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Third International Tax Dialogue Global Conference Financial Institutions and Instruments - Tax Challenges and Solutions. Private Equity and Hedge Funds: The Tax Challenge. Beijing, October 26-28, 2009. Marcello Distaso Baker & McKenzie Amsterdam. Everything starts from the Fund….

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Third International Tax Dialogue Global Conference Financial Institutions and Instruments - Tax Challenges and Solutions


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slide1

Third International Tax Dialogue Global Conference

Financial Institutions and Instruments - Tax Challenges and Solutions

Private Equity and Hedge Funds: The Tax Challenge

Beijing, October 26-28, 2009

Marcello Distaso

Baker & McKenzie

Amsterdam

everything starts from the fund
Everything starts from the Fund…
  • Different structures
  • Different categories bearing a different interest: Investors, Fund Managers, Sponsors
  • Common scope: maximizing the IRR

2

hedge fund basic structure
Hedge Fund – Basic Structure

Domestic

Investors

Foreign

Investors

Feeder

Fund

Feeder

Fund

GP

Master

Fund

Investment

4

slide5

Different Categories of Issues

  • Legal issues: flexible and ‘water proof’ documentation
  • Regulatory issues: acceptable regulatory environment
  • Tax issues: any tax paid at the level of the Fund represents a cost that reduces the IRR

5

slide6

Tax Objectives for Investors

  • Tax neutrality of fund vs direct investment in Targets
  • Avoid/defer taxation until distributions from the Fund
  • Minimize tax ‘leakage’ on Fund’s distributions
  • Fund structure should be flexible enough to allow each Investor to organize its own (tax) planning

6

slide7

Tax Objectives for Fund Managers

  • Efficient tax planning of the carried interest remuneration (i.e. capital gain/dividend vs employment income qualification)
  • Avoid/defer taxation until distributions from the Fund
  • Minimize tax ‘leakage’ on Fund’s distributions
  • Avoid personal tax liabilities in the target jurisdictions

7

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Pension Funds

US Investors

CH Investors

EU Investors

Special LP

Other Investors

Fund L.P.

Carried interest

GP

Fund Manager

Management Fee

Economic ownership of shares in Holdco

Equity

Legal title to shares in GP of the Fund

SPV

Equity

Local Bidco

Bank Loan

Target

Tax consolidation/merger

8

slide9

Tax issues at Target level

  • No local taxation: (i.e. interest and dividend withholding tax and capital gain tax) in the country of the Target Companies – Need for SPVs to guarantee ‘treaty protection’
  • Possibility to implement efficient debt-push-down on the bank leverage (e.g. tax consolidation or merger)
  • Possibility to minimize the tax exposure of effective management of the Fund in the target jurisdictions and the presence of a taxable permanent establishment

9

fiscal transparency
Fiscal Transparency
  • Advantages
    • no double tax charge
    • distributions retain character of underlying income/capital gains
    • fund cannot be a tax resident of any country
    • flow-through of foreign tax credits for taxable investors
  • Disadvantages
    • Not harmonized concept: different definitions
    • PE risk for partners in investee company and/or investment manager country
    • fund not entitled to double tax treaty benefits
    • immediate income/gain recognition by taxable investors

10

fiscal transparency11
Fiscal Transparency

Investor

Treaty country (low tax)

Feeder

Tax Haven

Partnership

Treaty country (low tax)

SPV

Investee country

Investee

Company

11

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Debt push-down: base case

Debt is pushed down to the NL/Lux SPV with a loan and to Target through a merger or a tax consolidation: the interest expense can finally be deducted against the operating profit of Target

Possible impact of local thin cap and anti abuse rules: no initial leverage at the level of Bidco, but subsequent third party debt at the level of the Target that pays capital or dividend to NL/Lux SPV

Fund 1

Fund 2

Equity/

Debt

NL/LUX SPV

Equity

Bank debt

Bidco

Bank debt

TARGET

Merger / tax consolidation

12

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Tax issues at SPV level

  • No taxation on dividend income or cap. gains
  • No incremental taxation (i.e. dividend withholding tax or local cap gain tax on the distributions of the SPVs to the Fund
  • No indirect taxation (i.e capital or stamp duty) on the equity funding of the SPVs
  • Usual suspects: NL, Lux, BE, Cyprus. Dutch Coop is currently ‘hot’…

13

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Tax issues at Fund level

  • No taxation on proceeds deriving from Targets or SPVs: tax transparency or full exemption
  • No incremental taxation (i.e. any WHT or local tax) on the distributions of proceeds to Investors
  • No local tax compliance for Investors
  • Possibility to avoid the VAT incremental cost for the Fund re the management fees and the advisory fees

14

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Carried Interest

  • Carried interest: an interest in the fund which entitles the holders to participate in the (super) profits of the fund once any preferred returns have been paid to the investors
  • Carried interest holders: individuals who are “partners” in the fund (either directly or through a carry vehicle) and potentially employees or directors of the management company or associated companies
  • Carried interest holders often contribute only nominal capital to the fund for their carried interest in the fund

15

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Carried Interest

  • Concerns: low investment and important upside potential
  • Traditional discussion: capital gains taxation versus “employment” income
  • Jurisdictions without specific guidance – jurisdictions with specific guidelines (e.g. UK)

16

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The life of a fund tax lawyer can be difficult…

Pension Funds

US Investors

CH Investors

EU Investors

Special LP

Other Investors

Fund L.P.

Carried interest

GP

Fund Manager

Management Fee

Economic ownership of shares in Holdco

Equity

Legal title to shares in GP of the Fund

SPV

Equity

Local Bidco

Bank Loan

Target

Tax consolidation/merger

17

thank you

Thank You!!

marcello.distaso@bakernet.com

Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm.