination claim. Currently, such liability risk does not appear alarming due to the relative rarity of persons identifying as neither male nor female and the lack of a statutory stipulation for such adverts. However, employers might be well-advised to follow this trend, particularly after Parliament confirmed the existence of a third gender option in birth registers in mid-December. Back to Top 4.3       Can Disclosure Obligation Reduce Gender Pay-Gap? In an attempt to weed out gender pay gaps, the German lawmaker has introduced the so-called Compensation Transparency Act in 2017. It obliges employers, inter alia, to disclose the median compensation of comparable colleagues of the opposite gender with comparable jobs within the company. The purpose is to give a potential claimant (usually a female employee) an impression of how much her comparable male colleagues earn in order for her to consider further steps, e.g. a claim for more money. However, the new law is widely perceived as pointless. First, the law itself and its processes are unduly complex. Second, even after making use of the law, the respective employee would still have to sue the company separately in order to achieve an increase in her compensation, bearing the burden of proof that the opposite-gender employee with higher compensation is comparable to her. Against this background, the law has hardly been used in practice and will likely have only minimal impact. Back to Top 4.4       Employers to Contribute 15% to Deferred Compensation Schemes In order to promote company pension schemes, employers are now obliged to financially support deferred compensation arrangements. So far, employer contributions to any company pension scheme had been voluntary. In the case of deferred compensation schemes, companies save money as a result of less social security charges. The flipside of this saving was a financial detriment to the employee’s statutory pension, as the latter depends on the salary actually paid to the employee (which is reduced as a result of the deferred compensation). To compensate the employee for this gap, the employer is now obliged to contribute up to 15% of the respective deferred compensation. The actual impact of this new rule should be limited, as many employers already actively support deferred compensation schemes. As such, the new obligatory contribution can be set off against existing employer contributions to the same pension scheme. Back to Top 5.         Real Estate – Notarization Requirement for Amendments to Real Estate Purchase Agreements Purchase agreements concerning German real estate require notarization in order to be effective. This notarization requirement relates not only to the purchase agreement as such but to all closely related (side) agreements. The transfer of title to the purchaser additionally requires an agreement in rem between the seller and the purchaser on the transfer (conveyance) and the subsequent registration of the transfer in the land register. To avoid additional notarial fees, parties usually include the conveyance in the notarial real estate purchase agreement. Amendment agreements to real estate purchase agreements are quite common (e.g., the parties subsequently agree on a purchase price adjustment or the purchaser has special requests in a real estate development scenario). Various Higher District Courts (Oberlandesgerichte), together with the prevailing opinion in literature, have held in the past that any amendments to real estate purchase agreements also require notarization unless such an amendment is designed to remove unforeseeable difficulties with the implementation of the agreement without significantly changing the parties’ mutual obligations. Any amendment agreement that does not meet the notarization requirement may render the entire purchase agreement (and not only the amendment agreement) null and void. With its decision on September 14, 2018, the German Federal Supreme Court (Bundesgerichtshof – BGH) added another exception to the notarization requirement and ruled that notarization of an amendment agreement is not required once the conveyance has become binding and the amendment does not change the existing real estate transfer obligations or create new ones. A conveyance becomes binding once it has been validly notarized. Before this new decision of the BGH, amendments to real estate purchase agreements were often notarized for the sake of precaution because it was difficult to determine whether the conditions for an exemption from the notarization requirement had been met. This new decision of the BGH gives the parties clear guidance as to when amendments to real estate purchase agreements require notarization. It should, however, be borne in mind that notarization is still required if the amendment provides for new transfer obligations concerning the real property or the conveyance has not become effective yet (e.g., because third party approval is still outstanding). Back to Top 6.         Compliance 6.1       Government Plans to Introduce Corporate Criminal Liability and Internal Investigations Act Plans of the Federal Government to introduce a new statute concerning corporate criminal liability and internal investigations are taking shape. Although a draft bill had already been announced for the end of 2018, pressure to respond to recent corporate scandals seems to be rising. With regard to the role and protection of work product generated during internal investigations, the highly disputed decisions of the Federal Constitutional Court (Bundesverfassungsgericht – BVerfG) in June 2018 (BVerfG, 2 BvR 1405/17, 2 BvR 1780/17 – June 27, 2018) (see 2017 Year-End German Law Update under 7.3) call for clearer statutory rules concerning the search of law firm premises and the seizure of documents collected in the course of an internal investigation. In its dismissal of complaints brought by Volkswagen and its lawyers from Jones Day, the Federal Constitutional Court made remarkable obiter dicta statements in which it emphasized the following: (1) the legal privilege enjoyed for the communication between the individual defendant (Beschuldigter) and its criminal defense counsel is limited to their communication only; (2) being considered a foreign corporate body, the court denied Jones Day standing in the proceedings, because the German constitution only grants rights to corporate bodies domiciled in Germany; and (3) a search of the offices of a law firm does not affect individual constitutional rights of the lawyers practicing in that office, because the office does not belong to the lawyers’ personal sphere, but only to their law firm. The decision and the additional exposure caused by it by making attorney work product created in the course of an internal investigation accessible was a major blow to German corporations’ efforts to foster internal investigations as a means to efficiently and effectively investigate serious compliance concerns. Because it does not appear likely that an entirely new statute concerning corporate criminal liability will materialize in the near future, the legal press expects the Federal Ministry of Justice to consider an approach in which the statutes dealing with questions around internal investigations and the protection of work product created in the course thereof will be clarified separately. In the meantime, the following measures are recommended to maximize the legal privilege for defense counsel (Verteidigerprivileg): (1) Establish clear instructions to an individual criminal defense lawyer setting forth the scope and purpose of the defense; (2) mark work product and communications that have been created in the course of the defense clearly as confidential correspondence with defense counsel (“Vertrauliche Verteidigerkorrespondenz”); and (3) clearly separate such correspondence from other correspondence with the same client in matters that are not clearly attributable to the criminal defense mandate. While none of these measures will guarantee that state prosecutors and courts will abstain from a search and seizure of such material, at least there are good and valid arguments to defend the legal privilege in any appeals process. However, with the guidance provided to courts by the recent constitutional decision, until new statutory provisions provide for clearer guidance, companies can expect this to become an up-hill battle. Back to Top 6.2       Update on the European Public Prosecutor’s Office and Proposed Cross-Border Electronic Evidence Rules Recently the European Union has started tightening its cooperation in the field of criminal procedure, which was previously viewed as a matter of national law under the sovereignty of the 28 EU member states. Two recent developments stand out that illustrate that remarkable new trend: (1) The introduction of the European Public Prosecutor’s Office (“EPPO”) that was given jurisdiction to conduct EU-wide investigations for certain matters independent of the prosecution of these matters under the national laws of the member states, and (2) the proposed EU-wide framework for cross-border access to electronically stored data (“e-evidence”) which has recently been introduced to the European Parliament. As reported previously (see 2017 Year-End German Law Update under 7.4), the European Prosecutor’s Office’s task is to independently investigate and prosecute severe crimes against the EU’s financial interests such as fraud against the EU budget or crimes related to EU subsidies. Corporations receiving funds from the EU may therefore be the first to be scrutinized by this new EU body. In 2018 two additional EU member states, the Netherlands and Malta, decided to join this initiative, extending the number of participating member states to 22. The EPPO will presumably begin its work by the end of 2020, because the start date may not be earlier than three years after the regulation’s entry into force. As a further measure to leverage multi-jurisdictional enforcement activities, in April 2018 the European Commission proposed a directive and a regulation that will significantly facilitate expedited cross-border access to e-evidence such as texts, emails or messaging apps by enforcement agencies and judicial authorities. The proposed framework would allow national enforcement authorities in accordance with their domestic procedure to request e-evidence directly from a service provider located in the jurisdiction of another EU member state. That other state’s authorities would not have the right to object to or to review the decision to search and seize the e-evidence sought by the national enforcement authority of the requesting EU member state. Companies refusing delivery risk a fine of up to 2% of their worldwide annual turnover. In addition, providers from a third country which operate in the EU are obliged to appoint a legal representative in the EU. The proposal has reached a majority vote in the Council of the EU and will now be negotiated in the European Parliament. Further controversial discussions between the European Parliament and the Commission took place on December 10, 2018. The Council of the EU aims at reaching an agreement between the three institutions by the end of term of the European Parliament in May 2019. Back to Top 7.         Antitrust and Merger Control 7.1       Antitrust and Merger Control Overview 2018 In 2018, Germany celebrated the 60th anniversary of both the German Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen -GWB) as well as the German federal cartel office (Bundeskartellamt) which were both established in 1958 and have since played a leading role in competition enforcement worldwide. The celebrations notwithstanding, the German antitrust watchdog has had a very active year in substantially all of its areas of competence. On the enforcement side, the Bundeskartellamt concluded a number of important cartel investigations. According to its annual review, the Bundeskartellamt carried out dawn raids at 51 companies and imposed fines totaling EUR 376 million against 22 companies or associations and 20 individuals from various industries including the steel, potato manufacturing, newspapers and rolled asphalt industries. Leniency applications remained an important source for the Bundeskartellamt‘s antitrust enforcement activities with a total of 21 leniency applications received in 2018 filling the pipeline for the next few months and years. On the merger control side, the Bundeskartellamt reviewed approximately 1,300 merger cases in 2018 – only 1% of which (i.e. 13 merger filings) required an in-depth phase 2 review. No mergers were prohibited but in one case only conditional clearance was granted and three filings were withdrawn in phase 2. In addition, the Bundeskartellamt had its first full year of additional responsibilities in the area of consumer protection, concluded a sector inquiry into internet comparison portals, and started a sector inquiry into the online marketing business as well as a joint project with the French competition authority CNIL regarding algorithms in the digital economy and their competitive effects. Back to Top 7.2       Cartel Damages Over the past few years, antitrust damages law has advanced in Germany and the European Union. One major legislative development was the EU Directive on actions for damages for infringements of competition law, which was implemented in Germany as part of the 9th amendment to the German Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen -GWB). In addition, there has also been some noteworthy case law concerning antitrust damages. To begin with, the German Federal Supreme Court (Bundesgerichtshof, BGH) strengthened the position of plaintiffs suing for antitrust damages in its decision Grauzementkartell II in 2018. The decision brought to an end an ongoing dispute between several Higher District Courts and District Courts, which had disagreed over whether a recently added provision of the GWB that suspends the statute of limitations in cases where antitrust authorities initiate investigations would also apply to claims that arose before the amendment entered into force (July 1, 2015). The Federal Supreme Court affirmed the suspension of the statute of limitations, basing its ruling on a well-established principle of German law regarding the intertemporal application of statutes of limitation. The decision concerns numerous antitrust damage suits, including several pending cases concerning trucks, rails tracks, and sugar cartels. Furthermore, recent case law shows that European domestic courts interpret arbitration agreements very broadly and also enforce them in cases involving antitrust damages. In 2017, the England and Wales High Court and the District Court Dortmund (Landgericht Dortmund) were presented with two antitrust disputes where the parties had agreed on an arbitration clause. Both courts denied jurisdiction because the antitrust damage claims were also covered by the arbitration agreements. They argued that the parties could have asserted claims for contractual damages instead, which would have been covered by the arbitration agreement. In the courts’ view, it would be unreasonable, however, if the choice between asserting a contractual or an antitrust claim would give the parties the opportunity to influence the jurisdiction of a court. As a consequence, the use of arbitration clauses (in particular if inconsistently used by suppliers or purchasers) may add significant complexity to antitrust damages litigation going forward. Thus, companies are well advised to examine their international supply agreements to determine whether included arbitration agreements will also apply to disputes about antitrust damages. Back to Top 7.3       Appeals against Fines Risky? In German antitrust proceedings, there is increasing pressure for enterprises to settle. Earlier this year, Radeberger, a producer of lager beer, withdrew its appeal against a significant fine of EUR 338 million, which the Bundeskartellamt had imposed on the company for its alleged participation in the so-called “beer cartel”. With this dramatic step, Radeberger paid heed to a worrisome development in German competition law. Repeatedly, enterprises have seen their cartel fines increased by staggering amounts on appeal (despite such appeals sometimes succeeding on some substantive legal issues). The reason for these “appeals for the worse” – as seen in the liquefied gas cartel (increase of fine from EUR 180 million to EUR 244 million), the sweets cartel (average increase of approx. 