private equity tax planning in 2010

PRIVATE EQUITY TAX PLANNING IN 2010

February 2010

Copyright © February 10 BDO LLP. All rights reserved.

FUND STRUCTURING TECHNIQUES


ADAM FRAISTel: +44 (0)20 7893 2392Email: [email protected]

February 2010

FUND STRUCTURING – WHAT ARE WE TRYING TO ACHIEVE?

Want to avoid withholding

on funding “return” and

CGT on exit

Want to receive as

capital and pay 18 per

cent or lower

Want to reduce tax below cost of

remuneration – 53.8 per cent (→

63.8 per cent)

Executives

CarryFund

MainFund

Carry

distributions

Investors

Bidco

Target

Executives

Management Entity

GP

Priority

Profit Share

“Remuneration”

Management fee

Investment

returns

Preferred

return & profit

share

WHAT INVESTORS WANT - AVOIDING WITHHOLDING TAX

International Strategies

• Use of double tax treaties but can be

time-consuming and sometimes complex

• Interposing a company resident in treaty

jurisdiction

UK Strategies

• Dividends do not attract withholding

• Quoted Eurobonds

• Discounted Securities

• Sale “cum interest”

Fund

Investments

Investors

Dividends on equity

Interest on loans

WHAT INVESTORS WANT - AVOIDING CGT ON EXITING

INVESTMENTS

Sale

Fund

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

company

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)

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

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

CARRIED INTEREST – THE FUTURE?

• Carried interest gains taxed as income

• Implications of what happens overseas

CARRIED INTEREST – INTERNATIONAL COMPARISONS

18.0%15.0%

12.5%

30.1%

21.0%

28.2%30.0%

35%

0%

5%

10%

15%

20%

25%

30%

35%

40%

UK US Germany Spain Italy Switzerland France

Countries

Tax rates

CGT Income tax


• Carried interests gains taxed as income


• Risk of higher CGT rates

TOP RATES OF TAX 1974 TO 2010

income tax

cgt

1974

10

80

70

60

50

40

30

20

2008 20101979 1988 1998


• Carried interests gains taxed as income


• Risk of higher CGT rates

• Arguments that the fund is trading in shares

• Lobbying versus political manoeuvring

GPLP GP Co

Fund GP LP

Fund LP

Other InvestorsGains &

Dividends

All other

income &

gains

PE Execs

Gains

Dividends Gains Interest

Dividends

TAX STRATEGIES FOR THE FUND MANAGER

ManagerLLP

Management fee

PE Execs

Profit share

GP Co

TheFund(s)

General Partner LP

CarryPartnership

UKadviser/

manager LLP

Overseas subsidiaries

PE Execs PE Execs

THE “TYPICAL” PE FUND STRUCTURE – UK PE TEAM

Investors

SPVs

Targets

LATEST TECHNIQUES FOR STRUCTURING

TRANSACTIONS

LEE JEFFERSONTel: +44 (0) 20 7893 3344Email: [email protected]

February 2010


A TYPICAL STRUCTURE

Generally seeking to:

• maximise effective tax relief on

acquisition debt against operating profits

• minimise withholding taxes

• minimise transaction taxes/capital taxes

• minimise tax on exit

• minimise tax for investors in the fund

• minimise tax on management

Target

Bidco

Newco 2

Newco 1

TopCo

FundLP

Senior

Bank Debt

Mezzanine or

subordinated

debt

Shareholder

debt

Management

Management

debt

MAXIMISE EFFECT TAX RELIEF ON ACQUISITION DEBT

AGAINST OPERATING PROFITS

• Debt push-down via group relief, tax

consolidation or mergers

• Opportunities for a double dip? (eg a

Belgium notional interest deduction

company?)

