Category Archives: Accounting and Audit

Lundbeck: the EU General Court Endorses the Reasoning of the European Commission in Relation to Reverse Payment Settlements

I. Introduction

With the Lundbeck Decision, the European Commission (the “Decision” and the “Commission,” respectively) ended its ten-year investigation on reverse payment settlements and found that the Danish pharmaceutical company, Lundbeck, and four generics producers had concluded anticompetitive agreements, in breach of Article 101 of the Treaty on the Functioning of the European Union (the “TFEU”).[1]  According to the Commission, this would have allowed Lundbeck to keep the price of its drug citalopram artificially high and delay the entry of cheaper medicines into the EU market.[2]

On 8 September 2016, the EU General Court (the “General Court”) confirmed that certain pharmaceutical “reverse payment settlements” can constitute a breach of the EU antitrust rules (the “Ruling”).[3]  Under the so-called “reverse payment settlement agreements”, an original pharmaceutical manufacturer, or “originator”, settles an IP challenge from a manufacturer of generics by paying the latter to stay out of the market.

II. Background

Lundbeck is “a global pharmaceutical company specializing in psychiatric and neurological disorders”.[4] These include medicinal products for treating depression.[5]  From the late 1970s, Lundbeck developed and patented an antidepressant medicinal product containing the active ingredient citalopram’.[6]

After its basic patent for the citalopram molecule had expired, Lundbeck only held a number of the so-called “process” patents, which, according to the Commission, provided only “a more limited protection”.[7]  In particular, Lundbeck had filed a salt crystallisation process patent.[8]

According to the Commission, in 2002, Lundbeck concluded six agreements concerning citalopram with four entities active in the production or sale of generic medicinal products, namely Merck KGaA / Generics (UK), Alpharma, Arrow, and Ranbaxy.  Always according to the Commission, in return for the generic undertakings’ commitment not to enter the citalopram market, Lundbeck paid them substantial amounts.[9]  In addition, Lundbeck purchased stocks of generic products for the sole purpose of destroying them, and offered guaranteed profits in a distribution agreement.[10]

In October 2003, the Commission was informed of the existence of the agreements at issue by the Konkurrence- og Forbrugerstyrelsen (the “KFST”, the Danish authority for competition and consumers).[11]  The Commission took over the case and, by the decision of 19 June 2013, made the following findings:  (i) Lundbeck and the generic undertakings were at least potential competitors;[12] and (ii) the agreements at issue constituted restrictions of competition by object, in breach of the prohibition of anti-competitive agreements provided under Article 101 TFEU.[13]  The Commission imposed a total fine of €93.7 million on Lundbeck and € 52.2 million on the generic undertakings.  The Commission took into consideration the length of its investigation (almost ten years) as a mitigating circumstance which led to fine reductions of 10%.[14]  Lundbeck and the generic undertakings brought actions before the General Court, seeking the annulment of the Commission’s decision.  The Court dismissed the actions brought by Lundbeck and the generic undertakings and confirmed the fines imposed on them by the Commission.[15]

After the Lundbeck case, in 2013 and 2014, the Commission imposed fines on companies in two other reverse settlement investigations – one concerning fentanyl, a pain-killer[16], and the other concerning perindopril, a cardiovascular medicine.[17]  The Fentanyl decision was not appealed.  Several appeals against the Servier decision are pending before the General Court.[18]  In 2016, in the Paroxetine Investigation, the UK Competition and Market Authority (“CMA”) issued infringement decisions to a number of companies regarding ”pay-for-delay” agreements over the supply of an antidepressant.[19] These agreements were found to be an infringement by object and effect. In March 2017, the CMA issued a statement of objections relating to an agreement aimed at delaying the entry into the market for the supply of Hydrocortisone tablets. The CMA has not yet issued its final decision.[20]

In addition, since 2009, the Commission has been continuously monitoring patent settlements in order to identify settlements which it regards as “potentially problematic” from an antitrust perspective, namely those that limit generic entry against a value transfer from an originator to a generic company.  The latest report was published in December 2016.[21]

III. The Ruling

First, like the Commission, the Court analysed whether Lundbeck and the generic manufacturers concerned were indeed potential competitors at the time the agreements at issue were concluded.[22]  The General Court made the following findings in this regard:

In order for an agreement to restrict potential competition, it must be established that, had an agreement not been concluded, the competitors would have had “real concrete possibilities” of entering that market.[23]  The Court held that the Commission had carried out a careful examination, as regards each of the generic undertakings concerned, of the real concrete possibilities they had of entering the market.  In doing so, the Commission relied on evidence such as the investments already made and the steps taken in order to obtain a marketing authorisation[24]

Moreover, the Court noted that in general, the generic undertakings had several real concrete possibilities of entering the market at the time the agreements at issue were concluded.[25]  Those possible routes included, inter alia, launching the generic product with the possibility of having to face infringement proceedings brought by Lundbeck (i.e., the so-called launching ‘at risk’).[26]  More precisely, the General Court was of the view that “the presumption of validity cannot be equated with a presumption of illegality of generic products validly placed on the market which the patent holder deems to be infringing the patent”.[27]  Consequently, the Court, continued, “’at risk’ entry is not unlawful in itself”.[28]

As rightly noted by commentators, these considerations introduce a further layer of complexity in the already intricate relationship between EU Competition law and IP law. In addition, since the right to exclude lies at the core of any IP right and (if there is no competing product) to have a monopoly is not illegal, unless it is attained or maintained by improper means,[29] it can be argued that the Commission’s findings infringes Article 345 TFEU, according to which “[t]he Treaties shall not prejudice the rules in the Member States governing the system of property ownership”.  Thus, Ibañez Colomo has noted that “Lundbeck departs from the principle whereby an agreement is not restrictive by object where it remains within the substantive scope of an intellectual property right”.[30]  This principle would derive from the Erauw-Jacquery,[31] Coditel II,[32] BAT v. Commission[33] and Nungesser[34] rulings of the ECJ.  Ibañez Colomo’s point becomes particularly clear at para. 335 of the (Lundbeck) Ruling where the General Court expressly noted that “even if the restrictions set out in the agreements at issue fall within the scope of the Lundbeck patents – that is to say that the agreements prevented only the market entry of generic citalopram deemed to potentially infringe those patents by the parties to the agreements and not that of every type of generic citalopram – they would nonetheless constitute restrictions on competition ‘by object’ since, inter alia, they prevented or rendered pointless any type of challenge to Lundbeck’s patents before the national courts, whereas, according to the Commission, that type of challenge is part of normal competition in relation to patents (recitals 603 to 605, 625, 641 and 674)”.[35]

Second, the Court analysed whether the Commission was entitled to conclude that the agreements at issue constituted a restriction of competition by object, a point to which we will turn next.

IV. Conclusions:  On Reverse Payments as Restrictions of Competition by Object

The Lundbeck ruling brings a number of what Donald Rumsfeld would probably refer to as “known unknowns”, that is things we know we do not know, in relation to reverse payment settlements.[36]  Indeed, the findings of the Lundbeck ruling can be summarised as follows (see also the table below):

  1. There are certain patent settlements which are likely to be considered compatible with Article 101 TFEU. This is the case of settlements:a. In which, in the words of the General Court, “(i) payment is linked to the strength of the patent, as perceived by each of the parties; (ii) [payment] is necessary in order to find an acceptable and legitimate solution in the eyes of two parties and (iii) [payment] is not accompanied by restrictions intended to delay the market entry of generics”.[37]

    The inclusion of the word “and” is worrying.  The requirements set out in the preceding paragraph should be alternative and not cumulative.  Otherwise for a settlement to be lawful it must not delay entry (which probably is enough, in and of itself, to avoid the antitrust concern, namely, a delayed entry of generics) and it must be necessary (i.e., it probably needs to meet the requirements of an ancillary restraints defence, more on which below) and the payment might be linked to the strength of the patent “as perceived by each of the parties”.  Such an intrinsically subjective requirement appears to the writer as particularly complicated to administrate and at odds with the objective nature of Article 101(1) TFEU.  It would appear that the Court is encouraging conversations such as the following: “let’s settle, but only if we can ensure the settlement reflects (and comes across as reflecting) your and my perception of the strength of the patent (and a number of other cumulative requirements my lawyers and I need to meet), otherwise we might have an antitrust concern”.

    b. Qualifying for an ancillary restraints defence. e., settlements in relation to which the parties to the settlement (for the burden of proof will be on them) can demonstrate they are objectively necessary and proportionate in order to defend their IP rights.[38]

  1. There are certain patent settlements which are likely to be considered incompatible with Article 101 TFEU as restrictions of competition by object. The ruling is not particularly clear in this regard.a. A literal reading of paragraph 334 of Lundbeck could potentially make “problematic” each patent settlement “where they [provide] for the exclusion from the market of one of the parties, which was at the very least a potential competitor of the other party, for a certain period, and where they were accompanied by a transfer of value from the patent holder to the generic undertaking liable to infringe that patent (‘reverse payments’).”

    b. A more holistic reading of Lundbeck would confine the Commission’s finding to the facts of the case. Even though it is difficult to pinpoint what the court considered to be the decisive factors when stating that a reserve settlement constituted a restriction by object, the following factors appear to have been relevant:

    1. The allegedly “disproportionate nature” of such payments “combined with other factors, such as the fact that the amounts of those payments seemed to correspond at least to the profit anticipated by the generic undertaking”.[39] Referring to the US Supreme Court ruling in Actavis,[40] the Court indicated that “the size of a reverse payment may constitute an indicator of the strength or weakness of a patent”.[41]  According to the Commission “the higher the originator undertaking estimates the chance of its patent being found invalid or not infringed, and the higher the damage to the originator undertaking resulting from successful generic entry, the more money it will be willing to pay the generic undertaking to avoid that risk”.[42]
    2. Indeed, the correspondence between the amount of the payment that seemed and the profit anticipated by the generic undertakings if they had entered the market.[43] According to the Commission “the value which Lundbeck transferred, took into consideration the turnover or profit the generic undertaking expected if it had successfully entered the market”. [44]
    3. The absence of provisions allowing the generic undertakings to launch their product on the market upon the expiry of the agreement without having to fear infringement actions brought by Lundbeck.[45]
    4. The presence in those agreements of restrictions going beyond the scope of Lundbeck’s patents,[46] such as restrictions with regard to citalopram products that could have been produced in a non-infringing manner.[47]
    5. According to the Court, “the agreement at issue transformed the uncertainty in relation to the outcome of such litigation into the certainty that the generics would not enter the market which may also constitute a restriction on competition by object when such limits do not result from an assessment, by the parties of the merits of the exclusive right at issue, but rather from the size of the reverse payment which, in such case, overshadows that assessment and induces the generic undertaking not to pursue its independent efforts to enter the market”.[48] The generics thus no longer had an incentive to continue their independent efforts to enter the market.[49]
  1. There are certain patent settlements which (presumably) are considered to be incompatible with Article 101 TFEU as restrictions of competition by their effects. Hic sunt dracones.  More precisely, given that none of the pay-for-delay decisions dealt with by the  Commission conducted an effects analysis, we are left without guidance as to how that analysis will be conducted.  Again, a known unknown.  The Commission’s ten-year investigation on reverse payment settlements has not shed light to how to conduct an effects analysis under Article 101(1) TFEU.  We are left, perhaps, with the findings of the US Supreme Court in Actavis, according to which, “the likelihood of a reverse payment bringing about anticompetitive effects depends upon its size, its scale in relation to the payer’s anticipated future litigation costs, its independence from other services for which it might represent payment and the lack of any other convincing justification.  The existence and degree of any anticompetitive consequences may also vary among industries”.[50]

Moreover, to the extent that the case for restrictions of competition by object is administrability, this author cannot but note that the Lundbeck ruling does not constitute a positive evolution.  The General Court noted that “it is established that certain collusive behaviour […] may be considered so likely to have negative effects, in particular on the price, quantity or quality of the goods and services, that it may be considered redundant, for the purposes of applying Article 101 TFEU to prove that they have actual effects on the market”.[51]  However, the Decision has 464 pages.  Given that the Fentanyl and Servier decisions occupy 147 and 813 pages, respectively, in investigations that lasted for almost ten years, 27 months and 5 years (again, respectively), one cannot but wonder whether the Commission’s resources would have been better spent analysing the actual effects of the agreement and not defending a legal category.

