While family businesses globally may be enhancing their strategies to survive and prosper, some are coming to the end of their family line and choosing to sell when the prospect of an attractive offer is presented. In many regions, the global economic downturn has put paid to a worthwhile sale in the immediate term: family owners are sitting tight till values improve. But in Latin America it’s a different story.

A significant share of the Latin American market comprises family-run companies — often in need of capital, or better standards of corporate governance, or both.

Some family businesses, founded in the 1950s, are reaching the third or fourth generation facing falling birth rates and a weaker tradition of handing management down to children. Owners are thinking about cashing in.

And now, the time is ripe — family-run, small to medium-sized businesses in the region are set to become a significant target for takeovers.

M&A activity in global context

At present, Latin America is a relatively small global player in mergers & acquisitions (M&A), accounting for just 5% of total global activity in January-September 2009. In fact, M&A all but dried up in the region during the global economic downturn after what had been a significant increase in the number and value of deals during 2003-2008.

The Latin America region was not alone: while recession typically results in a slowing of deal activity, as companies push back deals in the hope that valuations will fall, the economic downturn had a particularly suffocating effect on M&A globally. The sharp reduction in available credit made it extremely difficult for companies to raise finance for new deals.

During the worst period of the downturn, in the first half of 2009, the value of announced worldwide M&A activity dropped by 40% year-on-year, to USD 941bn. The number of deals also fell, albeit less dramatically, from 20,342 in the first half of 2008 to 17,389 in 2009.

And Latin America in particular was badly affected: deals in Mexico and Central America came to a virtual standstill. Announced M&A in Brazil fell from USD 50bn in the first half of 2008 to USD 29bn a year later.

In addition to these challenging financing conditions, because the US dollar is the global currency for M&A deals, exchange rate volatility in Latin America complicated valuations — many target enterprises held US dollar-denominated debt.

Yet, as the global economy has begun to recover, deal activity in Latin America is on the increase. Compared with mega deals in the region driven by a wave of privatisations during the 1990s, and mainly led by European and American investors, the focus is now on smaller transactions. The trend has shifted increasingly to mid-market deals (USD 39.5m – 395m) among intra-regional players.

According to a Brazilian M&A advisor, the number of deals is returning to pre-crisis levels. Sentiment already appears to have shifted in the market, with most advisors in the region expecting an increase in activity — in terms of both volume and value — during 2010. A spate of deals appears to substantiate this assessment, including the announcement,  in September 2009, from a French telecommunications company, Vivendi, that it was purchasing GVT, a Brazilian mobile phone firm, for USD 2.9bn. Indicators suggest that was the turning point in the region’s M&A market.

Reasons for M&A revival

The main reason for this shift is that credit markets have reopened and facilitated access to finance. Improvements in market conditions and risk appetite have been reflected in substantial amounts of primary bond issuance, and a narrowing of spreads on secondary markets, since global risk appetite returned from March 2009. The number of initial public offerings (IPOs) nose-dived in late 2008 and early- to mid-2009, but has recovered in recent months. Banco Santander Brasil’s USD 8bn deal, in October 2009, was the largest-ever IPO in Brazil.

Although these trends incorporate a recovery globally, several factors point to a pick-up in deals in Latin America in particular. Credit access is improving, but costs remain elevated, suggesting that a greater share of deals will be financed by cash or equity. This suggests a shift in the size of M&A deals, with small and medium-sized companies likely to become the main targets. They’re ripe for takeovers.

This M&A spur among family businesses may be heightened further by larger parent companies seeking to divest poorly performing assets to raise capital. Acquiring companies could view these factors as an opportunity to enter new markets — ­­and focus their attention on the mid-market sector. Also, less mature industries in Latin America could become targets of more developed industries in neighbouring countries — witness how Chile’s successful retail industry has expanded across the region in recent years.

There is also a sense that stock market falls in late 2009 have provided significant opportunities, particularly for the acquisition of financially distressed firms that are structurally sound but face cashflow problems from difficulties in rolling over debt repayments. Although the strength of the Brazilian stock market means this is likely to be less of a factor driving M&A in Brazil, it may encourage M&A in countries where stock exchanges have taken a harder hit.

A survey on corporate response to the downturn by the international Boston Consulting Group identified strategic M&A as the second most important priority for firms generating excess cash. One respondent stated that “eight times out of 10, companies wait too long and end up paying three times more than they would have, had they taken advantage of the situation when times were bad.”

Continuing balance sheet problems in developed economies are also likely to prompt large parent companies to divest assets in some emerging markets. Some of the large Latin American companies (multi-latinas) will be well placed to take advantage of this trend, contributing to the increasing trend of intra-regional M&A.

Barriers to investment

However, there are still significant barriers to intra-regional investment, which continue to hinder the attainment of M&A levels seen in other regions of the world: cultural factors remain a structural constraint.

Although family ownership is a potential spur to M&A activity, particularly in the case of small companies struggling with cashflow or succession issues, in the case of larger firms it can hinder M&A. This is particularly evident in Mexico, where a small number of families control several of the largest business groups, resulting in a high concentration of the stock exchange — more than half of the total share volume is controlled by five companies.