50%) and the wallpaper cartel (average increase of approx. 35%) – is the different approach taken by the Bundeskartellamt and the courts to calculating fines. As courts are not bound by the administrative practice of the Bundeskartellamt, many practitioners are calling for the legislator to step in and address the issue. Back to Top 7.4       Luxury Products on Amazon – The Coty Case In July 2018, the Frankfurt Higher District Court (Oberlandesgericht Frankfurt) delivered its judgement in the case Coty / Parfümerie Akzente, ruling that Coty, a luxury perfume producer, did not violate competition rules by imposing an obligation on its selected distributors to not sell on third-party platforms such as Amazon. The judgment followed an earlier decision of the Court of Justice of the European Union (ECJ) of December 2017, by which the ECJ had replied to the Frankfurt court’s referral. The ECJ had held that a vertical distribution agreement (such as the one in place between Coty and its distributor Parfümerie Akzente) did not as such violate Art. 101 of the Treaty on the Functioning of the European Union (TFEU) as long as the so-called Metro criteria were fulfilled. These criteria stipulate that distributors must be chosen on the basis of objective and qualitative criteria that are applied in a non-discriminatory fashion; that the characteristics of the product necessitate the use of a selective distribution network in order to preserve their quality; and, finally, that the criteria laid down do not go beyond what is necessary. Regarding the platform ban in question, the ECJ held that it was not disproportionate. Based on the ECJ’s interpretation of the law, the Frankfurt Higher District Court confirmed that the character of certain products may indeed necessitate a selective distribution system in order to preserve their prestigious reputation, which allowed consumers to distinguish them from similar goods, and that gaps in a selective distribution system (e.g. when products are sold by non-selected distributors) did not per se make the distribution system discriminatory. The Higher District Court also concluded that the platform ban in question was proportional. However, interestingly, it did not do so based on its own reasoning but based on the fact that the ECJ’s detailed analysis did not leave any scope for its own interpretation and, hence, precluded the Higher District Court from applying its own reasoning. Pointing to the European Commission’s E-Commerce Sector Inquiry, according to which sales platforms play a more important role in Germany than in other EU Member States, the Higher District Court, in fact, voiced doubts whether Coty’s sales ban could not have been imposed in a less interfering manner. Back to Top 8.         Litigation 8.1       The New German “Class Action” On November 1, 2018, a long anticipated amendment to the German Code of Civil Procedure (Zivilprozessordnung, ZPO) entered into force, introducing a new procedural remedy for consumers to enforce their rights in German courts: a collective action for declaratory relief. Although sometimes referred to as the new German “class action,” this new German action reveals distinct differences to the U.S.-American remedy. Foremost, the right to bring the collective action is limited to consumer protection organizations or other “qualified institutions” (qualifizierte Einrichtung) who can only represent “consumers” within the meaning of the German Code of Civil Procedure. In addition, affected consumers are not automatically included in the action as part of a class but must actively opt-in by registering their claims in a “claim index” (Klageregister). Furthermore, the collective action for declaratory relief does not grant any monetary relief to the plaintiffs which means that each consumer still has to enforce its claim in an individual suit to receive compensation from the defendant. Despite these differences, the essential and comparable element of the new legal remedy is its binding effect. Any other court which has to decide an individual dispute between the defendant and a registered consumer that is based on the same facts as the collective action is bound by the declaratory decision of the initial court. At the same time, any settlement reached by the parties has a binding effect on all registered consumers who did not decide to specifically opt-out. As a result, companies must be aware of the increased litigation risks arising from the introduction of the new collective action for declaratory relief. Even though its reach is not as extensive as the American class action, consumer protection organizations have already filed two proceedings against companies from the automotive and financial industry since the amendment has entered into force in November 2018, and will most likely continue to make comprehensive use of the new remedy in the future. Back to Top 8.2       The New 2018 DIS Arbitration Rules On March 1, 2018, the new 2018 DIS Arbitration Rules of the German Arbitration Institute (DIS) entered into force. The update aims to make Germany more attractive as a place for arbitration by adjusting the rules to international standards, promoting efficiency and thereby ensuring higher quality for arbitration proceedings. The majority of the updated provisions and rules are designed to accelerate the proceedings and thereby make arbitration more attractive and cost-effective for the parties. There are several new rules on time limitations and measures to enhance procedural efficiency, i.e. the possibility of expedited proceedings or the introduction of case management conferences. Furthermore, the rules now also allow for consolidation of several arbitrations and cover multi-party and multi-contract arbitration. Another major change is the introduction of the DIS Arbitration Council which, similar to the Arbitration Council of the ICC (International Chamber of Commerce), may decide upon challenges of an arbitrator and review arbitral awards for formal defects. This amendment shows that the influence of DIS on their arbitration proceedings has grown significantly. All in all, the modernized 2018 DIS Arbitration Rules resolve the deficiencies of their predecessor and strengthen the position of the German Institution of Arbitration among competing arbitration institutions. Back to Top 9.         IP & Technology – Draft Bill of German Trade Secret Act The EU Trade Secrets Directive (2016/943/EU) on the protection of undisclosed know-how and business information (trade secrets) against their unlawful acquisition, use and disclosure has already been in effect since July 5, 2016. Even though it was supposed to be implemented into national law by June 9, 2018 to harmonize the protection of trade secrets in the EU, the German legislator has so far only prepared and published a draft of the proposed German Trade Secret Act. Arguably, the most important change in the draft bill to the existing rules on trade secrets in Germany will be a new and EU-wide definition of trade secrets. This proposed definition requires the holder of a trade secret to take reasonable measures to keep a trade secret confidential in order to benefit from its protection – e.g. by implementing technical, contractual and organizational measures that ensure secrecy. This requirement goes beyond the current standard pursuant to which a manifest interest in keeping an information secret may be sufficient. Furthermore, the draft bill provides for additional protection of trade secrets in litigation matters. Last but not least, the draft bill also provides for increased protection of whistleblowers by reducing the barriers for the disclosure of trade secrets in the public interest and to the media. As a consequence, companies would be advised to review their internal procedures and policies regarding the protection of trade secrets at this stage, and may want to adapt their existing whistleblowing and compliance-management-systems as appropriate. Back to Top 10.       International Trade, Sanctions and Export Controls – The Conflict between Complying with the Re-Imposed U.S. Iran Sanctions and the EU Blocking Statute On May 8, 2018, President Donald Trump announced his decision to withdraw from the Joint Comprehensive Plan of Action (JCPOA) and re-impose U.S. nuclear-related sanctions. Under the JCPOA, General License H had permitted U.S.-owned or -controlled non-U.S. entities to engage in business with Iran. But with the end of the wind-down periods provided for in President Trump’s decision on November 5, 2018, such non-U.S. entities are now no longer broadly permitted to provide goods, services, or financing to Iranian counterparties, not even under agreements executed before the U.S. withdrawal from the JCPOA. In response to the May 8, 2018 decision, the EU amended the EU Blocking Statute on August 6, 2018. The effect of the amended EU Blocking Statute is to prohibit compliance by so-called EU operators with the re-imposed U.S. sanctions on Iran. Comparable and more generally drafted anti-blocking statutes had already existed in the EU and several of its member states which prohibited EU domiciled companies to commit to compliance with foreign boycott regulations. These competing obligations under EU and U.S. laws are a concern for U.S. companies that own or seek to acquire German companies that have a history of engagement with Iran – as well as for the German company itself and its management and the employees. But what does the EU prohibition against compliance with the re-imposed U.S. sanctions on Iran mean in practice? Most importantly, it must be noted that the EU Blocking Statute does not oblige EU operators to start or continue Iran related business. If, for example, an EU operator voluntarily decides, e.g. due to lack of profitability, to cease business operations in Iran and not to demonstrate compliance with the U.S. sanctions, the EU Blocking Statute does not apply. Obviously, such voluntary decision must be properly documented. Procedural aspects also remain challenging for companies: In the event a Germany subsidiary of a U.S. company were to decide to start or continue business with Iran, it would usually be required to reach out to the U.S. authorities to request a specific license for a particular transaction with Iran. Before doing so, however, EU operators must first contact the EU Commission directly (not the EU member state authorities) to request authorization to apply for such a U.S. special license. Likewise, if a Germany subsidiary were to decide not to start or to cease business with Iran for the sole reason of being compliant with the re-imposed U.S. Iran sanctions, it would have to apply for an exception from the EU Blocking Statute and would have to provide sufficient evidence that non-compliance would cause serious damage to at least one protected interest. The hurdles for an exception are high and difficult to predict. The EU Commission will e.g. consider, “(…) whether the applicant would face significant economic losses, which could for example threaten its viability or pose a serious risk of bankruptcy, or the security of supply of strategic goods or services within or to the Union or a Member State and the impact of any shortage or disruption therein.” As such, any company caught up in this conflict of interests between the re-imposed U.S. sanctions and the EU Blocking Statute should be aware of a heightened risk of litigation. Third parties, such as Iranian counterparties, might successfully sue for breach of contract with the support of the EU Blocking Regulation in cases of non-performance of contracts as a result of the re-imposed U.S. nuclear sanctions. Finally, EU operators are required to inform the EU Commission within 30 days from the date on which information is obtained that the economic and/or financial interests of the EU operator are affected, directly or indirectly, by the re-imposed U.S. Iran sanctions. If the EU operator is a legal person, this obligation is incumbent on its directors, managers and other persons with management responsibilities of such legal person. Back to Top The following Gibson Dunn lawyers assisted in preparing this client update:  Birgit Friedl, Marcus Geiss, Silke Beiter, Lutz Englisch, Daniel Gebauer, Kai Gesing, Maximilian Hoffmann, Philipp Mangini-Guidano, Jens-Olrik Murach, Markus Nauheim, Dirk Oberbracht, Richard Roeder, Martin Schmid, Annekatrin Schmoll, Jan Schubert, Benno Schwarz, Balthasar Strunz, Michael Walther, 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, 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 33 121, 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 33 180, bfriedl@gibsondunn.com) Silke Beiter (+49 89 189 33 121, sbeiter@gibsondunn.com) Marcus Geiss (+49 89 189 33 122, mgeiss@gibsondunn.com) Annekatrin Pelster (+49 69 247 411 521, apelster@gibsondunn.com Finance, Restructuring and Insolvency Sebastian Schoon (+49 89 189 33 160, sschoon@gibsondunn.com) Birgit Friedl (+49 89 189 33 180, bfriedl@gibsondunn.com) Alexander Klein (+49 69 247 411 518, aklein@gibsondunn.com) Marcus Geiss (+49 89 189 33 122, 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 Peter Decker (+49 89 189 33 115, pdecker@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) Antitrust Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Jens-Olrik Murach (+32 2 554 7240, jmurach@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com) Litigation 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) 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 33 218, rroeder@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