 

   [1]   Commission Decision C(2013) 3803 of 19 June 2013 relating to a proceeding under Article 101 [TFEU] and Article 53 of the EEA Agreement, Case AT.39226 — Lundbeck (the “Decision”).
   [2]   See European Commission Press Release IP/13/563, of 19 June 2013, available athttp://europa.eu/rapid/press-release_IP-13-563_en.htm?locale=en
   [3]   See T-472/13 Lundbeck v. Commission [NYR] (the “Ruling”), of 8 September 2016.
   [4]   See, for more detail, http://www.lundbeck.com/global/about-us.
   [5]   See Ruling, at para. 1.
   [6]   See Ruling, at para. 16.
   [7]   See European Commission Press Release IP/13/563, 19 June 2013, available athttp://europa.eu/rapid/press-release_IP-13-563_en.htm?locale=en.  It should be recalled, in this regard, that, according to Article 27 of the TRIPS (WTO) Agreement, “patents shall be available for any inventions, whether products or processes, in all fields of technology, provided that they are new, involve an inventive step and are capable of industrial application“.
   [8]   See Ruling, at para. 20.
   [9]   See Ruling, at paras. 26; 35; 39; 42-43 and 47-48.
  [10]   See Ruling, at para. 26; 35; 39; 42-43; 47-48.
  [11]   See Danish Competition and Consumer Authority Press Release 1120-0289-0039/VIS/SEK, 28 January 2004 , available at: http://www.kfst.dk/Afgoerelsesdatabase/Konkurrenceomraadet/Styrelsesafgoerelser/2004/Undersoegelse-af-Lundbeck?tc=E538038EB1E04A96B9964BE4C0F85F46 (Only available in Danish)
  [12]   See Decision at paras. 610 ff.
  [13]   See Decision at paras. 647 ff.
  [14]   See Decision, at paras. 1306, 1349 and 1380.
  [15]   See Ruling, Operative part.
  [16]   See European Commission Press Release IP/13/1233, Commission fines Johnson & Johnson and Novartis € 16 million for delaying market entry of generic pain-killer fentanyl, 10 December 2013, available at: http://europa.eu/rapid/press-release_IP-13-1233_en.htm.
  [17]   See European Commission Press Release IP/14/799, 9 July 2014, Commission fines Servier and five generic companies for curbing entry of cheaper versions of cardiovascular medicine, available at: http://europa.eu/rapid/press-release_IP-14-799_en.htm.
  [18]   See Case T-147/00 Laboratoires Servier v Commission.
  [19]   See Case CE/9531-11 Paroxetine, 12 February 2016.  For a comment on the case see Ezrachi, A., EU Competition Law: An Analytical Guide to the Leading Cases, 5th Edition, Bloomsbury, 2016, 396
  [20]   See CMA Press Release of 3 March 2017, available at: https://www.gov.uk/government/news/cma-alleges-anti-competitive-agreements-for-hydrocortisone-tablets. See also Nathalie Ska, Philipp Werner, and Christian Paul, “Pay-for-delay Agreements: Why the EU Should Judge them by their Effects,  Oxford Journal of European Competition Law & Practice, 3 May 2017.
  [21]   See, European Commission, “7th Report on the Monitoring of Patent Settlements (period: January-December 2015)”, 13 December 2016, available at:  http://ec.europa.eu/competition/sectors/pharmaceuticals/inquiry/patent_settlements_report7_en.pdf
  [22]   See Ruling.  The General Court separately analysed each agreement.  See, inter alia, in relation to Lundbeck and Merck, para. 225; in relation to Lundbeck and Arrow, paras. 266-270, in relation to Lundbeck and Alpharma, para. 290 and, in relation to Lundbeck and Ranbaxy, para. 330.
  [23]   See Ruling, at para. 100.  See further Case T-360/90 E.ON Ruhrgas and E.ON v Commission, at para. 86.
  [24]   See Ruling, at para. 131.
  [25]   See Ruling, at para. 97.  See further Decision, at para. 635.
  [26]   See Ruling, at paras. 121.
  [27]   See Ruling, at paras. 97.
[28]   See Ruling, at para. 122.
  [29]   See David J. Teece and Edward F. Sherry, “On patent monopolies: An economic re-appraisal”, CPI Antitrust Chronicle April 2017, available at: https://www.competitionpolicyinternational.com/wp-content/uploads/2017/04/CPI-Teece-Sherry.pdf.
  [30]   See Ibañez Colomo, P., “GC Judgment in Case T-472/13, Lundbeck v Commission: on patents and Schrödinger’s cat”, at Chillin’ Competition, 13 September 2016, available athttps://chillingcompetition.com/2016/09/13/gc-judgment-in-case-t-47213-lundbeck-v-commission-on-patents-and-schrodingers-cat/.
  [31]   See Case 27/87 SPRL Louis Erauw-Jacquery v La Hesbignonne SC, of 19 April 1988.
  [32]   See Case 262/81 Coditel SA, Compagnie generale pour la diffusion de la television, and others v Cine-Vog Films SA and others, of 6 October 1982.
  [33]   See Case 35/83 BAT Cigaretten-Fabriken GmbH v Commission, of 30 January 1985.
  [34]   See Case 258/78 Nungesser v Commission, of 8 June 1982.
  [35]   See Ruling, at paragraph 335.
  [36]   See Rumsfeld, D., Known Unknown:  A Memoir, Sentinel, 2011.
  [37]   See Ruling, at para. 350.
  [38]   See Ruling, at paras. 451 ff, in particular, at paras. 458 and 460.
  [39]   See Ruling, at paras. 354; 355.
  [40]   See Federal Trade Commission v. Actavis, 570 US (2013).
  [41]   See Ruling, at paragraph 353.
  [42]   See Decision, at para. 640.
  [43]   See Ruling, at paras. 354; 383; 414.
  [44]   See Decision, at paras. 6; 788; 824; 874; 962; 1013; 1087.
  [45]   See Ruling, at paras. 354; 383; 410.
  [46]   See Ruling, at paras. 354; 383.
  [47]   See Decision para. 693.
  [48]   See Ruling, at para. 336.
[49]   See Ruling, at paras. 355; 360.
  [50]   See Federal Trade Commission v Actavis 570 US 2013.
  [51]   See Ruing, at para. 341.

A Venture Capital and Private Equity career of A Lawyer

As I worked my way through law school, I had worked for 5 different law firms so by my third year had concluded I wanted to go into business rather than practice law.  I chose consulting both because the major consulting firms were willing to hire lawyers and consulting seemed like a great way to get “fire hose” overview of the business world.

While on a flight from London to Amsterdam to look at a potential acquisition for a Bain & Co. client, I saw an article on the Apple IPO and the role of Arthur Rock as an investor and Board member. His partner at the time was Harvard Law School graduate Thomas Davis, who also founded Mayfield Fund.  I had found my inspiration.  I thought venture capital represented a field where the deal skills of a lawyer and the market intelligence of a consultant might be a good fit.  I began to interview in earnest and landed a job at Centennial Ventures in Colorado.

Over the next 32 years I became a voracious student of all things technology and healthcare.  I chose those two fields because in the first case it is the agent of change and in the second case because of the size of the markets and how it affects all of us personally.  Over time I began to focus on later stage deals.  This was due to the fact that I am not an engineer or a doctor or a PhD, but a business trained lawyer.  The fit was therefore best in companies where a particular formula could be applied, along with my cumulative experience.

Eventually in 2010 I focused exclusively on deals with the following characteristics: (1) profitable (2) small companies ($5.0-$10 million in revenue typically) below the radar screen of the private equity firms (3) software/SaaS/cloud or healthcare services where I had been investing all this time, (4) majority ownership, the so-called control transactions (5) a heavy value element where EBITDA multiples would be no higher than 7.5 in technology and no higher than 6.0 in healthcare services (6) a minimum of $1.5 million in EBITDA.

A key characterization of these companies is that they are typically run by Baby Boomer-aged management who are looking to retire.  Usually there had been no outside money or just friends and family.  The entrepreneur wanted to get liquidity, diversify his holdings, and retire or semi-retire.  This meant that we as a sponsor group had to have the new management already selected and groomed by the original entrepreneur or bring our own new top management.

Management transition is a key issue in these deals. Roughly 10,000 Baby Boomers will turn 65 today, and about 10,000 more will cross that threshold every day for the next 19 years.  Most haven’t founded businesses, but this generation is the richest ever, forecast to have assets of about $54 trillion by 2030.

Our management is often younger, but more importantly either trained by a top MBA school or having extensive management experience or both.  The classic 21st century analytical management with familiarity with dashboards, key operating metrics or ratios, and internal operating software has a different perspective than the seat of the pants entrepreneur.  This is positive in terms of risk reduction and visibility to key levers of growth.  What are often missing are the industry contacts and the natural selling skills of the original CEO.

Think of these small buyouts, what we call micro-buyouts, as the bargain basement of technology deals, healthcare deals and many other industries. These are not the type of technology deals appealing to venture capitalist.  In fact, if these companies have ever received VC then we know they are “ruined” either because they became very successful or are of the size and valuation that we cannot afford, or they have burned through a lot of equity and don’t have much to show for it.  Either way, it makes the companies ill suited for a value-oriented majority control investor.