Weaker standards of due diligence may also continue to present a barrier to successful M&A. A 2008 survey conducted by the private sector firm mergermarket, which reports on potential deals, found that respondents identified a lack of reliable information on the target company as the most serious obstacle to M&A in Latin America. Respondents also highlighted difficulties associated with a business culture that is protective of its operations. Weaker standards of financial reporting also remain a problem, particularly when assets are overvalued. This is a particular problem in countries with complex tax regimes.

Although most of the region’s banks have emerged relatively unscathed from the global recession — boding well for growth prospects in 2010 — this has to some degree reflected the fact that financial systems are less developed than their Western counterparts, with little exposure to the toxic assets that inflicted so much damage in developed markets. However, given that deals are likely to be characterised by less-leveraged transactions, this is unlikely to be sufficiently important to prevent the growth of M&A in the region, although it will constrain the pace of expansion.

Spread of M&A prospects

The expected increase in M&A activity will not be spread evenly across the region. Deals are set to be concentrated in certain countries. Brazil, already accounting for the lion’s share of deal activity, will consolidate its position as a regional leader, with increasing investment from regional players, as well as further afield from the Middle East and Asia. This reflects both its scale and Brazil’s macro-economic progress made in recent years, which has allowed it to rebound quickly and strongly from the downturn, as well as the increasing depth and relative sophistication of its financial markets. Significant amounts of positive media coverage in recent times emphasise Brazil’s attributes as a high-quality investment destination.

Orthodox policy frameworks will also encourage an increase in M&A activity in Colombia, Chile and Peru. By contrast, deterioration in the business environment in Venezuela, Argentina and Bolivia makes it less likely that these countries will be targets for firms seeking significant acquisitions in new markets.

In terms of sectors, nearly 60% of current M&A activity in Latin America takes place in just three sectors: mining, financial services and retail. While these sectors are expected to remain important, expected significant consolidation in the fragmented education and health sectors will also create opportunities.

The healthcare sector, in particular, looks buoyant: global pharmaceutical firms have bucked the trend of a sharp M&A deceleration and witnessed some of the largest deals in recent years. Healthcare companies are likely to be looking for strategic acquisitions that serve as a stepping-stone into new markets.

Construction is also expected to be a dynamic growth area for M&A, given the emphasis of several governments in the region on improving infrastructure. This trend is being fostered by Spanish companies offloading their holdings by selling assets in Latin America.

All of which adds up to bright prospects for the mid-market in Latin America — and the prospect of more family businesses deciding that the time is right to move on.

UHY has extensive coverage of the Latin America region with firms in key business centres in Argentina, Brazil, Chile, Colombia, Ecuador, Guatemala, Mexico, Peru, Puerto Rico, Uruguay and Venezuela. UHY’s specialist knowledge of M&A is co-ordinated through a global Special Interest Group (SIG) made up of representatives from our business centres in different countries and regions who share technical knowledge and exchange information on opportunities for investment and details of interested potential buyers.

At first, it’s hard to put your finger on what makes Hannay Reels such a successful company.  This family-run manufacturer of hose reels is nestled in the Helderberg Mountains in Upstate New York – a location that doesn’t afford a particularly strong strategic advantage. In fact, you could argue that being in a US state that abounds in regulations, taxes and labour costs might logically undermine its market position among competitors.

But Hannay Reels has something special: a legacy of ‘homespun culture’ that Roger Hannay and his family continue to practise with their customers and 150 employees, all of whom they call ‘part of the family’. It’s been the backbone of their healthy USD 45 million-a-year business since 1933.  “I suppose we could hire professionals to run the business and be silent owners, but I don’t know of any other way to do business”  Hannay says.

Visitors to Hannay Reels, in the community of Westerlo, about 20 miles south of Albany – a client of UHY’s firm in the US, UHY Advisors – may not realise that the quaint office where people bring you coffee and take your coat is the company’s nerve centre that competes on the frontlines of a global marketplace. You get the sense you’ve gone back to a day when personal contact was paramount to maintaining strong customer relationships and promises made for delivery dates and high-quality products were kept.

Hannay Reels each year makes nearly 80,000 high-quality hose and cable reels using tonnes of steel, stainless steel and aluminium. The reels are used in industries from fire-fighting to fuel delivery and deep-sea exploration.

The company’s so-called ‘secret sauce’ – while competitors from China and other emerging markets offer lower-cost alternatives – is what matters most. “We have a motto here: ‘Built to last, delivered fast” says Hannay. “Because of this commitment, we’ve somewhat insulated ourselves from low-cost competitors.”

Core strengths 

So what can family businesses worldwide learn from the likes of Hannay Reels? 

Retaining a stable workforce has long been a core strength of the company – employees are with the company on average for 20 years, and many employees’ families have enjoyed several generations of parents, children, spouses, siblings and cousins at the plant.

But, exceptional employee loyalty apart, Hannay offers other tips for a successful family business:

• Make it in your own country – Companies should do everything they can to make their goods in their own country. They shouldn’t outsource simply to make a greater profit, but rather find other ways to be competitive, such as identifying markets that appreciate quality products, speedy delivery and good old-fashioned customer service.

• Commit to your community – It’s hard to think of what Westerlo, and surrounding rural towns, would be without Hannay Reels, which employs about 150 workers and contributes significantly to the tax base and local economy. The company and its employees also give generously to causes in the region and beyond.