• No withholding tax in the structure on

debt

• Ability to service the debt

• Thin cap and transfer pricing rules (and

worldwide debt cap rules)

• Management of timing of tax deductions,

especially on shareholder debtTarget

Bidco

Newco 2

Newco 1

TopCo

FundLP

Senior

Bank Debt

Mezzanine or

subordinated

debt

Shareholder

debt

Management

DEBT PUSH DOWN – AN EXAMPLE

• Every jurisdiction is different

• Some jurisdiction harder than others (Belgium, Canada)

• Even a basic leverage solution can become complex

Example

• UK target, but insufficient UK profits therefore ineffective interest shield

• German group had to be held by a trading entity due to WHT

• Therefore leverage under the UK Tradeco, using intra-group debt

• But still have Germany earning stripping rules which limit deduction to 30 per cent EBITDA

• UK tax – SSE for UK target

German Tradeco

German Holdco

UK Tradeco

UK Target

Bank

Debt

UK Bidco

GermanTradeco

OtherTradecos

CORPORATE RESIDENCE

• Maybe a structure you have seen as:

a) No WHT on interest paid from the UK to Lux

b) No WHT on redemption of CPECs

c) No capital gains tax on disposal by Lux

Midco

• Used for many jurisdictions

• UK tax rules – the basics

- UK incorporation

- UK “central management & control”

� Turns on a combination of where the

strategic

board meetings take place and the tax

residency of the board members

• Recent case won by HMRC – Laerstate

• Practicalities and Best Practice

Target

UK Bidco

Lux Midco

Lux Topco

FundLP

Bank

CPECs & PECs

debt

debt

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.”

THE WORLDWIDE DEBT CAP RULES

Aim of legislation

• To prevent groups putting a greater

amount of debt into the UK than the group

as a whole has borrowed

• Compare the consolidated worldwide

finance expense, ie for accounts v UK

companies finance expense for tax

Interaction with late paid interest

• Interest/discount spread in the accounts

• Tax rules only allow a tax deduction when

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

UK TopCo(Non-UK)

FundLP

Non-UKCo UKCo

Bank

Equity

Debt Debt

Bank

Group

• As defined by IAS

• “Ultimate Parent” – Not a CIS

Gateway Test

• Cap does not apply if UK net debt < 75 per cent

worldwide gross debt

Procedure to calculate Disallowed Amount/Example

• Available Amount = Worldwide group’s gross

consolidated finance expense

= 6 + 3 = 9

• Tested Amount = UKCo intra-group and third party

finance income and expense (so

long as this is a net expense),

for tax purposes (i.e. after

transfer pricing, late paid

interest, etc)

= 10

• Disallowed Amount = Tested Amount – Available

Amount

= 10 – 9 = 1

UK TopCo(Non-UK)

FundLP

Non-UKCo UKCo

Bank100 @

6% = 650 @

6% = 3

Equity

120

Debt

50 @

10% = 5

Debt

70 @

10% = 7

Bank

BUT YOU MAY NOT DO THIS ANYWAY!

THE WORLDWIDE DEBT CAP RULES

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

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?

MINIMISING VAT LEAKAGE

STEPHEN KEHOETel: +44 (0)20 7893 2404Email: [email protected]

February 2010


AGENDA

1. Fund Structure

2. Deal fees

3. EU challenge to VAT grouping

4. ECJ Ruling in SKF

TYPICAL UK STRUCTURE

FM

VAT groupregistration

GP

PPS

LP

ManagementFee

OFFSHORE STRUCTURES

• Fund and Manager offshore

• Offshore fund but Manager in the UK

• EU complications

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

TYPICAL STRUCTURE – POST COMPLETION

Newco

VAT group

Target Co

invoicedDealCosts

PROBLEM AREAS

1. Date of Newco’s incorporation

2. Engagement letters

3. Abort fees

4. Is NEWCO in business?

Newco

Target

The Fund Partly exempt

Servic

e?

Fully taxable

Supplier

InvoiceInvoice

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

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

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


THANK YOU FOR LISTENING

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