Still we have proven we can produce venture style investment returns without taking venture risk.  No, we are not going to hit a 100 to 1 return.  But we have produced 5X-realized returns since 2010 across 8 exits from 26 investments.   These returns come from 4 basic sources: (1) leverage (2) efficiencies (3) revenue growth (4) multiple expansion.  The large buyouts depend primarily on the first two.  They have the stability of operations to take on relatively high leverage and they can produce efficiencies by application of analytics, metrics, and internal software.

In our small buyouts the opposite is true.  The gains come primarily from growth.  We do leverage our companies, but the leverage is typically not more than 3X EBITDA or 50:50 equity/debt and often smaller.  We do not look for efficiencies in the classic sense of making EBITDA margin growth the primary goal.  We instead try to preserve as much as possible the typically high margins enjoyed by the original entrepreneur.

We instead often add expenses initially to drive growth.  The higher growth brings with the hope of eventually higher EBITDA margins from economies of scale.  Most important, by creating higher critical mass, we bring the company into the scale necessary to attract a much broader buying audience.  A $10 million company with $2.0 million of EBITDA might attract a 6X EBITDA multiple while a $20 million company with $4.0 million of EBITDA might attract an 8X EBITDA margin. This EBITA multiple expansion is critical to our returns.

Some who are lawyers might wonder whether they can be successful in technology businesses competing with engineers, or in general competing with MBA’s.  But the investment field is full of lawyers who first observe the business world, and then enter it successfully.  Deal skills are highly attractive to investment firms.  Analytical skills necessary to decide upon the attractive markets and the attractive business models are held by many lawyers.  The opportunities are there and the most important ingredient is a curious mind and an attraction to the field.

 

The Right to Information Act No. 12 of 2016 of Sri Lanka

The fight for responsible accountability, good governance which is against corruption can only be strengthened if the information held by responsible authorities is more readily available. The result of relaxing the obstructing tight mechanisms that prevent the access of information would create a more transparent system of administration.

It is remarkable and broadly accepted by legal academics that the true essence of democracy can be achieved by the declaration of “Right to Information” to the public. The scrutiny of such is notably to maintain a more democratic system in the country whilst entertaining the true spirit of transparency.

Sri-Lanka, having face a 30 year conflict of war and a rather traumatic era left the purported ‘right to information’ under the Constitution of Sri Lanka (Article 14A of the Constitution of Sri Lanka 1978), restricted to an article engraved in the Constitution until 2016. One may argue that the Constitution prevails over any other legal document. In a practical approach, however, the right will remain to be a grey area as the abovementioned article would entail an exhaustive list of laws relating to same. The absence of a legally binding document guaranteeing the right to information would leave a lacuna in the context of justice. Therefore, the enforceability of the right guaranteed by the Constitution will only be effective in reference to an act pertaining to “Right to Information”. This principle was established in the case of Giustiniani v. Y.P.F. S.A., a case decided in the territory of Argentina, in which the court ruled in favor of the plaintiff and further urged the public company Yacimientos Petroliferos Fiscales to produce a copy of the investment agreement related to the exploitation of hydrocarbon /oil resources.

The country although having other commitments to look into due to the war, yet functioned in ways and means to give effect to the United Nations proposed Resolution 59 (1) in the year 1946. This resolution was further taken up for discussion in the year 1995 by the UN Commission. Therein, it was stated that “Freedom will be bereft of all effectiveness if the people have no access to information. Access to information is basic to the democratic way of life. The tendency to withhold information from the people at large is therefore to be strongly checked.”[1] To give effect to the abovementioned resolution, Sri Lanka attempted to formulate a concrete ground for RTI in mid 1990’s (Legislative Draftsman’s Department, LDO Number 23/2003) which however, failed to conclude positively.

Furthermore, this principle was also encrypted under Article 19 of the International Covenant on Civil and Political Rights and Article 19 of the Universal Declaration of Human Rights which recognizes the right and access to information where Sri Lanka is a party to, with the placement of signature on the treaty.

On realizing the importance of such a right in existence, Sri Lanka, a country that looks over the democratic system, began the process of documenting the fundamental right. After several attempts of passing draft Right to Information Bills over the years, in August 2016, the Bill of Right to Information (“RTI Bill”) was passed with the view to provide a more centralized transparent system of governance. The RTI Bill was brought to the attention of the Parliament in the midst of March 2016. The sole purpose of promoting the Bill, as stated in the preamble of the RTI Bill, was to structure “a society in which the people of Sri Lanka would be able to more fully participate in public life through combating corruption and promoting accountability and good governance”[2]. The recognition of the absence of the right was further highlighted with the inception process for the 19th Amendment to the Constitution as a fundamental right. Supporting the views enacting the RTI, the Center of Law and Democracy assessed the RTI to be the 7th strongest in the world.

The prime need for the establishment of this fundamental piece of legislation was opined by Chief Justice Sarath N Silva whilst deciding the case of Environmental Foundation Limited v Urban Development Authority of Sri Lanka and others (Galle Face Green Case)[3]. He stated that “a bare denial of access to official information as contained in P10, sent by the UDA, in my view amounts to the infringement of the Petitioner’s fundamental rights as guaranteed by Article 14 (1) (a) of the constitution…the implicit right of a person to secure relevant information from a public authority in respect of a matter that should be in the public domain”.

However, the urge for the Right Information dates back to 1984 which was derived from the case of Visuvalingam v. Liyanage where it was held that the need for easy access to information was needed to be reckoned as the right to information from many sources was possible[4]. Therefore, it was prominently noted that the documentation of the right through an Act was essential to make the system of justice more approachable.

The RTI Act provides an absolute right and gives effect to the constitutional right of every citizen to access information under Section 3 of the RTI Act. Nevertheless, the granting of the right was on the other hand, followed with limitations. These limitations are in the form of a comprehensive list as stated under Section 5 of the RTI Act.

The limitations stipulated in the RTI Act include that the denial to access information may arise the personal information in concern has no public activity or interest. Disclosure of information is a threat to national security. Disclosure of such information could harm the economy of the country. Denial of information related to trade secrets or intellectual property. Providing medical records unless consented and permitted to by the person in question. Communication trails between a professional and public authority unless consented to i.e. communication between the attorney general and public authority. Existence of a fiduciary relationship. Information which may obstruct the detection of a crime. Exposure of identity of a confidential source may be revealed. Third party does not consent to the disclosure of the information. Contempt of court. Infringement of parliament privilege. Harm integrity of an examination being conducted by the Department of Examination.

Furthermore, in the process of debating the RTI Bill in Parliament, concerns and proposed changes in order to protect the confidentiality of sensitive information relating to Section 5 of the Act on ‘Denial of Information’ were raised. Accordingly, when the Parliament certified the RTI Bill, Section 5 of the Act was further expanded giving effect to Section 5 (m) whereby ‘if information is a cabinet memorandum in relation to which a decision has not been taken’ the request may be refused. Further, Section 5 (n) where ‘the information requested to be disclosed is with regard to an election conducted by the Commissioner of Elections’, which is required by the relevant election laws to be kept confidential. This was formally engraved in the Act as a stance for the public authorities to deny disclosure of information.

Moreover, many concerned parties raised their nonconforming views indicating that some of these exceptions stated under Section 5 were conflicting with the articles in the Constitution of Sri Lanka. One example of a recent dissimilarity raised to concern was the exemption stated under Section 5 in relation to denial of disclosure of information as it would harm the economy. The denial of information related to trade agreements as stated under Section 5 (v) was noted to be a clause conflicting with Article 14, 14A and 15 of the Constitution.

Dr. A.G. Damayanthi Perera, a Specialist in Food, Nutrition, an Independent Researcher, along with two other Software Engineers, raised the issue relating to the conflict of Section 5(v) by filing a petition in the Supreme Court of Sri Lanka. The Petition stated that, a developing country like Sri Lanka will find it difficult to tackle the challenging concepts in the corporate arena when dealing with overseas companies.

The exceptions to the fundamental rule of the right to information was also opined by Lord Toulson’s in the case of Kennedy v Charity Commission, in which he stated that “Judicial processes should be open to public scrutiny, unless and to the extent, that there are good reasons for secrecy”.[5] Thus, despite the right of information being a fundamental right, the times at which the denial to access of information is validly construed yet exist in the legal sense.

It is nonetheless important to note that the above limitations could be avoided where the request of information is very much urgent and as per severe circumstances surrounding the necessity of such information. This is engraved under Section 6 of the RTI Act. Additionally, if the disclosure of information is denied by the public authorities, the aggrieved party is within the capacity of making an appeal to the “Right to Information Commission”- a body corporate with perpetual succession which will be established in the conformity of Part IV of the RTI Act.

Above all, these flaws are contained within the proposed validity of the right to information. It is important to note the very exceptional advantages. The recently passed RTI Act will be a monitor for showcasing the reality, whilst making the latent motives of a government accessible to the public to some extent.

Many professionals in the arena of law supported the RTI Bill coming into force, claiming that the ideology of the Bill would restructure the transparency of the government and public authority dealings. Thus, the instances in which the public being blindfolded in times of corruption will be limited, and the Act will further provide the public with an avenue to raise their dissenting views and concerns of the same.

Looking over to our neighboring country, India, who enacted the fundamental right by way of the Right to Information Act 2005, would clear the murky waters of how successful the enactment would be in Sri Lanka. Dr. Rajesh Tandon made positive comments stating that Since the RTI law was introduced, India has seen an improvement in governance, dissemination of information and involvement of civil society in the governance process”[6]. However, the challenge in India is that acts such as the Official Secrecy Act and the Right to Information Act co-exist side by side with the right to information laws. Accordingly, the enactment of the Right to Information Act in India has exposed both how it can thrive a country to success and the possible existence of challenging conflicts to be tackled with.

Similarly, despite the anticipated positivity of the Act, a number of challenges remain when the implementation of the RTI in Sri Lanka is taken into consideration. For instance, archaic acts, such as the Establishments Code of Sri Lanka 1971 and the Sri Lanka Press Council Law No. 5 of 1973, continue to be in force. The existence of such Acts restricts the scope of the new Act in place and limits the public access to the benefits afforded in terms of Section 2 and 3 of the RTI Act. One such important Act that needs to be brought to attention is the Official Secrets Act No. 32 of 1955. The existence of this Act restricts access to documents that are confidential and documents that contain very sensitive information. Although, this act is buried and ignored and the terminology is stated to be outdated, the Act continues to be in force in Sri Lanka and consequently needs to be rectified by ways and means which will diminish the conflict with the new Act in place.

Nevertheless, the Parliament of Sri Lanka, which has the intention of achieving the promising outcomes of the act, certified the RTI Bill with a few proposed amendments on 04th August 2016. Although, the Act will take 6 months to be in force, the effectiveness and the essence of implementing the laws will continue to thrive for the aims of providing an approachable, transparent governance system. All in all, the implementation of a Right to Information Act in Sri Lanka is imperative to foster a nation of transparency, accountability and good governance and to ensure the rights of the public citizens of the country are safeguarded which Sri Lanka believes as a country driven by democratic principles.

