LexUniversal | Legal Articles

United States: Words Matter: Financial Advisors Need to Be Careful Using Form Engagement Letters

2009-11-09

Financial advisors may be held liable to third-party beneficiaries for breach of contract and fiduciary duty claims based in part on the specific language in a form public-company engagement letter that was used for a private company transaction. The decision by the U.S. District Court for the District of Massachusetts in Baker v. Goldman Sachs ¹ demonstrates that some of the provisions in a form engagement letter designed to protect financial advisors in a public company deal may present distinct risks to the same financial advisors in a private company transaction.

Background

Goldman Sachs & Co. (“Goldman”) represented Dragon Systems, Inc. (“Dragon”), a closely held company founded and controlled by Janet and James Baker (the “Bakers”), in the merger of Dragon into a subsidiary of Lernout & Hauspie Speech Products N.V. (collectively “L&H”) on June 7, 2000. The Bakers alleged that Dragon entered into an all-stock merger with L&H in reliance on Goldman’s advice and that the collapse of L&H following an accounting fraud scandal uncovered by The Wall Street Journal within months after the Dragon-L&H deal closed resulted in a loss to Dragon’s controlling shareholders of approximately $300 million.

In an attempt to recover the consideration they were to receive, the Bakers filed suit against Goldman, asserting the following claims: (1) breach of fiduciary duty, (2) violation of Massachusetts unfair-practices statute, (3) breach of contract, (4) breach of contract / third-party beneficiary, (5) breach of the implied covenant of good faith and fair dealing, (6) negligence and (7) negligent misrepresentation. Goldman moved to dismiss all claims, contending that the Bakers were not parties to the engagement letter between Dragon and the financial advisor, and that its contractual and fiduciary duties ran exclusively to Dragon.

U.S. District Court Decision

Applying New York contract law, the court denied the motion to dismiss in principal part with respect to all counts, except for breach of contract. The court ruled that although the Bakers were not parties to the engagement letter, Janet Baker was an intended third-party beneficiary because she was a member of Dragon’s board of directors and a majority shareholder at the time of Goldman’s engagement by Dragon.

When interpreting the engagement letter, the court ruled that, while Goldman was hired by Dragon, the engagement letter showed an express intent of Goldman to benefit members of Dragon’s board of directors. The engagement letter included language customarily used by financial advisors in public company transactions; specifically, it stated that “any written or oral advice provided by Goldman Sachs in connection with our engagement is exclusively for the information of the Board of Directors and senior management of the Company.” Goldman argued that it referred to the board of directors in a representative capacity. However, the court emphasized that the letter not only was addressed to Janet Baker in her individual capacity, but also that the letter used the word “you” rather than “company” when discussing Goldman’s duty to provide “financial advice and assistance.” The court determined that “you” should be given its plain meaning, and therefore interpreted “you” to refer to the addressee of the letter, giving her enforceable rights under the engagement letter.

With respect to the fiduciary duty claims, the court found that the relationship among the parties was “muddy” and that special circumstances existed to create a fiduciary relationship apart from the terms of the letter of which Janet Baker is allegedly the third-party beneficiary. The court distinguished this case from Joyce v. Morgan Stanley & Co.,² where the Seventh Circuit held that the engagement letter explicitly noted that Morgan Stanley was working only for the corporation. Unlike Joyce, the court in Baker emphasized that there was no explicit waiver in the engagement letter precluding an extra-contractual fiduciary duty. In addition, the court in Baker concluded that the Bakers were central players in the transaction and were in close and direct contact with the financial advisor—not mere bystanders as in the typical shareholder suit.

Lessons Learned Thus Far with Regard to Negotiating and Drafting Engagement Letters in Private Company Transactions

Baker involved a motion to dismiss; litigation regarding the merits of the claims is ongoing. Nevertheless, this decision may serve as a reminder to financial advisors to carefully draft engagement letters in private company transactions. This case demonstrates that careful thinking and drafting can be key in avoiding post-transaction litigation, particularly at these preliminary litigation steps. For instance, the Baker case instructs, when negotiating and drafting any engagement letter, that consideration should be given to being precise in the choice of language, including the addressees of the letter and the use of the word “you.” If the engagement is intended to be between the financial advisor and the company, use of the word “you” may be replaced with the word “company” and the addressee of the letter should be the company, with attention to the members of the board of directors. In addition, if the company is the only party entitled to rely on the advice given pursuant to an engagement letter, consideration should be given to the utility of including express statements that any advice provided by the financial advisor is exclusively for the benefit and information of the company. With respect to fiduciary duties, financial advisors may want to consider the inclusion of an explicit waiver precluding extra-contractual fiduciary duties. Advisors may also wish to carefully note the type and quality of contact among parties associated with a transaction and the capacity in which each party serves.

While the Baker decision addresses financial advisors specifically, many of these lessons can be applied to the recipients of these letters and services. In many instances, bankers and their recipients refer to these letters as “forms,” and this case demonstrates that courts are likely to read the letters carefully, even if the parties do not.

Notes

¹ Baker v. Goldman Sachs, No. 09-10053-PBS (D. Mass. Sept. 15, 2009).
² Joyce v. Morgan Stanley & Co., No. 07-1992 (7th Cir. Aug. 19, 2008).

United States: Exception to Pennsylvania's One-Disease Rule: Pre-1992 Asbestos Plaintiffs May File New Claims

2009-10-28

On October 21, 2009, the Pennsylvania Supreme Court issued an opinion in Abrams v. Pneumo Abex Corp., et. al.,¹ following oral argument almost exactly one year ago. This decision creates a significant exception for plaintiffs who sued for a non-malignant asbestos-related injury prior to 1992 and recovered damages both for the non-malignancy and for their increased risk and fear of developing cancer in the future.

One-Disease Claims

In 1992, the Pennsylvania Superior Court, in its seminal decision of Marinari v. Asbestos Corp., Ltd.,² changed Pennsylvania from a “one-disease” state to a “two-disease” state, meaning that plaintiffs have separate causes of action for non-malignant claims and malignant claims arising out of their alleged exposure to asbestos. Prior to 1992, Pennsylvania was a one-disease state, and plaintiffs had two years from the onset of the first symptoms allegedly caused by their asbestos exposure to sue for all current and future asbestos-related claims, both malignant and nonmalignant. Prior to Marinari, plaintiffs suing for a non-malignancy claim could also recover for the increased risk and fear of developing cancer in the future. After Marinari, plaintiffs suing for a non-malignancy claim could recover only for that claim—and not for the fear and risk of developing cancer in the future—but could file a subsequent action if they later developed cancer that they alleged was caused by asbestos exposure.

Abrams Creates a Limited Exception to One-Disease Rule

The plaintiffs in Abrams sued multiple defendants in 1985 for nonmalignant diseases allegedly caused by asbestos exposure and in 1993 settled all of their claims relating to their asbestos exposure, including increased risk and fear of developing cancer in the future. In 2002, both of the plaintiffs were diagnosed with lung cancer, which they attributed to their asbestos exposure. Shortly thereafter, the plaintiffs filed suit against multiple companies, including John Crane, Inc., which were not defendants in the 1985 suit. John Crane filed a motion for summary judgment, claiming that the plaintiffs’ 2003 suit was barred by their 1985 settlement, as they had already recovered for their increased risk and fear of cancer. The Pennsylvania high court disagreed, stating that the plaintiffs’ “prior recovery does not preclude a subsequent recovery, from a new defendant, of damages for the actual development of asbestos-related lung cancer.”

The Abrams decision is likely to create a new cause of action for plaintiffs who recovered for non-malignancy claims and increased risk and fear of cancer before Marinari was decided. Plaintiffs who recovered for non-malignancy claims under Pennsylvania’s former one-disease rule can now file a second claim for a malignancy that was allegedly caused by asbestos exposure, if they can identify a defendant that was not a party to the first action.

Conclusion

Asbestos defendants should be aware that they may now be receiving claims from plaintiffs who were previously compensated under the one-disease rule in Pennsylvania. Defendants should determine whether they were a party to the previous suit and, if so, seek to be dismissed from the new suit. If the defendant was not a party to the prior suit, it should analyze the claim and determine whether the plaintiff can substantiate a claim of asbestos exposure against the new defendant. Companies that are most likely to be presented with “new” claims are those that were not defendants in asbestos litigation, or those that had a limited number of claims prior to the Marinari decision in 1992.

Notes

¹ The Pennsylvania Supreme Court docket number is 17 EAP 2009. The majority opinion is available at http://www.courts.state.pa.us/OpPosting/Supreme/out/J-138A&B-2008mo.pdf, and the dissenting opinion is available at http://www.courts.state.pa.us/OpPosting/Supreme/out/J-138A&B-2008do.pdf.
² Marinari v. Asbestos Corp., Ltd., 612 A.2d 1021.

United States: State Tax Amnesty and Voluntary Disclosure Programs

2009-10-14

Our tax system is based on voluntary compliance. That is, the principle that taxpayers voluntarily comply with the tax laws and report their income and other tax items honestly. Some taxpayers, including individuals and businesses, neglect to file their tax returns and pay taxes due, at times because of unawareness, complexity in the tax law or inability to pay. Additionally, some returns are filed in error, resulting in the imposition of additional tax, interest and penalties. Tax amnesty and voluntary disclosure programs are designed with these taxpayers in mind.

