Our panel

Andrew Howard
Tax partner, Ropes & Gray

Kathleen Russ
Tax partner, Travers Smith

What are the biggest challenges facing private funds professionals with regards to the current tax environment? 

Andrew Howard: I would say the continued uncertainty around entitlement to reduced rate of withholding taxes and capital gains exemptions for asset holding companies established by funds. It is extremely difficult for funds to select and assess potential investments if it is not clear whether they can expect for tax to be paid only at investor level or whether they should plan for additional taxes to be paid locally on an exit (or even worse, as result of a challenge after an exit). Attempts at international consensus seem to have largely broken down and OECD, EU and local legislative developments just seem to layer unclear tests on top of uncertain tests.

Kathleen Russ: The sheer number of new tax rules and proposals for further change both in the UK and elsewhere is certainly a big challenge. Even though some of these are quite exciting and present opportunities for improving existing arrangements, their number makes it hard enough for tax professionals to keep on top of things, let alone fund professionals for whom tax is not the day job.

Our clients are also trying to work through the implications for their businesses and funds on a number of international initiatives. For example, the EU’s draft directives addressing shell companies (ATAD 3) and a perceived bias towards debt as opposed to equity, and the OECD’s GloBE initiative to introduce a global minimum 15 percent corporate tax rate for large multinational enterprises.

Another challenge for private fund professionals is the increased assertiveness of the UK’s HMRC and other tax authorities. I think this stems from a number of factors, including pressure on the public purse arising from the covid pandemic and tax authorities being given greater investigative and information-gathering powers. We are increasingly advising our asset management clients in relation to tax enquiries and disputes, and these can really suck up management time, making dealing with them a real resourcing challenge even for those with a significant back office.

How much of an impact will inflationary increases have on private funds and the way they operate?

AH: From a tax perspective, rising interest rates in response to inflation are likely to be significant. After a long period of low rates, we may go back to an environment where deductibility of finance expenses and other tax reliefs come into much greater focus, particularly in the UK, where corporation tax rates are about to rise significantly. Now that most jurisdictions have corporate interest restrictions, I expect we will increasingly see pre- and post-transaction reorganizations aimed at trying to marry up the jurisdictions in which debt is located with the jurisdictions where revenue is expected.

KR: This will depend on the asset class involved. Private funds exposed to fixed, long-term cashflows – such as debt with a fixed interest rate – are likely to find the value of those returns diminishing, but other funds that have index-linked returns, for example, certain core asset infrastructure funds, will benefit from inflationary increases. The performance of private equity funds can be less predictable, as the performance of equities tends to depend on how established the company is, the predictions for future growth and exposure to consumer behaviors. But the private funds market is very nimble. So, although there may be negative impact on some funds with established assets, we would expect the market to respond quickly and new funds to be raised that deploy capital very effectively in the prevailing market conditions.

If there was one thing that you would advise private funds professionals to focus on over the next six months with regards to their tax and accountancy activities, what would it be?

AH: Related to my first point, I’d suggest that funds focus on where their decision-makers are located and consider how they will be able to demonstrate substance in their holding company platform. Where decision-makers are already in the UK, I’d encourage professionals to consider the benefits on the UK’s new Qualifying Asset Holding Company regime.

KR: Following on from all the changes I mentioned earlier, it would be to make sure that their operations are still fit for purpose from a tax perspective. The tax ground on which some longstanding – and even some relatively recent – structures are standing may well have shifted or be about to shift, and not being on top of that can make life difficult. For some, decisions taken about where to locate their operations may need to be revisited in light of both new working patterns of their people and changes to corporate taxation, while for others, consideration may need to be given to their remuneration or profit extraction arrangements.

What is the most innovative development in the market right now that is helping private funds professionals with their tax operations?

AH: While I feel as though I should be pointing to something technological, I’m actually going to point to the QHAC regime again. There are countless entities designed to act as fund vehicles but this is the first I can think of that is specifically designed to fulfil the need funds have for an intermediate vehicle to hold their assets, so I think it is a highly innovative move from HMRC. Further, the process of design and implementation is an excellent example of collaboration among fund professionals, advisers and authorities to produce a well thought through vehicle that addresses the significant problem of UK tax rules unnecessarily incentivizing UK managed funds to use non-UK vehicles.

KR: We’re seeing real interest from asset managers and investors in the QAHC. Structured correctly, the QAHC can be pretty much tax neutral and has given the UK a holding vehicle that can compete with those on offer in rival fund jurisdictions, in particular Luxembourg. For fund houses who do not have, or are finding it difficult to maintain, the level of substance in Luxembourg necessary to make their holding companies located there tax-effective, the QAHC is proving a really interesting proposition. This substance issue is becoming particularly acute with ATAD 3 coming down the track.