new challenges in obtaining interest deduction and in ... · or hybrid financing . beps initiatives...

Co Chairs

Richard M. Lipton, USA

Jutta B. Schneider, Germany

Panellists

Albert Collado, Spain

Kevin Keyes, USA

Thierry Lesage, Luxembourg

Jonathan S. Schwarz, England

Paul Sleurink, The netherlands

CROSS-BORDER FUNDS / INVESTMENT VEHICLES:

INVESTMENT INTO GERMANY

Introduction

BEPS Initiatives and EU and other Measures against Preferential Tax Regimes

Commonly used Fund Structures

Effects on Investment Structures

Overview

Introduction

5

Fund

Private

Investors

Investor country tax treatment:

• Private investors

• Institutional investors

• Tax Exempt investors

Fund and/or intermediary country tax treatment:

• No / little tax leakage

• Ensure tax treaty benefits

Source country tax treatment:

• Tax of source income

• Interest deduction

• Tax of capital gains

• Withholding tax

• Anti-abuse rules

Principal fund structure

Tax Exempt

Investors

Feeder / Blocker

Corporation or

Partnership

Investment Portfolio

OpCo OpCo

OpCo

Intermediary

Institutional

Investors

Loan

or hybrid

financing

BEPS Initiatives and EU and other Measures against Preferential Tax

Regimes

BEPS Initiatives and EU and other Measures against Preferential Tax Regimes

Multi-national organizations

OECD Action Plan on Base Erosion and Profit Shifting - Action 6 : Preventing Treaty Abuse

EU Considerations

Uni- or bilateral initiatives

New limitations in tax treaties

New anti-abuse provisions in domestic law

Case law: recent decisions in favour of tax authorities

7

1. BEPS Action 6 : Preventing Treaty Abuse

Precedent work: OECD 2010 CIV Treaty Benefits report and subsequent Commentaries to MCOCDE

Working timetable

Work to be done and proposed measures

General Anti-Abuse Rule (GAAR)

Limitation on Benefits (LOB) provisions

Specific Anti-Abuse Rules

Clarification that DTT are not intended to generate double non-taxation

IBA Working Group comments

8

2. EU considerations

Withholding tax refunds for CIVs

New GAAR P/S Directive

EU Recommendation on Aggressive Tax Planning, Introduction of a common GAAR.

28 November 2014 join letter of the finance ministers of France, Germany and Italy to EU tax Commissioner Pierre Moscovici, asking the Commission to propose a comprehensive EU Directive to counter BEPS.

9

3. Uni- or bilateral measures

New limitations in tax treaties

New anti-abuse provisions in domestic law

Case law: recent decisions in favour of tax authorities

Application of anti-base erosion and other anti-abuse rules in tax audits and other proceedings

10

Common Fund Structures

Common fund structures: Example 1 – private equity

Luxembourg Intermediary(I)

Structure

Investors: Individuals, tax exempt investors/pension schemes, (corporates) investing directly or through Blocker/Feeder structures

LuxFund: non-regulated Luxembourg AIF

LuxCo: Luxembourg holding company, financed by debt (85%) and equity (15%)

GerFund: German limited partnership (Kommanditgesellschaft) investing in private equity assets, if investment of >50% in at least two OpCos

15% Equity

Investors

(Limited Partners)

LuxFund

GP < 5%

LuxCo

LuxGPCo

LP 100%

85%

Debt

Inv

GerFund

GerGPCo

GP 0% >50%

share

Investments

12

Tax treatment

LuxFund and GerFund: tax transparent for Luxembourg tax purposes

LuxGPCo and LuxCo: tax opaque for Luxembourg tax purposes

Income and gains of LuxCo from GerFund tax exempt in Luxembourg

Interest paid to LuxFund and profits distributed to Investors upon full or partial liquidation not subject to Luxembourg withholding tax

LuxFund: tax transparent for German tax purposes

LuxCo: tax opaque for German tax purposes

GerFund:

management holding and/or commercial activity

permanent establishment of LuxCo

only 5 % of income and gains from GerFund subject to tax in Germany (but trade tax for investments <15%)

no German withholding tax

15% Equity

Investors

(Limited Partners)

LuxFund

GP < 5%

LuxCo

LuxGPCo

LP 100%

85%

Debt


Luxembourg Intermediary(II)

Inv

GerFund

GerGPCo

GP 0% >50%

share

Investments

13


Dutch Intermediary(I)

Structure


NLFund: Dutch limited Partnership (CV)

NLCoop: Dutch cooperative (coöperatie)

GerFund: German limited partnership (Kommanditgesellschaft) investing in private equity assets, if investment of >50% in at least two OpCos