Both tax amnesty and voluntary disclosure programs encourage taxpayers to voluntarily file and pay back-taxes. In return, the taxing authority will not criminally prosecute and will reduce, or perhaps entirely waive, associated penalties, which often are steep. In order to qualify for the waiver of penalties under the typical amnesty program, the taxpayer must pay the entire amount of taxes, plus some or all of the interest that may be due by the program’s deadline or expiration date. Additionally, taxpayers may be required to sign a settlement agreement in which the taxpayer agrees to file all future tax returns and pay all future tax liabilities timely.

While a tax amnesty program typically provides comprehensive relief, albeit within a very short window of opportunity, and a fresh start, taxpayers considering an amnesty or voluntary disclosure program should consult with a qualified tax professional prior to participation, as the risks or occurrences of disqualification from amnesty programs are great for even the slightest omission of fact or procedure. If disqualification occurs, rest assured enforcement is not too far behind.

The goal of the taxing authority is to collect as much outstanding tax liability as possible within a very short time frame, often within two or three months subsequent to the announcement of the program. In most cases, taxing authorities will waive penalties, in full, if outstanding tax returns and related liabilities are paid during the amnesty period. If no action is taken during the amnesty period, the taxing authority will often impose larger than normal penalties. Tax amnesty programs differ from voluntary disclosure programs in that amnesty programs are typically of short duration while voluntary disclosure programs often provide a greater window of opportunity for entrance. The basis for waiver of interest and penalty also may differ between the two programs. California, for example, has no current tax amnesty program in place, but maintains both an ongoing voluntary disclosure program as well as a filing compliance agreement program for non-residents.

Pennsylvania offers a voluntary disclosure program for tax years 2005 through 2008. Taxpayers must make formal request to enter the program and cannot be under current investigation by the Pennsylvania Department of Revenue. Pennsylvania will waive all penalties but will require payment of interest. Taxpayers registered with the Pennsylvania Department of Revenue are not eligible for the program. Eligible taxpayers include unregistered taxpayers who:

Recently became aware of outstanding non-corporate tax liabilities.
Collected, but failed to remit, business trust fund taxes.

Recently became aware of outstanding corporate tax liabilities.

Qualifying taxpayers owing non-corporate tax liabilities will be responsible for satisfying outstanding tax liabilities for up to three years, while those taxpayers owing corporate tax liabilities will be responsible for satisfying outstanding tax liabilities for up to five years.

In addition to the Pennsylvania voluntary disclosure program, the proposed Pennsylvania budget, as of this writing currently being debated and as yet unapproved, contains provisions that would establish a Pennsylvania tax amnesty program proposed to be in effect until May 15, 2010. The program will apply to eligible taxpayers delinquent on payment of a liability for eligible taxes or unfiled returns as of June 30, 2008. This proposed program may provide even more advantages than the current Pennsylvania voluntary disclosure program as it will eliminate penalties and 50 percent of the interest otherwise owed. Watch for ongoing developments in the contentious Pennsylvania budget process.

New Jersey also offers a voluntary disclosure program for taxpayers meeting the following qualifications:

Taxpayers must not have had previous contact with the New Jersey Division of Taxation or any of its agents.
Taxpayers must be willing to pay all outstanding tax liabilities.
Taxpayers must file prior year returns within 60 days.
Taxpayers cannot propose to defer payment of outstanding tax liabilities.
Taxpayers cannot be New Jersey resident taxpayers for gross income tax purposes.
Taxpayers cannot be registered with the division for the taxes they wish to pay under the program.
Taxpayers cannot be under criminal investigation.

Taxpayers cannot have been previously contacted regarding their activities in New Jersey.

The division will agree to waive late filing penalties and criminal penalties relating to the tax return and periods subject to a voluntary disclosure agreement. A penalty of 5 percent, which cannot be abated, will be imposed for failure to take advantage of New Jersey’s tax amnesty program, which ended June 15. Additionally, the 5 percent late payment penalty will be imposed in all circumstances, and statutory interest will be assessed and calculated at the prime rate plus 3 percent for the tax returns and periods included in the agreement.

New York has a voluntary disclosure and compliance program with the following eligibility requirements:

Taxpayer must not be currently under audit.
Taxpayer must not have received a bill for outstanding tax obligations.
Taxpayer must not be under criminal investigation by a New York state agency or political subdivision of the state.

Taxpayer must not be seeking to disclose participation in a tax avoidance transaction that is a federal or New York state reportable or listed transaction.

New York will waive all penalties and will not criminally prosecute if otherwise able to do so outside of the program. Statutory interest will not abate.

Connecticut maintains an offshore voluntary disclosure program, following on the heels of the agreement between the Swiss government and the U.S. Department of Justice and Internal Revenue Service regarding the release of the names of U.S. residents suspected of using foreign bank accounts to evade taxes and is pursuing information from the U.S. government relating to Connecticut taxpayers who may have undisclosed assets in Swiss banks. Taxpayers enter the program by sending a cover letter to the Department of Revenue Services stating their intention to participate in the program. In addition to the letter, taxpayers must submit information about the offshore account, including:

A description of the source of funds or other assets in each account.
The date the initial deposit was made or the date on which the taxpayer took control or ownership of each account.
Documentation indicating whether the principal (which includes initial deposits and all subsequent contributions) has been taxed and the tax years involved.
The amount of potential tax liability.

Whether the taxpayer participated in the IRS Offshore Voluntary Disclosure Program.

In exchange for making a voluntary disclosure, taxpayers will generally eliminate the risk of criminal prosecution and Connecticut will not impose any civil penalties. Taxpayers will be subject to statutory interest and can participate in the program even if currently under examination.

The following regional states have recently announced attractive tax amnesty programs:

Delaware. The Delaware Division of Revenue has established a tax amnesty program that runs through Oct. 30. The program applies to tax liabilities that were due prior to Jan. 1, and also to corporate, personal income and gross receipts tax; use and gift taxes; lodging, estate, realty transfer and public utilities taxes; tax on the income of estates and trusts; occupational license fees and tax; contractors’ and manufacturers license fees and tax; retail and wholesale merchants’ license fees and tax; and tobacco product license fees and tax.Penalties and interest will be waived if taxpayers pay any and all outstanding tax liability during the amnesty period or enter into a payment plan that satisfies outstanding tax liabilities by June 30, 2010. A down payment is required by Oct. 30. The division will not assess any tax, penalty or interest for any voluntary tax returns filed under the initiative for periods before Jan. 1, 2004. Tax, penalty and interest may be assessed for subsequent periods. Delaware imposes a 5 percent per month penalty for failure to file timely returns, up to a maximum of 50 percent, as well as severe penalties, up to 75 percent of the balance due, for filing fraudulent returns. Provisions related to the 50 percent limitation on the penalty for failure to file timely returns and the 75 percent limitation on the penalty for any fraudulent returns have been removed beginning Dec. 31.

Maryland. Legislation has been enacted in Maryland allowing for a tax amnesty period through Oct. 30. The amnesty period is applicable to income, withholding, sales and use and admissions and amusement taxes. During this period, taxpayers may file any delinquent returns and pay all tax liabilities or enter into an agreement with the comptroller. The comptroller will waive one-half of the interest due and all civil penalties, except previously assessed fraud penalties.Taxpayers who have more than 500 U.S. employees, and who were previously granted amnesty in 2001 or were eligible for the 2004 Chapter 557 settlement period, are ineligible for the 2009 amnesty program. Taxpayers will not face any criminal charges arising from any filed return or paid taxes during the program.

Virginia. Virginia is offering an amnesty program for any person, individual, corporation, estate, trust or partnership required to file a return or pay any tax administered or collected by the state’s Department of Taxation. Virginia will waive all civil and criminal penalties and half of the assessed interest on prior tax year liabilities upon payment of outstanding tax liabilities and interest. The amnesty period is in effect from Oct. 7 through Dec. 5. For amnesty eligible tax assessments or delinquent return liabilities, all penalties and one half of the accrued interest will be waived upon payment of the full amount of the tax and one-half of the amount of accrued interest due.If an assessment or delinquent return is not eligible for amnesty benefits, or if a taxpayer does not comply with the requirements of amnesty, penalties and interest will not be waived.

If you are considering participation in a state tax amnesty program, now may be a very good time to do so. Prior to participation or disclosure of information, contact a tax professional to evaluate eligibility and to provide guidance and representation through the process.

This article originally appeared in The Legal Intelligencer

United States: Federal Contractor E-Verify Rule Implemented on September 8, 2009

2009-10-02

On September 8, 2009 the E-Verify Rule regarding federal contracts went into effect following eight months of delays. The final rule implements the Executive Order issued in June 2008 directing federal agencies to insert clauses into their contracts requiring that federal contractors agree to electronically verify the employment eligibility of employees hired during a contract term, as well as existing employees directly performing work under federal contracts in the United States.

