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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 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.

January 16, 2018 |
The Overhaul of France’s Tax Laws Has Been Enacted -What Will the 2018 Finance Act Change?

Click for PDF On December 21st, 2017, the French Parliament approved the first Finance Laws of Emmanuel Macron’s presidency (the “Finance Act”)[1].  The general objective pursued by the French Parliament through this tax reform is to sustain French economy’s attractiveness and competitiveness and to attract a significant part of the population’s savings into the productive economy and, hence, company stocks. We lay out below some of the key measures of the tax reform, which brings about new opportunities for our international clients.  Such key measures can be summarized as follows: For companies: Progressive reduction of corporate income tax rate from 33 1/3% to 25% as of 2022; Repeal of the 3%-distribution tax; Cancellation of the Carrez interest deduction limitation rule for EU companies. For individuals: Introduction of a 30% “flat tax” on income and gains from capital for individuals; Improvement of the Free Shares social and tax regime; and Narrowing the scope of the wealth tax to real estate assets only. I.     TAXATION OF COMPANIES 1.1     Progressive reduction of the 33 1/3% Corporate Income Tax rate to 25% The Finance Law provides for a gradual decrease of the CIT rate from 33 1/3% to 25% from 2019 to 2022. Fiscal years beginning Applicable CIT rates 2019 31% (28% below €500,000) 2020 28% 2021 26.5% 2022 25% In 2022, the effective rate will be as low as 25.8% (including the 3.3% social surcharge which will continue to apply to the CIT for profit in excess of €2,289,000[2]). 1.2     Repeal of the 3%-distribution tax Since 2012, a 3%-tax is due by French companies on their dividend distributions (in addition to the CIT applicable on their taxable profits). Following several court decisions challenging the legality of such tax[3], the tax is repealed for dividends paid as from January 1, 2018. However, the French Parliament has approved an exceptional contribution on profits in order to finance the reimbursement of the 3%-tax refund claims (amounting to c. € 10 billions) filed by taxpayers.  The rate of such exceptional contribution depends on the companies’ turnover.  Less than 300 companies should be impacted by such temporary rate increase.  In practice, for financial years opened in 2017 only: Companies whose turnover exceeds €1 billion will be subject to an effective CIT rate of 39.5%; Companies whose turnover exceeds €3 billion will be subject to an effective CIT rate of 44.5%. 1.3     Cancellation of the Carrez rule on interest deduction limitations for EU companies Applicable to financial years starting on or after January 1st, 2012, the Carrez rule disallows the deduction of financial expenses related to the acquisition of shares in subsidiaries for an eight-year period if the holding companies are unable to demonstrate: that they effectively take the decisions regarding their subsidiaries in France; and that they effectively exercise control or influence over the acquired subsidiaries from France. The purpose of this rule is to prevent the artificial allocation of debt in France where French companies controlled by non-French investors would be interposed to acquire shares of French or foreign subsidiaries. Due to the potential incompatibility of such provision with the European Union freedom of establishment principle, the Finance Law repeals the Carrez rule for the years ended as of December 31st, 2017, where the decisions, control or influence are made by EU holding companies.  On the other hand, the Carrez rule continues to apply if such decisions and control or influence are made by non-EU companies.  Such a situation could raise a discrimination issue with respect to French companies held by shareholders based in States having entered into a tax treaty with France containing a non-discrimination clause (such as the France/US tax treaty). 2.     TAXATION OF INDIVIDUALS 2.1     Introduction of a 30% flat tax on income and gains from capital as from January 1st, 2018 The Finance Law introduces a flat rate on personal income tax of 30% on investment income (such as interest and dividends) and on capital gains on shares of non-real estate companies/entities (vs. a marginal rate that could be as high as 60.5% for prior years).  A 3% to 4% additional contribution continues to apply for high income earners (above €500,000 for single or €1,000,000 for couples). 2.2     Reform of the Free Shares regime Regarding Free Shares and up to K€ 300 of acquisition gain (equal to the fair market value of the shares on the date of vesting), such gain will be taxed at the graduated scale of income tax rates after the application of a 50% rebate.  Unlike the previous regime, the benefit of such rebate is not subject to a minimal holding period of the shares.  In practice, such gain will most generally be taxed at the rate of 22.5%, plus social contributions at the rate of 17.2%, i.e. 39.7%. Above K€ 300, the acquisition gain remains taxed at the graduated scale of income tax rates (up to 45%, plus, if applicable the 3% to 4% additional contribution for high income earners) without any rebate and a 10% employee social contribution continues to apply to such gain. On the other hand, the rate of the 30% social contribution due by the employer (which applies from the first euro of acquisition gain) is reduced to 20%. The new Free Share regime applies to Free Shares attributed pursuant to Free Shares plans approved by AGM held after December 31st, 2017. 2.3     Wealth tax’s scope narrowed to real estate assets only Starting on January 1st, 2018, the French Impôt de Solidarité sur la Fortune will be replaced by the Impôt sur la Fortune Immobilière (“IFI”). In comparison with the former wealth tax, the taxable basis of the IFI is narrowed to real estate assets and property rights only.  It also includes securities of companies or entities owned by the taxpayer up to the fraction of the real estate assets held directly or indirectly by such entities (except if such assets are used for business purposes such as for commercial, industrial or hotel activities).  Most tax treaties concluded by France with foreign states should generally prevent such transparency rule to apply as far as non-(French) tax residents are concerned (except where more than 50% of the value of the company is derived from French real estate assets). Units or shares of OPCVM, investment funds or investment companies with fixed capital (Société d’Investissement à Capital Fixe, SICAF) holding real estate or property rights will be excluded from the new taxable basis if the taxpayer holds less than 10% of rights and if the assets of the fund are composed for less than 20% of real property rights.  Moreover, shares of listed real estate investment companies (SIIC) will be exempt from the tax if the taxpayer holds less than 5% of the share capital of the SIIC. Several anti-abuse provisions have been inserted in order to disallow or minimize the deductibility of back-to-back family financings or bullet loans entered into by taxpayers.  In addition, when the value of the taxable real estate assets is greater than € 5 million and the amount of deductible debt of the taxpayer exceeds 60% of this value, only 50% of the fraction of the debts exceeding this limit is deductible. The IFI threshold remains set at €1,300,000 and the tax brackets and rates are the same as for the former wealth tax. Portion of the net taxable value of the estate Rate (in percentage) Not exceeding €800,000 0 Above €800,000 and below or equal to €1,300,000 0.50 Above €1,300,000 and below or equal to €2,570,000 0.70 Above €2,570,000 and below or equal to €5,000,000 1 Above €5,000,000 and below or equal to €10,000,000 1.25 Above €10,000,000 1.50   [1]   2018 Finance Law n° 2017-1837 of December 30th, 2017 [2]   Effective rates would therefore be respectively 32% (28.9% below €500,000) in 2019, 28.9% in 2020 and 27.4% in 2021 for profit in excess of €2,289,000. [3]   ECJ May 17, 2017, AFEP, C-365/16 ; French Constitutional Court Decision n°2017-660 QPC October 6, 2017, Société de participations financière. 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 authors, Jérôme Delaurière, Ariel Harroch and Jeffrey M. Trinklein. Jérôme Delaurière – Paris (+33 (0)1 56 43 13 00, jdelauriere@gibsondunn.com Ariel Harroch – Paris (+33 (0)1 56 43 13 01, aharroch@gibsondunn.com) Jeffrey M. Trinklein – London/New York (+44 (0)20 7071 4224/+1 212-351-2344), jtrinklein@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.