December 17, 2018 |
UK Real Estate Tax – A New Landscape For Investors

Click for PDF This is an interesting time to be a UK citizen, not least because of the unpredictable political situation. However, UK tax policy regarding real estate investment and taxation of real estate structures has been a moving target since before the Brexit referendum. Whether to raise more revenue from the sector or to rectify existing gaps in the legislation, the regular changes to the UK tax rules on real estate indicate confusion amongst policy makers on the best approach. One could credibly accuse HMT and HMRC of reacting piecemeal to issues and not offering a coherent policy which provides certainty and predictability to the sector. Inbound investment is crucial to the present (and future) of the UK economy and the industry is stressing these points to the Government, despite their attention being elsewhere. How we got here Historically, the United Kingdom has always sought to tax non-residents on income which has a UK “source”, such as rent payable on land and buildings in the UK (albeit with deductions for associated revenue expenses, such as interest incurred on related finance). But it has not taxed capital gains realised by non-UK residents in respect of the underlying UK asset. There were exceptions, for example in cases where the land and buildings were held as dealing stock (including as part of a property development business), or where the building was used by the owner as part of the owner’s own operating business (such as a hotel owned by a hotel business). This changed in 2013 with the introduction of the annual tax on enveloped dwellings (ATED), and ATED-related capital gains tax was charged on disposals of “enveloped” residential property. Non-resident capital gains tax (NRCGT) was introduced in 2015 for disposals of closely-owned residential property not caught by the ATED rules. In 2016, the scope of the UK “transactions in land” rules were amended to capture a broader range of profits ultimately derived from property development and dealing in the UK where these had previously fallen outside the scope of the “dealing stock” charge. And there were further refinements to VAT and capital allowances rules impacting the sector, not to mention a wholesale restructuring of the way stamp duty land tax (SDLT) was assessed on property transactions. The Government published a consultative paper in November 2017 proposing that non-resident investors in UK real estate should be brought within the scope of UK tax with effect from April 2019, and draft legislation was published in July 2018. These proposals were modified in the Government’s Budget announcement in November 2018, and a Finance Bill embodying these final proposals is currently before Parliament. This alert reviews the state of the legislation currently before Parliament and summarises the principal changes made since our previous alert. This also includes changes announced in the Budget of which there was no prior notice, which impact the taxation of real estate beyond capital gains. The UK continues to be one of the most mature and diverse real estate markets in the world, but the proposed changes will potentially impact the economic return for overseas investors and therefore such investors may need to adapt their financial models to take into account the relevant new tax charges. 1. DISPOSALS BY NON-UK RESIDENTS OF INVESTMENTS IN UK LAND From April 2019, all non-UK resident persons will be taxable on gains on disposals of interests in any type of UK land or buildings. Changes introduced will apply not only to disposals of directly owned interests in UK land or buildings, but also to disposals of indirectly owned interests, i.e., the sale of interests in entities whose value is derived from UK land and buildings. The Finance Bill amends the existing provisions of the Taxation of Chargeable Gains Act 1992 (TCGA) Part 1 and introduces a new charge to Capital Gains Tax (CGT) or corporation tax on non-UK resident persons making gains on direct or indirect disposals of UK property. What is UK Land? The definition of an interest in UK land in the Finance Bill follows existing definitions under the UK tax code and is designed to capture the whole profits relating to UK land and buildings. To summarise, an “interest in UK land” will include: an estate, interest, right or power in or over land or buildings in the UK; or the benefit of an obligation, restriction or condition affecting the value of an estate, interest, right or power in or over land or buildings in the UK. However, it will not include: licences to use or occupy the land or buildings (e.g., permission to enter or use a building (such as an admission ticket or parking permit), as distinguished from a right attaching to the land, such as a lease – there are difficult cases at the margin; any right or interest held for securing the payment of money or the performance of an obligation (e.g., a right over land held by a bank as security for a loan); and certain other interests (e.g., a tenancy at will or a franchise). Direct Disposals From April 2019, all non-UK residents, whether liable to CGT or corporation tax, will be taxable on gains on disposals of directly held interests in any type of UK land. Indirect Disposals From April 2019, non-UK residents will also be taxed on any gains made on the disposals of significant interests in entities that directly or indirectly own interests in UK land. For tax to be imposed, the entity being disposed of must be “property rich”, and the non-UK resident must be a “substantial investor”. Substantial Investor A non-UK resident is a substantial investor in a property rich entity if, at the date of disposal or at any time within two years prior to disposal, the non-UK resident holds, or has held directly or indirectly, at least a 25% interest in a property rich entity. If the non-UK resident holds the 25% interest for an insignificant time period (relative to the total ownership within two years prior to the disposal), the 25% test will not be met. The 25% interest is determined by voting rights, income rights, rights on a winding up and rights to proceeds on a sale. Property Rich Entities An entity is property rich if at least 75% of the gross market value of its qualifying assets at the time of disposal are derived from UK land. This includes value deriving from any: shareholding in a company deriving its value directly or indirectly from UK land; partnership interests deriving their value directly or indirectly from UK land; interests in property held on trust; and option, consent, or embargo affecting the sale of the UK land. The qualifying asset test includes a complicated matching rule which can exclude some assets (e.g., relevant intercompany loans), and this will lead to the need for valuations for all qualifying assets and not just real estate assets. The Finance Bill contains tracing and attribution of value provisions. Those provisions provide that non-UK residents own an asset deriving 75% of its value from UK land if they: own a right or interest in a company; and at the date of the disposal, at least 75% of the total market value of that company’s qualifying assets derive directly or indirectly from interest in UK land. Deriving the market value of a company will involve tracing through any arrangements and entities (including subsidiaries, partnerships and trusts). When tracing through such arrangements and entities, there must be appropriate attributions to the shareholders, partners and beneficiaries. Trading Exemption Exceptions apply where all of the interests in UK land are used for a qualifying trading purpose (e.g., a factory owned by a manufacturing business). Interests in land that are not used for a qualifying trading purpose are ignored if they are insignificant. A reasonableness test is used to determine what constitutes an “insignificant interest”, taking into account all of the circumstances. Connected Companies Exemption Where two or more companies are disposed of as part of an arrangement and some, but not all, of these companies would meet the 75% property richness test, then special rules apply. If, taken together, the assets of all of the companies aggregated do not meet the 75% property richness test, then none of the companies will be considered to have met the test. Such disposals by non-UK residents will therefore fall outside the changes brought in by the Finance Bill to UK tax on capital gains. Anti-avoidance The Finance Bill also introduces anti-avoidance provisions that apply to the new rules on indirect disposals by non-UK residents of UK land. These rules apply where the non-UK resident tax payer enters into an arrangement, the main purpose of which (or one of the main purposes of which) is to obtain a tax advantage and either: the tax advantage relates to tax for which that person would be liable (but for the arrangement) under the CGT regime and the arrangements were entered into on or after 6 July 2018; or the advantage arises in the context of a double taxation arrangement (i.e., a “treaty shopping case”) and the arrangements were entered into on or after 22 November 2017. Re-basing There are now two key re-basing dates: 5 April 2015 and 5 April 2019. The default date for re-basing is identified by determining whether the non-UK resident disposal falls within one of the below categories: Directly held commercial property: Non-UK residents disposing of UK commercial property directly held at 5 April 2019 may re-base the land to its 5 April 2019 market value or elect to use the original base cost. Where a taxpayer takes the latter approach, any loss arising will not be an allowable loss. Directly held residential property within NRCGT or ATED: Non-UK residents disposing of UK residential property directly held since 6 April 2015 and chargeable to CGT prior to 6 April 2019 (i.e., UK land that was subject to the non-resident CGT regime or that would have been subject to ATED-related CGT had it been disposed of on or before 5 April 2019), may re-base the land to its 5 April 2015 market value or elect to use the original base cost. Alternatively, the taxpayer may elect for a straight-line time apportionment of any gain. Directly held residential property outside NRCGT or ATED: Non-UK residents disposing of UK residential property directly held at 5 April 2019 that was not chargeable on or before this date (i.e., residential property held by widely held non-UK resident companies, widely marketed collective investment schemes or non-UK resident life assurance businesses) may re-base the land to its 5 April 2019 market value or elect to use the original base cost. Where a taxpayer takes the latter approach, any loss arising will not to be an allowable loss. Directly held mixed use property: Non-UK residents disposing of UK mixed use (i.e., commercial and residential use) property directly held since 6 April 2015 and partly chargeable to CGT prior to 6 April 2019, may re-base the land to its 5 April 2015 market value and then again to its 5 April 2019 market value. The amount of any gain or loss accrued on the residential element on the re-basing to its 5 April 2019 market value is brought into charge to tax on the eventual sale. The non-UK resident taxpayer also has the option of using the original base cost, rather than re-basing the asset value. Indirect interests: Non-UK residents disposing of UK property indirectly held  (i.e., through one or more corporate entities) will rebase the shares to their 5 April 2019 market value or elect to use the original base cost. Where a taxpayer takes the latter approach, any loss arising will not be an allowable loss. Corporation Tax The UK property activities of non-UK resident companies will be brought within the scope of UK corporation tax from April 2020. They will be subject to UK corporation tax (rather than income tax) on their income from UK land from April 2020 – at which point the main corporation tax rate will be 17%. The delay in bringing companies within the corporation tax regime means the application of corporate interest restriction rules, hybrid rules and limits to carried forward losses are equally delayed. However, companies will not be able to take advantage of the lower tax rate until such time. Such companies will, from April 2020, become entitled to benefit from corporation tax reliefs such as the substantial shareholding exemption (SSE) and the no-gain, no-loss rules on intragroup asset transfers. One point to note is the interaction of SSE and the corporate interest restriction rules. The Public Benefit Infrastructure Exemption (PBIE) provides a more generous interest deduction than the standard debt cap – and it is available to some owners of UK investment property. However, companies eligible to benefit from SSE are unlikely to be able to benefit from PBIE (and vice versa). Where it is possible to structure ownership of a property in a manner that could benefit from either PBIE or SSE, a choice will need to be made at the time the property is acquired as to which relief is likely to be more valuable. There will be many situations involving indirect disposals where SSE may not be applied (e.g., on the disposal of a benefit of a debt or derivative deriving its value from UK land). Where SSE is not available, the application of the trading exemption (see above) will be crucial. Reliefs SSE is not available to non-corporate taxpayers (such as individuals and trustees). As noted above, where SSE is not available, the application of the trading exemption will be crucial. It is not clear whether roll-over relief for capital reorganisations will be permitted if interests are exchanged in a property rich entity in consideration of the issue of interests in an acquisition vehicle which is not property rich. Those who are exempt from capital gains for reasons other than being non-UK resident (e.g., pension funds and sovereign wealth funds) will continue to be exempt under the new rules. Availability of losses Losses arising to non-UK resident companies under the new rules will be available in the same way as capital losses for UK resident companies. CGT losses will follow the existing rules for NRCGT losses. NRCGT losses and ring-fenced ATED-related allowable losses accruing to a non-UK resident company before 6 April 2019 are deductible from any corporation tax due by the non-UK resident on chargeable gains (to the extent they have not already been deducted from gains). See also section 4 of this alert for further details on losses. Collective Investment Vehicles The default position for collective investment vehicles (CIV) will be that they are treated for capital gains purposes as if they were companies. The CIV definition in the legislation is broad, and should capture most UK property rich Jersey Property Unit Trusts (JPUTs) and Guernsey Property Unit Trusts (GPUTs), as well as widely-held offshore funds. An investment in such a fund will be treated as if the interests of the investors were shares in a company, so that where the fund is UK property rich, a disposal of an interest in it by a non-UK resident investor will be chargeable to UK tax under the new rules. But the deeming provisions will not go as far as treating CIVs as having ordinary share capital, so they will not be able to rely on provisions or reliefs that require a relationship to be established between a parent and subsidiary, or common subsidiaries of a parent, through ownership of ordinary share capital. One consequence of CIVs being treated as companies is that they will be subject to corporation tax after April 2020. Non-Application of 25% Ownership Exemption for CIVs Non-UK resident investors in CIVs that are UK property rich will be chargeable on gains on disposals of an interest in a UK property rich CIV regardless of their level of investment. They will not benefit from the 25% ownership threshold. The usual 25% substantial indirect interest test may be re-applied for certain funds where the CIV is only temporarily UK property rich. In these cases, the fund will need to meet a genuine diversity of ownership or non-close test, and be targeting UK property investments of no more than 40% of fund gross asset value in accordance with its prospectus or other fund documents. The Transparency Election CIVs that are already treated as transparent for tax purposes will be able to elect (irrevocably) to be treated as a partnership for the purposes of capital gains (and related provisions), thereby ensuring that the investors are taxed on disposals of the underlying assets of the partnership. Statement of Practice D12 (SP D12), and the usual taxation of partnership rules, will apply in calculating any gain or loss when the investor or the CIV makes a disposal. An investor who is exempt from capital gains (e.g., pension funds and sovereign wealth funds) would therefore be able to directly claim exemption on the disposal of assets by the CIV. In the case of a fund existing at 6 April 2019, the election must be made by 5 April 2020. The election can be made by the fund manager, and must be accompanied by the consent of all of the investors in the fund at the time of making the election. The investors’ consent may be assumed where it is evident that it has been made clear to investors that they are buying an interest in a fund that intends to make a transparency election. To qualify for the transparency exemption, the CIV will need to either be UK property rich at the time of the election, or have published scheme documents at that time clearly stating the intention of the CIV to invest predominantly in UK land. The transparency exemption is unlikely to be appropriate for CIVs that have regular changes of investors, as these changes may trigger regular disposals of other investors’ interests in the underlying assets because of the way in which SP D12 deals with the introduction and withdrawal of partners in a partnership. The Exemption Election Under the election for exemption, the CIV itself will not suffer tax on either direct or indirect disposals on the proportion of any gains attributable to the CIV holding UK land. The investors remain taxable under first principles on any disposal of an interest in a CIV that is a UK property rich entity. The election for exemption is not available to all funds. It is only available to non-UK resident companies that are the equivalent of UK REITs and some partnerships. An extensive set of qualifying criteria needs to be met in order to be able to make the election for exemption. In particular, these include a requirement for diverse ownership of the CIV. Where a CIV ceases to meet any of the qualifying criteria, this will trigger a deemed disposal and reacquisition of the interests of all the investors in the CIV. Certain reporting obligations apply in these instances. Tricky provisions apply where the CIV falls in and out of the conditions over certain periods of time. CIV Reporting Obligations Not only will CIVs and investors in the CIVs need to understand the new tax regime, they will also need to understand the new reporting obligations. CIVs will be required to make annual filings with HMRC providing details of the CIVs’ investors and disposals (if any). For CIVs established prior to 1 June 2019 there are dispensations in the information required where the manager is otherwise prevented from providing such information to HMRC for legal, regulatory or contractual reasons and so fund managers will need to review their constitutional documents to see if the obligations apply. 2. REPORTING AND PAYMENTS ON ACCOUNT OF CAPITAL GAINS With effect from 6 April 2019, disposals of UK land by non-UK resident persons must be reported within 30 days of completion, and payment on account of the tax liability must be made by the same date. This 30-day time limit also applies to disposals made by non-UK resident investors in CIVs. Where a fund is fiscally transparent, arrangement will need to be in place for fund managers to notify their investors when disposals occur. With effect from 6 April 2020, direct disposals of UK land on which a residential property gain accrues (by both UK residents and non-residents) must be reported within 30 days of completion, and payment on account of the tax liability must be made by the same date. 3. ANNUAL TAX ON ENVELOPED DWELLINGS ATED-related CGT will be abolished with effect from April 2019, as the new rules set out in section 1 of this alert would now cover disposals that would otherwise have been caught under the ATED-related CGT provisions. ATED will continue to apply as an annual tax. The rates of ATED will increase by 2.4% (in line with the consumer prices index) with effect from 1 April 2019. 4. CORPORATE CAPITAL LOSS RESTRICTION To ensure that large UK companies pay tax when they make significant capital gains, new rules will bring the tax treatment of corporate capital losses into line with the treatment of income losses. From 1 April 2020, the proportion of annual capital gains that can be relieved by brought-forward capital losses will be restricted to 50%. This will be relevant to non-UK resident property companies, when they come within the charge to UK corporation tax in April 2020. The measure will include an allowance that gives companies unrestricted use of up to £5 million capital or income losses each year. The measure will be subject to anti-avoidance rules that apply with effect from 29 October 2018. 5. CAPITAL ALLOWANCES The Finance Bill includes provisions for a new form of capital allowance relating to costs incurred in the construction, conversion or renovation of new commercial property – to be known as Structures and Buildings Allowance. The Structures and Buildings Allowance is subject to consultation, but it is expected to be given at a flat rate of 2% per annum over a 50-year period. The Finance Bill also includes the following additional provisions: An increase to the Annual Investment Allowance from £200,000 to £1 million from 1 January 2019 until 31 December 2020. A reduction of the capital allowances special rate from 8% to 6% from April 2019. The main pool rate will remain at 18%. An end to the Enhanced Capital Allowances and First Year Tax Credits for technologies on the Energy Technology List and Water Technology List from April 2020. An extension to the first year allowance for electric charge-points for four years until April 2023. 6. STAMP DUTY LAND TAX For transactions completed on or after 1 March 2019, the filing deadline for SDLT returns and the payment of SDLT will be reduced from 30 days to 14 days. The Government intends to consult on introducing a new 1% SDLT surcharge on the acquisition of residential property in England and Northern Ireland by non-UK residents. The consultation document will be published in January 2019. 7. VAT REVERSE CHARGE FOR BUILDING AND CONSTRUCTION SERVICES The Finance Bill introduces a VAT reverse charge on certain building and construction services that will come into effect on 1 October 2019. These rules are intended to reduce tax fraud within the construction industry where sub-contractors charge VAT, but disappear without accounting for HMRC for such VAT. The new rules will, in many cases, require the recipient of the supply of construction services (rather than the supplier) to account for VAT on the supply. The reverse charge will apply through the supply chain where payments are required to be reported through the Construction Industry Scheme up to the point where the customer receiving the supply is no longer a business that makes supplies of specified services, i.e., “end users”. 8. INTERNATIONAL TAX ENFORCEMENT: DISCLOSABLE ARRANGEMENTS The Finance Bill includes powers for the Government to make regulations to implement Council Directive 2018/822/EU (DAC6), which requires EU intermediaries (including banks, accounting firms, law firms, corporate service providers and certain other persons) involved in cross-border arrangements to make a disclosure to their tax authority if certain requirements are met. DAC6 is intended to give tax authorities early notice of new cross-border tax or avoidance schemes. This is intended to enable the authorities to investigate users and, if necessary, close down the schemes with legislative changes. DAC6 is widely drafted and clients with cross-border arrangements anywhere in the EU are advised to check whether arrangements entered into from June 2018 do not trigger a notification requirement. CONCLUSION As set out above, numerous tax changes have or will be implemented, each of which could impact the economic return for overseas investors with interests in UK real estate. Investors should consider the different UK tax implications that result from investing in such assets directly and indirectly. It will also be important to bear in mind that the nature of any potential transaction (and the level in the relevant structure at which the transaction occurs), as well as the type of entities involved, could create differences in the tax result and there may be no obvious policy reason as to why this should be the case. Therefore, investors will need to consider their individual positions accordingly. For example, the draft NRCGT legislation is intended to more closely align the tax treatment of non-UK residents with that of UK residents. Whether this is actually the case is very much open to debate. The funds industry was initially very concerned about this proposal, particularly given that funds and joint ventures are often structured to facilitate tax-exempt investors investing alongside taxable investors in such a way that no more tax is paid than if they acquired any assets directly. The original draft rules could have taxed such structures at multiple levels and various changes to the draft legislation have sought to address this, but some gaps and concerns still remain. It will also be important to monitor the ongoing efforts to bring non-resident property companies within the corporation tax regime from April 2020, as there remain a number of technical issues to be finalised, as well as fundamental differences in how capital gains are calculated depending on which part of the UK tax code an entity falls within (e.g., indexation for corporation tax payers). 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 or any of the following members of the Tax Practice Group: Sandy Bhogal – London (+44 (0) 20 7071 4266, sbhogal@gibsondunn.com) Nicholas Aleksander – London (+44 (0)20 7071 4232, naleksander@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 16, 2018 |
Taxing the Digital Economy

