The Euro Is Born
Why CPAs Need to Know About It
By Alan E. Weiner and David W. K. Chitty
Euroland Arrives on the World Scene
The euro is the new currency of 11 of the countries in the European Union, effective January 1, 1999. There will be a transition period. Local, or legacy, currencies will remain legal tender and the only medium of physical exchange until 2002, when euro bills and coins will first circulate. In the meantime, there are euro traveler's checks, and some credit card companies will process charges in euros immediately. Right now, all electronic transactions by businesses and investors in the euro zone can only be conducted in euros. In France, checks from the same bank account can be written in either euros or francs.
This article provides practical guidance on the transition to the new currency. CPAs involved in international business will want to be aware of the business, legal, and tax considerations. And hands-on issues have to be addressed sooner or later, such as how to produce the € and what travelers to Europe can expect during the phase-in period.
€ is the symbol designed to denominate the euro. Born January 1, 1999, the euro had a gestation period of about six years. But the dream for a common currency as a means to unify Europe goes back to the time when the destructive consequences of World War II were still fresh in leaders' minds. It's a big baby, taking its place with the $ (United States, Canada, and Australia), £, ¥, and numerous other world currencies. The euro (not to be confused with the 'eurodollar,' which refers to deposits of U. S. dollars held in European banks) is projected to significantly affect commercial transactions (i.e., borrowing, lending, banking), securities trading, investing, traveling and tourism, money laundering, and shopping.
Therefore, it is incumbent upon all businesses and professions to familiarize themselves with the euro during its introduction stage (January 1, 1999 July 1, 2002). During the transition, entities may be required, or may want, to report their financial statements in the euro; therefore learning about the euro can't wait until December 31, 1999. Advice on the euro will be needed for completed transactions, those about to be executed, and throughout the full range of business planning. Not to be overlooked is the euro's effect on interim financial statements and, of course, tax costs.
As with any new commercial birth, it will take years of actual experience to sort out the intricacies. There are no established texts to turn to; reference material is available from websites (see Exhibit 1) and periodicals, but there's no substitute for actual experience.
What Is the Euro?
The European single currency (the euro) replaces the existing currencies of the 11 participating European states and represents the most significant monetary union in world economic history. Once the euro's introductory period is complete, in 2002, the existing currencies (referred to as legacy currencies) of these countries will be completely withdrawn. By that time, the euro likely will have established itself as an international currency similar in stature to the U. S. dollar. A strong euro will help U.S. exports against European goods, but a weak euro will make U.S. goods more expensive abroad.
The 11 countries adopting the euro are Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain (see Exhibit 2 for an easy way to remember them). The remaining four European Union members have not adopted the euro at this stage (known as the first wave). Of these four, Denmark, Sweden, and the United Kingdom are not participating for domestic political reasons. Greece was ineligible to join because it failed the standards test; however, it has moved to reduce its deficit, debt, and inflation with the hope of joining in 2001.
The euro is run by the European Central Bank, located in Frankfurt, Germany. The bank coordinates monetary policy for the 11 participating countries and is responsible for setting a common interest rate. The existing central banks of the participating countries now have a subsidiary role to the European Central Bank: Their say in monetary policy is limited to their representation on the European Central Bank's board.
The objective of having one European currency is to simplify cross-border trade and to continue the process of economic integration. European companies that trade with businesses in other European countries will no longer incur transaction costs or face exchange risks. They also can more easily compare their product prices with their European competitors.
As a result of the introduction of the euro, for example, it is no longer possible to make a U. S. dollarlocal currency (i.e., German deutsche mark) exchange. Does this mean that francs, deutsche marks, and guilders are gone forever? Not quite yet. While the euro is the official electronic currency, actual notes and coins won't begin to circulate until January 1, 2002, and legacy currencies won't be entirely removed from circulation until July 1, 2002. Will there be confusion? Yes, there will. Will there be an opportunity to profit from the confusion? Yes, so caution is in order. A 100,000 lira note should not be accepted when expecting 100,000 euros.
