Global Tax Update

Issue 2 | October 2014 JONES DAY

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What's New

Multinational

OECD Releases First BEPS Recommendations toG20 in Accordance with Action PlanAs a part of the OECD/G20 project to combat baseerosion and profit shifting ("BEPS"), the OECDreleased the first set of reports andrecommendations on September 16, 2014. Thesereports address seven of the actions described in the15-point action plan to address BEPS published inJuly 2013.

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United States

Treasury Department and IRS Issue Long-Awaited Inversion GuidanceOn September 22, 2014, the U.S. TreasuryDepartment and the IRS issued long-awaitedinversion guidance in the form of Notice 2014-52.The Notice sets forth rules that are generallyeffective for transactions completed on or afterSeptember 22, 2014, and will be included inregulations that will be issued in the future. The newrules address two aspects of inversion transactions.First, they increase the likelihood that the inversionownership tests under section 7874 of the InternalRevenue Code will be met (the 60 percent and 80percent tests). Second, they limit the tax benefits ofcertain types of post-inversion planning.

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IRS Issues Guidance Regarding theDeductibility of Litigation Fees Incurred by

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Belgium

CONTRIBUTORS TO THIS ISSUE

Belgium

Howard M. LiebmanBrussels

Werner E. HeyvaertBrussels

China

Fuli CaoShanghai/Beijing

France

Siamak MostafaviParis

Emmanuel de la RochethulonParis

Germany

Branded Pharmaceutical Companies WhenDefending Their Patents Against Challenges toMarket Exclusivity by Generic CompaniesThere is welcome clarity for branded pharmaceuticalcompanies seeking to deduct legal fees incurred indefending their patents against challenges to marketexclusivity by generic companies. This clarity comesafter a year of uncertainty arising from a negativeopinion expressed by the IRS in a chief counselmemorandum in January 2013, which the IRS seemsto have now reversed in a second CCM issued 20months later.

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United Kingdom

Follower Notices and Accelerated PaymentsThe UK Finance Act 2014, enacted in July 2014,contains new legislation to deal with cases ofpurported tax avoidance, which marks a radicaldeparture from previous policy in this area.

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SDLT and Property Investment FundsThe UK government has announced that it will belooking at whether any changes are needed tocurrent stamp duty land tax rules to cater for twospecific forms of collective investment schemedesigned for investors in the UK market.

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Further Reference to CJEU on Card HandlingChargesThe First Tier Tax Tribunal has referred certainquestions regarding the liability for VAT of cardhandling charges to the Court of Justice of theEuropean Union ("CJEU") in the case of Bookit Ltd vThe Commissioners For Her Majesty's Revenue &Customs.

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The Netherlands

The Netherlands to Expand its Fiscal UnityRegime to Second-Tier Subsidiaries and SisterCompanies Following EU Court of Justice RulingOn June 12, 2014, the EU Court of Justice ruled intwo joint cases that the Dutch fiscal unity regimeinfringes on the EU freedom of establishment,because it does not allow a fiscal unity between (i) aDutch resident parent company and its second-tierDutch resident subsidiary held through an EUresident intermediate company, or (ii) two Dutchresident sister companies held by the same EUshareholder.

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Martin BünningFrankfurt

Andreas Köster-BöckenfördeFrankfurt

Italy

Marco LombardiMilan

Japan

Koichi InoueTokyo

Mexico

Rodrigo GómezMexico City

Spain

Pablo BaschwitzMadrid

The Netherlands

Lodewijk BergerAmsterdam

Lyda StoneAmsterdam

United Kingdom

Blaise L. Marin-CurtoudLondon

Charlotte L. SallabankLondon

United States

Raymond J. WiacekWashington

Joseph A. GoldmanWashington

Andrew M. EisenbergWashington

Colleen E. LaduzinkiNew York

Edward T. KennedyNew York

Todd WallaceDallas

Dutch Innovation Box Regime for Intangibles is Clarified in DecreeThe Innovation Box was introduced in 2007 to encourage companies to innovate andincrease their research and development activities. Under this optional regime, subject tocertain conditions, Dutch corporate taxpayers are taxed at an effective rate of 5 percent.In the newly published Decree, the Underminister of Finance clarifies the scope of theInnovation Box, in particular addressing the types of qualifying intangibles and the level ofinvolvement of the taxpayer required for the application of the regime.

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Spain

ECJ Rules that Spanish Law on Inheritance and Gift Tax is Contrary toCommunity LawThe Court of Justice of the European Union handed down a ruling on September 3, 2014(C-127/12, Commission/Spain), in which Spanish law on inheritance and gift tax(Impuesto sobre Sucesiones y Donaciones) is considered to restrict the free movement ofcapital since it involves differences in tax treatment between tax residents in Spain andnonresidents.

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Parent–Subsidiary DirectiveThe Explanatory Memorandum to the Draft Law amending nonresident income tax pointsout that the main reason for the tax reform is to adapt it, to a greater extent, to theEuropean Union regulatory framework. The draft law includes an anti-abuse clause,similar to the one currently in force, which prevents the application of the tax exemptionin Spain on dividends paid when most of the voting rights of the European Union residentshareholder are held, directly or indirectly, by individuals or legal entities that do notreside in a European Union member state.

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Mexico

Tax Rules Included in the Mexican Energy ReformOn August 6, 2014, the Mexican Congress approved some of the secondary legislationrelated to the so-called Mexican Energy Reform. The approved laws were published in theMexican Official Gazette on August 11, 2014. Among the approved secondary legislation isthe Hydrocarbons Revenues Law, which includes: (i) special tax provisions forgovernmental and nongovernmental entities entering into agreements for the extractionand exploration of hydrocarbons; and (ii) a new hydrocarbons tax applicable to theseentities.

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Three New Tax Treaties Signed by Mexico Will Be Applicable from January 1,2015During 2014, three new tax treaties signed by Mexico with Peru, the United ArabEmirates, and Malta have been published in the Mexican Official Gazette. According to thetax treaties, their benefits will be applicable from January 1, 2015, bringing Mexico's taxtreaty network to 59. Treaties with Costa Rica, Malaysia, and Nicaragua are currentlybeing negotiated by the Mexican government, and the modifications to the 1994Mexico–Belgium treaty are currently pending.

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Japan

Tokyo District Court Allows Tax Saving from Share RepurchaseOn May 9, 2014, the Tokyo District Court reversed a large tax that had been imposed ona large U.S. multinational's Japanese holding company.

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Judgment of Tokyo District Court: Application of a General Anti-Avoidance RuleConcerning Reorganization TransactionsOn March 18, 2014, the Tokyo District Court affirmed corporate tax assessments againsttwo tax payers: Yahoo Japan Corporation, a Tokyo Stock Exchange listed company, andIDC Frontier Inc., a wholly owned subsidiary of Yahoo Japan. The main issue of the YahooJapan case was whether, upon a tax-qualified merger, the surviving company (YahooJapan) was entitled to utilize net operating losses of the acquired company pursuant toArticle 57 of the Corporation Tax Act of Japan.

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Italy

Repeal of the Interest-Withholding Tax on Certain Cross-Border LoansAs a rule, if a nonresident lender grants a loan to an Italian resident borrower, theinterest paid on the loan is subject to a 26 percent withholding tax in Italy unless thelender is eligible for the exemption under the Italian laws that implemented the EUInterest and Royalties Directive. The withholding tax may be reduced (usually to 10percent) or, in very few cases, zeroed under the double tax treaties entered into by Italy,where applicable.

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Withholding Tax Exemption on Bond Interest BroadenedLaw Decree No. 91 of June 24, 2014, converted into law by the Italian Parliament onAugust 7, 2014, has broadened the scope of the withholding tax exemption applicable toeligible nonresident investors (i.e., investors resident in a white-listed country and with nopermanent establishment in Italy) on certain debt-like securities.

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Germany

New Developments for Real Property TransactionsOn July 9, 2014, the German Supreme Fiscal Court decided a real estate transfer tax casethat shines a new light on RETT structures. Contrary to the long-standing interpretation ofthe law, the court took the position that aspects of economic ownership are also relevantfor RETT purposes.

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France

Luxembourg–France Tax Treaty: Amendment SignedOn September 5, 2014, French Minister of Finance Michel Sapin and LuxembourgianMinister of Finance Pierre Gramegna signed an amendment to the France–LuxembourgTax Treaty. The amendment, in line with the current OECD Model Tax Convention onIncome and Capital, reverts to the tax treatment of capital gains arising on the direct andindirect disposal of real estate assets and puts an end to the potential double-taxexemption regularly applied until now regarding sale of real estate companies' shares.

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China

Draft Guidance for the General Anti-Avoidance RuleOn July 3, 2014, the State Administration of Taxation (the "SAT") released a discussiondraft on the Administrative Measures on the General Anti-Avoidance Rule (the "DraftMeasures). The General Anti-Avoidance Rule ("GAAR") was introduced in China CorporateIncome Tax Law effective on January 1, 2008. However, the provision of law and

subsequent interpretation tax circulars provide only some basic principles. The DraftMeasures provide comprehensive guidance on the implementation of GAAR.