Investors

(Limited Partners)

NLFund

NLCoop

NLGPCo

LP 100%

Inv

GerFund

GerGPCo

GP 0% >50%

share

Investments

(Hybrid)

Debt

14

Tax treatment

NLFund and GerFund tax transparent for Dutch tax purposes (subject to strict limitations on the transferability of participations)

NLGPCo and NLCoop tax opaque for Dutch tax purposes

Income and gains of NLCoop from GerFund, tax exempt in the Netherlands

Interest income of NLCoop or NLFund fully taxable in the Netherlands; debt funding to be made by investors (or offshore feeder) or as hybrid loans (equity for Dutch tax purposes)

Profits distributed to Investors not subject to Dutch dividend withholding tax, provided conditions are met

GerFund:

management holding and/or commercial activity

permanent establishment of NLCoop

only 5 % of income and gains from GerFund subject to tax in Germany (but trade tax for investments <15%)

no German withholding tax

Investors

(Limited Partners)

NLFund

NLCoop

NLGPCo

LP 100%


Dutch Intermediary(II)

Inv

GerFund

GerGPCo

GP 0% >50%

share

Investments

(Hybrid)

Debt

15

PropCo

Structure


LuxFund: non-regulated Luxembourg limited partnership

LuxCo: Luxembourg holding company

LuxCo: sets up PropCos acquiring German real property (or buys PropCos holding German real property with Third Party)

Third

Party

5.1% 100% / 94.9%

LuxGPCo

LuxFund

LuxFund

GP < 5%

Investors

(Limited Partners)

LuxCo

LuxGPCo

Debt

PropCo

100%

PropCo

Common fund structures: Example 2 – real estate

Luxembourg Intermediary (I)

16

Tax treatment

LuxFund: tax transparent for Luxembourg tax purposes.

LuxCo:

Profits from PropCos tax exempt in Luxembourg

No WHT on interest payments to LuxFund

Sale of PropCo shares taxable in Germany but 95% exempt (0.79% effective tax rate)

PropCos:

No German permanant establishement

No RETT on a share deal (purchase of PropCos)

Rental income subject to German corporate income tax (15.825%) but not to German trade tax

Several PropCos to avoid interest barrier

Rental income exempt in Luxembourg

No German withholding tax

Third

Party

5.1% 100% / 94.9%

LuxGPCo

LuxFund

LuxFund

GP < 5%

Investors

(Limited Partners)

LuxCo

LuxGPCo

PropCo

Debt 100%

PropCo

PropCo


Luxembourg Intermediary (II)

17

PropCo

Structure


NLFund: Dutch limited Partnership (CV)


NLCoop: sets up PropCos acquiring German real property (or buys PropCos holding German real property with Third Party)

Third

Party

5.1% 100% / 94.9%

LuxGPCo

LuxFund

NLFund

Investors

(Limited Partners)

NLCoop

NLGPCo

100%


Dutch Intermediary (I)

PropCo

PropCo

(Hybrid)

Debt

18

Tax treatment

NLFund: tax transparent for Dutch tax purposes.


Income and gains of NLCoop from PropCos tax exempt in the Netherlands

Interest income of NLCoop or NLFund fully taxable in the Netherlands; debt funding to be made by investors (or offshore feeder) or as hybrid loans (equity for Dutch tax purposes)

Profits distributed to Investors not subject to Dutch dividend withholding tax, provided conditions are met

PropCos:

No German permanant establishement

No RETT on a share deal (purchase of PropCos)

Rental income subject to German corporate income tax (15.825%) but not to German trade tax

Several PropCos to avoid interest barrier

Rental income exempt in Luxembourg

No German withholding tax

Third

Party

5.1% 100% / 94.9%

LuxGPCo

LuxFund

NLFund

Investors

(Limited Partners)

NLCoop

NLGPCo

PropCo

100%


Dutch Intermediary (II)

PropCo

PropCo

(Hybrid)

Debt

19

Common fund structures: Investor Considerations (I)

Individuals as Investors

Taxation of investors

Financing

Income stream

Disposal

Preferences

Transparent to minimise corporate/shareholder double taxation

Shares in LuxCo/NLCoop to facilitate change in portfolio without disposal

Flexibility of vehicle

Problems

Mismatching profits in source and investor country

Anti-deferral regimes

Investments

Investors

LP 100%

Feeder or Blocker

Partnership (Hybrid)

Debt

Lux/NL

Fund

LuxCo/

NLCoop

Lux/NLGPCo

Debt

20

Common fund structures: Investor Considerations (II)