January 7, 2018 |
2017 Year-End German Law Update

Click for PDF “May you live in interesting times” goes the old Chinese proverb, which is not meant for a friend but for an enemy. Whoever expressed such wish, interesting times have certainly come to pass for the German economy. Germany is an economic giant focused on the export of its sophisticated manufactured goods to the world’s leading markets, but it is also, in some ways, a military dwarf in a third-tier role in the re-sketching of the new world order. Germany’s globally admired engineering know-how and reputation has been severely damaged by the Volkswagen scandal and is structurally challenged by disruptive technologies and regulatory changes that may be calling for the end of the era of internal combustion engines. The top item on Germany’s foreign policy agenda, the further integration of the EU-member states into a powerful economic and political union, has for some years now given rise to daily crisis management, first caused by the financial crisis and, since last year, by the uncertainties of BREXIT. As if this was not enough, internal politics is still handling the social integration of more than a million refugees that entered the country in 2015, who rightly expect fair and just treatment, education, medical care and a future. It has been best practice to address such manifold issues with a strong and hands-on government, but – unfortunately – this is also currently missing. While the acting government is doing its best to handle the day-to-day tasks, one should not expect any bold move or strategic initiative before a stable, yet to be negotiated parliamentary coalition majority has installed new leadership, likely again under Angela Merkel. All that will drag well into 2018 and will not make life any easier. In stark contrast to the difficult situation the EU is facing in light of BREXIT, the single most impacting piece of regulation that will come into effect in May 2018 will be a European Regulation, the General Data Protection Regulation, which will harmonize data protection law across the EU and start a new era of data protection. Because of its broad scope and its extensive extraterritorial reach, combined with onerous penalties for non-compliance, it will open a new chapter in the way companies world-wide have to treat and process personal data. In all other areas of the law, we observe the continuation of a drive towards ever more transparency, whether through the introduction of new transparency registers disclosing relevant ultimate beneficial owner information or misconduct, through obligatory disclosure regimes (in the field of tax law), or through the automatic exchange under the OECD’s Common Reporting Standard of Information that hitherto fell under the protection of bank secrecy laws. While all these initiatives are well intentioned, they present formidable challenges for companies to comply with the increased complexity and adequately respond to the increased availability and flow of sensitive information. Even more powerful than the regulatory push is the combination of cyber-attacks, investigative journalism, and social media: within a heartbeat, companies or individuals may find themselves exposed on a global scale to severe allegations or fundamental challenges to the way they did or do business. While this trend is not of a legal nature, but a consequence of how we now communicate and whom we trust (or distrust), for those affected it may have immediate legal implications that are often highly complex and difficult to control and deal with. Interesting times usually are good times for lawyers that are determined to solve problems and tackle issues. This is what we love doing and what Gibson Dunn has done best time and again in the last 125 years. We therefore remain optimistic, even in view of the rough waters ahead which we and our clients will have to navigate. We want to thank you for your trust in our services in Germany and your business that we enjoy here and world-wide. We do hope that you will gain valuable insights from our Year-End Alert of legal developments in Germany that will help you to successfully focus and resource your projects and investments in Germany in 2018 and beyond; and we promise to be at your side if you need a partner to help you with sound and hands-on legal advice for your business in and with Germany or to help manage challenging or forward looking issues in the upcoming exciting times. ________________________________ Table of Contents 1.  Corporate, M&A 2.  Tax 3.  Financing and Restructuring 4.  Labor and Employment 5.  Real Estate 6.  Data Protection 7.  Compliance 8.  Antitrust and Merger Control ________________________________ 1. Corporate, M&A 1.1       Corporate, M&A – Transparency Register – New Transparency Obligations on Beneficial Ownership As part of the implementation of the 4th European Money Laundering Directive into German law, Germany has created a new central electronic register for information about the beneficial owners of legal persons organized under German private law as well as registered partnerships incorporated within Germany. Under the restated German Money Laundering Act (Geldwäschegesetz – GWG) which took effect on June 26, 2017, legal persons of German private law (e.g. capital corporations like stock corporations (AG) or limited liability companies (GmbH), registered associations (eingetragener Verein – e.V.), incorporated foundations (rechtsfähige Stiftungen)) and all registered partnerships (e.g. offene Handelsgesellschaft (OHG), Kommanditgesellschaft (KG) and GmbH & Co. KG) are now obliged to “obtain, keep on record and keep up to date” certain information about their “beneficial owners” (namely: first and last name, date of birth, place of residence and details of the beneficial interest) and to file the respective information with the transparency register without undue delay (section 20 (1) GWG). A “beneficial owner“ in this sense is a natural person who directly or indirectly holds or controls more than 25% of the capital or voting rights, or exercises control in a similar way (section 3 (2) GWG). Special rules apply for registered associations, trusts, non-charitable unregulated associations and similar legal arrangements. “Obtaining” the information does not require the entities to carry out extensive investigations, potentially through multi-national and multi-level chains of companies. It suffices to diligently review the information on record and to have in place appropriate internal structures to enable it to make a required filing without undue delay. The duty to keep the information up to date generally requires that the company checks at least on an annual basis whether there have been any changes in their beneficial owners and files an update, if necessary. A filing to the transparency register, however, is not required if the relevant information on the beneficial owner(s) is already contained in certain electronic registers (e.g. the commercial register or the so-called “Unternehmensregister“). This exemption only applies if all relevant data about the beneficial owners is included in the respective documents and the respective registers are still up to date. This essentially requires the obliged entities to diligently review the information available in the respective electronic registers. Furthermore, as a matter of principle, companies listed on a regulated market in the European Union (“EU“) or the European Economic Area (“EEA“) (excluding listings on unregulated markets such as e.g. the Entry Standard of the Frankfurt Stock Exchange) or on a stock exchange with equivalent transparency obligations with respect to voting rights are never required to make any filings to the transparency register. In order to enable the relevant entity to comply with its obligations, shareholders who qualify as beneficial owners or who are directly controlled by a beneficial owner, irrespective of their place of residence, must provide the relevant entity with the relevant information. If a direct shareholder is only indirectly controlled by a beneficial owner, the beneficial owner himself (and not the direct shareholder) must inform the company and provide it with the necessary information (section 20 (3) sentence 4 GWG). Non-compliance with these filing and information obligations may result in administrative fines of up to EUR 100,000. Serious, repeated or systematic breaches may even trigger sanctions up to the higher fine threshold of EUR 1 million or twice the economic benefit of the breach. The information submitted to the transparency register is not generally freely accessible. There are staggered access rights with only certain public authorities, including the Financial Intelligence Unit, law enforcement and tax authorities, having full access rights. Persons subject to know-your-customer (“KYC“) obligations under the Money Laundering Act such as e.g. financial institutions are only given access to the extent the information is required for them to fulfil their own KYC obligations. Other persons or the general public may only gain access if they can demonstrate a legitimate interest in such information. Going forward, every entity subject to the Money Laundering Act should verify whether it is beneficially owned within the aforementioned sense, and, if so, make the respective filing to the transparency register unless the relevant information is already contained in a public electronic register. Furthermore, relevant entities should check (at least) annually whether the information on their beneficial owner(s) as filed with the transparency or other public register is still correct. Also, appropriate internal procedures need to be set up to ensure that any relevant information is received by a person in charge of making filings to the registers. Back to Top 1.2       Corporate, M&A – New CSR Disclosure Obligations for German Public Interest Companies  Effective for fiscal years commencing on or after January 1, 2017, large companies with more than 500 employees are required to include certain non-financial information regarding their management of social and environmental challenges in their annual reporting (“CSR Information“). The new corporate social responsibility reporting rules (“CSR Reporting Rules“) implement the European CSR Directive into German law and are intended to help investors, consumers, policy makers and other stakeholders to evaluate the non-financial performance of large companies and encourage companies to develop a responsible and sustainable approach to business. The CSR Reporting Rules apply to companies with a balance sheet sum in excess of EUR 20 million and an annual turnover in excess of EUR 40 million, whose securities (stock or bonds etc.) are listed on a regulated market in the EU or the EEA as well as large banks and large insurance companies. It is estimated that approximately 550 companies in Germany are covered. Exemptions apply to consolidated subsidiaries if the parent company publishes the CSR Information in the group reporting. The CSR Reporting Rules require the relevant companies to inform on the policies they implemented, the results of such policies and the business risks in relation to (i) environmental protection, (ii) treatment of employees, (iii) social responsibility, (iv) respect for human rights and (v) anti-corruption and bribery. In addition, listed stock corporations are also obliged to inform with regard to diversity on their company boards. If a company has not implemented any such policy, an explicit and justified disclosure is required (“comply or explain”). Companies must further include significant non-financial performance indicators and must also include information on the amounts reported in this respect in their financial statements. The CSR Information can either be included in the annual report or by way of a separate CSR report, to be published on the company’s website or together with its regular annual report with the German Federal Gazette (Bundesanzeiger). The CSR Reporting Rules will certainly increase the administrative burden placed on companies when preparing their annual reporting documentation. It remains to be seen if the new rules will actually meet the expectations of the European legislator and foster and create a more sustainable approach of large companies to doing business in the future . Back to Top 1.3       Corporate, M&A – Corporate Governance Code Refines Standards for Compliance, Transparency and Supervisory Board Composition Since its first publication in 2002, the German Corporate Governance Code (Deutscher Corporate Governance Kodex – DCGK) which contains standards for good and responsible governance for German listed companies, has been revised nearly annually. Even though the DCGK contains only soft law (“comply or explain”) framed in the form of recommendations and suggestions, its regular updates can serve as barometer for trends in the public discussion and sometimes are also a forerunner for more binding legislative measures in the near future. The main changes in the most recent revision of the DCGK in February 2017 deal with aspects of compliance, transparency and supervisory board composition. Compliance The general concept of “compliance” was introduced by the DCGK in 2007. In this respect, the recent revision of the DCGK brought along two noteworthy new aspects. On the one hand, the DCGK now stresses in its preamble that good governance and management does not only require compliance with the law and internal policies but also ethically sound and responsive behavior (the “reputable businessperson concept”). On the other hand, the DCGK now recommends the introduction of a compliance management system (“CMS“). In keeping with the common principle of individually tailored compliance management systems that take into account the company’s specific risk situation, the DCGK now recommends appropriate measures reflecting the company’s risk situation and disclosing the main features of the CMS publically, thus enabling investors to make an informed decision on whether the CMS meets their expectations. It is further expressly recommended to provide employees with the opportunity to blow the whistle and also suggested to open up such whistle-blowing programs to third parties. Supervisory Board In line with the ongoing international trend of focusing on supervisory board composition, the DCGK now also recommends that the supervisory board not only should determine concrete objectives for its composition, but also develop a tailored skills and expertise profile for the entire board and to disclose in the corporate governance report to which extent such benchmarks and targets have been implemented in practice. In addition, the significance of having sufficient independent members on the supervisory board is emphasized by a new recommendation pursuant to which the supervisory board should disclose the appropriate number of independent supervisory board members as well as the members which meet the “independence” criteria in the corporate governance report. In accordance with international best practice, it is now also recommended to provide CVs for candidates for the supervisory board including inter alia relevant knowledge, skills and experience and to publish this information on the company’s website. With regard to supervisory board transparency, the DCGK now also recommends that the chairman of the supervisory board should be prepared, within an appropriate framework, to discuss topics relevant to the supervisory board with investors (please see in this regard our 2016-Year-End Alert, section 1.2). These new 2017 recommendations further highlight the significance of compliance and the role of the supervisory board not only for legislators but also for investors and other stakeholders. As soon as the annual declarations of non-conformity (“comply or explain”) are published over the coming weeks and months, it will be possible to assess how well these new recommendations will be received as well as what responses there will be to the planned additional supervisory board transparency (including, in particular, by family-controlled companies with employee co-determination on the supervisory board). Back to Top 1.4       Corporate, M&A – Employee Co-Determination: No European Extension As set out in greater detail in past alerts (please see in this regard our 2016 Year-End Alert, section 1.3 with further references), the scope and geographic reach of the German co-determination rules (as set out in the German Co-Determination Act; Mitbestimmungsgesetz – MitbestG and in the One-Third-Participation Act; Drittelbeteiligungsgesetz – DrittelbG) were the subject of several ongoing court cases. This discussion has been put to rest in 2017 by a decision of the European Court of Justice (ECJ, C-566/15 – July 18, 2017) that held that German co-determination rules and their restriction to German-based employees as the numeric basis for the relevant employee thresholds and as populace entitled to vote for such co-determined supervisory boards do not infringe against EU law principles of anti-discrimination and freedom of movement. The judgment has been received positively by both German trade unions and corporate players because it preserves the existing German co-determination regime and its traditional, local values against what many commentators would have perceived to be an undue pan-Europeanization of the thresholds and the right to vote for such bodies. In particular, the judgment averts the risk that many supervisory boards would have had to be re-elected based on a pan-European rather than solely German employee base. Back to Top 1.5       Corporate, M&A – Germany Tightens Rules on Foreign Takeovers On July 18, 2017, the amended provisions on foreign direct investments under the Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung – AWV), expanding and specifying the right of the Federal Ministry for Economic Affairs and Energy (“Ministry“) to review whether the takeover of domestic companies by investors outside the EU or the European Free Trade Area poses a danger to the public order or security of the Federal Republic of Germany came into force. The amendment has the following five main effects which will have a considerable impact on the M&A practice: (i) (non-exclusive) standard categories of companies and industries which are relevant to the public order or security for cross-sector review are introduced, (ii) the stricter sector-specific rules for industries of essential security interest (such as defense and IT-security) are expanded and specified, (iii) there is a reporting requirement for all takeovers within the relevant categories, (iv) the time periods for the review process are extended, and (v) there are stricter and more specific restrictions to prevent possible circumventions. Under the new rules, a special review by the German government is possible in cases of foreign takeovers of domestic companies which operate particularly in the following sectors: (i) critical infrastructure amenities, such as the energy, IT and telecommunications, transport, health, water, food and finance/insurance sectors (to the extent they are very important for the functioning of the community), (ii) sector-specific software for the operation of these critical infrastructure amenities, (iii) telecom carriers and surveillance technology and equipment, (iv) cloud computing services and (v) telematics services and components. The stricter sector-specific rules for foreign takeovers within the defense and IT-security industry are also expanded and now also apply to the manufacturers of defense equipment for reconnaissance and support. Furthermore, the reporting requirement no longer applies only to transactions within the defense and IT-security sectors, but also to all foreign takeovers that fall within the newly introduced cross-sector standard categories described above. The time periods allowed for the Ministry to intervene have been extended throughout. In particular, if an application for a clearance certificate is filed, the clearance certificate will be deemed granted in the absence of a formal review two months following receipt of the application rather than one month as in the past, and the review periods are suspended if the Ministry conducts negotiations with the parties involved. Further, a review may be commenced until five years after the signing of the purchase agreement, which in practice will likely result in an increase of applications for a clearance certificate in order to obtain more transaction certainty. Finally, the new rules provide for stricter and more specific restrictions of possible circumventions by, for example, the use of so-called “front companies” domiciled in the EU or the European Free Trade Area and will trigger the Ministry’s right to review if there are indications that an improper structuring or evasive transaction was at least partly chosen to circumvent the review by the Ministry. Although the scope of the German government’s ability to intervene in M&A processes has been expanded where critical industries are concerned, it is not clear yet to what extent stronger interference or more prohibitions or restrictions will actually occur in practice. And even though the new law provides further guidance, there are still areas of legal uncertainty which can have an impact on valuations and third party financing unless a clearance certificate is obtained. Due to the suspension of the review period in the case of negotiations with the Ministry, the review procedure has, at least in theory, no firm time limit. As a result, the M&A advisory practice has to be prepared for a more time-consuming and onerous process for transactions in the critical industries and may thus be forced to allow for more time between signing and closing. In addition, appropriate termination clauses (and possibly break fees) must be considered for purposes of the share purchase agreement in case a prohibition or restriction of the transaction on the basis of the amended AWV cannot be excluded. Back to Top 2. Tax 2.1       Tax – Unconstitutionality of German Change-of-Control Rules Tax loss carry forwards are an important asset in every M&A transaction. Over the past ten years the German change-of-control rules, which limit the use of losses and loss carry forwards (“Losses“) of a German target company, have undergone fundamental legislative changes. The current change-of-control rules may now face another significant revision as – according to the German Federal Constitutional Court (Bundesverfassungsgericht – BVerfG) and the Lower Tax Court of Hamburg – the current tax regime of the change-of-control rules violates the constitution. Under the current change-of-control 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 – since 2016 – for business continuations, especially in the venture capital industry. On March 29, 2017, the German Federal Constitutional Court ruled that the pro rata forfeiture of Losses (share transfer of more than 25% but not more than 50%) is not in line with the constitution. The BVerfG held that the provision leads to unequal treatment of companies. The aim of avoiding legal but undesired tax optimizations does not justify the broad and general scope of the provision. The BVerfG has asked the German legislator to amend the change-of-control rules retroactively for the period from January 1, 2008 until December 31, 2015 and bring them in line with the constitution. The legislative changes need to be finalized by December 31, 2018. Furthermore, in another case on August 29, 2017, the Lower Tax Court of Hamburg held that the change-of-control rules, which result in a full forfeiture of Losses after a transfer of more than 50% of the shares in a German corporation, are also incompatible with the constitution. The ruling is based on the 2008 wording of the change-of-control rules but the wording of these rules is similar to that of the current forfeiture rules. In view of the March 2017 ruling of the Federal Constitutional Court on the pro-rata forfeiture, the Lower Tax Court referred this case also to the Federal Constitutional Court to rule on this issue as well. If the Federal Constitutional Court decides in favor of the taxpayer the German tax legislator may completely revise the current tax loss limitation regime and limit its scope to, for example, abusive cases. A decision by the Federal Constitutional Court is expected in the course of 2018. Affected market participants are therefore well advised to closely monitor further developments and consider the impact of potential changes on past and future M&A deals with German entities. Appeals against tax assessments should be filed and stays of proceedings applied for by reference to the case before the Federal Constitutional Court in order to benefit from a potential retroactive amendment of the change-of-control rules. Back to Top 2.2       Tax – New German Tax Disclosure Rules for Tax Planning Schemes In light of the Panama and Paradise leaks, the respective Finance Ministers of the German federal states (Bundesländer) created a working group in November 2017 to establish how the new EU Disclosure Rules for advisers and taxpayers as published by the European Commission (“Commission“) on July 25, 2017 can be implemented into German law. Within the member states of the EU, mandatory tax disclosure rules for tax planning schemes already exist in the UK, Ireland and Portugal. Under the new EU disclosure rules certain tax planners and advisers (intermediaries) or certain tax payers themselves must disclose potentially aggressive cross-border tax planning arrangements to the tax authorities in their jurisdiction. This new requirement is a result of the disclosure rules as proposed by the OECD in its Base Erosion and Profit Shifting (BEPS) Action 12 report, among others. The proposal requires tax authorities in the EU to automatically exchange reported information with other tax authorities in the EU. Pursuant to the Commission’s proposal, an “intermediary” is the party responsible for designing, marketing, organizing or managing the implementation of a tax payer´s reportable cross border arrangement, while also providing that taxpayer with tax related services. If there is no intermediary, the proposal requires the taxpayer to report the arrangement directly. This is, for example, the case if the taxpayer designs and implements an arrangement in-house, if the intermediary in question does not have a presence within the EU or in case the intermediary cannot disclose the information because of legal professional privilege. The proposal does not define what “arrangement” or “aggressive” tax planning means but lists characteristics (so-called “hallmarks“) of cross-border tax planning schemes that would strongly indicate whether tax avoidance or abuse occurred. These hallmarks can either be generic or specific. Generic hallmarks include arrangements where the tax payer has complied with a confidentiality provision not to disclose how the arrangement could secure a tax advantage or where the intermediary is entitled to receive a fee with reference to the amount of the tax advantage derived from the arrangement. Specific hallmarks include arrangements that create hybrid mismatches or involve deductible cross border payments between related parties with a preferential tax regime in the recipient’s tax resident jurisdiction. The information to be exchanged includes the identities of the tax payer and the intermediary, details about the hallmarks, the date of the arrangement, the value of the transactions and the EU member states involved. The implementation of such mandatory disclosure rules on tax planning schemes are heavily discussed in Germany especially among the respective bar associations. Elements of the Commission’s proposal are regarded as a disproportionate burden for intermediaries and taxpayers in relation to the objective. Further clarity is needed to align the proposal with the general principle of legal certainty. Certain elements of the proposal may contravene EU law or even the German constitution. And the interaction with the duty of professional secrecy for lawyers and tax advisors is also still unclear. Major efforts are therefore needed for the German legislator to make such a disclosure regime workable both for taxpayers/intermediaries and the tax administrations. It remains to be seen how the Commission proposal will be implemented into German law in 2018 and how tax structuring will be affected. Back to Top 2.3       Tax – Voluntary Self-Disclosure to German Tax Authorities Becomes More Challenging German tax law allows voluntary self-disclosure to correct or supplement an incorrect or incomplete tax return. Valid self-disclosure precludes criminal liability for tax evasion. Such exemption from criminal prosecution, however, does not apply if the tax evasion has already been “detected” at the time of the self-disclosure and this is at least foreseeable for the tax payer. On May 5, 2017 the German Federal Supreme Court (Bundesgerichtshof – BGH) further specified the criteria for voluntary self-disclosure to secure an exemption from criminal prosecution (BGH, 1 StR 265/16 – May 9, 2017). The BGH ruled that exemption from criminal liability might not apply if a foreign authority had already discovered the non- or underreported tax amounts prior to such self-disclosure. Underlying the decision of the BGH was the case of a German employee of a German defense company, who had received payments from a Greek business partner, but declared neither the received payments nor the resulting income in his tax declaration. The payment was a reward for his contribution in selling weapons to the Greek government. The Greek authorities learned of the payment to the German employee early in 2004 in the course of an anti-bribery investigation and obtained account statements proving the payment through intermediary companies and foreign banks. On January 6, 2014, the German employee filed a voluntary self-disclosure to the German tax authorities declaring the previously omitted payments. The respective German tax authority found that this self-disclosure was not submitted in time to exempt the employee from criminal liability. The issue in this case was by whom and at what moment in time the tax evasion needed to be detected in order to render self-disclosure invalid. The BGH ruled that the voluntary self-disclosure by the German employee was futile due to the fact that the payment at issue had already been detected by the Greek authorities at the time of the self-disclosure. In this context, the BGH emphasized that it was not necessary for the competent tax authorities to have detected the tax evasion, but it was sufficient if any other authority was aware of the tax evasion. The BGH made clear that this included foreign authorities. Thus, a prior detection is relevant if on the basis of a preliminary assessment of the facts a conviction is ultimately likely to occur. This requirement is for example met if it can be expected that the foreign authority that detected the incorrect, incomplete or omitted fact will forward this information to the German tax authorities as in the case before the BGH. In particular, there was an international assistance procedure in place between German and Greek tax authorities and the way the payments were made by using intermediaries and foreign banks made it obvious to the Greek authorities that the relevant amounts had not been declared in Germany. Due to the media coverage of the case, this was also at least foreseeable for the German employee. This case is yet another cautionary tale for tax payers not to underestimate the effects of increased international cooperation of tax authorities. Back to Top 3. Financing and Restructuring 3.1       Financing and Restructuring – Upfront Banking Fees Held Void by German Federal Supreme Court On July 4, 2017, the German Federal Supreme Court (Bundesgerichtshof – BGH) handed down two important rulings on the permissibility of upfront banking fees in German law governed loan agreements. According to the BGH, boilerplate clauses imposing handling, processing or arrangement fees on borrowers are void if included in standard terms and conditions (Allgemeine Geschäftsbedingungen). With this case, the court extended its prior rulings on consumer loans to commercial loans. The BGH argued that clauses imposing a bank’s upfront fee on a borrower fundamentally contradict the German statutory law concept that the consideration for granting a loan is the payment of interest. If ancillary pricing arrangements (Preisnebenabreden) pass further costs and expenses on to the borrower, the borrower is unreasonably disadvantaged by the user (Verwender) of standard business terms, unless the additional consideration is agreed for specific services that go beyond the mere granting of the loan and the handling, processing or arrangement thereof. In the cases at hand, the borrowers were thus awarded repayment of the relevant fee. The implications of these rulings for the German loan market are far-reaching. The rulings affect all types of upfront fees for a lender’s services which are routinely passed on to borrowers even though they would otherwise be owed by the lender pursuant to statutory law, a regulatory regime or under a contract or which are conducted in the lender’s own interest. Consequently, this covers fees imposed on the borrower for the risk assessment (Bonitätsprüfung), the valuation of collateral, expenses for the collection of information on the assessment of a borrower’s financing requirements and the like. At this stage, it is not yet certain if, for example, agency fees or syndication fees could also be covered by the decision. There are, however, good arguments to reason that services rendered in connection with a syndication are not otherwise legally or contractually owed by a lender. Upfront fees paid in the past, i.e. in 2015 or later, can be reclaimed by borrowers. The BGH applied the general statutory three year limitation period and argued that the limitation period commenced at the end of 2011 after Higher District Courts (Oberlandesgerichte) had held upfront banking fees void in deviation from previous rulings. As of such time, borrowers should have been aware that a repayment claim of such fees was possible and could have filed a court action even though the enforcement of the repayment was not risk-free. Going forward, it can be expected that lenders will need to modify their approach as a result of the rulings: Choosing a foreign (i.e. non-German) law for a separate fee agreement could be an option for lenders, at least, if either the lender or the borrower is domiciled in the relevant jurisdiction or if there is a certain other connection to the jurisdiction of the chosen law. If the loan is granted by a German lender to a German borrower, the choice of foreign law would also be generally recognized, but under EU conflict of law provisions mandatory domestic law (such as the German law on standard terms) would likely still continue to apply. In response to the ruling, lenders are also currently considering alternative fee structures: Firstly, the relevant costs and expenses underlying such fees are being factored into the calculation of the interest and the borrower is then given the option to choose an upfront fee or a (higher) margin. This may, however, not always turn out to be practical, in particular given that a loan may be refinanced prior to generating the equivalent interest income. Secondly, a fee could be agreed in a separate fee letter which specifically sets out services which go beyond the typical services a bank renders in its own interest. It may, however be difficult to determine services which actually justify a fee. Finally, a lender might charge typical upfront fees following genuine individual negotiations. This requires that the lender not only shows that it was willing to negotiate the amount of the relevant fee, but also that it was generally willing to forego the typical upfront fee entirely. However, if the borrower rejects the upfront fee, the lender still needs to rely on alternative fee arrangements. Further elaboration by the courts and market practice should be closely monitored by lenders and borrowers alike. Back to Top 3.2       Financing and Restructuring – Lingering Uncertainty about