[1] 2 UN Doc. E/CN.4/1995/32, para. 35.

[2] Right to Information, Gazette, Preamble December 2015.

[3] (S.C.F.R 47/2014)

[4] 1984

[5] Kennedy v. the Charity Commission [2014] UKSC 20

[6] http://srilankabrief.org/2015/03/beyond-rti-towards-open-government-in-sri-lanka/

The Automatic Exchange of Financial Information in Bulgarian Context – the Reach

I. Introduction

In 2015 Bulgaria introduced in its Tax and Social Security Procedure Code (“TSSPC”) a system implementing the regionally and globally harmonized rules on automatic exchange of financial information in the field of taxation. The participating jurisdictions are the European Union member states under Directive 2014/107/EC amending Directive 2011/16/EU as regards mandatory automatic exchange of information in the field of taxation (“Directive 2014/107/ЕС”), the United States of America under the intergovernmental Agreement to Improve International Tax Compliance and to Implement FATCA (Foreign Account Tax Compliance Act) and any other jurisdiction, with which Bulgaria or the EU has concluded a treaty for exchange of information. As a result, a whole new section became effective in 2016, regulating the obligations of the financial institutions to collect and submit information and to conduct complex audits. Thus the Bulgarian legislator complied with its EU law and international obligations for fighting against tax evasion. The TSSPC also takes into account the Common Reporting Standard for automatic exchange of financial information (CRS) of the Organization for Economic Co-operation and Development (OECD).

Against this backdrop, the TSSPC aligns with the expectations for compliance with all of the above stated pieces of legislation and should not be regarded as the elephant in the room from comparative point of view especially when put next to other national legislations in the EU.

Further below, one could find an essential overview of the newly established countering tax evasion reporting system.

II. Who is affected?

The persons affected from the new rules on Automatic Exchange of Financial Information are to be differentiated in persons whose accounts are subject to processing and provision of information (i.e. “Reportable Persons”) and the institutions that are under the obligation to collect, process and submit the relevant information for the respective Reportable persons (“i.e. “Reporting Financial Institutions”).

  1. Reportable Persons

For the purposes of the TSSPC and the Automatic Exchange of Financial Information system a Reportable Person is (i) an individual or entity that is resident for tax purposes in one or more participating jurisdictions under the tax laws of such jurisdiction, or a hotchpot of a late that was resident for tax purposes of a participating jurisdiction. Where the tax residency of an entity such as a partnership, limited liability partnership or similar legal arrangement (except for trusts that are passive non-financial entities) cannot be determined, such entities shall be treated as resident in the jurisdiction in which their place of effective management is situated. The TSSPC provides explicitly that corporations, whose stocks are regularly traded on one or more established securities markets and its affiliated corporations, governmental entities, international organizations, central banks and financial institutions, are to be excluded from the list of persons for which reporting is made. Specific definition exists for Reportable Persons under the FATCA Agreement. A Reportable Person is any US person specified under Article 1, Paragraph (1), letter (aa) of the FATCA Agreement.

  1. Reporting Financial Institutions

The TSSPC categorizes the persons, who are under the obligation to collect, process and submit the information. The main group of persons refers to the so called “Reporting Bulgarian Financial Institutions”. In general terms these include custodial institutions, depository institutions (i.e. banks), investment entities, and some insurance companies.

Geographic-wise the coverage of the TSSPC spreads to encompass any financial institution that is resident for tax purposes in Bulgaria (excluding branches of such financial institutions located outside Bulgaria) and any branch of a financial institution that is not resident for tax purposes in Bulgaria, if that branch is located in Bulgaria.

III. What type of information would be collected and shared?

The Reporting Financial Institutions are under the obligation to provide to the Executive Director of the National Revenue Agency certain information on individuals or legal entities and their accounts, meeting the conditions for being qualified as reportable[1]. Such information would comprise the following:

  1. name / company name, address, the participating jurisdiction of which the respective person is a tax resident, the taxpayer identification number, date and place of birth (if an individual) for each account holder, who qualifies as a Reportable Person;
  2. where the account holder is an entity which, after implementation of due diligence procedures, has been identified as a passive non-financial entity with one or more controlling persons, who are Reportable Persons then the following information is to be provided: name, address, taxpayer identification number and participating jurisdiction or other jurisdiction of which the entity is a tax resident, as well as for each controlling Reportable Person the name, address, participating jurisdiction of which that person is a tax resident, the taxpayer identification number, date and place of birth;
  3. account number or, where there is no number, the functional equivalent;
  4. name and identification number of the reporting financial institution;
  5. account balance or value, including, in the case of a cash value insurance contract or an annuity contract – the cash value or surrender value, as of the end of the calendar year or the date on which the account is closed;
  6. in the event of a custodial account:
    1. the total gross amount of interest, the total gross amount of dividends, and the total gross amount of other income generated with respect to the assets held in the account, in each case paid or credited to the account (or with respect to the account) during the calendar year, and
    2. the total gross proceeds from the sale or redemption of financial assets paid or credited to the account during the calendar year, with respect to which the reporting financial institution acted as a custodian, broker, nominee, or otherwise as an agent for the account holder;
  7. in the event of a deposit account: the total gross amount of interest paid or accrued (credited) into the account during the calendar year;
  8. in the event of an account not specified in item 6 or item 7 above then the following information is to be provided: the total gross amount paid or accrued into the account to the benefit of the account holder during the year, with regard to which amount the Reporting Financial Institution has a reporting obligation, including the aggregate amount of any redemption payments to the account holder during the calendar year.

IV. How is it collected?

The Reporting Financial Institutions are obliged to follow specific due diligence procedures in order to acquire and process the necessary information for the Reportable Persons. The procedures for collection of complex and diverse data differ depending on whether the Reportable Person is a legal entity or a natural person and whether the accounts under examination are existing or newly created.

  1. Individuals

For natural persons it should be noted that there is also a difference in the methods of scrutiny of low value and high value accounts. The relevant threshold for differentiating between low value and high value accounts is USD 1,000,000. Against this background, the TSSPC chose to combine both the permanent residence address test and the indicia search test. The permanent residence address test uses information on the addresses of the Reported Person stored by the Reporting Financial Institution. The indicia search test on the other hand is based on the electronic data held by the Reporting Financial Institution for low value existing accounts. The indicia search test is to be used by the Reporting Financial Institution only where the Reporting Financial Institution does not apply the permanent residence address test. On the basis of such tests the Reporting Financial Institution may qualify a Reported Person as a tax resident of any of the participating jurisdictions. The test applicable for the FATCA Agreement obligations is in fact an adjusted version of the indicia search test, which includes also a check on whether the person is an US citizen and whether the person is born in the United States.

More stringent procedures apply for high value accounts of natural persons. In these cases the Reporting Financial Institution is to use the indicia search test without application of the permanent residence address test. The more stringent review requires the Reporting Financial Institution to scrutinize the electronic dossier of the respective person and the paper dossier for the last five years where necessary (as the case may be).

For the purposes of the FATCA Agreement, the Reporting Financial Institutions have the discretion not to implement the due diligence procedures and not report on the following already existing individual accounts:

  • a pre-existing individual account with a balance or value not exceeding the BGN equivalent of USD 50,000 as of 30 June 2014;
  • a cash value insurance contract or an annuity contract with a balance or value equal to or lower than the BGN equivalent of USD 250,000 as of 30 June 2014;
  • a deposit account with a balance equal to or lower than the BGN equivalent of USD 50,000 as of 30 June 2014.

Finally, with regard to individuals and for their newly created accounts, as a general rule, a self-certification procedure applies, which aims at collecting the necessary information for determination of the tax residency of the respective person on the basis of a sample declaration.

  1. Entities

Regarding existing accounts of legal entities the TSSPC introduces a threshold below which the Reporting Financial Institutions are not obliged to perform the due diligence check. Nevertheless, they retain their full right to do so. The threshold is the BGN equivalent of USD 250,000 (for the purposes of the FATCA Agreement the relevant sum is the BGN equivalent of USD 1,000,000) as of 31 December 2015 (for the purposes of the FATCA Agreement the relevant date is 30 June 2014). However, if the value of the accounts is over the threshold or exceeds at certain point in time the threshold the account would be subject to review.

With respect to accounts for which a due diligence check is performed, the Reporting Financial Institution should carry out an examination on whether the entity(ies) holding the account is a Reportable Person or a passive non-financial entity.

The Reporting Financial Institutions analyze available documentation and information in order to determine whether the entity is a Reportable Person. The TSSPC provides that the Reporting Financial Institutions could use the information kept for regulatory or customer relation purposes, including information submitted for compliance with the anti-money laundering legislation and the self-certification method.

The Reporting Financial Institution must determine whether the entity is a passive non-financial entity with one or more controlling persons who are reportable persons. This check is made on the basis of the information that the Reporting Financial Institution already has on the entity, including information provided for anti-money laundering purposes and also on publicly available information. If any of the controlling persons of the passive non-financial entity is a Reportable Person, then the reporting financial institution must treat the account as a reportable account. Specific rules for determining passive non-financial entities exist for the purposes of the FATCA Agreement.

For newly created entity accounts, a check needs to be performed by the Reporting Financial Institution whether the entity is a passive non-financial entity with one or more controlling persons who are reportable persons, similarly to the checks of existing accounts. Two of the main differences between the due diligence procedures for existing accounts and for newly created accounts are: first for the latter no thresholds apply and secondly the collection of the necessary information is made through the self-certification method (i.e. through submission of a sample-form declaration). For the purposes of the FATCA Agreement specific due diligence procedure applies.

V. Temporal Reach

From temporal standpoint 2016 is the first year for which automatic exchange of information would be effected between the National Revenue Authorities and the competent authorities of the participating jurisdictions. This, however, is subject to exceptions agreed under an international agreements for automatic exchange of financial information (i.e. in situation where such international agreements provide for other relevant dates). For instance, regarding the exchange of financial information with the competent authorities of the United States, the earliest starting year, as of which an exchange of information is to be performed, is 2014. Thus, depending on the data to be exchanged and the regime under which it is exchanged, it is possible that an exchange is performed retrospectively.

Last but not least, it should be recognized that the financial institutions providing information should complete the review of existing accounts of individuals of high value until 31st of December 2016 and existing accounts of individuals of low value until 31st of December 2017. A high value existing account under the TSSPC is an account with total amount or value that exceed the BGN equivalent of USD 1,000,000 as of the 31st of December 2015 or 31st of December of each subsequent year. For the purposes of FATCA Agreement the relevant dates for estimation of whether the threshold is met or exceeded are 30th of June 2014, 31st of December 2015 or 31st of December of each subsequent year. An existing low value account of an individual is one with total amount or value below the BGN equivalent of USD 1,000,000 as of 31st December 2015. For FATCA purposes the date is 30 June 2014.