London partner Sandy Bhogal and associate Panayiota Burquier are the authors of “Taxing the Digital Economy” [PDF] published in The International Comparative Legal Guide to: Corporate Tax 2019 on November 16, 2018.

November 2, 2018 |
The Impact on MNCs

London partner Sandy Bhogal is the author of “The Impact on MNCs” [PDF] published in Tax Journal on November 2, 2018.

November 2, 2018 |
Gibson Dunn Ranked in Chambers UK 2019

Gibson Dunn was recognized with two firm and 14 individual rankings in the 2019 edition of Chambers UK.  The firm was recognized in the categories: International Arbitration – UK-wide and Real Estate Finance – London.  The following partners were recognized in their respective practice areas:  Cyrus Benson in International Arbitration – UK-wide, Sandy Bhogal in Tax – London, James Cox in Employment: Employer – London, Charlie Geffen in Corporate/M&A: High End – London and Private Equity – UK-wide, Chris Haynes in Capital Markets: Equity – UK-wide, Anna Howell in Energy & Natural Resources: Oil & Gas – UK-wide, Penny Madden in International Arbitration – UK-wide, Ali Nikpay in Competition Law – London, Alan Samson in Real Estate – London and Real Estate Finance – London, Jeff Sullivan in International Arbitration – UK-wide and Public International Law – London, and Steve Thierbach in Capital Markets: Equity – UK-wide.

November 1, 2018 |
U.S. News – Best Lawyers® Awards Gibson Dunn 132 Top-Tier Rankings

U.S. News – Best Lawyers® awarded Gibson Dunn Tier 1 rankings in 132 practice area categories in its 2019 “Best Law Firms” [PDF] survey. Overall, the firm earned 169 rankings in nine metropolitan areas and nationally. Additionally, Gibson Dunn was recognized as “Law Firm of the Year” for Litigation – Antitrust and Litigation – Securities. Firms are recognized for “professional excellence with persistently impressive ratings from clients and peers.” The recognition was announced on November 1, 2018.