Tax Relief for Restructuring Profits Ever since the German Federal Ministry of Finance issued an administrative order in 2003 (“Restructuring Order“) the restructuring of distressed companies has benefited from tax relief for income tax on “restructuring profits”. In Germany, restructuring profits arise as a consequence of debt to equity swaps or debt waivers with regard to the portion of such debt that is unsustainable. Debtors and creditors typically ensured the application of the Restructuring Order by way of a binding advance tax ruling by the tax authorities thus providing for legal certainty in distressed debt scenarios for the parties involved. However, in November 2016, the German Federal Tax Court (Bundesfinanzhof – BFH) put an end to such preferential treatment of restructuring profits. The BFH held the Restructuring Order to be void arguing that the Federal Ministry of Finance had lacked the authority to issue the Restructuring Order. It held that such a measure would need to be adopted by the German legislator instead. The Ministry of Finance and the German restructuring market reacted with concern. As an immediate response to the ruling the Ministry of Finance issued a further order on April 27, 2017 (“Continuation Order”) to the effect that the Restructuring Order continued to apply in all cases in which creditors finally and with binding effect waived claims on or before February 8, 2017 (the date on which the ruling of the Federal Tax Court was published). But the battle continued. In August 2017, the Federal Tax Court also set aside this order for lack of authority by the Federal Ministry of Finance. In the meantime, the German Bundestag and the Bundesrat have passed legislation on tax relief for restructuring profits, but the German tax relief legislation will only enter into force once the European Commission issues a certificate of non-objection confirming the new German statutory tax relief’s compliance with EU restrictions on state aid. This leaves uncertainty as to whether the new law will enter into force in its current wording and when. Also, the new legislation will only cover debt waivers/restructuring profits arising after February 8, 2017 but at this stage does not provide for the treatment of cases before such time. In the absence of the 2003 Restructuring Order and the 2017 Continuation Order, tax relief would only be possible on the basis of equitable relief in exceptional circumstances. It appears obvious that no reliable restructuring concept can be based on potential equitable relief. Thus, it is advisable to look out for alternative structuring options in the interim: Subordination of debt: while this may eliminate an insolvency filing requirement for illiquidity or over indebtedness, the debt continues to exist. This may make it difficult for the debtor to obtain financing in the future. In certain circumstances, a carve-out of the assets together with a sustainable portion of the debt into a new vehicle while leaving behind and subordinating the remainder of the unsustainable portion of the debt, could be a feasible option. As the debt subsists, a silent liquidation of the debtor may not be possible considering the lingering tax burden on restructuring profits. Also, any such carve-out measures by which the debtor is stripped of assets may be challenged in case of a later insolvency of the debtor. A debt hive up without recourse may be a possible option, but a shareholder or its affiliates are not always willing to assume the debt. Also, as tax authorities have not issued any guidelines on the tax treatment of debt hive ups, a binding advance tax ruling from the tax authorities should be obtained before the debt hive up is executed. Still, a debt hive up could be an option if the replacement debtor is domiciled in a jurisdiction which does not impose detrimental tax consequences on the waiver of unsustainable debt. Converting the debt into a hybrid instrument which constitutes debt for German tax purposes and equity from a German GAAP perspective is no longer feasible. Pursuant to a tax decree from May 2016, the tax authorities argue that the creation of a hybrid instrument amounts to a taxable waiver of debt on the basis that tax accounting follows commercial accounting. It follows that irrespective of potential alternative structures which may suit a specific set of facts and circumstances, restructuring transactions in Germany continue to be challenging pending the entry into force of the new tax relief legislation. Back to Top 4. Labor and Employment 4.1       Labor and Employment – Defined Contribution Schemes Now Allowed In an effort to promote company pension schemes and to allow more flexible investments, the German Company Pension Act (Betriebsrentengesetz – BetrAVG) was amended considerably with effect as of January 1, 2018. The most salient novelty is the introduction of a purely defined contribution pension scheme, which had not been permitted in the past. Until now, the employer would always be ultimately liable for any kind of company pension scheme irrespective of the vehicle it was administered through. This is no longer the case with the newly introduced defined contribution scheme. The defined contribution scheme also entails considerable other easements for employers, e.g. pension adjustment obligations or the requirement of insolvency insurance no longer apply. As a consequence, a company offering a defined contribution pension scheme does not have to deal with the intricacies of providing a suitable investment to fulfil its pension promise, but will have met its duty in relation to the pension simply by paying the promised contribution (“pay and forget”). However, the introduction of such defined contribution schemes requires a legal basis either in a collective bargaining agreement (with a trade union) or in a works council agreement, if the union agreement so allows. If these requirements are met though, the new legal situation brings relief not only for employers offering company pension schemes but also for potential investors into German businesses for whom the German-specific defined benefit schemes have always been a great burden. Back to Top 4.2     Labor and Employment – Federal Labor Court Facilitates Compliance Investigations In a decision much acclaimed by the business community, the German Federal Labor Court (Bundesarbeitsgericht – BAG) held that intrusive investigative measures by companies against their employees do not necessarily require a suspicion of a criminal act by an employee; rather, less severe forms of misconduct can also trigger compliance investigations against employees (BAG, 2 AZR 597/16 – June 29, 2017). In the case at hand, an employee had taken sick leave, but during his sick leave proceeded to work for the company owned by his sons who happened to be competing against his current employer. After customers had dropped corresponding hints, the company assigned a detective to ascertain the employee’s violation of his contractual duties and subsequently fired the employee based on the detective’s findings. In the dismissal protection trial, the employee argued that German law only allowed such intrusive investigation measures if criminal acts were suspected. This restriction was, however, rejected by the BAG. This judgment ends a heated debate about the permissibility of internal investigation measures in the case of compliance violations. However, employers should always adhere to a last-resort principle when investigating possible violations. For instance, employees must not be seamlessly monitored at their workplace by way of a so-called “key logger” as the Federal Labor Court held in a different decision (BAG, 2 AZR 681/16 – July 27, 2017). Also, employers should keep in mind a recent ruling of the European Court of Human Rights of September 5, 2017 (ECHR, 61496/08). Accordingly, the workforce should be informed in advance that and how their email correspondence at the workplace can be monitored. Back to Top 5. Real Estate Real Estate – Invalidity of Written Form Remediation Clauses for Long-term Lease Agreements On September 27, 2017, the German Federal Supreme Court (Bundesgerichtshof – BGH) ruled that so-called “written form remediation clauses” (Schriftformheilungsklauseln) in lease agreements are invalid because they are incompatible with the mandatory provisions of section 550 of the German Civil Code (Bürgerliches Gesetzbuch – BGB; BGH, XII ZR 114/16 – September 27, 2017). The written form for lease agreements requires that all material agreements concerning the lease, in particular the lease term, identification of the leased premises and the rent amount, must be made in writing. If a lease agreement entered into for a period of more than one year does not comply with this written form requirement, mandatory German law allows either lease party to terminate the lease agreement with the statutory notice period irrespective of whether or not a fixed lease term was agreed upon. The statutory notice period for commercial lease agreements is six months (less three business days) to the end of any calendar quarter. To avoid the risk of termination for non-compliance with the written form requirement, German commercial lease agreements regularly contain a general written form remediation clause. Pursuant to such clause, the parties of the lease agreement undertake to remediate any defect in the written form upon request of one of the parties. While such general written form remediation clauses were upheld in several decisions by various Higher District Courts (Oberlandesgerichte) in the past, the BGH had already rejected the validity of such clauses vis-à-vis the purchasers of real property in 2014. With this new decision, the BGH has gone one step further and denied the validity of general written form remediation clauses altogether. Only in exceptional circumstances, the lease parties are not entitled to invoke the non-compliance with the written form requirement on account of a breach of the good faith principle. Such exceptional circumstances may exist, for example, if the other party faced insolvency if the lease were terminated early as a result of the non-compliance or if the lease parties had agreed in the lease agreement to remediate such specific written form defect. This new decision of the BGH forces the parties to long-term commercial lease agreements to put even greater emphasis on ensuring that their lease agreements comply with the written form requirement at all times because remediation clauses as potential second lines of defense no longer apply. Likewise, the due diligence process of German real estate transactions will have to focus even more on the compliance of lease agreements with the written form requirement. Back to Top 6.  Data Protection Data Protection – Employee Data Protection Under New EU Regulation After a two-year transition period, the EU General Data Protection Regulation (“GDPR“) will enter into force on May 25, 2018. The GDPR has several implications for data protection law covering German employees, which is already very strictly regulated. For example, under the GDPR any handling of personnel data by the employer requires a legal basis. In addition to statutory laws or collective agreements, another possible legal basis is the employee’s explicit written consent. The transfer of personnel data to a country outside of the European Union (“EU“) will have to comply with the requirements prescribed by the GDPR. If the target country has not been regarded as having an adequate data protection level by the EU Commission, additional safeguards will be required to protect the personnel data upon transfer outside of the EU. Otherwise, a data transfer is generally not permitted. The most threatening consequence of the GDPR is the introduction of a new sanctions regime. It now allows fines against companies of up to 4% of the entire group’s revenue worldwide. Consequently, these new features, especially the drastic new sanction regime, call for assessments of, and adequate changes to, existing compliance management systems with regard to data protection issues. Back to Top 7. Compliance 7.1       Compliance – Misalignment of International Sanction Regimes Requires Enhanced Attention to the EU Blocking Regulation and the German Anti-Boycott Provisions The Trump administration has been very active in broadening the scope and reach of the U.S. sanctions regime, most recently with the implementation of “Countering America’s Adversaries Through Sanctions Act (H.R. 3364) (‘CAATSA‘)” on August 2, 2017 and the guidance documents that followed. CAATSA includes significant new law codifying and expanding U.S. sanctions on Russia, North Korea, and Iran. The European Union (“EU“) has not followed suit. More so, the EU and European leaders openly stated their frustration about both a perceived lack of consultation during the process and the substance of the new U.S. sanctions. Specifically, the EU and European leaders are concerned about the fact that CAATSA authorizes secondary sanctions on any person supporting a range of activities. Among these are the development of Russian energy export pipeline projects, certain transactions with the Russian intelligence or defense sectors or investing in or otherwise facilitating privatizations of Russia’s state-owned assets that unjustly benefits Russian officials or their close associates or family members. The U.S. sanctions regime differentiates between primary sanctions that apply to U.S. persons (U.S. citizens, permanent U.S. residents and companies under U.S. jurisdiction) and U.S. origin goods, and secondary sanctions that expand the reach of U.S. sanctions by penalizing non-U.S. persons for their involvement in certain targeted activities. Secondary sanctions can take many forms but generally operate by restricting or threatening to restrict non-U.S. person access to the U.S. market, including its global financial institutions. European, especially export-heavy and internationally operating German companies are thus facing a dilemma. While they have to fear possible U.S. secondary sanctions for not complying with U.S. regulations, potential penalties also loom from European member state authorities when doing so. These problems are grounded in European and German legislation aimed at protecting from and counteracting financial and economic sanctions issued by countries outside of the EU and Germany, unless such sanctions are themselves authorized under relevant UN, European, and German sanctions legislation. On the European level, Council Regulation (EC) No 2271/96 of November, 22 1996 as amended (“EU Blocking Regulation“) is aimed at protecting European persons against the effects of the extra-territorial application of laws, such as certain U.S. sanctions directed at Cuba, Iran and Libya. Furthermore, it also aims to counteract the effects of the extra-territorial application of such sanctions by prohibiting European persons from complying with any requirement or prohibition, including requests of foreign courts, based on or resulting, directly or indirectly, from such U.S. sanctions. For companies subject to German jurisdiction, section 7 of the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung – AWV), states that “[t]he issuing of a declaration in foreign trade and payments transactions whereby a resident participates in a boycott against another country (boycott declaration) shall be prohibited” to the extent such a declaration would be contradictory to UN, EU and German policy. With the sanctions regime on the one hand and the blocking legislation at EU and German level on the other hand, committing to full compliance with U.S. sanctions whilst falling within German jurisdiction, could be deemed a violation of the AWV.  Violating the AWV can lead to fines by the German authorities and, under German civil law, might render a relevant contractual provision invalid. For companies conducting business transactions on a global scale, the developing non-alignment of U.S. and European / German sanctions requires special attention. Specifically, covenants with respect to compliance with U.S. or other non-EU sanctions should be reviewed and carefully drafted in light of the diverging developments of U.S. and other non-EU sanctions on the one hand and European / German sanctions on the other hand. Back to Top 7.2       Compliance – Restated (Anti-) Money Laundering Act – Significant New Requirements for the Non-Financial Sector and Good Traders On June 26, 2017, the restated German Money Laundering Act (Geldwäschegesetz – GWG), which transposes the 4th European Anti-Money Laundering Directive (Directive (EU 2015/849 of the European Parliament and of the Council) into German law, became effective. While the scope of businesses that are required to conduct anti-money laundering procedures remains generally unchanged, the GWG introduced a number of new requirements, in particular for non-financial businesses, and significantly increases the sanctions for non-compliance with these obligations. The GWG now extends anti money laundering (“AML“) risk management concepts previously known from the financial sector also to non-financial businesses including good traders. As a matter of principle, all obliged businesses are now required to undertake a written risk analysis for their business and have in place internal risk management procedures proportionate to the type and scope of the business and the risks involved in order to effectively mitigate and manage the risks of money laundering and terrorist financing. In case the obliged business is the parent company of a group, a group-wide risk analysis and group-wide risk management procedures are required covering subsidiaries worldwide who also engage in relevant businesses. The risk analysis must be reviewed regularly, updated if required and submitted to the supervisory authority upon request. Internal risk management procedures include, in particular, client due diligence (“know-your customer”), which requires the identification and verification of customers, persons acting on behalf of customers as well as of beneficial owners of the customer (see also section 1.1 above on the Transparency Register). In addition, staff must be monitored for their reliability and trained regularly on methods and types of money laundering and terrorist financing and the applicable legal obligations under the GWG as well as data protection law, and whistle-blowing systems must be implemented. Furthermore, businesses of the financial and insurance sector as well as providers of gambling services must appoint a money laundering officer (“MLO“) at senior management level as well as a deputy, who are responsible for ensuring compliance with AML rules. Other businesses may also be ordered by their supervisory authority to appoint a MLO and a deputy. Good traders including conventional industrial companies are subject to the AML requirements under the GWG, irrespective of the type of goods they are trading in. However, some of the requirements either do not apply or are significantly eased. Good traders must only conduct a risk analysis and have in place internal AML risk management procedures if they accept or make (!) cash payments of EUR 10,000 or more. Furthermore, client due diligence is only required with respect to transactions in which they make or accept cash payments of EUR 10,000 or more, or in case there is a suspicion of money laundering or terrorist financing. Suspicious transactions must be reported to the Financial Intelligence Unit (“FIU“) without undue delay. As a result, also low cash or cash free good traders are well advised to train their staff to enable them to detect suspicious transactions and to have in place appropriate documentation and reporting lines to make sure that suspicious transactions are filed with the FIU. Non-compliance with the GWG obligations can be punished with administrative fines of up to EUR 100,000. Serious, repeated or systematic breaches may even trigger sanctions up to the higher fine threshold of EUR 1 million or twice the economic benefit of the breach. For the financial sector, even higher fines of up to the higher of EUR 5 million or 10% of the total annual turnover are possible. Furthermore, offenders will be published with their names by relevant supervisory authorities (“naming and shaming”). Relevant non-financial businesses are thus well advised to review their existing AML compliance system in order to ensure that the new requirements are covered. For good traders prohibiting cash transactions of EUR 10,000 or more and implementing appropriate safeguards to ensure that the threshold is not circumvented by splitting a transaction into various smaller sums, is a first and vital step. Furthermore, holding companies businesses who mainly acquire and hold participations (e.g. certain private equity companies), must keep in mind that enterprises qualifying as “finance enterprise” within the meaning of section 1 (3) of the German Banking Act (Kreditwesengesetz – KWG) are subject to the GWG with no exemptions. Back to Top  7.3       Compliance – Protection of the Attorney Client Privilege in Germany Remains Unusual The constitutional complaint (Verfassungsbeschwerde) brought by Volkswagen AG’s external legal counsel requesting the return of work product prepared during the internal investigation for Volkswagen AG remains pending before the German Federal Constitutional Court (Bundesverfassungsgericht – BVerfG). The Munich public prosecutors had seized these documents in a dawn raid of the law firm’s offices. While the BVerfG has granted injunctive relief (BVerfG, 2 BvR 1287/17, 2 BvR 1583/17 – July 25, 2017) and ordered the authorities, pending a decision on the merits of the case, to refrain from reviewing the seized material, this case is a timely reminder that the concept of the attorney client privilege in Germany is very different to that in common law jurisdictions. In a nutshell: In-house lawyers do not enjoy legal privilege. Material that would otherwise be privileged can be seized on the client’s premises – with the exception of correspondence with and work product from / for criminal defense counsel. The German courts are divided on the question of whether corporate clients can already appoint criminal defense counsel as soon as they are concerned that they may be the target of a future criminal investigation, or only when they have been formally made the subject of such an investigation. Searches and seizures at a law firm, however, are a different matter. A couple of years ago, the German legislator changed the German Code of Criminal Procedure (Strafprozessordnung – StPO) to give attorneys in general, not only criminal defense counsel, more protection against investigative measures (section 160a StPO). Despite this legislation, the first and second instance judges involved in the matter decided in favor of the prosecutors. As noted above, the German Federal Constitutional Court has put an end to this, at least for now. According to the court, the complaints of the external legal counsel and its clients were not “obviously without any merits” and, therefore, needed to be considered in the proceedings on the merits of the case. In order not to moot these proceedings, the court ordered the prosecutors to desist from a review of the seized material, and put it under seal until a full decision on the merits is available. In the interim period, the interest of the external legal counsel and its clients to protect the privilege outweighed the public interest in a speedy criminal investigation. At this stage, it is unclear when and how the court will decide on the merits. Back to Top 7.4       Compliance – The European Public Prosecutor’s Office Will Be Established – Eventually After approximately four years of discussions, 20 out of the 28 EU member states agreed in June 2017 on the creation of a European Public Prosecutor’s Office (“EPPO“). In October, the relevant member states adopted the corresponding regulation (Regulation (EU) 2017/1939 – “Regulation“). The EPPO will be in charge of investigating, prosecuting and bringing to justice the perpetrators of offences against the EU’s financial interests. The EPPO is intended to be a decentralized authority, which operates via and on the basis of European Delegated Prosecutors located in each member state. The central office in Luxembourg will have a European Chief Prosecutor supported by 20 European Prosecutors, as well as technical and investigatory staff. While EU officials praise this Regulation as an “important step in European justice cooperation“, it remains to be seen whether this really is a measure which ensures that “criminals [who] act across borders […] are brought to justice and […] taxpayers’ money is recovered” (U. Reinsalu, Estonian Minister of Justice). It will take at least until 2020 until the EPPO is established, and criminals will certainly not restrict their activities to the territories of those 20 countries which will cooperate under the new authority (being: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Estonia, Germany, Greece, Finland, France, Italy, Latvia, Lithuania, Luxembourg, Portugal, Romania, Slovenia, Slovakia and Spain). In addition, as the national sovereignty of the EU member states in judicial matters remains completely intact, the EPPO will not truly investigate “on the ground”, but mainly assume a coordinating role. Last but not least, its jurisdiction will be limited to “offences against the EU’s financial interests”, in particular criminal VAT evasion, subsidy fraud and corruption involving EU officials. A strong enforcement, at least prima facie, looks different. To end on a positive note, however: the new body is certainly an improvement on the status quo in which the local prosecutors from 28 member states often lack coordination and team spirit. Back to Top 7.5       Compliance – Court Allows for Reduced Fines in Compliance Defense Case The German Federal Supreme Court (Bundesgerichtshof – BGH) handed down a decision recognizing for the first time that a company’s implementation of a compliance management system (“CMS“) constitutes a mitigating factor for the assessment of fines imposed on such company where violations committed by its employees are imputed to the company (BGH 1 StR 265/16 – May 9, 2017). According to the BGH, not only the implementation of a compliance management system at the time of the detection of the offense should be considered, but the court may also take into account subsequent efforts of a company to enhance its respective internal processes that were found deficient. The BGH held that such remediation measures can be considered as a mitigating factor when assessing the amount of fines if they are deemed suitable to “substantially prevent an equivalent violation in the future.” The BGH’s ruling has finally clarified the highest German court’s views on a long-lasting discussion about whether establishing and maintaining a CMS may limit a company’s liability for legal infringements. The recognition of a company’s efforts to establish, maintain and improve an effective CMS should encourage companies to continue working on their compliance culture, processes and systems. Similarly, management’s efforts to establish, maintain and enhance a CMS, and conduct timely remediation measures, upon becoming aware of deficiencies in the CMS, may become relevant factors when assessing potential civil liability exposure of corporate executives pursuant to section. 43 German Limited Liability Companies Act (Gesetz betreffend Gesellschaften mit beschränkter Haftung – GmbHG) and section 93 (German Stock Companies Act (Aktiengesetz – AktG). Consequently, the implications of this landmark decision are important both for corporations and their senior executives. Back to Top 8.  Antitrust and Merger Control In 2017, the German Federal Cartel Office (Bundeskartellamt – BKartA) examined about 1,300 merger filings, imposed fines in the amount of approximately EUR 60 million on companies for cartel agreements and conducted several infringement proceedings. On June 9, 2017, the ninth amendment to the German Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen – GWB) came into force. The most important changes concern the implementation of the European Damages Directive (Directive 2014/104/EU of the European Parliament and of the Council of November, 26 2014), but a new merger control threshold was also introduced into law. Implementation of the European Damages Directive The amendment introduced various procedural facilitations for claimants in civil cartel damage proceedings. There is now a refutable presumption in favor of cartel victims that a cartel caused damage. However, the claimant still has the burden of proof regarding the often difficult to argue fact, if it was actually affected by the cartel and the amount of damages attributable to the infringement. The implemented passing-on defense allows indirect customer claimants to prove that they suffered damages from the cartel – even if not direct customers of the cartel members – because the intermediary was presumably able to pass on the cartel overcharge to his own customers (the claimants). The underlying refutable presumption that overcharges were passed on is not available in the relationship between the cartel member and its direct customer because the passing-on defense must not benefit the cartel members. In deviation from general principles of German civil procedural law, according to which each party has to produce the relevant evidence for the facts it relies on, the GWB amendment has significantly broadened the scope for requesting disclosure of documents. The right to request disclosure from the opposing party now to a certain degree resembles discovery proceedings in Anglo-American jurisdictions and has therefore also been referred to as “discovery light”. However, the documents still need to be identified as precisely as possible and the request must be reasonable, i.e., not place an undue burden on the opposing party. Documents can also be requested from third parties. Leniency applications and settlement documents are not captured by the disclosure provisions. Furthermore, certain exceptions to the principle of joint and several liability of cartelists for damage claims in relation to (i) internal regress against small and medium-sized enterprises, (ii) leniency applicants, and (iii) settlements between cartelists and claimants were implemented. In the latter case, non-settling cartelists may not recover contribution for the remaining claim from settling cartelists. Finally, the regular limitation period for antitrust damages claims has been extended from three to five years. Cartel Enforcement and Corporate Liability Parent companies can now also be held liable for their subsidiary’s anti-competitive conduct under the GWB even if they were not party to the infringement themselves. The crucial factor – comparable to existing European practice – is the exercise of decisive control. Furthermore, legal universal successors and economic successors of the infringer can also be held liable for cartel fines. This prevents companies from escaping cartel fines by restructuring their business. Publicity The Bundeskartellamt has further been assigned the duty to inform the public about decisions on cartel fines by publishing details about such decisions on its webpage. Taking into account recent efforts to establish a competition register for public procurement procedures, companies will face increased public attention for competition law infringements, which may result in infringers being barred from public or private contracting. Whistleblower Hotline Following the example of the Bundeskartellamt and other antitrust authorities, the European Commission (“Commission“) has implemented a whistleblowing mailbox. The IT-based system operated by an external service provider allows anonymous hints to or bilateral exchanges with the Commission – in particular to strengthen its cartel enforcement activities. The hope is that the whistleblower hotline will add to the Commission’s enforcement strengths and will balance out potentially decreasing leniency applications due to companies applying for leniency increasingly facing the risk of private cartel damage litigation once the cartel has been disclosed. Merger Control Thresholds To provide for control over transactions that do not meet the current thresholds but may nevertheless have significant impact on the domestic market (in particular in the digital economy), a “size of transaction test” was implemented; mergers with a purchase price or other consideration in excess of EUR 400 million now require approval by the Bundeskartellamt if at least two parties to the transaction achieve at least EUR 25 million and EUR 5 million in domestic turnover, respectively. Likewise, in Austria a similar threshold was established (EUR 200 million consideration plus a domestic turnover of at least EUR 15 million). The concept of ministerial approval (Ministererlaubnis), i.e., an extra-judicial instrument for the Minister of Economic Affairs to exceptionally approve mergers prohibited by the Bundeskartellamt, has been reformed by accelerating and substantiating the process. In May 2017, the Bundeskartellamt published guidance on remedies in merger control making the assessment of commitments more transparent. Remedies such as the acceptance of conditions (Bedingungen) and obligations (Auflagen) can facilitate clearance of a merger even if the merger actually fulfils the requirements for a prohibition. The English version of the guidance is available at: http://www.bundeskartellamt.de/SharedDocs/Publikation/EN/Leitlinien/Guidance%20on%20Remedies%20in%20Merger%20Control.html; jsessionid=5EA81D6D85D9FD8891765A5EA9C26E68.1_cid378?nn=3600108. Case Law Finally on January 26, 2017, there has been a noteworthy decision by the Higher District Court of Düsseldorf (OLG Düsseldorf, Az. V-4 Kart 4/15 OWI – January 26, 2017; not yet final): The court confirmed a decision of the Bundeskartellamt that had imposed fines on several sweets manufacturers for exchanging competitively sensitive information and even increased the fines. This case demonstrates the different approach taken by courts in calculating cartel fines based on the group turnover instead of revenues achieved in the German market. Back to Top     The following Gibson Dunn lawyers assisted in preparing this client update:  Birgit Friedl, Marcus Geiss, Jutta Otto, Silke Beiter, Peter Decker, Ferdinand Fromholzer, Daniel Gebauer, Kai Gesing, Franziska Gruber, Johanna Hauser, Maximilian Hoffmann, Markus Nauheim, Richard Roeder, Katharina Saulich, Martin Schmid, Sebastian Schoon, Benno Schwarz, Michael Walther, Finn Zeidler, Mark Zimmer and Caroline Ziser Smith. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. The two German offices of Gibson Dunn in Munich and Frankfurt bring together lawyers with extensive knowledge of corporate / M&A, financing, restructuring and bankruptcy, tax, labor, real estate, antitrust, intellectual property law and extensive compliance / white collar crime experience. The German offices are comprised of seasoned lawyers with a breadth of experience who have assisted clients in various industries and in jurisdictions around the world. Our German lawyers work closely with the firm’s practice groups in other jurisdictions to provide cutting-edge legal advice and guidance in the most complex transactions and legal matters. For further information, please contact the Gibson Dunn lawyer with whom you work or any of the following members of the German offices: General Corporate, Corporate Transactions and Capital Markets Lutz Englisch (+49 89 189 33 150), lenglisch@gibsondunn.com) Markus Nauheim (+49 89 189 33 122, mnauheim@gibsondunn.com) Ferdinand Fromholzer (+49 89 189 33 170, ffromholzer@gibsondunn.com) Dirk Oberbracht (+49 69 247 411 510, doberbracht@gibsondunn.com) Wilhelm Reinhardt (+49 69 247 411 520, wreinhardt@gibsondunn.com) Birgit Friedl (+49 89 189 33 180, bfriedl@gibsondunn.com) Silke Beiter (+49 89 189 33 170, 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) 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 and Merger Control Michael Walther (+49 89 189 33 180, mwalther@gibsondunn.com) Kai Gesing (+49 89 189 33 180, kgesing@gibsondunn.com) © 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.