The review of existing accounts of entities (legal entity or legal arrangement, including company, partnership, trust or foundation) with total amount or value exceeding the BGN equivalent of USD 250,000 should be completed until 31st of December 2017, and for FATCA purposes until 30th of June 2016.

The Reporting Financial Institutions should supply the collected information to the National Revenue Authorities on an annual basis in electronic manner by 30th of June of the year following the year of collection of the financial information.

VI. Conclusion

The TSSPC implements the idea of introducing a somehow uniform standard in the automatic exchange of financial information. The TSSPC relies on three main methods in the process of collection and processing of the relevant data. These are the permanent residence address test, the indicia search test and the self-certification method. The first two tests count mainly on the anti-money laundering and know your client data bases kept by the Reporting Institutions. Nevertheless, all these methods of collection and processing of information and the possibility of having the obligation to make a retrospective examination of accounts and persons in fact affect both the economic operators acting as Reporting Financial Institutions and their clients, namely the Reportable Persons. They create burdensome administrative obligations for both service providers and clients, the effectiveness of which is yet to be seen. Thus, the assessment on whether this new system is proportionate to the aim of countering tax evasion and whether the same results can be achieved through less restrictive and less burdensome measures is also yet to be made.

[1]           Reportable account means a financial account that is maintained by a reporting financial institution and is held by one or more reportable persons or by a passive non-financial entity with one or more controlling persons that are reportable persons, provided it has been identified as such pursuant to the relevant due diligence procedures.

Quantum awards in international arbitration – how can arbitrators and experts get it right?”

Forensic accountants sometimes describe their skill and raison d’être as being to simplify complex accounting concepts for dispute resolution lawyers.  Yet, at the recent ICCA commercial and investment arbitration conference, some of the world’s leading arbitrators said that they really found quantum experts’ reports very difficult to understand.

Furthermore, it has been stated that the process of scrutinising draft arbitration awards at the ICC picks up errors in the calculation of damages in up to 40% of draft awards.

As quantum experts have become a normal part of clients’ teams in international arbitration cases, what can be done to improve the situation as well as get awards right?

The responsibility of quantum experts

As quantum experts who regularly act in international arbitration, our view is that experts should have the responsibility of making their reports understandable and as simple as possible for both the lawyers on both sides and the arbitrators.  How can we complain that an arbitration tribunal has made a mistake in its award simply because the tribunal could not understand the reports?  For example, can a tribunal really be expected to understand 800 pages of spreadsheets in pdf format with no explanation that states the purpose of each page?  It must be the responsibility of the expert to explain and justify his own model rather than relying on the opposing expert to understand and explain it.

As quantum awards have followed particular trends, such as increasingly being based on Discounted Cash Flow (DCF) and a Discount rate, based on the Capital Asset Pricing Model formula, so arbitrators have learnt the terminology that quantum experts use and have often tried to adjust the models themselves.  However, it is still the quantum expert’s responsibility to explain in simple terms why they have adopted this or that methodology for calculating the quantum in a dispute, and to explain all the inputs and calculations in their model.

The responsibility of arbitrators

In their turn, given that they are making an award that may mean the payment of hundreds of millions of dollars from one company to another or from a country and its taxpayers to a company, arbitrators have a responsibility of ensuring that the quantum section of their award is properly calculated and is economically robust.

We respect the fact that arbitrators do not tend to be accountants, and so they can be excused for finding the legal aspects of an award more interesting than the quantum element, and they can also be excused if they do not articulate the quantum section of their award in the same way that a forensic accountant might use.  However, the parties surely have a right to expect that the award should be properly calculated and based on a logical and coherent argument, which includes the calculation of any damages awarded. Given the current dissatisfaction in some quarters with the Investor State Dispute Settlement System (“ISDS”), this could indeed provide an additional (and unnecessary) reason for dissatisfaction with ISDS in general.

Types of quantum errors in arbitration awards

Far be it from us to point to any awards which include errors, but in our experience, various types of error may arise – for example:

(a) arithmetical errors that are apparent on the face of the award itself;

(b) computational errors that arise where the arbitrators have calculated their own award by taking the quantum experts’ calculations and making their own changes; or

(c) conceptual errors that arise where the arbitrators have recalculated the award themselves, but have misunderstood or overlooked some fundamental concept in the quantum experts’ reports.

Clearly there can be disagreements between experts, or between one expert and the tribunal, on either the calculations or the economic theory, and the losing expert may complain that these are errors – but, if one expert has argued credibly for one methodology or valuation technique and the tribunal finds in his favour and against the other side, this is not something we refer to here as an error.

Fortunately, we are not aware of any examples of type (a) errors, and this is the sort of error that should be picked up by review procedures such as the ICC’s scrutiny process; it is also the sort of error that is referred to as “manifest error” in expert determinations, and is extremely rare.  However, it is the type (b) and (c) errors we want to focus on below, and to discuss possible ways in which tribunals could avoid them.

Computational errors

In the English High Court, it is common for judgments to be submitted to the parties’ counsel immediately prior to publication, to enable them to correct any factual inaccuracies – such a mechanism could be used for the parties to review an arbitration award and correct for any computational error.  Alternatively, we acted in one case where the judge gave the parties and their quantum experts a half hour recess to agree on the quantum number between them – as by this stage both quantum experts had each other’s models on their laptops we were able to come to an agreed number.

A principal argument put forward for not letting the parties or their quantum experts to check the award before it was finalised is that the tribunal has to be seen as the final arbiter of the case – and any submission of a “draft” award to the parties risks being taken by the party as an opportunity or a necessity for them to produce further submissions to argue their case after evidence has closed.  However, if the tribunal is absolutely clear that the parties are only invited to comment on the arithmetical accuracy and logic of the draft award, that should be less of a problem.  This process would have been very useful in one particular award that we have seen where the tribunal simply copied the wrong sequence of ten cells in a spreadsheet into its final award calculation. Had the parties seen the draft award in advance, both parties’ experts ought to have identified this and reached an agreement for the tribunal as to which were the correct cells to copy.

In our experience, it is becoming increasingly common for the tribunal to request the experts’ models in electronic form;  this is done to enable the experts  to save time and costs by testing each other’s models and thus being able to point out any errors before the hearing, and also so that the tribunal itself can take away the model for its deliberations, understand it and make appropriate modifications to it in order to generate a quantum number  that is in line with the award on the merits.

In theory, a younger generation of arbitrators is likely to have more experience of using Excel spreadsheets so they can manipulate the models themselves, but in practice, the models that we quantum experts use in our DCF calculations are still rarely simple enough for non-accountants to edit.  A tribunal recently took us up on our offer to agree on a model with the opposing expert for the tribunal to use in coming to its award – but, even though less than ten accounting items remained in dispute, it was not easy to design a foolproof model for the tribunal to use.  In this case, it was already simpler because the tribunal had directed us to prepare a joint statement, and that in itself had considerably narrowed the number of items remaining in dispute.

Conceptual errors

With respect to Russia’s challenge to the PCA award on the Yukos case, Russia’s expert seems to have been prepared to accept the tribunal finding in favour of the claimants on quantum if that finding had been based on sound economic argument – but he pointed out that what he found troubling was where the tribunal adopted its own non-standard method, which he considered to be based on flawed economic theory that would not have been accepted by either side’s quantum expert.

This type of “error” is more difficult to deal with, as it is not simply arithmetical, but arises from a tribunal either straying outside its expertise, or deciding that it has a novel insight into economic theory that may not be supported by any body of economists or forensic accountants– even though if an expert was to adopt such a non-standard theory, his report could justifiably be attacked for being outside of generally accepted accounting/economic/valuation parameters.  Probably, the answer to this type of “error” is that tribunals simply need to be extremely careful when they arrive at quantum awards that are outside the parameters of the calculations put forward by the two opposing experts.  It may not be unreasonable for a tribunal to award quantum on a basis that was not pleaded – but it is taking risks when it chooses a basis that was not tested at the hearing.

Possibly one radical solution that would assist tribunals to avoid these conceptual errors would be more use of tribunal-appointed quantum experts or a form of tribunal quantum secretary, who would be able to check the tribunal’s calculations and advise on the accuracy and the logic of the tribunal’s deliberations in advance – or even the appointment of a forensic accountant as the third member of the tribunal, along the lines adopted by the UNCC Panels a decade ago.  This, of course, raises other hot topics such as the role of a tribunal secretary – but is worthy of consideration in a situation where the quantum at stake is hundreds of times greater than the cost of a tribunal appointed expert or secretary.

The ICC’s vetting procedures

And one final thought –if the ICC’s scrutiny procedures are really picking up quantum errors in up to 40% of awards before they are issued, this scrutiny procedure is to be applauded – but maybe the other arbitral institutions should consider adopting a similar procedure, or even employing a forensic accountant to do the scrutinising in-house.

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Brexit – What Does It Mean For You?

As we are all aware, the UK electorate has voted in the recent Referendum to leave the European Union (EU). What does this mean? What implications will it have for you, your investors and your business? It is early days in the process but we set out below what is currently happening, the processes involved and how this is likely to affect fund managers in the coming months and years.

What has happened in the UK?

There was a view by many in the UK, that the EU regulation, with which it had to conform, was too overbearing and too restrictive. In addition, the UK population has seen fairly high population increases in the last 10 years, primarily as a result of immigration and primarily as a result of the EU’s policy of free movement of labour. As a consequence there was bad feeling towards the EU from the voting population which culminated in the politicians agreeing to a public referendum. The major political parties supported “Remain” and tried to persuade the voting public to vote accordingly. Other smaller parties, and some politicians from the major parties who “switched sides” were in favour of “Out”. The final outcome was a 51.9%/48.1% vote in favour of leaving the EU.

However, this is merely a recommendation from the people to the politicians – it is not binding but the politicians have said they will follow “the peoples” recommendation. Parliament needs to debate and then formerly serve a notice under “Article 50” of the legal agreement between the EU countries. Until the UK serves notice, the UK remains part of the EU and nothing changes either in legislation, taxes or the like.

However the situation has been made more complex by the resignation of the English Prime Minister, David Cameron. Whilst some in the EU are pressing for the UK to serve Article 50 notice as quickly as possible, without a Prime Minister, this is physically impossible. A new Prime Minister has now been selected, although some are speculating that the Article 50 notice will not be given until October or November and some are suggesting that it may not be until 2017.

The reality is that many in the EU did not want the UK to leave. The UK is the second largest economy in the EU and an important trading partner for many e.g. the UK is the largest export market for German car manufacturers. So despite the rhetoric in the EU parliament, many are keen to do a “sensible” deal with the UK.

How will this affect UK domiciled Private Equity and Real Estate fund managers?

The reality is that:

  1. Nothing is changing in the immediate future
  2. Nothing further will change in the UK for at least 2 years after the serving of Article 50, whenever that may be

As a consequence there is no need to make any immediate changes to fund structures. However there is no doubt that things will change in the future. The key questions for managers to ask themselves are:

  • Do I really need to be in the EU or not?
  • What are the advantages/disadvantages?
  • What are the implications?

These are questions to think about in the future – and there may be a range of answers.

The UK already has a good range of fund structures – and these are likely to be enhanced. In addition, the UK will undoubtedly be looking to ensure AIFMD passporting for its products even as a third party country. Some are talking about dual streamed products containing both EU and non-EU fund structures to accommodate different sorts of investors (a model already used by some). The reality is that it’s too early to determine which are the best routes to take. But without doubt Brexit needs to be on the agenda – and be actively considered by managers on an ongoing basis.

What about non-EU managers with UK entities regulated by the FCA?

Increasingly, non-EU managers have been setting up UK entities, regulated by the FCA, to support portfolio management and distribution activities both in the UK and throughout Europe. Again the reality of the Brexit Referendum is that (i) nothing will change in the immediate future and (ii) nothing further will happen until the Article 50 notice has been served and the transition period of at least two years has been completed.

This means that in the shorter term, managers can still continue to manage assets in the UK and Europe from their operations in the UK and can continue to market funds across Europe, whether they are via passporting or local private placement arrangements. So the immediate message is that “nothing changes” and it’s “business as usual”.

Going forward, there is no doubt that the UK will gain access to the EU financial markets. The EU want to invest with UK domiciled fund managers and have access to the products they have on offer. The world is increasingly globalised and investors need global diversification. However, how this is achieved has yet to be decided. Once again the message has to be “no panic now but watch this space”.

And non-EU managers marketing their funds into the UK and elsewhere into Europe?

Again – nothing has changed in Europe – although things may be changing in the very near future – but not because of Brexit. ESMA is due to report on the “Passporting” of third countries any day now and that could open Europe up to many fund managers. It could of course also close down the Private Placement Regimes used by many – Germany is already saying it will close its PPR once passporting is in place – but that was before Brexit!!

In many ways ESMA’s announcement will be more important than Brexit. ESMA has already indicated that it would be in support of extending a third country passport to Guernsey, Jersey and Switzerland but rather than give piecemeal approvals and potentially give a competitive advantage to certain domiciles, the Commission then asked ESMA to give further consideration to Hong Kong, Singapore and the US, with a second list of Australia, Canada, Japan, the Cayman Islands, the Isle of Man and Bermuda. ESMA’s announcement, due any day, will have a major effect on how funds market themselves into Europe going forward – and Brexit will be less important.

Recent Changes to Australian Foreign Investment Laws

Following the Foreign Investment Review Board’s (FIRB) updated foreign investment policy (effective 1 December 2015), which coincided with the introduction of mandatory fees for foreign investors, the Treasurer of the Commonwealth of Australia announced on 22 February 2016 new conditions for all foreign investment applications in Australia to ensure that companies, and their ‘associates’ (as defined in section 318 of the Income Tax Assessment Act 1936 (Cth)), investing in Australia pay tax on their Australian earnings.

Foreign investment into Australia requiring FIRB approval will only be permitted where it passes the ‘national interest’ test (in light of factors such as national security, the impact of competition, the character of the investor, and the impact on the economy and community). The new taxation conditions on foreign investment do not represent a change in the law, but rather increase the focus on taxation and add to the ‘national interest’ test (that is, foreign investors must comply with the new taxation conditions in order to satisfy the ‘national interest’ test). The new taxation conditions include the following:

  1. the applicant and its associates must comply with Australia’s taxation laws;
  2. the applicant and its associates provide information or documents required by the Australian Taxation Office (ATO) in connection with the application;
  3. the applicant and its associates must notify the ATO of any material transactions or other dealings to which transfer pricing rules in the Income Tax Assessment Act 1997 (Cth) or anti-avoidance rules in the Income Tax Assessment Act 1936 (Cth) may apply (if not already previous notified);
  4. the applicant and its associates must pay any outstanding taxation debts; and
  5. the applicant must provide an annual report to FIRB on compliance with the taxation conditions.

Where significant tax risks are identified, further conditions may also apply, including:

  1. the applicant must engage in good faith with the ATO to resolve any tax issues (for example, negotiation of an advance pricing arrangement or seeking a ruling from the ATO);
  2. the applicant must provide information to the ATO on a periodic basis (for example, a forecast of tax payable).

These new taxation conditions will apply prospectively. Under section 72 of the Foreign Acquisitions and Takeovers Act 1975 (Cth), the new conditions appear to commence for all applications being considered or received after 22 February 2016.

Failure to comply with these taxation conditions may be very significant to a foreign investor and could result in prosecution, fines and potentially forced sale of assets.

Foreign investors should ensure that they obtain appropriate taxation advice to ensure that they comply with the new taxation conditions and avoid unintentional breach of the new taxation conditions.

New Withholding Requirements for Purchasers of Interests in Australian Land

From 1 July 2016, purchasers of direct and indirect interests in land in Australia could potentially be subject to an additional cost of 10% of the purchase price if they fail to withhold that amount from payments made to vendors if the relevant clearance certificates or residency declarations are not provided.  The new rules will apply to contracts entered into from 1 July 2016, but both purchasers and vendors will need to get ready for these changes well before any sale is executed to ensure they are not adversely affected.

Summary

The withholding provisions apply to require the purchaser to pay to the Commissioner of Taxation (Commissioner) an amount equal to 10% of the purchase price (including the money paid and the market value of any property given) of the asset on or before becoming the asset owner for assets acquired from a non-resident which are:

  • Taxable Australian Real Property (TARP) such as land, fixtures, mining tenements in Australia;
  • indirect Australian real property interests (for example more than 10% of the shares in a company where 50% or more of the assets of the company are TARP); or
  • an option or right to acquire TARP or indirect Australian real property interests.

There are a number of exceptions and exemptions, and the procedures are quite different for direct and indirect real property interests.

Direct Australian Real Property Interests (TARP)

The withholding provisions apply to real property located in Australia including a lease of land, mining, quarrying or prospecting rights in Australia, and include fixtures to the land and options or rights to acquire real property.  This can include real property sold as part of the sale of a business, or the sale or grant of leases.  Company title interests also fall under this category (even though technically they are indirect interests in land).

A vendor will be assumed to be a non-resident unless they supply a clearance certificate to the purchaser prior to settlement which has been issued by the Commissioner certifying that they are an Australian resident.  In order for a vendor to obtain a clearance certificate they may be required to ensure all their tax returns are up to date.  Clearance certificates will be valid for 12 months, so it is recommended that any vendors intending to sell property apply for a clearance certificate well before the proposed settlement date. If there are a number of vendors, a clearance certificate must be obtained for each.

There are a number of exceptions from the withholding provisions:

  • Where the value of the land is less than AU$2 million (where there are multiple purchasers it is the total value of the land, not just the purchaser’s interest);
  • Where every vendor has supplied a clearance certificate;
  • Where the vendor is a company under administration or the transaction is part of the administration of a bankrupt estate or an arrangement with creditors; or
  • Where another withholding obligation applies to the transaction.

If the vendor is not able to provide a clearance certificate, the purchaser must pay 10% of the purchase price to the Australian Taxation Office (ATO) unless they receive a variation certificate issued by the ATO before settlement.  The vendor can apply for a variation certificate if they believe the actual tax payable in respect of the sale will be less than 10%, such as if they have carried forward tax losses, or if there are multiple vendors with only one being a non-resident.  A secured creditor can also apply for a variation certificate if they consider the proceeds of sale will be insufficient to discharge the debt as well as pay the Commissioner.  In each case a variation will only be effective if it is provided to the purchaser.

Indirect Real Property Interests

There are also withholding provisions which apply to indirect Australian real property interests such as shares in a company or units in a trust where an interest of 10% or more is held in an entity where 50% or more of the assets of the entity are Australian real property.  The potential exceptions from withholding for indirect interests in real property are quite different from direct interests.  The AU$2 million threshold does not apply to indirect interests in real estate, so interests of any value are potentially caught.  However there is no need for a vendor of indirect interests to provide a clearance certificate as residency can be established in other ways.

There are a number of exceptions from the withholding provisions for indirect interests, for example where:

  • the vendor has made a declaration that they are an Australian resident;
  • the vendor has made a declaration the assets are not indirect Australian real property assets;
  • the purchaser has reasonable grounds to believe every vendor is an Australian resident (the ‘knowledge condition’);
  • a variation certificate has been provided to the purchaser prior to settlement (by either the vendor or a secured creditor as outlined above) and the variation reduces the withholding payment to nil;
  • the transaction is conducted through an approved stock exchange or crossing system;
  • the transaction is a securities lending arrangement;
  • the vendor is a company under administration or the transaction is part of the administration of a bankrupt estate or an arrangement with creditors; or
  • an amount is already required to be withheld as withholding tax for some other reason.

Payments to the ATO

In the case of both direct and indirect interests of property, the purchaser may withhold the required amount from the purchase price payable to the vendor.  However if the purchaser fails to withhold, the obligation to pay to the Commissioner still exists and the purchaser may be liable for an administrative penalty and interest costs. These rules therefore place onerous obligations on the purchaser.

Inaccurate Declarations

A purchaser is entitled to rely on a vendor’s declaration of residency or declaration that the interest is not an indirect real property interest unless they know the statement to be incorrect.  They are able to rely on the declaration even if they have grounds to doubt the accuracy of the declaration unless they have specific knowledge that the statement is false.

The vendor may however be liable for penalties if the statements made are false or misleading.

Practical Points

This legislation raises a large number of important issues for purchasers, vendors and secured creditors.  These include:

  1. All vendors who are considering selling direct interests in land which could have a value over AU$2 million should consider whether their tax affairs are in order and apply for a clearance certificate well before the proposed settlement date.
  2. Vendors of shares or units in trusts should consider whether the stake would constitute an indirect real property interest in order to determine whether they were able to make an appropriate declaration to avoid having tax withheld.
  3. If the vendor is not able to obtain a clearance certificate or make a relevant declaration, they should consider whether they would be entitled to a variation of the amount of tax withheld. They should allow plenty of time prior to settlement to obtain the variation certificate.
  4. Secured creditors who become aware of a proposed sale should consider whether they should seek a variation certificate.
  5. Purchasers of direct real estate need to ensure that a clearance certificate is provided on or before settlement.
  6. Purchasers should ensure the appropriate declarations are included in all contracts of sale of indirect interests in land.
  7. If the purchaser is required to pay an amount to the ATO, they will need to ensure that they have sufficient funds available to make the payment at settlement (this is particularly relevant if the acquisition is made for non-cash consideration), and they complete an online “Purchaser Payment Notification” form on or before settlement.