Which federal contracts will be affected by the rule?
The rule applies to solicitations issued and federal contracts awarded on or after September 8, 2009. The E-Verify clause will be inserted into prime federal contracts with a period of performance longer than 120 days and a value above the simplified acquisition threshold ($100,000). If a prime contract includes the E-Verify clause, the prime contractor will be required to include the E-Verify clause in subcontracts for services or construction with a value over $3,000.

Does the rule apply to existing contracts?
The rule generally does not apply to existing contracts, with the exception of certain indefinite-delivery/indefinite-quantity (IDIQ) contracts. Federal agencies have been instructed to amend current IDIQ contracts to include the E-Verify requirement for future orders if the remaining period of performance extends at least six months beyond September 8, 2009, and the amount of work or number of orders expected under the remaining performance period is substantial. Federal agencies cannot unilaterally impose the E-Verify requirement even on IDIQ contracts but must negotiate the inclusion of the requirement on a bilateral basis with the contractor.

What will federal contractors and subcontractors be required to do if the contract includes the E-Verify clause?
Employers (or “contractors”) that are not currently enrolled in E-Verify who are awarded a federal contract containing the E-Verify clause will be required to enroll in the E-Verify program for all worksites within 30 calendar days of the contract or subcontract award date. They must begin using the system to verify all newly hired employees within 90 days from the date of enrollment with E-Verify. Affected employers must also initiate verification queries for employees already on staff who are assigned to the contract within 90 days after enrollment or within 30 days of the employee’s assignment to the contract, whichever is later. After the 90-day phase-in period, affected employers will be required to initiate verification of each newly-hired employee within three business days after his or her start date.

Employers that have already been enrolled in E-Verify at the time they are awarded a federal contract containing the E-Verify clause but not yet designated as a Federal Contractor in E-Verify will need to update the company profile in the E-Verify system through the “Maintain Company” page within 30 days of the contract award date to designate the company as a Federal Contractor. In addition, if only selected worksites were previously enrolled in E-Verify, the company will need to add all remaining worksites to the systems. Employers in this case will be required to continue to initiate verification of newly-hired employees within three business days of their start dates for new hires at hiring sites already using the system. However, they will have 90 days from the date the company profile was updated to Federal Contractor status to begin using E-Verify for new hires at hiring sites not previously enrolled in E-Verify and for each employee already on staff at any hiring site who is assigned to work on the contract. Once the employer designates the organization as a Federal Contractor, all E-Verify users at the company will need to take a federal contractor tutorial that explains the new policies and features that are unique to federal contractors. E-Verify users will not be able to proceed with processing cases in E-Verify until the tutorial has been taken.

Employers that have already been enrolled in E-Verify as designated Federal Contractors at the time an additional contract containing the E-Verify clause is awarded will be required to continue using the program as noted above and initiate verification of all existing employees assigned to the covered contract within 90 days of the contract award date or 30 days of the employee’s assignment to work on the contract, whichever date is later. Participating employers must continue to use E-Verify throughout the duration of the federal contract for all new hires, regardless of whether the new employees are assigned to the contract, unless certain exceptions apply.

Once an employer is enrolled and using E-Verify for all new hires as a result of a federal contract, which additional employees must be verified through the E-Verify system?
In addition to requiring the electronically verification of the employment eligibility of all new employees, the E-Verify clause will require federal contractors to E-Verify current employees who were hired after November 6, 1986 and who will directly perform work under federal contracts (containing the E-Verify requirement) in the United States. An employee is not considered to be directly performing work under the contract if the employee normally performs support work, such as indirect or overhead functions, and does not perform any substantial duties under the contract. However, the rule does not exempt employees based solely on the intermittent nature of the work or the length of time spent performing the work. Therefore, an employee would be included even if the employee is only working on the contract for a short amount of time. The rule applies only to employees working in the United States, which is currently defined to include the fifty states, the District of Columbia, Guam, Puerto Rico, and the U.S. Virgin Islands.

May employers elect to E-Verify all employees in response to this rule instead of tracking who is assigned to work on the contract?
The final rule also provides contractors the option of using E-Verify for all employees hired after November 6, 1986, including any existing employees not currently assigned to work on a federal contract. A contractor that chooses to exercise this option must notify DHS through the E-Verify program and must initiate verifications for the contractor’s entire workforce within 180 days of such notice to DHS. This option is presented at the time an employer enrolls in E-Verify as a Federal Contractor or updates the Company Profile.

Are there any exemptions to the E-Verify requirement that will be imposed in federal contracts?
Certain types of prime contracts are exempt from the rule. Exemptions include contracts for less than $100,000 or covering terms of less than 120 days, as well as contracts where all work is performed outside the United States. Contracts that include only commercially available off-the-shelf (COTS) items (or minor modifications to a COTS item) and related services will also be exempt. A COTS item is a commercial item that is sold in substantial quantities in the commercial marketplace and is offered to the government in the same form, or with minor modifications. Nearly all food and agriculture products fall within the definition of COTS items and are exempt from the rule.

Federal contractors will also not be required to use E-Verify for any employee who has been granted and holds an active federal agency HSPD-12 compliant credential or a U.S. Government security clearance for access to confidential, secret, or top secret information in accordance with the National Industrial Security Program Operating Manual. However, the employer will still need to complete the Form I-9 at the time of hire for such employees.

If a current employee’s name was previously run through E-Verify, the employee should not be re-verified through E-Verify by the same employer, even if the employee is later assigned to work on another contract. However, if a former employee is re-hired, the employer will need to initiate a new E-Verify query even if one was performed at the time the individual was previously hired.

An additional exception is available under the Federal Contractor rule for institutions of higher education, state or local governments, federally recognized Indian Tribes, and sureties performing under a takeover agreement, which allows those types of employers to elect only to E-Verify employees assigned to designated contracts or subcontracts, whether new hires or previously hired.

Has the government provided any guidance on how contractors should implement the rule?
Once the rule was implemented, the federal government released a new version of the E-Verify Manual for Federal Contractors and a Supplemental Guide for Federal Contractors which contain detailed information about using E-Verify and the unique requirements imposed on contractors who must utilize the Federal Contractor version of the system. In addition, the current version of the E-Verify Memorandum of Understanding (“MOU”) contains an overview of contractors’ obligations once enrolled in E-Verify. These are available online from the Department of Homeland Security (“DHS”) here (links appear at the bottom of the page). Additional information for Federal Contractors, including Frequently Asked Questions issued by DHS, is also available at the same website.

BAL Comment

Please note that the E-Verify requirement does not automatically attach to all employers engaged in federal contracts simply because the rule has now been implemented.

The requirement will attach by virtue of E-Verify clauses to be contained in all solicitations and federal contracts awarded after September 8, 2009. This requirement may also be triggered when certain already-existing IDIQ contracts are modified – on a bilateral basis – to include the clause for future orders. Modification of existing IDIQ contracts may be sought under the following circumstances:

If the remaining period of performance extends at least six months after September 8, 2009,

and the amount of work or number of orders remaining is substantial.

In the meantime, for employers enrolled in E-Verify, verification of employees through E-Verify is limited to new hires only, and general E-Verify guidelines must be followed.

In light of the extreme difficulty in identifying and monitoring which existing employees might be assigned to a given federal contract, a number of companies will be forced to evaluate the option of E-Verifying their entire workforces. The obligation to E-Verify existing workers assigned to federal contracts is the most vexing component of the new rule and will inevitably significantly increase the burden of these provisions, regardless how each company proceeds.

Brazil: Brazil to Grant Tax Exemptions to 2014 Soccer World Cup Contracts

2009-09-28

Originally published in the September 28 edition of World Tax Daily (Copyrights Tax Analysts)

Brazil’s Federal Revenue Department (FRD) on September 23 announced that contracts signed for the 2014 Soccer World Cup to take place in Brazil contain full tax exemptions, including from income tax on profits, for Fédération Internationale de Football Association (FIFA) companies domiciled outside Brazil.

FRD Division Chief of Tax Studies Augusto da Cunha made the announcement in a hearing before the Chamber of Deputies’ Commission of Financial Enforcement and Control. Cunha said the executive branch will send related law projects to Congress. He also said FRD officials have been working to close loopholes that might facilitate money laundering.

After the law projects are finalized and submitted to Congress, some contracts already signed by FIFA might have to be reviewed to ensure that they comply with the new tax provisions and exemptions, Cunha said.

FRD officials are communicating with German authorities and organizers about what exemptions were granted when the 2006 FIFA World Cup was held in Germany. One of the proposals for the 2014 World Cup is to create a flat 10 percent tax on sales of tickets and hotel services.

According to Mauro Nascimento, director of social programs for the Ministry of Planning, a study by the 2014 World Cup Local Organization Committee estimates the World Cup could generate BRL 65 billion in income, including infrastructure investments, advertising, lodging, and sponsorships. The committee estimates that during the weeks of the event 600,000 tourists will visit Brazil and spend $5,500 each, or $3.3 billion.

