Using a Spanish Holding Company for Latin American Investments

By Victor Cabrera, Antonio Lobon and Marc Skaletsky (KPMG LLP)

Excerpt from Practical Latin American Tax Strategies published by WorldTrade Executive.

Spain has emerged as one of the most attractive jurisdictions for multinational corporations (MNCs), including U.S. MNCs, to establish a holding company for Latin American operations. In 1996, Spain enacted into law its holding company regime (Entidad de Tenencia de Valores Extranjero, or "ETVE").

Key factors in the attractiveness of an ETVE having business substance include (i) Spain's extensive tax and investment treaty network with various Latin American countries, and (ii) Spain’s European Union (EU) membership and the resulting coverage by the EU Parent-Subsidiary and Merger Directives.

Because of Spain’s treaty network and the European character of the ETVE, it has become an interesting vehicle for channeling capital investments into Latin America as well as a tax efficient repatriation route for EU capital investments by non-EU companies. Additional benefits include Spain’s cultural, linguistic, and historical business ties with the region.

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Latin American Private Equity Activity: Midyear Report

Venture Equity Latin America, a WorldTrade Executive publication, recently published its mid year report for 2008. The following are some highlights.

The first half of 2008 witnessed private equity investments in Latin America ranging from power distribution to agriculture. Investments made during this period did not match last year’s high levels as around $1.7 billion was invested in the first half of 2008 compared to roughly $2.3 billion in the first half of 2007. The level of investment recorded during the first half of this year came closer to the investment level seen in the first half of 2006, which was roughly $1.6 billion.

After significant investment activity last year, which amounted to around $7.5 billion and which was already high during the first half of 2007, it does not look as though investments this year will exceed last year’s hugely successful levels, unless there are sizeable investments made in the latter half of this year. Of course, investments during the first half of 2008 have been made against an uncertain international finance backdrop, which has witnessed and is experiencing the repercussions of the global credit crunch, the impacts of the Bear Stearns collapse, and ongoing issues with subprime mortgages and associated lenders.

Despite the lower levels of investment seen so far in Latin America, it is worth noting that demand for larger assets has continued to increase as illustrated in part by the $870 million investment in the SAESA Group of Companies (SAESA Group) by the Morgan Stanley Infrastructure consortium.

So far in 2008, 3 private equity investments of over $50 million have been made and the following 4 deals registered at $100 million or more.

• Morgan Stanley Infrastructure consortium, which includes the Ontario Teachers’ Pension Plan led an $870 million investment in the SAESA Group of Companies (SAESA Group), which handle power distribution in Chile.
• GP Investimentos invested in energy in Brazil through its investment of $112 million in Sociedade Tecnica de Perfuacao (SOTEP) and the investment was made through its fund, San Antonio Global.
• GP Investments made an education related investment in Brazil when it invested $163 million for a 20% stake in Estacio Participacoes.
• GP Investments acquired Laticinios Morrinho’s, a dairy products company in Brazil, for $189 million.

Fundraising so far in 2008 helped to offset the lower investment levels in the first half of 2008 as fundraising during this period surpassed the fundraising level seen in the first half of 2007. During the first half of 2008, fundraising totaled around $1.981 billion and there were 17 funds with closings. This can be compared to the first half of 2007, which saw around $1.5 billion in fundraising and at that point, there were 20 funds with closings.

Like last year, much of the fundraising activity was again centered in Brazil but there was also strong fundraising regionally too. There was limited fundraising in Mexico and Argentina during this period but Peru found itself the focus of multiple funds. The increased interest in Peru could be explained by insights shared in the Venture Equity Latin America 2007 Mid-Year Report, which stated that due to ongoing competition for assets, especially energy assets, some funds would probably look for assets in less-heavily cultivated areas, such as Peru.

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Upcoming Investment Opportunities in Brazilian Infrastructure

Excerpt from Venture Equity Latin America
published by WorldTrade Executive, Inc.

By María Fernanda Farall (Jones Day)

The Brazilian government is in the process of implementing a new set of infrastructure projects pursuant to its Programa de Aceleração do Crescimento (Growth Acceleration Program), which is commonly referred to as PAC. In 2007, President Silva’s administration created this program to promote the growth of the Brazilian economy through a series of infrastructure projects pertaining to logistics (e.g., railroads, roads, and ports), energy, water, and housing.

Timing for the launching and promotion of these new projects by the Brazilian government could not be better –with its long-term credit recently being upgraded by Standard and Poor’s Rating Service to investment grade status, Brazil is being perceived as a safe place for foreign investment. These projects offer many investment opportunities to foreign investors.

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Mexico Amends Key Government Procurement Law

Based on article in Latin American Law & Business Report
published by WorldTrade Executive, Inc,

Original Article Written by
By Alejandro López-Velarde (López Velarde, Wilson, Abogados, S.C.) and Regina Kuchle (AstraZeneca)

The following is an editor's summary:

The Mexican government amended a key government procurement law in July known as the Public Acquisitions and Service Law. The most important State monopolies and health institutions such as Pemex, the Federal Electricity Commission, the Social Security Institute are governed by the law, and it governs approximately 42% of the federal budget.

The law allows the federal executive to issue guidelines and regulations to change the current structure of acquisitions, leases and services. Public entitites will be able to request from otential suppliers a "Reverse Auction, in order to obtain a lower price. The executive needs to publish a Reverse Auction Methodology in the Official Gazette.

There is some worry that these procedures may not be Constitutional.

Latin American M&A Survey

Excerpt from Venture Equity Latin America
Published by WorldTrade Executive, Inc.

By Law Firm of Greenberg Traurig in association with mergermarket

Greenberg Traurig commissioned mergermarket to conduct a study of Latin American M&A activity. In Q1 2008, mergermarket interviewed 109 investment bankers, private equity practitioners and corporate executives regarding their opinions on the opportunities and challenges of the Latin American M&A market. All results were anonymous and are presented in aggregate.

Survey findings

Over three quarters of respondents expect overall Latin American M&A levels to rise in 2008
What do you expect to happen to the level of M&A within the Latin American region for 2008?

• Respondents appear to be bullish regarding anticipated overall M&A activity in 2008 within the Latin American region. A significant 60% of respondents expect activity to increase, while 16% anticipate a significant increase with a corporate respondent qualifying this viewpoint by commenting: “I believe that in general there will be a large influx of international interest which will trigger local interest. M&A looks set to increase as a result.”

• One fifth of respondents believe Latin American M&A activity will stay at current levels with one respondent noting: “I expect the level of M&A within the Latin American region to be the same as 2007 as there have been no major political or economic changes.” Notably, only 4% expect M&A activity to fall in 2008.

85% predict an increase in inbound cross-border M&A into Latin America

What do you expect to happen to the level of incoming crossborder M&A into Latin America for 2008?

• A resounding 85% of respondents believe that incoming cross-border M&A in Latin America will either increase (65%) or increase greatly (20%) in 2008. Indeed, one private equity respondent anticipates there to be significant inbound activity in Latin America as well as in other emerging markets, explaining: “We have raised a fair amount of money in our fund geared at emerging markets. We have already done one deal in Mexico and are looking for opportunities all across Latin America. I expect there to be some M&A activity between local banks in Latin America and multinationals from the USA and Europe.” Moreover, other respondents claimed that increased economic and political stability will result in greater levels of foreign investment.

• Elsewhere, 12% of respondents believe the level of inbound cross-border M&A activity will remain the same while remarkably only 3% foresee a decrease.

Brazil and Mexico are tipped to see the most significant M&A activity in the region

What countries or regions do you expect to see the highest levels of inbound M&A activity?

• Brazil (86%) and Mexico (70%) emerged as the two territories in which the clear majority of respondents expect to witness the most significant levels of inbound M&A in Latin America. Respondents alluded to Brazil’s rapid growth driving M&A, while one corporate respondent noted that Mexico has several attractive qualities commenting: “The country has good potential for FDI due to its close proximity to the United States. Carlos Slim recently spoke about a Mexican Silicon Valley being developed in the state of Senora and this could develop into a hotspot for M&A.”

• Elsewhere, Argentina (41%), Chile (29%) and Central America (25%) were also cited by more than a quarter of respondents. Given their historic low levels of M&A activity, it is somewhat unsurprising that Venezuela, the Dominican Republic and Puerto Rico are considered unlikely to see significant inbound M&A activity in 2008.

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Tax Issues Facing Supply Arrangements in Latin America

Excerpt from Practical Latin American Tax Strategies
published by WorldTrade Executive, Inc.

By Victor Cabrera, Jose Leiman, And Marc Skaletsky
(KPMG LLP)


Over the past decade, many large multinational corporations (MNCs) have been moving their European and Asian operations from a decentralized group of stand alone full-fledged manufacturing and distribution (M&D) subsidiaries towards a “hub-and-spoke” system. Under these arrangements, the hub (the “Principal”) assumes functions and risks from the M&D subsidiaries. This centralization of functions and risks in the Principal hopefully brings a commensurate share of consolidated profits.1 The conversion of full-fledged M&D subsidiaries to a hub-and-spoke arrangement raises a series of non-tax and tax considerations and associated issues that must be resolved in order to implement the structure successfully.

Given the potential benefits of the hub-and-spoke structure, many MNCs have sought to implement the structure for their Latin American operations. However, when MNCs cast their sights on Latin America, they are quite often faced with a diverse and sprawling network of jurisdictions, each with its own rules and views on the operation of structures within their borders. Many MNCs doing business in Latin America learn that applying the European or Asian hub-and-spoke template to Latin America does not always result in a natural fit. In particular, MNCs that seek to implement a hub-and-spoke arrangement in Latin America must deal with the regional issues described below.

First, the determination of where to locate the Principal is not as easy in Latin America as it is in Europe or Asia. The ideal hub would be located in the region, have a low internal tax rate, and enjoy a strong treaty network. Moreover, to the extent that the MNC is U.S.-based, the potential to defer profits from U.S. tax is preferred. Unfortunately, no country satisfies all these criteria; therefore, MNCs need to optimize the location of the Principal based on their specific facts.

Second, Latin America lacks the economic integration of the European Union. As a result, MNCs operating in Latin America are forced to deal with authorities that take a provincial perspective on revenue collection at the cost of market efficiencies. In considering value-chain reorganizations in the region, MNCs must take into account the peculiarities of each jurisdiction and the current and evolving tax environment in the applicable countries. As with structures throughout other regions, it is important that an underlying business rationale drive the value chain reorganization within Latin America.

A third important factor is the ever increasing aggressiveness of the Latin American tax authorities. This aggressiveness manifests itself in a variety of forms. For example, many tax authorities in the region are attempting to assert “substance over form” principles to challenge structures that they consider “aggressive.” Even if they cannot successfully attack the overall structure, the tax authorities may attempt to draw profits back into their tax nets by asserting that the Principal has a local taxable presence or permanent establishment (PE). As electronic tax filing requirements and information sharing among the authorities increase in the region, the tax authorities have greater tools in their audit arsenals to press these arguments.

The foregoing factors require taxpayers to place their Latin American supply chain structures on a solid footing from a tax perspective. Mitigating unnecessary tax risks and unwelcome local publicity are, needless to say, high on the agenda of every MNC’s senior leadership team. With these considerations in mind, the MNC should ensure that it incorporates the elements described below into any supply chain conversion.

First and foremost, economic substance is an essential component of any supply chain conversion. As previously noted, MNCs must be sensitive to a “substance over form” argument by the Latin American taxing authorities. This means that any restructuring of existing operations should produce substantial operational changes and a corresponding adjustment to the parties’ potential for profits and risk of loss. A prudent MNC contemporaneously documents the business reasons for the restructuring and its anticipated economic impact on the enterprise. Anticipated local tax savings is typically not a valid business reason for local purposes. Moreover, savings generated by lower customs, VAT and payroll taxes will often not be considered an adequate business purpose absent a demonstration that the Principal has assumed substantial business functions and risks. The business reasons supporting the conversion ideally should include both commercial and operational benefits. Contemporaneous documentation of the business reasons behind the restructuring of the value chain is important for the MNC to maintain and will be very important if and when the arrangement is ever challenged by the taxing authorities on audit.

Even a structure with economic substance may, however, have adverse tax consequences if the parties’ new arrangements are not supported by a robust and geographically focused transfer pricing study. For this reason, the migration of functions and risks from local M&D subsidiaries to the Principal must be supported by an analysis demonstrating that the parties’ post-conversion potential for profit and loss is commensurate with their post-conversion functions and risks. Moreover, the analysis should demonstrate that the conversion does not result in a transfer of value from M&D subsidiaries to the Principal. What this means is that any reduction in the M&D subsidiaries potential for profit must be balanced with a commensurate reduction in their risk of loss.

In reducing the M&D subsidiaries’ risk of loss, the MNC should be careful that it does not transform them into agents of the Principal that are guaranteed a return for services, regardless of their performance. If the M&D subsidiaries are viewed as agents of the Principal, the Latin American fiscal authorities may assert that the Principal has created either a PE under the provisions of a bilateral tax treaty, or an internal tax presence or nexus in the absence of a tax treaty.

Our article in Practical Latin American Tax Strategies explores the aspects of the typical Principal M&D arrangement to its three primary classes of participants: the Principal, the Manufacturers, and the Distributors.


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Regional Reorganization: Be Aware of Tax Issues

Excerpt from Practical Latin American Tax Strategies
published by WorldTrade Executive, Inc.

By John A. Salerno and Julian R. Vasquez (PricewaterhouseCoopers LLP)

Multinationals considering the reorganization of their group legal entity or operational structures in Latin America need to be cognizant of the potential income tax implications related to the sale or transfer of shares or other equity interests in their affiliates.

While most companies are keenly aware of the tax implications relating to the sale of a direct or indirect subsidiary to a third party, many do not realize that an intra-group transfer of shares in connection with, for example, the formation of a regional holding company structure or post-deal integration planning, may also trigger tax in certain Latin American countries. Absent tax treaty protection the tax cost of the transfer of shares can be quite high.

In some cases the relevant taxable “transfer” is not so evident, and may occur, for example, as a result of the liquidation of a nonresident shareholder of a Latin American company.
Domestic law or tax treaty-based strategies often exist to minimize or eliminate the local country income tax burden on capital gains. Thus, particularly in the case of transactions with related parties, slight modifications of a transactional structure may, in certain cases, yield a more favorable tax result.

This article, which appears in full in the May 2008 Practical Latin American Tax Strategies summarizes the income tax treatment of the transfer of privately-held and publicly-traded shares in ten Latin American jurisdictions, and highlights some tax strategies. A portion of the article relating to Brazil follows:

Brazil

Private Companies

Gains recognized in connection with the sale or transfer of shares of a Brazilian privately-held company by one nonresident to another are generally subject to capital gains tax at a 15% rate. This rate is increased to 25% to the extent that the seller (or transferor) is located in a tax haven jurisdiction.

The gain is subject to Brazilian tax even when both seller/transferor and buyer/transferee are nonresidents of Brazil. Unlike Argentina, Brazilian law imposes the obligation to pay the Brazilian capital gains tax on the buyer's (or transferee's) representative domiciled in Brazil (note that foreign shareholders of Brazilian companies are required to have a Brazilian-domiciled representative, in addition to being registered before the local Revenue Service).

Capital gains generally correspond to the positive difference between (i) the amount for which the shares are sold/transferred (i.e., the selling price), and (ii) the amount at which those shares are registered in the name of the seller (transferor) with the Brazilian Central Bank. In the case of the sale/transfer of shares that were previously acquired from other parties, there may be grounds to sustain that the acquisition price should be used in lieu of the amount registered with the Brazilian Central Bank as foreign capital.

Tax treaties generally do not provide relief from income taxes imposed on capital gains recognized by nonresidents (except for the Brazil-Japan treaty, which exempts capital gains from Brazilian tax). Certain tax planning, however, may be available to mitigate taxes on capital gains.

Publicly-Traded Companies
Capital gains recognized by foreign investors in connection with the sale of Brazilian publicly-traded shares are subject to Brazilian tax at a 0% or 15% rate as follows:.

- 0% when the foreign investor is not located in a tax haven jurisdiction and the investment was originally made in accordance with Resolution 2689 (which provides for special foreign investment accounts that may only be used by the foreign investor in the acquisition of certain regulated investments, such as the shares of Brazilian companies listed with the Brazilian SEC).

- 15% in all other cases.

Other Taxes

No other Brazilian taxes should apply on the transfer of shares/interests in local entities.

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