Tax Exempt Investors


Financing

Income stream

Disposal

Preferences

Corporate vehicle (BlockerCorp. /LuxCo/NLCoop/PropCo to minimise risk of taxable income)

Dividends where treaty exempts

Debt where interest deductible by GerFund or LuxCo/NLCoop/PropCo

Hybrid financing where possible

Investments

Investors

Feeder or

Blocker

Corporation

(Hybrid)

Debt

Feeder

Partnership

Lux/NL

Fund

LuxCo/

NLCoop

Lux/NLGPCo

Debt

21

BEPS/EU/Treaty/Domestic Structuring Issues

Issues to consider:

Substance of SPVs

Business purpose

Effective place of management

Dual resident companies

Substance requirements for partnerships as permanent establishment

Dividends exempt under P/S Directive, tax treaty

Business reasons behind existence of parent / intermediary

Substance, business purpose etc.

Management holding

Listed company/fund

Debt /hybrid financing as alternative

Limitations on deductibility of interest / witholding tax on interest / anti-hybrids

Capital gain exemption

BEPS/EU/Treaty/Domestic Source Country Issues / Intermediary Country Issues Investors

Inv

GerGPCo

GP 0% >50%

share

Investments

GerFund

(Hybrid)

Debt

Lux/NL

Fund

Lux/NLGPCo

Debt

LuxCo/

NLCoop

Feeder / Blocker

Corporation or

Partnership

PropCo

PropCo

PropCo

23

THANK YOU!

Richard M. Lipton + 1 312 861 7590 [email protected]

Jutta B. Schneider +49 6187 99432 02 [email protected]

Albert Collado +34 93 253 37 00 [email protected]

Kevin Keyes +1 202 533 3000 [email protected]

Thierry Lesage +352 40 78 78 257 [email protected]

Jonathan S. Schwarz +44 20 7936 3988 [email protected]

Paul Sleurink +31 20 577 1719 [email protected]

24

Attachments

Attachment I: Luxembourg (Thierry Lesage) Example 1 – private equity

Background

LuxFund is a non-regulated Luxembourg AIF which invests indirectly into GerFund. It has been set up by LuxGPCo as general partner (holding less than 5% of LuxFund’s interests) and several Investors as limited partners.

LuxCo, a Luxembourg holding company, is held at 100% by LuxFund and invest into GerFund which is a German limited partnership (Kommanditgesellschaft) investing in private equity assets.

Luxembourg tax treatment

LuxFund and GerFund are treated as tax transparent entities for Luxembourg tax purposes while LuxGPCo and LuxCo are tax opaque.

Gerfund qualifies as a permanent establishment of LuxCo within the meaning of the double tax treaty between Luxembourg and Germany (“DTT”). Hence, income and gains derived from GerFund are exempt in Luxembourg.

Interest paid to LuxFund will not be subject to withholding tax (“WHT”). No WHT will apply on profits distributed to Investors through LuxFund upon full or partial liquidation.

Investors

(limited partners)

LuxFund

GP

LuxCo

LuxGPCo

LP

GerFund

85%

debt 15% Equity

Investments

< 5%

Germany

Luxembourg

Various countries

26

Attachment I: Luxembourg (Thierry Lesage) Example 2 – real estate

Background

LuxFund is a non-regulated Luxembourg limited partnership which has been set up by LuxGPCo as general partner (holding less than 5% of LuxFund’s interests) and several Investors as limited partners.

LuxCo is a Luxembourg holding company held at 100% by the LuxFund.

LuxCo, together with Third party, sets up PropCo which in turn acquires a real property in Germany.

Tax treatment

LuxFund is treated as a tax transparent entity for Luxembourg tax purposes.

Rental income derived by PropCo (i) subject to German corporate income tax. (15.825%) but not to German trade tax and (ii) exempt in Luxembourg based on the DTT.

The profits derived by LuxCo from GerCo will be tax exempt. No WHT will apply on interest payments by LuxCo to LuxFund.

A sale of PropCo shares will be taxable in Germany but exempt up to 95% (0.79% effective tax rate).

No RETT triggered on a share deal.

Debt

Various countries

Luxembourg

Germany

Investors

(Limited partners)

PropCo

Third

Party LuxCo

Real Estate

LuxFund

5.1% 94.9%

LuxGPCo

GP

< 5%

27

Attachment I: Luxembourg (Thierry Lesage) Example 3 – Regulated fund structure

Background

Lux SICAR is an investment company in risk capital regulated by the Law of 15 June 2004 and incorporated as a Luxembourg partnership limited by shares (SCA) with the Investors as limited partners and LuxGPCo as general partner.

