- The newly-created Spanish “bad bank” (SAREB) has been transferred a EUR 50.8 billion pool of loans and real estate assets from Spanish credit entities that were totally or partially nationalized, as well as the legal mandate to liquidate the entire portfolio in 15 years.
- A legal framework has been enacted to facilitate the divestment process. In particular, a new type of investment vehicle with a privileged tax regime has been implemented to attract investment by non-Spanish resident investors. The vehicle is taxed at a 1% CIT rate and income obtained by non-resident investors (including residents in tax havens) will be tax exempt in Spain.
- SAREB already announced divestitures in 2013 and the pipeline for new projects is extensive and appears to have attracted the attention of the largest international real estate firms as a result of the significant price discounts and the efficiency of the investment structure.
- Amid the generally improved outlook of the Spanish economy and the increased stability in the Eurozone, the Spanish real estate market appears to be taking off after multiple years of significantly reduced activity.
In the context of the EUR 100 billion external financial assistance requested by the Spanish Government with the aim of facilitating the restructuring and recapitalization of the Spanish banking sector, a memorandum of understanding (MOU) was agreed in July 2012 by and between the Spanish Government and certain European Union authorities (with the participation of the International Monetary Fund) by virtue of which specific political and financial-related conditions were imposed on Spain.
Key elements of the roadmap provided under the MOU included: (i) the identification of the individual capital needs by each of the Spanish banks by means of a “bottom-up” stress test (as well as a determination of which banks would need public support to complete the necessary recapitalization); and (ii) the segregation of the impaired assets of banks under public control or receiving public assistance and their transfer to a “bad bank”.
As a result of the stress test undertaken by Oliver Wyman and released in September 2012, the Spanish banking sector was divided into four groups: group 1 (comprising banks already nationalized, such as Bankia); group 2 (banks with capital needs that would likely lead to the bank requiring public assistance); group 3 (with lower capital needs and no expectation of public intervention); and group 4 (without further capital needs).
In November 2012, legislation enacted in consultation with the European Commission, the European Central Bank, the European Stability Mechanism and the International Monetary Fund provided for the creation of the Spanish “bad bank” (denominated the Sociedad de Gestion de Activos Procedentes de la Restructuracion Bancaria, or SAREB) and the establishment of a specific legal and tax framework applicable to the bank.
Creation and main features of SAREB
SAREB is a for-profit corporation which overarching objective is the management and, ultimately, the divestiture of the assets received from the contributing banks within a period of no more than 15 years.
The contributing banks are those financial institutions included under groups 1 and 2. Assets transferred to SAREB between December 2012 and February 2013 were primarily: (i) foreclosed real estate assets with a net book value exceeding EUR 100,000; (ii) (not necessarily non-performing) loans to real estate developers with a net book value exceeding EUR 250,000; and (iii) controlling shareholdings in real estate companies. Assets for an aggregate value of approximately EUR 50.8 billion have been transferred to SAREB, which price reflects an average haircut over gross book value of approximately 63% for foreclosed assets and 45% for loans. As consideration, SAREB issued state-guaranteed senior debt securities in favor of the participating banks. The securities have been structured to meet all requirements to be accepted as collateral for purposes of European Central Bank financing.
In order to fund operational needs, SAREB has raised equity for an aggregate amount of EUR 4.8 billion (25% share capital and 75% subordinated debt). A public-controlled fund for the restructuring of the Spanish financial sector (FROB) is the major shareholder with 45% of the equity holdings, while the remaining equity (55%) is held by a number of Spanish and foreign financial institutions (including Spanish banks under groups 3 and 4), insurance companies, and leading industrial corporations.
Divestment alternatives: Banking Assets Funds
Although SAREB may decide to refinance or further develop some of the assets received in order to maximize their value, the ultimate objective is the profitable liquidation of the entire pool of assets within the 15-year statutory deadline, either through the full collection of the principal of the loan (where feasible) or, most likely, by transferring the asset.
While the discounted price at which SAREB acquired the assets is itself an incentive for transfers, an ad hoc structure was created by law to facilitate the acquisition by foreign institutional investors of SAREB assets in tax-advantageous conditions.
In short, SAREB is able to divest the assets by incorporating insolvency-remote vehicles (denominated Banking Assets Funds, or BAFs) that provide structural flexibility and a favorable tax regime for investors and the BAFs themselves, subject to the condition that either SAREB or the FROB retain a stake.
