With the onset of higher personal tax rates, more complex rules on the tax deductibility of interest and an election round the corner, now is the time to be thinking about structuring your tax affairs.
BDO ran a seminar for private equity executives that demonstrated:
- How to structure your fund
- How to plan during the life of your fund
- Latest techniques for structuring transactions
- Minimising VAT leakage
Find out more in the slides of the presentation.
3. FUND STRUCTURING – WHAT ARE WE TRYING TO ACHIEVE?
Want to reduce tax below cost of Want to receive as
Executives Executives
remuneration – 53.8 per cent (→ capital and pay 18 per
63.8 per cent) “Remuneration” cent or lower
Management Entity
Management fee
Want to avoid withholding GP
Carry
on funding “return” and
Fund
CGT on exit Carry
distributions
Priority
Investors
Profit Share
Preferred Main
return & profit Fund
share
Investment
returns
Bidco
Target
4. WHAT INVESTORS WANT - AVOIDING WITHHOLDING TAX
Investors International Strategies
• Use of double tax treaties but can be
time-consuming and sometimes complex
• Interposing a company resident in treaty
jurisdiction
Fund
UK Strategies
• Dividends do not attract withholding
Dividends on equity • Quoted Eurobonds
Interest on loans
• Discounted Securities
Investments • Sale “cum interest”
5. WHAT INVESTORS WANT - AVOIDING CGT ON EXITING
INVESTMENTS
Investors
• Only relevant where target country levies
source CGT (not UK)
Strategies
• Use of double tax treaties but again time-
consuming and complex
• Favoured strategy is to interpose a treaty
Fund
company
Sale
Investments
6. WHAT PE EXECS WANT FROM MANAGEMENT FEES AND
CARRY
• Reduce their exposure to income tax
• Capital gains – flat rate of 18 per cent
• Dividends
- 25 per cent
- 36 per cent from 6 April 2010 (taxable income > £150k)
• Earned income/interest
- 40 per cent
- 50 per cent from 6 April 2010 (taxable income > £150k)
• National insurance
- 1 per cent on all income
- 2 per cent from 6 April 2011
- 12.8 per cent for employers (13.8 per cent from 6 April 2011)
7. CARRIED INTEREST – WHY MIGHT YOU PAY MORE THAN 18
PER CENT?
• Taxed as employment income
- On receipt
- On sale
• So what do you do?
- Do not be an employee!
- Or, meet the MOU
• Increase in carry entitlement post fund set up could be taxed as income
8. CARRIED INTEREST – HOW COULD YOU PAY LESS THAN 18
PER CENT?
• With base cost shift
• If you are non-domiciled and plan well!
• Go offshore
• If distributions to the carry partnership are non-taxable
9. CARRIED INTEREST – THE FUTURE?
• Carried interest gains taxed as income
• Implications of what happens overseas
10. CARRIED INTEREST – INTERNATIONAL COMPARISONS
Tax rates
40%
35%
30%
25% 35%
20%
15% 30.0% 30.1%
28.2%
10% 21.0%
18.0%
15.0%
12.5%
5%
0%
UK US Germany Spain Italy Switzerland France
Countries
CGT Income tax
11. CARRIED INTEREST – THE FUTURE?
• Carried interests gains taxed as income
• Implications of what happens overseas
• Risk of higher CGT rates
12. TOP RATES OF TAX 1974 TO 2010
80
70
60
50
income tax
40
30
20
cgt
10
1974 1979 1988 1998 2008 2010
13. CARRIED INTEREST – THE FUTURE?
• Carried interests gains taxed as income
• Implications of what happens overseas
• Risk of higher CGT rates
• Arguments that the fund is trading in shares
• Lobbying versus political manoeuvring
14. TAX STRATEGIES FOR THE FUND MANAGER
PE Execs
Profit share
Manager
LLP
Management fee
PE Execs GPLP GP Co
Dividends
Gains
Fund GP LP
Other Investors
Gains &
Dividends
All other
income &
gains Fund LP
Dividends Gains Interest
15. THE “TYPICAL” PE FUND STRUCTURE – UK PE TEAM
PE Execs PE Execs
GP Co
UK
General Carry Investors
adviser/
Partner LP Partnership
manager LLP
Overseas
subsidiaries
The
Fund(s)
SPVs
Targets
17. A TYPICAL STRUCTURE
Management Generally seeking to:
Fund
LP
• maximise effective tax relief on
Shareholder
acquisition debt against operating profits
debt TopCo
Management
debt • minimise withholding taxes
Newco 1
• minimise transaction taxes/capital taxes
• minimise tax on exit
Mezzanine or
Newco 2 subordinated
debt
• minimise tax for investors in the fund
Senior
• minimise tax on management
Bidco Bank Debt
Target
18. MAXIMISE EFFECT TAX RELIEF ON ACQUISITION DEBT
AGAINST OPERATING PROFITS
Management • Debt push-down via group relief, tax
Fund
LP consolidation or mergers
Shareholder
• Opportunities for a double dip? (eg a
debt TopCo Belgium notional interest deduction
company?)