Austrian taxation of private foundations in connection with profit allocations to foreign beneficiaries contrary to EU law (C-589/13)

On 17 September 2015, the Court of Justice of the European Union (‘CJEU’) rendered its decision in the case F.E. Familienprivatstiftung Eisenstadt (C-589/13) concerning the Austrian system of interim taxation of national private foundations in the case of profit allocations made to non-resident beneficiaries. The CJEU held that the unfavorable treatment of private foundations which make profit allocations to non-resident beneficiaries as compared to those making profit allocations to local beneficiaries infringes the free movement of capital.

The Austrian system of interim taxation

In the given case an Austrian private foundation generated capital gains which fell under the Austrian system of ‘interim taxation’. Under this taxation scheme certain profit items (i.e. certain capital gains and income from the disposal of private real estate) of a private foundation are subject to an interim tax at a rate of 25 % (corporate income tax). Before the introduction of the interim tax these profit items remained untaxed at the level of the private foundation and only the profit allocations to beneficiaries made out of this income were taxed with WHT at a rate of 25%. That mechanism allowed private foundations to reinvest profits from capital investments without consideration of any tax reductions which led to higher investment income as long as no profit allocations were made (‘snowball-effect’). However, this beneficial tax treatment – due to political reasons – had to be limited which resulted in the implementation of an interim tax. Since the interim tax should not lead to a higher overall tax burden on these profit items than under the old system (overall 25% tax burden), the base of the interim tax was reduced in so far as any profit allocations were made to beneficiaries in the same assessment period, provided the profit allocations – which are in principle subject to WHT – were not fully or partly exempted on the basis of a DTC (regularly fulfilled in case of domestic beneficiaries). If profit allocations are made in the following years for which WHT has been withheld, interim tax will be credited (in the amount of 25% of the profit allocations). Upon termination of the private foundation all interim tax not credited so far, will be refunded then.

Scenario with foreign beneficiaries:Scenario without foreign beneficiaries:

The facts of the case

In the case at hand an Austrian private foundation made profit allocations to beneficiaries resident in Belgium and Germany which requested relief from the WHT deducted from their profit allocations based on the applicable DTC’s. Consequently, the Austrian tax authorities denied the corresponding reduction of the profit subject to interim tax at the level of the private foundation in the same period. The private foundation appealed before the Federal Fiscal Court (Austrian Tax Court of 2nd Instance) against this decision. However, the Federal Fiscal Court upheld the decision of the tax authorities by stating that exemption from WHT was granted in respect of the profit allocations on the basis of the DTCs, which meant that these profit allocations could not be deducted from the taxable amount of the interim tax. In a next step, the private foundation appealed against the decision of the Federal Fiscal Court before the Austrian Administrative High Court (VwGH). The Administrative High Court held it likely that the unfavorable treatment of private foundations, which arises only in the case of profit allocations to foreign beneficiaries but not in the case of profit allocations to domestic beneficiaries constitutes a restriction of the free movement of capital and referred the following question to the CJEU for a preliminary ruling: ‘Is Article 56 EC to be interpreted as precluding a system for the taxation of capital gains and income from the disposal of holdings of an Austrian private foundation in the case where that system provides for a tax charge to be imposed on the foundation in the form of an ‘interim tax’ in order to ensure single national taxation only in the case where, on the basis of a double taxation convention, the recipient of [profit allocations] from the private foundation is exempt from capital gains tax which in principle is chargeable on [profit allocations].’

The CJEU’s decision

According to the CJEU, profit allocations made by private foundations fall under the provisions of the Treaty on the movement of capital. Such profit allocations can be compared with gifts and therefore the application of Art 63 TFEU can be derived from the judgements in Persche[1] and Mattner[2]. Both the initial contribution of the assets to the private foundation by the founder as well as the subsequent payments made from profits generated by those assets to the beneficiaries fall within the concept of ‘movement of capital’ within the meaning of Art 63 para 1 TFEU.[3]

With regard to a possible infringement of that fundamental freedom the CJEU first argues that the different treatment of Austrian private foundations in their right to an immediate reduction of the interim tax base (depending on whether the beneficiaries of the profit allocation are or are not subject to Austrian WHT) forms – due to the associated liquidity disadvantage – a restriction of the free movement of capital. Although profit allocations for which such a right to immediate reduction or immediate reimbursement is excluded can also include profit allocations to beneficiaries residing in Austria where those beneficiaries are exempted from WHT, they cover in particular profit allocations made to non-resident beneficiaries in so far as under Art 21 DTC such profit allocations are not taxable in Austria since they are subject to the exclusive powers of taxation of the State of residence of the beneficiary.[4]

The CJEU concluded that the making of profit allocations by private foundations to resident beneficiaries is a situation objectively comparable to that where the same private foundations make profit allocations to beneficiaries residing in another Member State. Since Austria renounced the exercise of its powers of taxation over profit allocations to persons residing in other Member States, it cannot invoke a difference in the objective situation between resident private foundations which make profit allocations to domestic and those which make profit allocations to foreign beneficiaries in order to subject private foundations making profit allocations to the latter to a specific tax on the ground that those beneficiaries are not subject to its tax jurisdiction.[5]

The difference in treatment cannot be justified by an overriding reason in the public interest. As Austria, via the conclusion of DTC, has abandoned its powers of taxation on profit allocations to persons residing in other Member States, Austria cannot refer to a balanced allocation of powers of taxation in order to levy a specific tax on foundations that make profit allocations to such persons on the basis that those persons are not subject to its tax jurisdiction.[6]

The Court then went further to state that a ‘principle of single taxation’ has never been accepted as a distinct justification. According to settled case law any advantage resulting from the low taxation to which a subsidiary is subject cannot by itself authorise another Member State to offset that advantage by less favourable tax treatment of the parent company.[7] These considerations also apply to the case at hand, concerning a difference in tax treatment of private foundations according to whether the profit allocations they have made lead to their beneficiaries being taxed in Austria.

The restriction neither can be justified by the need to safeguard the coherency of the national tax regime. The coherency argument requires a direct link to be established between the tax advantage concerned and the offsetting of that advantage by a particular tax. According to the CJEU no such a direct link exists in the present case because of two reasons. First, the benefit of the reduction of the interim tax and the taxation of the beneficiaries concern different taxpayers. Secondly, whereas the tax advantage of the foreign beneficiary consists in a permanent exemption from the WHT, a private foundation suffers only a temporary disadvantage due to the interim tax. This is because all interim tax (insofar not credited till then) will be refunded upon termination of the private foundation.

Conclusion

This decision of the CJEU makes clear that the Austrian system of interim taxation, which refuses the right to deduct WHT-exempt profit allocations to foreign beneficiaries from the taxable basis of the interim tax, is not in line with EU law. Profit allocations of Austrian private foundations made to domestic and foreign beneficiaries should lead to a corresponding reduction of interim tax, irrespective of any tax treaty benefit applied to the profit allocations. Since the free movement of capital also applies to third country situations profit allocations to beneficiaries residing in countries outside the EU should qualify for a corresponding reduction of interim tax as well.

Way forward

Under a bill issued on 9 December 2015 the system of interim taxation was modified in order to address the CJEU judgement in F.E. Privatstiftung Eisenstadt. The new system came into force on 1 January 2016. Under the new system profit allocations to foreign beneficiaries should lead to a reduction from interim tax insofar as the profit allocations are definitely charged with Austrian WHT. Profit allocations that are only partly exempt from WHT tax, would then partly be recognized for the reduction from interim tax. Under the old system of interim taxation a partial reduction from WHT led to a full denial of reduction from interim tax.

In the event of termination of the private foundation it is now foreseen that not all interim tax will be refunded anymore, but also only to the extent (final) profit allocations are definitely charged with WHT. This amendment could even lead to situations were private foundations with foreign beneficiaries are tax even worse under the new system as compared to the old system.

As under the new bill a private foundation with foreign beneficiaries would still be treated less favorably than one with domestic beneficiaries also the new bill seems to violate EU law.

As already described above the justification of the old system of interim taxation based on the coherency of the Austrian tax system failed because of two reasons: (a) the benefit of the reduction of the interim tax and the taxation of the beneficiaries concern different taxpayers and (b) whereas the tax advantage of the foreign beneficiary consists in a permanent exemption from the WHT, a private foundation suffers only a temporary disadvantage due to the interim tax. By the new system of interim taxation (i.e. refund of interim tax upon termination of the private foundation only to the extent (final) profit allocations are definitely charged with WHT) only point (b) will be taken account of. However in its judgement F.E. Familienprivatstiftung Eisenstadt, the CJEU explicitly states the justification based on the coherency of the national tax system, fails ‘for several reasons’.[8] Therefore point (a) still prevents a justification of the new system of interim tax on the basis of the coherency argument.

To sum up the CJEU in its judgement F.E. Familienprivatstiftung Eisenstadt concluded that profit allocations to foreign beneficiaries should always lead to a full corresponding reduction of interim tax, irrespective of any DTC exemption. The Austrian legislator should therefore re-implement the system of interim taxation in a way that it does not differentiate between WHT-exemption anymore. For now it seems highly questionable whether the CJEU would accept the new system which came into force beginning of 2016. Therefore, Austrian private foundations with foreign beneficiaries which are subjected to significant interim tax and do not benefit from a reduction of it due to the regulation above should analyse whether it makes sense to challenge the Austrian regulation by referring to EU law.

[1] EU:C:2009:33 (Persche), para 27.

[2] EU:C:2010:216 (Mattner), para 20.

[3] EU:C:2015:612 (F.E. Familienprivatstiftung Eisenstadt), para 39.

[4] EU:C:2015:612 (F.E. Familienprivatstiftung Eisenstadt), para 43.

[5] EU:C:2015:612 (F.E. Familienprivatstiftung Eisenstadt), para 64.

[6] EU:C:2015:612 (F.E. Familienprivatstiftung Eisenstadt), para 71.

[7] EU:C:2015:612 (F.E. Familienprivatstiftung Eisenstadt), para 76.

[8] EU:C:2015:612 (F.E. Familienprivatstiftung Eisenstadt), para 82.

Jordan Income Tax Law Reform

Jordan’s new Income tax law number (34) of the year 2014 (published in the official gazette) is put in force as of January 1, 2015. Major changes included in the new tax law related to capital market gains are the following:

  • The new tax law included some changes regarding the withholding tax related to income from investment, and any other non-exempted income paid by a resident directly or indirectly to a non-resident person. Article (12/B) of the new income tax law, states the following: “Every person responsible for the payment of a non-exempted income, directly or indirectly to a non-resident person shall at the time of payment deduct tax at the rate of (10%), He shall also prepare and submit to the Income Tax Department, and the beneficiary a declaration of the amounts generated and the tax deducted.
  • The amounts deducted in accordance with Para (1) above can be considered as final taxes in accordance with the instructions issued thereto”.