• Customers are king – This axiom will never go out of style, says Hannay. Everything you do needs to be focused on the customer’s experience, from ordering the product to using it.

• Make leaders accessible – Don’t hide in your office. Regularly get out and walk the production floor to observe and talk with employees. “I answer my own phone when anyone calls and our customers prefer that”, says Hannay.

• A stable, quality-driven workforce makes it all possible – Get to know your employees by name and be there for them. Trust in them and they will generally respond with quality work. “Some of our reels made more than 50 years ago are still being used today”, says Hannay.

• Keep it in the family – Too many family businesses allow outsiders to have ownership, such as through private equity investors. “It can dilute the common philosophy and approach to major areas of the business,“ says Hannay. “Only family members who are active in the company should hold stock.”

• Say little, do much – It’s worked for every generation since Clifford Hannay made his first reel in the 1930s — and now Hannay Reels is a leader in its industry sector. 

Family businesses like Hannay Reels are all around us — from neighbourhood stores and the millions of small and mid-size companies that underpin many economies, to household names such as BMW, Samsung and Wal-Mart. One-third of all companies in the S&P 500 index, and 40% of the 250 largest companies in France and Germany, are defined as family businesses, meaning that a family owns a significant share and can influence important decisions, particularly the election of the Chairman and CEO.

Key activities for success  

So what else can we learn from family businesses? Research by global business consultants McKinsey pinpoints five key activities that must work well and in synchrony for family businesses to be successful.  

They are:

• ­Harmonious relations within the family and an understanding of how it should be involved with the business

• An ownership structure that provides sufficient capital for growth while allowing the family to control key parts of the business

• Strong governance of the company and a dynamic business portfolio

• Professional management of the family’s wealth

• Charitable giving­ to promote family values across generations.
   

The research also shows that family businesses tend to have lower levels of financial leverage, and a lower cost of debt, than their corporate peers; and that publicly traded, family-influenced companies often have higher shareholder returns than do companies in leading indices such as MCSI Europe, MSCI World and S&P 500.

Generational issues 

As family businesses expand from their entrepreneurial beginnings, they often face performance and governance challenges. For example, generations that follow the founder may insist on running the company, even though they are not suited for the job. And, as the number of family shareholders increases exponentially generation by generation, with fewer family members actually working in the business, the commitment to carry on as a family business cannot be taken for granted.

Indeed, less than 30% of family businesses survive into the third generation of family ownership. However, those that do so tend to perform well over time compared with their corporate peers.

“To be successful as both the company and the family grow, a family business must meet two intertwined challenges: achieving strong business performance and keeping the family committed to, and capable of, carrying on as the owner” say the McKinsey researchers.

Family businesses can go under for many reasons, including family conflicts over money, nepotism leading to poor management, and in-fighting over the succession of power from one generation to the next. Regulating the family’s roles as shareholders, board members and managers is essential because it can help avoid these pitfalls.

Large family businesses that survive for many generations ensure they permeate their ethos of ownership with a strong sense of purpose. Over decades, they develop oral and written agreements that address issues, such as the composition and election of the company’s board, the key board decisions that require a consensus or a qualified majority, the appointment of the CEO, the conditions in which family members can (and can’t) work in the business, and boundaries for corporate and financial strategy.

The continual development and interpretation of these agreements, and the governance decisions guided by them, may involve several kinds of family forums. A family council representing different branches and generations of the family, for instance, may be responsible to a larger family assembly used to build consensus on major issues, says McKinsey.

Long-term survivors usually share a meritocratic approach to management. There’s no single rule for all, however — policies depend partly on the size of the family, its values, the education of its members, and the industries in which the business competes.

For example, the Australia-based investment business ROI Group, which now spans four generations of the Owens family, encourages family members to work outside the business first and gain relevant experience before seeking senior-management positions at ROI. Any appointment offered to them must be approved both by the owners’ board, which represents the family, and the advisory council, a group of independent business advisors who provide strategic guidance to the board. 
As families grow and ownership fragments, family institutions play an important role in making continued ownership meaningful by nurturing family values and giving new generations a sense of pride in the company’s contribution to society.

Ownership issues  

How to maintain family control or influence while raising fresh capital for the business and satisfying the family’s cash needs is a juggling act that must be addressed, as it’s a major source of potential conflict, particularly in the transition of power from one generation to the next. Enduring family businesses regulate ownership issues — for example, how shares can (and cannot) be traded inside and outside the family — through carefully designed shareholders’ agreements that often last for 15 to 20 years.

Many family businesses are privately held holding companies with reasonably independent subsidiaries that might be publicly owned. Though in general the family holding company fully controls the more important ones. By keeping the holding private, the family avoids conflicts of interest with more diversified institutional investors looking for higher, short-term returns. Financial policies often aim to keep the family in control. Many family businesses pay relatively low dividends because re-investing profits is a good way to expand without diluting ownership by issuing new stock or taking on big debts. “In fact, some families decide to shut out external investors of the entire business and fuel growth by re-investing most of the profits, which requires good profitability and relatively low dividends” says McKinsey. “Others decide to bring in private equity as a way to inject capital and introduce a more effective corporate governance culture.” 