Newco 1 • No withholding tax in the structure on
debt
Newco 2
Mezzanine or
subordinated
• Ability to service the debt
debt
• Thin cap and transfer pricing rules (and
Bidco
Senior
Bank Debt
worldwide debt cap rules)
• Management of timing of tax deductions,
Target
especially on shareholder debt
19. DEBT PUSH DOWN – AN EXAMPLE
• Every jurisdiction is different
• Some jurisdiction harder than others
UK Bidco Bank
(Belgium, Canada)
• Even a basic leverage solution can become
UK Target complex
Example
• UK target, but insufficient UK profits
Other German therefore ineffective interest shield
UK Tradeco
Tradecos Tradeco
• German group had to be held by a trading
Debt
entity due to WHT
German
Holdco • Therefore leverage under the UK Tradeco,
using intra-group debt
German • But still have Germany earning stripping
Tradeco rules which limit deduction to 30 per cent
EBITDA
• UK tax – SSE for UK target
20. CORPORATE RESIDENCE
• Maybe a structure you have seen as:
Fund a) No WHT on interest paid from the UK to Lux
LP
b) No WHT on redemption of CPECs
CPECs & PECs
c) No capital gains tax on disposal by Lux
Lux Topco Midco
• Used for many jurisdictions
debt
• UK tax rules – the basics
Lux Midco
- UK incorporation
debt - UK “central management & control”
Turns on a combination of where the
UK Bidco Bank
strategic
board meetings take place and the tax
residency of the board members
Target
• Recent case won by HMRC – Laerstate
• Practicalities and Best Practice
21. CORPORATE RESIDENCE
UK companies seeking to minimise tax bills by locating abroad would face years of scrutiny to
ensure senior management decision have genuinely relocated, a senior official at HM Revenue &
Customs has said.
Even if board meetings are held outside Britain among non-resident directors, a company could
be deemed UK-resident if evidence – potentially including travel schedules, e-mails, diary entries
and notes of phone calls – suggested key decisions were taken from within the UK.
Mr Hartnett said: “Some companies claim to have changed their resident and left the UK.
Investigation and litigation in the UK will establish that.”
22. THE WORLDWIDE DEBT CAP RULES
Aim of legislation
• To prevent groups putting a greater
Fund amount of debt into the UK than the group
LP
as a whole has borrowed
Equity
• Compare the consolidated worldwide
finance expense, ie for accounts v UK
UK TopCo
(Non-UK) companies finance expense for tax
Debt Debt
Interaction with late paid interest
• Interest/discount spread in the accounts
Non-UKCo UKCo • Tax rules only allow a tax deduction when
Bank Bank paid in some situations
• So finance expense for accounts < finance
expense for tax where interest has rolled
up
Commencement Date
• A.P.s beginning on or after 1 January 2010
23. THE WORLDWIDE DEBT CAP RULES
Group
• As defined by IAS
Fund • “Ultimate Parent” – Not a CIS
LP
Gateway Test
Equity • Cap does not apply if UK net debt < 75 per cent
120 worldwide gross debt
Procedure to calculate Disallowed Amount/Example
UK TopCo
Debt (Non-UK) Debt • Available Amount = Worldwide group’s gross
50 @ 70 @ consolidated finance expense
10% = 5 10% = 7
= 6+3=9
• Tested Amount = UKCo intra-group and third party
finance income and expense (so
Non-UKCo UKCo long as this is a net expense),
100 @ 50 @
Bank 6% = 6 6% = 3 Bank for tax purposes (i.e. after
transfer pricing, late paid
interest, etc)
= 10
BUT YOU MAY NOT DO • Disallowed Amount = Tested Amount – Available
Amount
THIS ANYWAY! = 10 – 9 = 1
24. TIMING OF TAX DEDUCTION ON SHAREHOLDER DEBT
To PIK or not to PIK
• Market value
• Dry tax charge for management and co investment?
• Administration and withholding tax
• Trap for the unwary?
→Capitalisation = An issue of shares = a funding bond
→Accrued income scheme
25. TRANSFER PRICING & SHAREHOLDER DEBT (AND BANK DEBT)
• Determine the amount of debt that a borrower could borrow from an
unconnected lender having regard to the terms on which an unconnected
borrower would be willing to lend
• New TP group set up in 2009 by HMRC
• New penalty regime (which can be 10 per cent of the reduction in losses)
• Transfer Pricing litigation – DSR Retail Ltd came in 2009
- More in the pipeline
- Outsourcing to a firm of lawyers!
• Where are HMRC currently?
29. OFFSHORE STRUCTURES
• Fund and Manager offshore
• Offshore fund but Manager in the UK
• EU complications
30. DEAL FEES - WHEN IS VAT RECOVERABLE?
• You have received the service
• You have been invoiced for the cost
• You have used the services to support a taxable business activity
31. TYPICAL STRUCTURE – POST COMPLETION
invoiced
Deal Newco
Costs
VAT group
Target Co
32. PROBLEM AREAS
The Fund Partly exempt
1. Date of Newco’s incorporation
e?
vic
Ser
2. Engagement letters
Supplier
Invoice
Invoice Newco
3. Abort fees
4. Is NEWCO in business?
Target
Fully taxable
33. RECOMMENDATIONS
• Incorporate NEWCO from day 1
• All engagement letters with NEWCO
• DD reports addressed to NEWCO
• Board minutes record NEWCO’s intentions to make acquisitions and manage the
business
34. EU CHALLENGE TO VAT GROUPS
• Holding companies & possibly GPs may be excluded
• Implications for deal fees and fund management fees
• Litigation is likely to take 12-18 months and any action should not be
retrospective
35. ECJ RULING IN SKF AB
• Historically VAT cannot be recovered on costs relating to a company sale, unless
the purchaser is based outside the EU
• ECJ was asked, should this always be the case?
• No if similar to a TOGC or there is no direct link between the costs and the
share sale
• National Courts to decide, HMRC are placing claims on hold pending a review by
their lawyers