BAFs can therefore be featured as joint ventures between investors and SAREB, and can be used to repackage different types of assets. Furthermore, BAFs’ liabilities can include loans, debt securities, quasi-equity instruments, several types of credit enhancement instruments or a combination of several. As a result, investors will have the flexibility to invest or co-invest in one or multiple tranches of BAFs whose assets were previously cherry-picked by investors (or “put on sale” by SAREB). Although the representation and management of the BAFs is legally reserved to regulated Spanish entities (securitization funds management companies), there is an expectation that, and experience has already shown, the leading role when it comes to material decisions (e.g., the sale of an asset allocated in a BAF) will be placed in the hands of investors or an asset manager appointed by them.
Nevertheless, in general, the main benefit of investing in SAREB assets through a stake in a BAF, as opposed to a direct acquisition of the relevant assets by the institutional investor or a subsidiary of the same, is tax-related. While the BAF itself enjoys a privilege treatment (for instance, a 1% corporate income tax rate as opposed to 30% for regular Spanish corporation), the key element of the scheme is the privileged tax regime applicable to the BAF’s stakeholders, particularly non-resident holders: non-resident entities without a permanent establishment in Spain investing in BAFs, including those domiciled in tax havens, will benefit from a full Non-Resident Income Tax exemption on income (interest, distributions) and gains (transfers) deriving from their BAFs’ stakes. Thus, from a tax standpoint, investment in real estate assets using a BAF would be the optimal option in contrast to using a regular corporation for the same objective (which would imply 30% CIT and, if not properly structured, Spanish taxation on income received from the vehicle).The privileged tax regime will only apply as long as SAREB or the FROB remains exposed to the BAF with, in principle, a stake of at least 5%.
Although the resulting outcome of the BAF joint structure is that SAREB will only partially dispose of the assets (as it would still have indirect exposure to them through its stake in the BAF), these assets will now be managed by specialist investors and SAREB will likely benefit from some portion of the upside upon exit.
Debut transactions and prospects
Following the completion of the process to group all assets transferred from the contributing banks and a comprehensive internal commercial and legal due diligence, SAREB has started to test the waters with a number of projects involving diverse types of assets.
Transparency and competitiveness have been key elements in all divestment processes. SAREB has proactively put specific groups of assets “in play” (perhaps after perceiving specific interest in the marketplace) and, with the assistance of corporate and real estate advisors, have organized auctions general open to bidders. The improved outlook of the Spanish economy, the increased stability in the Eurozone and the attractive features of the potential transactions (both in terms of price and tax-efficiency) have incentivized some of the largest international private equity and real estate investment houses to submit bids in these auctions.
Bull Project, whose EUR 100 million portfolio included real estate developments located in eight different Spanish regions, was the first auction completed last August. The selected buyer was H.I.G. Capital (through its affiliate Bayside Capital) and the transaction was structured through a BAF which will be held by H.I.G (with a 51% stake) and SAREB (with a 49% stake). Prestigious funds such Lone Star, Apollo, Colony, Centerbridge and Cerberus were reportedly among the other bidders in the auction.
As of July 2013, SAREB had sold 1,800 retail residential assets through the participating banks’ branch network. That figure increased to around 6,400 real estate assets as of November 2013. In addition, a portfolio of stakes in syndicated loans granted to Spanish listed real estate companies (Metrovacesa and Colonial, for approximately EUR 1.2 billion) have also been transferred to an undisclosed investor and Burlington, respectively. Other transactions in SAREB’s pipeline (including urban and rural land, luxury homes, shopping malls, office projects and additional stakes in loans to Spanish listed real estate companies), are expected to be announced before the end of the year or in the first quarter of 2014.
The general perception that the Spanish economy and real estate market have bottomed out and that prices now reflect the fair market value of the real estate assets is also contributing to a significant activation of the Spanish real estate M&A sector after several years of dramatic downturn. Some of the 2012 and 2013 deals included the acquisitions by TPG, Cerberus and a consortium of Kennedy Wilson and Varde of the Caixabank, Bankia and Catalunya Bank’s real estate portfolio management companies, respectively (and Grupo Santander and Banco Popular are also in the process of selling their recovery units). In all the cases of these sales of servicing companies by healthy banks, the managed assets are not transferred, but retained by the transferor. Other recent highlights include the purchase of Aktua (the former customer collection company within the Santander group) by Centerbridge, the approximately EUR 200 million sale by the Madrid regional government of a group of 3,000 subsidized apartments to a Goldman Sachs affiliate, and the pool of 1,860 rent-controlled properties sold by the City of Madrid to Blackstone for EUR 125 million.