Others take the Initial Public Offering (IPO) route and float a portion of the shares. An IPO can also be a way to provide liquidity at a fair market price for family members wanting to exit as shareholders. To keep control, many family businesses restrict the trading of shares. Family shareholders who want to sell must offer their siblings, and then their cousins, the right of first refusal. In addition, the holding company generally buys back shares from exiting family members. Payout policies are usually long-term to avoid decapitalising the business.

Because exit is restricted and dividends are comparatively low, some family businesses have resorted to ‘generational liquidity events’ to satisfy the family’s cash needs. These may take the form of sales of publicly traded businesses in the holding, or of sales of family shares to employees, or to the company itself, with proceeds going to the family.

With clear rules and guidelines as an anchor, family enterprises can get on with their business strategies.

Strong governance 

Large and durable family businesses also tend to have strong governance. Members of these families avoid the principal–agent issue by participating actively in the work of company boards, where they monitor performance diligently and draw on deep industry knowledge gained through a long history. On average, 39% of family business board members are directors from within the business (including 20% who belong to the family), compared with 23% in non-family companies, according to the S&P 500.

Of course, it’s important to complement the family’s knowledge with fresh strategic perspectives of qualified outsiders. Even when a family holds all of the equity in a company, its board will most likely include a significant proportion of outside directors. One family business has a rule that half of the seats on its board must be occupied by outside CEOs who run businesses at least three times larger than the family one.

Procedures for all nominations to the board — insiders as well as outsiders — differ from company to company. Some boards select new members and then seek consent from an inner family committee and formal approval by a shareholder assembly. Mechanisms differ: what counts most is for the family to understand the importance of a strong board, which should be deeply involved in top-executive matters and manage the business portfolio actively. Many have meetings that stretch over several days to discuss corporate strategy in detail.

Family businesses, like their non-family peers, face the challenge of attracting and retaining world-class talent to the board and to key executive positions. In this respect, they have a handicap because non-family executives might fear that family members make important decisions informally and that a glass ceiling limits outsiders’ career opportunities. Yet, family businesses often emphasise caring and loyalty, which some talented people see as values above and beyond what non-family corporations offer.

Long-term growth strategies 

Successful family companies usually seek steady long-term growth and performance to avoid risking the family’s wealth and control of the business. This approach shields them from being tempted to pursue maximum short-term performance at the expense of long-term company health. Longer-term planning, and more moderate risk-taking, serve the interests of debt holders too, so family businesses tend to have not only lower levels of financial leverage but also a lower cost of debt than that of their corporate peers.

The longer perspective may make family businesses less successful during booms but increases their chances of staying alive in periods of crisis and of achieving healthy returns over time. In fact, despite challenges facing family-influenced businesses, from 1997 to 2009 a broad index of publicly traded ones in the US and Western Europe achieved total returns to shareholders two to three percentage points higher than those of the MSCI World, the S&P 500, and the MSCI Europe indexes. 

This long-term focus, says McKinsey, implies relatively conservative portfolio strategies based on competencies built over time, coupled with moderate diversification around the core business and, in many cases, a natural preference for organic growth. 
Family-influenced businesses also tend to be prudent in mergers & acquisitions, making smaller but more value-creating deals than their corporate counterparts do, according to McKinsey’s analysis of M&A deals worth more than USD 500 million in the US and Western Europe from 2005 to late 2009. The average deal of family businesses was 15% smaller, but the total value added through it — measured by market capitalisation after the announcement — was 10.5 percentage points, compared with 6.3 points for their non-family counterparts. 

Wealth management 

Nonetheless, too much prudence can be dangerous, says McKinsey. Family owners, who usually have a significant part of their wealth associated with the business, face the challenge of preventing an excessive aversion to risk from influencing company decisions. Excessive risk aversion might, for example, unduly limit investments to maintain and build competitive advantage and to diversify the family’s wealth. Diversification is important, not only for overall long-term performance but also for control, says McKinsey, because it helps make it unnecessary for family members to take money out of the business and diversify their assets themselves. That’s why most large, successful family-influenced survivors are multi-business companies that renew their portfolios over time. 

• Five key factors increase the chances of wealth management success:

• A high level of professionalism through institutionalised processes and procedures

• Rigorous investment and divestment criteria

• Strict performance management

• Strong risk-management culture, with aggregated risk measurement and monitoring

• Thoughtful talent management. 

McKinsey adds: “Almost all companies start out as family businesses, but only those that master the challenges intrinsic to this form of ownership endure and prosper over the generations. The work involved is complex, extensive, and never-ending, but the evidence suggests that it is worth the effort for the family, the business and society at large.” 

UHY has offices in most major business centres around the world. For details of UHY’s family business support in your region, please contact the UHY executive office. 

Global accountancy network UHY publishes its latest edition of UHY International Business – Issue 21. This bi-annual publication features fresh insight, provided by our members, on the most current business challenges and key issues faced by companies and individuals around the world. Issue 21 covers the following topics:

• ‘Making of a family business’ 
  As family businesses expand from their entrepreneurial beginnings, they face unique performance and governance challenges. To be successful, a family business must achieve strong business performance and must keep the family committed to, and capable of, carrying on as the owner…
• ‘Signs of a rebound spur M&A’ in Latin America’ 
  While family businesses globally may be enhancing their strategies to survive and prosper, some are coming to the end of their family line and choosing to sell when the prospect of an attractive offer is presented. In many regions, due to the global economic downturn, family owners are sitting tight, but in Latin America it’s a different story…
• ‘R&D- incentives for growth’ 
  While economies around the world struggle out of the economic downturn, many businesses, are continuing to invest significantly in research and development (R&D). These businesses realise that cutting R&D budgets can limit future growth. But to stretch budgets further, companies are evaluating not just how much R&D to conduct but also where to do it…
   

UHY has targeted the following countries for expansion in 2010: Finland, Japan, the Philippines, Serbia, Costa Rica, Bolivia and Azerbaijan.

