Litigation Risk

Litigation Risk

Despite prudent decisions and the best possible advice, corporate directors face an increase in international legal actions that can impact their personal assets. think:act examines what top managers should look for in corporate D&O (directors and officers) programs.

The Enron scandal of the last decade transformed corporate governance. It also had a lasting effect on the D&O insurance market, given CEO Jeffrey Skilling's legal bills estimated at $23 million: The case piqued interest in the coverage that protects company officers from personal financial liability if they are sued. And, as insurers assessed the riskier business climate, premiums began to rise. Like malpractice insurance for high-level managers, the "directors and officers" insurance forms a worldwide market today, worth $8.8 billion in 2008, and covers top managers in the event of a breach of duty and a resulting lawsuit. Usually reserved for companies with a fair share of assets and management board structures, the pricey insurance policies, with premiums that can reach up to several hundred thousand euros a year for millions in coverage, essentially let individuals hedge the personal financial risks they face by playing in the top league. At the same time, the policies are a tool for making corporate entities responsible for the actions of their employees and protecting corporate assets.

 

D&O  Policy Holders are more likely than ever to be sued.

In the aftermath of the subprime financial crisis, companies as well as their directors are advised to be even more cautious about potential financial liability for their management decisions, says attorney Kevin M. LaCroix, the author of the D&O Diary and a director of OakBridge Insurance Services. That's because D&O policyholders are now more likely to be sued, and more likely to be sued for larger amounts, than in the presubprime era. Whereas class-action lawsuits were once common only in the US, such lawsuits— with their massive potential for financial damage—are gaining popularity outside North America as part of governance reform aimed at securing recourse for shareholders. According to Advisen, an insurance research firm, cases settled since 2005 in Europe were for average settlements of €117 million. Although some anti-corporate activists argue that the coverage creates an incentive for misbehavior, scholars find no evidence that the coverage motivates mismanagement, just as carrying auto liability insurance hardly gives drivers a reason to cause an accident. Suits against managers can come with a host of punitive effects, including reputational  loss, jail time and possible fines in the event of a scandal. Enron's Skilling is serving a 24-year term in prison and was fined $45 million. Fines are typically excluded from a policy's benefits. D&O coverage tends to be best advised on by lawyers and specialized insurance brokers. The specialists recommend that policies go far beyond the basic requirements of being large enough to cover the cost of settlements. They stress that policies must be tailored for each individual buyer, depending on the area of business and the risks present. In the US, a large number of D&O claims are made for a manager's conduct related to human resources, such as hiring and firing decisions. But an increasing number of claims are being filed against directors and officers for securities-related misconduct. What's more, American law is known to have a long arm from which managers around the world might need to defend themselves. Witness the Enron-related case of the NatWest Three. The British bankers involved were extradited to and tried in the United States, where they also served prison terms for wire fraud committed in the UK.

Megan Colwell, an expert in management liability insurance at Woodruff Sawyer & Co., a California insurance brokerage and specialist of international legal actions, offers her clients a choice of roughly 10 to 15 insurers. Her firm is paid by commission from insurance companies or consulting fees from the client. Colwell recommends that companies with international operations acquire specialized advice to align their corporate D&O program to the risks in different countries.

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Transfer priciing in China

Transfer priciing in China

 

Braxton is an international tax specialist in transfer pricing.  This also covers China. Years ago, when we actively represented corporate clients in Chinese tax matters, there was not a transfer pricing "problem" for smaller wholly foreign enterprises, as the number of SAT specialists was so small that they could only delve into matters of corporate entities far larger than those I represented. But now it is quite different. On July 12 Circular 323 was issued by the SAT. The SAT is beginning a nationwide inspection of transfer pricing documentation. Local authorities have been instructed to select for audit for years 2008 and 2009 a minimum of 10 percent of taxpayers who have related-party transactions. While we don't know if this instruction filtered down to all levels of SAT offices, we do know that it has reached the Guangzhou SAT. It is time for some of those smaller businesses - the type that we used to work with - to be concerned about having their transfer pricing documentation in order. From what we hear, it will be more than the minimum of 10 percent who will be audited.