Those figures have drawn the attention of the executive branch, the FRD, and even Congress, which will be called on to review and vote on tax matters related to the biggest sporting event to occur in Brazil in decades.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São Paulo

United States: EEOC Issues Proposed Revisions to ADA Regulations and Interpretive Guidance

2009-09-25

On September 23, 2009, the Equal Employment Opportunity Commission’s (“EEOC”) proposed revisions to the existing Americans with Disabilities Act (“ADA”) regulations and accompanying interpretative guidance were published in the Federal Register. The EEOC’s Notice of Proposed Rulemaking (“NPRM”) was prepared to bring the ADA regulations and interpretive guidance into compliance with the ADA Amendments Act of 2008, as directed by Congress. Interested parties may provide public comments on the NPRM on or before November 23, 2009.

Effective January 1, 2009, the ADA Amendments Act of 2008 implements Congress’ desire to widely expand the definition of “disability” and, therefore, the number of individuals entitled to protection under the ADA.

While the NPRM retains the current definition of disability—(1) a physical or mental impairment that substantially limits one or more major life activities, (2) a record of such impairment or (3) being regarded as having an impairment—it follows Congress’ directive and would amend the ADA regulations to provide for the definition of “disability” to be construed broadly.

What Is a Major Life Activity?

The NPRM provides that major life activities are basic activities, including major bodily functions, that most people in the general population can perform with little or no difficulty.

The NPRM sets forth a specific, nonexhaustive list of major life activities, including caring for oneself, performing manual tasks, seeing, hearing, eating, sleeping, walking, standing, sitting, reaching, lifting, bending, speaking, breathing, learning, reading, concentrating, thinking, communicating, interacting with others and working. Three of the major life activities—reaching, interacting with others and sitting—are new in the NPRM and were not listed in the text of the ADA Amendments Act.

In addition, the NPRM issues a specific, nonexhaustive list of major bodily functions that constitute major life activities. They include functions of the immune system; special sense organs and skin; normal cell growth; and digestive, genitourinary, bowel, bladder, neurological, brain, respiratory, circulatory, cardiovascular, endocrine, hemic, lymphatic, musculoskeletal and reproductive functions. A number of the major bodily functions—special sense organs and skin, genitourinary, cardiovascular, hemic, lymphatic and musculoskeletal—are new in the NPRM and were not listed in the ADA Amendments Act.

How Is Substantially Limited Defined?

The NPRM provides that an impairment is a disability if it substantially limits an individual’s ability to perform a major life activity as compared to “most people in the general population.” This is a slight variation from the current ADA regulations, which focus on whether an individual can perform a major life activity as compared to how an “average person in the general population can perform” a major life activity.

The NPRM also removes the prior factors that are currently considered in determining whether an impairment is “substantially limiting“—specifically, the nature, severity and duration of the impairment and the permanent or long-term impact of the condition.

Instead, the NPRM proposes several rules of construction, including:

The focus should be on whether discrimination occurred, not on whether the individual meets the definition of “disability.”
To be disabled, an individual does not have to demonstrate that he or she is limited in the ability to perform activities of “central importance to daily life.” This rule of construction reflects Congress’ legislative rejection of the U.S. Supreme Court’s analysis in Toyota Motor Manufacturing, Kentucky. v. Williams.¹ To illustrate this point, the NPRM proposes that an employee with a 20-pound lifting restriction that is not of short-term duration is substantially limited in lifting, and he or she does not need to demonstrate the inability to perform activities of daily life that require lifting in order to demonstrate that he or she is substantially limited in lifting.

The term “substantially limits” should not require extensive analysis.

Mitigating Measures

Consistent with the text of the ADA Amendments Act, the NPRM provides that the ameliorative effects of mitigating measures (e.g., medication or hearing aids, use of assistive technology, auxiliary aids or services) would not be taken into account in determining whether an impairment substantially limits a major life activity.

In addition, the NPRM provides that an individual who has only minor or no limitations related to an impairment because of the use of mitigating measures will still be considered disabled if the impairment would be substantially limiting without the individual’s use of those mitigating measures. It is important to note that the NPRM does not propose a method for making this determination.

Episodic Impairments or Impairments in Remission
The NPRM reiterates the text of the ADA Amendments Act by providing that impairments that are episodic ( e.g., epilepsy) or in remission (e.g., cancer) would constitute disabilities if they would be substantially limiting “when active.” The NPRM does not propose a specific method for how to make this determination.

Categories of Impairments

The text of the ADA Amendments Act indicates that the expansive definition of “disability” will be a categorical, and less individualized, assessment of whether someone has a disability. While the NPRM proposes that an individualized assessment would continue to be part of the analysis, it provides that certain impairments (e.g., autism, cancer, cerebral palsy, diabetes, epilepsy, and AIDS or HIV) would consistently meet the definition of “disability,” and the individualized assessment could be conducted “quickly and easily” to reach that determination.

The NPRM adds a list of impairments that may be disabling for some individuals (e.g., asthma, high blood pressure, learning disabilities). With respect to these types of conditions, the NPRM proposes that the individualized analysis should be slightly more comprehensive.

Major Life Activity of Working

The NPRM proposes that to be substantially limited in the major life activity of working, an individual must be unable to perform a “type of work,” taking into account the nature of the individual’s work and job-related requirements. This new standard replaces the current standard of needing to determine whether an individual is substantially limited from working a “class” or “broad range” of jobs.

Regarded as Disabled

The NPRM reiterates the significant change to the definition of “regarded as” disabled established by the ADA Amendments Act. The NPRM provides that an individual would be “regarded as” disabled if the individual is subjected to an action prohibited by the ADA (e.g., termination, demotion) based on an actual or perceived impairment, regardless of whether the impairment limits or is perceived to limit a major life activity.

Conclusion

The NPRM sets forth the EEOC’s expansive interpretation of the definition of disability, and there is likely to be an increase in the number of individuals considered to be disabled. However, the EEOC suggests that many individuals determined to be disabled are unlikely to seek any accommodations, and the accommodations that are requested can be adequately addressed through existing employer policies or other applicable laws, such as the Family and Medical Leave Act.

It is important to note that the NPRM proposes revisions only to the definition of “disability” and, consistent with the ADA Amendments Act, does not alter the ADA’s analysis of what constitutes a reasonable accommodation or whether the accommodation requested would present an undue hardship or pose a direct threat. Employers will still have available to them the possibility of challenging accommodation requests based on those factors.

Note

¹ Toyota Motor Mfg., Ky. v. Williams, 534 U.S. 134 (2002).

Brazil: Brazilian House Commission Approves Tax Amnesty for Undeclared Assets Held Abroad

2009-09-25

Originally published in the September 25 edition of World Tax Daily (Copyrights Tax Analysts)

The Finance and Taxation Commission of Brazil’s Chamber of Deputies on September 23 approved a law project that would grant tax amnesty for repatriation of undeclared financial assets held abroad by Brazilian taxpayers (corporate and individual).

Law Project 5,228/2005 was originally presented by lawmaker José Mentor in 2005 but was not reviewed until recently. The project was approved along with another project, Law Project 113/2003, on the same subject.

The tax amnesty under Mentor’s project would grant a favorable income tax rate of 3 percent or 6 percent, depending on whether the funds are repatriated into Brazil or kept abroad. For repatriated funds, the tax rate would be 3 percent; if the taxpayer declares the funds but keeps them abroad, the rate would be 6 percent. That taxation would be final, and those funds would not be taxed again in Brazil.

The project would grant full amnesty for any other tax related to the undeclared funds, all applicable penalties, and interest.

Legalization or repatriation of undeclared funds enables corporate taxpayers to avoid the levy of the 25 percent corporate income tax, 9 percent CSL (Social Contribution on Net Income), 7.6 percent COFINS (Contribution for the Financing of Social Security) and 1.65 percent P.I.S (Program for Social Integration contribution) on the undeclared funds.

The two projects will now go before the Commission of Constitution and Justice. The commissions have conclusive powers, meaning that if the commission approves the law project, it will be forwarded directly to the Senate with no need for a vote by the chamber.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São Paulo

Brazil: Brazilian Government Seeks Speedy Approval of New Tax on Savings Accounts

2009-09-25

Originally published in the September 21 edition of World Tax Daily (Copyrights Tax Analysts)

Following waning support for a previous proposal, the Brazilian government has formulated a new way to tax savings accounts and is pushing to have the new tax approved by the end of the year.

Under the proposal announced by Finance Minister Guido Mantega in May, the tax would be progressive and would depend on the level of Brazil’s official interest rate (SELIC) — the rate was 10.25 percent per annum (p.a.) in May and is now at 8.75 percent p.a. The tax would not apply to savings account interest if the SELIC stays at or above 10.5 percent p.a. As the SELIC rate is reduced, the progressive tax would start at 20 percent and increase to a maximum of 100 percent if the SELIC fell below 7.25 percent p.a. The tax base would be a percentage of the 0.5 percent mandatory monthly interest applicable to savings accounts.

The new proposal completely changes the way savings accounts would be taxed. The one similarity to the original proposal is the exempt bracket of BRL 50,000. Interest earned in savings accounts with balances below BRL 50,000 would not be taxed. Interest earned in savings accounts with balances greater than BRL 50,000 would be taxed only on the portion of interest related to the balance exceeding BRL 50,000. In other words, there would be a general tax exemption for interest earned over the first BRL 50,000 in any savings account held in Brazil.