December 21, 2017 |
Houston, We have New Tax Rates – Guiding Oil and Gas Companies Through Tax Reform

​Houston partner James Chenoweth and Dallas partner David Sinak are the authors of “Houston, We have New Tax Rates – Guiding Oil and Gas Companies Through Tax Reform,” [PDF] published by The Texas Lawbook on December 21, 2017.

December 8, 2017 |
Brexit – Initial deal agreed

The UK Government and the European Commission have issued a joint report setting out the progress of the phase 1 negotiations for the Brexit divorce terms. This report is being put forward with a view to the European Council recommending the commencement of phase 2 negotiations on the future trading relationship between the UK and the EU.  It is issued with the caveat that “nothing is agreed until everything is agreed”. A copy of the text of the UK-EU report is here. The key provisions are: Citizens’ rights: All EU citizens resident in the UK and all UK citizens resident in the EU at the date of Brexit will have ongoing rights to remain together with their immediate families (and future children) subject to various restrictions. After Brexit there will be a simple registration system for EU citizens coming to live and work in the UK. Ireland and Northern Ireland: In the absence of alternative agreed solutions (i.e. a satisfactory free trade deal between the UK and the EU), the UK will maintain full alignment with the rules of the single market and the customs union which support North-South cooperation in Ireland; the UK will also ensure that no new regulatory barriers develop between Northern Ireland and the rest of the UK. Financial settlement: There is no specific figure but the broad principles of the financial settlement have been agreed.  The UK government currently estimates the bill at around £35-£40 billion. Other high-level provisions relate to ongoing EU judicial procedures, the functioning of the EU institutions, agencies and bodies and police and judicial cooperation in criminal matters. The EU has dropped its demand for the divorce settlement to come under the direct jurisdiction of the Court of Justice of the European Union (CJEU).  However, the UK will pay “due regard” to European court rulings on citizens’ rights.  For at least eight years, British courts may also refer questions on EU law to the CJEU. The European Council is expected to approve the joint report on 14/15 December 2017.  This will mean negotiations can move on to details of a transitional period and the final post-Brexit EU-UK relationship. There are reports that the UK is expected to remain within the single market and customs union for a two year transitionary period.  Whilst there is no certainty on what will follow, there is a possibility that the EU and UK concessions on Ireland and Northern Ireland may help the UK to strike a long-term deal on staying in the customs union and single market (the so-called “soft Brexit”). There is still much to be discussed.  “We all know breaking up is hard, but breaking up and building a new relationship is harder,” commented Donald Tusk, European Council president.  “The most difficult challenge is still ahead.” This client alert was prepared by London partners Stephen Gillespie, Charlie Geffen and Nicholas Aleksander and of counsel Anne MacPherson. We have a working group in London (led by Stephen Gillespie, 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 Stephen Gillespie – Finance SGillespie@gibsondunn.com Tel: 020 7071 4230 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Nicholas Aleksander – Tax NAleksander@gibsondunn.com Tel: 020 7071 4232 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

December 7, 2017 |
What House And Senate Tax Bills Mean For Oil And Gas Cos.

​Houston partner James Chenoweth and New York partner Eric Sloan are the authors of “What House And Senate Tax Bills Mean For Oil And Gas Cos.,” [PDF] published by Law360 on December 7, 2017.

December 7, 2017 |
Black and Grey: The EU Publishes Its Lists of Tax Havens

On Tuesday, December 5, 2017, the EU announced its long-awaited list of seventeen “non-cooperative” tax jurisdictions (the “Black List”) and identified a further 47 jurisdictions with whom discussions about tax reform are ongoing (the “Grey List”).  The countries identified in both lists were among a number of jurisdictions invited by the EU to engage in a dialogue on tax governance issues in early 2017.  The Black List identifies jurisdictions that failed to engage in a meaningful dialogue with the EU or to take action to address deficiencies identified in their tax practices. The Grey List identifies jurisdictions whose tax policies and practices continue to present concerns but which have committed to address issues raised by the EU. The origins of the list date back to a European Commission Recommendation from 2012, which was followed by detailed assessment work carried out since June 2015, pursuant to a published Commission action plan. The EU has not announced any immediate steps to be taken against the blacklisted jurisdictions and instead has deferred to EU member states to take action. The jurisdictions on the Black List are: American Samoa Marshall Islands St Lucia Bahrain Mongolia Samoa Barbados Namibia South Korea Grenada Palau Trinidad & Tobago Guam Panama Tunisia Macau United Arab Emirates In its announcement on December 5 the EU noted that these seventeen jurisdictions had “taken no meaningful action to effectively address the deficiencies [identified by the EU in relation to their tax legislation and policies] and do not engage in a meaningful dialogue…that could lead to…commitments” to resolve issues raised. The EU confirmed that the jurisdictions will remain on the Black List until they meet certain criteria it identified in a publication of November 8, 2016 in relation to tax transparency, fair taxation, and the implementation of the OECD Base Erosion and Profit Shifting (BEPS) package. In addition the EU published a Grey List containing a total of 47 other jurisdictions, and identified one or more specific ongoing concerns in relation to each of those jurisdictions. The jurisdictions on the Grey List are: Armenia Guernsey Niue Aruba Hong Kong Oman Belize Isle of Man Peru Bermuda Jamaica Qatar Bosnia and Herzegovina Jersey Saint Vincent and Grenadines Botswana Jordan San Marino Cape Verde Liechtenstein Serbia Cayman Islands Malaysia Seychelles Cook Islands Maldives Swaziland Curaçao Mauritius Taiwan Faroe Islands Montenegro Thailand Fiji Morocco Turkey FYR Macedonia Nauru Uruguay Georgia New Caledonia Vanuatu Greenland Vietnam In its conclusions on the Grey List the EU described these 47 jurisdictions as presenting concerns in relation to the criteria published on November 8, 2016 referred to above, and noted that it will continue to monitor the implementation of agreed steps to address the identified deficiencies. The stated purpose of the Grey List is therefore to act as a spur to continuing reform and progress in these jurisdictions. Having expressed its sympathy for jurisdictions hit by the severe hurricanes in the Caribbean this year, the EU has put its screening process for eight Caribbean jurisdictions on hold.  These jurisdictions are: Anguilla, Antigua and Barbuda, Bahamas, British Virgin Islands, Dominica, Saint Kitts and Nevis, the Turks and Caicos Islands, and the United States Virgin Islands. Contacts with those jurisdictions will resume by February 2018, with the screening process in relation to those jurisdictions to be completed by the end of 2018. While there is much to debate and dispute as to the allocation of jurisdictions to these lists, it should also be noted that the EU excluded from consideration EU member states themselves. This spares from consideration Gibraltar, as it is (pending BREXIT) formally part of the EU. After BREXIT there will be no bar to the United Kingdom or Gibraltar being considered for inclusion on either list. In the run up to the publication of the lists, there was much speculation as to the sanctions and punishments that the EU would impose on jurisdictions included in the Black List. It had been suggested the EU could impose an EU-wide withholding tax on financial transfers into such jurisdictions, as well as a transfer tax on transfers out of those jurisdictions. While such measures may be adopted if the European Commission considers blacklisted jurisdictions to be continuing to be non-cooperative, in the short term the EU has decided to leave the question of the imposition of sanctions to the individual EU member states themselves. This decision undercuts one of the stated purposes of the Black List – namely that of replacing the existing patchwork of national measures against non-cooperative jurisdictions with a coordinated approach by the EU. Nonetheless, inclusion on the Black List signals the EU’s view that a particular jurisdiction fails to comply with tax good governance standards. This carries with it a measure of reputational damage for the jurisdictions in question vis-à-vis investors. Clients and friends operating in the United Kingdom or in Europe may well have become familiar during the course of this year with the need to conduct a “risk assessment” for the purposes of complying with the EU’s Fourth Money Laundering Directive (implemented in the United Kingdom, for example, by The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017). One of the risks to be assessed as part of such work is “geographic risk”, with the assessing body required to take into consideration published views of international bodies. The publication of the Black List and Grey List should now be taken into account in the conduct, or periodic review, of that risk assessment. Those conducting risk assessments may need to consider the appropriateness of enhanced due diligence for entities incorporated in, doing business in, or with links to jurisdictions included on either list. Clients and friends operating in the United Kingdom may also have completed, or be embarking on, a similar risk assessment under the United Kingdom’s Criminal Finances Act 2017 regarding the “failure to prevent the facilitation of tax evasion” offences. Our recent  client alert on these offences can be found here. Again “geographic risk” forms part of such assessments. As in the AML sphere, best practice will be to take account of the EU’s Black  List and Grey List in the conduct of, or periodic review of, such a risk assessment. Operations in these jurisdictions (especially those blacklisted) or work relating to these jurisdictions may require enhanced scrutiny as part of any risk assessment, and, where necessary, possibly enhanced controls or training as part of the implementation of “reasonable prevention procedures”. When it comes time to update a company’s Bribery Act risk assessment, again the impact of these lists should be considered as part of that process. Finally, it is worth noting that these designations are relevant only with respect to the EU. In the United States, for example, no such list has been proposed to date, and the imposition of sanctions by EU member states is not expected to have any direct US legal or tax consequences for entities from the blacklisted jurisdictions. We will continue to monitor developments and will provide an update when the EU makes its decision in 2018 on eight outstanding Caribbean jurisdictions. The following Gibson Dunn lawyers assisted in preparing this client update: Mark Handley and Meghan Higgins. 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 firm’s Tax and White Collar Defense and Investigations practice groups in the firm’s London office: Nicholas Aleksander (+44 (0)20 7071 4232, naleksander@gibsondunn.com) Jeffrey M. Trinklein (+44 (0)20 7071 4224; +1 212-351-2344, jtrinklein@gibsondunn.com) Patrick Doris (+44 (0)20 7071 4276, pdoris@gibsondunn.com) Allan Neil (+44 (0)20 7071 4296, aneil@gibsondunn.com) Mark Handley (+44 (0)20 7071 4277, mhandley@gibsondunn.com) Meghan Higgins (+44 (0)20 7071 4282, mhiggins@gibsondunn.com) © 2017 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 24, 2017 |
International Investors to Be Liable to UK Tax on Capital Gains Derived from UK Real Estate from 2019