October 30, 2018 |
Webcast: Spinning Out and Splitting Off – Navigating Complex Challenges in Corporate Separations

In the current strong market environment, spin-off deals have become a regular feature of the M&A landscape as strategic companies look for ways to maximize the value of various assets. Although the announcements have become routine, planning for and completing these transactions is a significant and multi-disciplinary undertaking. By its nature, a spin-off is at least a 3-in-1 transaction starting with the reorganization and carveout of the assets to be separated, followed by the negotiation of separation-related documents and finally the offering of the securities—and that does not even account for the significant tax, corporate governance, finance, IP and employee benefits aspects of the transaction. In this program, a panel of lawyers from a number of these key practice areas provided insights based on their recent experience structuring and executing spin-off transactions. They walked through the hot topics, common issues and potential work-arounds. View Slides (PDF) PANELISTS: Daniel Angel is a partner in Gibson Dunn’s New York office, Co-Chair of the firm’s Technology Transactions Practice Group and a member of its Strategic Sourcing and Commercial Transactions Practice Group. He is a transactional attorney who has represented clients on technology-related transactions since 2003. Mr. Angel has worked with a broad variety of clients ranging from market leaders to start-ups in a wide range of industries including financial services, private equity funds, life sciences, specialty chemicals, insurance, energy and telecommunications. Michael J. Collins is a partner in Gibson Dunn’s Washington, D.C. office and Co-Chair of the Executive Compensation and Employee Benefits Practice Group. His practice focuses on all aspects of employee benefits and executive compensation. He represents buyers and sellers in corporate transactions and companies in drafting and negotiating employment and equity compensation arrangements. Andrew L. Fabens is a partner in Gibson Dunn’s New York office, Co-Chair of the firm’s Capital Markets Practice Group and a member of the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Fabens advises companies on long-term and strategic capital planning, disclosure and reporting obligations under U.S. federal securities laws, corporate governance issues and stock exchange listing obligations. He represents issuers and underwriters in public and private corporate finance transactions, both in the United States and internationally. Stephen I. Glover is a partner in Gibson Dunn’s Washington, D.C. office and Co-Chair of the firm’s Mergers and Acquisitions Practice Group. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, including spin-offs and related transactions, as well as other corporate matters. Mr. Glover’s clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He also advises private equity firms, individual investors and others. Elizabeth A. Ising is a partner in Gibson Dunn’s Washington, D.C. office, Co-Chair of the firm’s Securities Regulation and Corporate Governance Practice Group and a member of the firm’s Hostile M&A and Shareholder Activism team and Financial Institutions Practice Group. She advises clients, including public companies and their boards of directors, on corporate governance, securities law and regulatory matters and executive compensation best practices and disclosures. Saee Muzumdar is a partner in Gibson Dunn’s New York office and a member of the firm’s Mergers and Acquisitions Practice Group. Ms. Muzumdar is a corporate transactional lawyer whose practice includes representing both strategic companies and private equity clients (including their portfolio companies) in connection with all aspects of their domestic and cross-border M&A activities and general corporate counseling. Daniel A. Zygielbaum is an associate in Gibson Dunn’s Washington, D.C. office and a member of the firm’s Tax and Real Estate Investment Trust (REIT) Practice Groups. Mr. Zygielbaum’s practice focuses on international and domestic taxation of corporations, partnerships (including private equity funds), limited liability companies, REITs and their debt and equity investors. He advises clients on tax planning for fund formations and corporate and real estate acquisitions, dispositions, reorganizations and joint ventures. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.50 credit hours, of which 1.50 credit hours may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. This program has been approved for credit in accordance with the requirements of the Texas State Bar for a maximum of 1.50 credit hours, of which 1.50 credit hour may be applied toward the area of accredited general requirement. Attorneys seeking Texas credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.50 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

October 22, 2018 |
IRS Provides Much Needed Guidance on Opportunity Zones through Issuance of Proposed Regulations

Click for PDF On October 19, 2018, the Internal Revenue Service (the “IRS“) and the Treasury Department issued proposed regulations (the “Proposed Regulations“) providing rules regarding the establishment and operation of “qualified opportunity funds” and their investment in “opportunity zones.”[1]  The Proposed Regulations address many open questions with respect to qualified opportunity funds, while expressly providing in the preamble that additional guidance will be forthcoming to address issues not resolved by the Proposed Regulations.  The Proposed Regulations should provide investors, sponsors and developers with the answers needed to move forward with projects in opportunity zones. Opportunity Zones Qualified opportunity funds were created as part of the tax law signed into law in December 2017 (commonly known as the Tax Cuts and Jobs Act (“TCJA“)) to incentivize private investment in economically underperforming areas by providing tax benefits for investments through qualified opportunity funds in opportunity zones.  Opportunity zones are low-income communities that were designated by each of the States as qualified opportunity zones – as of this writing, all opportunity zones have been designated, and each designation remains in effect from the date of designation until the end of the tenth year after such designation. Investments in qualified opportunity funds can qualify for three principal tax benefits: (i) a temporary deferral of capital gains that are reinvested in a qualified opportunity fund, (ii) a partial exclusion of those reinvested capital gains on a sliding scale and (iii) a permanent exclusion of all gains realized on an investment in a qualified opportunity fund that is held for a ten-year period. In general, all capital gains realized by a person that are reinvested within 180 days of the recognition of such gain in a qualified opportunity fund for which an election is made are deferred for U.S. federal income tax purposes until the earlier of (i) the date on which such investment is sold or exchanged and (ii) December 31, 2026. In addition, an investor’s tax basis in a qualified opportunity fund for purposes of determining gain or loss, is increased by 10 percent of the amount of gain deferred if the investment is held for five years prior to December 31, 2026 and is increased by an additional 5 percent (for a total increase of 15 percent) of the amount of gain deferred if the investment is held for seven years prior to December 31, 2026. Finally, for investments in a qualified opportunity fund that are attributable to reinvested capital gains and held for at least 10 years, the basis of such investment is increased to the fair market value of the investment on the date of the sale or exchange of such investment, effectively eliminating any gain (other than the deferred gain that was reinvested in the qualified opportunity fund and taxable or excluded as described above) in the investment for U.S. federal income tax purposes (such benefit, the “Ten Year Benefit“). A qualified opportunity fund, in general terms, is a corporation or partnership that invests at least 90 percent of its assets in “qualified opportunity zone property,” which is defined under the TCJA as “qualified opportunity zone business property,” “qualified opportunity zone stock” and “qualified opportunity zone partnership interests.”  Qualified opportunity zone business property is tangible property used in a trade or business within an opportunity zone if, among other requirements, (i) the property is acquired by the qualified opportunity fund by purchase, after December 31, 2017, from an unrelated person, (ii) either the original use of the property in the opportunity zone commences with the qualified opportunity fund or the qualified opportunity fund “substantially improves” the property by doubling the basis of the property over any 30 month period after the property is acquired and (iii) substantially all of the use of the property is within an opportunity zone.  Essentially, qualified opportunity zone stock and qualified opportunity zone partnership interests are stock or interests in a corporation or partnership acquired in a primary issuance for cash after December 31, 2017 and where “substantially all” of the tangible property, whether leased or owned, of the corporation or partnership is qualified opportunity zone business property. The Proposed Regulations – Summary and Observations The powerful tax incentives provided by opportunity zones attracted substantial interest from investors and the real estate community, but many unresolved questions have prevented some taxpayers from availing themselves of the benefits of the law.  A few highlights from the Proposed Regulations, as well as certain issues that were not resolved, are outlined below. Capital Gains The language of the TCJA left open the possibility that both capital gains and ordinary gains (e.g., dealer income) could qualify for deferral if invested in a qualified opportunity fund.  The Proposed Regulations provide that only capital gains, whether short-term or long-term, qualify for deferral if invested in a qualified opportunity fund and further provide that when recognized, any deferred gain will retain its original character as short-term or long-term. Taxpayer Entitled to Deferral The Proposed Regulations make clear that if a partnership recognizes capital gains, then the partnership, and if the partnership does not so elect, the partners, may elect to defer such capital gains.  In addition, the Proposed Regulations provide that in measuring the 180-day period by which capital gains need to be invested in a qualified opportunity fund, the 180-day period for a partner begins on the last day of the partnership’s taxable year in which the gain is recognized, or if a partner elects, the date the partnership recognized the gain.  The Proposed Regulations also state that rules analogous to the partnership rules apply to other pass-through entities, such as S corporations. Ten Year Benefit The Ten Year Benefit attributable to investments in qualified opportunity funds will be realized only if the investment is held for 10 years.  Because all designations of qualified opportunity zones under the TCJA automatically expire no later than December 31, 2028, there was some uncertainly as to whether the Ten Year Benefit applied to investments disposed of after that date.  The Proposed Regulations expressly provide that the Ten Year Benefit rule applies to investments disposed of prior to January 1, 2048. Qualified Opportunity Funds The Proposed Regulations generally provide that a qualified opportunity fund is required to be classified as a corporation or partnership for U.S. federal income tax purposes, must be created or organized in one of the 50 States, the District of Columbia, or, in certain cases a U.S. possession, and will be entitled to self-certify its qualification to be a qualified opportunity fund on an IRS Form 8996, a draft form of which was issued contemporaneously with the issuance of the Proposed Regulations. Substantial Improvements Existing buildings in qualified opportunity zones generally will qualify as qualified opportunity zone business property only if the building is substantially improved, which requires the tax basis of the building to be doubled in any 30-month period after the property is acquired.  In very helpful rule for the real estate community, the Proposed Regulations provide that, in determining whether a building has been substantially improved, any basis attributable to land will not be taken into account.  This rule will allow major renovation projects to qualify for qualified opportunity zone tax benefits, rather than just ground up development.  This rule will also place a premium on taxpayers’ ability to sustain a challenge to an allocation of purchase price to land versus improvements. Ownership of Qualified Opportunity Zone Business Property In order for a fund to qualify as a qualified opportunity fund, at least 90 percent of the fund’s assets must be invested in qualified opportunity zone property, which includes qualified opportunity zone business property.  For shares or interests in a corporation or partnership to qualify as qualified opportunity zone stock or a qualified opportunity zone partnership interest, “substantially all” of the corporation’s or partnership’s assets must be comprised of qualified opportunity zone business property. In a very helpful rule, the Proposed Regulations provide that cash and other working capital assets held for up to 31 months will count as qualified opportunity zone business property, so long as (i) the cash and other working capital assets are held for the acquisition, construction and/or or substantial improvement of tangible property in an opportunity zone, (ii) there is a written plan that identifies the cash and other working capital as held for such purposes, and (iii) the cash and other working capital assets are expended in a manner substantially consistent with that plan. In addition, the Proposed Regulations provide that for purposes of determining whether “substantially all” of a corporation’s or partnership’s tangible property is qualified opportunity zone business property, only 70 percent of the tangible property owned or leased by the corporation or partnership in its trade or business must be qualified opportunity zone business property. Qualified Opportunity Funds Organized as Tax Partnerships Under general partnership tax principles, when a partnership borrows money, the partners are treated as contributing money to the partnership for purposes of determining their tax basis in their partnership interest.  As a result of this rule, there was uncertainty regarding whether investments by a qualified opportunity fund that were funded with debt would result in a partner being treated, in respect of the deemed contribution of money attributable to such debt, as making a contribution to the partnership that was not in respect of reinvested capital gains and, thus, resulting in a portion of such partner’s investment in the qualified opportunity fund failing to qualify for the Ten Year Benefit.  The Proposed Regulations expressly provide that debt incurred by a qualified opportunity fund will not impact the portion of a partner’s investment in the qualified opportunity fund that qualifies for the Ten Year Benefit. The Proposed Regulations did not address many of the other open issues with respect to qualified opportunity funds organized as partnerships, including whether investors are treated as having sold a portion of their interest in a qualified opportunity fund and thus can enjoy the Ten Year Benefit if a qualified opportunity fund treated as a partnership and holding multiple investments disposes of one or more (but not all) of its investments.  Accordingly, until further guidance is issued, we expect to see most qualified opportunity funds organized as single asset corporations or partnerships. Effective Date In general, taxpayers are permitted to rely upon the Proposed Regulations so long as they apply the Proposed Regulations in their entirety and in a consistent manner.    [1]   Prop. Treas. Reg. §1.1400Z-2 (REG-115420-18). 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 following authors: Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com) Paul S. Issler – Los Angeles (+1 213-229-7763, pissler@gibsondunn.com) Daniel A. Zygielbaum – New York (+1 202-887-3768, dzygielbaum@gibsondunn.com) Please also feel free to contact any of the following leaders and members of the Tax practice group: Jeffrey M. Trinklein – Co-Chair, London/New York (+44 (0)20 7071 4224 / +1 212-351-2344), jtrinklein@gibsondunn.com) David Sinak – Co-Chair, Dallas (+1 214-698-3107, dsinak@gibsondunn.com) David B. Rosenauer – New York (+1 212-351-3853, drosenauer@gibsondunn.com) Eric B. Sloan – New York (+1 212-351-2340, esloan@gibsondunn.com) Romina Weiss – New York (+1 212-351-3929, rweiss@gibsondunn.com) Benjamin Rippeon – Washington, D.C. (+1 202-955-8265, brippeon@gibsondunn.com) Hatef Behnia – Los Angeles (+1 213-229-7534, hbehnia@gibsondunn.com) Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com) Scott Knutson – Orange County (+1 949-451-3961, sknutson@gibsondunn.com) © 2018 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 10, 2018 |
Why We Think the UK Is Heading for a “Soft Brexit”

