Action stations

The “most significant re-write of the international tax rules in a century,” the OECD’s rules on base erosion and profit shifting (BEPS), is all but implemented. But one of the new rules, Action 6, could hit private equity hard, and how it will affect funds is still up for debate.

Action 6 attempts to prevent Collective Investment Vehicles (CIVs) benefitting from the ‘double non-taxation’ which often results from cross-border arrangements. This is important for private equity fund structures because they preserve tax neutrality for investors, who are often entitled to treaty benefits.

The OECD classes private equity funds as non-CIVs, because they are not retail funds, and is still looking at how these should be handled.

The British Private Equity and Venture Capital Association, like other lobby groups, sees Action 6 as one of the biggest concerns for the private and venture capital funds industries.

“Action 6 covers an area which will impact countries where private equity and venture capital funds are invested and not just those countries where the funds are set up or managed,” says Gurpreet Manku, director of policy at the BVCA.

“If the OECD’s proposals are implemented without taking into consideration the specific structure and nature of private equity funds, this would severely impact the ability of private equity funds to raise money from investors and invest in companies internationally.”

This will depend on the precise recommendations that follow the conclusion of the OECD’s work, says Manku. “For example, it will need to ensure that an investor that invests through a fund structure is left in the same position economically as if they had invested directly into an asset.”

This has the potential to increase the compliance burden on both managers and investors. “Even if [industry associations] find a way to ensure that private equity funds still benefit from tax treaties, additional requirements may be placed on managers to prove that the fund and its investors are eligible for the benefits of these treaties,” says Michael Collins, chief executive of Invest Europe.

One possible solution for the treatment of non-CIVs sees funds implementing a ‘limitation of benefits test.’ This would require fund managers to determine the treaty status of the ultimate beneficial owners or investors in each fund, but would prove difficult for managers without the level of information required.

Invest Europe, along with other industry associations around the world, has been raising awareness of the BEPS project and its implications for private equity. “We are aiming to make sure that the global private equity industry understands what is going on [with BEPS] and are giving their views to their national tax administrations and finance ministries. This is a process which is set to continue with Action 6,” says Collins.

Mixed views

In the US, BEPS generates conflicting sentiment. While the government initially said its existing rules are generally consistent with the BEPS proposals, in July the Treasury Department and Internal Revenue Service finalized a regulation requiring US-based multinational corporations to provide detailed, country-by-country income tax information on an annual basis for each nation in which they do business. But this does not necessarily mean the government is on board with the project.

“Overall, BEPS continues to spark a lot of bipartisan concern in the United States,” says Jason Mulvihill, general counsel for the American Investment Council. “Many policymakers are concerned that BEPS will cost US businesses more and make them less competitive – all to the benefit of countries other than the United States. That is generally not a winning combination in Washington.”

The AIC does not believe private equity funds should fall under the scope of BEPS because they are not vehicles for treaty shopping. Also, many are used by non-taxable entities, such as pensions, charitable foundations, and university endowments, and are not vehicles for deferring the recognition of income.

Further, private equity funds generally have a broad and diverse investor base, and are subject to extensive regulatory regimes around the world. “Accordingly, private equity funds should continue to be able to access tax treaties going forward,” Mulvihill says.

Investor base

The OECD has acknowledged private equity funds typically raise capital – and invest in – a broad range of jurisdictions, so it is critical they can operate effectively cross-border.

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 Mulvihill.

Collins of Invest Europe adds: “In the worst case scenario, the fund itself could be taxed and investors would no longer be able to benefit from tax treaties. 

“Therefore, when the returns of the fund are distributed to investors they should pay the tax they owe to their tax authorities and access to tax treaties is essential to achieving this.”

The BVCA has been in talks with the UK’s HM Treasury and HM Revenue and Customs, as well as the OECD. But when it comes to determining the fate of the industry’s access to tax treaties it is hard for anyone, even industry bodies in the thick of negotiations, to foresee which direction the OECD will take.

“In relation to Action 6, we are currently in the hands of the OECD and are waiting to learn what its next step will be and when it is going to release new guidance or publish another consultation,” adds Collins.