According to Dyogo Oliveira, deputy secretary of economic policy of Brazil’s Finance Ministry, the government abandoned the original proposal because tax calculation would have been very complex and enforcement would have been difficult. The new proposal is simpler, easier to monitor, and does not depend on the SELIC interest rate.

The tax rate would be 22.5 percent, equal to the maximum tax rate applicable to fixed income investments. The tax would be calculated by financial institutions and withheld from interest credited to savings accounts monthly. For example, consider a taxpayer with a savings account with a balance of BRL 70,000 and interest of 0.5 percent credited in a given month.

Without tax, the total amount of interest earned by the taxpayer would be BRL 350 (0.5 percent of BRL 70,000). If the new tax is approved, it would be applied as follows:

exempt bracket: BRL 50,000 × 0.5 percent = BRL 250;

taxable bracket: BRL 20,000 × 0.5 percent = BRL 100;

tax calculation: BRL 100 × 22.5 percent = BRL 22.5; and

net interest earned: BRL 250 + (BRL 100 – BRL 22.5) = BRL 327.50.

If the taxpayer holds several savings accounts with balances smaller than BRL 50,000, each in different financial institutions but whose total exceeds BRL 50,000, the balances would not be consolidated and no tax would be withheld at the end of each month. But at year-end, the taxpayer would have to consolidate the balances and pay the tax. The Federal Revenue Department will likely create a special form for this purpose.

The government is hurrying to have the proposal approved by Congress in 2009. A law project will likely be sent to Congress within the next few days to allow the tax to be applied as of January 1, 2010. Opposition parties say they are against the new tax and will do whatever they can to block it, especially in the Senate, where the government does not have guaranteed majority support. A media campaign against the project is also being considered, especially given that all House seats and two-thirds of Brazil’s Senate seats will be up for vote in the 2010 general election.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São Paulo

United States: U.S. Treasury Department Permits More Modifications for Securitized Commercial Mortgages

2009-09-24

The U.S. Department of the Treasury (the “Treasury Department”) is now providing greater flexibility for securitized commercial mortgage loans to be modified before a loan default occurs or is reasonably foreseen. Nearly two years ago, the Treasury Department and the IRS asked for input on whether federal regulations should be amended to permit more modifications that would not cause an otherwise “qualified mortgage” to lose its qualification and jeopardize the tax status of the Real Estate Mortgage Investment Conduit (“REMIC”) holding pools of commercial mortgages in securitizations. The Treasury Department issued final regulations (effective on or after September 16, 2009) to expand the list of permitted modifications that can be made to commercial mortgages held by REMICs. These new regulations are likely to offer opportunities for commercial mortgage borrowers and servicers to agree on modifications to a commercial mortgage without jeopardizing the federal nontaxable status of the REMIC that holds the securitized mortgage.

Background

As long as it holds “qualified mortgages,” a REMIC is considered a pass-through entity and is not subject to federal tax if it otherwise satisfies requirements established under federal statutes and regulations. With certain limited exceptions, REMIC regulations prohibit the “exchange” of one mortgage held by a REMIC for another mortgage. REMIC regulations have treated a “significant modification” of a mortgage as a deemed exchange of the unmodified mortgage for the modified mortgage. The modified mortgage is then no longer considered a “qualified” mortgage and thereby risks the REMIC’s losing its nontaxable status. Mortgage servicers are bound by pooling and servicing agreements with regard to the actions they are permitted to take when a commercial mortgage in the portfolio encounters trouble. Many of the restrictions imposed on a mortgage servicer result from the limits of REMIC regulations. For example, changes in mortgage loan collateral or in mortgage guarantees, credit enhancements and changes in the recourse nature of a mortgage loan obligation—and certain lien releases—have been grounds for the potential disqualification of an otherwise qualified mortgage. Until a mortgage loan goes into default, mortgage servicers have been limited by REMIC regulations in the actions they can take with a borrower to modify a mortgage to avoid a future default.

The New Regulations

The new REMIC regulations permit certain changes in mortgages before the occurrence of an actual default or a reasonably foreseeable default, as long as the loan obligation continues to be “principally secured by an interest in real property.” Before these new regulations, unless a default occurred or was reasonably foreseen, only the following were permitted: mortgage defeasance (subject to certain time limitations); waivers of due-on-sale or due-on-encumbrance clauses; and conversion of an interest rate by a mortgagor pursuant to the terms of a convertible mortgage.

The types of additional modifications that are now permitted if the loan obligation is “principally secured by an interest in real property” include: (i) changing a loan from nonrecourse (or substantially nonrecourse) to recourse (or substantially recourse); and (ii) releasing, substituting, adding or otherwise altering (a) a substantial amount of collateral for, (b)a guarantee on, or© another form of credit enhancement for a recourse or nonrecourse obligation.

REMIC regulations treat the “principally secured by an interest in real property” requirement as met when the fair market value of the real property securing a loan equals at least 80 percent of the amount of the loan when the loan was originated or contributed to the REMIC. When a mortgage is modified, the regulations require a retesting of the 80-percent requirement. The Treasury Department’s expanded list of permitted modifications retains the retesting requirement, but with an alternative method for satisfying that test. A mortgage that is modified by a servicer in any one of the ways permitted will meet the test of being “principally secured by an interest in real property” if the fair market value of the interest in real property that secures the loan immediately after the modification equals or exceeds the fair market value of the interest in real property securing the loan before the modification. This test of premodification and postmodification fair market values may not require a new appraisal. Under the new regulations, this test can be satisfied if the mortgage servicer reasonably believes that the modified mortgage satisfies the 80-percent test at the time of the modification, provided that the servicer has based that reasonable belief on a commercially reasonable valuation method. The new regulations list as acceptable methods: a current appraisal, the updating of an original appraisal or “some other commercially reasonable valuation method“—but the servicer must not know or have reason to know that the value after the modification is less than it was before the modification.

Conclusion

While borrowers and mortgage loan servicers considering loan modifications before a loan default will still be faced with the limitations imposed on servicers by the specific terms of the pooling and servicing agreement applicable to a particular mortgage, the Treasury Department has—through its new regulations—introduced the possibility of additional flexibility by providing a wider array of mortgage loan modifications that will not jeopardize the nontaxable status of REMICs.

As required by United States Treasury Regulations, the reader should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

United States: Carbon Tipping Point?..........continued

2009-09-18

This fall, Congress will consider what promises to be the single most important piece of energy legislation of the past thirty two years. Never mind that it will be couched in terms of pollution emission reductions rather than energy policy, the fact remains that climate change legislation will herald the most significant change in energy policy since passage of the Public Utility Regulatory Policies Act of 1978(PURPA).

PURPA created the non-utility generation industry and then suffered death by a thousand cuts (many self-inflicted as a result of bad decisions taken by PURPA proponents). The Energy Policy Act of 1992 included the first effort at reforming the Public Utility Holding Company Act (PUHCA) and made initial progress in promoting energy efficiency. The Energy Policy Act of 2005 effectively repealed PUHCA, but neither the ’92 or ’05 Act changed the fundamental rules of play for fuels and electric generation. Climate change legislation promises to do just that by requiring hydrocarbon fueled power plants to pay for the right to emit carbon, and possibly other greenhouse gases as well.

Passage of climate change legislation will signal the end of cost-free carbon emissions and the beginning of a legally imposed transition to a carbon constrained economy. It is clear that substantial change is at hand.

Much less clear is how well existing energy companies, whether focused on traditional fuels or renewable resources, will adapt to the new environment.

The State of Play

Much ink has been spilled debating whether “global warming” or “climate change” even exist. As a political matter, that battle has been won by the proponents of climate change legislation. Although climate change remains sufficiently complex to preclude simple analysis, the essence of the matter has devolved into two basic propositions: that empirical data undoubtedly demonstrates a trend of substantial changes in climate patterns caused by
human activity, and that the risks inherent in doing nothing and being wrong exceed the risks of doing something and being wrong.

The Current Debate

The current debate is about what to do and how to do it. That dialogue initially focused on the politics of a carbon tax versus a “cap and trade” regime (i.e., “taxes bad”/“cap and trade” less so). With a growing consensus that the carbon tax is politically untenable, arguments have shifted to whether cap and trade is an economically efficient way to level the playing field between traditional fuels and renewable resources, or is itself a tax.

Cap and Trade

Again, proponents of “cap and trade” are winning this argument. Their opponents have failed to explain why higher priced energy necessarily equates to a net loss of jobs and, in any event, why lost jobs should trump the lost lives and property caused by climate change. Equally important, opponents have failed to rebut basic arguments favoring cap and trade that extend beyond environmental risks (e.g., that cap and trade will encourage energy efficiency and increase U.S. energy security).

For these and other reasons, Congress is likely to adopt some form of cap and trade legislation this Fall. The final product will be heavily negotiated and likely to leave both sides less than satisfied, but will nevertheless usher in the first statutorily- sanctioned nationwide carbon trading in U.S. history.