 

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Moving from the UK to a prescribed territory

Moving from the UK to a prescribed territory

According to the Savings Directive, "If a UK individual changes address to a prescribed territory you will need to report on the basis of the new address. This may mean you need to obtain additional information and/or update your system.

For example, a UK paying agent pays savings income to an individual who lives in the UK. This is not reportable under the scheme. He has a contractual relationship made on or after 1 January 2004 with the individual.

If the payee moves to Spain, they will become reportable and the paying agent will need to update his records to fulfill his obligations under the scheme. Since he has a relationship which began on or after 1 January 2004 with the individual, he will also need to verify the name and address in addition to obtaining and verifying the TIN or the date and place of birth.

Where both the identity and UK address were verified to KYC standards, and the contractual relationship began after 1 January 2004, subsequent changes can be 'self certified' in accordance with paragraph 183.

 

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Collective investment funds: income realised at sale or redemption of fund units

According to the Savings Directive, "Savings income also arises when units or shares in a collective investment fund are sold to a paying agent (or a receiving agent) or redeemed by the fund. This is analogous to the inclusion of accrued interest in the sale or redemption price of a security (see paragraphs 97 to 103 above).

Savings income only arises under this heading if the fund has invested more than 25% of its assets directly or indirectly (via other collective investment funds or residual entities) in money debts. Up to and including 31 December 2010 the figure was 40% of its assets. This applies to all funds and does not depend on any requirements of the territory in which the fund is established.

A In determining whether a sale or redemption of units or shares in a collective investment fund is reportable under these arrangements the information described at paragraphs 121 – 123 below may be used and relied upon. The paragraphs 118B – below provide additional guidance for particular circumstances if need be.

Where a fund has historically invested more than 40% of its assets in money debts it is unlikely to be affected by the reduction of the percentage to 25% from 1 January 2011 – by definition income realised at sale or redemption will be reportable throughout.

However if a fund under its rules or instrument of incorporation (see 121 below) or actual composition of assets (see 122 below) operates so as not to pass the 40% threshold, it will need to ensure, as soon as practical, after 1 January 2011 that its asset holding in money debts (including holdings of grandfathered bonds) is reduced so as not to pass the 25% threshold if the intention is that it continues to operate so that sales/redemptions will not be reportable under these regulations.

Providing a fund does so reduce its holdings in money debts sales/redemptions will not be reportable as savings income throughout.

In this context a fund will be regarded as having acted as soon as practical if by the start of the first accounting period commencing on or after 1 January 2011 or the 30 April 2011, whichever is the later, its assets in money debts do not pass the lower threshold.

This period should facilitate the necessary changes to be made and enable the fund to operate as it intended.

If the fund has met the old threshold under its rules but decides not to meet the new lower threshold then savings income will arise on a sale/redemption once its assets in money debts pass the 25% threshold."

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REVERSE TAKEOVERS IN THE PLUS MARKET (LONDON)

Greener House Investments Plc also recently completed a reverse takeover, acquiring Fresh T Limited, a privately owned company specialising in Software as a Service.
 
Following the reverse takeover, the enlarged group was renamed
 
FreshTL Plc was readmitted to the PLUS markets.
 
Hanseatic & Baltic Properties Plc
 
was suspended from the PLUS markets in January 2010 in anticipation of a reverse takeover of United Sino, a Libyan property development company. However, the deal was terminated in April citing "Sino were unable to guarantee raising sufficient funds for us to satisfy ourselves that the enlarged group would have had sufficient working capital to carry out the projects." Hanseatic & Baltic Properties Plc has been restored to trading on PLUS.

 

Award International Holdings plc recently completed a reverse takeover, acquiring a full service digital marketing specialist, Fuse 8, for £5m which will be satisfied by the issue of 10,215,000 consideration shares.

 
The directors had examined many acquisition opportunities since Award became an investment company and believe that Fuse 8 presented an exciting prospect for existing Shareholders.
 
Following the reverse takeover, the enlarged company was renamed Fuse 8 Plc and listed on the AIM Market.

 
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Private Foundation in Guarnsey

Background

Much of Guernsey's economic success over past decades
has been largely due to its adaptability and flexibility to react
to changing market situations and conditions. This
adaptability is no better illustrated than by the Island's
willingness to amend and review legislation to ensure that it
retains its position within the increasingly competitive
market place of international finance and over recent years
there have been many examples of this.