Background 1.1          The UK has the largest commercial property market in Europe, attracting over $31bn of investment in the first half of 2017 (even after the Brexit vote). International investors dominate in London, lured by big buildings with long leases to established businesses and a stable legal environment – international investors account for about 75% of investment in property in central-London. 1.2          The UK traditionally had not taxed international investors on capital gains derived from investment in UK land and buildings. As such, the UK has long been a favoured destination for international real estate investors who have, year after year, consistently invested billions of dollars, euros, and pounds into both commercial and residential schemes. As compared with its peers, the UK has always been viewed as one of the most favourable real estate markets on the globe. The landscape may be about to change. 1.3          It has always taxed rental income (although with a generous deduction allowed for interest costs incurred on acquisition finance). Since 2013, the UK has imposed taxation on international investors on gains derived from some residential UK property, and these provisions were broadened in 2015. 1.4          The UK Government announced in the Autumn 2017 Budget (22 November 2017) that tax will be charged on gains made by international investors on disposals of all types of UK land and buildings – residential and commercial, and whether held owned directly or indirectly. The proposed changes extend the existing rules that apply to residential property and are due to come into effect from April 2019. 1.5          The UK Government has published a consultation document (“Consultation Document”)[1]  on the implementation of the new taxation regime. The Consultation Document proposes that a single regime will be created for the disposal of interests in both residential and non-residential property. 1.6          The proposed rules are intended to apply not only to direct disposals of UK immovable property, but also to indirect disposals – in other words the sale of interests in entities whose value is derived from UK land and buildings. 1.7          Anti-forestalling measures will be introduced with effect from 22 November 2017 (being the day on which the announcement was made), to prevent circumvention of the tax through “treaty shopping”. Autumn Budget 2017 Consultation Document 2.1          The Consultation Document makes it clear that the UK Government’s policy is to amend the law with effect from April 2019 to bring non-UK residents within the charge to UK tax on disposals of all kinds of UK immoveable property, more closely aligning the tax treatment of non-UK residents with that of UK residents, and reducing the incentive for multinational groups to hold UK land and buildings through offshore structures. 2.2         The consultation being conducted relates to the implementation of this policy, not to its principle. In the current political climate in the UK, our view is that it is highly likely that the proposals in the Consultation Document will be implemented. Direct disposals 3.1          The UK Government intends that all gains accruing on disposals of interests in UK immovable property will become chargeable to UK tax with effect from April 2019. 3.2         Non-residents will be taxed on any gains made on the direct disposal of UK land and buildings. In addition, disposals by non-resident widely-held companies will be brought into charge to tax. 3.3         The rate of tax on any direct disposals will be the UK capital gains tax (subject to the move to corporation tax for corporate owners – see below). 3.4         Non-residential property already owned as at April 2019 will be re-based to its April 2019 value – with the intention that non-residential property will only be taxed to the extent of its appreciation in value after April 2019. 3.5         Gains arising on the disposal of residential property are already within the scope of UK tax, and the re-basing point for residential property will remain at April 2015. In cases of mixed-use property (where the property includes both residential and non-residential elements), or in the case of change of use (for example, the conversion of residential property to non-residential use, or vice versa in the period between April 2015 and April 2019), there will need to be an allocation of the gain between the different elements, using the different rebasing points. 3.6         The NRCGT regime currently excludes widely-held companies from the scope of tax. That exemption will be removed with effect from April 2019. 3.7         Gains will be computed in the same way as for UK resident investors. Any losses arising on the disposal of UK property will be available for offset against UK taxable gains. For companies within the scope of corporation tax, the losses will be treated in the same way as other capital gains and losses for corporation tax purposes. For other investors, capital losses will be available for offset against capital gains arising on the disposal of other UK property. 3.8         Owners who are exempt from UK tax, otherwise than because of their non-resident status (such as certain pension schemes or sovereign investors), will be exempt from the tax. 3.9         If the property owner has made an overall loss on a direct disposal of the property, but re-basing results in a taxable gain, there will be an option for the loss to be computed using the original acquisition cost. Indirect disposals 4.1          Disposals of significant interests in entities that own (directly or indirectly) interests in UK real estate will also be brought within the scope of UK tax. 4.2         The following tests must be met at the date of disposal in order for a tax charge to be imposed: 4.2.1      The entity being disposed must be “property rich”; and 4.2.2     The non-resident must hold a 25% or greater interest in the entity, or have held 25% or more at some point in the five years ending on that date 4.3         Property Rich:  An entity is “property rich”, if 75% or more of its gross asset value as at the time of the disposal is derived from UK immovable property. This includes any shareholding in a company deriving its value directly and indirectly from the UK property, any partnership interests, any interest in settled property as well as any option, consent or embargo affecting the disposition of the UK property. The test looks through layers of ownership to arrive at a just and reasonable attribution of value. The value of both residential and non-residential UK properties will count towards the 75%. However, the value of non-UK property will not count towards the 75%. 4.4         The property richness test is applied to the gross value of the entity’s assets, so liabilities such as acquisition finance are excluded in making the assessment. The test uses the market value of the assets of the entity at the time of the disposal. 4.5         If an entity is not property rich at the time the investor acquires his investment, but becomes property rich subsequently, the whole of the gain is within the scope of UK tax – not just the amount attributable to the period after the company becomes property rich (subject to April 2019 rebasing). Rebasing to April 2019 is the only calculation permitted for investments held prior to that date (the ability to use original acquisition cost is not permitted for indirect disposals). 4.6         25% Ownership:  The 25% ownership test is intended to exclude minority investors who may not necessarily be aware of the underlying asset mix of the entity, and who are unlikely to have control or influence over the entity’s activities. 4.7         In determining whether an owner has a 25% interest, the owner will need to look back over five years to see if the test was met at any time in the five-year period. In addition, holdings of related parties will also be taken into account in the determination. For these purposes, related parties will include persons who are “connected” (using the existing rules in the UK Corporation Tax Act) but also persons “acting together”, to include situations where persons come together with a common object in relation to a UK property owning entity. The “acting together” rules will be modelled on those in the UK’s corporate interest restriction provisions. 4.8         Although the tax charge will be limited to gains accruing after April 2019 (because of the re-basing), the “look back” would take account of holdings of the owner prior to April 2019 (if that falls within the 5 year look-back period). So an investor who currently owns 50% of a UK property investment company, but sells down to 24% before April 2019, would not avoid the new tax charge if she or he sold the remaining holding before 2024 (the tax charge would be limited to the appreciation of the value of the 24% stake, and would be re-based to April 2019 values). 4.9         Groups:  The property richness test will be applied to the totality of entities being sold in a transaction. So if an investor were to sell shares in a holding company which was not itself property-rich, but which owned entities that were, the 75% test would be satisfied if, taken together, the entities being sold met the 75% test. 4.10       Calculation of gain:  Gains will be calculated on the basis of the interest being sold, using the normal rules that apply to the disposal of shares (or other investments). Anti-avoidance provisions will apply in the same way as they would to UK resident taxpayers. Investors who are exempt from UK tax, otherwise than because of their non-resident status (such as certain pension schemes), will be exempt from the tax. 4.11        Substantial shareholder exemption:  The Finance (No 2) Act 2017 introduced changes to the substantial shareholder exemption (“SSE”) to extend the exemption to qualifying institutional investors. SSE will apply to disposals of property rich companies (or groups) by such investors. Residential property 5.1          The current NRCGT rules apply only to direct disposals, and do not apply to disposals by widely-held companies. 5.2         NRCGT will be amended so that it extends to widely-held companies, and also to bring indirect disposals within the scope of the tax. The exemption within NRCGT for life-assurance companies owning residential properties will also be removed. 5.3         Widely-held companies will use April 2019 as the NRCGT rebasing point for all property disposals (both residential and non-residential). Closely-held companies will continue to use April 2015 as the rebasing point for direct disposals of residential property (and will use April 2019 for disposals of non-residential property). 5.4         April 2019 will be the NRCGT rebasing point for all disposals of indirect interests. 5.5         The NRCGT rules will extend to widely held companies whereby any disposals of UK residential property will be charged to corporation tax. Non-resident close companies disposing of residential property will also be charged corporation tax instead of capital gains tax. 5.6         The UK Government is considering harmonising the existing regime for ATED-related gains with the wider proposals for taxing non-resident gains on UK immovable property, and one of the areas of consultation within the Consultation Document relates to the simplification and harmonisation of the ATED rules. Double Tax Treaties 6.1          It is generally accepted that the primary taxing rights over immoveable property (such as land and buildings) belongs to the state in which the immovable property is located. 6.2         As historically the UK has not exercised this right, it has not been concerned to ensure that this right is fully reflected in its double tax treaties. A number of treaties will require amendment to give the UK full taxing rights in relation to indirect disposals. In the meantime, the impact of a particular treaty may be to exempt from UK tax a disposal of an indirect interest in UK land and buildings – this is subject to the anti-forestalling provisions described below. 6.3         All of the UK’s double tax treaties include a provision allowing the UK to impose tax on a direct disposal of UK immoveable property. 6.4         Most (but not all) of the UK’s tax treaties include a “securitised land” provision, which allows the UK to impose tax on gains on the disposal of interests in entities that are UK-property rich. 6.5         But some older treaties do not include a securitised land provision, and these allocate taxing rights on the disposal of interests in a UK-property rich entity to the country of residence of the investor, and not the UK. Even where a treaty includes a securitised land provision, some apply only to shares in companies, and not to interests in other entities (such as partnerships or unit trusts), and in some of the treaties, the securitised land provisions apply only to the disposal by the investor of the interest it holds in the entity, and would not apply to disposals by underlying entities. In these cases, the UK’s taxing rights will be limited. 6.6         In cases where no tax treaty exists, the UK will be able to apply the indirect disposal charge without constraint. 6.7         Where a doubt tax treaty does exist, but does not allow the UK to tax indirect disposals without constraint, the UK government has announced its intention to negotiate with the other state to amend the treaty. Subject to the anti-forestalling provisions, if a non-resident investor disposes of his interest in a UK-property rich entity prior to the amendment taking effect, then the investor may be able to benefit from any exemption from UK tax in the treaty. 6.8         However, an anti-forestalling rule will apply to prevent investors from being able to reorganise their affairs in order to take advantage of a treaty exemption to which they are not already entitled. The anti-forestalling rule will apply to any arrangements entered into or after 22 November 2017 with the intention of obtaining a tax advantage relating to these new tax provisions through the operation of the provisions of a double tax treaty exemption. In these circumstances, HMRC will have the power to counteract the tax advantage by means of a tax assessment or the disallowance of a claim. Collective Investment Vehicles 7.1          UK REITs:  The profits and gains of the property rental business of a UK REIT are exempt from tax, and there is no intention to change this rule. A UK REIT is required to distribute at least 90% of its rental income by way of dividend, which is then taxed in the hands of its shareholders. There is no requirement for a UK REIT to distribute capital gains, but if those gains are distributed by way of dividend, those dividends will also be taxable in the hands of shareholders. 7.2         Currently UK residents shareholders are taxed on gains realised on the disposal of shares in a UK REIT, whereas non-resident shareholders are not. Under the new rules, if a UK REIT satisfies the property richness test, then a non-resident disposing of shares in the UK REIT will be within the scope of UK tax (if the non-resident has a 25% or greater interest in the REIT at the time of disposal or in the prior 5 years). 7.3         The intention is that a similar analysis would apply to other UK collective investment vehicles (such as property authorised investment funds and exempt unauthorised unit trusts), and the vehicle itself would not be liable to tax on the direct disposal of UK property. However, a non-resident investor would be liable to UK tax on a disposal of its investment in the vehicle (assuming the vehicle was “property rich” and the investor’s interest exceeded 25% (at the time of disposal or in the prior five years). 7.4         Overseas collective investment vehicles: Some funds are outside the scope of UK tax on capital gains only because of their non-resident status. This will change with the new rules. Direct disposals by such collective vehicles will come within the scope of UK tax with effect from April 2019. And from that same date, disposals by investors of their interests in such vehicles will also become taxable (assuming the vehicle was “property rich” and the investor’s interest exceeded 25% (at the time of disposal or in the prior five years). Corporation tax 8.1          In March 2017, the UK Government published its consultation on “Non-resident companies chargeable to Income Tax and Non-resident CGT”, which sought views on bringing closely held companies that own UK property within the scope of UK corporation tax. 8.2         A response to that consultation is expected to be published shortly, but the indication is that non-UK resident companies that own UK property will be brought within the scope of UK corporation tax as regards their UK property business. 8.3         The move to the corporation tax regime will have the effect of reducing the headline tax rate for such companies. The Government has announced that the main corporation tax rate will be 19% for the financial years 2018 and 2019, and will reduce to 17% for the financial year 2020. 8.4         In addition, the regime for tax reliefs for financing costs is somewhat more flexible under corporation tax rules than under income tax rules, and technical issues that can arise when a property is refinanced should no longer apply. 8.5         However, companies within the scope of corporation tax are subject to interest restrictions (broadly 30% of consolidated “tax EBITDA” with a de minimis of £2 million), and to the ability to carry-forward losses. There are limited exceptions for public infrastructure projects. These rules are complicated and outside the scope of this alert as are the application of the hybrid entity rules and the carry-forward loss limitations, which will also become applicable. Administration and compliance 9.1          Non-resident direct owners of UK property are already within the scope of UK tax (at least as regards rental income) and will be filing UK tax returns in respect of rental income under the Non-Resident Landlord Scheme. However, investors in property-rich entities will not be used to filing UK tax returns. 9.2         HMRC anticipate that most persons within the scope of the new charge will be aware of their obligations to file UK tax returns and pay UK tax, and will be compliant. But in order to ensure that HMRC are aware of transactions, reporting obligations will be imposed on professional advisors, as described below. 9.3         Under the current NRCGT 9.3 regime, a transaction must be reported by the seller to HMRC electronically within 30 days of completion. If the seller is already within the self-assessment regime, they may defer payment of the tax until the tax is due under the normal reporting process. Otherwise, they must pay within 30 days. The same process will apply to the new charge for investors who are not within the scope of corporation tax. This will apply to direct and indirect disposals, and for residential and non-residential properties. 9.4         For companies within the charge to corporation tax, they will be required to register for self-assessment with HMRC, and return (and pay) any tax within the normal corporation tax self-assessment process. 9.5         So that HMRC will become aware of indirect disposals, reporting obligations will be imposed on advisors who meet the following conditions: 9.5.1      The advisor is based in the UK; 9.5.2     The advisor is paid a fee for advice or services relating to a transaction within the new rules; 9.5.3      The advisor has reason to believe that a contract has been concluded for a disposal falling within the new regime; 9.5.4     The advisor cannot reasonably satisfy themselves that the transaction has been reported to HMRC. 9.6         The time limit for the advisor is 60 days – which should allow time for the non-resident to report the transaction himself, and show an official receipt for its report to its advisor. 9.7         HMRC will have powers to recover unpaid tax from a UK representative of a non-resident investor and from related companies. 9.8 Penalties and interest charges will be imposed for compliance failures. Conclusions 10.1        In some respects, the move by the UK Government to impose tax on foreign investors in UK real estate should come as no surprise. In a time of austerity, raising tax receipts is an important part of the public finances, and seeking tax from overseas investors (who have no vote) is an obvious target. 10.2       Imposing capital gains tax on international investors in real estate brings the UK in line with most other jurisdictions. 10.3       At the moment, all we have is a consultation document. The Government has stated that it will publish its response to the consultation in Summer 2018, together with draft legislation. The actual legislation will be introduced with the Finance Bill in April 2019, to take effect from April 2019. Until we have sight of the draft legislation, it is difficult to provide anything other than a high level overview of the proposals. 10.4       However, there are some immediate thoughts that come to mind. 10.5       First, consideration should be given to the timing of capital expenditure. If an amount to be spent on capex will not be immediately reflected in the value of the building, consideration should be given to deferring the expenditure until after April 2019. This is so the full amount of the expenditure is treated as “enhancement” expenditure for base cost purposes, rather than getting lost in the rebasing valuation as at April 2019. 10.6       Second, if property is currently owned through a company incorporated and resident in a country with a favourable tax treaty with the UK, disposals of interests in such company may be exempted from the new indirect disposal charge under the terms of the treaty (which under UK general tax rules will trump domestic law), at least until such time as the UK and the other jurisdiction amend the treaty (and, unless the new multilateral instrument process can be utilised, the process of amending tax treaties is rarely rapid). To the extent that such structures can be kept in place without changes, they should. 10.7       However, the anti-forestalling provisions will counteract any attempt to redomicile a structure that does not already benefit from treaty reliefs into a favourable treaty jurisdiction. Quite how the anti-forestalling provisions will apply is not stated in HMRC’s technical note, and may be challenging to implement without the consent of the other jurisdiction involved. 10.8       Third, international investors, who benefit from UK tax exemptions (otherwise than because of their non-resident status), may want to restructure their ownership arrangements in order to benefit from their tax-exempt status, particularly if they own UK property through special purpose vehicles resident outside the UK.. This could be of particular relevance to overseas pension funds and sovereign investors, who would not be liable to UK tax if they hold property directly (or through fiscally transparent entities). Any restructuring may need to be put into place before April 2019 to ensure that the restructuring does not itself trigger a tax charge under the new regime. 10.9       Fourth, the structure of the proposed arrangements can give rise to the possibility of tax being charged at multiple levels where property is held by an international property investment funds through SPVs. Depending upon the proportion of UK and non-UK properties held by the fund, charges could arise on the disposal of individual SPVs (owning UK properties) and on the disposal by investors in their holding in the fund. Staging and timing of disposals may be important to mitigate the impact of potential double tax charges, so that at the point at which investors realise their holding in the fund, it is no longer “property rich”. 10.10     Fifth, The use of tax efficient onshore-UK structures (such as UK REITs, PAIFs and ACSs), is likely to become more prevalent, if only to restrict any tax charge to just one layer, and not at multiple levels. However, the Consultation Document does state that the Government will be considering whether changes to these regimes will be required to prevent tax avoidance. 10.11      Sixth, the interaction between these new provisions and the Substantial Shareholder Exemption is not entirely clear from the Consultation Document. Whilst the application of SSE to Qualifying Institutional Investors is clearly preserved, it is unclear whether SSE would be available for disposals that would otherwise qualify for the SSE. This is of particular importance to active trading businesses (such as hotels and care homes) that have a significant property component to their overall valuation. In the case of OpCo-PropCo structures, depending upon how the provisions are legislated, there might be benefits in migrating PropCos into the UK so that they clearly qualify for SSE on a disposal of the entire business. 10.12     Finally, challenges will also bring opportunities. Although some investors may find that their after-tax return from UK property investment will be diminished as a result of these changes, investors who are already within the scope of UK tax (or exempt from tax) will be no worse off as a result of these changes, and may find opportunities for investment. It would be no surprise if the spectre of this legislation brings into play “price chip” discussions as cash-rich investors seek to capitalise on uncertainties that inevitably will feature in the minds of sellers. ________________________ [1]  See HM Treasury and HM Revenue & Custom Autumn Budget 2017 – Open Consultation on Taxing gains made by non-residents on UK immovable property (22 November 2017), available athttps://www.gov.uk/government/consultations/taxing-gains-made-by-non-residents-on-uk-immovable-property   The following Gibson Dunn lawyers assisted in preparing this client update: Nicholas Aleksander, Jeff Trinklein, Alan Samson, and Barbara Onuonga. 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 and Real Estate Practice Group: Nicholas Aleksander – London (+44 (0)20 7071 4232, naleksander@gibsondunn.com) Jeffrey M. Trinklein – London/New York (+44 (0)20 7071 4224 +1 212-351-2344), jtrinklein@gibsondunn.com) Alan Samson – London (+44 (0)20 7071 4222, asamson@gibsondunn.com)   © 2017 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 8, 2017 |
Potential Changes in Taxation of Executive Compensation and Employee Benefits Under the Proposed House Tax Legislation

On November 2, 2017, House Republicans released their much-anticipated tax reform proposal, entitled the Tax Cuts and Jobs Act (the “Act”).  We provided a summary of the Act here, which noted that there is significant uncertainty as to whether some or all of the provisions in the Act will take effect, and, if they do, in what form.  If enacted, certain provisions of the Act would have a major impact on executive compensation and various employee benefits, including qualified retirement plans and fringe benefits.  We summarize the provisions of the Act relating to executive compensation and employee benefits below. Effective Elimination of Unfunded Non-Qualified Deferred Compensation As an offset to lower individual tax rates, the Act substantially limits amounts on which taxes can be deferred by individuals as nonqualified deferred compensation.  The basic principle is that an individual would be taxed on compensation as soon as that compensation is no longer subject to an obligation to perform future substantial services.  Other types of restrictions, such as bona fide performance goals, that under current law delay taxation until if and when they are achieved, would not defer taxation.[1]  The proposed tax legislation takes the form of introducing a new Code section—Section 409B.  The existing elaborate rules governing the taxation of nonqualified deferred compensation under Section 409A would be repealed in their entirety. Section 409B would effectively eliminate long-term nonqualified deferred compensation as a means of delaying income taxation for years into the future by virtue of taxing compensation once any service requirement has been fulfilled.  Unlike Section 409A, there would be no penalties in the form of additional income taxes, interest and penalty taxes imposed under Section 409B. Certain concepts under Section 409A will or should remain.  First, the concept of payment on or before 2 ½ months after the end of a tax year in which the right to compensation vests (the so-called “short-term deferral rule”) would remain in effect.  Second, transfers of property in connection with the performance of services, which are taxed under Section 83, would not be covered under Section 409B.  Third, since Section 422 would not be repealed under the Act, incentive stock options should remain in effect.  The proposed legislation gives the Treasury Department broad authority to exempt various forms of compensation from Section 409B, so we would expect (as is the case in the Section 409A regulations) that if this legislation were enacted in its present form, the Section 409B regulations would expressly exempt incentive stock options. Options generally, however, receive unusually unfavorable treatment under Section 409B.  Both options and stock appreciation rights would become taxable when any service-based requirements are satisfied, regardless of whether or not the option is exercised, the underlying stock is publicly traded, or the option is then still subject to other restrictions such as performance goals that have not yet then been achieved.   We expect this provision in particular to draw much comment and criticism.  At least one member of Congress has already proposed allowing deferral of taxation of options until five years after vesting (or, if earlier, when the option is exercised). Deferred compensation plans sponsored by tax-exempt organizations (other than state and local governments) under Section 457 would be eliminated.  Section 457A (which covers deferred compensation paid by partnerships and certain foreign corporations) would also be repealed, presumably because the standard for taxation that is established for those arrangements is the same as has been proposed under Section 409B. These provisions would become generally effective for compensation attributable to services performed on or after January 1, 2018.  Deferred compensation accrued prior to 2018 is not entirely grandfathered, rather it must be taxed (generally upon actual payment) no later than December 31, 2025.  Note that this requirement includes even deferred compensation accrued prior to 2005, the year in which Section 409A originally became effective. Expansion of Non-deductibility of “Excessive” Executive Compensation under Section 162(m) The Act would substantially expand the scope of non-deductible executive compensation above $1 million in a single fiscal year for public companies.  It does so by making a number of important changes to Code Section 162(m). The current exemption for “performance-based compensation” (which covers cash incentive bonuses and a number of different types of equity compensation, such as options and performance shares) would be eliminated.  The exemption for commission payments would also be repealed. The scope of those executives whose compensation is covered by Section 162(m) would be expanded in two ways.  First, the Act conforms the definition of “covered employee” to the current definition of “named executive officer” applicable to proxy disclosure for public companies under federal securities law.  This has the effect of covering Chief Financial Officers, whose compensation has not been covered under current Section 162(m) in recent years.  It also results in covering any person who serves as a company’s principal executive officer or principal financial officer at any time.  Second, while under current law the group of covered employees is determined at the end of a public company’s fiscal year and applies only to compensation paid in that fiscal year, under the Act once an executive becomes a covered employee, that status is retained for the remainder of that executive’s life and therefore covers all compensation paid to the executive for the remainder of his or her life.  There is even a special rule to pick up compensation paid to beneficiaries after the death of a covered employee. The Act broadens the scope of companies treated as “publicly held corporations” subject to this law, including not only companies that have registered their stock or other equity securities with the Securities & Exchange Commission, but also certain other companies that file reports with the SEC (such as companies only filing reports relating to their debt securities).  This latter extension could be problematic since many of these additional companies are not currently required under securities laws to identify their named executive officers in SEC filings. These changes to Section 162(m) would be effective for tax years beginning after December 31, 2017. Changes Affecting Tax-Qualified Retirement Plans The Act also includes several changes directed at tax-qualified retirement plans.  Unlike the executive compensation provisions discussed in this client alert, none of these changes should be controversial, and we think it is likely that some or all of these changes will be enacted (either as part of the Act or in other legislation). During the drafting of the Act, there were rumblings that the Act could make a number of unpopular changes, such as significantly reducing the limit on employee “401(k)” contributions and characterizing all employee contributions as “Roth” after-tax contributions.  However, none of those provisions were included in the current version of the Act. The changes in the Act that would impact tax-qualified plans are: IRA Conversions.  Under current law, individuals are permitted to recharacterize contributions to “traditional” IRAs as contributions to “Roth” IRAs, and vice versa.  Under the Act, this will no longer be permitted after December 31, 2017.   Thus, individuals would be stuck with the initial tax treatment they choose for their IRAs. Reduction in Age for Permissible In-Service Distributions.  Currently, individuals who continue working generally cannot take distributions from defined benefit pension plans and money purchase pension plans until age 62.  Commencing with plan years beginning after December 31, 2017, the Act would allow plans to permit in-service distributions commencing at age 59-1/2, similar to the rules for 401(k) plans. Hardship Distributions.  Beginning in 2018, the Act would modify the rules applicable to hardship distributions from 401(k) plans.  First, the Act would eliminate the rule that participants must be suspended from making employee contributions for six months following a hardship withdrawal.  Second, the Act would repeal the requirement to take a plan loan before a hardship withdrawal is permitted.  Third, the types of contributions that may be withdrawn would be expanded to include qualified nonelective contributions, qualified matching contributions and post-1988 earnings. More Flexibility to Repay Plan Loans.  Under current law, a plan loan generally goes into default (triggering a deemed distribution and, in many cases, a 10% excise tax) unless the loan is repaid in full within 60 days following termination of employment.  The Act would extend that deadline to the individual’s due date (including extensions) for filing his or her individual tax return for the year of termination of employment. Closed Plan Nondiscrimination Testing.  In recent years, many employers have closed defined benefit pension plan participation to new employees, so that only previous hires continue to accrue benefits.  As the “grandfathered” group ages and becomes more highly-compensated relative to the rest of the workforce, that can result in the plan’s failure to satisfy various IRS nondiscrimination rules.  Subject to various requirements, the Act would provide relief to these plans, as well as to defined contribution plans where enhanced contributions are made for a “grandfathered” group who stopped accruing benefits under a pension plan in connection with a “freeze” of that plan. Repeal or Limitation of Certain Exclusions Relating to Fringe Benefits In the name of “simplification”, the Act also repeals or limits a number of exclusions or exemptions relating to employer-provided fringe benefits from an employees’ taxable income.  The fringe benefits affected include the following: Dependent Care Assistance Programs.  The Act eliminates dependent care flexible spending accounts (dependent care FSAs) by repealing Code Section 129.  Currently, an employee can contribute up to $5,000 on a pre-tax basis to fund child care costs or expenses related to care for a disabled spouse or other dependent or an elderly or disable parent.  Contributions to dependent care FSAs would no longer be excluded from income under the Act.  The Act would not have any impact on health FSAs that allow for contributions on a pre-tax basis up to $2,500 to cover health care expenses not covered by insurance. Adoption Assistance Programs.  The Act eliminates adoption assistance programs by repealing Code Section 137.  Under the Act, employers would no longer be permitted to exclude from income amounts paid or expenses incurred by the employer for qualified adoption expenses under an adoption assistance program. Educational Assistance Programs.  The Act eliminates educational assistance programs by repealing Code Section 127, which provides for an exclusion from taxable income of up to $5,250 of employer-provided educational assistance. Employer-Provided Lodging.  Currently, Code Section 119 excludes from an employee’s taxable income the value of certain employer-provided lodging where an employee is required to accept lodging on the employer’s business premises as a condition of employment.  The Act would add a new subsection (e) to Section 119 that would limit the aggregate amount that could be excluded from income in any one year to $50,000, which limit would be further reduced for certain highly compensated employees and 5% owners. Employee Achievement Awards.  The Act repeals Code Section 74(c) (and related provisions), which provides that certain employee achievement awards are not included in an employee’s taxable income (and are therefore not deductible by the employer). Gibson, Dunn & Crutcher is focused on the Act and how it would affect our clients, and we will continue to provide updates as more information about the Act or tax reform in general becomes available.    [1]   Although presumably the presence of these vesting conditions should affect the valuation of the compensation to be paid. The following Gibson Dunn lawyers assisted in preparing this client update: Steve Fackler, Michael Collins, Sean Feller and Arsineh Ananian. 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) © 2017 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 3, 2017 |
House GOP Releases Major Tax Reform Bill

