Workshop B: International Tax Issues - PowerPoint PPT Presentation

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Workshop B: International Tax Issues

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  1. Workshop B:International Tax Issues U.S. Investors – Non-U.S. Investments

  2. U.S. Investors Tax Issues – Non-U.S. Investments • Principal Tax Objectives in Structuring Private Equity Transactions – General Overview • Tax Efficiency for US Investors • Emerging Markets Issues • Examples

  3. General Tax Objectives – Overview • Tax Efficiency for Portfolio Company • Local tax burden (on-going) • Refinancing and cash flows • Tax Efficiency for US Investors • UBTI • “Dry income” • 15% tax rate (on refinancing and exit) • Practical Constraints on Tax Efficiencies • Reconcile Tax Efficiencies with Client’s Objectives • ERISA Issues • Maximum Efficiency versus Optimal Efficiency • Complexity • Cost-Benefit Analysis • Dealing with Management

  4. Tax Efficiency for US Investors • UBTI • “Dry” Income • Subpart F Exposure • PFIC Exposure • 15% Rate on Dividends • E&P Management for Recapitalizations • Capital Gains on Exit • Dealing with Management

  5. Tax Efficiency for US Investors UBTI • UBTI Concerns • What is Fund’s standard as established under the Partnership Agreement? • “Best efforts” • “Reasonable best efforts” • “Reasonable efforts” • Potential issues • Investment in flow-through entities • Third-party bridge loans to fund • Fund guarantee of loan to BidCo • Deal fees

  6. Tax Efficiency for US Investors Dry Income • “Dry income” Concerns • Shareholder debt (OID) • Discounted notes • PIK Debt • Preferred stock discount (hybrid instruments) • Use of E&P blocker • Subpart F income • Local tax sharing payments • Group contribution • Group relief • Reporting issues

  7. Tax Efficiency for US InvestorsSubpart F • Manage Subpart F Exposure • CFC status • Vote and value test (§ 957(a)) • Control of board (shareholders’ agreement) • Direct and indirect ownership (§ 958(a)) • Constructive ownership rules (§ 958(b))

  8. Tax Efficiency for US InvestorsSubpart F • Mitigating Exposure • 338 elections (clean up earnings and profits of foreign subsidiaries, step up basis of assets for depreciation and amortization) • Check-the-box elections (essential where inter-company flows of funds among subsidiaries in different countries) • Security/Guarantee package for financing (where US subsidiaries involved) (§ 956) • Monitor inter-company transactions

  9. Tax Efficiency for US InvestorsPFIC • PFIC Considerations • Income and assets test • 75% or more of gross income is passive income • Average percentage of assets that produce passive income is at least 50% • Note “look through” rules for 25%-owned corporations • QEF election • Current inclusion of share of ordinary income and capital gains • Ensures capital gain treatment on exit • Reporting issues

  10. Tax Efficiency for US Investors15% Rate • Preserve 15% Rate for Individuals • Qualified dividend income • Qualified foreign corporation must be eligible for benefits of a comprehensive income tax treaty (§ 1(h)(11)(c)(2)(ii)) • Must analyze limitations on benefit provisions • 1248 recharacterization • Capital gains treatment on distributions of proceeds on partial or full exit • Partial IPO issues

  11. E&P Management for Recapitalization If refinancing is at BidCo level, minimize E&P from portfolio company BidCo structure Block flow of debt (UBTI) at top of structure Manage E&P in between Section 338 elections on acquisitions Limit upstream distributions Potentially lend amounts in excess of E&P up the chain If no current deficit in between fall back on same country exception Consider impact of local tax sharing PEFunds Debt & Equity HoldCo Mezzanine MidCo Bank Loan BidCo Existing Debt (?) Target OpCo 1 OpCo 2 Tax Efficiency for US InvestorsE&P

  12. Tax Efficiency for US Investors Capital Gains • Capital Gains on Exit • Identify steps for trade sale, IPO, and other exit options when structure is set-up • Know your point of exit • Consider sale and purchase agreement provisions as to buyer election under section 338(g) • Some structures easier to unwind than others • Holdings companies for countries that tax local capital gains