Following the revision of the Guernsey Trust Law - which
was approved by the Guernsey parliament in July this year
and now awaits approval by Privy Counsel - the Island is
now planning to introduce legislation to allow the
establishment of Foundations. This innovation will add a
useful new tool to the Island's current financial product mix
and will help ensure that Guernsey remains able to offer a
highly flexible spectrum of financial services to its global
client base.

The Foundation

Foundations have been created under the laws of other
jurisdictions from as early as 1926 (Liechtenstein). More
recently Panama introduced legislation in 1995, Netherlands
Antilles in 1998 and the Bahamas in 2004. Foundations over
this period have become increasingly popular across the
globe but particularly in civil law jurisdictions where the
concept of the Anglo-Saxon Trust is less well known and not
always wholly understood. In certain situations Foundations
can offer a viable alternative to the trust for commercial
structures, estate planning and for charitable purposes.
Whilst there is no single definition of a Foundation, there are
a number of common features and some interesting
comparisons to be made with trusts and companies alike.

Unlike a trust, a Foundation is a distinct legal entity and has
its own legal personality. It can hold assets, sue (or be sued)
in its own name, may enter into agreements with third
parties but unlike a company it has no shareholders. Since
some Foundations are established for charitable purposes,
they may or may not have beneficiaries.

A Foundation is formed by a Founder (either an individual or
corporate body) who provides the assets to be administered
by the Foundation under contractual rather than fiduciary
principles – giving a degree of comfort to those clients
unfamiliar with equitable principles. Beneficiaries of a
Foundation therefore have contractual rights rather than
proprietary rights in its assets. A key attraction is the ability
for the Foundation to reserve powers to its Founder. A
Founder may retain more control than is usual with a Settlor
of a trust. Commonly reserved powers include those relating
to such issues as investment strategy, the appointment and
removal of beneficiaries or even the power to revoke the
Foundation.

The Potential Guernsey Foundation

It is proposed that a Guernsey Foundation would be
established by Charter and run by a Council responsible for
fulfilling the Foundation's purpose as defined in the Charter
– which would also include the Foundation's name, details
of all Council members its registered office (which would be
in Guernsey) and the Foundation's purpose.
tself may be quite generic - for example "estate planning", or
may be something quite specific. It is envisaged that at least
one member of the Council will be a corporate body. The
Foundation would be entered on the public register however
details of the beneficiaries (if any) would remain confidential
as with a Trust subject only to the pre-existing rules
regarding disclosure in proper cases.

The provision of Council members or administrative services
to Foundations will be, a regulated activity as are trustee
services at present ensuring that the interests of clients and
the reputation of the Bailiwick is upheld.

Over and above the Charter, there will normally be a set of
Rules governing the mode of operation for the Council -
whose members would be subject to duties similar to those
of company directors. Unlike the Charter the Rules would be
a private document and not on the public registry.

It is not proposed that a Guernsey Foundation will be
restricted in terms of the type of assets it can hold. Therefore
whilst it is not envisaged that they will be used for purely
commercial purposes, they will potentially be able to hold
shares in a company carrying on commercial activities.
Filing requirements are likely to be limited to changes in
registered office and Council members and changes to the
Charter all of which would need to be registered immediately
the changes occur. If this is the case it's unlikely that an
annual return be required. The filing of audited financial
statements would be subject to the same exemptions
applicable to Guernsey companies meaning many of them
would fall outside the audit requirement. This will ensure that
pricing can remain competitive.

It is also proposed that the tax treatment of Foundations be
similar to that of Trusts with Guernsey trustees.
A Foundation can also have an Adviser whose role would be
set out in the Foundation Charter and Rules. This is largely
similar to the role of Protector within a Trust structure both
having powers such as to appoint or remove Council
members and beneficiaries, or the Adviser's consent may be
required before the Council carries out certain acts.
It should also be possible for a Guernsey Foundation to
migrate to another jurisdiction if so required and equally for
a Foundation established elsewhere to migrate into the
Island, a long as it fulfils requirements under the Guernsey
legislative framework.

