Discussion: Corporate Tax
Julie Divola from Pillsbury Winthrop Shaw Pittman LLP in California and Leandro Passarella from Passarella Abogados in Argentina discuss the key issues facing corporate tax lawyers today.
Participants
Julie Divola
Pillsbury Winthrop Shaw Pittman LLP
Leandro Passarella
Passarella Abogados
Who’s Who Legal: What new measures have the tax authorities imposed in your jurisdiction is the past year? How is this influencing foreign investment? And how is it affecting the demand for tax advice?
Julie Divola: In the United States, the economic substance doctrine was codified this year. It is often described as the US version of a GAAR (general antiavoidance rule). In my practice, I have not seen it have an impact on foreign investment. The extent to which it has an impact on practice seems to vary depending on the practitioner (and the matter). Because a finding of economic substance results in a strict liability penalty of 40 per cent (reduced to 20 per cent in most cases with disclosure), it definitely becomes a factor, especially for highly tax-structured transactions.
Other measures that impact tax structuring are the potential change in tax rates. As of 1 January 2011, for example, the tax rate on dividends is scheduled to increase from 15 per cent to 39.6 per cent. Capital gains is scheduled to increase from 15 per cen to 20 per cent and ordinary income tax rates are scheduled to increase from 35 per cent to 39.6 per cent. All of this has an impact on tax practice and structuring. In some cases, it seems that there is a motivation to have deals completed this year before rates increase.
Another change that has been debated (but not passed) that seems to be having an impact on current US tax planning are the proposals to change the treatment of carried interests (ie, the partnership profits interests received by fund managers). Many funds are considering whether they should restructure their portfolio investments now so that they’ll be in a better position in the event that the rules are changed to eliminate the favourable treatment of carried interests.
Leandro Passarella: There have not been significant changes to the Argentine tax system in the past year influencing foreign investment, which is increasing at a lower rate than the region in general (mainly due to political concerns that hopefully will be cleared next year with the presidential election). However, there have been recent Tax Court and Court of Appeal decisions relating to transfer pricing and interest deductions, which may have an impact in future cross-border transactions.
In addition, the Argentine tax authorities have announced that they will review Argentina’s double tax treaty network, especially from a revenue loss perspective, to determine whether any of Argentina’s 17 current double tax treaties need to be amended or should be terminated (mainly, because the flow of investments between both contracting states is not comparable).
From a local tax standpoint, the re-imposition of stamp taxes in the City of Buenos Aires (driven mainly by revenue shortages) may be considered one of the most salient measures affecting both domestic and foreign investment alike. The City of Buenos Aires was the only main Argentine jurisdiction that did not apply this tax, making it the jurisdiction where all agreements were executed to the maximum extent possible. As the local tax authorities have put it, this is a tax levied on “legal certainty.” As a reaction to this “new-old” tax, several agreements – especially those where it is clear that no legal issues will be raised in the future (eg, intercompany agreements) – have been structured as letters that are accepted tacitly. Otherwise, the tax hits transactions at 0.8 per cent on the value of the transaction.
Who’s Who Legal: A number of our sources said that large corporations in their jurisdictions were reducing the number of external tax advisors they engage, thereby increasing competitiveness for contracts among private practice lawyers. Is this the case where you are? In such conditions, is a small to mid-sized law firm with lower overheads better placed than a full service firm?
Julie Divola: There has been tremendous pressure to reduce fees for all clients (including large corporate clients) in the last few years. I assume that this has in large part been due to the state of the economy and the overall focus by businesses to cut expenses. In addition, transactional tax activity was dramatically slower last year because of reduced deal activity (my personal experience has been that it has been much more active this year, with deal structures that are more complicated than ever). Fee pressure from clients and reduced deal activity has lead to a great deal of competition among lawyers in private practice. In some ways, I think that small to mid-size firms may be better positioned in this market, especially if they are given more flexibility to use creative fee structures. Still, I don’t think that the tax practice in large law firms has suffered overall as much as some other practice areas. Even when merger and acquisition activity was at its slowest, there was (and continues to be) a fair amount of workout activity that requires sophisticated tax expertise. In addition, tax controversy lawyers remain very busy because the taxing authorities have been particularly aggressive in recent years. Finally, numerous changes in the tax laws have led to an additional demand for tax services.
Leandro Passarella: Yes, this is true for Argentina. The financial crisis has made several clients “trim the fat” and cut costs, which has affected external advisors in general (not only tax advisors). This has significantly affected large firms, which see their costs maintained or increased, while their revenues may decrease or stay the same (in an inflationary context with a fixed exchange rate). At the same time, clients are – like in a turbulent stock exchange – “flying to quality” when looking for assistance in their complex tax matters (both tax planning and tax controversy).
In Argentina, you may find highly-qualified tax advisors both in large and small to mid-size (boutique) firms, making competition among them interesting. In addition, small and mid-size firms have earned recognition among peers and clients in the local or international markets (or both). Therefore, they also have a “trademark” or “factory stamp” that can compete with those of large firms.
On the other hand, small and mid-size firms may be better positioned than large firms because not only do they have the expertise but also the flexibility to provide clients with cost-efficient solutions.
At this point, it all depends on the client: whether it feels more comfortable and secure working with a large firm, or with the team of a trusted boutique firm.
Who’s Who Legal: We received contrasting reports from lawyers about the viability of a large tax practice in the current climate, with some suggesting now was a good time to expand while others noted that tax work was now little more than a service function in the larger corporate department. How does the current level of work within your tax group compare with previous years? Is it sustainable to have a large tax practice in the current market?
Julie Divola: I think that there is still significant demand in a large firm for a full service tax practice. Although merger and acquisition activity was slower last year, our clients still required workout and tax controversy advice. In addition, although the economy remains volatile, M&A activity in the United States has increased dramatically this year. That doesn’t necessarily translate into a belief that now is a good time to expand a tax practice. If for no other reason, I think uncertainty about the future and the volatile economic environment suggest that expansion should be approached with caution. Separately, I think that one issue is whether large firms still need tax lawyers, and I believe that they do (as much as ever). Another question is whether large firms properly compensate their tax lawyers and I’m not sure that’s always the case, particularly in this market. In large law firms I see increased pressure (and value associated with) lawyers who can generate business. To the extent that tax lawyers support the corporate rainmakers, their compensation tends to suffer in the current market. I’m sure this trend varies by firm and practice. For example, tax controversy lawyers and those who are better at generating their own clients, don’t have the same concerns.
Leandro Passarella: There is no definitive answer to this question. The fact that the crisis has not yet ended makes firms think cautiously about growing. However, sometimes critical times are good to make radical changes. In that case (as it is in all business areas), it mostly depends on the availability of financial resources.
The level of work of our group has been sustained or has even increased. Therefore, the need to grow in the short term is a possibility. In that case, the key issue is to find the right people to bring to your group, so as to be able to continue providing the same signature service to your clients.
Who’s Who Legal: Several of the lawyers we surveyed have noted sustained high levels of tax disputes. Is tax controversy still a busy area in your jurisdictions? What are the trends in settlements?
Leandro Passarella: It is a busy area in Argentina. The tax authorities at all levels – federal, provincial and municipal – are in need of revenues. Therefore, they are challenging structures (eg, the use of foreign trading companies for exports), as well as limiting tax benefits by means of restricted interpretation of the tax laws. Besides, they are using new information technology tools, which allows them to target and find elusive taxpayers. While in the first case you see taxpayers battling for their positions, in the latter case taxpayers usually accept the tax authorities’ adjustments because legal arguments are scarce when trying to defend their position (Argentina does not have a settlement mechanism to solve tax disputes).