Click for PDF Our discussions with politicians, civil servants, journalists and other commentators lead us to believe that the most likely outcome of the Brexit negotiations is that a deal will be agreed at the “softer” end of the spectrum, that the Conservative Government will survive and that Theresa May will remain as Prime Minister at least until a Brexit deal is agreed (although perhaps not thereafter).  There is certainly a risk of a chaotic or “hard” Brexit.  On the EU side, September’s summit in Salzburg demonstrated the possibility of unexpected outcomes.  And in the UK, the splits in the ruling Conservative Party and the support it relies upon from the DUP (the Northern Irish party that supports the Government) could in theory result in the ousting of Prime Minister May, which would likely lead to an extension of the Brexit deadline of 29 March 2019.  However, for the reasons set out below we believe a hard or chaotic Brexit is now less likely than more likely. Some background to the negotiations can be found here.  It should be noted that any legally binding deal will be limited to the terms of the UK’s departure from the EU (“the Withdrawal Agreement”) and will not cover the future trading relationship.  But there will be a political statement of intent on the future trading relationship (“the Future Framework”) that will then be subject to further detailed negotiation. There is a European Council meeting on 17/18 October although it is not expected that a final agreement will be reached by then.  However, the current expectation is that a special meeting of the European Council will take place in November (probably over a weekend) to finalise both the Withdrawal Agreement and the Future Framework. Whatever deal Theresa May finally agrees with the EU needs to be approved by the UK Parliament.  A debate and vote will likely take place within two or three weeks of a deal being agreed – so late November or early December.  If Parliament rejects the deal the perceived wisdom is that the ensuing political crisis could only be resolved either by another referendum or a general election. However: the strongest Brexiteers do not want to risk a second referendum in case they lose; the ruling Conservative Party do not want to risk a general election which may result in it losing power and Jeremy Corbyn becoming Prime Minister; and Parliament is unlikely to allow the UK to leave without a deal. As a result we believe that Prime Minister May has more flexibility to compromise with the EU than the political noise would suggest and that, however much they dislike the eventual deal, ardent Brexiteers will likely support it in Parliament.  This is because it will mean the UK has formally left the EU and the Brexiteers live to fight another day. The UK’s current proposal (the so-called “Chequers Proposal”) is likely to be diluted further in favour of the EU, but as long as the final deal results in a formal departure of the UK from the EU in March 2019, we believe Parliament is more likely than not to support it, however unsatisfactory it is to the Brexiteers. The key battleground is whether the UK should remain in a Customs Union beyond a long stop date for a transitional period.  The UK Government proposes a free trade agreement in goods but not services, with restrictions on free movement and the ability for the UK to strike its own free trade deals.  This has been rejected by the EU on the grounds that it seeks to separate services from goods which is inconsistent with the single market and breaches one of the fundamental EU principles of free movement of people.  The Chequers Proposal is unlikely to survive in its current form but the EU has acknowledged that it creates the basis for the start of a negotiation. There has also been discussion of a “Canada style” free-trade agreement, which is supported by the ardent Brexiteers but rejected by the UK Government because it would require checks on goods travelling across borders.  This would create a “hard border” in Northern Ireland which breaches the Good Friday Agreement and would not be accepted by any of the major UK political parties or the EU.  The consequential friction at the borders is also unattractive to businesses that operate on a “just in time” basis – particularly the car manufacturers.  The EU has suggested there could instead be regulatory alignment between Northern Ireland and the EU, but this has been accepted as unworkable because it would create a split within the UK and is unacceptable to the DUP, the Northern Ireland party whose support of the Conservatives in Parliament is critical to their survival.  This is the area of greatest risk but it remains the case that a “no deal” scenario would guarantee a hard border in Ireland. If no deal is reached by 21 January 2019 the Prime Minister is required to make a statement to MPs.  The Government would then have 14 days to decide how to proceed, and the House of Commons would be given the opportunity to vote on these alternate plans.  Although any motion to reject the Government’s proposal would not be legally binding, it would very likely catalyse the opposition and lead to an early general election or a second referendum.  In any of those circumstances, the EU has already signalled that it would be prepared to grant an extension to the Article 50 period. This client alert was prepared by London partners Charlie Geffen and Nicholas Aleksander and of counsel Anne MacPherson. We have a working group in London (led by Nicholas Aleksander, Patrick Doris, Charlie Geffen, Ali Nikpay and Selina Sagayam) addressing Brexit related issues.  Please feel free to contact any member of the working group or any of the other lawyers mentioned below. Ali Nikpay – Antitrust ANikpay@gibsondunn.com Tel: 020 7071 4273 Charlie Geffen – Corporate CGeffen@gibsondunn.com Tel: 020 7071 4225 Nicholas Aleksander – Tax NAleksander@gibsondunn.com Tel: 020 7071 4232 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 Thomas M. Budd – Finance TBudd@gibsondunn.com Tel:  020 7071 4234 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 © 2018 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 3, 2018 |
The 100 Percent Tax-Exempt Use Property Trap: Funds Beware

Dallas associate Michael Cannon is the author of “The 100 Percent Tax-Exempt Use Property Trap: Funds Beware” [PDF] published in Tax Notes on September 3, 2018.

August 30, 2018 |
IRS Issues Initial Selective Guidance on New Section 162(m) Provisions, including Transition Rules

