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Financial Safety Nets Required for Reach Consortia
10:41 AM MST | February 26, 2009 | By ALEX SCOTT
By Hans Schoolderman, director/PricewaterhouseCoopers Advisory NV
Swings in company fortunes during the current unprecedented economic downturn are increasing the probability of turbulence for those managing REACH consortia.
The impact of the sudden economic downturn is plain to see. Mergers are aborted or postponed, plants are being mothballed and some companies are being forced to seek chapter 11 protection. Revenue drops of 30% or more are normal.
According to PricewaterhouseCoopers' 12th annual global CEO survey, chemical executives are particularly worried about the impact of the recent problems in the global banking system. More than two-thirds of chemicals CEOs anticipate that financing costs will increase and that they will have to delay some of their investments. These circumstances bring new threats to the efficient operation of REACH consortia, namely:
Q: Changes in the availability of specialist internal resources planned for consortia are likely to occur. This is a threat to the continuity of the consortia projects.
Q: Portfolios and business cases are being re-assessed and put on hold, potentially leading to unforeseen changes in consortia memberships. Membership withdrawals will directly impact the project funding.
Q: Cash is king. This thinking will cause a re-examination of the treasury and financing of consortia tasks such as whether members are willing to undertake studies on behalf of the consortium.
It is expected that each consortium will be confronted with a higher number of members that are no longer able to meet their obligations. The approach towards consortia agreements was developed in a different economic situation. The challenge now is to develop a successful operating model that is less vulnerable to the impact of the economic downturn.
We recommend that consortia take steps to protect themselves as far as possible from the threats listed above. One of the clearest ways to do this is to separate the structure of the consortium from its individual members to ensure that the consortium is able to continue in the event that any members withdraw. This objective can be easily met against limited additional costs.
More detailed considerations on the consortium structure, scenarios to convert to a legal structure and the way these scenarios would ease known consortium issues such as compliance with VAT laws are discussed below.
The REACH Regulation does not specify the way participants should co-operate to meet their obligations with respect to their SIEF objectives and joint submission of data. There are several ways to do this, each with its benefits and disadvantages.
One of the more structured forms of co-operation is a formal REACH consortium with the objective to submit joint registration dossiers on behalf of its members for chosen substances.
A REACH consortium can be formed by two or more participants by:
Only signing a consortium agreement by the participants without establishing a legal entity;
Incorporation of an association/foundation;
Incorporation of a limited liability company.
The following factors should be taken into consideration in deciding which of these is most appropriate for any particular group:
Number of (expected) members;
Expected volume of cash transactions;
Expected purchase of test dossiers;
Sensitivity of information;
Economic interest and tax considerations.
Non legal entities
Several practical issues should be considered before forming a REACH consortium without establishing a legal entity such as an association or a foundation:
Q Establishing a bank account: A requirement for opening a bank account is that a legal entity exists. Without a legal body it is not possible to open an account for the necessary cash transfers. The consortium could choose to make use of a bank account of a third party (e.g. a member or third party consultant, if allowed). However, the disadvantage is that in this case the cash is legally owned by the respective member or third party and all cash transactions will run through the bank account of this member or third party.
Q Auditing financial statements: Most consortium agreements require a financial audit of the its financial statements. However, the performance of such an audit on agreements only is complicated as there are no general accounting rules nor standards for these non-legal entities.
Q Lead registrant responsibilities: Since the REACH consortium needs to have an adequate financial accounting system, including a bank account to transfer the settlements between members, the lead registrant could be appointed to fulfil this role. In this case, their roles and responsibilities would include:
Adequate financial accounting;
Enter into commitments and corresponding liabilities with respect to technical tests/dossiers;
Be the owner of technical tests (temporarily);
Calculate the cost allocation between the consortium and its members;
Be responsible for all cash receipts and payments.
The obvious risk is that if the consortium is set up over a longer period of time, there is a risk that the lead registrant could be involved in a merger and/or takeover or even need to seek chapter 11 protection. This would then create problems concerning the ownership of both tangible assets eg. cash and intangible assets eg. test results.
Legal entity scenarios
There are two possibilities to set up a consortium as a legal entity – it can be established as a foundation or association, or as a limited liability company.
Foundation or association
The one major disadvantage of an association compared with a foundation is that there are prescribed legal requirements for decision making by an association. Therefore, a foundation seems better suited to the purposes of a consortium. Consortia then have two options – they can either 'incorporate' or 'convert to' a foundation or association.
Q Incorporation: In this situation a foundation is established. The purpose of this legal entity is to perform the administrative tasks of the consortium. The advantage is that in this case the financial performance of the consortium is separated and more transparent. In addition, continuity is secured and clear accounting standards exist to enable the foundation's accounts to be audited. The consortium operates with an agreement in parallel to the foundation. The activities of the foundation can be clearly defined. The Executive Committee of the consortium can also act as the executive board of the foundation, while other members can have a supervisory and counselling role.
Q Conversion: This holds the same advantages as incorporation compared to forming non-legal entities, the difference is the foundation replaces the existing consortium agreement. It adapts all activities of the consortium. It is less flexible compared to incorporation where the foundation is established to perform the administrative tasks of the consortium only. In case of conversion all activities and tasks are being performed by the foundation (the foundation is the consortium), whereas in case of incorporation only the administrative activities and tasks are performed by the foundation (the foundation exists next to the consortium).
Limited liability company
A limited liability company could be established either to perform the administrative tasks of the consortium only, or to replace the existing consortium agreement. However, two disadvantages of a legal entity compared with a foundation or association are:
Q Since each consortium member would receive a share in the limited liability company, these shares should be valued in case of an exit or entrance by one of the members;
Q The share in the consortium should be valued for reporting purposes in the accounts for the entity held by individual members.
Dealing with VAT issues
A further financial issue that consortia must identify in advance what the 'value added tax' VAT consequences will be for the consortium manager, the entire consortium and the individual members. As a consequence of the likely cross border nature of consortia, the VAT rules in the various EU countries involved will be relevant. Furthermore, the consequences for any non-EU members need to be addressed. Although the VAT rules in essence are comparable within the EU, there may be differences depending on local rules.
The consortium will potentially purchase and perform many different services. Costs will be (re)charged to and within the consortium. Depending on the qualification of these services for VAT purposes, local VAT might be due regardless where the invoice is sent. VAT may be due in the country of the service supplier or in the country of the recipient of the services. This depends on the nature of the services, their qualification for VAT purposes, and the qualification of the recipient as VAT entrepreneur or non-VAT entrepreneur.
Issues to take into account are:
VAT position of the consortium manager and consortium members (entrepreneur or not?)
VAT treatment of the services of the consortium manager to the members and vice versa;
VAT treatment of the (membership) fees charged by the consortium;
VAT treatment of the cost reimbursement to the consortium (if applicable);
VAT recovery by the consortium and or consortium members;
Although every consortium is unique, some general recommendations to deal with the new challenges posed by the economic downturn are:
Organise funding in advance;
Avoid mixing the administration of the consortium and the corporate administration of one of the individual members;
Consider converting the administrative function of the consortium into a legal entity (a foundation) as this is fully transparent, separates the project (cash) from the members, secures the continuity of the consortium and does not create entry or exit barriers for members.
An added value of a foundation is that it allows an advanced VAT ruling to generate cash with input VAT deduction;
Agree on procedures to support easy exits to prevent disputes and a high administrative burden to the project management.
For further information contact Hans Schoolderman, director/PricewaterhouseCoopers Advisory NV
email@example.com or Paulus Wijffels, partner/PricewaterhouseCoopers Accountants NV