The ratio of the legacy currencies to the euro was irrevocably fixed on December 31, 1998. It is now just the euro that floats against the dollar, just like the dollar floats against the yen and the pound. As of December 31, the rate of exchange of the euro to the dollar was $1.17 for €1; on March 10, it was $1.09. The other floating and fixed rates can be seen in Exhibit 3.
January 1, 1999. The euro is born and exchange rates between the 11 participating countries are fixed. (Each baby born in France on that date received a welcoming gift of 100 euros.) Because the exchange rates are fixed, the local country's currency can be thought of as a subdivision of the euro (just like 100 pennies equals one U.S. dollar). There is no obligation to open euro-denominated bank accounts (but customers and suppliers may force businesses to do otherwise), and checks can be written in either currency. Nevertheless, electronically the euro has arrived and is being used for "smart" cards, credit cards, and Internet purchases.
January 1, 2002. Euro notes (ranging from 5 to 500 euros) and coins (ranging from 1 euro-cent to a 2-euro piece) will be officially introduced. The old notes and coins in legacy currencies can still be used until June 30, 2002.
July 1, 2002. Farewell, into oblivion, for francs, deutsche marks, and guilders (but not pounds, drachmas, krona, or krone, unless England, Greece, Sweden, and Denmark have since adopted the euro).
There will be much talk about the euro but, except for electronic transactions and investments, the average "bloke" won't know a euro from a schilling for three years.
Effects on Contracts
"Continuity of contracts," a principle which prohibits the contracting parties from altering or terminating a contract as a result of the introduction of the euro (unless the parties previously have agreed otherwise), has been approved by European Union countries. Nevertheless, while the continuity rule is binding, contracts still must be reviewed. Of some comfort is the fact that New York, Illinois, and California have codified the European Union's continuity-of-contract requirement (N.Y. General Obligations Law, sections 5-1601 to 5-1604); case law might reach a similar result in other American states.
The good news is that the temporary and proposed regulations (TD 8776) provide generally that the euro conversion does not trigger a taxable realization. The IRS could have ruled otherwise, but by treating the conversion as a tax-neutral event, it recognized that this was a compulsory conversion more akin to a currency redenomination. Revenue Canada and the United Kingdom's Inland Revenue have taken a similar approach. Germany has ruled that any currency gain or loss arising on the conversion can be deferred for up to five years.
The cost of acquiring new euro-compliant software or upgrading existing software gives rise to a new tax question. Is the cost currently deductible? In Rev. Proc. 97-50, 1997-45 IRB 8, the IRS held that self-developed software for the Y2K solution could be expensed immediately, whereas purchased software had to be amortized over the shorter of its useful life or five years. In the preamble to the regulations, the treatment of euro conversion costs was explicitly left open. Reportedly, the IRS will use a facts and circumstances test upon examination; it would simplify matters greatly if the IRS were to adopt the Y2K rules and spare businesses the added cost of evaluating the facts of each purchase.
Calculating foreign tax credits (FTC) may prove confusing. The determination of carryforwards and carrybacks, the different baskets under which the credits are computed, and other already mystifying calculations may be further affected by the introduction of the euro.
European taxpayers (corporate and individual) must file tax returns in the old currencies, even if they are paid in euros, unless and until the countries have authorized a euro tax return. The euro governments may be the last cars on the euro train.
The European Union has developed accounting guidance to assist with the preparation of financial statements in euros. This guidance requires that most costs incurred in adapting systems and procedures to accept the euro are charged to income as incurred. If costs are incurred that genuinely enhance a system's performance or capability and the company has an existing policy of capitalizing such costs, it may be possible to place these costs on the balance sheet as long-term assets. Financial statements must contain comparative figures expressed in euros. To ease preparation in the first year, the comparatives should be converted at the official fixed rate, regardless of the rates when the statements were first prepared.
Guidance on the release of long-term exchange gains or losses on foreign currency investments has also been developed, because in some European countries it has been an established practice to place these items on the balance sheet.