  13. Tax Efficiency for US Investors Management • Dealing with Management • Determine where they will participate • Generally, management will own proportional basket of stock/securities of issuer • Institutional strip • Effect of participation in check-the-box entities • Consider effect of management’s roll-up (rollover) mechanism • effect on eligibility for §338 election (QSP) • effect on check-the-box entities

  14. Tax Efficiency for US Investors Other considerations • Other Considerations • Dual consolidated losses • Concern of corporate investors in PE Fund • Section 956 investments • Security package and financing of lower-tier US Subsidiary • QSP substitutes – pre-acquisition check-box • Generally no FTC planning • Withholding Tax Planning • Debt Pushdowns • Anticipate in planning structure • US reporting requirements

  15. Emerging Markets Issues • China • Tax Reform effective January 1, 2008 • General rate increasing to 25% • Exemption from dividend withholding tax removed • Implementation of CFC rules • Limits on interest deductions for real estate financing • Foreign exchange controls • Transfer pricing considerations

  16. Emerging Markets Issues (cont.) • India • Changes to tax holiday regime • Changes to “super” R&D deductions • Transfer Pricing Audits • PE Exposure • Management Fees • Russia • 5 year reform plan in place

  17. LuxCo is funded with preferred equity certificates (“PECs”) and convertible preferred equity certificates (“CPECs”) (hybrid instruments (debt in Luxembourg, equity in US)) and ordinary equity to minimize capital duty charges and to facilitate distribution of proceeds of refinancing or exit free of withholding taxes LuxCo funds HoldCo with equity and debt (terms match PECs, leaving small margin subject to tax in Luxembourg) LuxCo and HoldCo are disregarded entities PE funds (US investors) seen as investing equity in BidCo PECs and CPECs are effectively ignored for US tax purposes HoldCo, BidCo and Target are consolidated (fiscal unity) for local law purposes US Investors PEFunds Equity(PECs, CPECs) HoldCo LuxCo Equity and Debt HoldCo, BidCo and Target are incorporated in same country Equity BidCo Acquisition Financing Target Example (1)

  18. Example (1) – cont’d • Interest on shareholder debt deductible on accrual basis in group. Subject to thin capitalization rules • Refinancing at BidCo or Target level • 15% US rate if dividend treatment on distribution from BidCo and BidCo qualities under Treaty • Exit is via sale of HoldCo and liquidation of LuxCo

  19. LuxCo 1 is funded with PECs, CPECs and equity Classification of PECs and CPECs as equity for US tax purposes essential LuxCo 2 is funded with equity (E&P blocker) LuxCo 1 and LuxCo 2 file under fiscal unity regime (but note “claw back” risk) LuxCo 2 funds BidCo with equity and interest-bearing debt (terms to match PECs, leaving a small margin taxable in Luxembourg) BidCo and Target are part of local country fiscal unity regime Lack of flexibility on refinancing (minimize Subpart F income) Exit at Luxco 1 level or BidCo level. LuxCo 2 exit generates Subpart F income unless “check and sell” per Dover US Investors PEFunds CPECs (0%) PECs (interest bearing)Equity LuxCo 2 LuxCo 1 Equity Equity and Debt BidCo Acquisition Financing Target Example (2)

  20. LuxCo 1 is funded with PECs, CPECs and equity LuxCo 2 is funded with PECs and Equity Partnership is incorporated in same country as MidCo/BidCo/Target (or a different country but only for taxable years beginning after 12/31/05 and before 01/01/09) Partnership is checked closed as corporation Deferral of tax on accruals on shareholder loan (not Subpart F income) 1248 Exit(?) - planning necessary? US Investors PEFunds PEC EquityPECs CPECS Luxco 1 LuxCo 2 1% 99% Partnershipcapital Partnership MidCo Loan BidCo Target Example (3) Equity Equity Bank Debt

  21. Stephen BatesKPMG LLP (415)