Click for PDF On August 21, 2018, the IRS released Notice 2018-68, which provides initial guidance regarding changes made to Section 162(m) of the Internal Revenue Code (“Section 162(m)”) by last year’s Tax Cuts and Jobs Act (the “Act”). Since 1993, Section 162(m) has imposed a limit on federal income tax deductibility by publicly traded corporations for compensation paid to certain senior executives—generally the same executives whose compensation is disclosed in the corporation’s proxy statement, who are referred to under Section 162(m) as “covered employees”.  Section 162(m) has not imposed material increased tax costs on most publicly traded corporations since its enactment, probably mostly due to the exception for “performance-based compensation”—which includes cash bonuses, stock options, performance stock and similar awards— and the exclusion for amounts paid after termination of employment (such as deferred compensation and severance), at the same time that executive pay has increased significantly because of grants of cash and stock awards based on performance. The Act amends Section 162(m) in a number of substantial ways to expand the scope of coverage and limit the exceptions for compensation subject to its deduction limit.  The general view is that these amendments were part of a much broader effort to find ways to limit the federal government’s revenue loss resulting from the Act’s dramatic decrease in overall corporate income tax rates, with the maximum rate dropping from 35 to 21 percent.  The Act, among other things, (1) includes a public corporation’s Chief Financial Officer as a “covered employee” (which was the case prior to changes in the proxy reporting rules in 2009), (2) provides that once an executive becomes a “covered employee”, that executive remains a “covered employee” in perpetuity, (3) eliminates the current exception from the $1 million deductibility limit for “performance-based compensation”, and (4) applies the limit even for amounts paid after termination of employment. The Act generally becomes effective for a public corporation’s tax year beginning in 2018.  As part of the transition to the new law, the Act contains an exemption from the new law for “written binding contracts” in effect on November 2, 2017 (the date that the bill was introduced in the House of Representatives).  Specifically, the Act states that the changes to Section 162(m) “shall not apply to remuneration which is provided pursuant to a written binding contract which was in effect on November 2, 2017, and which was not modified in any material respect on or after such date.”  In other words, the pre-Act Section 162(m) rules generally continue to apply to these arrangements.  Notice 2018-68 is intended to answer some of the many questions raised by taxpayers, particularly with respect to the changes in the definition of “covered employee” and the application of the transition rule (also referred to as the “grandfather rules”). Who is considered a “covered employee?” Under the Act, a “covered employee” means any employee who is a principal executive officer (PEO) or principal financial officer (PFO) of a publicly held corporation or was an individual acting in that capacity at any time during the tax year . It also includes any additional employees whose total compensation for the applicable tax year places that employee among the three-highest compensated officers of the taxable year. At first glance, the definition looks like it covers the same group of executives whose compensation is subject to disclosure under federal securities laws in a publicly traded corporation’s proxy statement.  However, the Notice clarifies that there is no “end of year” requirement for determining the three highest compensated executives who did not serve during the year as PEO or PFO, which means that an executive officer can be a “covered employee” under Section 162(m) even if his or her compensation is not required to be disclosed in the corporation’s Summary Compensation Table under the rules of the Securities and Exchange Commission (“SEC”). The Notice provides an example where a corporation’s three most highly-compensated executives other than the PFO and PEO all terminated employment during the applicable taxable year.  In that instance, even though one of those individuals would not be considered a “named executive officer” under SEC rules, all three are considered “covered employees” under the new rules. Additionally, since the IRS will disregard the limited disclosure rules under the securities laws for smaller reporting companies and emerging growth companies for Section 162(m) purposes, those companies will find that they will need to calculate total compensation for more executives for purposes of Section 162(m) than is needed to satisfy the reporting requirements under the SEC’s rules. The Act also expands the definition of “covered employee” such that once an executive is a covered employee in any taxable year beginning after December 31, 2016, that status is retained forever and therefore covers all compensation paid to the executive for the remainder of his or her life, including compensation paid after the executive’s termination of employment (and even if it is paid to a beneficiary or heir after the executive’s death).  Prior law provided that an executive would cease to be a “covered employee” after his or her departure from the corporation, and therefore compensation paid after the executive was no longer a “covered employee” was not subject to Section 162(m). The IRS has provided a few examples to illustrate these changes. While the IRS has requested comments on how the rules should be applied to a corporation whose taxable year ends on a different date than its last completed fiscal year, the working principle that it has adopted in one of the examples is that if the corporation has a short tax year of less than 12 calendar months, the calculations to determine who is a “covered employee” will need to be completed independently for the short year. What constitutes compensation paid under a written binding contract? In general, compensation is considered as paid, or payable, under a written binding contract only to the extent that the corporation is obligated to pay the compensation under applicable law. Unless an agreement is renewed or modified, any compensatory payments made pursuant to such a written binding contract that was in effect on November 2, 2017, and that would have not been subject to the deduction limitation under Section 162(m) as it existed before the Act, are not subject to the deductibility limitation under the new rules.  The Notice emphasizes that in the case of executive employment agreements, even those with automatic renewal provisions, payments made under the agreement will generally be subject to the new law at the time that the contract is renewed or extended. Under prior law, “performance-based compensation” did not lose its exemption if the compensation committee of the board of directors of the corporation decided to unilaterally reduce the amount, which was called “negative discretion”.  The Notice provides an example clarifying that to the extent an agreement or plan allows for a corporation to exercise this negative discretion with respect to performance-based compensation under a pre-November 3, 2017 written binding contract, the corporation may only deduct the amount that is not subject to such discretion.  This example implies that where a corporation had a right to reduce performance-based compensation to zero regardless of actual performance, no portion of the compensation would be considered grandfathered for purposes of the Act.  However, this example, and the underlying reasoning, should not apply to plans or agreements by which negative discretion is exercised by establishing the actual performance goals to be achieved, which have been referred to as “umbrella plans” or a “plan within a plan”, so long as the actual goals were established on or before November 2, 2017.  Of course, this arrangement will only be grandfathered for as long as those pre-established goals remain in effect.  In addition, whether there was a right to reduce compensation payable presumably would have to be determined under applicable state law.  For example, if a plan includes a negative discretion right that the company has never exercised, this practice may mean that there is no actual negative discretion for state contract law purposes. The Notice also provides some examples clarifying that payments made pursuant to non-qualified deferred compensation programs in effect on November 2, 2017 will be grandfathered to the extent the corporation cannot unilaterally freeze or reduce future contributions.  Since in our experience most non-qualified deferred compensation plans contain provisions that allow the plan sponsor to amend or terminate those plans with few restrictions, these examples send a signal that those public corporations with non-qualified deferred compensation arrangements may need to reach out to the plan administrators to make sure that benefits as of November 2, 2017 are being calculated for future use, since for those sorts of plans, that may well be the only eligible benefit not subject to the new rules. What is considered a material modification? An agreement will be considered materially modified (and thus no longer eligible for grandfather treatment under the Act) if the agreement is amended to (1) increase the amount of compensation paid (other than in an amount equal to or less than a cost-of-living increase), (2) accelerate the payment of compensation without a time-value discount, (3) defer the payment of compensation, except to the extent any increase in the value of the deferred amount is based on either a reasonable rate of interest or a predetermined actual investment, or (4) make payments on the basis of substantially the same elements or conditions as the compensation payable pursuant to such agreement. The Notice contains an example in which a covered employee who has a grandfathered employment agreement providing for the payment of a fixed salary receives a restricted stock grant after November 2, 2017.  The example states that the grant of restricted stock is not a material modification because the stock grant is not paid on “substantially the same elements or conditions” as the salary.  (However, any payments under the stock grant itself will be subject to the new law.) To the extent an agreement is considered materially modified, all amounts received under the agreement after the effective date of such modification will be subject to the new rules, while the amounts received prior to the modification will remain protected under the grandfather rules. Does the Act impact renewable agreements? An agreement that is renewed after November 2, 2017 will be no longer be protected by the grandfather rules. An agreement is considered renewed on the date the agreement can be terminated by the corporation. An agreement is not considered renewable if it can only be terminated either (1) by the employee or (2) by having to terminate not only the agreement, but also the employee’s employment with the corporation. How should public corporations proceed? The changes to Section 162(m) made by the Act will result in large losses of tax deductions for compensation paid to executives classified as “covered employees”.  Based on the guidance issued in the Notice, the IRS has indicated that it intends to interpret the statute and the transition rule in ways that are intended to maximize the amount of compensation that will be subject to the new rules.  In particular, the Notice and its examples indicate that the IRS plans to interpret the “written binding contract” transition rule narrowly. When determining if an agreement is a “written binding contract,” we recommend consulting with counsel since the assessment of whether an agreement is required to be paid under applicable law will require analysis of applicable state law. We recommend that public corporations subject to Section 162(m) take careful inventory of all outstanding plans, agreements and arrangements that were in place on or before November 2, 2017 with one or more executives who are “covered employees”.  These arrangements should be reviewed to determine if and to what extent the grandfather rules can be relied upon.  In the case of deferred compensation, corporations should determine the amounts attributable to each participant who is or may become a “covered employee” that were accrued on or before November 2, 2017.  Such amounts will remain deductible when paid to the extent that they would have been deductible under the prior rules.  In some cases, coordination with plan administrators will be necessary.  Additionally, corporations should consider the potential tax impact of the new law and the IRS’s interpretive guidance prior to making any changes to plans or agreements in effect as of November 2, 2017. This Client Alert necessarily only scratches the surface of this complex topic.  Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues.  Please contact the Gibson Dunn lawyer with whom you usually work, or the following authors: Stephen W. Fackler – Palo Alto/New York (+1 650-849-5385/+1 212-351-2392, sfackler@gibsondunn.com) Michael J. Collins – Washington, D.C. (+1 202-887-3551, mcollins@gibsondunn.com) Sean C. Feller – Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com) Arsineh Ananian – Los Angeles (+1 213-229-7764, aananian@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 7, 2018 |
Eric Sloan Selected as American Bar Association Tax Section Vice Chair

New York partner Eric Sloan was appointed to a two-year term as Vice Chair – Government Relations for the Tax Section of the American Bar Association. Working together with other leaders of the ABA Tax Section, Sloan will be responsible for the Tax Section’s relationship with the government. His principle focus will be submitting comment letters to assist the Treasury Department in administering tax laws, particularly identifying and addressing the numerous issues arising from the enactment of the 2017 Tax Act.

August 1, 2018 |
Who’s Who Legal Recognizes Nine Gibson Dunn Partners

Nine Gibson Dunn partners were recognized by Who’s Who Legal in their respective fields. In Who’s Who Legal Corporate Tax 2018, three partners were recognized: Sandy Bhogal (London), Hatef Behnia (Los Angeles) and Eric Sloan (New York). In the 2018 Who’s Who Legal Project Finance guide, two partners were recognized: Michael Darden (Houston) and Tomer Pinkusiewicz (New York). In the Who’s Who Legal Labour, Employment & Benefits 2018 guide, two partners were recognized: William Kilberg (Washington, D.C.) and Eugene Scalia (Washington, D.C.). Two partners were recognized by Who’s Who Legal Patents 2018: Josh Krevitt (New York) and William Rooklidge (Orange County). These guides were published in July and August of 2018.

July 13, 2018 |
The Impact on MNCs

London partner Sandy Bhogal is the author of “The Impact on MNCs” [PDF] published in Tax Journal on July 13, 2018.

July 12, 2018 |
The Politics of Brexit for those Outside the UK

Click for PDF Following the widely reported Cabinet meeting at Chequers, the Prime Minister’s country residence, on Friday 6 June 2018, the UK Government has now published its “White Paper” setting out its negotiating position with the EU.  A copy of the White Paper can be found here. The long-delayed White Paper centres around a free trade area for goods, based on a common rulebook.  The ancillary customs arrangement plan, in which the UK would collects tariffs on behalf of the EU, would then “enable the UK to control its own tariffs for trade with the rest of the world”.  However, the Government’s previous “mutual recognition plan” for financial services has been abandoned; instead the White Paper proposes a looser partnership under the framework of the EU’s existing equivalence regime. The responses to the White Paper encapsulate the difficulties of this process.  Eurosceptics remain unhappy that the Government’s position is far too close to a “Soft Brexit” and have threatened to rebel against the proposed customs scheme; Remainers are upset that services (which represent 79% of the UK’s GDP) are excluded. The full detail of the 98-page White Paper is less important at this stage than the negotiating dynamics.  Assuming both the UK and the EU want a deal, which is likely to be the case, M&A practitioners will be familiar with the concept that the stronger party, here the EU, will want to push the weaker party, the UK, as close to the edge as possible without tipping them over.  In that sense the UK has, perhaps inadvertently, somewhat strengthened its negotiating position – albeit in a fragile way. The rules of the UK political game In the UK the principle of separation of powers is strong as far as the independence of the judiciary is concerned.  In January 2017 the UK Supreme Court decided that the Prime Minister could not trigger the Brexit process without the authority of an express Act of Parliament. However, unlike the United States and other presidential systems, there is virtually no separation of powers between legislature and executive.  Government ministers are always also members of Parliament (both upper and lower houses).  The government of the day is dependent on maintaining the confidence of the House of Commons – and will normally be drawn from the political party with the largest number of seats in the House of Commons.  The Prime Minister will be the person who is the leader of that party. The governing Conservative Party today holds the largest number of seats in the House of Commons, but does not have an overall majority.  The Conservative Government is reliant on a “confidence and supply” agreement with the Northern Ireland Democratic Unionist Party (“DUP”) to give it a working majority. Maintaining an open land border between Northern Ireland and the Republic of Ireland is crucial to maintaining the Good Friday Agreement – which underpins the Irish peace process.  Maintaining an open border between Northern Ireland and the rest of the UK is of fundamental importance to the unionist parties in Northern Ireland – not least the DUP.  Thus, the management of the flow of goods and people across the Irish land border, and between Northern Ireland and the UK, have become critical issues in the Brexit debate and negotiations.  The White Paper’s proposed free trade area for goods would avoid friction at the border. Parliament will have a vote on the final Brexit deal, but if the Government loses that vote then it will almost certainly fall and a General Election will follow – more on this below. In addition, if the Prime Minister does not continue to have the support of her party, she would cease to be leader and be replaced.  Providing the Conservative Party continued to maintain its effective majority in the House of Commons, there would not necessarily be a general election on a change in prime minister (as happened when Margaret Thatcher was replaced by John Major in 1990) The position of the UK Government The UK Cabinet had four prominent campaigners for Brexit: David Davis (Secretary for Exiting the EU), Boris Johnson (Foreign Secretary), Michael Gove (Environment and Agriculture Secretary) and Liam Fox (Secretary for International Trade).  David Davis and Boris Johnson have both resigned in protest after the Chequers meeting but, so far, Michael Gove and Liam Fox have stayed in the Cabinet.  To that extent, at least for the moment, the Brexit camp has been split and although the Leave activists are unhappy, they are now weaker and more divided for the reasons described below. The Prime Minister can face a personal vote of confidence if 48 Conservative MPs demand such a vote.  However, she can only be removed if at least 159 of the 316 Conservative MPs then vote against her.  It is currently unlikely that this will happen (although the balance may well change once Brexit has happened – and in the lead up to a general election).  Although more than 48 Conservative MPs would in principle be willing to call a vote of confidence, it is believed that they would not win the subsequent vote to remove her.  If by chance that did happen, then Conservative MPs would select two of their members, who would be put to a vote of Conservative activists.  It is likely that at least one of them would be a strong Leaver, and would win the activists’ vote. The position in Parliament The current view on the maths is as follows: The Conservatives and DUP have 326 MPs out of a total of 650.  It is thought that somewhere between 60 and 80 Conservative MPs might vote against a “Soft Brexit” as currently proposed – and one has to assume it will become softer as negotiations with the EU continue.  The opposition Labour party is equally split.  The Labour leadership of Jeremy Corbyn and John McDonnell are likely to vote against any Brexit deal in order to bring the Government down, irrespective of whether that would lead to the UK crashing out of the EU with no deal.  However it is thought that sufficient opposition MPs would side with the Government in order to vote a “Soft Brexit” through the House of Commons. Once the final position is resolved, whether a “Soft Brexit” or no deal, it is likely that there will be a leadership challenge against Mrs May from within the Conservative Party. The position of the EU So far the EU have been relatively restrained in their public comments, on the basis that they have been waiting to see the detail of the White Paper. The EU has stated on many occasions that the UK cannot “pick and choose” between those parts of the EU Single Market that it likes, and those it does not.  For this reason, the proposals in the White Paper (which do not embrace all of the requirements of the Single Market), are unlikely to be welcomed by the EU.  It is highly likely that the EU will push back on the UK position to some degree, but it is a dangerous game for all sides to risk a “no deal” outcome.  Absent agreement on an extension the UK will leave the EU at 11 pm on 29 March 2019, but any deal will need to be agreed by late autumn 2018 so national parliaments in the EU and UK have time to vote on it. Finally Whatever happens with the EU the further political risk is the possibility that the Conservatives will be punished in any future General Election – allowing the left wing Jeremy Corbyn into power. It is very hard to quantify this risk.  In a recent poll Jeremy Corbyn edged slightly ahead of Theresa May as a preferred Prime Minister, although “Don’t Knows” had a clear majority. This client alert was prepared by London partners Charlie Geffen and Nicholas Aleksander and of counsel Anne MacPherson. We have a working group in London (led by Nicholas Aleksander, Patrick Doris, Charlie Geffen, Ali Nikpay and Selina Sagayam) addressing Brexit related issues.  Please feel free to contact any member of the working group or any of the other lawyers mentioned below. Ali Nikpay – Antitrust ANikpay@gibsondunn.com Tel: 020 7071 4273 Charlie Geffen – Corporate CGeffen@gibsondunn.com Tel: 020 7071 4225 Nicholas Aleksander – Tax NAleksander@gibsondunn.com Tel: 020 7071 4232 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 Thomas M. Budd – Finance TBudd@gibsondunn.com Tel:  020 7071 4234 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 © 2018 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 25, 2018 |
Gibson Dunn Receives Chambers USA Excellence Award

