Potential break-up of the Eurozone: overview of tax implications

20 January 2012

The unprecedented levels of uncertainty experienced in the Eurozone during 2011 are expected to continue into 2012. PwC have considered a range of potential scenarios for 2012 (see PwC paper What next for the Eurozone). Amongst the possible scenarios, the possibility of a partial break-up of the Eurozone (“a partial break-up”) has risen over the last months. Many businesses have started to undertake contingency planning in order to be able to face the consequences of the potential exit of one or more countries from the Eurozone.

In their contingency planning the treasury/financial issues arising from of a partial break-up will understandably be the main focus of businesses.

However there are likely to be tax issues arising from a partial break-up. The purpose of this note is to summarise some of those potential tax issues.

Redonomination of contracts


A partial break-up, and the exit from the Eurozone by one or several Member States (e.g. Greece), may involve a redenomination of euro-denominated contracts (i.e. loans and trade payables) into a new local currency (“NLC”).  In such a case, it is expected that the NLC would rapidly depreciate once floated leading to the recognition of losses at the level of the lender. 

Alternatively if the contract remains in euros then losses would be expected at the level of the borrower if their functional currency changes from the euro to the NLC.

Whether a specific contract will remain in euros or is redenominated into the NLC is a complex question of contract law and will need to be considered on a contract by contract basis.

Where the contract is a debt between connected parties then there is uncertainty about the tax deductibility of the losses arising in the lender where the contract is redenominated into the NLC. Whilst any loss arising should be tax deductible if is regarded as a foreign exchange (“FX”) loss, the loss would not be tax deductible it was considered to be an impairment.

In the event that one or several Member States exit the eurozone but the Euro remains in place among the other eurozone countries, the risk of redenomination is likely to be higher for assets/liabilities governed by local law rather than for assets/liabilities governed by foreign law.

Lenders may seek to amend the governing law of the contracts considered at risk in order to get protection from the risk of redenomination.   In addition new contracts may be negotiated on terms including clauses dealing with a partial break up.

Such contractual changes may give rise to a series of tax considerations:

  • Do the changes give rise to a new contract from an accounting perspective?  This may result in the recognition of profit or losses for accounting purposes which could also be taxable or relievable.
  • Do the changes give rise to a new contract from a legal and tax perspective? Modification of an existing contract could potentially represent the termination of the original contract and the creation of a new contract. This could crystallise a taxing event i.e. could the changes trigger a disposal for capital gains purposes.
  • Where the contracts are between related parties then an additional question is whether an arm’s length fee should be paid to the counterparty as compensation for the change in terms.  The tax treatment of this fee would need to be considered from both parties perspectives, and whether this payment would be taxable on one side and deductible on the other.

The impact of NLCs on hedging arrangements
The redenomination of certain euro assets or liabilities could lead to hedges becoming ineffective.  For example, in a situation where a euro loan payable hedges shares held in a Greek company, the asset could be redenominated to the NLC, whereas the liability could remain in euro thus resulting in an ineffective hedge from an economic perspective.  This hedge may also become ineffective from a tax perspective so that FX gains or losses arising in UK Co could no longer be deferred under the tax matching rules.

200112cClearly similar issues arise in any circumstance where euro positions are hedged and one side of the arrangements (either the hedge or the hedged item) converts into a NLC.

What next?
It is important that, as part of wider contingency planning undertaken by businesses, the potential tax implications arising from the redenominiation of euro-denominated assets/liabilities are carefully analysed in the light of the applicable legal, accounting and tax legislation.


TrackBack URL for this entry:

Listed below are links to weblogs that reference Potential break-up of the Eurozone: overview of tax implications:


Verify your Comment

Previewing your Comment

This is only a preview. Your comment has not yet been posted.

Your comment could not be posted. Error type:
Your comment has been saved. Comments are moderated and will not appear until approved by the author. Post another comment

The letters and numbers you entered did not match the image. Please try again.

As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments.

Having trouble reading this image? View an alternate.


Post a comment

Comments are moderated and will not appear until the author has approved them.