The Blowback for Renewables

The prospect of climate change legislation is already creating palpable effects in the marketplace. Sponsors of hydrocarbon fueled projects are reflecting carbon costs of more than $20 per ton (in 2006 dollars) in their economic models based on carbon market results to date.

Whatever else may be said about these cost estimates, they reflect the widespread assumption that carbon pricing will increase the costs of producing electricity with traditional fuels.
By contrast, the renewable energy industry continues to rely as much on getting paid for what it doesn’t produce—greenhouse gases—as for what it does produce (clean energy). This remains problematic for a variety of reasons.

First, there is no mechanism for ensuring that renewable energy projects receive the full carbon avoidance value of the electricity they generate. In fact, it may be argued that the monopsony power of electric utilities, combined with the nascent status of carbon markets, virtually guarantee that renewable energy will receive less than full value for its contribution to carbon mitigation.

Second, the energy market’s ability to accurately reflect carbon costs in electricity prices is impaired by regulatory policies and market power. In states using “cost of service” regulation, for example, utilities will simply pass along higher costs of hydrocarbon based electricity to their customers. Thus, higher electric prices will be limited to a specific utility’s service territory, while the benefits of carbon avoidance will reach much farther. In addition, most renewable energy projects assign their carbon credits to the entity purchasing their power (typically an electric utility). As a result, renewable energy sponsors lose the long term upside value of carbon credits and electric utilities lack economic, as opposed to legally mandated, incentives to adopt carbon mitigating technologies.

Third, and most obviously, renewable resources are intermittent in nature. There is no assurance that the sun will shine, the wind will blow or even that the river will flow as in the past. In many cases, the necessary renewable resources for generating electricity at a project’s full capacity are available less than 50% of the time. Nuclear energy, tapping into this problem, is promoting itself as “greener” than hydrocarbon fuels and more reliable than renewables.

Lower prices for oil and gas are further depressing the growth of renewable energy. Renewable energy economics have traditionally been predicated on the availability of both tax credits and “tax equity” investors that can utilize such credits. In the current environment, tax equity is expensive or non-existent, and projects that were economic with oil prices over $100/barrel are now significantly less so.

Equally important, the credit crisis has severely limited access to long-term debt for renewables and thus reduced the sponsor population to a relatively small number of large institutions with strong balance sheets targeting above-market returns.

Thus, future hydrocarbon projects are being burdened with higher production costs while renewable energy projects fail to receive full value for their largely carbonfree energy. In short, barring a technological “game changer” (see below), energy prices will increase in the wake of climate change legislation, but the magnitude of the price rise, and its effects on renewable energy growth, may be less than desired by policy makers.

Three additional trends that will vector the transition to carbon caps deserve consideration:

Allowances: These carbon credits will be allocated to major carbon emitters in the cap and trade legislation. Watch for whether allowances will be auctioned or given away, and how they are apportioned among competing emitters, (e.g. incumbents vs. independents).

Intra-Industry Competition: Fuel suppliers (i.e. oil, gas and coal companies) are looking to continue their expansion into the renewables space, while electric utilities are becoming more focused on R&D, technological innovation and “smart grid” issues. Look for potential “crowding out” of smaller companies.

Strategic Transmission: Governmental mandates for expanding renewable energy (e.g., renewable portfolio standards) will require expansion of the existing transmission grid. Watch for higher returns in transmission projects that simultaneously facilitate service to growing customer loads while supporting the growth of distributed generation and renewable resources.

Department of Energy Loan Guarantees

Title XVII of the Energy Policy Act of 2005 authorized the Department of Energy (DOE) to provide loan guarantees in support of “innovative” energy technologies. In the immediate aftermath of Title XVII’s enactment, relatively few transaction applications were processed, and even fewer closed. The Obama Administration has now taken the initiative on Title XVII, first by obtaining appropriations as part of the economic stimulus legislation passed early this year, and second by enhancing DOE’s resources for processing and closing loan guarantee transactions. A series of solicitations for electric generation projects using both innovative technologies and more traditional renewable energy resources are contemplated, as well as one for electric transmission projects.

Strategic Imperatives

While passage of climate change legislation is by no means assured, pressure from state and regional initiatives, not to mention global pressure from Kyoto signatories, means that a carbon-constrained U.S. economy in the near future is a virtual certainty. By imposing a cost on carbon emissions, carbon caps will promote both increased efficiency and reduced emissions.

Technological improvements will make renewable resources more competitive as well. The precise pattern and pace of technological “game changers” in these and other areas is as yet undetermined, but will necessarily become a fact of life.

That said, climate change legislation is no guarantee of success for renewable energy. If current economic conditions and the advantages of industry incumbents persist, renewable energy may harvest relatively few immediate benefits from this signal policy shift. On the other hand, breakthrough technologies tend to level the playing field for renewable energy and take the economic sting out of carbon mitigation.

With the economic incentives flowing from carbon pricing, significant improvements in efficiency and technological innovation are mainly a matter of time, and we can look forward to an energy sector that is at once more competitive and more responsive to environmental needs.

Roger Stark is a partner with Curtis,Mallet Prevost, Colt & Mosle LLP.

United States: Secretary Napolitano Announces New Agreement for State and Local Immigration Enforcement Partnerships & Adds 11 New Agreements

2009-09-04

On July 10, 2009, Department of Homeland Security (DHS) Secretary Janet Napolitano announced that U.S. Immigration and Customs Enforcement (ICE) has standardized the Memorandum of Agreement (MOA) used to enter into “287(g)” partnerships providing uniform policies for partner state and local immigration enforcement efforts throughout the United States. Additionally, ICE announced 11 new 287(g) agreements with law enforcement agencies from around the country. To date, ICE has trained more than 1,000 officers operating under 66 local 287(g) agreements between DHS and law enforcement agencies nationwide.

Section 287(g) of the Immigration and Nationality Act (INA) authorizes state or local police to be trained in enforcing immigration laws if they first enter into an agreement with the U.S. attorney general to do so. MOAs have been viewed as providing little or nothing in the way of monitoring or compliance measurement and having minimal or ineffectual complaint procedures. The §287(g) program is controversial concerning the effect it has on the reporting of crimes by victims or witnesses who are undocumented or have undocumented family members. Nonetheless local police essentially deputized and trained to enforce immigration laws, as if they were ICE agents themselves, is an increasing trend.

ICE Assistant Secretary John Morton is very aware of the criticisms of and concerns about the 287(g) program. He indicated that ICE has taken significant steps to change the face of the program, and that he must personally approve all new delegations. The new delegations will have a different focus with an emphasis on threats to public safety and a movement away from straight civil immigration law violations. All MOAs will have sunsets, and will have individualized appendices that lay out what the locale’s authority is and is not. It is intended that 287(g) programs will have more robust management and supervision, and be subject to more reporting and data collection.

Of much greater concern, however, is that most police participation in immigration enforcement likely occurs outside §287(g) agreements with little supervision or monitoring, particularly with respect to racial profiling and the use of a simple traffic stop as a pretext to inquire about immigration status, a call to ICE, or a check of the computer to see if there is an outstanding deportation order. Such a stop by police may be illegal and able to be challenged by an immigration attorney. Non-American citizens with criminal convictions need to be cautious in today’s anti-immigrant environment.

Brazil: Latin America Markets – Global Economic Crisis and Opportunities

2009-08-28

The most important elements of Latin American capital markets are low liquidity and high dependency on the U.S. capital markets. Latin American capital markets are quite recent in comparison with its North American or European equivalents, but have experienced a significant growth in the past decade. One of the most important reasons for such growth was the control of inflation, which was particularly a problem in Brazil and imposed a heavy burden on its economic development. For the past twelve years inflation has been under control in Brazil and it is no longer a problem. Another relevant factor was the political stability and a more favorable approach towards foreign investments. These major changes, allied with an era of global economic growth and excessive liquidity in the international markets, created the right environment for the development of Latin American capital markets.

Latin American capital and financial markets benefited heavily from a great influx of foreign capital, which comprised foreign direct investments and portfolio investment. However, this development of Latin American capital markets was also somewhat hindered by the concurrent expansion of North American or European capital markets. With a global favorable environment for listings and IPOs (initial public offerings), many players opted to assess the foreign capital markets using Depositary Receipts (DRs). By adopting this tactic, the companies sought a more mature market, with higher liquidity of the stock exchange and deeper penetration in the international capital markets. This caused a migration of market liquidity from the home country of the company to the country in which the DRs were traded.

Evidently, not only the international conjuncture mentioned above created the right environment for the development of capital markets. Economics, politics and regulation also had a decisive role. As mentioned above, most countries in the region experienced control of inflation, political stability and openness to foreign capital. Some countries like Brazil, Argentina and Chile, also passed laws and regulations to specifically foster their domestic capital markets.

More recently, and in light of the international economic crisis, some important issues are emerging. As the capital and financial markets went through an impressive downturn, with very strong repatriation of foreign capital and listed companies losing market value, we are seeing an increase in shareholders class actions against the companies and their management. Another trend, but only for those companies that remain capitalized, is the purchase of their own stock (taking advantage of the relatively low prices of the shares) and/or the purchase of strategic assets with undervaluated prices.