Furthermore, all signs seem to indicate that the Spanish real estate market will continue to provide attractive opportunities for international funds in future months. SAREB projects will continue to fuel the activity, as SAREB’s business plan contemplates the divestiture of half of its portfolio during its first five years of existence. Additionally, most of the Spanish banks within groups 3 and 4 created their own “bad banks” in late 2012, into which they transferred all foreclosed assets as well as those acquired through debt-to-asset transactions. As the banks try to refocus on their core business, most of these “bad banks” (some of which became major Spanish real estate companies in terms of volume of assets) are up for sale, attracting the attention of the international investors.
For investors in distressed assets, undertaking appropriate servicing actions is a key element in their long-term plans to recover value on acquired bad debts. The offsetting up of local teams and the acquisition of Spanish collection platforms and real estate management companies by the largest international funds suggests that the investors are here to stay (at least for a while).
Nevertheless, there is no hope, or fear, of a new construction “boom” in Spain, as the main indicators on new construction, construction employment and cement consumption have remained weak. Conversely, experts consider that Spain is living in a period of price correction and reordering of the real estate existing stock which will produce attractive yields to those who are able to anticipate and invest at these valuation levels.
In cross-border acquisitions, more than one country’s tax rules will apply. English law is frequently chosen to govern such transactions. This article highlights a number of the main tax issues arising in cross-border share and asset purchases, and discusses how some of these issues can be eliminated or mitigated through efficient structuring or specifically addressed in the sale and purchase agreement.
A cross-border private acquisition is an acquisition of one or more private businesses comprising companies and/ or assets, where the purchaser, the seller and the target companies/assets are not all in the same jurisdiction. The cross-border element of these transactions inevitably means that more than one country’s tax rules will be in play in the same transaction. English law is frequently chosen to govern these transactions and it is usually commercially desirable to have one set of contractual provisions applying across the board.
In this article, we highlight a number of the main issues that do not arise on solely UK acquisitions. Some of these can be eliminated or mitigated through efficient structuring and some may need to be dealt with specifically in the sale and purchase agreement.
ISSUES COMMON TO SHARE AND ASSET PURCHASES
Withholdings required from the purchase price
If a withholding for or on account of tax is required from the purchase price, it would go directly to value by affecting the amount receivable by the seller or, if a gross up is included in the agreement, payable by the purchaser.
Who should bear the cost or risk of a withholding? Where it is clear that a withholding is required, the question is made easier as the cost is known, so it can easily be factored into price.
The more difficult question is who should bear the risk where it is not certain that a withholding is required as it is harder to factor that risk into price. On one hand, withholding is a requirement on the purchaser and the purchaser will at the time of payment need to decide whether to withhold. And, if there is no gross up, there is not much commercial pressure on a purchaser to be robust in taking a view that a withholding is not required. On the other hand, in most circumstances withholdings relate to the location of the assets being sold and the tax position of the seller.
Should the parties seek confirmation from the appropriate tax authorities that no withholding is required or would that raise an unnecessary red flag? If the seller takes the risk, should there be conduct rights and/or an indemnity against the purchaser’s costs of being pursued by a tax authority after completion in respect of a withholding that the tax authority asserts should have been, but was not, made?
Allocation of consideration
In a cross-border transaction, more than one tax authority is likely to have a vested interest in how the purchase price is allocated between the target assets and/or shares. Not only might such authority disagree with the parties’ allocation, it might also disagree with the opinion of other tax authorities. This makes the issue of allocation more complicated than on a purely UK transaction and so the parties will need to ensure that they have robust defensible positions so that they obtain the tax value they expect from the transaction.
Indemnity and warranty payments
In a UK transaction, ESC D33 provides comfort that where payment is made by a seller of an asset to a purchaser under a warranty or indemnity included under the terms of sale, the consideration for the sale will be adjusted and that payment will not be treated as a capital sum derived from the asset. Most jurisdictions take an equivalent approach, but not all may.
