The OECD’s Action Plan on BEPS was published in July 2013 with a view to addressing perceived flaws in international tax rules and consultations have started. This is not a subject that should be ignored or left to tax experts, but is something that all stakeholders should engage with. The tax profile of private equity investment is straightforward and non-abusive and this message needs to be clearly made. If not, bad policy is likely to ensue.
The tax profile of private equity partnerships is remarkably straightforward. The general partner is an SPV and the limited partners typically comprise pension funds, family offices, insurance companies, banks, sovereign wealth funds, not-for-profit organisations, educational endowment funds, charities, and other investment funds based in a broad range of onshore jurisdictions (as money always resides onshore). Many of these limited partners can, in general, benefit from tax treaties in their jurisdictions of residence. From a tax perspective, it is therefore important that the structure of the fund is tax neutral for the partners involved, which can be achieved through co-investment (in the legal form of a tax transparent partnership agreement). Co-investment means that the partners are deemed to invest directly in the portfolio companies and not in a fund vehicle (whether good or bad in nature). All that is relevant in determining the application of taxing rights, consequently, is the location of the partners and the portfolio companies. The fund should be irrelevant.
This picture is complicated slightly where private equity partnerships invest on a cross-border basis and the tax position of the partners could vary from deal to deal requiring different procedures. It would be impractical for them to take advice each time there was a deal; therefore, to mitigate this problem and to achieve administrative simplicity (e.g. by avoiding multiple relief claims), general partners often choose to incorporate acquisition vehicles in a common third country that is well known and perceived as low risk. The obviousness of this approach should be immediately apparent. Operationally, these acquisition vehicles have a dual purpose:
+ holding activities – namely, holding participations (i.e. qualifying shareholdings) in relevant portfolio companies. Returns are usually tax exempt and should be ignored when considering treaty abuses; and
+ financing activities – these typically take the form of back-to-back loans with a small profit margin being realised by the acquisition vehicle. These loans are priced in the context of a negotiated transaction and, therefore, determining the correct price of the back-to-back loan on a cost plus basis should not involve complexity.
The use of acquisition vehicles often results in little or no tax saving in a private equity context (as withholding taxes are rarely an issue) and it would be unfortunate if BEPS-inspired anti-abuse rules had the effect of exaggerating the costs of these vehicles (by imposing uncommercial substance requirements) and diverting taxing rights away from the proper jurisdictions. This, after all, would result in the very base erosion and profit shifting that BEPS is meant to be avoiding.
Private equity partnerships and, where relevant, acquisition companies, should be understood as simple investment platforms. Unlike multinational companies, platforms do not generate wealth and, therefore, should not ordinarily be taxable. Wealth is generated by the investment activities of the partners and in the portfolio companies themselves, and this is where taxing rights should fall. Accusing passive investment platforms of ‘aggressive tax avoidance’ or the jurisdictions that host them is conceptually absurd. Unfortunately, however, this fact is not widely understood and is politically inconvenient.
For a copy of the Aztec Group’s latest response, please click here.
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