UHY is also seeking to expand its representation in Germany to Stuttgart, to complement existing coverage in the country. 

Visit the How to Apply section of this website for details on how to submit your firm for consideration to join one of the world’s fastest growing global accountancy networks.

Initiatives from the Organisation for Economic Co-operation and Development, the G20 and various national governments have been portrayed in the business press as an assault on low-tax jurisdictions.

It has been suggested that taxpayers with offshore investments cannot afford to ‘lie low’ for much longer as the regulatory noose tightens.

But we’ve heard this before. The question is: Will governments back off after legislating, granting amnesties and demanding identity disclosures? Or, in economic hardship times, will these cash-strapped governments become energised still further as they see offshore regulation as a means of trawling for increased revenues without having to fear backlash from their electorates?

Whether individual national government intent on this issue is materialising into global or regional action (particularly within the European Union) is also ripe for discussion; as well as what restructuring and new tax planning can be adopted for clients in what may become a more transparent offshore age.”

National offshore initiatives

One of the more structured national initiatives targeting offshore is being promoted by the UK government where Her Majesty’s Revenue & Customs (HMRC) is warning: “This will be the last opportunity of its kind.” In its sights are taxpayers with offshore investments who, it believes, may not be disclosing, in full, income from abroad. They now have an NDO – a New Disclosure Opportunity.

The NDO ‘carrot’ is a low penalty rate of 10% of the tax not declared (unless the taxpayer is shown to have ignored 2007 Offshore Disclosure Facility (ODF) warnings, where the penalty will be 20%).

Ignore the new scheme, says the government, and you run the risk of prosecution and heavier penalties.

The UK government has added muscle to its threat by, using groundbreaking legal procedures, obtaining details of interest arising offshore to British account holders of 300 financial institutions.

Its previous ODF campaign, which ran until November 2007, raised about £450 million (USD 750m) from 45,000 individuals – lower than the HMRC had hoped.

Spurred on by economic necessity, the UK government is now pinpointing these 300 banks and building societies (savings organisations) in the UK with offshore operations, and has been aided by the signing of agreements between the UK and other countries allowing exchange of information.

The HMRC’s controversial purchase of information on Liechtenstein accounts resulted in investigations into hundreds of UK taxpayers. It has also carried out raids on several London safety deposit facilities.

HMRC set a deadline for individuals to notify their intention to disclose online under the NDO scheme at the end of November 2009. The disclosure itself then has to be made by the middle of March 2010. A disclosure has to include a calculation of all taxes, interest and penalties payable, together with details of all offshore bank accounts and assets held offshore since April 2008. Prosecution will be avoided unless tax evasion is connected with a serious crime beyond taxation. 

Meanwhile, in Italy, a tax amnesty on money illegally held abroad, valid till mid-December 2009, is a desperate attempt by the government to attract capital home in a time of economic crisis, not least to boost tax revenue.

The Scudo-Fiscale (fiscal shield) programme allows citizens to bring money from offshore tax havens while remaining anonymous and avoiding sanctions for past tax evasion. All they have to do is move their money to an Italian account within two months and pay a 5% fee.

But critics say the plan is the latest in a long line of amnesties that have created a culture of tax evasion for wealthy Italians.

“The idea, in theory, is to give people a last chance,” says Paolo Guerrieri, who teaches international economics at La Sapienza University, Rome. “But, in practice, this is an incitement to tax evasion. Here in Italy these kinds of ’emergency measures’ are so frequent that people know they can just wait for the next amnesty. It’s an insult to honest citizens.”

However, whether in the UK, Italy or any other global jurisdiction, those who have avoided tax illegally through offshore investments may have an extra incentive to take advantage of an amnesty this time: the Swiss have relaxed their banking secrecy rules, and the odds are being heightened that tax evaders may be disclosed.

During the G20 summit in March 2009, Swiss authorities agreed to cooperate more with other nations in tracking down tax evasion. The move followed pressure from the US and European countries worried about the impact of tax evasion on their economies.

Most European nations need extra cash now, Guerrieri says, but Italy’s situation is unique: “We’re openly surrendering the possibility to build a sound fiscal system [in exchange] for an immediate profit. And eventually we’ll pay the price. No wonder Italy has one of the highest tax evasion rates in the continent.” 

Italian capital held illegally abroad is estimated at about 300 billion euros (USD 450 billion), according to government figures. At least one-third of that money is thought to be in Swiss banks.

The Italian government expects 100 billion euros (USD 150 billion) abroad to re-enter Italy through its amnesty, which would mean an extra 5 billion euros (USD 7.5 billion) of tax income for the state. 