An interesting possibility is to establish structures using both
Foundations and Trusts. Private Trust Companies ("PTCs")
are very much in vogue. These are companies established
for the sole purpose of acting as trustee for one trust or, say,
one family. One issue that often concerns advisers is as to
the identity of those who will own the PTC. Often a purpose
trust is established to hold the shares in the PTC but as
Foundations need not have any beneficiaries it is possible
that they will be used as trustees themselves; a Private Trust
Foundation?

Conclusion
The introduction of Guernsey Foundations will offer the
Island's clients an excellent alternative structure assisting
with wealth management and will provide further choice and
flexibility to the Island's fiduciary sector.
The Foundation combines the flexibility of a trust with the
greater degree of transparency of a company. Given the
ability of a Founder to retain a certain amount of control and
the existing market demand for the Foundation structure
from civil law jurisdictions in particular, the Foundation can
only enhance the Island's competitive position in the market
place.


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Hybrid entities and reverse hybrid entities

International tax planners often refer to "hybrid entities" and "reverse hybrid entities." 

From a U.S. tax perspective, a hybrid entity is an entity that is "fiscally transparent" for U.S. tax purposes but not fiscally transparent for foreign tax purposes.  In general, an entity is fiscally transparent if the entity's current year profits are currently taxable to the owners of the entity, regardless of whether the entity made any distributions to its owners during that year. 

 Partnerships are typically fiscally transparent entities.  Corporations are typically not fiscally transparent entities.  Limited liability companies and various types of foreign entities may or may not be fiscally transparent.

 Flexibility in international tax planning may be accomplished by the use of a foreign entity that is a corporation in its country of origin, but has the ability to check the box and elect its classification under Federal tax rules. This article presents a primer on establishing and planning for the use of such "hybrid" entities.

Final entity classification regulations--the "check-the-box" (CTB) rules issued in December 1996(1)--allow taxpayers to elect to treat most business entities (including foreign business entities) for Federal tax purposes as corporations, partnerships or (if the entity has one member) disregarded entities. While specified foreign business entities are excluded from the elective system and are treated per se as corporations, they are generally limited to publicly traded-type entities (e.g., U.K. PLCs, German AGs and French SAs; a list is contained in Regs. Sec. 301.7701-2(b)(8)). Despite the apparent restrictions imposed by the per se list, typically, at least one entity in any given country is viewed as a corporation under local law, but is eligible to check the box (e.g., the U.K. Limited Company, German GmbH and French SARL). Further, Regs. Sec. 301.7701-2(d)(1) grandfathered certain business entities on the per se list in existence on May 8, 1996, allowing them to retain their previous partnership or branch status. The CTB elective regime replaced the former four-factor approach under Regs. Sec. 301.7701-2 for classifying entities, which was cumbersome to apply and sometimes generated uncertainties, particularly for foreign entities.

The final CTB regulations ushered in a new era of flexibility in international tax planning for U.S. persons. However, IRS actions since the issuance of the final CTB regulations have eroded some of the rules' flexibility. This article will discuss establishing a foreign hybrid under the new CTB regime and planning opportunities.

For Federal tax purposes, taxpayers may elect to treat a foreign business entity as either a corporation or as a flowthrough entity, regardless of the foreign country's classification, if the entity type is not on the per se list. (An entity type on the list is automatically treated as a corporation for Federal tax purposes). Thus, a foreign entity taxable as a corporation in its country of incorporation can choose to be treated as a partnership or a branch for Federal tax purposes; such an entity is generally known as a "hybrid" Conversely, an entity classified as a partnership (or other type of flowthrough entity) in its country of formation or residence can choose to be treated as a corporation for Federal tax purposes; such an entity is generally known as a "reverse hybrid."

 A reverse hybrid entity is the "reverse" of a hybrid entity in that the entity is fiscally transparent for foreign tax purposes but not fiscally transparent for U.S. tax purposes.  Entities that are treated the same for U.S. and foreign tax purposes are not "hybrid" entities.

 The use of domestic reverse hybrids in cross-border financing continues despite the issuance by the Internal Revenue Service (IRS) of regulations designed to shut down abuses in the area. These devices, if structured correctly, may enable taxpayers to enjoy double-dip tax benefits with respect to interest expense and reduced withholding under US income tax treaties.

 

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