As of January 1, 2002, balance sheets of companies in the participating countries must be stated in euros; however, fiscal year entities must adopt the euro at the beginning of their 20012002 fiscal year.
Business Considerations in Euro Countries
The ultimate benefits to the 11 participating members are substantial: lower interest rates and reduced inflation. However, there are some inevitable costs associated with the transition. For instance, one of the first euro costs to be incurred by businesses worldwide will be the compliant software and keyboard cost to find room for the c.
During the transition period, businesses are encouraged, but not required, to use dual price displays. Confusion will abound. By January 1, 2002, the new currency (seven bills and eight coins) will have to be distributed to all businesses; coin-operated machines must be reset; cash registers must accommodate both new and old currencies, and clerks must be prepared to accept and return cash in both currencies. It would not be surprising to see a mixture of the two currencies as part of the same transaction, and consumers will need to do the conversions in their heads. Product sizes may have to be changed. For these reasons, participating countries have the right to shorten the six-month period for the use of dual currencies.
As of January 1, 1999, a French company transacting with a German company can no longer convert francs into deutsche marks electronically. Rather, the francs first are converted to euros and then to deutsche marks (unless, of course, the transaction is made in euros to begin with). This is called "triangulation." Although American companies not operating in Europe don't legally have to triangulate, they may want to. Published exchange rates for the legacy currencies are valid only for everyday transactions, such as exchanges into local currency for shopping or taxis.
A major feature of the euro is the elimination of foreign currency fluctuation among the 11 countries--no loss, no gain--each business and consumer will know precisely what they're paying. The euro will float against the currencies of the United Kingdom, Denmark, Greece, and Sweden, which have not adopted the euro. During the transition period, the value of the local currency will fluctuate precisely as the euro fluctuates. If the euro increases by two percent, then so will the lira, franc, and mark.
Businesses are permitted but not required to accept charge card purchases in euros. Also, GE Capital Card Services has created a euro-denominated corporate MasterCard aimed at corporate purchasing departments in U.S. and foreign companies. Goods can be bought in the local currency and GE Capital will convert it into euros. This service is currently available for purchases in France, Germany, the Netherlands, Ireland, and Italy, with other countries to follow.
Businesses already should have planned for the euro. Banks and security houses have poured millions of hours, as well as millions of dollars, francs, guilders, deutsche marks, and pesetas in preparation.
For those that have not, the following action plan should be considered:
Effective January 4, 1999, all financial markets in the 11 member countries started trading securities in euros, and all new government bond issues of the 11 members will be in euros. This does not mean, however, that all existing debt (government or business) instruments are being immediately converted to euros.
Measuring performance is more difficult, at least temporarily. Funds may want to maintain their existing models in the legacy currency while at the same time developing new performance models for the euro.
Investors throughout the world have long looked to the U.S. dollar for stability and liquidity. The euro is expected to give the U.S. dollar a run for its money. Even money launderers and other criminals will probably test the euro, especially the 500 euro note (the suitcases won't be as bulky as they are with $100 bills).
For the next few years, especially after January 1, 2002 (when the hard currency euro kicks in), European travel should be more fun than ever. First of all, euro charges are likely to appear on credit card statements for purchases in any of the 11 participating countries. Buyers will need to be careful since businesses will have dual price displays, and the seller is permitted to charge in either local currency or in euros. If the seller permits the buyer to choose the currency, it must be done at the time of the transaction.
On January 1, 1999, American Express, Thomas Cook, and Visa International began selling euro-denominated traveler's checks. That's helpful, but merchants in the participating countries are not required to accept euros until 2002.
And once outside the major cities, travelers may need local currencies for many transactions. The traveler may need to take a euro traveler's check to a cambio and convert it to lira or francs or deutsche marks.
Nevertheless, the euro traveler's check will be helpful for visitors to Paris, Dublin, Munich, Madrid, and Vienna on the same trip. Business travelers may be thankful for having used euro traveler's checks at the end of an extensive European trip--there will be no need to reconcile multiple currencies.