Demand for wealth management 

The upsurge of government regulations, designed to flush out a minority engaged in evasion, has brought about increased demand from tax-compliant individuals looking to manage their assets internationally, says STEP (Society of Trust and Estate Practitioners), which has canvassed views of its members – lawyers, accountants and bankers worldwide. Their clients are feeling victimised and want their personal data to be better protected “from corrupt institutions and careless governments”, says STEP director of policy Keith Johnston. “They want compliant confidentiality.”

STEP’s two surveys (Offshore Evolution: The STEP Membership Perspective, building on a parent report, Offshore Evolution: Transparency and Solutions in Cross Border Wealth Structuring: see: www.step.org) highlight the growing need for professional advisers who have the capability to give tax advice on a global, not just local, basis.

“Much more sophisticated advice is needed to manage the complexity of tax issues wherever a client may have assets or connections,” says STEP. “Clients want home country compliance and international tax neutrality to avoid additional layers of tax.”

Three key trends are identified:

Economic conditions will mean tax competition between countries will increase and the distinction between offshore and onshore will fade.

Investors and their advisors will choose jurisdictions for tax neutrality, so that investors from several jurisdictions are not subject to the additional layers of tax that sometimes arise in a cross-border context.

“All this requires much more sophisticated tax and regulatory advice where integration is key,” says STEP. “This means bringing together the advice from country A and country B to achieve the best outcome overall.”

Modernising practices are integrating trust and estate planning into a wider wealth management business. Trustees are adopting best practices in investment management and enhancing compliance processes to reduce risk.

Products and services are being combined together to create new revenue opportunities for wealth-structuring professionals. New strategies are being added to the toolbox and existing strategies are being combined in new ways to create customised solutions in higher-value structures.

Offshore investment needs

Ongoing consultation and advice is fundamental to offshore investment – and even more so now that governments are targeting offshore, says UHY’s offshore trust and fiduciary member firm, The Louvre Group.

Louvre is a privately-owned trust and fiduciary company that has been established for more than 35 years and employs over 65 staff in ‘white-listed’, offshore jurisdictions – it has six strategically placed, interactive offices in Guernsey, Geneva, London, Hong Kong, Dubai and the Cayman Islands.

The group provides trust, fiduciary and fund services for international, private and corporate clients.

“Offshore markets have changed significantly over the past two or three years,” says Louvre director Geoff Trebert. “Clients’ needs have become much more complex and international. Traditional private and company structures and trusts, although still required, are no longer always appropriate: clients need effective solutions to highly complex issues.

“We have applied our core skills and knowledge to providing a range of new services, including QROPS (Qualifying Recognised Overseas Pensions Schemes) and EBTs (Employee Benefit Trusts), to clients who have global interests and wish to preserve and grow their wealth in these challenging economic times.”

QROPS and EBTs have been combined in an innovative approach by Louvre on behalf of high-net-worth clients. EBTs are a useful vehicle whilst the client is working, and QROPS comes into its own when retirement planning is on the agenda. Combining the two, for one client in a lifetime solution, is an area that Louvre is deploying more frequently. 

What was known as ‘A-Day’ (‘Appointed-Day’) – 6 April 2006 – produced radical changes in respect of the rules governing transfers from the UK-registered pension schemes to offshore pension schemes. Individuals are now able to transfer their UK pension funds to an overseas pension scheme, provided it is a ‘Qualifying Recognised Overseas Pension Scheme’, and it is registered with HMRC.

The scheme is available for UK residents planning to leave the UK, already living overseas, or internationally mobile employees who plan to live overseas. Its benefits include the ability to receive transfers from UK-approved pension schemes, with no need to purchase an annuity. The plan also provides flexibility in taking benefits and managing investments, potentially reducing exposure to UK taxes.

Employee Benefit Trusts (EBT) are another growth area. An EBT is a trust set up by an employer for the benefit of employees (including directors) and former employees, their spouses and dependants. Such trusts may be established within or outside the UK under UK or foreign law. An EBT is normally funded by an initial contribution (usually nominal) plus a series of periodic contributions. Such contributions are at the discretion of the employing company.

As well as receiving contributions from the sponsoring company, EBT trustees are usually empowered to augment trust funds by borrowing from the employer or from third parties (banks, etc) and by accumulating income. 

EBTs are used for various purposes, including where an unquoted company wants to make share ownership more meaningful for its employees, warehouse shares for future distribution to employees, or facilitate exit strategies for company owners who wish to transfer ownership to employees over a period of time – rather than just sell the business on the open market. EBTs can also be used in respect of private share plans.

“We always think strategically for our clients when managing their wealth, and using a variety of structures at different times of the client’s life-cycle is a crucial part of our service,” says Trebert.

“A typical example of this was where a UK-based client had, for a number of years, been a member of an EBT which was administered by us. On retirement the client decided he wanted to relocate to South Africa. Benefits that were in the EBT were used to acquire several business interests in South Africa for which Louvre provided the company administration and directors.

“Our company administration and management experience means that the client could enjoy his retirement at the same time as knowing his finances would be managed for his family to enjoy. In addition, we also transferred five of his UK-based pensions into the Louvre QROPS.”

Among UHY’s wealth management services offered globally by UHY member firms for international clients is Private Client Services, London, UK, which supports individuals in their personal tax affairs when they develop UK interests.