At its annual USA Excellence Awards, Chambers and Partners named Gibson Dunn the winner in the Corporate Crime & Government Investigations category. The awards “reflect notable achievements over the past 12 months, including outstanding work, impressive strategic growth and excellence in client service.” This year the firm was also shortlisted in nine other categories: Antitrust, Energy/Projects: Oil & Gas, Energy/Projects: Power (including Renewables), Intellectual Property (including Patent, Copyright & Trademark), Labor & Employment, Real Estate, Securities and Financial Services Regulation and Tax team categories. Debra Wong Yang was also shortlisted in the individual category of Litigation: White Collar Crime & Government Investigations. The awards were presented on May 24, 2018.  

March 12, 2018 |
Brexit – converting the political deal into a legal deal and the end state

Click for PDF In our client alert of 8 December 2017 we summarised the political deal relating to the terms of withdrawal of the UK from the EU with a two year transition.  It is important to remember that this “Phase 1” deal only relates to the separation terms and not to the future relationship between the UK and the EU post Brexit. In her Mansion House speech on 2 March 2018 UK Prime Minister Theresa May set out Britain’s vision for a future relationship.  The full text of her speech can be found here.  It continues to make it clear that the UK will remain outside the Single Market and Customs Union. On the critical issue of the Irish border, the UK Government’s position remains that a technological solution is available to ensure that there is neither a hard border within Ireland nor a border in the Irish Sea which would divide the UK.  Neither the EU nor Ireland itself accept that a technological solution is workable, and there remain doubts whether such a solution is possible if the UK is outside the EU Customs Union (or something equivalent to a customs union).  The terms of the political deal in December make it clear that, in the absence of an agreed solution on this issue, the UK will maintain full alignment with the rules of the Single Market and Customs Union. The UK’s main opposition party, The Labour Party, has now shifted its position to support the UK remaining in a customs union. The Government is proposing a “customs partnership” which would mirror the EU’s requirements for imports and rules of origin. Theresa May has acknowledged both that access to the markets of the UK and EU will be less than it is today and that the decisions of the CJEU will continue to affect the UK after Brexit. On a future trade agreement, the UK’s position is that it will not accept the rights of Canada and the obligations of Norway and that a “bespoke model” is not the only solution. There is, however, an acknowledgement that, if the UK wants access to the EU’s market, it will need to commit to some areas of regulation such as state aid and anti-trust. Prime Minister May has confirmed that the UK will not engage in a “race to the bottom” in its standards in areas such as worker’s rights and environmental protections, and that there should be a comprehensive system of mutual recognition of regulatory standards. She has also said that there will need to be an independent arbitration mechanism to deal with any disagreements in relation to any future trade agreement. Theresa May has also said that financial services should be part of a deep and comprehensive partnership. The UK will also pay to remain in the European Medicines Agency, the European Chemicals Agency and the European Aviation Safety Agency but will not remain part of the EU’s Digital Single Market. Donald Tusk, the European Council President, has rejected much of the substance of the UK’s position, stating that the only possible arrangement is a free trade agreement excluding the mutual recognition model at the heart of the UK’s proposals.  Crucially, however, he has said that there would be more room for negotiation should the UK’s red lines on the Customs Union and Single Market “evolve”. It is clear that this is an opening position for the two sides in the negotiations and that there is a long history of EU negotiations being settled at the very last minute.  The current timetable envisages clarity on the final terms of the transition and the “end state” by the European Council meeting on 18/19 October 2018. This client alert was prepared by London partners Charlie Geffen and Nicholas Aleksander and of counsel Anne MacPherson. We have a working group in London (led by Nicholas Aleksander, Patrick Doris, Charlie Geffen, Ali Nikpay and Selina Sagayam) that has been considering these issues for many months.  Please feel free to contact any member of the working group or any of the other lawyers mentioned below. Ali Nikpay – Antitrust ANikpay@gibsondunn.com Tel: 020 7071 4273 Charlie Geffen – Corporate CGeffen@gibsondunn.com Tel: 020 7071 4225 Nicholas Aleksander – Tax NAleksander@gibsondunn.com Tel: 020 7071 4232 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 Thomas M. Budd – Finance TBudd@gibsondunn.com Tel:  020 7071 4234 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 © 2018 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 31, 2018 |
IRS Issues First “Required Amendments List” for Tax-Qualified Retirement Plans Under New Program

Click for PDF In Revenue Procedure 2016-37 (issued in June 2016), the Internal Revenue Service substantially modified its determination letter program for tax-qualified retirement plans, such as pension plans and 401(k) plans.  (See the Gibson Dunn client alert:  http://www.gibsondunn.com/publications/Pages/IRS–Additional-Guidance–Changes-to-Determination-Letter-Program-for-Qualified-Retirement-Plans.aspx).  In the past, retirement plans would be eligible to submit an application for a determination letter every five years, and adopt “interim amendments” each year based on an IRS-provided list.  A favorable IRS determination letter states that the IRS has concluded that the terms of the retirement plan comply with the tax laws in effect at the time that the letter is issued.  It has the practical effect of preventing the IRS from asserting that the form of the plan does not comply with the extremely complicated tax laws regulating retirement plans, and arguing that as a result, the plan should be disqualified from enjoying the favorable tax treatment for tax-qualified retirement plans under the Internal Revenue Code.  Since one of the consequences of disqualification is the immediate taxation of all vested benefits of every participant in the plan as well as current taxation of all earnings on plan investments, retirement plans have routinely applied to obtain a favorable determination letter every five years.  The IRS letter has been widely viewed as a form of inexpensive insurance against the risk of plan disqualification. The new determination letter program dramatically reduces the number of retirement plans that are eligible to request an individual determination letter from the IRS.  As a general rule, only newly adopted plans and terminating plans may apply for determination letters.  Ongoing retirement plans are basically excluded from requesting this letter.  Thus, many plan sponsors will not have the comfort of an IRS “seal of approval” that a plan continues to be tax-qualified in form. Under the new program, it becomes much more important to follow the IRS’s publication of updated amendments and incorporate them into an ongoing plan in a timely manner.  Under Rev. Proc. 2016-37, the so-called “remedial amendment period” (the period during which legally-required plan amendments must be adopted) runs through the end of the second plan year beginning after the IRS issues its “required amendment list” (the “RA List”).  The IRS recently issued its first RA List under the new program in Notice 2017-72.  Since most tax-qualified retirement plans use the calendar year as their plan year, the amendments set forth in Notice 2017-72 will need to be adopted by a calendar year retirement plan no later than December 31, 2019. This first RA List addresses only three items.  First, and, most broadly applicable, cash balance and other “hybrid” pension plans must be amended to reflect final regulations that were issued in 2014 and 2015 and generally became effective in 2017.  Second, “eligible cooperative plans” and “eligible charity plans” must include provisions restricting benefit distributions in certain circumstances that are applicable pursuant to the Pension Protection Act of 2006.  Third, for defined benefit plans that offer partial annuity options, regulations issued in 2016 must be incorporated to the extent necessary.  Thus, this first RA List has limited applicability.  Among other things, there are no provisions affecting 401(k) and other defined contribution plans. The most important takeaway from Notice 2017-72 is the reminder that the determination letter program has effectively ended for most retirement plans.  This will put more pressure on plan sponsors to ensure plans are timely updated and periodically reviewed by knowledgeable experts.  It can also be expected that plan auditors and acquirors in corporate transactions may seek legal opinions or other comfort that plans are tax-qualified in form since with the passage of time, the last IRS determination letter issued to a plan will become increasingly dated.  Employers who last received a favorable determination letter several years ago also should carefully review whether all prior IRS-required amendments have been adopted, because adopting “interim amendments” and then waiting until the next 5-year determination letter cycle to update plan documents is no longer an option. Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues.  Please contact the Gibson Dunn lawyer with whom you usually work, or the following: Stephen W. Fackler – Palo Alto and New York (+1 650-849-5385 and 212-351-2392, sfackler@gibsondunn.com) Michael J. Collins – Washington, D.C. (+1 202-887-3551, mcollins@gibsondunn.com) Sean C. Feller – Los Angeles (+1 310-551-8746, sfeller@gibsondunn.com) Krista Hanvey – Dallas (+1 214-698-3425; khanvey@gibsondunn.com)  © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.