It is worth mentioning that the amendment to this provision raised the withholding taxes from (5%) to (10%), taking in consideration the above article includes interest income generated from investments and any other non-exempted interest income paid by a resident directly or indirectly to a non-resident person including coupon interest payments of government and corporate bonds.

Para (H) of the same article states that the person responsible for deducting taxes related to article (12/B) above shall deduct and pay the withholding taxes within (30) days of payment date, The tax that has not been deducted and paid shall be recovered and collected as if it were tax due from such person.

Para (I) of this article also referred to instructions that will be issued to set procedures and provisions necessary to enforce this article. The said instruction has not been issued yet.

The new tax law kept the following activities exempted from tax, and added to those exemptions income derived from trading of Sukuk instruments:

  • Profits from stocks and dividends distributed by a resident to another resident, except profits of mutual investment funds of banks and financial companies, telecommunication companies, insurance, financial services companies. Exempted from taxes.
  • Capital gains incurred inside the Kingdom, other than profits from assets subject to depreciation.
  • Income derived from inside the kingdom from trading in dividends and stocks, bonds, equity loan, sukuk, treasury bonds, mutual investment funds, currencies, commodities in addition to futures and options contracts related to any of them, except that incurred by banks, financial companies, financial intermediation and insurance companies and legal persons who undertake out financial lease activities.
  • Personal exemption of 12,000 Jordanian dinar (JOD) – provided they stay in Jordan for more than 183 days during the calendar year (continuous or interrupted)
  • Family exemption of JOD 12,000 – provided the family stays in Jordan for more than 183 days during the calendar year (continuous or interrupted.)
  • Monthly retirement benefit exemption of JOD 3,500 – down from JOD 4,000 under the old Law
  • Additional personal and family exemption of JOD 4,000 on medical expenses, university education expenses and interests paid on housing loans, housing rent, technical services, engineering services, and legal services.
  • For the additional personal and family exemption, supporting documents and invoices must be available, and the exemption is granted case-by-case basis following the Income Tax Department’s review of the supporting documents.

WITHHOLDING TAX CHANGES

Withholding tax for non-resident services providers is increased to 10 percent (up from 7 percent.

The 5 percent withholding tax on real estate rent has been abolished.

As of 1 January 2015, certain service providers are subject to a 5-percent retention, including doctors, lawyers, engineers, Certified Public Accountants, experts, consultants, insurance agents, custom clearing agents, arbitrators, speculators, agents and commission brokers, financial brokers, freight forwarders, and other persons specified by the Minister of Finance in related regulations.

The withholding tax on cash and in-kind prizes and Jordanian Lottery winnings in excess of JOD 1000 per each prize is increased to 15 percent (from 10%).

In-kind and in-cash dividends are not subject to withholding tax when paid by a resident to a non-resident party.

INTERIM CORPORATE INCOME TAX PAYMENTS

Corporate taxpayers that had annual total gross income over JOD 1 million (previously JOD 500,000) in the preceding tax year are required to pay interim corporate tax payments at a rate of 40 percent of the corporate income tax liability calculated based on the reported interim financial information related to the interim period (previously 37.5 percent), or 40 percent (previously 37.5 percent) of the income tax amount declared to the tax authority in the preceding tax year. These payments are due within 30 days from the end of the first half and second half of the fiscal year.

LOSSES CARRIED FORWARD

Under the new law, approved losses can be carried forward for up to 5 years (the period was unlimited in the previous law).

SOCIAL SECURITY CONTRIBUTIONS

Monthly social security contributions increased to 20.25 percent (from 19.50 percent), as of 1 January 2015, implemented as follows:

The employees’ monthly contribution increased to 7 percent (from 6.75 percent).

The employer’s monthly contribution increased to 13.25 percent (from 12.75 percent).

EXEMPTION FROM FINES AND PENALTIES

An exemption has been granted from penalties and fines related income tax, sales tax, customs duty, stamp duty and property tax1. The exemption covers penalties related to the tax years 2014 and before, provided that taxes and duties claimed have been fully settled before 31 March 2015. Such exemption is reduced to 75 percent if the amounts are fully paid during the period from 1 April to 30 June. From 1 July 2015 to 30 September 2015, the penalties are phased out at 50 percent.

EXEMPTION FOR RENEWABLE ENERGY INPUTS

Jordan’s Renewable Energy Law2 is amended to include a full exemption from sales tax and customs duty on the renewable energy inputs, including spare parts and equipment.

Treaties for the Prevention of Double Taxation

Jordan has signed agreements for the prevention of double Taxation with Austria, Bahrain, Belgium, Canada, Cyprus, Denmark, Egypt, France, Iraq, Kuwait, Libya, Malaysia, Oman, Pakistan, Qatar, Romania, Saudi Arabia, Spain, Syria, Tunisia, Turkey, United Arab Emirates, United Kingdom, the United States and Yemen.

Snapshot of the New Tax Law:

 

  1. For individuals

– A tax free threshold of JD12, 000 for individuals, the same as the previous law.

– A further JD4, 000 exemptions is also added if supported by invoices of expenses related to medical services, and interest paid on housing loans.

– 7 percent tax for the first JD10, 000 above the exempted JD12, 000. In the previous law, the first JD12, 000, after the exempted amount, was subject to a 7 percent tax.

– Under the new law, a second bracket has been created with the second JD10, 000 subject to a 14 percent tax. There will further be a 20 percent tax for individuals who earn above this.

– This is compared to the previous tax law, which entailed a tax of 14 percent on any sum above the first taxed JD12, 000.

– The new law provides a tax free threshold of JD24, 000 for a household’s combined annual income, plus the JD4, 000 exemptions on expenses related to medical services and interest paid on housing loans.

  1. For businesses?

– Banks: 35 percent income tax (up from 30 percent)

– Industrial sector: 14 percent levy on every JD100, 000 generated, which rises to 20 percent on every JD1 above that amount. (The same as the previous law)

– Telecommunications, electricity distribution, mining, insurance, brokerage, finance and companies or persons who provide rental and leasing services: 24 percent tax on every JD1 earned

 Agriculture: Totally exempt from tax (Previously 14 percent tax after the first JD75, 000)

– Other businesses and partly owned government entities: 20 percent tax (up from 14 percent tax)

New Image: The Changing Role of ABL

As the number of acquisitions and management buy-outs appears to be on the rise in the UK, Evette Orams, Managing Director of Hilton-Baird Financial Solutions, explores the reasons behind an interesting shift in the financial composition of those deals.

News that the UK boasted the fastest growing economy of all the G7 countries in both 2013 and 2014 has served to confirm the strides that the nation has taken since the depths of the global downturn.

Even if an element of caution does still remain, confidence continues to creep back into the markets as businesses increasingly realign their goals from survival to growth. While the approach of different businesses to secure this expansion might vary according to their size, it is becoming evident that many are opting for an aggressive growth strategy.

One thing I’ve noticed of late is a growing number of acquisitions, management buy-outs (MBOs) and buy-ins (MBIs) taking place. This is to be expected in a recovery to a degree, as the healthiest companies make the most of the opportunities that present themselves. Yet the interesting part is the make-up of those deals, or rather the methods of funding that are being used to facilitate the transactions.

Where the MBO/MBI space was once dominated by equity-backed investments, it would appear that asset based lenders are now having an even bigger involvement as businesses look to make the most of their assets.

So what are the reasons behind this shift, and will it continue?

Sticking point

Equity finance clearly carries a number of benefits to businesses seeking growth capital. There’s much more to it than simply the funding element; the expertise and support of the investor, together with their ‘contact book’, can make a huge difference to the business’s growth potential. The sticking point has always been the need to cede equity.

Arguably, however, there just hasn’t been a viable alternative available to businesses when it comes to raising the finance to complete an acquisition, MBO or MBI.

Due to the sums of money required, it is rare for growing companies to be able to rely on their existing cash flow to fund the transaction without jeopardising their immediate financial health. Traditional debt finance, meanwhile, can be a costly and risky option, though the banks’ adoption of a more cautious stance in the wake of the financial crisis has made the likes of loans and overdrafts difficult to secure anyway.

What many have realised is that the strength of their existing business is in fact their biggest asset when it comes to raising finance.

The UK’s mid-market businesses are performing very strongly. Together they employ nearly 10 million members of staff and turn over a collective £1.5 trillion every year. This means that they are typically asset-rich with a great amount of cash therefore tied up in a wide range of assets, cash that’s becoming far simpler to access as the asset based finance sector continues to evolve.

Transformation

Asset based finance has undergone a significant transformation in the UK in recent years. Although it too contracted sharply as the global downturn struck, it has come back fighting and played a key role in fuelling the economic recovery.

According to the Asset Based Finance Association (ABFA), advances made to British businesses between April and June 2015 against the value of assets including debtors, stock, property, plant and machinery reached £19.3 billion. This is 32 per cent higher than the £14.6 billion that was advanced during the corresponding quarter five years earlier, in 2010.

There are a number of well-documented reasons for this dramatic increase. The decline in bank lending is of course one, which has also led to the alternative finance market expanding at breakneck speed (peer-to-peer lending and crowdfunding reportedly grew by 160 per cent in 2014 alone to provide £1.2 billion of funding).

Similarly, the introduction of the ABFA’s Code of Conduct has arguably helped to enhance the sector’s image, giving clients fresh confidence in the lenders and reassurances that any discrepancies or disputes can be resolved with the help of the trade association.

Yet a more overlooked reason is the sheer suitability of asset based finance in the current climate. Whether a business is struggling to maintain a steady cash flow or requires additional funding to capitalise on expansion opportunities, the features of this form of funding make it an extremely useful solution – particularly in times of economic recovery.

Crucially, this is what has appealed to so many larger companies who are looking to finance their growth plans.

A viable alternative

The statistics back this up. In Q2 2010, only 14.9 per cent of the asset based finance industry’s clients had an annual turnover of more than £5 million, according to the ABFA’s quarterly statistics. Fast forward five years, however, and this figure has risen steadily to 19.2 per cent as the profile of the sector has shifted.

Further still, comparing the data over the past five years reveals a notable change in the assets being funded. While advances against stock has risen by 160 per cent, for instance, funding against plant and machinery has increased by 327 per cent. Those assets alone now account for 6.1 per cent of overall asset based lending, up from 2.8 per cent in 2010.

While equity finance of course still has a place in acquisition and MBO/MBI transactions, it would appear as though, for the first time in a long time, businesses are being presented with a real alternative to ceding equity when looking to expand.

The challenge now is for the market to sustain its evolution, thriving on the success stories that are coming out of it. If it can, the MBO/MBI landscape will be just as different in another five years from now.