ITD Global Conference Corporate-Shareholder Tax Issues [Part XIV]

1. ITD Global ConferenceCorporate-ShareholderTax Issues [Part XIV] [Financial Institutions and Instruments—Tax Challenges and Solutions] Seth E. Terkper

2. Nature of Corporate Entities • Corporate bodies (companies) are deemed • To be separate legal and accounting entities • Business (artificial) separate from investors (natural or artificial) • Shareholders (equity) are owners; bondholders (debt) lenders • Unique ownership, management & supervisory structures • Compare to sole proprietors & partnerships • Financing and asset structure (Balance Sheet) • Assets (A) – Liabilities (L) = Net Assets (NA) = Equity (E) • A = FA + CA; WC = CA-CL; and E includes retained earnings • L = bonds + bank (loan/overdraft) + trade (credit) • Equity and bonds (and derivatives) • Traded (Stock X, OTC or private); not always held to term ITD Seminar_S. Terkper

3. Leverage or gearing • Equity/debt ratio • Positive ratio (e.g., 2:1) means equity finances most FA & WC • Negative NA means heavier reliance on debt • Debt may include bank loans and trade credit • Finance sector—traditionally high leverage ratios • Deemed safe because of guarantees • WC (CA:CL ratio) may rely heavily on debt • Dilutes conventional meaning of gearing • High leverage roped creditors, banks and depositors (and even consumers) during financial crisis ITD Seminar_S. Terkper

4. Returns to investors • Interest (incl. premiums/discounts) • Pre-tax returns to bondholders is part of business expenses • Deemed favourable since bondholders pay only PIT • Dividends and retained earnings • Dividends paidafter interest & corporate income tax (CIT) • Double taxation due to incidence of PIT & CIT • No imputation or tax credit • Tax deferred on retained or undistributed earnings • Capital gains tax • Tax on realization (i.e., sales/transfers) means tax deferral • Also subject to low tax rate in several jurisdictions • Comprehensive income taxation • 1990s reforms recommending uniform PIT, CIT and capital gains tax rate structure not implemented ITD Seminar_S. Terkper

5. Shareholder tax issues • Tax neutrality • Debt/equity mix irrelevant in economic context • Denoted as (1-rint) = (1-rcit)(1-rdiv) [re: Modigliani-Miller, others] • In practice, above symmetry may be difficult to achieve • Meaning (1-rint) > (1-rc)(1-rdiv) or (1-rint) < (1-rcit)(1-rdiv) • Regulatory, tax & accounting interventions • Aims at conventional gearing and complex instruments • Pre-tax (interest); double taxation (dividend) and deferral (CGT) may be significant enough to cause distortions • Derivatives/swaps (debt, equity, interest, credit etc) • Asymmetry due to non-tax factors (managers’ risk-taking) • May require the use of tax to correct such distortions, evasion and avoidance ITD Seminar_S. Terkper

6. Shareholder tax issues • Gearing ratio • Countries restrict debt/equity ratio (Ghana 2:1) • An anti-evasion and anti-avoidance response to tax planning • Restriction applies to financial institutions • Main effect on off-shore financing of subsidiaries, mainly natural resource sector • Gearing may involve working or operating capital • For example, borrowing from banks to finance mortgage/mortgage-backed securities was important factor in global crisis ITD Seminar_S. Terkper

7. Shareholder tax issues • Tax rates • Often no special CIT/PIT rates for financial sector • No imputation or tax credit in many countries • However, relief may be embodied in some tax treaties • Special rates/exemptions for bank savings and pension returns • Final flat rates for CGT (5-10 percent) ITD Seminar_S. Terkper

8. Shareholder tax issues • Complex financial institutions & instruments • Derivatives/swap dilute conventional investment and returns structure • Investors face risk-management, tax planning and compliance (evasion and avoidance issues) • Not critical in developing countries—unsophisticated markets • Likely transaction-by-transaction approach • Attempt to attribute returns to debt and/or equity • Retains interest (pre-tax); dividends (double-tax/deferral); and capital gains (realized) categorization ITD Seminar_S. Terkper

9. Shareholder tax issues • Other tax issues • Investment incentives • Several: include generous sector preferences (e.g., real estate, capital allowances, low CIT rates and tax holidays • Given fixed interest rates, implies significant pre-tax benefits that flow to equity investment • Exemptions and withholding—returns on savings, pensions and government bonds often subject to low rate/exemption • Bad debts– no special loan provisioning for financial sector • Indirect tax—VAT exemption of financial services: cross-sectoral benefits/costs (i.e., cascading) • Financial sector is fastest growing nonetheless ITD Seminar_S. Terkper

10. Conclusions • Tax arbitrage and planning • Medium-to-long term goal is to make country low tax regime • Debt/equity ratio: not likely to be abolished • Therefore, could continue to limit tax planning • Transfer pricing (e.g., management fees/ services in resource (and expanding financial) sector • Need to observe investor behaviour in emerging oil sector ITD Seminar_S. Terkper

11. Conclusions • Taxation and investment decisions • Tax issues low in making most investment decisions • Investors tend to find optimal debt/equity ratio • In spite, countries willing to attract generous incentives • Incentives may be generous enough to influence decisions and influence debt/equity decisions • Incentives likely to favour equity, given predetermined returns on debt • Most likely to be exploited by multinational companies, notably in natural resource sector • Hence, aim of most tax compliance regulations (.e.g., gearing ratio) is to influence parent-subsidiary decisions ITD Seminar_S. Terkper

12. Thank you ITD Seminar_S. Terkper