Lux SICAR invests into equity securities of German operating companies (GerCos).

Luxembourg tax treatment

Lux SICAR is fully subject to Luxembourg taxes. However, the profits derived by Lux SICAR from its participation in GerCos will be exempt from Luxembourg income tax.

No WHT will apply on profits distributed by Lux SICAR to the Investors.

Points of attention

German anti-treaty shopping rule (WHT levy at 26.375%).

Alternative structure may be envisaged to mitigate the WHT levy (e.g. structuring via a German holding company or a KG).

Lux SICAR

(SCA)

LuxGPCo

100% Equity

Investors

GerCos

Various countries

Luxembourg

Germany

GerCos GerCos

28

29

Structure

Investors:

[same as Luxembourg]

NLFund: Dutch limited partnership (CV)


GerFund:


Attachment II: The Netherlands (Paul Sleurink) Example 1a (Private Equity)

30

Tax Treatment

NLFund and GerFund tax transparent for Dutch tax purposes (subject to strict limitations on the transferability of participations)


Income and gains derived by NLCoop, through GerFund, from equity investments in German portfolio companies tax exempt in the Netherlands on the basis of the participation exemption

Interest income received by NLCoop or NLFund fully taxable in the Netherlands. Debt funding needs to be made either by the investors (or offshore entities held by the investors) or in the form of hybrid loans that are treated as equity for Dutch tax purposes

Profits distributed to investors, via NLFund, not subject to Dutch dividend withholding tax, provided that conditions are met (the investors' membership in NLCoop should, inter alia, be part of an enterprise carried out by NLFund). If NLFund is a feeder fund, it may be more difficult to establish that it carries on an enterprise

Relief from Dutch dividend withholding tax may be available on the basis of treaties or domestic law (in particular in relation to tax exempt investors, see slide [●] [should refer to the tax exempt investor slide under Common fund structures: Investor Considerations])

NLFund: tax transparent for Dutch tax purposes, permanent establishment of investors

NLCoop: tax opaque for Dutch tax purposes

Attachment II: The Netherlands (Paul Sleurink) Example 1a (Private Equity)

31

Structure

Investors:


NLCoop: Dutch Cooperative (coöperatie)

Tax Treatment

GerFund tax transparent for Dutch tax purposes (subject to strict limitations on the transferability of participations)

NLCoop tax opaque for Dutch tax purposes

Income and gains derived by NLCoop, through GerFund, from equity investments in German portfolio companies tax exempt in the Netherlands on the basis of the participation exemption

Interest income received by NLCoop fully taxable in the Netherlands. Debt funding needs to be made either by the investors (or offshore entities held by the investors) or in the form of hybrid loans that are treated as equity for Dutch tax purposes

Profits distributed to investors not subject to Dutch dividend withholding tax, provided that conditions are met

NLCoop: tax opaque for Dutch tax purposes

GerFund: [same as Luxembourg, German considerations to be confirmed]

Attachment II: The Netherlands (Paul Sleurink) Example 1b (Private Equity)

32

Structure

Investors:


NLFund: Dutch limited partnership (CV)


NLCoop: sets up PropCos acquiring German real property (or buys such PropCos)

Attachment II: The Netherlands (Paul Sleurink) Example 2 (Real Estate)

33

Tax Treatment

NLFund: tax transparent for Dutch tax purposes (subject to strict limitations on the transferability of participations)

NLCoop:

tax opaque for Dutch tax purposes

income and gains derived by NLCoop, through the PropCos, from investments in German real property tax exempt in the Netherlands on the basis of the participation exemption

interest income received by NLCoop fully taxable in the Netherlands. Debt funding needs to be made either by the investors (or offshore entities held by the investors) or in the form of hybrid loans that are treated as equity for Dutch tax purposes

profits distributed to investors not subject to Dutch dividend withholding tax, provided that conditions are met (which is difficult in this situation unless there is active real estate development or redevelopment)

PropCos:

no Dutch RETT (as no Dutch real property is held by the PropCos)

rental income exempt in the Netherlands (article 4 of the NL-Germany double taxation agreement

[German considerations to be confirmed, we presume that interest on debts made to Propcos is deductible in Germany subject to limitations on interest deduction]

Attachment II: The Netherlands (Paul Sleurink) Example 2 (Real Estate)

34

Individuals as Investors



Preferences

NLFund transparent to minimise double taxation

Flexibility of vehicle

Problems


Business asset test Dutch wage withholding tax

Tax exempt investors



Preferences

Corporate vehicle

Dividends where exempt under Dutch domestic law or double taxation agreement

Debt where interest deductible by GerFund or NLCoop / PropCos

Tax exempt investors that are qualifying pension funds or non-profit organisations are generally eligible to a full refund of Dutch dividend withholding tax

Tax position can generally be optimised by shifting profits in the form of interest to tax exempt investors

Attachment II: The Netherlands (Paul Sleurink) Investor Considerations

35

USA (1) – U.S. Taxable Investors

U.S. individual investors generally seek to preserve the character of income generated by an investment in a private equity fund (“PE fund”) where such income is taxed at favorable rates.