On November 2, 2017, House Republicans released their much anticipated tax reform proposal, entitled the Tax Cuts and Jobs Act (the “Act”).  (On November 3, 2017, Chairman Brady released a “Chairman’s mark” that removed one international tax provision and made several technical and conforming changes.) The Act must be approved by both the House and the Senate and signed by the President in order to become law, so there is significant uncertainty as to whether some or all of the provisions in the Act will take effect, and, if they do, in what form. If enacted, the Act would make a number of major changes to the U.S. federal taxation of businesses and individuals, including lowering the corporate income tax rate to 20%, introducing a 25% individual income tax rate for certain income from passthrough entities and personal service corporations, changing the treatment of interest and certain other business expenses, moving toward a territorial system of international taxation, introducing new provisions designed to combat base erosion, streamlining individual income tax rates, repealing the alternative minimum tax, subjecting “super tax-exempt” investors to the unrelated business income tax and raising the financing costs for future infrastructure transactions.  We summarize below certain provisions of the Act. A.Business Tax Reform 1. Tax Rates – Corporations Corporate graduated tax rates of up to 35% would be replaced with a 20% flat rate, with one exception: personal service corporations would be subject to a 25% flat rate. 2. Tax Rates – Business Income of Sole Proprietorships and Passthrough Entities “Business income” from sole proprietorships and passthrough entities (i.e., entities classified as partnerships and S corporations) would be subject to a maximum tax rate of 25%, instead of the applicable individual rates. The amount of income derived from a sole proprietorship or passthrough entity that would be treated as “business income” eligible for the 25% maximum tax rate would depend, in part, on whether the individual owner is actively involved in the business (determined under the existing passive activity loss rules).  Generally, where an individual owner is actively involved in the business, 30% of the income derived from the business would be treated as “business income” subject to the maximum 25% rate, and 70% of the income would be treated as non-business income taxed at applicable individual rates.  Taxpayers would have the option to elect out of the default rule to treat more than 30% of their income as “business income” based on the income of the business and the amount of capital invested in the business.  The election would be binding for five years.  Absent such an election, 100% of the income of personal service businesses, such as law firms, accounting firms, and professional service firms, would be treated as non-business income not eligible for the 25% rate.  Individuals who are actively involved in the business would also be subject to self-employment tax on their distributive shares of non-business income, and the exemption from self-employment tax for limited partners would be eliminated.[1]  In contrast to income generated from  businesses in which a taxpayer is actively engaged, all of the income derived from business activities in which the taxpayer is not active (i.e., passive activities) would be eligible for the 25% maximum rate. Income already subject to preferential rates, such as net capital gains and qualified dividend income, would not be affected by these rules.  However, dividends from real estate investment trusts that are not qualified dividends generally would be eligible for the 25% rate. 3.   Limitation on Business Interest In general, a taxpayer would not be permitted to deduct business interest in excess of its business interest income and 30% of its “adjusted taxable income” (generally income before interest income and expense, net operating losses, depreciation, amortization, and depletion).  For partnerships, the limitation would be determined at the partnership level.  Any interest amount disallowed may be carried forward to the succeeding five taxable years, subject to certain limitations.  This rule would apply to taxable years beginning after December 31, 2017. The limitation on interest deductions would not apply to real property trades or businesses (as currently defined under section 469[2]) or certain public utilities.  The limitation also would not apply to “small businesses” (i.e., businesses with average gross receipts of $25 million or less). Due to the limitation on interest deductions, the “earnings stripping” rules of section 163(j) would be repealed.  Those rules generally limit the deductibility of interest by a thinly capitalized corporation where the interest is paid to certain related party lenders. 4.   Net Operating Losses The Act would make substantial changes to the net operating loss (“NOL”) rules.  First, deductions arising from NOLs generated in taxable years beginning after December 31, 2017, would not be allowed to be carried back to offset income in prior years (with a narrow exception for small businesses and farms).  Second, NOLs would be able to be carried forward indefinitely, instead of being limited to a 20-year period.  Finally, NOLs would be permitted to offset only 90% of taxable income, instead of all taxable income as current law generally permits.  5.   Cost Recovery The Act would replace the current 50% bonus depreciation deduction for “qualified property” placed in service before January 1, 2020, with a 100% deduction for such property that is acquired and placed in service after September 27, 2017, and before the end of 2022 (or 2023 for certain long-life property).  In addition, the Act would allow the deduction for taxpayers acquiring used property, which is currently excluded from the bonus depreciation rule.  “Qualified property” for this purpose generally would include most tangible personal property, but would not include property used by certain utility companies or in a real property trade or business. The Act also would expand immediate expensing of any “section 179 property” (including certain tangible property) placed in service in any taxable year by increasing the amount a business is entitled to expense from $500,000 to $5 million, with the phase-out amount increasing from $2 million to $20 million. 6.   Renewable Energy Credits Among the Act’s changes to the renewable energy-related tax credit provisions of the Code are modifications to the production tax credit (“PTC”) (generally relevant to wind energy projects) and the investment tax credit (“ITC”) (generally relevant to solar energy projects). For the wind PTC, the Act would reduce from 2.3 to 1.5 cents per kWh of qualified production for facilities the construction of which begins after the Act’s enactment.  In addition, the Act would modify the beginning of construction rules (which determine whether a facility is eligible for PTCs) by adding a “continuous construction” requirement.  This modification, which is proposed to be retroactive, could have a substantial, negative impact on wind project sponsors that undertook some construction activities before 2017, but have not maintained a continuous program of construction in the meantime. The modifications to the ITC are less material.  The existing 30% ITC for utility scale solar projects (including the rules for its gradual phase-out) is left untouched by the Act.  The permanent 10% ITC, however, would be completely eliminated under the Act.  7.   Other Business Tax Reforms The Act would make a number of other significant business tax reforms: (i) self-created patents and copyrights for musical compositions would no longer be treated as capital assets or eligible for long-term capital gain treatment; (ii) a sale or exchange of 50% or more of the total interest in partnership capital and profits within a 12-month period would no longer cause a “technical termination” of a partnership; (iii) section 1031 like-kind exchanges would be limited to exchanges of real property; (iv) multiple business tax credits would be repealed (e.g., the credit for qualified clinical testing expenses for certain drugs, the new markets tax credit, and the historic rehabilitation credit); and (v) the Act would repeal the exclusion from gross income for interest earned on certain types of bonds, including certain private activity bonds, advance refunding bonds, certain tax credit bonds, and bonds for professional sports stadiums, increasing significantly the borrowing cost for infrastructure and other projects that have historically relied on tax-exempt financing. 8.   Compensation-Related Reforms The Act would substantially limit the amount of non-qualified deferred compensation on which taxes can be deferred by taxing employees on compensation as soon as such compensation is no longer subject to an obligation to perform future substantial services.  The scope of the provision is very broad, going well beyond section 409A to include stock options and various other types of compensation that are not “deferred compensation” under current law.  In addition, the Act would expand section 162(m) so that performance-based compensation would not be excluded from the $1 million limit on deductions for compensation paid by public companies to certain high-ranking employees, and amounts paid after termination of employment to covered employees would be subject to the deduction limit. The Act also would repeal or limit various exemptions from employees’ gross income, such as employer-provided housing, employee achievement awards, dependent care assistance programs, qualified moving expense reimbursements, and adoption assistance programs. B.    International Tax Reform 1.   Establishment of Partial Participation Exemption The Act would fundamentally alter the current international tax regime by moving the United States from a worldwide tax system to a partial territorial tax system. Under existing law, the United States generally taxes U.S. multinational corporations on their worldwide income, which includes income earned by foreign subsidiaries abroad, but generally only when the income is repatriated to the United States.  To reduce the impact of double taxation, current law allows for certain credits or deductions with respect to foreign taxes paid by foreign subsidiaries. The Act would generally exempt from U.S. taxation any income earned abroad by foreign subsidiaries beginning in 2018, through a newly established participation exemption.  In general, under the participation exemption, foreign-source dividends paid by a foreign corporation to a U.S. corporate shareholder that owns at least 10% of the foreign corporation (a “U.S. Corporate Shareholder”) would be exempt from U.S. tax.  However, the Act would not exempt from U.S. taxation gain from the sale of the foreign corporation’s stock.  The U.S. Corporate Shareholder would no longer be entitled to a deduction or credit for foreign taxes paid or accrued with respect to the dividend. Other rules would be modified as a result of the move to a territorial tax system.  First, the Act would modify the rules applicable to controlled foreign corporations (“CFCs”), which include foreign subsidiaries of U.S. corporations.  U.S. Corporate Shareholders would no longer be taxed if a foreign subsidiary makes an investment in “U.S. property” (which generally includes tangible personal property in the United States, stock of U.S. corporations, obligations of U.S. persons, and certain types of U.S. intellectual property).  Second, solely for purposes of calculating losses with respect to a sale or exchange of stock of a foreign subsidiary, a U.S. Corporate Shareholder would reduce its basis in the stock by the amount of any exempt foreign-source dividends. 2.   Transitional Rule for Current Earnings A transitional rule would address existing earnings held offshore by foreign subsidiaries.  Under this rule, U.S. Corporate Shareholders would essentially be required to pay U.S. tax on those earnings as if the earnings had been repatriated to the United States.  In particular, a U.S. Corporate Shareholder would include in income for the last taxable year of the foreign subsidiary beginning before 2018 its pro rata share of net earnings and profits (“E&P”) accumulated by the foreign subsidiary after 1986, to the extent that the E&P had not already been subject to U.S. tax.  The E&P would be subject to a one-time tax of 12% for E&P held as cash (or cash equivalents) or 5% for E&P held as property.  U.S. Corporate Shareholders would be permitted to pay the tax liability in 8 annual instalments of 12.5% of the total amount due.  3.   Current Inclusion for Certain Passive Income (Base Erosion) The Act would introduce several new rules to combat U.S. base erosion, including new section 951A, which would require certain U.S. shareholders to include in their taxable income for the year 50% of their “foreign high return amount,” even if the amount remained offshore.  The Act defines the “foreign high return amount” as the excess of a CFC’s aggregate net income over a return (equal to the short-term AFR plus 7%) on the CFC’s aggregate adjusted bases in depreciable tangible property, adjusted downward for interest expense.  Foreign high returns would not include certain income, including income effectively connected with a U.S. trade or business, subpart F income, financing income exempt from subpart F, and certain related-party payments.  This provision is essentially designed to tax income earned from intangible assets held in a foreign subsidiary.  Foreign tax credits generated during one taxable year would be available (subject to an 80% limitation) to offset U.S. tax on foreign high return inclusions for that year. A second provision designed to combat base erosion would introduce a worldwide thin-cap rule that limits the deductible net interest expense of a U.S. corporation that is a member of an international financial reporting group to the extent the U.S. corporation’s share of the group’s global net interest expense exceeds 110% of the U.S. corporation’s share of the group’s EBITDA.  For this purpose, an “international financial reporting group” is any group of entities that includes at least one foreign corporation engaged in a U.S. trade or business, or at least one domestic and one foreign corporation that prepares consolidated financial statements and has annual gross receipts in excess of $100 million.  This 110% limitation would apply to the extent it would disallow a greater amount of interest deductions than would the proposed limitation on business interest expense discussed above.  Any disallowed interest could be carried forward up to five years. The final base erosion provision would impose a 20% excise tax on payments (other than interest) that are deductible or includible in either the cost of goods sold or the basis of a depreciable or amortizable asset and that are made by a U.S. corporation to a related foreign corporation, unless the related foreign corporation elects to treat the payments as income effectively connected with a U.S. trade or business.  Subject to certain exceptions, this provision generally would have the effect of subjecting the foreign corporation’s net profits (or gross receipts) with respect to the payments to full U.S. income taxation.  This provision would apply only to international financial reporting groups with payments from U.S. corporations to their foreign affiliates totaling at least $100 million annually.  It is similar in concept to certain aspects of prior border adjustment proposals, except that it is only applicable to related parties, and seems designed to apply to certain “principal” structures that have been used by multinational groups to attract group profits to offshore cost centers. C.    Tax Reforms for Individuals 1.   Individual Tax Brackets, Deductions and Credits The Act would replace the existing seven individual income tax brackets with four brackets: 12%, 25%, 35%, and 39.6%.  However, the Act would phase out the 12% bracket for certain high-income taxpayers.  The Act also would roughly double the size of the standard deduction, reduce certain deductions such as the mortgage interest deduction, and repeal or revise other deductions, exemptions, and credits.  In particular, the Act would eliminate the deduction for state and local income taxes, although property taxes of up to $10,000 would remain deductible.  The limitation on itemized deductions for upper-income taxpayers would be repealed.  No changes are proposed to the net investment income tax of 3.8% that is used to finance the provisions of the Affordable Care Act, so the top individual tax rate on certain investment income would remain at 43.4%. The Act also would repeal the alternative minimum tax (“AMT”).  Taxpayers would be entitled to claim a refund of unused AMT credit carryforwards. 2.   Changes to Estate Tax The Act would double the exemption for the estate and gift tax from $5 million to $10 million (indexed for inflation).  Beginning after 2023, the Act would eliminate the estate tax while continuing to give beneficiaries a stepped-up basis in inherited property. D.    Provisions Affecting Exempt Organizations The Act would make a number of changes that would adversely affect the taxation of exempt organizations and private foundations, as well as sponsors in the private equity sector.  Notably, the Act would subject all entities that are exempt from tax under section 501(a) to the unrelated business income tax (“UBIT”), including state pension plans that are exempt from tax under section 115(l) (i.e., “super tax-exempt” investors) and historically have taken the position that they are not subject to any UBIT.  This amendment could have a significant impact on the future structuring considerations for private equity funds as well as the willingness of super tax-exempt investors to make a direct investment in a partnership or other passthrough entity that generates unrelated business taxable income. Gibson, Dunn & Crutcher is focused on the Act and how it would affect our clients, and we will continue to provide updates as more information about the Act or tax reform in general becomes available.    [1]   The Act appears to make all passthrough income, even for “passive” owners, subject to self-employment tax, but we believe this is a drafting error that will be corrected.    [2]   Unless indicated otherwise, all “section” references are to the Internal Revenue Code of 1986, as amended (the “Code”). The following Gibson Dunn lawyers assisted in the preparation of this client alert:  Benjamin Rippeon, James Chenoweth, Brian Kniesly, Arthur Pasternak, David Sinak, Eric Sloan, Jeffrey Trinklein, Romina Weiss, Arsineh Ananian, Vanessa Grieve, Kathryn Kelly, Lorna Wilson, and Daniel Zygielbaum. 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 Art Pasternak – Co-Chair, Washington, D.C. (202-955-8582, apasternak@gibsondunn.com) Jeffrey M. Trinklein – Co-Chair, London/New York (+44 (0)20 7071 4224 +1 212-351-2344), jtrinklein@gibsondunn.com) Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@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) James Chenoweth – Houston (+1 346-718-6718, jchenoweth@gibsondunn.com) Hatef Behnia – Los Angeles (+1 213-229-7534, hbehnia@gibsondunn.com) Paul S. Issler – Los Angeles (+1 213-229-7763, pissler@gibsondunn.com) Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com) Scott Knutson – Orange County (+1 949-451-3961, sknutson@gibsondunn.com) David Sinak – Dallas (+1 214-698-3107, dsinak@gibsondunn.com) © 2017 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 29, 2017 |
UK Criminal Finances Act 2017: New Corporate Facilitation of Tax Evasion Offence – Act Now to Secure the Reasonable Prevention Procedures Defence

