Reducing effective income tax problem

dyatlov

So my friend has to do a presentation on a tax problem, but she can't figure it out, neither can I. The description seems sort of incomplete, but here it is:

An Italian financial institution (“Bank”) has pre-tax profits of €1bn. It pays income tax at 30%. Management believes that Bank’s shareholders expect some intelligent risk-free tax planning reducing Bank’s effective tax rate down to 25%. They have been approached in this respect by a UK based structure finance bank. UK bank suggests for Bank to acquire shares under a ‘repo’ in a Luxembourg Issuer SPV for a consideration of 500m.
The repo-seller would be the Luxembourg Parent SPV (having initially subscribed for the shares), wholly owned by the UK bank.
The repo sales price would be determined according to following formula: Sales price = Par + Interest (5%) on a notional of 500m – (97% x Dividends received by Italian shareholder during the life of the repo).
The structure would last slightly less than 12 months, such that a dividend withholding tax of 10% would become due. Under Italian tax law, the foreign withholding tax on dividends is creditable against the corporation income tax of the Italian recipient.

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So what is required is to show how the systems works so that the effective tax is reduced to 25%. In no way can I figure out the way it happens, I've approached this in all the possible ways. Anyone has ideas?

Elaine_Wilson

Thought I'd have a look at this but as I know nothing about repos the rest of this post may be rubbish.

First of all you say the consideration for the repo is 500m. Should this be 500k, which is what I have assumed in the following?

In very simple terms (as that's the my mind works) -

The bank makes 1m profit.
It uses half of this to buy shares.
It holds these shares for just under a year.
During that year it receives a net dividend of 450k being 500k less 10% withholding tax.
It sells the shares for 40k.

If that is what happens then the tax position of the bank is as follows.

On the 1m profit tax at 30% would be 300k. But they can deduct the withholding tax of 50k so the net tax is 250k. This is an effective rate of 25%.

What about the cash flow? At the start of the year there is cash out of 500k. Near the end the dividend brings in 450k. Then the sale of the shares brings in another 40k. So, only 10k down but the tax liability is reduced by 50k giving an overall gain of 40k.

I'm not quite sure how the UK bank and the subsidiaries fare in this but they have had the use of 500k for almost a year at a cost of 40k. I suspect they may well be able to do something clever with the withholding tax by setting it off somewhere.

By the way, the sale price for the shares was calculated at 500k plus 5% notional interest (25k) minus 97% of dividend (485k) = 40k.

When you find out what the real answer is please report back as I'd like to know.