TAX ALERT |
Authored by RSM US LLP
Private equity fund 2021 year-end global updates
The year of 2021 was a year of significant tax proposals and changes. Particularly, throughout 2021 many jurisdictions have either proposed or introduced rules that appear to advance the goals of the OECD’s anti-tax avoidance and profit shifting pillars. Below is a summary of recent global developments that may impact tax planning with respect to private equity funds going forward into 2022:
OECD and European Union Global Minimum tax expected implementation
Consistent with the OECD’s Base Erosion and Profit Shifting (BEPS) initiative and motivated by the economic downturn resulting from the COVID-19 pandemic, jurisdictions throughout the world are working together to discourage multinational entities from shifting profits to low-tax jurisdictions. In particular, the OECD described Global anti-Base Erosion Rules (GloBE) within its Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalisation of the Economy (Oct. 8, 2021) (the OECD Statement), and those rules call for the imposition of a minimum tax rate of 15%. This minimum tax would apply to multinational enterprises that generate EUR 750 million (approximately USD 853 million) in annual global revenue. The OECD Statement mentions that jurisdictions are free to implement the GloBE rules to multinational enterprises even if such entities do not meet the threshold. The Inclusive Framework on BEPS, comprised of 137 member jurisdictions, have agreed with the above OECD Statement as of Nov. 4, 2021.
A draft Model Framework for the global minimum tax rules was released by the OECD on Dec. 14, 2021 (see, Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two): Inclusive Framework on BEPS). While the specifics of the rules are beyond the scope of this article, the rules will act as a technical guide for the application of the GloBE by jurisdictions that have agreed to enact a 15% global minimum tax as part of their own local law.
The OECD is an international organization that issues policies, analysis and statistics for the purposes of promoting global policies. The European Union (EU), a political and economic union of 27 member states that are primarily located in Europe, will likely issue a Directive designed to implement the GloBE by mid-2022 in order to meet a 2023 deadline for the rules to take effect. Based on statements made by an EU executive, the European Commission is expected to publish a Directive by December 2022, which each EU member state must implement into their own legal code. The Directive is expected to set minimum standards that each state must comply with. A proposed Directive is to be discussed by the EU finance ministers in early 2022. Under EU Directives, tax proposals require unanimous agreement from all 27 member states.
Recent changes in Hong Kong taxes
In recent years, the Hong Kong government has promoted the private equity and venture capital industry by adopting a “three-step approach”: (i) new limited partnership fund regime; (ii) tax concessions; and (iii) its re-domiciliation mechanism. It is anticipated that the “three-step approach” would enhance the competitiveness of Hong Kong’s market, and promote Hong Kong as one of the top global destinations for the operation of private equity and venture capital funds.
The Limited Partnership Fund Ordinance, which came into operation on Aug. 31, 2020, enables funds to be registered in the form of limited partnership in Hong Kong by utilizing the Company Registry. A limited partnership should benefit from contractual flexibility in Hong Kong under these rules. Over 300 funds registered under the new regime since its launch.
In line with the “three-step approach,” legislation was also passed to offer a 0% tax rate for qualifying carried interest distributed by eligible private equity funds operating in Hong Kong. The reduced tax rate applies to eligible carried interest received by, or accrued to, qualifying carried interest recipients on or after April 1, 2020. For the application of tax concessions, the qualifying carried interest recipients must meet substance requirements in Hong Kong, including the number of qualified full-time employees and operating expenditures incurred in Hong Kong. The legislation also expands the classes of assets that may be held and administered by a special purpose entity on behalf of a fund.
The final step in the government’s plan allows for a fund created in corporate or limited partnership form under the law of a jurisdiction outside Hong Kong to be eligible to be registered as an open-ended fund company (OFC) or limited partnership fund (LPF) in Hong Kong under the re-domiciliation mechanism, which came into effect on Nov. 1, 2021. The continuity of the fund, including contracts made and property acquired are expected to be preserved, and would have the same rights and obligations as any other newly established OFC or LPF in Hong Kong.
Based on the above, and from a U.S. tax perspective, if U.S. investors consider entering into the Hong Kong market, it is important to note that the U.S. and Hong Kong have not entered into a bilateral income tax treaty. Thus, the benefits that investors often expect from income tax treaties (e.g., reduced withholding rates, mechanisms to resolve double tax issues may not be available).
Recent changes in Ireland taxes
Over the last number of years, the Irish tax measures relating to M&A have been gradually evolving. This trend has been continued in Finance Bill 2021, which was published by the Minister of Finance in October 2021. The Finance Bill is passed through the various legislative stages and the Finance Act 2021 was signed into law in December 2021.
One of the key pillars of the Irish Budget process has been continuing the adoption of international tax reforms and several other new measures. As part of the international tax reforms, Ireland is introducing new anti-reverse-hybrid rules and a new interest limitation ratio which are expected to sit alongside Ireland’s existing rules regarding tax deductions for interest. These new measures come into effect in January 2022 and are based on the EU’s Anti-Tax Avoidance Directive (ATAD). It will be a key aspect of structuring any M&A transactions involving Ireland to consider these new measures, particularly in cross border transactions. In addition, in line with the ATAD, Ireland amended its exit tax rules in 2018 and 2019 to bring into tax any unrealized gains on certain capital assets where there is a transfer outside of Ireland. The tax rate for the exit charge is set at 12.5%, rather than the capital gains tax rate of 33%; however, consideration should be given to the impact of future changes in legislation resulting from any EU GloBE Directive may have on the above tax rate on exit charges.
Recent changes in Dutch taxes
The European Commission launched an initiative on May 20, 2021 to address the use of shell companies in international arrangements to reduce income taxes. The initiative aims to define substance requirements for arrangements operating in the EU. The draft measures of the EU will be published by the end of 2021 and are expected to result in a proposal for a third Anti-Tax Avoidance Directive (ATAD 3), to be adopted by the beginning of 2022. The EU defines shell companies as “legal entities with no or only minimal substance, performing no or very little economic activity and they continue to pose a risk of being used in aggressive tax planning structures.”
Economic substance has become a key element in the international context and is relevant for the application of national tax laws, double tax treaties and to avoid the application of national anti-abuse rules. Accordingly, taxpayers are required to maintain a significant level of assets, employees, functions, assume risks and use and enjoy the income received to be entitled to the benefits of certain double tax treaties and EU tax Directives. Business substance is a combination of many elements which include human and material resources.
If the substance requirements are not met by a shell company, certain benefits otherwise available to such company may be denied. The denial of tax benefits would likely include denial of double tax relief, application of treaty benefits, or deductibility of costs, participation exemption, domestic withholding tax exemptions and residence certificate issuance, among other items. Public disclosure of information about the shell entity and sanctions on the entity, directors and/or beneficiaries are also being considered. This proposal, if adopted, is expected to reinforce the pressure regarding the use of intermediate holding companies. To mitigate costs, multinational groups may need to select one single jurisdiction to establish their holding companies and build up the necessary level of substance.
Recent changes in UK taxes
In October 2021 the UK government released a policy paper for a new Asset Holding Companies regime, which is a proposal in the UK’s Finance Bill 2021-22 intended to be a competitive tax regime with typical holding company jurisdictions such as Luxembourg and Ireland, supported by the UK’s comprehensive financial infrastructure and large treaty network. The Asset Holding Companies regime applies to most unlisted investment funds, including private equity funds, that mainly carry out investment activity, and are at least 70% owned by diversely owned funds, charities, long-term insurance businesses, sovereign immune entities and pension schemes.
The above regime is not intended to affect the taxation of profits from trading activities, UK land or intangibles. The proposed legislation was introduced in Finance Bill 2021-22 and is expected to establish a tax regime that includes the exemption of gains on disposals of certain shares and overseas property by Asset Holding Companies and allowing deductions for certain interest payments that would usually be disallowed as distributions (along with changes to the hybrid rules), among other changes. If approved, many of the changes proposed in the UK’s Finance Bill 2021-22 are expected to come into effect with respect to the UK’s next tax year beginning in April 2022.
According to HMRC, the general aim of the above measure is to facilitate the flow of capital, income and gains between investors and underlying investments where there are intermediate holding companies, to tax investors broadly as if they invested in the underlying assets and that intermediate holding companies pay no more tax than is proportionate to the activities they perform.
This article was written by Ramon Camacho, Lynn Ellenberg, Anthony Reda and originally appeared on 2022-01-31.
2021 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.