Europe’s leaders are striving to demonstrate their commitment to defend the euro on the markets, but the Eurozone’s outlook for 2013 is still grim. Most countries are heading into recession and unemployment rates continue to rise. Also, there is ongoing speculation that the Eurozone will disintegrate or that a Eurozone country may unilaterally withdraw from the European Monetary Union (EMU) .
Many companies are struggling to understand the effect such events may have on contracts whose payments are euro-denominated. Early identification of the most likely tax and transfer pricing risks will help companies understand which practical tax and transfer pricing aspects they could confront upon a Eurozone breakup.
When euro-denominated contracts are between parties from the same Eurozone country, then a departure from the Eurozone by that country should not in principle affect either party. In such circumstances, it is likely that the contract would, by virtue of the implementing legislation, simply be redenominated in the new currency of the relevant country at the rate that country has specified, and the parties will simply continue to perform their contractual obligations as usual. Tax and transfer pricing issues only arise when the contract involves multi-jurisdictional or cross-border transactions that are either euro-denominated or have some euro payment requirements.
If a country exits the Eurozone, or the euro collapses entirely, then the main tax issue for taxpayers would be currency risk (also called foreign exchange risk). As an illustration, a Dutch taxpayer files its corporate tax return in euros. The taxpayer assumes no currency risk if it holds a euro-denominated receivable from a Greek party. If a disintegration of the Eurozone occurs, however, then the receivable will be redenominated in a currency other than the euro. Any currency gains derived from the receivable are in principle taxable from a tax perspective. At the same time, any currency losses relating to the receivable are deductible.
The taxpayer that experiences such a currency risk may also face a transfer pricing challenge. For example, a Dutch taxpayer engaged in intercompany financing activities – for example, borrowing funds and on-lending these funds, - often concludes an Advance Pricing Agreement (APA) with the Dutch tax authorities. Such APAs determine the spread to be reported for Dutch corporate tax purposes. An APA is concluded on the basis that the Dutch taxpayer bears only limited risks, and certainly not currency risks. If, upon the disintegration of the Eurozone, the taxpayer suddenly starts bearing currency risks, then the APA may likely become void due to the change in facts and circumstances.
In addition, based on internationally accepted rules, intercompany transactions should adhere to the arm's length principle. Pursuant to this principle, an intercompany loan should bear a business-like interest rate. When establishing an arm's-length interest rate for an intercompany loan, the potential Eurozone disintegration can be taken into account as a risk, because an exit out of the Eurozone could throw the involved country into a depression, resulting in greater country risk and a negative impact on the credit rating of companies located in that country.
Similarly, a disintegration of the Eurozone will affect multinational companies engaging in other activities in addition to financing. As an example, consider, a multinational company with a manufacturing plant in Germany and a distributor in Greece. If Greece leaves the Eurozone, should the German manufacturer continue to sell to the Greek distributor in euros or in a new Greek currency? Given that the new Greek currency would most likely rapidly devalue against the euro, the distributor would suffer losses when sales continue being made in euros; but if the distributor decides to sell in the new Greek currency, then the manufacturer would suffer losses. Another possible option in such a scenario could be to agree to split such losses between the manufacturer and the distributor. Whichever option is chosen, the company should make sure that it also is considering transfer pricing concerns, in order to avoid scrutiny from tax authorities.
What is the key takeaway from this? A Eurozone disintegration, while unlikely, is still a possibility. With such uncertainties, companies should take steps to reduce the most obvious risks. Much has already been written about companies' business and legal risks associated with the Eurozone crisis — but companies should also identify and take into consideration the very real tax and transfer pricing risks.
For more information about international tax and transfer pricing issues in the Eurozone, please contact Ágata Uceda, Jian-Cheng Ku or B.J. Dechsakulthorn.
FROM THE ARCHIVES
Identifying and assessing the legal risks relating to the Eurozone Crisis