I. Introduction The UK Criminal Finances Act 2017 (the CFA) became law on 27 April 2017. On 30 September Part 3 of the CFA, which creates two new corporate criminal offences, will come into force. The two new offences are: Section 45 – failure of a relevant body to prevent facilitation of UK tax evasion (the UK Offence), and Section 46 – failure of a relevant body to prevent facilitation of foreign tax evasion (the Non-UK Offence). The Offences are similar in design to the ‘corporate’ failure to prevent bribery offence under section 7 of the Bribery Act 2010.  A key similarity is that the only available defence is to have in place reasonable prevention procedures designed to prevent the facilitation. The Offences represent a very significant development in corporate criminal law in the UK. On September 1, 2017 the HM Revenue and Customs (HMRC) published the required guidance on measures to be taken by businesses to put in place the reasonable prevention procedures (the HMRC Guidance).  The HMRC Guidance amends and replaces the draft guidance published in October 2016. The CFA also empowers the Chancellor to approve guidance issued by other bodies, such as sectoral regulators.  This sort of recognition mechanism has been used previously in anti-money laundering legislation; for example the Joint Money Laundering Steering Group (a grouping of trade associations in the UK financial services industry) publishes guidance which has been given official approval.  The CFA envisages that similar industry guidelines will be produced in this context. The HMRC Guidance contains useful practical examples and discussion that will inform any interpretation of the legislation.  However, it is not definitive, nor does it operate as a ‘safe-harbour’ to provide immunity from prosecution in cases where it has been followed. As with the similar Bribery Act guidance, it is not binding on the courts, although it is expected to be of highly persuasive effect at the very least. This Client Alert provides an overview of the Offences, analyses some of the more interesting issues which have the potential to shape the scope of their application, as well as examining the political drivers and regulatory appetite in this space. II. The Offences A. Overview In order to commit either of the two new Offences, it is necessary for two underlying predicate offences to have been committed.  First, there must be an underlying tax evasion offence committed by a taxpayer. Secondly, the associated person of the “relevant body” must have facilitated that evasion.  The HMRC Guidance describes the offence by the taxpayer as “Stage 1“; the facilitation by the associated person as “Stage 2“.  The failure to prevent as “Stage 3“. In outline, a relevant body commits one of the Offences where a person associated with it, acting in that capacity, criminally facilitates an act of fraudulent tax evasion by another person, and that relevant body does not have reasonable prevention procedures in place. It must be stressed that “tax” is defined very broadly in the CFA. Under section 52(1) tax is stated to include “duty and any other form of taxation (however described)”. All government levies, excises, tariffs, as well as VAT, national insurance contributions, capital gains tax, income tax, corporation tax, inheritance tax – and all other taxes – are covered. B. Jurisdiction The two offences both have extraterritorial effect and both require a nexus to the UK, although the minimum nexus required differs between the two Offences. The only UK nexus required for the UK Offence is that it involves the evasion of UK tax. There is no other required link to the UK – not the location of any conduct and nor does the relevant body need to be incorporated or formed in the UK. For the Non-UK Offence the required minimum nexus is that the relevant body either be incorporated or formed in the UK, or that it carries on a business or part of the business in the UK or any conduct constituting part of the foreign tax evasion facilitation offence takes place in the UK.  Note that this minimum nexus may be more readily satisfied than at first it might appear, as the offence may be committed through a non-UK affiliate of the relevant body if the affiliate is an “associated person” of the relevant body under the CFA.  Moreover, case law suggests that the requirement for conduct taking place in the UK may be satisfied by payments or correspondence through the UK. The definitions of the elements of the Offences repay closer scrutiny.  They raise a number of interesting questions regarding their own scope as well as highlighting potential practical difficulties associated with implementation of the new legislation. C. “relevant body” Under the CFA, it is only a “relevant body” that can be charged with either of the Offences. A “relevant body” means a body corporate or partnership.  This also extends to an entity of a similar character formed under the law of a foreign country. The Offences therefore apply to all companies, LLPs and partnerships. The Offences cannot be committed by individuals. The relevant body’s liability is strict in the sense that liability does not require any mental element on the part of the relevant body to be established. The importance of this is that enforcement of the Offences will not be restricted by the historical difficulties associated with successfully prosecuting corporations in the UK due to the need to find a “controlling mind and will” (broadly, a director) of the company to whom the relevant mens rea can be attributed.  This strict liability approach is similar to that taken under the offence of failure to prevent bribery in section 7 of the Bribery Act 2010.  It is noteworthy in this respect that the majority of Deferred Prosecution Agreements (DPAs) in the UK to date have related to section 7 of the Bribery Act. A relevant body can be found guilty of an Offence, even if the “associated person” has not been convicted or even prosecuted for a tax evasion offence, and even if the underlying tax evader has not faced prosecution.  It is open to an “associated person” to report tax evasion and facilitation to the prosecuting authorities in return for immunity for themselves, whilst opening the door to a prosecution of a relevant body. Such agreements are available under the Serious Organised Crime Prevention Act 2005, and have been upheld by the courts (R v Dougall [2010] EWCA 1048). This scenario is likely to be a particularly concerning one for relevant bodies given the incentive it gives associated persons and the authorities to seek to strike deals with one another. D. “associated person” The CFA (section 44(4)) defines a person as being an “associated person” of a relevant body if that person is an employee, agent acting in that capacity or any other person who performs services for or on behalf of the relevant body.  The associated person can be an individual or a body corporate. While under the Bribery Act there was only a rebuttable presumption that an employee, was an “associated person”, under the CFA, an employee (when acting in that capacity) is an associated persons. By contrast, subsidiaries are not specifically identified as associated persons on the face of the CFA.  Nonetheless, where subsidiaries or affiliates (or their employees) act on behalf of or, or perform services for, the relevant body, the subsidiary or affiliate will be an “associated person”. It is notable that the width of this definition is capable of including third party organisations, such as suppliers and subcontractors, and it has even been speculated that it could potentially extend to persons to whom the relevant body refers work. In one recent Bribery Act enforcement in Scotland (Rand-Rex Limited) a company’s customer (in the form of a distributor who purchased the company’s goods for on-sale) was its “associated person”. The question as to whether a person is performing services for or on behalf of an organisation is to be determined by reference to all the circumstances and not just the nature of the relationship between that person and the organisation. The contractual status or the formal title given to an individual performing services for or on behalf of the organisation does not matter.  The HMRC Guidance (p. 7) states that “The concept of a person who ‘performs services for or on behalf of’ the organisation is intended to be broad in scope, to embrace the whole range of persons who might be capable of facilitating tax evasion whilst acting on behalf of the relevant body“. The outer limits of this broad definition can be most easily seen in respect to referrals.  The HMRC Guidance states that a “vanilla” referral would not attract liability on the basis that it was “not a case of sub-contracting“.   Such a referral is explained (p. 36) as being “an introduction in good faith where the referrer believes the external service provider is unlikely to be involved in facilitating tax evasion“. E. “in that capacity” The offence is only committed where the facilitation or evasion is undertaken by someone acting in the capacity of an associated person. This is an evolution of a similar concept in the Bribery Act and serves to restrict liability that would otherwise flow from the broadly drawn definition of “associated person“.  There are at least two situations in which one can envisage this becoming relevant. First, where an employee engages in criminal facilitation outside the scope of his employment, amounting to a “frolic of his own“, he will not be acting in the capacity of an associated person. An example of this (given in the HMRC Guidance, page 32) would be where an associated person facilitates their spouse’s avoidance of tax.  In such circumstances, the employer of the associated person would not be committing the offence. Secondly, where an associated person is associated with multiple relevant bodies, that person’s conduct will not automatically have the potential to trigger liability for all of the relevant bodies.  Instead, any activity of the associated person that does not fall within its relationship with a relevant body cannot be said to be a situation in which the individual is acting in their capacity as an associated person of that relevant body.  Here, the example given in the HMRC Guidance (at page 32) is of a consultancy firm introducing clients to a bank. The consultancy is not used by the bank to provide tax advice to its clients but, unbeknownst to the bank, the consultancy offers additional services to those clients and criminally facilitates tax evasion. Here the bank would not be liable as the tax services were provided outside of the consultancy’s relationship with the bank and therefore not provided for or on its behalf. F. “tax evasion offence” and “tax evasion facilitation offence” In respect of the UK Offence, identifying a UK tax evasion offence at stage 1 is relatively straightforward.  It is either: the common law offence of cheating the public revenue; or an offence in any part of the UK consisting of being knowingly involved in, or taking steps with a view to, the fraudulent evasion of tax. This latter category is narrower than it might first appear.  It does not extend to all tax evasion offences, only those involving an element of deliberate fraud.  The HMRC Guidance offers as relevant offences for this purpose fraudulent VAT evasion (section 72, Value Added Tax Act 1974), fraudulent evasion of income taxes (section 106A, Taxes Management Act 1970) and the Law Society Guidance further adds fraudulent evasion of national security contributions (section 114, Social Security Administration Act 1992), false accounting (section 17, Theft Act 1968), and the offences in sections 2 to 7, Fraud Act 2006 (in so far as they relate to tax evasion). Tax avoidance – the adoption of legal means to limit one’s tax – will not trigger liability. Although the HMRC Guidance makes clear that aggressive tax avoidance schemes and not the target for the Offences, the boundary between aggressive tax avoidance and tax evasion is not always clear-cut. The same is true when dealing with stage 2 in respect of the UK Offence. For the purposes of the CFA, criminal facilitation by an associated person is committed where a person: is involved in or knowingly concerned in, or takes steps with a view to; or aids, abets, counsels or procures, cheating the public revenue and/or the fraudulent evasion of UK tax by another person. Things are slightly different when it comes to the Non-UK Offence, where there is a double criminality requirement.  For the Non-UK Offence to be made out both the criminal evasion of tax (stage 1) and the criminal facilitation of evasion (stage 2) must represent conduct amounting “to an offence under the law of a foreign country” (section 46(5)).  And, in addition, both the foreign tax evasion offence and the foreign tax evasion facilitation offence must amount to offences under English law.  In short, the Non-UK Offence cannot be committed in respect of any act that would be lawful in relation to a UK tax. Under English law, the content of foreign law is an issue of fact determined by the trial court on the basis of expert evidence.  Consequently, if prosecutions are brought under the Non-UK Offence, criminal courts in the UK will have to consider expert evidence of foreign criminal tax law. A High Court judge making findings of facts about foreign law whilst sitting alone in the Commercial Court is one thing, but the prospect of a lay jury in a Crown Court being asked to determine matters of criminal guilt or innocence in connection with technical aspects of the French tax code, or that of any other country, having heard conflicting expert foreign law evidence on the issue, is a prospect that prosecutors are likely to find unappealing.  The difficulties inherent in such a prosecution invites the hypothesis that the Non-UK Offence may have been designed to be dealt with more by way of DPA than by actual prosecutions. This is made possible as both of the Offences have been added to the list of offences for which DPAs are available to prosecutors in the UK.  Readers will recall that a DPA is an agreement between a company or partnership and a prosecuting agency under which the company or partnership admits certain facts, cooperates with prosecutors (including in relation to other potential defendants), accepts certain outcomes (potentially including fines, disgorgements, compensation payments, compliance requirements, liability for investigation costs, etc) and in return avoids a criminal conviction. III. The defence A. Overview As the offence is one of strict liability, once the predicate offences (stage 1 and stage 2) are made out, and it is established that the facilitator is an associated person of the relevant body, the only defence is the one of having reasonable prevention procedures in place. This defence is made out where a relevant body shows that, at the time the tax evasion facilitation offence was committed, it had in place such “prevention procedures” as it was reasonable in all the circumstances to expect it to have in place, or that it was not reasonable in all the circumstances to expect the relevant body to have any prevention procedures in place (section 45(2)). This is very similar to the “adequate procedures“ defence in section 7 of the Bribery Act, although the CFA defence is supplemented by a further safe harbour in which it is possible to show that it was not reasonable to expect the company to have any procedures in place to prevent the facilitation of tax evasion in question. B. Prevention procedures  The “Reasonable prevention procedures” can refer to both formal policies and the practical steps taken to enforce compliance. Whilst it is possible to augment anti-money laundering and Bribery Act policies, any policy must consider the risk of tax evasion facilitation independently. The simple addition of wording relating to tax evasion to a company’s compliance manuals will not be sufficient. Any measures put in place will need to be regularly reviewed to reflect changes to the company’s risk profile. Examples of procedures that companies should consider include: A formal anti-tax evasion policy; Internal training, including specific content for operations most exposed to risk ; Revisions to terms of engagement with clients and customers; Monitoring of their high-risk operations; Identification of, and appropriate engagement and communication with, those persons, both within the relevant body’s corporate group and beyond, who act in the capacity of associated persons of the relevant body; Due diligence processes for service providers (and others), and revisions to their contractual terms and conditions; Consideration of risks associated with finance, billing and invoicing; and Increased supervision and monitoring of employees where appropriate. Ultimately, the prevention measures that should be implemented will flow from a proper assessment of the circumstances of the relevant body’s business. The assessment of what procedures are needed is intrinsically linked to a proportionate, risk-based evaluation of the scope of operations of the relevant body, and the risks arising from those operations. C. Reasonable in all the circumstances The procedures do not, in order to meet the demands of the defence, have to eliminate all conceivable risk; even if they fail to prevent an associated person from facilitating tax evasion, the company will still be able to claim the defence as long as the procedures were “reasonable in all circumstances“. What is considered “reasonable in all circumstances” will depend upon the particular business of the company. The HMRC Guidance confirms that the procedures should be proportionate to the risk the company faces. High-risk factors, which mean that more robust policies and procedures are required, include: Customers – unusual circumstances, non-residents, cash intensive businesses or complex or opaque ownership structures; Countries – countries with inadequate anti-money laundering and counter-terrorist financing measures as well as those subject to sanctions; Sectors – e.g. private banking, legal services, tax advice and company service providers. Wherever these factors are found, preventative measures will have to be correspondingly more stringent in order to satisfy the reasonableness threshold. It is also worth highlighting that the HMRC Guidance (p. 12) contains an explicit acknowledgement that any consideration of what is reasonable on the part of HMRC will change as time passes. What is reasonable on the day that the new Offences come into force will not be the same as when the offences have been established for some time. The HMRC Guidance clearly envisages that it will take time for relevant bodies to get accustomed to the new duties and obligations imposed by the CFA, along with allowances being made in the early stages of implementation.  Organisations should consider this a clear signal on the part of the authorities that they expect a real shift in corporate behaviour following the CFA’s entry into force. The reasonableness of the measures implemented should also be viewed through the lens of the HMRC Guidance which identifies six guiding principles that should inform the formulation of prevention procedures. They are the same as under the Bribery Act: Risk assessment Proportionality of risk-based prevention procedures Top level commitment Due diligence Communication (including training) Monitoring and review These can be examined in turn. Firstly, the HMRC Guidance (p. 16) describes risk assessment as ultimately requiring relevant bodies to “‘sit at the desk’ of their employees, agents and those who provide services for them or on their behalf and ask whether they have a motive, the opportunity and the means to criminally facilitate tax evasion offences, and if so how this risk might be managed“. Secondly, by addressing proportionality, it is acknowledged (p. 21) that the authorities are not intending the required measures to be unduly burdensome, albeit they cannot be mere lip-service to the goals of the CFA. Thirdly, the HMRC Guidance (p. 25) stresses the desirability of senior management being involved in the formulation and implementation of procedures. Whilst recognising that senior level time cannot be spent on the minutiae of these sorts of issues, expressions of board-level commitment to and endorsement of preventative measures will go a long way to demonstrate that a relevant body has an appropriate culture and attitude towards dealing with tax evasion. The fourth principle is a recognition of the need to undertake due diligence in sufficient depth to identify risks and enable companies to respond accordingly. The HMRC Guidance (p. 27) acknowledges that some organisations in high-risk sectors such as lawyers and tax advisors will already have such systems in place, albeit noting that simply applying the old measures to this new risk will be unlikely to be enough. Principle five focuses upon the requirement to propagate the details of any measures throughout a relevant body. It is made clear (at p. 28) that HMRC expects that all staff, officers and employees of businesses should be made aware that they are expected to have a zero tolerance policy towards the facilitation of tax evasion. This does not however mean that everyone must undergo extensive training. Nor is it necessary for all associated persons to gain a deep understanding of tax law in any jurisdiction, with training only needing to be proportionate to the risks found in each instance. Principle six makes express a theme that runs throughout the guidance, namely that the risks relating to the facilitation of tax avoidance must be kept under constant review by relevant bodies and changes to procedures made as appropriate. Although understandably generic, these principles can be useful in the preparation of an outline of an organisation’s formal anti-tax evasion policies.  As with similar guidance produced to accompany the Modern Slavery Act 2015, the HMRC Guidance should be looked at as a touchstone for organisations when drafting the relevant procedures and materials envisaged by the legislation.  There is no sense here that the CFA is seeking to “catch out” companies.  The Government noted (in a memorandum relating to the human rights law compliance of the Criminal Finances Bill as it made its way through Parliament) that “There is very little prospect of a defendant relevant body being wrongly convicted as a result of practical difficulties in proving a defence that it in fact has; the defence will be easy to prove if it exists”.  Relying on the implementation of policies and procedures that have been drafted with these principles running through them will clearly place a defendant company in a stronger position than simply pointing to existing policies that have been lightly edited. IV. Penalties If a company is found guilty of either of the Offences, it faces unlimited financial penalties.  The approach to setting the fines for corporate offenders pursuant to Section 164 Criminal Justice Act 2003 requires that the fine must reflect both the seriousness of the offence and the factual circumstances of the offender.  The sentencing guidelines for corporate tax evasion offenders set the level of fine by using the offender’s actual or intended net gain as a starting point.  This is then multiplied depending on the aggravating and mitigating factors in the specific case.  The mid-range multiplier for a mid-level case is to double the starting point in order to arrive at the fine – the offender will be fined double the amount that they tried to evade.  We would expect a similar approach to be taken in respect of the new Offences.  It is likely that there would be adverse publicity for a company found guilty of an Offence, and a regulated business would need to consider the regulatory impact resulting from any prosecution. A professional services firm is unlikely to take much comfort from a DPA as opposed to a criminal prosecution and conviction. V. Enforcement appetite and political drivers The UK Offence will be investigated by HMRC, with prosecutions brought by the Crown Prosecution Service (the CPS). The Non-UK Offence will be investigated by the Serious Fraud Office (the SFO), or the National Crime Agency, and prosecutions brought by the SFO or the CPS. Due to the extra-territorial implications of the Non-UK Offence, proceedings cannot be brought against a company for this offence unless the Director of Public Prosecutions or the Director of the SFO gives their consent (although it is anticipated that consent is most likely to be denied in cases where the overseas tax in question is repugnant to UK foreign policy). The HMRC Guidance notes that it will be preferable for the jurisdiction that has suffered the tax loss to bring any prosecution. The tone of the HMRC Guidance appears to suggest that the appetite for enforcement is outweighed by the desire to affect self-started change in high risk sectors.  The existence of the HMRC Guidance and the availability of for DPAs may be expected to lead to a balanced and nuanced approach to enforcement. Companies should be under no illusion, however, that egregious failure to put in place prevention procedures leading to tax evasion going unchecked, particularly when coupled with a failure to report failings to the authorities, is likely to result in prosecution. Enforcement agencies (both criminal and fiscal) across a range of countries, including HMRC, have established a highly integrated network of systematic co-operation, particularly across Europe and between Europe and the U.S., and the broad political appetite to clamp down on tax evasion shows no sign of diminishing. Enforcement under the CFA will form a useful new tool for enforcement authorities. VI. What should companies do next? It is not too late.  The reasonable prevention procedures defence is not available only to those companies who have put all the necessary procedures in place in advance of the 30 September 2017 deadline.  A proportionate, risk-based risk assessment can be provided quickly and efficiently, and can provide substantial comfort going forward.  Moreover, if companies are confident in their existing AML and anti-bribery procedures, they may well find that the incremental work needed to manage CFA risks (and potentially avail themselves of the defence should it ever prove necessary to seek to do so), is more modest than might otherwise be imagined. We will keep our clients and friends updated on developments in the enforcement of these new offences. This alert was prepared by Nick Aleksander, Patrick Doris, Mark Handley, Steve Melrose and Jonathan Cockfield. Gibson Dunn lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following lawyers in the firm’s London office: Nicholas Aleksander (+44 (0)20 7071 4232, naleksander@gibsondunn.com) Philip Rocher (+44 (0)20 7071 4202, procher@gibsondunn.com) Patrick Doris (+44 (0)20 7071 4276, pdoris@gibsondunn.com) Charles Falconer (+44 (0)20 7071 4270, cfalconer@gibsondunn.com) Osma Hudda (+44 (0)20 7071 4247, ohudda@gibsondunn.com) Penny Madden (+44 (0)20 7071 4226, pmadden@gibsondunn.com) Allan Neil (+44 (0)20 7071 4296, aneil@gibsondunn.com) Ali Nikpay (+44 (0)20 7071 4273, anikpay@gibsondunn.com) Deirdre Taylor (+44 (0)20 7071 4274, dtaylor2@gibsondunn.com) Mark Handley (+44 20 7071 4277, mhandley@gibsondunn.com) Steve Melrose (+44 (0)20 7071 4219, smelrose@gibsondunn.com) Sunita Patel (+44 (0)20 7071 4289, spatel2@gibsondunn.com) © 2017 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 5, 2017 |
Internal Revenue Service Announces Relief for Southeast Texas Due to Hurricane Harvey