Information Technology and the Euro
Not only have businesses been scampering to make their computer systems Y2K compliant, but now they must make sure their technology is euro compliant. The website is a place to work through a euroY2K link. The arrival of the euro means upgrades for accounting software. The capability to sell the same product at different prices in different European countries will be less of an edge because of the ease of comparing prices from country to country (just like the local supermarket, which is required to give the consumer the price per unit of every product).
By the way, in connection with integrating the euro symbol in its software, Microsoft has issued a support fact sheet for its Office 95 and later products. The operating system (for screen fonts and keyboard drivers) must support the euro character (seewww.microsoft.com/windows/ euro.asp). The € symbol can be produced in newer versions of Microsoft Word software by holding down the Alt button while entering 0128 on the numeric keypad; the € symbol appears when the Alt button is released. But having the right software is only half the story. The printer must also be fairly up-to-date, otherwise the € will appear on the monitor but a blank space or box will be printed. Microsoft suggests contacting the printer manufacturer for guidance on specific models.
The United Kingdom and the Euro
The United Kingdom's decision not to join the first wave largely arose because its role in Europe remains a contentious political issue and there is no national consensus regarding participation. There is, however, growing support among the U.K. business community for joining the second wave in the early years of the new century. Recently, more than 100 businesses wrote to the Financial Times supporting U.K. participation. The U.K. government is running a publicity campaign to raise public awareness of the euro's implications, and in January the Finance Minister made a statement on plans for eventual participation. Expectation is growing that the United Kingdom will join after a public referendum in its next general election. This will likely mean participation in 2002 at the earliest.
As the pound is a separate currency, it will float against the euro. There are no special tax implications, but financial statements may be prepared in euros.
Other Items of Euro Interest
A number of websites provide information about the euro (see Exhibit 1). At one site, we learned that "euro" does not have a plural. You can have one euro or five euro. We were ready to search and replace our plural usage in this article, when we heard that the European Union press office and the Bank of England (Hey, wait just a minute--England, which has not yet adopted the euro, is making a euro decision?) decided that English speaking countries will be permitted to add an "s". Nevertheless, you will not find "euros" on the printed currency.
Except in France, the nickname used around the world for the 11 participating countries is "Euroland" (which The Wall Street Journal says sounds like a theme park). In France, the French language academy has opted to christen it "la zone euro" or "the euro zone" (which The Wall Street Journal says sounds like an air freshener).
The 11 participating member countries have certain autonomy and, therefore, businesses contemplating significant and unusual foreign transactions should consider checking with a local accountant or attorney. For example, initially the Netherlands will try to limit the use of the euro to international commercial transactions (and encourage individuals to continue to use the guilder). On the other hand, France (where checks are more popular than credit cards) will allow its banks to issue multiple checkbooks (one in francs and one in euros) for the same bank account.
As noted earlier, an expected result of the euro is lower interest rates. In December, the central banks of 10 of the 11 countries reduced their short-term interest rates to 3.0% and the 11th country reduced its to 3.5%. This in turn caused two nonparticipating countries (the Czech Republic and Denmark) to reduce their interest rates.
Also, the euro will make it significantly easier for businesses to combine existing operations or merge. The number of banks and investment houses may shrink dramatically as cross-border institutions merge (creating a reduction in workforce and a savings in back office operations). The biggest advantage--and concern--of the euro will be the stability of the economy and unemployment in the 11 countries. If bad times fall upon some but not all members, companies might move their operations to lower wage-paying euro nations and the effects could be grave. *
Alan E. Weiner, JD, LLM, CPA, is the senior tax partner at Holtz Rubenstein & Co., LLP, CPAs, located in Melville, N.Y. He is Vice President, the Americas, of DFK International and recently chaired its international tax committee. Weiner is also president-elect of the New York State Society of Certified Public Accountants.tDavid W. K. Chitty, BA, ACA, is a technical partner of Chantrey Vellacott, DFK, Chartered Accountants, London. An accomplished author, he is also the international audit coordinator of DFK International, an international group of accounting firms. ants.
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