Long-term capital gains and certain dividends are currently taxed at 20% (ignoring the 3.8% nii tax).

Ordinary income is generally taxable at 39.6% rate (ignoring the 3.8% nii tax).

U.S. corporate investors pay the same 35% rate of tax on all income and are generally indifferent from a tax perspective to the character of income. However, since capital losses cannot offset ordinary income, a benefit to preserving capital gain character may still exist.

For these reasons, PE funds traditionally are structured as partnerships, which are treated as “flow-through” entities for tax purposes.

Each partner is taxed individually as if it earned the income directly.

Capital gain allocations from the PE fund (resulting from portfolio company dispositions and distributions) flow through.

Qualified dividend income for individual taxable investors also flows through.

Gain on the sale of a partnership interest should also be capital (subject to section 751).

Attachment III: USA (Kevin Keyes)

36

USA (2) - U.S. Taxable Investors – (cont’d)

US taxable investors also want to avoid “phantom” or “dry” income, such as:

Phantom interest income (OID) that can arise with debt financing.

Phantom (deemed) dividend income (Section 305(c)) that is possible with equity financing.

Guaranteed payments (Section 707(c)) that can arise if the issuer is taxed as a partnership for US tax purposes.

In addition, phantom income can arise under various U.S. anti-deferral regimes if the investor holds, directly or indirectly, an interest a non-U.S. entity that is treated as corporation for U.S. tax purposes.

These rules are designed to prevent U.S. persons from indefinitely deferring U.S. taxes by holding assets in a foreign corporation (i.e., an offshore “piggybank”) and converting any eventually repatriated earnings into capital gains.

The main U.S. anti-deferral regimes apply to controlled foreign corporations (“CFCs”) and passive foreign investment companies (“PFICs”).

The CFC rules require U.S. investors to include on their annual tax return certain income of a CFC for U.S. tax purposes. A foreign corporation generally is deemed a CFC if more than 50% of its interest (by vote or value) is owned by “U.S. shareholders,” which each own more than 10% of the interest (by vote).

A U.S. partnership that owns greater than 10% of a foreign corporation is considered a “U.S. shareholder” for purposes of determining the ownership threshold (i.e., no pass-through treatment).

However, a foreign partnership is treated as a pass-through entity for CFC purposes and thus, the ownership is determined at the partner level.

Additionally, U.S. investors must treat a portion of any gain or loss realized by the fund upon disposition of the stock of a CFC and allocable to them as ordinary. This may limit the ability of investors to offset other gains with losses generated by a CFC investment.


37

USA (3) - U.S. Taxable Investors – (cont’d)

A U.S. person who invests in a non-U.S. corporation that is a PFIC will generally be subject to an interest charge designed to produce the economic equivalent of current taxation, unless the person is eligible to, and elects, pass-through treatment under the qualified electing fund (“QEF”) rules.

A foreign corporation is generally regarded as a PFIC if EITHER 75% or more of its gross income for a tax year is “passive income”, OR at least 50% of its assets are passive.

In applying these tests, look through 25% owned subsidiaries.

Making a “QEF election” with respect to a PFIC generally means that a shareholder will include in income a pro rata portion of the PFIC’s earnings as though the PFIC were treated as a partnership for U.S. tax purposes.

A QEF election can create burdens for the parties, as certain annual financial information must be obtained from the PFIC.

Failure to make a QEF election subjects U.S. investors to adverse consequences, including taxation under a punitive “excess distributions” regime on sales and distributions, loss of deferral due to the interest charge, loss of the capital gains preferential rate, inability to use NOLs or other deductions to offset PFIC taxes, and current taxation of certain otherwise tax-free dispositions.


38

USA (4) - U.S. Tax-Exempt Investors

U.S. tax-exempt investors generally seek to avoid the imposition of taxes on “unrelated business taxable income” (UBTI) and the related filing requirements.

Tax Consequences of UBTI: Tax is imposed on UBTI at regular graduated rates, computed under the same rules that apply to domestic corporations (i.e., reduced by allowable deductions).

UBTI generally arises in two contexts:

Trade or business type income

Active trade or business conducted by pass-through entities (e.g., oil and gas partnerships).

