Introduction
With the ongoing globalisation, companies are facing increasing competitive pressure. This has intensified in the wake of the economic downturn. Managers have to respond to the change and one way is to reorganize their company structure to produce more efficiently and to generate cost savings in order to survive and grow in the global market. Although an adverse impact of restructuring should not be neglected. Business restructurings may result in enormous tax impact. Germany for instance introduced transfer of functions regulations in the meaning of Section 1 paragraph 3 clause 9 of the German Foreign Tax Act. This article provides ideas why the current economic downturn might be a restructuring opportunity. 

Restructuring in the economic downturn
Due to the impact of the credit crunch and the ongoing economic downturn, various companies are facing periods of losses or small profits. Managers have to rethink their strategic orientation and how they can "spice up" their business models. This crisis could be viewed as an opportunity for optimizing the business structure and achieving competitive advantages in the future, including via cross-border transfer of functions. Due to the German law, a one time exit charge is imposed on the cross-border transfer of functions out of Germany. The entrepreneurial freedom of decision is consequently somewhat restricted and could constrain the strategic business reorientation. The transfer price for this shall be determined primarily using the factual arm’s length test. Anyhow, the German financial administration itself asserts that this is not the rule of thumb. So, that this exit charge is normally calculated by a hypothetical arm's length test. That means that the taxpayer has to determine this exit charge based on the transfer package approach. The valuation is based on the capitalised net profits after tax (net present value) of the transferring and the receiving company. The valuation of both parties should form an agreement zone, e.g. the minimum price of the transferor and the ceiling price of the transferee. The median is the initial point for the exit charge. If the taxpayer cannot demonstrate that  another value within the agreement zone is more appropriate. This transfer package approach is relevant for taxation, if the summation of the individual valuation of assets does not lead to a result within this approach.

The capitalised net profit method requires each party to forecast the future net profits after tax and to estimate the discount rates in order to determine the transfer package value. For this, the risk free market interest rate adjusted by a risk premium is used which should reflect the functions performed and the risks assumed.  Based on this approach, the current unfavourable financial results and negative forecasts would lead to lower capitalised net profits after tax. The agreement zone will be lowered which ultimately lower the exit charge. The decreased profitability provides the taxpayer with an argumentation background. The current interest level (pursuant to the yield curve of Deutsche Bundesbank) for the risk free market interest rate is low. Contrarily the risk premium should be higher. The net effect, whether the discount rate increases or decreases, results from this point. The discount rate has an upward trend when the increase in risk premium is stronger than the decline in the risk free market interest rate.

The main criterion is the future net profit after tax, because companies could transfer a loss or only small profit making function to another company in order to be profitable again. In this connection, the Transfer of Functions Order states in Section 7 subsection 3 that the costs of closure could be the scope for the agreement. "The behaviour of an orderly and conscientious business manager might be to cut his losses by agreeing a price for the transfer that only partially covers the costs of closure, or to pay compensation to the transferee to take over the loss maker." Even if this does not fit exactly, the transferor and also the transferee would calculate with lower net profits after tax than in profitable periods. Because of this, the minimum price of the transferor and the ceiling price of the transferee will drop. Therefore the agreement zone will be lower. Due to this fact, it could be possible that now the sum of the individual valuation of assets lead to a result within this transfer package approach. Then the individual valuation approach is relevant for taxation. 

If this does not succeed, the taxpayer nevertheless has a credible argument to reject the median as the basis for the exit charge. No orderly and conscientious business manager would continue a function, which is loss generating, so the transferring company is in a weaker negotiating position than the buyer. If at all the median could only be an impartial arbitrator resolution. Against the background of the going concern assumption the shifting of a function provides at least two more opportunities. In the course of the transfer of functions approach the hidden reserves have to be uncovered and are subject to taxation. If the company faces losses and/or has tax loss carry-forwards the uncovering of the hidden reserves will not be taken (fully) into account for the taxable amount. Hence, this reduces the exit charge for the business restructuring. This opportunity is more worthwhile, if for instance the company can not use these losses anymore or in the near future. Another opportunity is to strengthen the equity capital base due to the restructuring so that the creditworthiness will increase.

The uncovering of the hidden reserves leads to a stabilisation of the equity capital base. This could be followed by an increase of the creditworthiness, which leads to a better rating and therefore to a lower interest rate.It is necessary that the conditions in the country of the transferee are also considered. Without depicting in detail the transferee's perspective, it is questioned if the host financial administration accepts the transfer package valuation and hence, the capitalisation and amortisation of the transfer package. Because of the unique German approach it does not seem common that foreign countries accept a whole valuation. An individual valuation is more general, e.g. in India and the United States. On the other hand, this could be a opportunity for these countries to attract new investments (for instance Germany accepts the transfer package valuation and thus the capitalisation and amortisation). If it is not accepted by the host country, this will lead to double taxation. Nevertheless, the double taxation will be lower, because of the lower transfer price of the function. There is therefore, a savings potential in a sense, when the restructuring is performed during the economic downturn. On the other hand, it is possible that the individual valuation approach is adopted because the summation of individual valuation of assets leads to a result within the price range  of the transfer package approach. Then the capitalisation and amortisation of each asset is possible and the risk of double taxation problem would be reduced.
 

Conclusion
A business restructuring could be a necessary step to compete in the global market, especially in the ongoing economic downturn. An exit charge resulting from shifting a function out of Germany could be significantly reduced in a period of turmoil. Therefore, as in the current financial situation, companies may find business restructuring opportunities for their future position in the global market. Nevertheless, the taxpayer should not make hasty decisions. A strategic long-term view should be taken into account.

Jobst Wilmanns

Stefan Greil

Jobst Wilmanns
Transfer Pricing Partner
Email: Jobst.Wilmanns@de.pwc.com

Stefan Greil
Transfer Pricing Associate
Email: Stefan.Greil@de.pwc.com

PricewaterhouseCoopers AG WPG
Frankfurt am Main, Germany
Tel.: +49 69 9585 0