Financial funnies and tax traps

Europe is proving to be a popular destination for US companies looking to set up operations or raise finance abroad. However, the European market is very different to the US so requires careful research and planning. Geoff Woodhouse, partner in the International Business Group at Moore Stephens LLP in London, looks at some of the financial and tax implications for US companies looking to enter the European market

US companies are increasingly looking to Europe to set up new operations, new businesses or simply to raise finance. But like any new business venture, it requires planning and guidance to get it right, particularly when it comes to financial issues.

There are many reasons why a US firm will want to establish an operation in Europe but primarily it is to gain access to the EU market. The EU has expanded significantly with a number of member states, particularly the Central and Eastern European accession countries, now coming on board, that offer very favourable opportunities for manufacturing in particular. US companies are also increasingly setting their sights on Europe, particularly London, to help raise money. Turning their backs on the likes of NASDAQ, firms are looking to the AIM market in particular as a new source of finance.

Regulation and compliance have played a large part in forcing US companies to look further afield. The US has become engulfed in regulation and additional costs, partly due to the implementation of the Sarbanes-Oxley Act of 2002, which has become a major issue for small listed companies in particular. For example, Section 404 of the Act requires management of companies registered with the Securities and Exchange Commission to report on the effectiveness of internal controls over financial reporting at the end of each financial year.

Section 404 also requires management to obtain a report from the company’s auditors attesting to management’s assertion about the effectiveness of internal control. Unsurprisingly, both management and auditors have taken fright and are either substantially increasing their compliance costs or looking overseas. Europe is an obvious choice because of cultural and trading ties and a seemingly less regulated environment.

In Europe we have made the financial reporting and listing rules rather easier for US companies by adopting International Financial Reporting Standards (IFRS) for listed groups across the EU. The IFRS rules will be somewhat familiar to US firms due to their similarity (and increasing harmonisation) with US GAAP. European corporate law remains rather foreign for US investors, however that is changing. The UK, for example, has recently put forward a company law reform bill in a bid to reduce regulation — something that will no doubt attract US interest.

Also luring US companies to European shores are Europe’s historic ties with other areas of the world. The UK in particular has strong ties with the likes of China, India and Dubai making it an ideal inroad into these markets for US firms looking to branch out in the short, medium or long-term. But, like any new market, entering Europe is not without its pitfalls. One of the biggest hurdles for US firms to overcome is European social and employment law.

Whereas US firms will be used to “at will” rules, the EU has very strict regulations in place when it comes to working time, minimum wage, consultation and dismissal — something US companies may find difficult to swallow. Another potential sticking point is the corporate pension deficit. Notwithstanding the US corporates’ commitments to post-retirement healthcare, levels of pension underfunding in Europe are considerably higher than in the US. This is something that will require careful consideration and planning prior to the acquisition of a European corporate which still has a defined benefit pension scheme.

US firms looking to raise finance in Europe should also be aware of changes afoot regarding the capital markets. The European markets may well currently offer much lighter regulation than that encountered in the US but all that could be about to change with the pending introduction of a European version of the Public Company Accounting Oversight Board (PCAOB) tightening up corporate governance and financial reporting.

Staying with regulation, US companies will also have to familiarise themselves with the UK Financial Services Authority (FSA) and European equivalents. As UK firms will tell you, it’s hard enough getting to grips with ever-changing FSA regulation when you’re UK-based let alone if you’re coming in from outside. Europe is also home to a number of tax issues and traps. For example, Luxembourg and the Netherlands have substantial capital taxes which will be very unfamiliar to US corporates. Withholding tax is another feature in certain jurisdictions which can pose problems for US investors. With tax treaties between the US and Europe being far from perfect, if they’re not careful US companies could end up paying tax twice.

US companies planning to set up European subsidiaries should also watch out for the extensive transfer pricing regulations in Europe which can make intra-group transactions difficult. US firms will also need to think about the management and control of their European operations prior to any move into Europe. In most EU member states, a company incorporated there will automatically be resident there. However, if it is effectively managed and controlled from the US, then we would look to the “tie-breaker” clause in the relevant tax treaty to determine where the company is really resident for tax purposes.

There are also certain peculiarities of European corporate governance that you should be aware of, particularly in civil law jurisdictions. In many states, for example, the executive management board is overseen by a supervisory board and often there is a requirement for employee/union participation. These concepts will be unfamiliar to US companies so should be researched and understood thoroughly before going ahead with any European investment.

As with any new venture, getting the right guidance and assistance from day one is vital. There are numerous financial and tax implications of entering the European market so it is important to seek advice from a firm that is familiar with the European systems. Moore Stephens, for example, regularly advises US companies on structuring a business for the European market, corporate finance including transaction support and due diligence, corporate governance, risk management, tax advice and general business assistance.

Given the unfamiliarity of the European market for many US companies, having access to advice that is tailored to suit you and your business is priceless.

 

Geoff Woodhouse is a Fellow of the Institute of Chartered Accountants in England and Wales and an Associate of the American Institute of Certified Public Accountants.

 

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