The Internal Revenue Service (the “IRS”) has announced relief from certain time sensitive deadlines for taxpayers affected by Hurricane Harvey (https://www.irs.gov/newsroom/tax-relief-for-victims-of-hurricane-harvey-in-texas). Pursuant to the announcement, affected Taxpayers (described below) may defer certain time-sensitive actions otherwise to be made on or after August 23, 2017 and before January 31, 2018 (the “Postponement Period”) to January 31, 2018. The IRS also reminded taxpayers of their ability to report deductions for casualty losses unreimbursed by insurance for Harvey in 2016 or 2017 and provided guidance on how to get expedited refund processing for 2016. In addition, the IRS has announced relief intended to ease the process whereby employer-sponsored retirement plans, such as 401(k) plans, may extend loans and make hardship distributions to individuals impacted by Hurricane Harvey and their family members (https://www.irs.gov/pub/irs-drop/a-17-11.pdf) (the “Relief Announcement”). Actions Postponed Tax Reporting and Payment Deadlines. Affected Taxpayers may postpone payment and filing deadlines for federal income taxes (e.g., individual, corporate and partnership tax return filings, estimated tax payments otherwise due September 15, 2017 and January 15, 2018) that would have been due during the Postponement Period until January 31, 2018. Payroll and certain excise tax reporting is postponed but not payment of employment and excise tax deposits (although penalties on deposits due on or after August 23, 2017 and before September 7, 2017 will be abated if paid by September 7, 2017). Employee plan reporting on Form 5500 due during the Postponement Period is included in the relief. Like-Kind Exchange Reporting Deadlines. The last day of the 45-day identification period and the 180 day exchange period and applicable reverse like kind exchange periods are postponed for Affected Taxpayers to the end of the Postponement Period and possibly up to 120 days thereafter. This rule also applies for some non-Affected Taxpayers in certain cases where the property at issue, a counterparty, a titleholder, or material documents are in the affected areas or lender or title insurance issues arise due to Hurricane Harvey. Affected Taxpayers Residence or Place of Business. Individuals with a principal residence in an affected area and business entities or sole proprietorships whose principal place of business is in an affected area Relief Workers. An individual relief worker affiliated with a recognized government or philanthropic organization and who is assisting in an affected area Location of Tax Records. Individuals, business entities, sole proprietorships, estates and trusts if such taxpayer has tax records necessary to meet a deadline and those records are maintained in an affected area Spouses and Traveling Victims. Spouses of an affected taxpayer (with respect to a joint return) and individuals visiting the affected area but are killed or injured as a result of the disaster Texas Counties Treated as Disaster Areas* Aransas Gonzales Newton Austin Hardin Nueces Bastrop Harris Orange Bee Jackson Polk Brazoria Jasper Refugio Calhoun Jefferson Sabine Chambers Karnes San Jacinto Colorado Kleberg San Patricio DeWitt Lavaca Tyler Fayette Lee Victoria Fort Bend Liberty Walker Galveston Matagorda Waller Goliad Montgomery Wharton *As of September 5, 2017 Casualty Losses In the announcement, the IRS reminds taxpayers that they may opt to deduct unreimbursed casualty losses from a federally declared disaster area in the year of the disaster or in the preceding taxable year. See IRS Publication 547 here: (https://www.irs.gov/publications/p547/ar02.html#en_US_2016_publink1000225399). Note casualty loss deductions are subject to other limitations, such as a floor of $100 and 10% of adjusted gross income, each discussed in IRS Publication 547. Affected taxpayers declaring the deduction on their 2016 return should put the disaster designation “Texas, Hurricane Harvey” at the top of Form 4684 (https://www.irs.gov/forms-pubs/form-4684-casualties-and-thefts) to expedite their refund claim. Benefit Plans This Relief Announcement extends to 401(k), 403(b) and 457(b) plans, IRAs, and qualified defined benefit pension plans with stand-alone accounts that hold employee contributions and rollover amounts.  Employees and close family members (e.g., spouse, children, grandchildren, parents, grandparents and other dependents) who live or work in areas affected by Hurricane Harvey and designated for individual assistance by the Federal Emergency Management Agency (FEMA) are eligible for relief under the Relief Announcement.[1] The Relief Announcement provides the following forms of relief: A plan will not be treated as failing to satisfy any requirement under the Internal Revenue Code (“Code”) merely because the plan makes a loan, or a hardship distribution for a need arising from Hurricane Harvey. When determining whether to make a hardship distribution, plan administrators may rely upon representations from the employee or former employee as to the need for and amount of a hardship distribution (unless the plan administrator has actual knowledge to the contrary). The relief applies to any hardship of the employee, not just the types enumerated under the Code. The six-month ban on 401(k) and 403(b) contributions that normally affects employees who take hardship distributions will not apply. Plans will be allowed to make loans or hardship distributions before the plan is formally amended to provide for such features.  However, the plan must be amended to allow for plan loans and/or hardship distributions no later than the end of the first plan year beginning after December 31, 2017 (i.e., on or before December 31, 2018 for calendar year plans). Even in a situation where a plan administrator has not assembled all of the documentation required for a loan or distribution, loans and distributions may be made so long as the plan administrator makes a good-faith diligent effort under the circumstances to comply with those requirements.  As soon as practicable, the plan administrator (or financial institution in the case of IRAs) must make a reasonable attempt to assemble any forgone documentation. The relief provided under the Relief Announcement only applies to loans and hardship distributions made on or prior to January 31, 2018.  It is important to note that the tax treatment of loans and distributions remains unchanged. Thus, any distribution (not including amounts already taxed) made pursuant to the relief provided in the Relief Announcement will be includible in gross income and generally subject to the 10-percent additional tax imposed under Code section 72(t).    [1]   Parts of Texas are currently eligible for individual assistance. A complete list of eligible counties is available at https://www.fema.gov/disasters.  If additional areas in Texas or other states are identified by FEMA for individual assistance because of damage related to Hurricane Harvey, the relief provided in the Relief Announcement will also apply from the date specified by FEMA as the beginning of the incident period. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these and other tax- or benefits-related developments.  If you have any questions, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax or Executive Compensation and Employee Benefits practice groups, or the authors: James Chenoweth – Houston (+1 346-718-6718, jchenoweth@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) David Sinak – Dallas (+1 214-698-3107, dsinak@gibsondunn.com) Michael Q. Cannon – Dallas (+1 214-698-3232, mcannon@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 20, 2017 |
French Market Update – July 2017

France is great again? Many of you have read positive articles on the new government in France and its freshly elected President, Emmanuel Macron. Is it real? First, one needs to understand the context: a quasi-unknown individual a year ago, Mr. Macron has stunned all by winning the first, then second, round of the presidential election, as an "anti-populist", pro-European, candidate. Almost as surprisingly, his party (called "Republic on the Move!"), which has been in existence for less than a year, won an absolute majority (with 350 seats over 577) in the subsequent parliamentary election, held on June 11 and 18, 2017, reducing, for example, the Socialist representatives to 28 from 280 in 2012. This, in turn, means that for the next five years, Mr. Macron has both a mandate and an ability to implement his program. France, in electing him with such latitude, rejected the extreme right (with a Frexit program) and the extreme left (with a very high taxation program). One of Mr. Macron’s key strengths has been his "extreme centrist" positioning, based on the simple concept that necessary policies are neither leftist or rightist ones; they are just common sense and should be supported by all reasonable politicians regardless of their original party. He also promoted a very large number of non-politicians to political positions, thus considerably altering the political landscape. Being an ex-Rothschild banker, Mr. Macron is guided by a resolute desire to "open the country for business" and eliminate the disincentives to investment in France, particularly at a time when Brexit causes potential issues for businesses based in the UK. He also understands the need to act fast, and intends to pass his most emblematic promises, aiming at triggering a supply-side shock and boosting confidence, before the end of 2017. What are these promises? An extensive labor reform to "move the rules of the game" aiming at lowering the unemployment rate to 7% at the end of his term in 2022. Proposed measures include caps on financial penalties for companies sued for firing employees, allowing businesses more flexibility to define internal working rules, merging the various employee representative bodies currently existing in French business organizations to improve social dialogue. To achieve this reform expeditiously, the French Government wants to use a special procedure to pass the measures this Summer without extended debate in parliament. The details of the reform are expected to be announced at the end of August. Strong workers antagonism is likely, but the climate has changed and popular support for movements has weakened.  Tax reform aimed at restoring France’s attractiveness: Among the key signals sent to the business community: a decrease of the corporate income tax (from 34.3% today to 25% in 2022), and, as from 2019, the replacement of the tax credit for competitiveness and employment (CICE) by a substantial reduction in the employers’ social contributions.     Another aspect of the proposed tax reform will be the replacement of the general wealth tax by a special wealth tax limited to real estate and the creation of a "flat tax" on capital gains and dividends at a rate of about 30%. The purpose of this proposal is to favor financial investments over real estate ones.  These long-awaited measures will kick-in as soon as 2018. A 50-billion euro investment program: Although not yet fully financed, this plan will likely rely on the existing program "Investing for the Future" launched by President Sarkozy and on a new wave of privatizations. This program embraces huge investments in training (up to €15bn), supports to the ecological transition, the digitalization of the healthcare system, investments in infrastructures (such as transports) and modernization of the State services, all of which will favor future business fluidity. A large number of these projects will be open for bidding to non-French entities. An additional 10 billion euro "innovation program" is planned to invest into Cleantech, Greentech, AI, all in order to attract and retain start-ups. A new momentum for foreign investments in France After seven years of profound economic crisis, and five years of French bashing due to the former president’s administration, his tax increases and anti-business stance, France now benefits a true shift in perception. These changes have the effect to make France a desirable investment target, especially for business and real estate. Opportunities for foreign investors are relatively cheap, especially given the quality of the administration, education, health and infrastructure and the stability of the political system. France has numerous fundamental strengths including its central location in Europe, excellent communication and transport infrastructure, significant industrial achievements in a wide range of sectors, high productivity, and a well-qualified workforce. All these strengths support opportunities for foreign investments, from the United States and elsewhere. 2017 marks Gibson Dunn’s 50th year in France.  With 45 lawyers, whose expertise covers all aspects of business law, such as corporate transactions, restructuring/insolvency, private equity, litigation, compliance, public law and regulatory, technology and innovation, and finance, as well as tax and real estate, our Paris office,  is well-positioned to assist all the Firm’s clients as their strategy shifts towards France. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyers with whom you usually work, or the following authors in the firm’s Paris office: Bernard Grinspan (+33 1 56 43 13 00, bgrinspan@gibsondunn.com) Judith Raoul-Bardy (+33 1 56 43 13 00, jraoulbardy@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

July 10, 2017 |
California Supreme Court Upholds Los Angeles County’s Interpretation of Documentary Transfer Tax Act

On June 29, 2017, in a widely anticipated ruling, the Supreme Court of California held that a transfer of an interest in a legal entity that results in a change in ownership of real property held by the legal entity for property tax purposes triggers the California documentary transfer tax (the "DTT").[1]  This decision affirms the lower court’s view that property tax "change in ownership" principles apply for purposes of the DTT. Facts of the Case As discussed in more detail in our prior Client Alert, Ardmore involved a series of transactions involving, over time, the transfer of an apartment building by a trust (Trust) to a wholly owned limited liability company (Ardmore), a transfer by the Trust of its interest in Ardmore to a "trust-owned partnership" (Partnership), a "distribution" of interests in the Partnership by the Trust to certain subtrusts of the Trust, and a "distribution" and "sale" of a 45% interest in the Partnership by the subtrusts to each of two other trusts formed for the grantor’s two sons (90% total transferred). The Los Angeles County Assessor concluded that the transaction resulted in a change in ownership of the apartment building and reappraised the property on that basis.  Ardmore did not dispute that the transactions resulted in a change in ownership of the property for property tax purposes and paid the supplemental property tax assessment.  Following the property tax assessment, the Los Angeles County Registrar-Recorder/County Clerk demanded that Ardmore pay DTT, asserting that the change in ownership for property tax purposes also gave rise to liability under the Documentary Transfer Tax Act (the DTTA).[2] California Property Tax/Change in Ownership California imposes real property tax based on the assessed value of real property.  Real property is reassessed to its appraised value whenever there is a "change in ownership."[3]  As a general matter, property owned by a legal entity is not reassessed upon a transfer of interests in the entity.[4]  The two most common exceptions to this rule relate to changes in control and original coowners.      A change in control occurs when a person obtains (directly or indirectly) more than 50% of the interests[5] in the entity.[6]  The "original coowner" exception applies only after property is transferred to an entity in an otherwise exempt transfer described in R&T Code section 62(a)(2).[7]  Under this exception, the owners of the transferee entity immediately after the exempt transfer become "original coowners," and if cumulatively more than 50% of the interests in the transferee entity are subsequently transferred by the original coowners, the property is considered to have undergone a change in ownership regardless of the fact that no one person obtained more than 50% of the interests in the transferee entity.[8] These rules were implemented following the passage of Proposition 13 in 1978.  The DTTA, including the exemptions discussed below, was enacted in 1967. The Court’s Opinion The Supreme Court of California, in a majority opinion joined by all but Justice Leondra Kruger, affirmed the lower court in holding that the sale of 90% of the interests in the Partnership subjected Ardmore to DTT. The Majority Opinion Authored by Justice Carol Corrigan, the majority held that a written instrument conveying an interest in a legal entity that owns real property may be taxable under the DTTA "as long as there is a written instrument reflecting a sale of the property for consideration"[9] – "even if the instrument does not directly reference the real property and is not recorded."[10]  The Court began with the text of R&T Code section 11911,[11] concluding that it, when read in context with other provisions of the DTTA, contemplates the application of the DTT to transfers of interests in a legal entity.  This conclusion was based largely on the Court’s interpretation of R&T Code section 11925, which provides that, in the case of realty held by a partnership or other entity classified as a partnership for federal income tax purposes (a tax partnership), no DTT is imposed as a result of a transfer of an interest in the tax partnership as long as certain requirements are met (namely that the tax partnership continues to hold the property and no termination of the tax partnership occurs under Section 708 of the Internal Revenue Code (Section 708)).  Without discussing the unique nature of partnerships and the "entity" versus "aggregate" treatment that has been applied to partnerships under both tax and non-tax law, the Court determined that the exception for continuing partnerships signified an intention by the legislature to apply the DTT to transfers of interests in entities.  Next, relying on federal authorities interpreting the former federal documentary stamp act (upon which the DTTA was based), the Court concluded that "federal courts often focused on whether there was a change in beneficial ownership of the real property" in determining whether the federal stamp act applied.[12]  In doing so, the Court distinguished United States v. Seattle Bank, in which the U.S. Supreme Court held that the transfer of real property resulting from a statutory consolidation of a national bank and state bank was not taxable under the federal stamp act.[13]  According to the Court, the U.S. Supreme Court in Seattle Bank did not decline to tax the transfer under the federal stamp act because there were no formal instruments directly referencing the real property transferred; rather, the transfer was not taxed "because the substance of the transfer did not involve the purchase or sale of property."[14] Combining the above principles, the Court concluded that the "critical factor" in determining whether the DTT may be imposed is whether there was a sale resulting in a transfer of beneficial ownership of real property and that the rules describing what constitutes a change in ownership for property tax purposes also apply for purposes of the DTTA,[15] notwithstanding that the property tax rules were issued a decade following enactment of the DTT statute.  Because certain transfers of interests in entities can constitute a change in ownership for property tax purposes,[16] the Court concluded that the DTT may be imposed "so long as there is a written instrument reflecting the sale of the property for consideration."[17] Justice Kruger’s Dissent In a dissenting opinion, Justice Leondra Kruger argued that the federal cases relied upon by the majority point to the conclusion that the DTTA should not apply to transfers in interests in legal entities that own real estate, that the DTTA and the property tax change in ownership rules were enacted at different times for different purposes, and that applying the change in ownership rules to the DTT raises difficult questions, including questions concerning valuation. Practical Implications While some California jurisdictions, including San Francisco, have already amended the DTT provisions of their municipal codes to include as "realty sold" any acquisition or transfer of ownership interests in a legal entity that results in a change of ownership of the underlying property for property tax purposes, Los Angeles never amended its municipal code to link the DTT with the property tax change in ownership rules.  Nevertheless, it is clear that Los Angeles will continue to apply the DTT to situations in which a property tax change in ownership occurs (assuming the exception in R&T Code section 11925(a), discussed below, does not apply).  In addition, other jurisdictions that have not amended the DTT provisions of their municipal codes may now rely on Ardmore to similarly impose the DTT in such situations. Worth noting is the exception in R&T Code section 11925(a), which remains intact.  Under this exception, no DTT is applied with respect to property held by a tax partnership upon the transfer of interests in such tax partnership if it is considered a continuing partnership within the meaning of Section 708 and it continues to hold the property.[18]  Thus, transfers of interests in a tax partnership should not result in a DTT if (a) the property is and continues to be held directly by the tax partnership, and (b) the transfer does not result in a termination of the tax partnership under Section 708.  This should be the case even if the transfer results in a change in ownership for property tax purposes.[19] Somewhat less clear is the result where the property is not held by the tax partnership directly, but rather is held by a subsidiary of the tax partnership, even if the subsidiary is disregarded for income tax purposes.  While those were the facts in Ardmore, the Court did not address this issue.[20]  If R&T Code section 11925 does not apply to property held in a subsidiary, then (a) the exception in R&T Code section 11925(a) to continuing partnerships likewise should not apply, and (b) the "exception to the exception" for Section 708 terminations in R&T Code section 11925(b) also should not apply.  For instance, if R&T Code section 11925 does not apply to property held in a subsidiary of a tax partnership, then (a) a transfer of interests in the tax partnership that does not trigger a Section 708 termination but that does result in a change in ownership for property tax purposes would trigger DTT on property held by the subsidiary, but (b) a transfer of interests in the tax partnership that does trigger a Section 708 termination but that does not result in a change in ownership for property tax purposes would not trigger DTT on property held by the subsidiary.[21] Interestingly, some cities and counties never amended their DTT provisions to reflect the application of Section 708 to entities that are not partnerships for state law purposes but are classified as partnerships for federal income tax purposes.  In theory, those cities and counties could claim that the exception for continuing partnerships does not apply to property that is held directly by another form of tax partnership, such as a limited liability company that is classified as a partnership for federal income tax purposes. As noted in Justice Kruger’s dissenting opinion, questions remain in determining how Ardmore will apply to future transactions, including the manner in which the tax is computed.  The majority opinion did not address the computational issues that arise when a less-than-100% transfer occurs.  The statute addresses this issue in situations where the property is owned by an partnership that terminates under Section 708.[22]  However, there is no comparable provision applicable to other entity interest transfers that now trigger a DTT.  The dissenting opinion uses as an example the possible transfer of the 10% remaining interest in the Partnership to one of the trusts that previously acquired 45%.  This transfer would result in another property tax change in ownership under R&T Code section 64(c)(1), and Justice Kruger questions whether that change in ownership would trigger yet another DTT on 100% of the value of the property.  Please contact any Gibson Dunn tax lawyer for updates on this issue.    [1]   926 Ardmore Ave., LLC, v. County of Los Angeles, S222329 (Cal. June 29, 2017).    [2]   Cal. Rev. & Tax. Code (R&T Code) § 11901 et seq.    [3]   California Constitution, Article XIIIA, Section 2(a).    [4]   R&T Code section 64(a).    [5]   Interests are determined by reference to voting stock in the case of a corporation, and profits and capital in the case of a partnership or limited liability company.  R&T Code section 64(c)(1); Rule 462.180 of Title 18, Division 1, Chapter 4, of the California Code of Regulations.    [6]   R&T Code section 64(c)(1).    [7]   These generally are transfers where the proportional interests of the transferors and transferees in the property remain the same after the transfer.    [8]   R&T Code section 64(d).    [9]   Slip opn. at 20. [10]   Slip opn. at 13. [11]   R&T Code section 11911 authorizes California counties to levy a tax on "each deed, instrument, or writing by which any lands, tenements, or other realty sold within the county shall be granted, assigned, transferred, or otherwise conveyed to, or vested in, the purchaser or purchasers . . . ." [12]   Slip opn. at 17. [13]   United States v. Seattle Bank, 321 U.S. 583 (1944). [14]   Slip opn. at 17. [15]   Slip opn. at 19-20 (noting that "the change in ownership rules are designed to identify precisely the types of indirect real property transfers that the [DTTA] is designed to tax"). [16]   See discussion above under "California Property Tax/Change in Ownership." [17]   Slip opn. at 20. [18]   While Section 708 does not use the phrase "continuing partnership," this phrase fairly clearly should be read to refer to a tax partnership that does not terminate under Section 708. [19]   For example, assume tax partnership P that owns real property and is owned equally by three partners, A, B and C.  If A purchases the entire interest of B (and assuming no other relevant sales or exchanges occurred within 12 months), there would be a change in ownership for property tax purposes under R&T Code section 64(c)(1), but no termination of P under Section 708.  Therefore, absent other adverse facts, the transaction would not give rise to DTT. [20]   According to the Court, Ardmore conceded at trial that R&T Code section 11925 did not apply.  Slip opn. at 6, fn 7.  The opinion of the lower court (unpublished), however, stated that R&T Code section 11925 did not apply to the transaction, meaning whether a Section 708 termination occurred was immaterial to the lower court. [21]   For example, using the same facts as in footnote 19, if the property were held in a subsidiary of P and R&T Code section 11925 does not apply to property held in a subsidiary, then the purchase by B from A would give rise to DTT.  On the other hand, if A sold its entire interest in P to D and B concurrently sold its entire interest in P to E, while the transactions would result in a Section 708 termination, no property tax change in ownership would occur (again, assuming no other adverse facts) and therefore the DTT should not apply.      [22]   R&T Code section 11925(b) provides that "the partnership or other entity shall be treated as having executed an instrument whereby there was conveyed, for fair market value (exclusive of the value of any lien or encumbrance remaining thereon), all realty held by the partnership or other entity at the time of the termination."   Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these and other tax-related developments.  If you have any questions, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax Practice Group, or any of the following: Los Angeles  Hatef Behnia (+1 213-229-7534, hbehnia@gibsondunn.com)Paul S. Issler (+1 213-229-7763, pissler@gibsondunn.com)Dora Arash (+1 213-229-7134, darash@gibsondunn.com) Orange County Scott Knutson (+1 949-451-3961, sknutson@gibsondunn.com) © 2017 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.