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Private Equity Tax Planning in 2010
The document discusses private equity tax planning strategies for 2010, focusing on fund structuring techniques that aim to minimize taxes on income and capital gains for executives and investors. It highlights various tax avoidance strategies, including the use of double tax treaties and offshore structuring, and outlines the implications of changes in tax rates and regulations. Additionally, the document touches upon challenges faced in managing VAT and implications of recent legal rulings regarding tax recoverability on service fees.
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Private Equity Tax Planning in 2010
- 1. PRIVATE EQUITY TAXPLANNING IN 2010 February 2010 Copyright © February 10 BDO LLP. All rights reserved.
- 2. FUND STRUCTURING TECHNIQUES ADAMFRAIS Tel: +44 (0)20 7893 2392 Email: adam.frais@bdo.co.uk February 2010 Copyright © February 10 BDO LLP. All rights reserved.
- 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 EXECSWANT 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 OFTAX 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 FORTHE 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” PEFUND 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
- 16. LATEST TECHNIQUES FORSTRUCTURING TRANSACTIONS LEE JEFFERSON Tel: +44 (0) 20 7893 3344 Email: lee.jefferson@bdo.co.uk February 2010 Copyright © February 10 BDO LLP. All rights reserved.
- 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 TAXRELIEF 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 DEBTCAP 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 DEBTCAP 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 TAXDEDUCTION 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?
- 26. MINIMISING VAT LEAKAGE STEPHENKEHOE Tel: +44 (0)20 7893 2404 Email: stephen.kehoe@bdo.co.uk February 2010 Copyright © February 10 BDO LLP. All rights reserved.
- 27. AGENDA 1. Fund Structure 2.Deal fees 3. EU challenge to VAT grouping 4. ECJ Ruling in SKF
- 28. TYPICAL UK STRUCTURE FM Management VAT group Fee registration GP PPS LP
- 29. OFFSHORE STRUCTURES • Fundand 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 NEWCOfrom 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 TOVAT 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 INSKF 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
- 36. THANK YOU FORLISTENING ANY QUESTIONS? Copyright © February 10 BDO LLP. All rights reserved.