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Belgium

Recharged Costs and Expenses of Stock Option Plans Not Tax Deductible for theBelgian EmployerOn June 25, 2014, the Brussels Court of Appeal confirmed an earlier ruling (dating from2010) from the Tribunal of First Instance. The tribunal had found that costs and expensesin connection with an international stock option plan recharged by a South African parentcompany to its Belgian subsidiary are not tax deductible by the latter to the extent acapital loss has been suffered on the shares that had to be acquired in order to bedelivered to Belgian optionees following the exercise of their stock options.

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No Corporate Income Tax on an Undervaluation of Shares Acquired by BelgianHolding CompanyFollowing a very long and winding road in several courts, it has finally been confirmedthat Belgium cannot impose corporate tax on any undervaluation of or underpayment forshares acquired by a Belgian corporate taxpayer. Thus, when a Belgian corporation buysshares at a price below fair market and subsequently sells those same shares at thehigher market value, the capital gain so booked qualifies, in principle, for the participationexemption.

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"Protectionist" French Excise Tax on Certain Types of Beer Complies with EU LawOn September 13, 2014, it was reported by the trade press that the EuropeanCommission had found that the increase by 160 percent of French excise tax on certaintypes of high-alcohol-content and luxury beers that was introduced on January 1, 2013did not fall afoul of the free-market principles of the EU.

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

Multinational

OECD Releases First BEPS Recommendations toG20 in Accordance with Action PlanAs a part of the OECD/G20 project to combat baseerosion and profit shifting ("BEPS"), the OECDreleased the first set of reports andrecommendations on September 16, 2014. Thesereports address seven of the actions described in the15-point action plan to address BEPS published inJuly 2013 (the "Action Plan") and consist of thefollowing items:

• Recommendations for domestic rules to neutralizehybrid mismatch arrangements and recommendedchanges to the OECD Model Tax Convention to dealwith transparent entities (Action 2, the "HybridsReport");

• Proposed changes to the OECD Model TaxConvention for preventing tax treaty abuse (Action6, the "Treaty Abuse Report");

• Revisions to the OECD Transfer Pricing Guidelinesto align transfer pricing outcomes with value creationin the area of intangibles (Action 8, the "IntangiblesReport");

• Revised standards for transfer pricingdocumentation and a template for country-by-country reporting of income, earnings, taxes paid,and certain measures of economic activity (Action13, the "Documentation Report");

• A report on the issues raised by the digitaleconomy (Action 1, the "Digital Economy Report");

• A report on harmful tax practices, outlining the

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progress of the review of preferential regimes, etc.(Action 5, the "Harmful Tax Practices Report"); and

• A report on the feasibility of developing amultilateral instrument to amend bilateral taxtreaties (Action 15, the "Multilateral InstrumentReport").

These deliverables include specific proposed changesto domestic laws, tax treaties, and transfer pricingguidelines that, if adopted, could significantly affectboth the taxation and compliance burdens ofmultinational enterprises ("MNEs"). After thediscussions by G20 finance ministers in September2014, these reports will be presented to G20 leadersin November 2014, and the OECD continues work onthe remaining actions by 2015 in accordance withthe Action Plan. As the 2014 deliverables are closelyconnected to the 2015 deliverables and there is stilldisagreement on some of the issues, therecommendations made in the 2014 reports willremain in draft form until then. However, it isexpected that some countries may beginimplementing some of the proposals before finalizedversions have been released, and the UnitedKingdom has already announced its intention toimplement country-by-country reporting along thelines of the suggestions in the DocumentationReport. Some key points of the new reports aresummarized below.Hybrid Mismatch Arrangements (Action 2). TheHybrids Report, which differs little from the priordraft released in March 2014, provides a set ofrecommended changes to domestic law designed toprevent hybrid mismatch arrangements (asdescribed below) even in situations where it isunclear which country has lost revenue. The reportalso provides proposed changes to the OECD ModelTax Convention regarding dual resident entities (acase-by-case approach) and fiscally transparententities (rules in line with the OECD PartnershipReport in 1999). Finally, the report raises additionalissues, including intragroup hybrid regulatory capitaland on-market stock lending transactions, whichneed to be further explored.

The report includes specific recommendations onimprovements to domestic law, including denyingparticipation exemptions for deductible paymentsand a set of hybrid mismatch rules. Although thereport encourages all countries to adopt therecommended changes to domestic law, the hybridmismatch rules are designed with both a primaryrule and a secondary defensive rule to be applied incase the primary rule is not adopted by the relevantjurisdiction. The hybrid mismatch rules requirelinking of domestic law, whereby the tax treatmentof a payment is determined, in part, by thetreatment of that payment under the laws of anothercountry. The report discusses some of the difficulties

with implementing such a rule, and the OECD is stillconsidering appropriate mechanisms for ensuring thenecessary cooperation between taxing authorities forsuch a rule to be administrable. The scope of theprimary and defensive rules has been narrowed fromthe prior draft, and the rules now generally areapplicable only in related-party contexts (as definedbelow) and to payments made pursuant to anarrangement designed to produce the hybridmismatch.

A brief overview of the hybrid mismatch rules isprovided below. With regard to situations where asingle payment gives rise to duplicate deductions indifferent countries, the report recommends as aprimary rule that the payee's jurisdiction deny theduplicate deduction in all cases. As a secondarydefensive rule, the report recommends that thepayer's country of residence deny the deduction, butonly in the case of payments between members of acontrol group (a 50 percent or greater ownershipthreshold). In the case of a payment that isdeductible to the payer but not included into incomeby the payee, the primary rule is to deny the payer'sdeduction, and the defensive rule is to include thepayment into the payee's ordinary income; both theprimary and defensive rule apply only to paymentsbetween related parties (a 25 percent or greaterownership threshold, increased from the 10 percentproposed in the earlier draft). Finally, in the case ofdisregarded payments (i.e., payments deductible bypayers while being disregarded in the payees'jurisdiction) involving a hybrid entity where theparties are members of the same controlled group,the primary rule is to deny the deduction, and thedefensive rule is to require inclusion.

Preventing Tax Treaty Abuse (Action 6). TheTreaty Abuse Report recommends three changes tothe OECD Model Tax Convention. First, the reportrecommends inclusion in the preamble of treaties anexpress statement that the common intention of thetreaty partners is to eliminate double taxationwithout creating opportunities for nontaxation orreduced taxation through tax evasion or avoidance.Such a statement would be relevant in theinterpretation and application of the provisions of agiven treaty.

Additionally, the report recommends including anobjective anti-abuse limitation of benefits rule (a"LOB Rule") based on the provisions in existing taxtreaties concluded by the U.S. and some othercountries, as well as a more general subjective anti-abuse rule denying a treaty benefit where obtainingthat benefit was one of the principal purposes of anyarrangement or transaction that resulted in thatbenefit (a "PPT Rule"). While these rules are alreadyrecognized in the existing Commentary on Article 1

of the OECD Model Tax Convention, the reportproposes to establish an independent article with anew Commentary for these rules.

The report recommends that tax treaties includeboth the LOB Rule and PPT Rule. However, inresponse to strong U.S. criticism of the subjectivePPT Rule, the report's proposal allows some flexibilityas long as countries effectively address treatyabuses. The report requires countries to have only aminimum level of protection against treaty abuse,which can be satisfied with the LOB Rule(supplemented by a mechanism to address conduitarrangements as necessary) without the PPT Rule.Under this flexible approach, U.S. tax treaties thatinclude a LOB Rule (incorporating objectivestandards such as the publicly traded entity test, theownership and base erosion test, the derivativebenefits test, and the active trade or business test)could comply with the report's recommendations.However, countries lacking laws akin to theeconomic substance doctrine in the United Statesmay need to apply a PPT Rule in order to meet thisminimum standard.

In addition, the report recommends other anti-abuserules to address some specific transactions such ascertain dividend transfer transactions andtransactions circumventing source taxation of sharesin real property holding entities. The report indicatesthat further work will be needed with respect to theprecise contents of the proposed model provisionsand related Commentary, and that the drafts aresubject to improvement before the final version is tobe released in September 2015. In particular, someof the terms of the proposed LOB provision, such asthe scope of the derivative benefits rule, are stillunder discussion. Additionally, there is still someuncertainty regarding the level of tax-motivateddecision-making that is permissible under theproposed preamble language and the PPT Rule.

Transfer Pricing Aspects of Intangibles (Action8). The Intangibles Report contains final and interimrevisions to the OECD Transfer Pricing Guidelines forMultinational Enterprises and Tax Administrations .The report explains that due to the overlap of thetransfer pricing aspects of intangibles with the othertransfer pricing parts of the BEPS project (Action 9,transfer pricing aspects of risks and capital andAction 10, transfer pricing aspects of other high-risktransactions) large portions of the revisions are stillin draft form pending the issuance of the deliverablesunder Actions 9 and 10 in 2015. In particular, theOECD is continuing to examine: (i) permitting taxingauthorities to use actual results retrospectively todetermine the value of transferred intangibles, (ii)treating entities whose activities are limited tofunding intangibles development as lenders or

otherwise limiting their returns, (iii) requiringcontingent payment terms and/or the application ofthe profit split method to certain transfers ofintangibles, and (iv) the treatment of situationsinvolving excessive capitalization of low-functionentities. These items are scheduled to be included inthe 2015 deliverables.

Consistent with the Action Plan, the report does notpropose a change from the arm's-length standard,but instead explains that the parties to a transactionshould be compensated based on an analysis of thefunctions performed and risks assumed, and not justthe legal ownership of the intangibles or thecontractual arrangements in place. Significantly, thereport provides in interim guidance that where thelegal owner of an intangible outsources most or all ofthe important functions related to that intangible, itis "highly doubtful" that the owner is entitled to amaterial portion of the return derived from theexploitation of the intangible. Similarly, where anentity only bears funding risks associated with anintangible, the entity is generally only entitled to arisk-weighted return on such funding.

The report also contains final and interim guidanceand examples regarding multinational groupsynergies, identifying intangibles, transfers ofintangibles in development or that otherwise haveuncertain value, the use of both the profit splitmethod and "other methods," and valuationtechniques (such as the discounted cash flowmethod) regarding transfers of intangibles.

Transfer Pricing Documentation and Country-by-Country Reporting (Action 13). TheDocumentation Report contains a new three-tiereddocumentation requirement to be included in theOECD Transfer Pricing Guidelines for MultinationalEnterprises and Tax Administrations that is designedto provide tax authorities with additional informationnecessary for transfer pricing inquiries and riskassessment. In light of the global trend for increasedtransparency, the report proposes a set of standarddocumentation requirements so as to avoid countriesfrom promulgating different increased documentationrequirements. The proposal requires MNEs toprepare three separate types of documentation asdescribed below:

• A "Master File" available to all relevant jurisdictionsproviding an overview of the MNE's global operationsand policies so as to provide an appropriate contextfor the other information. The Master File wouldinclude information regarding organizationalstructure, the MNE's intangibles, intercompanyfinancial activities, financial and tax positions, and adescription of the MNE's business(es);

• A "Local File" for each country providing moredetailed information relating to specific intercompanytransactions, including relevant financial informationand transfer pricing analysis (including acomparability and functional analysis and anindication of the most appropriate method) regardingthose transactions; and

• A "Country-by-Country Report" for annualsubmission to each tax jurisdiction in which abusiness unit of the MNE that is included in theconsolidated group for financial reporting purposes(a "Constituent Entity") is a resident for taxpurposes. This Country-by-Country Report willprovide aggregate information relating to the globalallocation of income, taxes, and business activitiesamong the relevant tax jurisdictions (specifically,jurisdiction-by-jurisdiction information relating torevenues, pre- and post-tax profits, income taxaccrued and paid, stated capital, accumulatedearnings, number of employees, and tangibleassets), as well as a list of all of the MNE'sConstituent Entities including jurisdiction ofincorporation (if different from tax residence) andthe nature of the entity's main business.

Some emerging market countries pushed to requirereporting of additional transaction data regardingrelated party interest payments, royalty payments,and service fees in the Country-by-Country Report,concerned that if taxpayers are permitted thediscretion to determine what information is relevantfor transfer pricing purposes, the taxpayers mayunderreport. The compromise reached was to requirea review of the country-by-country reporting before2020 to determine if the information in the Country-by-Country Report is sufficient for the taxingauthorities and not being abused by the taxingauthorities.

In addition, the report gives some guidelines as todocumentation-related issues including timing of thepreparation of the documentation, materiality oftransactions, frequency of documentation updates,and penalties. Additional work will be undertakenwith respect to the means of filing the requiredinformation and disseminating such information totax administrations over the next several months. Asconcerns have been raised regarding the disclosureby tax authorities of trade secrets or othercommercially sensitive information, the reportrequires tax authorities take all reasonable steps toensure the confidentiality of such information.

Issues Raised by the Digital Economy (Action1). The Digital Economy Report discusses at lengththe various challenges raised regarding BEPS due tothe advent of information and communicationtechnology, particularly with regard to nexus issues,attributing value to transactions in which data is

collected, used, or supplied, and the characterizationof new products and services. Because such asignificant part of the worldwide economy is now"digital," the report recommends against ring-fencingthe digital economy from the rest of the economy fortax purposes. Additionally, the report identifiesseveral BEPS strategies permitted by the digitaleconomy, particularly regarding value added taxes,that currently attract concern. The report discussespotential options, such as modifying the "preparatoryor auxiliary" exemptions from permanentestablishment status in the context of a direct tax,and requiring nonresident suppliers to register andaccount for the VAT on cross-border business-to-consumer supplies. The report concludes that furtherconsideration is needed regarding some of thesestructures, and it provides insight into how some ofthese concerns can be addressed in other parts ofthe BEPS project.

Harmful Tax Practices (Action 5). The HarmfulTax Practices Report is an interim report on theprogress made by the Forum on Harmful TaxPractices (the "Forum") on the outputs to bedelivered under Action 5, including the review of thepreferential tax regimes of OECD member countries.Although the report does not conclude that anyspecific regimes are harmful, it lists some regimesthat the Forum has concluded are not harmful.Additionally, the report discusses requiringsubstantial activity to access the benefits of apreferential regime, improving transparency andcompulsory exchange of information on rulings fortax holidays, and establishing a strategy to expandparticipation to non-OECD member countries.

Developing a Multilateral Instrument to ModifyTax Treaties (Action 15). The MultilateralInstrument Report concludes that addressing certainof the treaty-based BEPS actions through amultilateral agreement, rather than throughamendments to every bilateral treaty, would be bothefficient and effective, particularly for issues that aremultilateral in nature, including mutual agreementprocedures, dual-residence structures, fiscallytransparent entities, and triangular arrangements.Although there was some initial concern that such amultilateral agreement would attempt to addresssome of the more complex international tax issuessuch as controlled foreign corporation regimes andtransfer pricing, the Multilateral Instrument Reportconfines its scope to traditional treaty provisions(The precise content of a multilateral instrumentwould not be fixed until 2015, however).

Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

United States

Treasury Department and IRS Issue Long-Awaited Inversion Guidance

On September 22, 2014, the U.S. TreasuryDepartment and the IRS issued long-awaitedinversion guidance in the form of Notice 2014-52.The Notice sets forth rules that are generallyeffective for transactions completed on or afterSeptember 22, 2014, and will be included inregulations that will be issued in the future. The newrules address two aspects of inversion transactions.First, they increase the likelihood that the inversionownership tests under section 7874 of the InternalRevenue Code will be met (the 60 percent and 80percent tests). Second, they limit the tax benefits ofcertain types of post-inversion planning.

Changes to the earnings stripping rules (whichprovide inverted U.S. target corporations animmediate tax benefit) are conspicuously absentfrom the Notice. However, the Notice indicates thatTreasury and the IRS are considering (and requestcomments on) guidance to address strategies thatshift U.S.-source earnings to lower-tax jurisdictions.Descriptions of the new rules are set forth below.

Increased Likelihood that Ownership Tests areSatisfied. Under section 7874, a foreign acquiringcorporation is treated as a U.S. corporation for U.S.tax purposes (meaning that the foreign corporationis taxed by the U.S. on its worldwide income) if itacquires substantially all of the stock (or property) ofa U.S. target corporation and the shareholders of theU.S. target corporation (or the U.S. targetcorporation) receive at least 80 percent of theforeign acquiror stock in the exchange. A lesser tax

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impact results if the U.S. target corporation'sshareholders (or the U.S. target corporation) receiveat least 60 percent, but less than 80 percent, of theforeign acquiror stock in the exchange. The Noticedescribes three new rules that increase the likelihoodthat the 60 percent and 80 percent ownership testswill be met. These changes will be effective foracquisitions that close on or after September 22,2014.

• For the purposes of the ownership tests, a portionof the stock of a foreign acquiror is excluded fromthe denominator if more than 50 percent of theassets owned by the foreign acquiror's expandedaffiliated group ("EAG") (not including the U.S.target corporation and its subsidiaries) are passiveassets, which is determined on a consolidatedbalance sheet basis. An EAG is a group ofcorporations linked by more than 50 percentownership.

• Non-ordinary course distributions (includingredemption distributions) by the U.S. target duringthe 36-month period preceding the inversiontransaction are disregarded in applying theownership tests.

• Under the current section 7874 regulations, stockof the foreign acquiror that is held by members of itsEAG is generally disregarded in applying theownership tests. The Notice changes this rule forcertain multistep transactions where a U.S. parenttransfers its U.S. subsidiary to a foreign subsidiaryand then distributes the stock of the foreignsubsidiary to its shareholders (a so-called"spinversion"), subjecting the U.S. parent'sownership of foreign subsidiary stock to theownership tests.

Each of these changes increases the percentage offoreign acquiror stock held by the shareholders ofthe U.S. target corporation (or the U.S. targetcorporation) under the inversion ownership tests,thus increasing the likelihood that the acquisition willbe subject to the inversion rules.

Limitations on Inversion Benefits. The Noticealso includes three new rules that affect the benefitsof post-inversion planning. The first two rules wouldapply to acquisitions completed on or afterSeptember 22, 2014, but only if the shareholders ofthe U.S. target corporation (or the U.S. targetcorporation) receive at least 60 percent, but lessthan 80 percent, of the foreign acquiror stock in aninversion that closes on or after September 22,2014. The third rule applies to acquisitionscompleted on or after September 22, 2014, whetheror not there has been an inversion:

• The Code subjects foreign corporations controlled

by U.S. shareholders ("CFCs") to current U.S.taxation on their investments in U.S. property,including loans to their U.S. affiliates. However,"hopscotch" loans from a CFC to its U.S.shareholder's foreign parent following an inversion(bypassing the CFC's direct U.S. parent) were notsubject to this rule. The Notice creates a new rulewhereby stock and obligations of the new foreignparent (and of related non-CFC foreign affiliates)that are held by a CFC of an inverted company aretreated as investments in U.S. property for the10-year period following the inversion.

• Under new rules to be issued under section7701(l), when a CFC of the U.S. target is "de-controlled" in a transaction that involves a relatedforeign affiliate and does not otherwise give rise tothe inclusion by the U.S. target of the untaxedearnings of the CFC, the event will berecharacterized as an issuance of an instrument bythe U.S. target to the related foreign affiliate, andany distributions made by the de-controlled CFC tothe related foreign affiliate will instead be treated asmade by the CFC to the U.S. target, and then by theU.S. target to the related foreign affiliate.

Under the current section 304 regulations, in somesituations, a foreign parent could transfer stock of itsU.S. subsidiary to the U.S. subsidiary's CFC inexchange for cash or property tax-free, thuspermitting the foreign parent to access the CFC'searnings without subjecting them to U.S. tax. TheNotice prevents the foreign parent from accessingthe earnings of the CFC in such a transaction,causing the CFC to retain its earnings for possiblefuture taxable distributions to the U.S. subsidiary.

IRS Issues Guidance Regarding theDeductibility of Litigation Fees Incurred byBranded Pharmaceutical Companies WhenDefending Their Patents Against Challenges toMarket Exclusivity by Generic Companies

There is welcome clarity for branded pharmaceuticalcompanies seeking to deduct legal fees incurred indefending their patents against challenges to marketexclusivity by generic companies. This clarity comesafter a year of uncertainty arising from a negativeopinion expressed by the IRS in a chief counselmemorandum ("CCM") in January 2013, which theIRS seems to have now reversed in a second CCMissued 20 months later. (CCMs are generic legaladvice prepared by the IRS Office of Chief Counselfor IRS field agents and other employees conveyingthe chief counsel's legal interpretation of a taxmatter.)

FDA approval must be obtained before a new drugmay be legally marketed and sold in the UnitedStates. To expedite the availability of less costlygeneric drugs, an abbreviated new drug application

("ANDA") may be submitted by generic applicants.The ANDA applicant must make certificationsregarding the existing patents owned by the brandedpharmaceutical company. A common certification ofgeneric applicants is a so-called "Paragraph IV"ANDA, in which the applicant asserts that the patentis invalid, unenforceable, or will not be infringed. Thegeneric applicant is required to promptly notify thedrug patent holder of its Paragraph IV ANDA, and thedrug patent holder may file an infringement suitagainst the ANDA applicant to prevent the FDA fromapproving the ANDA.

Most branded pharmaceutical companies havehistorically deducted the costs of suing such genericANDA applicants because, under the operative"origin of the claim" test, the litigation arises out ofthe taxpayer's ordinary business activity. This issupported by case law, including Urquhart v.Commissioner, which held that expenses incurred bya patent holder suing for infringement weredeductible. This deductibility was furtherpromulgated by the capitalization regulations ofTreasury Regulations §1.263(a)-4, the preamble towhich cited Urquhart, requiring capitalization oflitigation costs only if incurred to facilitate thecreation, acquisition, or defense of, or perfection oftitle to, intangible property.

Despite these established rules, on January 18,2013, the IRS in CCM 20131001F concluded thatcertain legal fees incurred by patent holders suinggeneric applicants pursuant to Paragraph IV ANDAswere not deductible and instead must be amortizedover the remaining lives of the asserted patents. TheCCM reasoned that, where an alleged infringer raisesan invalidity defense, proving validity constitutes thedefense or perfection of title to the asserted patenteven where ownership of the patent is not in dispute.

On September 12, 2014, the IRS released CCM AM2014-006 concluding that legal fees incurred bypatent holders bringing infringement lawsuitspursuant to Paragraph IV ANDAs are in most casesdeductible as ordinary and necessary businessexpenses, regardless of whether an invaliditydefense is raised. Although the 2014 CCM does notmention the 2013 CCM, the contrary conclusion inthe later CCM suggests that the IRS Office of ChiefCounsel has reversed its view regarding thedeductibility of these expenses. The new CCM statesthat litigation fees may be capitalized if the trueownership of the patent is at issue in the litigation,but notes that such an ownership dispute would behighly unusual in the context of a Paragraph IVANDA.

Interestingly, although the legal fees incurred by thepatent holder are deductible under the newguidance, the legal fees incurred by the genericmanufacturer in the same lawsuit are generally

nondeductible according to the IRS Office of ChiefCounsel.

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

United Kingdom

Follower Notices and Accelerated Payments

The UK Finance Act 2014, enacted in July 2014,contains new legislation to deal with cases ofpurported tax avoidance, which marks a radicaldeparture from previous policy in this area.

Until Finance Act 2014, it was generally the case thatwhere a taxpayer contested a direct tax assessmentmade by a tax authority, the appeal would suspendthe need for paying the disputed liability (althoughinterest would continue to run should the taxpayerprove to be unsuccessful). As part of its strategy tocombat what it perceives to be unacceptable taxavoidance, the UK government has introducedlegislation that reverses this principle in certaincases.

Under the new legislation, the UK tax authoritiesmay issue so-called accelerated payment noticesprovided certain conditions are satisfied. Inparticular, notices may be issued where thearrangements giving rise to the tax dispute wereearlier disclosed to HMRC under the disclosure of taxavoidance regulations ("DOTAS"). Under thoseregulations, avoidance arrangements promoters (orscheme users where there is no promoter) arerequired to notify of tax avoidance arrangements ifthey meet certain conditions. Once notified, thearrangements are given a scheme number, and ataxpayer entering into the arrangements is requiredto include the scheme number in his tax return.

HMRC has already issued a large number ofaccelerated payment notices for arrangements thatare being litigated and that were disclosed under

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DOTAS. There are very limited grounds for appealingan accelerated payment notice once it has beenissued. The only grounds for appeal (outside thenotice having been issued when the requiredconditions were not met) are that the amount of taxset out in the accelerated payment notice isincorrect. If the taxpayer believes this is the case, hehas a limited amount of time to makerepresentations to HMRC. If no representations aremade or if they are dismissed, the amount specifiedmust be paid within 90 days of the issue of theaccelerated payment notice or the representationsbeing dismissed.

Finance Act 2014 also contains provisions underwhich HMRC may issue so-called follower notices.These notices can be issued where a court ruling hasbeen handed down in relation to a particular matterand HMRC believes that the ruling is relevant to aninquiry or appeal. Although on its face the legislationis not limited to marketed avoidance schemes, HMRChas stated that it would apply the legislation mainlyin this area. Taxpayers receiving follower notices arenot required to settle their case, but they will facespecific penalties if they do not.

SDLT and Property Investment Funds

The UK government has announced that it will belooking at whether any changes are needed tocurrent stamp duty land tax ("SDLT") rules to caterfor two specific forms of collective investmentscheme designed for investors in the UK market.

HMRC estimates that there is currently £60 billion ofreal estate in various forms of collective investmentschemes, including schemes that are domiciledoffshore. The real estate is largely commercial,rather than residential, and is held in a wide varietyof vehicles. In addition, insurance companies andpension funds are thought to hold as much as £78billion of UK real estate, again large commercial innature.

In response to the demand for tax-efficientinvestment vehicles, the UK government has createdtwo specific fund structures. Property authorizedinvestment funds ("PAIFs") are open endedinvestment companies that are authorized by theUK's Financial Conduct Authority and that can investin real estate directly or indirectly though shares inUK real estate investment trusts and similar offshoreentities. Authorized contractual schemes wereintroduced in 2013, and the first such scheme hasrecently been launched in the market.

HMRC is consulting on the introduction of a seedingrelief from SDLT for PAIFs under which the initialtransfer of real estate to a PAIF would be exempted

from SDLT. A previous similar relief for unauthorizedunit trusts was withdrawn in 2006 because it wasused as an avoidance mechanism, and HMRC istherefore careful to stress that the relief will beproperly targeted.

Authorized contractual schemes are fully transparentand a transfer of an interest in such a scheme istreated in the same way as a transfer of the realestate itself. The government is consulting on theintroduction of a relief for transfers of interest inthese schemes (including a relief for the initial issueof units). In order to prevent avoidance, a specificcharge would be introduced on acquisitions of realestate from connected parties.

Further Reference to CJEU on Card HandlingCharges

The First Tier Tax Tribunal has referred certainquestions regarding the liability for VAT of cardhandling charges to the Court of Justice of theEuropean Union ("CJEU") in the case of Bookit Ltd vThe Commissioners For Her Majesty's Revenue &Customs.

Bookit had previously litigated the VAT treatment ofcard handling charges in 2006. At that time, theCourt of Appeal held that the card handling chargeswere exempt from VAT and fell within the exclusionfor transactions concerning deposit and currentaccount payments, checks, and other negotiableinstruments in the Council Directive 2006/112/EC.

The Tribunal found that there were sufficient groundson which to refer a question to CJEU on whether thecard handling fees were exempt or not. In particular,the Tribunal found that it was unclear what factorsdistinguish the provision of financial informationwithout which a payment would not be made. In aprevious CJEU case, those factors had been held notto fall within the exemption, but data handlingservices, which functionally have the effect oftransferring funds, CJEU had accepted were withinthe exemption. The tribunal dismissed an argumentbased on abuse of rights raised by the UK taxauthorities in relation to the arrangements in theBookit case.

As is sometimes the case, successive CJEU decisionson card handling charges have created someconfusion as to whether the supply concerned isexempt. This is especially the case here because thedecision turns on the exact nature of the servicesprovided and the technical aspects of the process oftransferring funds. As card handling charges havebecome extremely common, the reference to CJEUshould provide much-needed clarity on the scope ofthe exemption.

Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

The Netherlands

The Netherlands to Expand its Fiscal UnityRegime to Second-Tier Subsidiaries and SisterCompanies Following EU Court of Justice Ruling

On June 12, 2014, the EU Court of Justice ("ECJ")ruled in two joint cases that the Dutch fiscal unityregime infringes on the EU freedom ofestablishment, because it does not allow a fiscalunity between (i) a Dutch resident parent companyand its second-tier Dutch resident subsidiary heldthrough an EU resident intermediate company, or (ii)two Dutch resident sister companies held by thesame EU shareholder. The ECJ further ruled thatthere is no justification available for thisinfringement. The Netherlands will have to eliminatethis infringement from its tax law. In the meantime,the Dutch tax authorities will have to approvepending fiscal unity requests for these type ofstructures.

As a starting point, each Dutch resident entity has tofile a corporate tax return and is liable to corporatetax on a stand-alone basis. The Dutch fiscal unityregime allows two Dutch corporate taxpayers to forma consolidated group, a "fiscal unity," for corporatetax purposes. The member companies of a fiscalunity may file a single, consolidated corporate taxreturn and pool their profits and losses. Transactionsbetween fiscal unity member companies are ignoredfor Dutch corporate tax purposes. The minimumthreshold currently requires a parent company tohold at least 95 percent of the shares, which shouldgive right to at least 95 percent of the votes andprofits, in a subsidiary to be able to form a fiscalunity.

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Initially, a fiscal unity was possible only betweenDutch incorporated entities. The regime wasbroadened to include certain types of foreignincorporated companies, provided they were residentin the Netherlands, and, in accordance with the EUfreedoms and international nondiscriminationprinciples, over time extended to include the Dutchpermanent establishments ("PEs") of foreign residententities. However, prior to the ECJ rulings, in orderto be part of a fiscal unity, the regime required eachcompany in the ownership chain—both the parentand the direct and lower-tier subsidiaries—to beresident (or have a PE) in the Netherlands.

In the 2008 Papillon case, the ECJ ruled that aFrench parent and its second-tier subsidiary shouldbe able to apply the French tax consolidation regime,as long as the intermediate holding company is aresident of an EU member state. This ultimately ledto the EU Commission formally requesting theNetherlands to amend its fiscal unity regime on June16, 2011. So far, this has not happened. In the June2014 cases, however, the ECJ did not find anyjustification for the limitations in the Dutch regime.It found that the rules cannot be justified by theneed to prevent double loss deduction, nor are therules sufficiently specific to be justified by the needto prevent tax evasion or tax avoidance. Many arguethat these two ECJ cases may open the door to taxplanning regarding double loss deduction.

A bill to amend the fiscal unity regime has not beenpresented yet and consequently, the measures thatwill be taken are not yet clear. However, based onthe two ECJ cases, the Dutch tax authorities shouldtechnically have no choice but to approve pendingfiscal unity requests between a Dutch resident parentcompany and its second-tier Dutch residentsubsidiary held through an EU resident intermediatecompany or between two Dutch resident sistercompanies held by the same EU shareholder.Moreover, the ECJ rulings may have consequencesfor other tax consolidation regimes in the EU. Thesemay be favorable developments for internationalgroups structured through various EU memberstates.

Dutch Innovation Box Regime for Intangibles isClarified in Decree

The Innovation Box was introduced in 2007 toencourage companies to innovate and increase theirresearch and development ("R&D"). Under thisoptional regime, subject to certain conditions, Dutchcorporate taxpayers are taxed at an effective rateof 5 percent. In the newly published Decree, theUnderminister of Finance clarifies the scope of theInnovation Box, in particular addressing the types ofqualifying intangibles and the level of involvement of

the taxpayer required for the application of theregime.

The Innovation Box can apply to both intangibles forwhich the taxpayer has obtained a Dutch or foreignpatent and intangibles originating in activities forwhich an R&D Certificate has been obtained from theNetherlands Enterprise Agency. An R&D Certificatecan be obtained for most true R&D activities(generally speaking, all research, testing, adaptationand improvement should qualify, while testing,analyzing or supporting the R&D of another shouldnot qualify) and does not require application (or anintention to apply) for a patent. Consequently, theInnovation Box can also be applied by taxpayersengaged in activity that is not patentable.

The Innovation Box can apply only to self-developedintangibles. As regards patented intangibles, thisconcept extends to the development of the intangibleby another (affiliated or nonaffiliated) company,provided the development has taken place for therisk and account of the taxpayer (typically, contractR&D). This requires the taxpayer to avail of thenecessary functions to coordinate and manage theactivity and to take strategic decisions. It does notrequire that the contract R&D takes place in theNetherlands, so long as the coordination andmanagement of the R&D are performed in theNetherlands.

As regards R&D Certificate intangibles, the conceptof self-development is interpreted in a stricter wayand requires the taxpayer to avail of research staffto carry out the R&D itself; management of R&DCertified activities performed by another isconsidered insufficient to apply the Innovation Box.

It is important to note that the Innovation Boxregime extends to all economic benefits derived fromthe intangible, including profits from the sale ofproducts, royalty income from licensing the patentedintangible and capital gains derived from a disposalof all or part of the intangible. The amount ofbenefits is unlimited. Which part of the taxpayer'sincome can be considered to be derived from theintangible is a matter of transfer pricing and thechallenge is therefore to substantiate optimalallocation under the arm's-length principle. Theallocation of income may be confirmed by the Dutchtax authorities in an advance pricing agreement("APA"), valid for a number of years.

Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

Spain

ECJ Rules that Spanish Law on Inheritance andGift Tax is Contrary to Community Law

The Court of Justice of the European Union handeddown a ruling on September 3, 2014 (C-127/12,Commission/Spain), in which Spanish law oninheritance and gift tax (Impuesto sobre Sucesionesy Donaciones) is considered to restrict the freemovement of capital since it involves differences intax treatment between tax residents in Spain andnonresidents.

The controversy giving rise to the ruling of the courtderives from the fact that regional/state law appliesonly in connection with the territory of a state. Thus,when an heir, donee, or legatee nonresident in Spainis involved, or in the event of an inheritance ordonation of a real estate asset located outside theSpanish territory, given the lack of a stateconnection, the inheritance or donation will besubject to national law, with the tax cost thereof.However, in the event of inheritances or donationsmade between Spanish tax residents (that is, with aregional/state connection), the reductions envisagedby the various states are applicable, and the taxburden for a comparable situation is generally lower.We have, therefore, a situation in which nonresidentsare normally subject to a higher taxation by themere fact of being nonresidents and cannot benefitfrom the regional/state tax benefits that otherwiseapply to residents in Spain.

Parent–Subsidiary Directive

The Explanatory Memorandum to the Draft Lawamending nonresident income tax points out that the

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main reason for the tax reform is to adapt it, to agreater extent, to the European Union regulatoryframework. The draft law includes an anti-abuseclause, similar to the one currently in force, whichprevents the application of the tax exemption inSpain on dividends paid when most of the votingrights of the European Union resident shareholderare held, directly or indirectly, by individuals or legalentities that do not reside in a European Unionmember state.

The currently existing rule includes three exceptionsto the application of the anti-abuse clause: (i) thatthe parent company actually performs a businessactivity that is directly related to the businessactivity performed by the Spanish subsidiary; (ii)that the purpose of the parent company is thedirection and management of the Spanish subsidiarythrough an appropriate organization of material andhuman resources; or (iii) that it proves that it hasbeen incorporated for valid economic reasons andnot merely to take advantage of the exemptionscheme.

With the new wording of the draft law, the current"safe harbors" are removed and are replaced by ageneric requirement that the incorporation andoperation of the nonresident parent company mustbe for "valid economic reasons" and "substantivebusiness reasons."

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Disclaimer: Jones Day publications should not be construed as legal advice on any specific facts orcircumstances. The contents are intended for general information purposes only and may not be quoted orreferred to in any other publication or proceeding without the prior written consent of the Firm, to be given orwithheld at our discretion. The electronic mailing/distribution of this publication is not intended to create, andreceipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personalviews of the author and do not necessarily reflect those of the Firm.

© 2014 Jones Day. All rights reserved. 51 Louisiana Avenue, N.W., Washington, D.C. 20001-2113www.jonesday.com

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

Mexico

Tax Rules Included in the Mexican EnergyReform

On August 6, 2014, the Mexican Congress approvedsome of the secondary legislation related to the so-called Mexican Energy Reform. The approved lawswere published in the Mexican Official Gazette onAugust 11, 2014. Among the approved secondarylegislation is the Hydrocarbons Revenues Law, whichincludes: (i) special tax provisions for governmentaland nongovernmental entities entering intoagreements for the extraction and exploration ofhydrocarbons; and (ii) a new hydrocarbons taxapplicable to these entities.

The most relevant special tax provisions are:

• Special depreciation yearly rates applicable forassets and investment for the exploration andextraction of hydrocarbons, such as: (i) 100 percentdepreciation rate for investments made for theexploration activities; (ii) 25 percent depreciationrate for investments made for the development andextraction of oil and natural gas; and (iii) 10 percentdepreciation rate for investments made for thewarehousing and transportation activities that areindispensable to complying with the agreements.

• Specific rules dealing with the way in which severalentities participating as a "consortium" (for theexploration and extraction of hydrocarbons) couldidentify its accruable income and authorizeddeductions to calculate individual income tax.

• A tax loss carry-forward term of 15 years (thegeneral carry-forward period provided in the Mexican

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Income Tax Law is 10 years), for those taxpayersthat carried out activities in maritime zones with aflow depth greater than 500 meters.

• A special 0 percent valued tax rate applicable fortransactions related to the exploration and extractionof hydrocarbons.

• Rules for the creation of permanent establishmentsin Mexico when foreign entities perform activitiesrelated to the exploration and extraction ofhydrocarbons.

The most important features of the hydrocarbons taxare:

• The taxpayers are governmental andnongovernmental entities entering into agreementsfor the extraction and exploration of hydrocarbons.

• The tax is calculated on a monthly basis and will becalculated by applying the following rates to eachsquare kilometer in which the exploration andextraction of hydrocarbons takes place: (i)Mex$1,500 (approximately US$115) for each squarekilometer used in the exploration phase; and (ii)Mex$6,000 (approximately US$460) for each squarekilometer used in the extraction phase. These rateswill be adjusted by inflationary effects on January 1of every year. The tax return for this tax should befiled no later than the 17th day of the followingmonth corresponding to the payment of the tax.

• In case it is impossible to explore or extracthydrocarbons, the taxpayer must justify theimpossibility in order to obtain an exemption forpaying the hydrocarbons tax from the Mexican taxauthorities.

Three New Tax Treaties Signed by Mexico WillBe Applicable from January 1, 2015

During 2014, three new tax treaties signed byMexico with Peru, the United Arab Emirates, andMalta have been published in the Mexican OfficialGazette. According to the tax treaties, their benefitswill be applicable from January 1, 2015, bringingMexico's tax treaty network to 59. Treaties withCosta Rica, Malaysia, and Nicaragua are currentlybeing negotiated by the Mexican government, andthe modifications to the 1994 Mexico–Belgium treatyare currently pending.

The withholding tax rates under these three treatiesand the Mexican Income Tax Law are the following:

MexicanIncome TaxLaw

Tax Treatywith Peru

TaxTreatywith UAE

Tax Treatywith Malta

Dividends 10% 10% and 15% 0% 0%

Interest4.9% up to35%

0% and 15%0%, 4.9%,and 10%

0%, 5%, and10%

Royalties25% and35%

15% 10% 10%

CapitalGains

25% and35%

0% if someownershiprequirementsare met

–

0% if someownershiprequirementsare met

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

Japan

Tokyo District Court Allows Tax Saving fromShare Repurchase

On May 9, 2014, the Tokyo District Court reversed alarge tax that had been imposed on a large U.S.multinational's Japanese holding company ("JapanHoldCo").

Under the Japanese Corporate Tax Law, if ashareholder returns shares to an issuing company(i.e., the issuing company acquires treasury shares),a portion of the consideration paid to the shareholderis deemed to be a dividend. Further, all or a portionof such deemed dividend will not be consideredtaxable income (in the case at issue, the entiredeemed dividend was not considered taxable incomeof Japan HoldCo) and will be subtracted for thepurpose of calculation of a capital gain or loss.Therefore, if the sale price (paid by the issuingcompany to the shareholder) and the book value ofthe transferred shares are equal, the shareholder willincur a capital loss equal to the amount of thedeemed dividend resulting from the share transfer tothe issuing company.

On April 22, 2002, Japan HoldCo acquired all of theoutstanding shares of an affiliated company ("JapanLtd."). Thereafter, on December 20, 2002, December22, 2003, and December 28, 2005, Japan HoldCosold a portion of Japan Ltd.'s shares back to JapanLtd. itself and incurred a total capital loss ofapproximately JPY400 billion. In 2008, Japan HoldCoand its subsidiaries (including Japan Ltd.) adopted aconsolidated tax return and set off the JPY400 billionloss against the consolidated group's revenue. As aresult, the amount of corporate tax imposed on

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Japan HoldCo and its affiliates was reduced byapproximately JPY120 billion.

In response to the above transactions and tax filing,the tax authorities denied Japan HoldCo's recognitionof the JPY400 billion loss pursuant to Section 132.1of the Corporate Tax Law and reimposed taxes ofapproximately JPY120 billion with penalties andinterest. Under Section 132.1 of the Corporate TaxLaw, if an act or calculation made by a closely heldcorporation (including a wholly owned company suchas Japan HoldCo) unfairly reduces the amount ofcorporate tax, the tax authorities may disregard oneor more of such acts or calculations and recalculatethe amount of corporate tax owed.

In the case at issue, the tax authorities argued thata series of transactions was made for the purpose oftax avoidance and thus unfairly reduced the amountof corporate tax. However, the Tokyo District Court,in ruling against the tax authorities, stated, amongother things, that (i) it is difficult to say that theseries of transactions did not have any reasonablebasis, and (ii) there are several facts that areinconsistent with the tax authorities' argument.

The tax authorities appealed the judgment, and thecase is now being reviewed by the Tokyo High Court.

Note: Due to the 2010 tax reform, if thesetransactions were to happen today, realization of theJPY400 billion loss would be denied.

Judgment of Tokyo District Court: Applicationof a General Anti-Avoidance Rule ConcerningReorganization Transactions

On March 18, 2014, the Tokyo District Court affirmedcorporate tax assessments against two tax payers:Yahoo Japan Corporation ("Yahoo Japan"), a TokyoStock Exchange listed company, and IDC FrontierInc. ("IDCF"), a wholly owned subsidiary of YahooJapan.

The main issue of the Yahoo Japan case waswhether, upon a tax-qualified merger, the survivingcompany (Yahoo Japan) was entitled to utilize netoperating losses ("NOLs") of the acquired companypursuant to Article 57 of the Corporation Tax Act ofJapan ("Act"). In Yahoo Japan, while Yahoo Japanformally satisfied the requirements of Article 57, thetax authorities denied Yahoo Japan's utilization of theNOLs of the acquired company by applying Article132-2 of the Act, a general anti-avoidance rule.Under Article 132-2, if the corporate tax burden isdetermined to be unduly decreased due to areorganization transaction (i.e., it would be unfair forYahoo Japan to utilize the tax losses of the acquiredcompany after the merger), the Japanese tax

authorities are empowered to deny thereorganization transactions (e.g., merger, companysplit, share exchange, etc.) or the book entriesthereof and compute the taxable income or netoperating losses as they deem appropriate

The main issue in the IDCF case was whether acompany (IDCF) that was newly incorporated as awholly owned subsidiary of the transferor upon acompany split was entitled to recognize goodwill(which is recognized only in the case of anonqualified company split and is depreciable for fiveyears on a straight line basis) pursuant to Article62-8 of the Act. In IDCF, the transferor companywas scheduled to sell its shares in IDCF upon thecompletion of company split, and thus the companysplit did not formally fulfill the requirements of a tax-qualified company split. Accordingly, IDCFrecognized goodwill pursuant to Article 62-8 of theAct. Nonetheless, the tax authorities also deniedIDCF's recognition of the goodwill and deduction ofdepreciation expense for corporate tax purposes byapplying Article 132-2 of the Act.

The court held in each case that Article 132-2 of theAct is applicable not only to (i) cases where thereasonableness or economic substance of areorganization transaction is questionable, but also(ii) cases where acts constituting part ofreorganization transactions formally satisfy certainrequisite conditions of corporate reorganizationtaxation (by virtue of which the company can enjoy adecrease of its tax burden). However, the allowanceof such a decrease in the tax burden would clearlyconflict with the underlying policy of the corporatereorganization taxation system or the relevantprovisions. Further, the court concluded in each casethat the tax authorities' denial pursuant to Article132-2 was legitimate and dismissed Yahoo Japan'sand IDCF's claim.

These two judgments were the first judgment inwhich a court applied Article 132-2 of the Act, andthe scope of the Article 132-2 was interpretedbroadly. Both Yahoo Japan and IDCF appealed thejudgments, and the cases are now pending in theTokyo High Court.

If the decisions of the Tokyo District Court areupheld, the predictability of tax decisions forcorporate reorganizations would regress, and taxpractitioners would be required to give carefulconsideration to the risk of denial by the taxauthorities pursuant to Article 132-2 of the Act whenproviding tax advice.

Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

Italy

Repeal of the Interest-Withholding Tax onCertain Cross-Border Loans

As a rule, if a nonresident lender grants a loan to anItalian resident borrower, the interest paid on theloan is subject to a 26 percent withholding tax inItaly unless the lender is eligible for the exemptionunder the Italian laws that implemented the EUInterest and Royalties Directive. The withholding taxmay be reduced (usually to 10 percent) or, in veryfew cases, zeroed under the double tax treatiesentered into by Italy, where applicable.

Law Decree No. 91 of June 24, 2014, converted intolaw by the Italian Parliament on August 7, 2014,repealed the interest withholding tax in cases ofcross-border loans that meet certain requirements.As a result, no withholding tax is now levied on theinterest if (i) the loan is a medium- or long-termloan; (ii) the borrower is an enterprise (e.g., anItalian commercial partnership, a resident company,or the Italian permanent establishment of anonresident enterprise); and (iii) the lender is any ofthe following:

• A bank established under the laws of an EUMember State;

• An insurance company established and licensedunder the laws of an EU Member State; or

• An unleveraged undertaking for collectiveinvestment (e.g., an investment fund) that is set upin an EU Member State or in an EEA country allowingfor an adequate exchange of information with Italy(i.e., Iceland and Norway).

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Because the new rules state that the borrower mustbe an enterprise, the withholding tax exemptionshould not apply when the borrower is an Italianundertaking for collective investment (e.g., an Italianinvestment fund). Moreover, it will have to beclarified in due course whether the withholding taxexemption is available if the borrower is an Italianstatic holding company.

Withholding Tax Exemption on Bond InterestBroadened

Law Decree No. 91 of June 24, 2014, converted intolaw by the Italian Parliament on August 7, 2014, hasbroadened the scope of the withholding taxexemption applicable to eligible nonresidentinvestors (i.e., investors resident in a white-listedcountry and with no permanent establishment inItaly) on certain debt-like securities.

Before the enactment of the new rules, nonresidentholders could benefit from a withholding taxexemption on interest paid on the followingsecurities:

• Bonds, bond-like securities, and commercial papersthat were issued by Italian-resident banks,regardless of whether these securities were listed ona regulated market;

• Bonds, bond-like securities, and commercialpapers, whether listed or not, that were issued byresident companies whose shares were traded onregulated markets or multilateral trading facilities ofan EU Member State or an EEA country included inthe Italian white list (i.e., Iceland and Norway); and

• Bonds, bond-like securities, and commercial papersthat, although issued by nonlisted residentcompanies, were listed on a regulated market or amultilateral trading facility of an EU Member State oran EEA country included in the Italian white list (i.e.,Iceland and Norway).

The Law Decree has added a new item to the list ofexemptions—interest on bonds, bond-like securities,and commercial papers issued by nonlisted residentcompanies will be exempt from Italian withholdingtax if the security holder is a "qualified investor"under article 100 of the Italian Unified Financial Act(e.g., banks, broker-dealers, investment funds,pension funds, etc.), regardless of whether thesecurity is listed. It is not clear whether theexemption is available only in the event the entirebond issuance is subscribed to by "qualifiedinvestors."

Finally, the Law Decree has introduced a blanketwithholding tax exemption that applies to interest

deriving from any type of bond, bond-like security,and commercial paper and paid to undertakings forcollective investment, whether set up in Italy or inanother EU Member State, if: (i) their units areentirely held by "qualified investors"; and (ii) morethan 50 percent of their assets are the aforesaiddebt securities and commercial papers.

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

Germany

New Developments for Real PropertyTransactions

On July 9, 2014, the German Supreme Fiscal Courtdecided a real estate transfer tax ("RETT") case thatshines a new light on RETT structures. Contrary tothe long-standing interpretation of the law, the courttook the position that aspects of economic ownershipare also relevant for RETT purposes.

Until now, it was the unanimous agreement of taxexperts in literature, legislation, and courts that forRETT purposes, the civil law position and structuredetermines whether or not RETT is triggered in atransaction. Now the Supreme Fiscal Court has heldthat in cases where the law refers to indirect transferof a property, the civil law structure is not relevantalone. In such a case, the rules stipulating economicownership approach might be applicable.

The case dealt with a very common GmbH & Co. KGstructure. The limited partnership owned realproperty. Two individuals held the GmbH, which wasthe general partner in the partnership. The generalpartner GmbH held no participation. In addition, thetwo individuals were the limited partners. Bothpartners sold their interests in the partnership exceptfor a small interest of 5.6 percent, which was kept byone partner. The shares in the general partner GmbHwere sold as well. Since less than 95 percent of thepartnership interest was sold, no RETT incurred.

Several weeks after the sale, the partners in thetransaction agreed on put and call options on the last5.6 percent, agreed on the purchase price, andtransferred the profit participation right immediately.

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The purchaser was granted power of attorney forrepresenting the last partner, who still held the 5.6percent.

This deal structure was evidently put in place toavoid the incurrence of RETT because under civil lawprinciples, only 94.4 percent of the partnershipinterest was sold so that no RETT was incurred. Thisstrategy was recognized by the Lower Fiscal Court.The Supreme Fiscal Court, however, overruled theLower Court and argued that in the case of anindirect transfer of property, the civil law positionmight not apply in all cases. This is particularly truein cases such as the one at hand, where thepurchaser of a partnership interest is able throughmultiple agreements to control the property, has theopportunity and risks of the property, and has a legalposition similar to ownership.

Since real property transactions are in many casesstructured as a sale of partnership interests,including a retention of 5.1 percent of partnershipinterest, the new decision plainly puts the focus ofthe tax authorities on an economic ownershipapproach. Therefore, agreements in connection withthe transfer of a partnership interest that put apurchaser in the position of an economic owner mustbe avoided.

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Disclaimer: Jones Day publications should not be construed as legal advice on any specific facts orcircumstances. The contents are intended for general information purposes only and may not be quoted orreferred to in any other publication or proceeding without the prior written consent of the Firm, to be given orwithheld at our discretion. The electronic mailing/distribution of this publication is not intended to create, andreceipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personalviews of the author and do not necessarily reflect those of the Firm.

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

France

Luxembourg–France Tax Treaty: AmendmentSigned on September 5, 2014

On September 5, 2014, French Minister of FinanceMichel Sapin and Luxembourgian Minister of FinancePierre Gramegna signed an amendment to theFrance–Luxembourg Tax Treaty (1958) (the "TaxTreaty"), as amended by the 1970 exchange ofletters and by the 1970, 2006, and 2009 protocols.

The amendment, in line with the current OECD ModelTax Convention on Income and Capital, reverts tothe tax treatment of capital gains arising on thedirect and indirect disposal of real estate assets andputs an end to the potential double-tax exemptionregularly applied until now regarding sale of realestate companies' shares.

Former Tax Treatment. The former tax treatypermitted the avoidance of taxation on capital gainsarising from the disposal of real estate assets locatedin a related country held through one or severalinterposed entities in the other country. Indeed, suchsale did not qualify as real estate income withrespect to the Tax Treaty and was therefore nottaxable, neither in France nor in Luxembourg.

For instance, where a Luxco sold the equity interestheld in a French real estate entity, no taxation wasapplied since the capital gain arising on this salewas:

• Tax exempt in Luxembourg, as the Luxembourgtax authorities treated the sale as a sale of Frenchreal estate that was taxable in France only pursuantto the former Article 3 of the Tax Treaty; and

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• Also tax exempt in France, as the Tax Treaty didnot provide that an equity interest in a real estatepartnership must be viewed as a real estateinvestment, so the gains were not taxable in Franceunless the selling Luxco had a permanentestablishment in France.

Tax Treatment Resulting from the Amendment.The amendment modifies this tax treatment and putsan end to the above potential double-tax exemption.Indeed, the amendment provides a new paragraphto Article 3 of the Tax Treaty (i.e., a "Prépondéranceimmobilière" clause) specifying the case of the saleof shares of a company, fiduciary, or any otherinstitution or entity whose assets consist for morethan 50 percent of their value—directly or indirectlythrough one or several companies, fiduciaries,institutions, or other entities—of real estate assets.

Under this new rule, capital gains arising on the saleof shares of such entities would be taxable only inthe country in which the related real estate assetsare located.

The amendment will enter into force on the first dayof the month following the reciprocal notification ofits ratification in both states.

Pursuant to Article 2.2 of the amendment, the newrule will apply:

• To capital gains taxable after the calendar yearduring which it enters into force, for income taxeslevied as a withholding tax;

• To capital gains occurring during tax yearsbeginning after the calendar year during which itenters into force, for income taxes not levied as awithholding tax; and

• To taxation whose action rendering the taxesassessable occurs after the calendar year duringwhich it enters into force, for other income taxes.

Accordingly, where the amendment would be ratifiedby both states before December 31, 2014, onlycapital gains realized as from January 1, 2015,should fall under the scope of this new rule.

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

China

Draft Guidance for the General Anti-AvoidanceRule

On July 3, 2014, the State Administration of Taxation(the "SAT") released a discussion draft on theAdministrative Measures on the General Anti-Avoidance Rule (the "Draft Measures). The GeneralAnti-Avoidance Rule ("GAAR") was introduced inChina Corporate Income Tax Law effective onJanuary 1, 2008. However, the provision of law andsubsequent interpretation tax circulars provide onlysome basic principles. The Draft Measures providecomprehensive guidance on the implementation ofGAAR.

According the Draft Measures, GAAR applies to a taxavoidance scheme where the sole or main purpose orone of the main purposes is to obtain a tax benefit,and the form of scheme is permitted in accordancewith the tax rules, but the form is not consistent withits commercial substance. The tax authorities maymake special adjustments based on the principle ofsubstance over form.

The adjustment methods include:

• Recharacterize the whole or part of a transaction;

• Disregard a party to the transaction or treat theparties to the transaction as the same entity, for taxpurposes;

• Redefine relevant income, deduction, taxincentives, foreign tax credit, etc. and reallocatethem among the parties to the transaction; and

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• Other reasonable methods.

The Draft Measures also provide investigationprocedures and documentation requirements.

Once the tax authority commences a GAARinvestigation on an enterprise, the enterprise shouldprovide, within 60 days of the investigation notice,the documents to prove its arrangement is not a tax-avoidance scheme, including:

• The background of arrangement;

• Explanation of reasonable commercial purpose;

• Internal decision-making and administrativedocuments concerning the arrangement such asboard resolution, memorandum, and emails;

• The details of transaction information of thearrangement such as contracts, supplementalagreements, and the evidence of payment or receiptof consideration;

• Communications with tax advisors;

• Communications with other parties to thetransaction;

• Other information evidencing that the transactionis not a tax-avoidance scheme; and

• Other information that the tax authority believesnecessary.

The tax bureau at local level may initiate a GAARinvestigation. However, both the formalcommencement of such investigation and theconclusion of the case must be reported to andapproved by the SAT.

Although the Draft Measures provide helpfulguidance on the implementation of GAAR, the taxcircular, if finalized and issued in current form, cangive tax authorities broad authority to invoke as longas one of the main purposes is to obtain a taxbenefit.

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Global Tax Update

Issue 2 | October 2014 JONES DAY

What's New

Belgium

Recharged Costs and Expenses of Stock OptionPlans Not Tax Deductible for the BelgianEmployer

On June 25, 2014, the Brussels Court of Appealconfirmed an earlier ruling (dating from 2010) fromthe Tribunal of First Instance. The tribunal had foundthat costs and expenses in connection with aninternational stock option plan recharged by a SouthAfrican parent company to its Belgian subsidiary arenot tax deductible by the latter to the extent acapital loss has been suffered on the shares that hadto be acquired in order to be delivered to Belgianoptionees following the exercise of their stockoptions.

Under Belgian corporate income tax rules (Article198, §1, 7º, Income Tax Code 1992), capital lossesincurred on the sale of shares are, in principle, nottax deductible for corporations by virtue of theparticipation exemption regime. Although this hasbeen disputed for some time, the Belgian taxauthorities and the majority of court decisions takethe position that this rule also applies when a Belgiancorporate taxpayer acquires shares at a high price inorder to deliver them to an optionee exercising his orher stock options at a discounted price (normally thefair market value of the shares at the time of grantor vesting).

Until recently, it was less clear what the taxtreatment should be for costs and expenses incurredby a non-Belgian group company, e.g., a foreignparent company, when recharged to the Belgiansubsidiary in connection with stock options grantedto and exercised by employees or other optionees of

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that Belgian subsidiary. Under this scheme, the costsand expenses booked by the Belgian subsidiary arenot (entirely or partially) earmarked as a capital losson shares in the commercial books of the Belgiansubsidiary, and there are good arguments to treatthem as personnel (labor) costs for accountingpurposes. Except if the tax law explicitly providesdifferently, the tax treatment of costs and expensesfollows the accounting treatment. As a result, manypractitioners in Belgium have taken the position thatthe total amount of recharged costs and expensesshould in fact be tax deductible for the Belgiansubsidiary.

In the case at hand, the taxpayer adhered to thatposition and contended that the costs and expensesthat were recharged to it by its South African parentcompany did not (partially) constitute capital losseson shares and, therefore, should be tax deductiblesubject to the normal conditions, i.e., that the costsand expenses are properly documented and meetthe arm's-length standard. However, both theTribunal of First Instance and now also the Court ofAppeals ruled that to the extent the recharged costsembody or include the amount of any capital loss onthe shares that were sold to the Belgian employeesand other optionees at a discount, they should thennot be tax deductible for the Belgian subsidiary, as ifthe latter would have otherwise incurred the capitalloss directly.

The first commentaries to the Court of Appeals rulingindicate that there is no unanimity amongcommentators and that there is a good chance thatthe taxpayer will take the case to the Court ofCassation for a definitive decision.

No Corporate Income Tax on an Undervaluationof Shares Acquired by Belgian HoldingCompany

Following a very long and winding road in severalcourts, it has finally been confirmed that Belgiumcannot impose corporate tax on any undervaluationof or underpayment for shares acquired by a Belgiancorporate taxpayer. Thus, when a Belgiancorporation buys shares at a price below fair marketand subsequently sells those same shares at thehigher market value, the capital gain so bookedqualifies, in principle, for the participationexemption. For more than 10 years, the Belgian taxauthorities have contended that the differencebetween the low purchase price and the fair marketsales price constitutes a so-called undervaluation ofassets, which is an element of any Belgian corporatetaxpayer's taxable base (Article 24, 4º, Income TaxCode 1992). Following a ruling from the EuropeanCourt of Justice ("ECJ") (see below), the BelgianCourt of Cassation (Supreme Court-equivalent) has

now confirmed that there is no legal basis to imposetax on any undervaluation of assets. Hence thenormal rules of the participation exemption willapply.

More specifically, on October 3, 2013, the ECJ ruledthat there is no EU rule that forces enterprises tomark up the accounting value of shares in order tobring them in line with the higher fair market value(no mark-to-market principle). Case C-322/12,Gimle S.A. By contrast, the Belgian tax authoritieshad contended that any failure to mark up thesubstantially-below-fair-market acquisition value of aparticipation constitutes an infringement of the "trueand fair view principle" contained in the FourthCouncil Directive 78/660/EEC of July 25, 1978. As aresult, such a failure should give the authorities theright to impose corporate tax on the differencebetween the low acquisition price and thesubstantially higher fair market value, in accordancewith Article 24, 4º of the Belgian Income Tax Code1992.

Since it was the Belgian Court of Cassation thatsubmitted the issue to the ECJ in the form of apreliminary question, the court still had to render itsfinal verdict based on the ECJ's ruling. At last, onMay 16, 2014, the Court of Cassation confirmed thatit would follow the view of the ECJ that noaccounting rule had been breached by the taxpayerwhen it refrained from marking up the acquisitionvalue of its participation in its statutory books toreflect the (higher) market value. As a result, thecapital gain that was crystallized in the books of thetaxpayer when it sold the participation at marketvalue constituted a capital gain on shares, which iseligible for the participation exemption (Article 192Income Tax Code 1992), if all other relevantconditions are satisfied.

Quite a few cases along the same lines were pendingin various Belgian tribunals and courts, and mostwere put on hold pending the outcome of the Gimlecase. It can be expected that those cases will now besettled in accordance with the outcome describedabove.

"Protectionist" French Excise Tax on CertainTypes of Beer Complies with EU Law

On September 13, 2014, it was reported by thetrade press that the European Commission had foundthat the increase by 160 percent of French excise taxon certain types of high-alcohol-content and luxurybeers that was introduced on January 1, 2013 didnot fall afoul of the free-market principles of the EU.

Under pressure from a coalition of domestic brewers,Belgium had complained to the Commission that the

sharp increase of a very specific excise tax in Francewas, in reality, aimed at hindering the sale of beersthat are typically brewed in Belgium and exported toFrance. Belgium felt that the French tax was aimedat protecting the domestic French beer and wineproducers because it was so specifically tailored interms of the types of beers it targeted in practice.

However, after a second complaint from Belgium, theCommission stuck to its initial conclusion that theadditional French excise tax is not sufficiently specificto be earmarked as a protectionist measure shieldingthe French market from beers imported fromBelgium.

The Belgian brewers have allegedly lost €58.6 millionin sales since the introduction of the increasedFrench tax on January 1, 2013. At the time ofwriting, it was not clear yet whether or not Belgiumor (a coalition of) Belgian brewers would take thecase directly to the European Court of Justice.Normally, when the Commission declines acomplaint, the odds of obtaining a favorable rulingfrom the ECJ are against the complainants.

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Disclaimer: Jones Day publications should not be construed as legal advice on any specific facts orcircumstances. The contents are intended for general information purposes only and may not be quoted orreferred to in any other publication or proceeding without the prior written consent of the Firm, to be given orwithheld at our discretion. The electronic mailing/distribution of this publication is not intended to create, andreceipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personalviews of the author and do not necessarily reflect those of the Firm.

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