Other jurisdictions may take different approaches on related matters. On a recent Brazilian transaction the target company would have obtained tax relief for the settlement of certain tax liabilities covered by the tax covenant (whilst this may be the case in the UK for employer’s NICs, it is not generally so) and the purchaser was expecting tax depreciation in respect of a significant part of the purchase price. As payments under the tax covenant would have constituted reductions in consideration, the purchaser would have suffered a significant loss of tax depreciation on those payments being made. Here, the combination of a payment under the tax covenant (which would ordinarily have been calculated taking into account the tax relief available on settlement of the tax liability) and a gross up for tax on receipt would not, due to the reduced tax depreciation, have put the purchaser back in the position it would have been in had the relevant tax liability not arisen. That would have been unacceptable from the purchaser’s perspective. The parties could have used a gross up that, as well as covering tax on receipt, covered the loss of tax depreciation. In the circumstances, however, the parties decided it was preferable for both sides to ignore the tax relief available on settlement of the tax liability in calculating the amount due under the tax covenant, the benefit of which would roughly equate to the lost tax depreciation, and to use a gross up for tax on receipt only.
Any stamp duties or other transfer taxes arising on the transaction should be identified at an early stage. It might be that on a global purchase some of those could be mitigated by, for example, having a local transfer agreement for a particular jurisdiction.
Could anything done by the seller affect the transfer taxes payable? In Italy there is currently a concern that a pre-sale business hive-out to another group company followed by a sale of the transferee to a third party might be recharacterised as a direct sale of the business to the third party, resulting in significant transfer taxes for which the parties involved could be jointly liable.
Transitional services may be required by the purchaser. In a cross-border deal, care should be taken to ensure that there is no unnecessary tax leakage in providing or paying for those services, particularly due to withholding tax on cross-border payments and different VAT requirements in the relevant jurisdictions.
ISSUES ON SHARE PURCHASES
On acquiring companies, a purchaser may request a tax covenant to protect it against unexpected tax liabilities of those target companies. A UK-style tax covenant can generally be tweaked to cover non-UK jurisdictions in which the target companies are liable for their own tax liabilities; however, special attention must be given to jurisdictions in which target companies are taxed on a consolidated group basis and part of the consolidated group is purchased.
As a matter of local law, are those target companies responsible for tax relating to their own actions or income, profits and gains? If not, subject to the next point, is a tax covenant actually required?
Are there any “re-charges” in respect of that tax for which the target companies could be liable and are those target companies in any way liable for the consolidated group’s tax? If so, a tax covenant would need to be tailored accordingly.
Do exit charges arise on leaving the consolidated group? Who benefits from pre-completion reliefs and is there a requirement for payments to be made in respect of them? Care must be taken to ensure that local tax law does not cut across the intention behind the contractual tax protection.
Change of control
When companies are acquired, there is likely to be a change of control both at the level of acquisition and for subsidiaries below. This can lead to tax being triggered in the acquired group (such as, in some circumstances, German real estate tax) as well as deferred tax assets being put at (increased) risk. It might be possible to mitigate some of those effects through careful structuring.
We note above that it is usually commercially desirable to have one set of contractual provisions applying across the board. That is true in relation to ongoing compliance matters, although there may be certain bespoke provisions needed in relation to particular jurisdictions. Further, if the seller is exiting a particular jurisdiction, it might make sense for the purchaser (or target company) to prepare pre-sale tax returns with the seller having a right of review, as opposed to the other way around.
ISSUES ON ASSET PURCHASES
In a UK share purchase it is common for a purchaser to seek protection in respect of certain of the target company’s tax liabilities, but, on an asset sale, protection is not generally sought for any tax relating to the business’s pre-completion profits. That is because, as a matter of English law, such tax liabilities do not transfer to a purchaser. That might not be the case in other jurisdictions and, in such cases, bespoke protection for succession taxes may be advisable.
Do the parties expect the asset transfer to constitute a transfer of a going concern and so be outside the scope of VAT? Whilst VAT law in all EC countries should derive from the same starting point (Articles 19 and 29 of the Principal VAT Directive (Directive 2006/112/EC)), each such country may require the fulfilment of different conditions in order for relief to be available — the sale contract would need to cover those conditions.
Whilst the above is by no means an exhaustive list of the issues on cross-border acquisitions, it gives a flavour of some that can arise. Each transaction tends to involve bespoke issues which will need to be addressed.