Certain fee income (e.g., management or monitoring fees, origination or commitment fees).

Debt-financed income (i.e., making a levered investment)

Investment in a leveraged, pass-through portfolio company.

Permanent leverage.

Convenience facility (e.g., bridge financing).

Short-term debt generally does not give rise to UBTI if debt is retired more than 12 months before investment return is realized.

Note that depending on the structure, this may put significant constraints on fund level leverage.

Fractions Rule: Certain debt-financed real property income is excluded from the computation of the UBTI of certain “qualified organizations.”


39

USA (5) - U.S. Tax-Exempt Investors - (cont’d)

Dealing with UBTI:

Tax-exempts usually want to block UBTI. Therefore will usually want to either:

Invest through a feeder fund set up as a corporation for tax purposes (i.e., treat the fund as a blocker, which permits leverage at the fund level), or

Have the PE Fund use deal-specific blockers, to shield them from any UBTI that may be generated (i.e., blockers below the fund, which does not permit fund-level leverage).

In a fund-of-funds, managers typically have no control over the structure of investments or use of leverage made by underlying funds.

Fund-of-funds group typically blocks the whole fund by setting up the fund as a blocker, which permits them to incur fund-level leverage.

Note however that this method may cause U.S. tax-exempts to lose the ability to claim treaty benefits through the fund, as the entity is a corporation for U.S. purposes.

In a buyout fund, managers may have more control over investment structures and to avoid UBTI may (i) refrain from using leverage and (ii) set up blockers below the fund.


Regarding acquisition financing, the risk of phantom income might be managed through hybrid financing where some portion of the acquisition financing to be supplied by the PE fund is represented by an Instrument that is treated as “equity” for US tax purposes, but “debt” for local law purposes.

Local law debt treatment permits an interest deduction in source country.

Coupon is treated as dividend for US tax purposes, which is generally reported when actually or constructively received (cash basis reporting).

Consider how to achieve US “equity” status for local law debt.

What equity features can be added to the Instrument without losing debt status in local country?

Depends on the jurisdiction where acquisition vehicle is formed.

On-lending down the chain should also employ hybrid financing, particularly if the on-lending acquisition vehicle will be taxed as a partnership.

Still need to make sure phantom dividend or other phantom income does not arise.

40

USA (6) – Acquisition Financing: Use of Hybrids


Also need to consider treatment on repatriation (e.g. leveraged recapitalization) -- how is repayment treated?

Repayment of hybrid instruments issued by a partnership should be treated as a distribution by the partnership -- either liquidating or non-liquidating, depending on the facts.

Repayment of hybrid instrument issued by a corporation may give rise to dividend treatment for US tax purposes (even though treated as debt repayment in host country).

41

USA (7) - Acquisition Financing: Use of Hybrids - (cont’d)


USA (8) - BEPS Considerations

As part of its Action Plan 2, the OECD has noted that hybrid arrangements can take various forms --

Hybrid entities: Entities that are treated as transparent for tax purposes in one country and as non-transparent in another country.

Hybrid instruments: Instruments which are treated differently for tax purposes in the countries involved, most prominently as debt in one country and as equity in another country.

Hybrid transfers: Arrangements that are treated as transfer of ownership of an asset for one country’s tax purposes but not for tax purposes of another country, which generally sees a collateralized loan.

The OECD also has observed that tax benefits from hybrid arrangements include the following:

Double deduction schemes: Arrangements where a deduction related to the same contractual obligation is claimed for income tax purposes in two different countries.

Deduction / no inclusion schemes: Arrangements that create a deduction in one country, typically a deduction for interest expenses, but avoid a corresponding inclusion in the taxable income in another country.

Foreign tax credit generators: Arrangements that generate foreign tax credits that arguably would otherwise not be available, at least not to the same extent, or not without more corresponding taxable foreign income.

Examples of hybrid arrangements.

42


USA (9) - “Double Deduction” with Hybrid Entity

Interest

43

Hybrid Entity

B Co

(Target)

Loan

Group tax regime

A Co

The OECD provided the following as an

example of a “double dip” structure.

A Co forms an entity (Hybrid) in the

same jurisdiction as B Co (Target).

Hybrid is disregarded in the A Co

jurisdiction, but is regarded in B Co’s

jurisdiction.

Hybrid incurs debt to finance the

acquisition of Target.

Goal: Interest on debt is deductible in A

Co jurisdiction.

Interest also deductible in B Co

jurisdiction by virtue of fiscal unity with

Hybrid.

In the U.S., the application of the dual

consolidated loss rules would prevent

double dipping in this particular

structure.


