ABA Section of International Law Legal Challenges for Foreign Investment in Latin America May 89, 20

1
ABA Section of International LawLegal Challenges
for Foreign Investment in Latin AmericaMay 8-9,
2008 São Paulo, Brazil

• The Latin American Tax System and Foreign
  Investment

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Overview

• Holding Company Jurisdictions
• Financing Structures
• Other Structures

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Holding Company Jurisdictions
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Holding Company JurisdictionsTypes of
Jurisdictions

• High-Tax
• Jurisdictions
• High-tax rates
• CFC rules
• Not good for holding companies
• U.S., U.K., Germany, France, China

• Tax-Haven
• Jurisdictions
• Totally tax-free
• No tax treaties
• Cayman
• Bermuda
• BVI
• Anti-tax haven rules- e.g., Brazil, Mexico

• Tax-Friendly
• Jurisdictions
• No tax on capital gains and dividends
• Good for holding companies
• May have capital duties
• Can be good for interest and royalties
• Good treaty networks
• Netherlands, Spain Luxembourg, Switzerland
• Otherwise, high-tax countries

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Holding Company JurisdictionsTypes of
Jurisdictions

• Ireland
• 12.5 rate on all income, including interest and
  royalties
  
• Good treaty network
• Good for RD, software, licensing, etc.
• Not a good holding company jurisdiction
• Hong Kong
• Dividends and capital gains exempt
• Good holding company jurisdiction for China
• Good treaty with China
• 17.5 corporate tax rate
• Foreign source income taxed at 50

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Holding Company JurisdictionsNetherlands

• Participation exemption on capital gains and
  dividends
  
• Subject to tax requirements
• Cannot be passive investment
• 25 withholding tax on dividends paid to
  shareholders, although many tax treaties reduce
  this tax
  
• Good treaty network
• No capital duty

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Holding Company JurisdictionsLuxembourg

• Participation exemption on capital gains and
  dividends
  
• 11 subject to tax requirement
• 29.6 corporate tax rate on interest, royalties
  or other types of non-exempt income
  
• Tax planning to shelter royalties in interest
• 1 capital duty
• Tax planning to avoid capital duties (Gibralter)

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Holding Company JurisdictionsLuxembourg

• Preferred Equity Certificates (PEC)
• Can be debt for Luxembourg purposes but equity
  for U.S. tax purposes
  
• No capital duty on amounts invested in PECs
• Usually a 50 year instrument
• Convertible Preferred Equity Certificates
  (CPEC)
  
• Like a PEC but is convertible into equity
• Lower interest rate, usually 1 to 2
• Interest is deductible
• No capital duty on CPECs

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Holding Company JurisdictionsLuxembourg

• Thin capitalization rules allow 85 PECs, 14
  CPECs and 1 real equity
  
• 1 capital duty on real equity
• Accrued interest on PECs/CPECs deductible
• Rulings common and easy to get

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Holding Company JurisdictionsSwitzerland

• Dividends and capital gains can be exempt under
  the holding company exemption
  
• Varying rules in the different cantons Zug and
  Zurich are tax friendly cantons
  
• Foreign sourced royalties and interest can be
  taxed favorably, at rates less than 8
  
• Consequently, Switzerland is a good jurisdiction
  for RD

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Financing Structures
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Financing StructuresDebt Push-Down

• Deduct interest against local tax
• Withholding tax in LatAm country (Brazil 15
  Mexico 10-15, etc.)
  
• Forex Issues
• Tax planning needed for interest income in Hold
  Co jurisdiction

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Financing StructuresDebt Push-Down

• Does not work in Argentina interest not
  deductible

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Financing StructuresDebt Push-Down - Mexico
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Financing StructuresDebt Push-Down - Mexico

• Deduct interest of Mex Holdco against income of
  Mex Opco under holding company regime
  
• Not a perfect result creates a deferred tax
  liability
  
• Better to merge Mex Holdco and Mex Opco
• Need Hacienda approval for second merger

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Financing StructuresDebt Push-Down - Mexico

• 31 debt/equity limitation under Mexican thin
  capitalization rules
  
• 10 withholding tax under Mexico-Luxembourg
  Treaty
  
• Need tax planning for interest received in Lux
• Lux HoldCo exposed to Mexican capital gains tax
  on sale

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Financing StructuresUse of Switzerland for
Mexican Investment

• Same results on interest paid to Lux Hold Co
• e.g., 10 withholding, 31 debt/equity limit
• Solve capital gains tax issue with Swiss Hold Co
  (Mexico-Switzerland Tax Treaty provides an
  exemption for capital gains)

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Financing StructuresUse of Switzerland for
Mexican Investment

• No tax in Switzerland on dividends and capital
  gains
  
• Be careful to maintain holding company exemption
• Need tax planning to avoid 1 capital duty
• Contribute significant participation in one or
  more companies
  
• No dividend withholding tax under
  Luxembourg-Switzerland Tax Treaty
  
• Need substance in Luxembourg

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Financing StructuresUse of Hybrid Debt

• Lux Hold Co accrues interest on PECs/CPECs to
  offset against interest income from LatAm
  Companies
  
• Can defer paying interest as long as desired
• When paid, interest can be treated as dividend
  for U.S. purposes, carrying out foreign tax
  credits
  
• APB 23 considerations

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Financing StructuresSwiss Finance Branch

• Pay corporate tax in Switzerland and Luxembourg
  on a small spread
  
• Need 100 million of debt for Swiss purposes

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Other Structures
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Other StructuresTax Haven Problems

• Beware!
• Embedded 40 tax on entire value

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Other StructuresCarbon Energy Trading

• LatAm Hydro Co produces carbon emission reduction
  credits (CERs) that are tradable
  
• Offshore Co pays discounted price in advance for
  CERs that eventually become available once the
  power plant is operating
  
• Capture profits in Offshore Co, subject to local
  transfer pricing
  
• Tax planning needed for subpart F issues if Hedge
  Fund is in U.S. (many hedge funds are offshore)

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Other StructuresOffshore Leasing Co. - Chile

• 4 Chilean withholding on rental payments to
  Offshore Co.
  
• Chilean transfer pricing
• Tax planning needed (e.g., check-the-box) for
  U.S. subpart issues