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Foreign Exchange

How to prepare for a eurozone break-up

Multinationals operating in Europe would be foolish not to consider the treasury and tax implications of a country exiting the single currency and conduct some impact assessments to help ensure the best outcomes for the business if such a situation does arise, says the International Tax Review.

Nobody wants to see the dissolution of the eurozone, mostly because of fears it would have a knock-on effect of creating another global recession, but repeated bailouts of vulnerable eurozone members by countries whose economies themselves are struggling to grow is not a sustainable model. Even if we disregard fears of a full-scale eurozone break-up, nobody can say with any certainty that vulnerable jurisdictions, such as Greece, Portugal, Italy and Spain, will remain in the eurozone much longer.

If an at-risk jurisdiction exits the eurozone, it is likely the exit would lead to a redenomination of the country’s currency, and devaluation of that currency against the euro.

This eventuality would throw up all kinds of gain and loss realizations for multinationals operating in such a jurisdiction, not to mention the dangers of local banking systems freezing up during the currency transition period.

A lot of the actions companies would need to take to prepare or respond are primarily treasury orientated.

However, most of these actions would have a knock-on impact on tax. And it is important companies consider such consequences now, so they can achieve the best tax result when difficult decisions have to be taken.

Redenomination of currencies in potential eurozone exit countries could lead to existing hedges becoming ineffective.

For instance, if a company is borrowing euros to hedge assets, but those assets subsequently become non-euro assets, then that poses problems.

Multinational treasurers might well consider adjusting the hedging profile of their groups in response to these risks. And the tax director must ensure these hedges work in terms of post-tax outcomes.

So tax directors should work closely with treasury when adjusting hedges to prevent big losses in individual jurisdictions where it could be difficult to obtain effective tax relief.

It is also important for tax directors to understand what types of contracts they have with potential exit jurisdictions.

For instance, potential problems with VAT could arise where a eurozone company supplies goods to a company in a country which exits the euro.

If VAT is payable to tax authorities in the eurozone country, but the exit country’s currency is devalued, then as a result of the devaluation, the VAT paid to the seller will be reduced where the sales contract is governed by exit country law.

In most cross-border agreements, the governing law will be provided for in a specific clause, and companies should check whether changing this to a different jurisdiction will give a better tax result.

Similarly, loan contracts should be examined.

Loans from a company in a non-eurozone – or stable eurozone – country to a company in a potential exit country could be exposed to risk.

If a loan contract is denominated in euros, but is subsequently re-denominated into a new local currency after the exit country leaves the eurozone, in accordance with the governing law of the contract, the amount repayable to the lender company could be substantially devalued.

Characterization of this loss is then important – for instance in the UK an impairment loss on contracts with related parties is not generally tax deductible but an exchange loss should be.

From a treasury perspective, it makes sense to extract cash from vulnerable eurozone countries, shifting it to accounts in the UK or the Netherlands for instance, to ensure that if a country’s banking system were to freeze for a period after a eurozone exit, the group would still have access to the money.

However, this could create a lot of short-term cross-border intra-group financing which raises tax issues that must also be considered.

Tax might not be the primary consideration if companies are reacting to a eurozone break-up, but if comparable options become available, then companies would be wise to conduct assessments now, so they know which choice would produce the best tax outcome possible.

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