Saturday, July 21, 2018
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Enrique Feás

​Business domicile: the ship "Catalonia" begins to turn

State Economist

The exit of companies from Catalonia since the 1st October is giving rise to much confusion about what are the effects of changes in the different domiciles of a company, probably derived from two errors.


Timon


A first mistake is to consider that the decision to move the registered office, the fiscal domicile or the effective management location are independent, autonomous and static decisions by the company, when in fact they are not any of the three things: they are not independent, because in many cases you cannot change one address without changing the other; they are not autonomous, because some are required by national or international regulation or can be rejected by the Administration; and they are not static, because in general they are part of a slow process of the company's risk reduction in Catalonia.


And therein lies the second error: not to notice that the Catalonian economy and business network are large enough and complex enough to be able to observe quite short-term economic effects of these decisions. In the end, they are like great ships: they cannot suddenly vary their course, and the effects of the changes are noticed little by little, as they become more irreversible.


The reality is that Catalonian companies exposed to the uncertainty of these months are progressively adjusting to three types of risks: legal risk, fiscal risk and economic risk.


Thus, the initial change of headquarters essentially responded to the need to reduce the legal risk of the parent company, associated with their nationality. As the Law on Capital Companies establishes that the nationality of a company is depends on the location of its registered office, the change was equivalent to a business positioning: its consideration as a Spanish company in case of independence, and its submission to the legal system and the courts Spanish people. This was key for implementing international conventions -such as the Reciprocal Protection and Promotion Agreements for Investments, which are quite significant for multinationals- or for European or Euro zone legislation -access to a single market, European licence or access to Euro system or liquidity of the ECB-. In any case, and to avoid social venues of convenience, both the Spanish law and several European directives require that this coincides with the effective management headquarters or with that of its main establishment or operation.


THE CONCEPT "EFFECTIVE MANAGEMENT HEADQUARTERS" IS NOT ERRONEOUS


Having said that, the change in corporate headquarters did not eliminate the fiscal risk, That is, the possibility that a supposed Catalonian tax authority could demand taxes from the company not on the basis of the income obtained in Catalonia, but on the basis of its worldwide income. To avoid this risk, it was necessary to move the fiscal domicile. The problem is that, unlike the decision of location of the head office, on which the company has enough autonomy, the decision to change the tax domicile can be rejected by the Administration if said address does not coincide with the effective head office, which is what the national fiscal (General Tax Act) and international (Model of the OECD Convention) legislation considers as a determining factor when determining tax residence. Thus, if a Catalonian company moved its registered office and tax office, but kept its effective address in Catalonia, an alleged Catalonian Tax Agency would have legal basis to continue considering the company as a tax resident in Catalonia and force it to pay taxes on its worldwide income -in the absence of Double Taxation Agreement-.


Therefore the decision of many companies to move their fiscal domicile shows two things: the persistence of a certain fiscal risk in Catalonia -perhaps not only derived from independence, but also from a possible new government- and the intention to move also the seat of effective management, since the change of one without the other could be legally challenged.


We should note that that the concept of "effective management headquarters" is not unequivocal. 


The OECD defines it as "the place where the key business decisions and the management decisions necessary to carry out the group of business or professional activities of the entity are made", and to determine it, it has to be taken into consideration, case by case, "all relevant facts and circumstances", since "an entity can combine more than one management site, but it will have only one effective management location". 


Generally, the place where the board of directors meets and the general meeting of shareholders is used, but other factors can be taken into account, such as the place of residence of the members of the administrative body, where the human and material resources necessary to the activity of the company are, or even the bank accounts from which it operates.


All in all, after the change of corporate headquarters, the change of fiscal domicile -which will largely entail a change of effective management location- is just another step in the movement of the corporate vessel to guarantee an exclusive subjection to a legal and fiscal sovereignty outside of Catalonia. and a step much more irreversible than the previous one.


PART OF THEIR EXPORTS WILL NOT BE ACCOUNTED FOR IN CATALONIA


What are the other implications do these changes of venue? 


We can perceive three types: the payments to the Spanish and Autonomous Region tax authorities, the statistics and the economic ones on the GDP and employment.


As already explained previously, in the short term there are no effects on the Spanish and regional tax authority payments, since all corporate taxes are collected by the state (including those related to VAT). The only small variations would be taxes related to certain corporate operations or those derived from the greater activity around the new headquarters (registration of the new domicile, notarian, advisory and advocacy related to effective management).


There are statistical implications related to a change of venue, derived from the spatial segregation of management and production activities. Thus, in companies with several production centres it is quite frequent that the exports of final products are made by the headquarters -after acquisition of the product at the domestic production centre at an internal price-; this is because companies generally prefer to manage international risks from headquarters -on the other hand, imports of raw materials are usually each production centre's expenses.


In this way, it is likely that a part of the international exports that were previously computed as originating from Catalonia are now computed as originating from the new headquarters location. For the same reason, foreign investments -particularly inter-company participation and loans, rather than green field investments- are generally made and received at the headquarters, then it is possible that an increase is perceived in other Autonomous Regions other than Catalonia as the origin and destination of foreign investment.


The important thing is to know the effects of company changes on GDP and employment. 


We should not underestimate the importance of the transfer of effective management, which may take with it international departments, R&D centres or after-sales services. In the latter case, it could harm productivity or regional GDP, particularly in highly technological sectors where there is little added value incorporated into mere production. However, the most significant impact will depend on business decisions taken on the third risk: the economic risk linked to the region, or "Catalonia risk".


THE UNCERTAINTY SEEMS TO HAVE REDUCED


At the moment, the uncertainty regarding a unilateral independence seems to have reduced, and it is possible that there are still no incentives to reduce productive assets or human resources in Catalonia. However, we should not forget that all major international investors have postponed their decisions until 2018 to assess the new risk depending on the autonomous government that will come out of the ballot on 21st December. There are two scenarios here: either the mood calm down and things return to normal, in which case the vessel "Catalonia" could straighten its course; or the instability, the uncertainty and the threat of rupture persist, in which case we would not only expect a reduction in activity and employment in Catalonia, but also a high cost to future opportunity in terms of new investments that would undoubtedly be diverted to other regions.


Additionally, the cost of uncertainty is not limited to the current decline in activity and employment, but also to all the lost opportunities of increasing real or potential growth. When the economic risk causes the ship to change direction definitively, even the most seasoned captain will not be able to correct it.



Article originally published on blognewdeal.com and its publication has been authorized by the author.

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THE ECONOMY JOURNAL

Ronda Universitat 12, 7ª Planta -08007 Barcelona
Tlf (34) 93 301 05 12
Inscrita en el Registro Mercantil de Barcelona al tomo 39.480,
folio 12, hoja B347324, Inscripcion 1

THE ECONOMY JOURNAL ALL RIGHTS RESERVED