The crisis also entailed liquidity problems, rating downgrades, economic recession, unemployment, insolvency and defaults of all sorts. Therefore, based on the experience of our legal practice at Azevedo Sette Advogados in Brazil we believe the areas that will see most activity in 2009/2010 are related to restructuring, M&A, insolvency, credit recovery and litigation.

Frederico Bopp Dieterich, partner, Azevedo Sette Advogados, Belo Horizonte

United States: Foreign Corrupt Practices Act Enforcement on the Rise

2009-08-24

The Foreign Corrupt Practices Act (“FCPA”) has become increasingly important as virtually every company conducts at least some aspect of business overseas. The FCPA criminalizes bribery of foreign officials by U.S. corporations and individuals pursuing business in foreign countries. The FCPA also includes accounting regulations designed to prevent cash transactions or “off the books” payments from being made to foreign governments.

Penalties for violating the anti-bribery provisions of the FCPA are substantial – individuals face criminal fines of up to $250,000, five years in prison, or both, while corporations face criminal penalties of up to $2 million per violation. Likewise, individuals who criminally violate the books and records and internal controls provisions face up to twenty years in prison, a $5 million penalty, or both, and corporations face up to a $25 million fine per violation. In addition, civil penalties may be imposed for both types of violations.

The government has responded to the globalization of business by increasing its FCPA enforcement activity. In 2008, the U.S. Department of Justice and Securities and Exchange Commission (“SEC”) initiated a record-number of foreign corruption investigations. In fact, last year the DOJ and SEC collected more than $924 million in combined penalties from corporations and individuals for FCPA violations. The overall trend of increased enforcement activity has continued during the first half of 2009, and there is no indication that this trend will soon subside. Just as the government is increasing enforcement efforts, businesses need to take compliance to the next level as well.

Businesses that lack an anti-corruption compliance program face great legal, financial, and reputational risks. The first step to avoiding a violation and liability is establishing an effective compliance program that not only exists on paper but is actually put into practice. At a minimum, a company should consider the following: establishing standards and procedures to prevent, detect, and respond to criminal conduct; conducting compliance training; creating record-keeping systems to properly account for all overseas transactions; developing a reporting system whereby individuals can report criminal conduct; and conducting periodic reviews and audits of the company’s compliance systems to ensure that they are functioning properly

Brazil: Brazil's Supreme Court Confirms Expiration of Extra Excise Tax Credit for Exporters

2009-08-17

Originally published in the August 17 edition of World Tax Daily (Copyrights Tax Analysts)

Brazilian exporters suffered one of the most significant defeats in the history of tax litigation in Brazil on August 13 when the Supreme Court ruled that the extra federal excise tax (IPI) credit for exporters, which exporters have claimed for almost 20 years, expired in 1990.

The decision puts an end to one of the most important tax disputes before Brazilian courts — one that generated reversing and conflicting decisions over the years — and gives the government the opportunity to claim billions in unpaid taxes.

By unanimous vote, the Supreme Court ruled that the extra IPI credit, created in 1969 to stimulate exports, was revoked in 1990 because the tax benefit was not confirmed by Congress within two years after the promulgation of the 1988 Federal Constitution.

Background

The extra IPI credit was created in 1969 by Decree-Law 491/1969 (and eventually amended by Decree-Law 1,248/1972) to enable exporters to recover some of the tax costs of goods produced in Brazil and exported. The legislation granted a 15 percent presumed tax credit that exporters could use to offset against IPI liabilities and other federal taxes. In 1979, Decree-Law 1,658 established a gradual reduction of the extra credit, which would lead to its expiration in 1983. Over the years, subsequent legislation revoked the expiration of the extra credit and extended it indefinitely.

In 1988 a new Federal Constitution was promulgated. Article 41 of its Transitory Dispositions required federal, state, and municipal governments to review all tax incentives granted to business sectors existing at the time the constitution entered into force. Paragraph 1 of article 41 provided that those tax incentives should be deemed revoked if not confirmed by law within two years after the promulgation of the new constitution.

Disputes began after 1990 over whether the extra IPI credit had expired because it had not been confirmed by law. Taxpayers have argued for years that the extra IPI credit was not granted to a given business sector but to exporters in general. Therefore, exporters could not be deemed as a separate business sector; exports would be one income component of any trading business (such as automobile, furniture, food, or beverage businesses) but not a separate sector.

Judgment of the Supreme Court

Upon reviewing Extraordinary Appeal 577,302, filed by Pettenati S/A Indústria Têxtil, the Supreme Court ruled that the extra IPI credit was granted to a specific business sector, exporting, and that the extra credit expired in 1990 because it has not been confirmed by a law enacted within two years after the 1988 constitution.

Observers estimate that the government will be entitled to claim BRL 50 billion in unpaid taxes as a result of offsets made with the extra IPI credit.

After the decision, representatives of the Federal Revenue Attorney General’s Office (Procuradoria Geral da Fazenda Nacional) said that taxpayers disputing the extra credit should seriously consider applying for the new federal tax payment schedule, which allows unpaid taxes to be paid in up to 180 months with significant discounts for interest and penalties. Applications can be filed between August 17 and November 30. Attorneys present at the Supreme Court session said they will try to bring other similar cases for the Court’s review in a last attempt to reverse the defeat.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São Paulo

Brazil: Rate Increase Constitutional, Brazil's Supreme Court Confirms

2009-08-11

Originally published in the August 11 edition of World Tax Daily (Copyrights Tax Analysts)

Brazil’s Supreme Court on August 5 confirmed its prior positions on the constitutionality of the rate increase and tax base expansion of the Contribution for the Financing of Social Security (COFINS).

The ruling extinguished taxpayers’ last hope to have the COFINS rate increase from 2 percent to 3 percent declared unconstitutional. Both the rate increase and the tax base expansion were made in 1999 by Law 9,718/1999.

The expansion of the COFINS tax base, which the Supreme Court initially found unconstitutional in November 2005, has been routinely confirmed by the Court in several recent decisions.¹ The Supreme Court had found the COFINS rate increase constitutional in 2005, but taxpayers persisted in trying to reverse the unfavorable decision.

An opportunity arose when the Court accepted for review Extraordinary Appeal 527,602, filed by publishing company Plural Editora e Gráfica Ltda in January 2007. Taxpayers had hoped — because of changes in the Supreme Court’s composition since 2005 — that the Court would reverse its position on the COFINS rate increase. The main argument in the appeal was that COFINS, and its original 2 percent rate, was created by Complementary Law 70/91 and only another complementary law could increase its rate. Because Law 9,718/1999 was formally an ordinary law, it could not increase the rate to 3 percent.

Justice Eros Grau, who was designated to deliver the Court’s position, entered his opinion in favor of the taxpayer, accepting the unconstitutionality of the COFINS rate increase. However, the other justices present ruled that Law 9,718/1999 did not violate the Federal Constitution and that the rate increase was constitutional.

The decision seems to settle once and for all the constitutionality issue of the COFINS rate increase. The decision’s practical implications may be minimal, however; because the Court ruled the tax base expansion unconstitutional in 2005, many taxpayers have given up challenging the rate increase to pursue other issues.

Footnote

¹ Extraordinary appeals 357,950; 390,840; 358,273; and 346,084.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São Paulo

Brazil: Brazil's Revenue Department Clarifies Tax Treatment of Stock Option Grants

2009-08-10

Originally published in the August 10 edition of World Tax Daily (Copyrights Tax Analysts)

Brazil’s Federal Revenue Department (FRD), in a recent private letter ruling (PLR 98/08), clarified the tax treatment of stock options awarded by a foreign company to an officer of its Brazilian subsidiary.

PLR 98/08 also addresses the tax treatment of stock options that are repurchased in a corporate reorganization before exercise.

The FRD concluded that the value attributed by the foreign company to the options granted at no cost to a Brazilian individual does not qualify as payment of compensation due to the lack of relationship between the beneficiary and the foreign company. However, if the options are repurchased by the foreign company before exercise, the sales price received by the Brazilian individual qualifies as capital gains subject to tax in Brazil.

PLR 98/08, issued by the FRD’s Regional Superintendence for the Seventh Region,¹ was published in Brazil’s official gazette on March 30. PLR 98/08 is valid only between the tax administration and the filing taxpayer. However, it serves as an important precedent to taxpayers when receiving stock options from their employers. Its summary reads:

The value attributed to stock options, granted for free by a company headquartered abroad to an officer of a subsidiary headquartered in Brazil, does not qualify as payment of compensation, due to the lack of any relationship between the beneficiary and grantor. However, the acquisition of such options by the [foreign] holding company resulting from a corporate reorganization qualifies as “repurchase” of rights subject to capital gains by the individual seller. The positive difference between sales price and acquisition cost (the latter equal to zero) must be subject by seller to tax (resident and domiciled in Brazil) at the rate of 15 percent and paid by the last business day of the month following receipt of sales price.

Analysis

The letter ruling’s summary is unusually long, with an odd description of its rationale. The text indicates that the grant of stock options by foreign companies is not subject to tax in Brazil, but the letter ruling creates confusion over why no such tax should apply. It says that no tax applies because there is no relationship between the foreign grantor and the Brazilian beneficiary.

However, such an argument should not be relevant to determine taxation. The most important aspect preventing taxation should be that the stock option does not represent an accretion to the taxpayer’s wealth at the time of grant. That is because article 43 of Brazil’s National Tax Code states that the income tax base is accretion to the taxpayer’s wealth, without which no tax should apply.

In the case of stock option grants, the taxpayer does not have any immediate accretion to his personal wealth, but rather a right to acquire a given stock in the future for a given purchase price established at the time of grant. At the time of grant, the taxpayer has only a purchase right with zero acquisition cost.

However, PLR 98/08 confirms that the sale of the options before the exercise is subject to capital gains tax. That position makes sense and is in accordance with Brazil’s tax rules because the stock options, before exercise, are an asset to the taxpayer with zero acquisition cost. If the options are an asset to the taxpayer, any gain arising from their sale should be treated as capital gain taxed at 15 percent.

Although some of the letter ruling’s statements seem inaccurate, the good news for the taxpayer is that the FRD states that no taxable income must be reported at the time the grant is received, at no cost, by the taxpayer.

Footnote

¹ The FRD’s Regional Superintendence for the Seventh Region has jurisdiction over the states of Rio de Janeiro and Espírito Santo in southeastern Brazil.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São Paulo

Brazil: Brazilian Congress Ratifies Vienna Convention on Law of Treaties

2009-08-05

Originally published in the August 4 edition of World Tax Daily (Copyrights Tax Analysts)

Brazil’s official gazette of July 20 published Legislative Decree 436, marking congressional approval of the 1969 Vienna Convention on the Law of Treaties.

For the convention to become effective, President Luiz Inácio Lula da Silva must issue a presidential decree incorporating it into Brazilian domestic law. This is expected to occur within the next few weeks.

Almost 40 years after its signature, the Vienna Convention on the Law of Treaties will soon enter into force in Brazil. Although the convention generally regulates the way international treaties must be concluded between states, professionals believe the introduction of the convention into Brazil’s legal system will contribute to a more favorable approach toward tax treaties vis-à-vis local tax laws.

Brazilian courts have not consistently interpreted international tax laws to prevail over local tax rules when a potential conflict exists. The Supreme Court (STF) in 1997 ¹ ruled that international treaties and conventions executed by Brazil have the same power as ordinary laws approved by Congress and are subject to the Brazilian Federal Constitution.

The case dealt with a potential constitutional conflict between Brazil’s Constitution and the International Labour Organization’s Termination of Employment Convention (Convention 158). The STF ruled that international treaties or conventions that, formally or materially, violate the Brazilian Constitution are not legally valid in Brazil even after being introduced into Brazil’s legal system.

The Vienna Convention establishes some rules that may change the way Brazil’s executive and judicial branches view and apply international conventions and treaties. Historically, the Federal Revenue Department has been reluctant to accept tax treaty provisions that reduce Brazil’s ability to impose a tax or prevent the application of a more burdensome Brazilian tax rule.

Provisions like article 27 of the Vienna Convention, which establishes that a state may not invoke the provisions of its internal law as justification for its failure to perform a treaty provision, may become instrumental in forcing Brazilian tax authorities to accept the authority and effectiveness of a tax treaty provision over a local tax rule.

Another important provision of the Vienna Convention that may assist taxpayers in enforcing a treaty provision over local tax rules is article 18, which provides that a state must refrain from acts that would defeat the object and purpose of a treaty. That article may be especially important when challenging tax regulations or rulings from the Federal Revenue Department that try to avoid the application of a tax treaty provision.

Likewise, article 32 of the convention may be useful in tax litigation involving a conflict between a tax treaty and domestic tax rules because it allows one to examine the treaty’s preparatory work and the circumstances of its conclusion to confirm Brazil’s intention in executing the treaty.

Professionals believe the entry into force of the Vienna Convention may change — in a way more favorable to taxpayers — how Brazilian courts interpret and apply tax treaty provisions. For example, the convention could give the taxpayer additional arguments should the government appeal a taxpayer-favorable decision from the Regional Federal Court of Appeals for the Fourth Region. The court ruled that service payments remitted to Canada, and before 2006 to Germany, are not subject to Brazilian withholding tax because the payments qualify as business profits under Brazil’s income tax treaties with those countries.²

Footnotes

¹ Unconstitutionality Direct Action no. 1,480.

² Case 2002.71.00.006530-5, originally filed by Cia Petroquimica do Sul (COPESUL).

United States: New Jersey Taxes on the Rise

2009-07-31

New Jersey recently enacted legislation which increases individual tax rates, taxes lottery winnings and limits the property tax deduction. The new law increases the individual income tax rates for taxpayers with gross income exceeding $400,000 for the entire 2009 tax year. In response to the rate increase, the N.J. Division of Taxation has issued revised withholding tables, which take effect immediately and must be instituted by all employers no later than October 1, 2009. On January 1, 2010, the withholding rates will revert back to the prior rates.

Through December 2009, employers must withhold at a rate of 12 percent from salaries, wages and other remuneration paid in excess of $400,000. The N.J. Division of Taxation has issued two sets of revised withholding tables: one for the period of October 1, 2009 through December 31, 2009, and the second for January 1, 2010, and forward. The 2009 tax rates increase as follows:

From 6.37 percent to 8 percent on gross income greater than $400,000 but equal to or less than $500,000
From 8.97 percent to 10.25 percent on gross income greater than $500,000 but equal to or less than $1,000,000

From 8.97 percent to 10.75 percent on gross income greater than $1,000,000

Penalties and interest will not be imposed on the underpayment of estimated tax or withholding due to the tax increase on wages received prior to October 1, 2009.

In addition to the tax rate increase, beginning in 2009, New Jersey will now tax lottery winnings that were previously exempt from New Jersey income tax. New Jersey gross income tax withholding of 3 percent is required on lottery winnings in excess of $10,000.

Finally, the property tax deduction of up to $10,000 is eliminated beginning in 2009 for taxpayers with gross income in excess of $250,000 and who are not over 65 years of age or eligible for deductions based on blindness or disability. The deduction is capped at $5,000 for taxpayers with gross income of at least $150,000 but less than $250,000.

United States: FTC Extends Compliance Deadline Again for

2009-07-31

The Federal Trade Commission (“FTC”) announced on July 29, 2009, that the agency would once again delay enforcement of the “Red Flags Rule“—this time until November 1, 2009. The red flag rules and guidelines require financial institutions and creditors to formulate and implement identity-theft prevention programs. In a recent enforcement policy statement, the FTC explained that the new rules applied to a wide range of industries and entities, many of which were unaware until very recently that they would be considered a “financial institution” or “creditor” for the purposes of the rules. Many of these businesses were generally not required to comply with FTC rules in other contexts and had not been aware of the red flag rules.

For more information, please see our previous Alerts on the topic by clicking on the links below:

Red Flag Identity Theft Rules Apply to Unsuspecting Businesses; FTC Extends Compliance Deadline Again

Red Flag Rules May Snare Unsuspecting Businesses

Feds Force Businesses to Implement Identity Theft Prevention Measures by Fall 2008

Brazil: House Commission Approves Publication of Financial Statements by Large Companies

2009-07-22

Brazil’s House Commission of Economic Development, Industry and Commerce on July 15 approved a law project that requires all large companies, including limited liability companies, to publish their financial statements.

Law project 4272/2008 was presented to the House of Representatives on November 11, 2008 by lawmaker Rodovalho. It amends article 3 of Law No. 11,638/2007, which amended Brazil’s Corporations Act (Law 6,404/76) and introduced a set of complex requirements that change accounting rules and financial statements for Brazilian corporations and large companies not formed as corporations.

Since enactment article 3 of Law No. 11,638/2007 subjects large companies not formed as corporations to many of its requirements, such as those concerning bookkeeping, financial statements, and the need for registered independent auditors. The requirements affect many large companies formed as limited liability companies (limitadas), as they are by far the most popular form of legal entity. Until Law No. 11,638/2007, limitadas were excluded from following most Corporations Act requirements.

Under article 3 of Law 11,638/2007, for legal purposes, a large company is a company or group of companies under common control that, in the preceding year, had assets in excess of BRL 240 million (approximately $120 million) or annual gross income above BRL 300 million (approximately $150 million).

Project 4272/2008 adds a new requirement to article 3 of Law No. 11,638/2007: large companies falling under the article shall make public (by publication in newspapers) their annual financial statements. Lawmaker Rodovalho argues that Brazilian large companies formed as limitadas have historically opposed to publication of financial statements. The new requirement will benefit the market as a whole and give more transparency and credibility to financial statements of large companies not formed as corporations.

The project now follows to the House Commission of Constitution and Justice. The commissions have conclusive powers, meaning that if both approve the law project, it will be forwarded directly to the Senate with no need for a vote by the chamber.

David Roberto R. Soares da Silva, tax partner, Azevedo Sette Advogados, São Paulo