USA (10) - Inbound Repo Financing

sale

Assume US Sub 1 (“Sub 1”) owns all of the common

and voting preferred stock of another US corporation,

US Sub 2 (“Sub 2”).

Sub 1 initially sells voting preferred shares of Sub 2 to

NewCo.

Simultaneously Sub 1 agrees to repurchase the

preferred shares at a slightly higher price that

provides ForCo with an interest-like return on its

investment.

Benefits and burdens, and US tax ownership, of

Sub 2 shares remain with Sub 1.

Goal: Treat the transaction as a secured loan for US

tax purposes, but as a “sale” of Sub 2 shares for

foreign tax purposes.

Goal: Obtain participation exemption or other tax relief

for dividends paid by Sub 2.

44

US Sub1

US Sub2

Forward

Repurchase

Preferred

Shares

100%


ForCo (Country x)

USA (11) - Use of Note and Forward Purchase

Agreement

US Sub 1

Assume US Sub 1 (“Sub 1”) owns all of stock of a non-US corporation

(“Sub 2”) and all of the interests in LLC, a disregarded entity for US tax

purposes.

Sub 2 has a need for funding.

LLC borrows from a third party and loans the funds to Sub 2 in exchange

for a note. The note provides for current interest payments in Sub 2 stock

and a single cash payment at maturity.

At the same time, Sub 1 enters into a forward agreement with Sub 2 to buy

Sub 2 stock for cash on the settlement date.

The maturity date and settlement date are the same. The payment terms

on the note and forward also match.

For Country Y purposes, Sub 2 and LLC are treated as separate entities,

and the forward and note are treated as separate instruments. On the

Country Y tax return, Sub 2 claims an interest expense deduction. LLC

has interest income and an offsetting interest expense.

For US tax purposes, Sub 1 and Sub 2 are parties to both the note and

forward contract (LLC is ignored).

Sub 1 has interest expense deduction on the bank loan.

US tax goal is to integrate the note and forward agreement to conclude

that there is, in substance, no obligation to repay principal.

Equity characterization results; § 305(a) tax-free treatment of yield

paid in shares. See GLAM 2006-001.

45

Forward

Agreement

Sub 2 (Country Y)

LLC Cash

Note

German Target

Bank


46

USA (12) - Other Concerns of U.S. Investors in

Non-U.S. Fund

As noted above, partnership treatment is often desirable for U.S. tax purposes.

However, if a partnership’s interests are treated as if they are traded on an established securities market or its equivalent, then the partnership may lose its flow-through treatment and be taxed as a corporation (a “publicly traded partnership”) for U.S. federal income tax purposes.

Avoid problem by prohibiting transfers without GP consent.

Only certain transfers are exempt from PTP. Must monitor and log which transfers are approved because some are measured cumulatively for the year.

Tax filing obligations in non-U.S. jurisdictions.

Non-U.S. withholding tax.

Treaty analysis.


47

Appendix Selected U.S. Rules of Interest


USA (1) - Debt vs. Equity

Generally, whether an instrument will be classified as “debt” or “equity” for US tax purposes depends on the relevant facts and circumstances.

U.S. courts look to a number of factors. No single factor is controlling.

Important “debt” factors include:

A fixed maturity date in the not too distant future.

The presence of creditor’s rights (e.g., acceleration on default, etc.) that may be enforced by the lender.

Repayment is expected to be made in accordance with the terms of the instrument.

Evidence that a third party would have advanced the funds as debt under the same terms.

Significant “equity” factors include:

A long term to maturity (e.g., 30 years or more, and it is helpful if term can be further extended at the sole option of the issuer).

Lack of creditors rights.

Subordination to trade creditors.

Limitation and payment if the debtor is (or would be) rendered insolvent or bankrupt.

Thin capitalization.

Debt is held proportionally with stock.

Debt may be repaid with shares of the issuer.

48


USA (2) - Debt vs. Equity

From the issuer’s perspective, debt may be preferable because interest is deductible, while dividends are not.

From the holder’s perspective “equity” treatment may be preferred, since (subject to certain exceptions for constructive dividends) dividend income is generally reported only when cash is actually or constructively received. Dividend income may also generate FTCs for the holder.

Hybrid instruments may be used to obtain the benefits of debt treatment for the issuer without the disadvantages to the holder.

49


USA (3) - Earnings-Stripping Rules

A current deduction for certain interest paid or accrued by a U.S. corporation to a related foreign person may be denied, where the foreign person is not subject to US tax on such interest, or benefits from a reduced rate of tax under a treaty.

