Tax has, in recent months, become a frontpage issue with reaction to businesses not “paying their fair share” sitting alongside pressure on government finances and an uncertain political environment. In our view, the cumulative effect of tax developments in the UK and beyond will impact private equity on multiple fronts, but particularly deal structure.
Since the introduction of the US Foreign Account Tax Compliance Act (FATCA) regime in 2010, there has been a global trend towards greater tax disclosure and information sharing. Much of the recent adverse publicity around tax has focused on complex structures, the use of tax havens and limitations of disclosure to tax authorities. As part of its BEPS (base erosion and profit shifting) project, the Organization for Economic Cooperation and Development (OECD) proposed disclosure of aggressive tax planning and country by country reporting of tax information, with information potentially being shared between tax authorities. As a result of this, deal structures are set to become increasingly disclosable, and establishing tax arrangements that will remain effective over time will be more challenging.
The OECD initiative will also result in imminent changes to other aspects of the international tax code. In the UK, the focus on restricting deductibility of interest and discouraging the use of so-called “hybrid instruments” will affect private equity deal structures and in our view, will bring greater focus to allocating debt across jurisdictions in line with where EBITDA threshold targets are met. Although HMRC consultation is ongoing, legislation is set to come into effect in 2017, and those structuring current deals should take account of the changes.
In the UK, HMRC has previously targeted specific aspects of private equity structuring, such as the taxation of disguised management fees and income based carried interest. Former UK Chancellor George Osborne indicated that the UK might further reduce the headline rate of corporation tax in order to encourage investment. A lower rate would benefit UK-based portfolio companies, but would push the country further towards “tax haven” status, which could change its attractiveness as a holding company jurisdiction. However, the previous Chancellor’s comments have been downplayed by the new Conservative government, and future developments in the UK tax regime may be subject to political headwinds. Like the UK, private equity in the US could also see plenty of changes, regardless of the outcome of the upcoming presidential elections.
Further, the European Commission’s recent investigations into tax related State Aid have been noteworthy in terms of the wide reaching extent and quantum of the amounts at stake (total aggregate recovery amount in excess of €13 billion to date). The focus of the European Commission has been on tax rulings granted by certain Member States (in particular, the question of whether the relevant ruling has granted the taxpayer company an advantage on a selective basis). While the relevant State Aid laws are complex and the majority of tax rulings are unlikely to fall foul of the State Aid regime, new investments and portfolio company structures and related tax arrangements ought to be reviewed to ensure compliance.
In light of these prospective changes, deal teams should consult with tax advisers to ensure that assumptions in tax models are robust for the lifetime of the investment.