Partner Jeremy Herridge, who heads up the operation, moved to London from the Isle of Man where he developed expertise in offshore and international tax planning. 

“Our typical clients are private individuals, executives and employees, including high-net-worth individuals and entrepreneurs,” says Herridge. “We also offer services to companies sending employees to the UK.” 

Practical needs of clients worldwide moving to the UK include consultancy on residence, domicile issues and tax compliance.

For example, if clients plan to go to the UK with the intention of spending more than an average of 90 days per tax year there, they risk becoming ‘tax-resident’ on arrival – with significant implications for tax payments.

‘Domicile’ has a technical meaning for tax purposes, and is not the same as residence or nationality. It is not easy for a client to change his/her domicile, but it can be done if they make their main home in another country and make a firm decision to keep it there permanently or indefinitely.

If they are UK-resident, but non-UK domiciled, they can apply to be taxed on a ‘remittance basis’, which means they will not be taxed on non-UK income and gains if they leave them outside the UK.

The benefits of getting it right from the outset are significant: once clients have been UK-resident for at least seven of the previous nine tax years, they would need to pay a charge of £30,000 to claim the remittance basis, or else pay tax on their worldwide income and gains.

Similarly, benefits may accrue from limits on salary tax in the UK. A client’s salary for working in the UK will generally be taxable in the UK regardless of residence status, but if he/she is also resident in another country, there may be a tax treaty with the UK that limits the UK tax.

If a client will be working in the UK, and also outside the UK, it may be possible to arrange affairs so his/her non-UK work is not taxed.

Within Private Client Services’ portfolio:
 

• A UK property developer wanted to take advantage of a downturn in the property market to take a long holiday in Malta and cash in on some of his investments. UHY’s firm in Malta, UHY Pace, Galea Musù & Co, helped him take advantage of the country’s favourable remittance rules to extract profits from the UK with significant tax advantage.
   
• A client wanted to expand his food wholesale business into mainland Europe. Private Client Services advised him on a tax-efficient holding structure for the business. UHY’s firm in France, GVA, advised on the establishment of a French company and how the transactions with the UK should be structured.

   

Determined efforts by the Mexican government to confront organised crime and corruption in business – with added weight from its own Sarbanes-Oxley-type legislation on corporate governance – are beginning to pay off.

Extra impetus has come from across the border, where the US government has been aggressively punishing companies for violating its Foreign Corrupt Practices Act anywhere in the world – not least, of late, in business deals within Mexico. 

And now, in Mexico, the ‘tide is changing’ – pressures to weed out business corruption are having an effect, evidenced by organised crime gang violence on the streets, speculate economic analysts. 

Certainly, heightened US focus on intra-trade with its southern neighbour, coupled with the US government’s new-found zeal for aggressively pursuing corporate offenders wherever they may be found, is driving boardroom awareness of the need to adhere to corporate governance laws and standards. 

And increasingly, US company directors have been looking to mitigate against the alarming costs incurred to investigate ‘suspect activity’ within their ranks which becomes an emergency if the government is already knocking with a subpoena. 
As a result, UHY’s Forensic, Litigation and Valuation Services (FLVS) Group in the US is currently experiencing an upsurge of clients wanting to proactively identify, at their own pace, any problems in their cross-border business dealings within Mexico, rather than be caught out by either government. 

“Companies that conduct business in Mexico should routinely investigate their business practices to ensure that neither their employees, nor their agents nor distributors, are violating either the Foreign Corrupt Practices Act or Mexican anti-corruption laws,” advocates FLVS managing director Jeff Harfemist.

A different business culture

Mexico has long since had trade agreements with North America, Canada and Japan stretching back more than 20 years and it is the third-largest trading partner with the US for both exports and imports. Total trade between the countries exceeds USD 315 billion per annum, topped only by Canada and China. Total US trade with China in 2008 was only 10% greater than trade with Mexico. In fact the US exports nearly twice as much to Mexico as it does to China. As a result, sound and ethical business practice in Mexico is a substantial issue for US companies.

The same applies elsewhere, but on a lesser scale. Whereas 80.2% of Mexican exports are to the US, exports to Canada represent 2.4% and to Germany 1.7% (2008 figures). Mexico exports manufactured goods, oil and oil products, silver, fruits, vegetables, coffee and cotton and has 12 free trade agreements with more than 40 countries including Guatemala, Honduras, El Salvador, the European Free Trade Area, and Japan – putting more than 90% of trade under free trade agreements.

According to attorney Bradley Richards, a leading partner in the corporate department of lawyers Haynes and Boone LLP (the largest law firm in Texas), who works with UHY’s FLVS Group on certain engagements: “Mexico is a great location for a company’s first investment outside the US. It has a strong rule of law, easy transportation links, strong treaty arrangements with the US, and a favourable business climate. But, it is a different culture, and one cultural attribute has been significant low-level bribery.” 

Bribery in Mexico, referred to colloquially as ‘bites’ or ‘mordida’, is a long-standing tradition. According to recent reports out of Mexico by anti-corruption activists, Mexicans paid more than two billion dollars in bribes in 2008, representing approximately 8% of their income. 

Corruption is said to infiltrate the police and nearly every provider of services in the country. Bribes are considered essentially ‘user fees’ that augment the compensation of poorly paid government workers. Since the 1990s, the Mexican government has tried to change this behaviour, and to improve the lives of its people, but with modest success.

This tradition is equally apparent in business – and the Mexican government has been finding business bribes just as difficult to eradicate. Mexico (like China) has been awarded only a 3.6 out of 10 rating on the Transparency International’s Corruption Perceptions Index, which measures the degree of corruption associated with doing business in various countries.

Mexico adopted the Organisation for Economic Co-operation and Development ‘Convention Against Corruption’ by amending its penal laws in 1999 to prohibit bribery of foreign government officials.

Since then, it has passed numerous laws in its bid to increase government transparency and eliminate corruption within government. “And enforcement in the commercial arena has been attempted, with mixed results,” says Harfenist. “From a regulatory standpoint, Mexico has a very strong anti-corruption set of laws,” he says. “Administrations have made fighting corruption a priority. Although they have made some progress in the enforcement of these laws, businesses still report that corruption remains a major issue.

“Activists are demanding that anti-corruption laws be enforced. The current Mexican government is working with the US to try to get ahead of this problem. This may put US businesses who conduct business in Mexico squarely in the regulators’ cross-hairs. It’s critical that US entities exhibit exemplary behaviour as this effort unfolds.”

FCPA liability

The Foreign Corrupt Practices Act (FCPA) in the US prohibits the bribing of foreign officials, which includes not only those working for the government but also those working for businesses owned in whole, or in part, by the government. A bribe is anything of value paid or promised (even if never paid) to secure a business advantage. The bribe can be paid directly or indirectly.

Bribes paid by agents or distributors that result in an advantage for a company will nearly always be considered violations of the FCPA by that company. The burden shifts immediately to the company to prove it did not pay or authorise, even if indirectly, the payment of the bribes. “Proving a negative is never easy,” says Harfenist.

“It is widely reported that prosecutions involving allegations of corruption are on the rise and that the Obama administration has no intention of slowing down that train. In addition, the costs associated with non-compliance are rising dramatically. Penalties are now often assessed by many of the non-US involved countries and nearly always involve the severe punishment of one or more executives implicated in the investigations.”

While prosecution of government officials in Mexico may be mixed, when a bribe is discovered by the Mexican authorities, there is no hesitation to turn in the US bribe payer and to cooperate with US authorities. Mexico may also prosecute the payer under its domestic laws. More stringent on individuals than US law, Mexican law nearly always requires punishment for at least one executive involved in, or charged with, overseeing the operations in which the violations occurred, whether they had knowledge or not. 

FCPA violation examples in Mexico

In September 2007, Paradigm B.V. settled with the US’ Department of Justice for a fine of USD 1 million, in part as a result of improper payments to Mexican government officials. In addition to violations in other countries, Paradigm Mexico provided a USD 12,000 trip, USD 10,000 in entertainment expenses and a house to certain employees and wives of employees of Pemex, Mexico’s national oil company.

One of the world’s largest offshore drilling companies, Pride International, Inc, based in Houston, US, performed its own internal investigation and uncovered improper payments to government officials in Mexico and Venezuela. The payments in Mexico were made to get certain equipment through customs, to move personnel through immigration processes and for entertainment of government officials. Pride self-reported these violations to the Department of Justice and the Securities Exchange Commission.

Investigating current practices

To improve outcomes, says FVLS, US investors should:

• Review the business, legal and cultural factors that will impact the investment
• Ensure proper diligence before making the investment
• Develop a plan to ensure compliance with US and Mexican anti-corruption laws after the investment has been made. 

Any company conducting business in Mexico, whether directly or through agents or distributors, should periodically conduct a multi-step investigation of its in-country operations.

The system of internal controls should be reviewed both in terms of its overall adequacy, areas of weakness, the potential for collusive behaviour, and the level of consistent enforcement with stated anti-corruption policies and procedures.

The first step involves developing a detailed understanding of the business, including the nature of its customers, the channels used to go to market, the competitive landscape of the industry in which it operates, and the factors (both internal and external) that are exerting pressure on the company.

Next, a detailed review of financial records is performed using forensic tools to identify, among other factors, potentially anomalous transactions, including payments with unusual attributes, vendors with suspect origins, atypical travel and entertainment expenses, and reimbursements without proper documentation and back up.

Intelligence is gathered by experienced investigators on all of the suspected participants in the business to determine backgrounds, connections, ownership of entities and other suspicious affiliations.

Local professionals are employed to address unique accounting issues, local customs and cultural aspects of the case, and to present reputational information that may only be known locally.

The whereabouts of the company’s electronically stored information is identified, categorised, and where pertinent, collected in a forensically sound manner, in case future analysis is needed.

Connections are made between the financial data uncovered and those involved to determine whether a deeper review should be undertaken and in which direction it should go.

All investigations are carried out through an attorney to protect all available privileges.

Once the investigation is completed, it is up to the company and its lawyers to determine whether to report any findings of problematic behaviours to government agencies; and to correct any weaknesses found in financial controls.

Conclusion

As world trade grows and barriers come down, corruption is gradually being eliminated in even the most troubling countries. “It may never disappear,” says Harfenist, “but countries like Mexico are working diligently to improve international trade opportunities by making it a safer and a more ethical place to operate.”