The Panama Leaks in 2016 gave added urgency to the Organisation for Economic Co-operation and Development’s attempts to clamp down on tax avoidance via its BEPS project, a global initiative to prevent base erosion and profits shifting.
While the OECD’s action points are aimed mainly at multinational corporations, they are beginning to be felt in the private equity industry.
As Shannon Stafford, head of tax for The Carlyle Group, told pfm this year: “The concern for us has always been that we are investing as a fund with the goal of tax neutrality. BEPS, meanwhile, is written for multinational corporations… things like treaty provisions, country-by-country reporting… these have left a lot of people in our industry scratching their heads.”
The worries surround two sections of BEPS, especially Action 6, which attempts to prevent Collective Investment Vehicles benefitting from the ‘double non-taxation’ that results from cross-border arrangements. This is important for fund structures because these sort of arrangements provide tax neutrality for investors, entitling them to treaty benefits.
The OECD is still considering how the initiative would apply to private equity funds, which are regarded as non-CIVs because they are not retail funds. One solution would see non-CIVs implementing a ‘limitation of benefits test’. This would require fund managers to determine the treaty status of the ultimate beneficiaries of each fund.
Stafford said Carlyle will face difficulties in maintaining tax neutrality once this comes into effect: “Elements like the ‘principal purpose test’ and ‘limitations on benefits’ rules as part of application to benefits under a double tax treaty are giving us plenty to think about.”
Industry groups say this is a big concern. Gurpreet Manku, director of policy at the British Private Equity and Venture Capital Association, said Action 6 could end up impacting countries where funds are invested, as well as the places where funds are set up or managed.
And if the OECD decides not to allow private equity funds to continue to access tax treaties, “investors around the world could experience additional difficulties investing in private equity for no valid reason,” says Jason Mulvihill, general counsel for the American Investment Council.
Another area of concern is Action 4, which covers the tax deductibility of borrowing costs. The consequences could be seen in the 2016 UK budget which decided from 1 April 2017 to limit interest deductions to 30 percent of UK earnings before EBITDA for companies with net interest expenses above £2 million.
Private equity transactions often involve substantial levels of debt finance and these rules will hit leverage arrangements of some portfolio companies.
“The group tests and fixed ratio tests will affect portfolio companies and groups owned by (or invested in by) private equity funds, potentially limiting where and how much interest is deductible,” the BVCA said in a letter to the OECD.
Although the US is not expected to implement BEPS for the next few years, the Obama Administration has also proposed legislation.
As Geoffrey Bailhache, head of EMEA legal and compliance at Black-stone, says: “BEPS may prove to be one of the most important things that is going to impact our industry in the next decade.”