A current deduction may be denied to the extent interest expense exceeds 50% of adjusted taxable income for the year.

However, under a safe harbor, this limitation does not apply if the debt-to-equity ratio is 1.5-to-1 or lower.

This rule is known as the “earnings stripping rule.” It also applies where a related foreign person guarantees a loan made by a third party.

Where the rule applies, the portion of interest expense that is not currently deductible is generally carried forward and tested for deductibility in future years.

Thus, the earnings stripping rule is less onerous than equity treatment, since equity treatment results in a denial of an interest deduction altogether.

50


USA (4) - Dual Consolidated Losses

The dual consolidated loss (DCL) rules operate to limit use of a DCL.

Goal: To prevent double-dipping.

Double dipping occurs where a dual resident corporation (DRC) uses a single economic loss once to offset income subject to US tax (but not foreign tax) and a second time to offset income subject to foreign tax (but not US tax).

Rules also apply to losses attributable to a “separate unit” (e.g., a branch or partnership) of a domestic corporation.

Use of DCL is limited unless the taxpayer demonstrates to the IRS that no “foreign use” of the loss can occur, or a “domestic use” election is made.

51


USA (5) - Foreign Tax Credit Rules

A US person is taxable on its worldwide income, including dividend income and income of CFCs when includible under subpart F (as deemed dividends). Thus, in a cross-border context, double taxation may result because the same income may be taxed both in the source country and in the U.S.

Double taxation of foreign profits is mitigated in the U.S. through the foreign tax credit (“FTC”) system. Subject to certain limitations, a taxpayer may use the FTC to reduce U.S. federal income tax on a dollar-for-dollar basis.

U.S. law allows a taxpayer to take a credit (a “direct” FTC) against its U.S. federal income tax liability for income taxes it is required to, and actually does, pay or accrue to a foreign government.

U.S. law also allows a domestic corporate shareholder to claim a credit (an “indirect” FTC) against U.S. federal income tax for the foreign income tax paid by the foreign subsidiary.

In general, an indirect credit may be claimed with respect to dividend income (including subpart F inclusions in respect of a CFC) from a foreign corporation in which the U.S. corporation owns 10% or more of the voting stock. Interest income does not generate an indirect credit.

Under U.S. law, to claim the credit, the amount of foreign taxes paid by the payor must be included in the shareholder’s gross income (the “gross-up”).

52



The U.S. limits the amount of the foreign tax credit to the same proportion of U.S. tax as foreign source income bears to worldwide income.

The rules are complex, but taxpayers generally must allocate foreign-source income and related income taxes to various categories of income known as “baskets.” For taxable years beginning after December 31, 2006, there are two baskets of income ― passive and general. Foreign taxes allocated (for U.S. purposes) to one category cannot offset U.S. tax otherwise due on income in another category.

The FTC allowable with respect to income in a basket is limited to the U.S. tax otherwise due on worldwide income multiplied by a fraction, the numerator of which is the foreign source income in that basket and the denominator of which is worldwide income (both U.S. source and foreign source) in all categories.

This rule operates to limit the credit in any year to the amount of U.S. tax otherwise payable on foreign-source income. Thus, the effective rate of tax on the foreign-source income of a U.S. taxpayer is the higher of the U.S. or the foreign rate.

Credits in excess of the limitation can be carried back to the previous taxable year and forward to the succeeding ten taxable years.

53



Money is generally treated as fungible -- borrowing will generally free other funds for other

purposes. Thus, under U.S. law, some portion of the U.S. shareholder’s interest expense must be taken into account for U.S. tax purposes in calculating the foreign source income amount in the limiting fraction for the foreign tax credit.

An allocation of interest expense against foreign source income can reduce the overall limitation and, thus, reduce the amount of FTC that may be claimed.

The rules for apportioning interest expense between US and foreign source income are very complex.

Members of a US affiliated group are generally treated as a single domestic corporation, and interest is apportioned among the members based on relative amounts of foreign and US assets.

Under these rules, a US group may wish to borrow at the US parent level and relend to CFCs, rather than borrow directly at the CFC level.

54


USA (8) - Section 956 Limits on Debt Security

A deemed dividend to a US shareholder may arise where the US shareholder incurs debt and its CFC is the lender, or provides credit support for the debt.

Credit support may be direct or indirect.

Credit support arises where the CFC pledges its assets or provides a guaranty in support of the US shareholder’s debt.

Credit support also arises if more than two-thirds of the voting stock of the CFC is pledged to secure the debt.

If this rule applies, the US shareholder is taxed on an amount equal to the lesser of the CFC’s earnings and profits or the outstanding principal amount of the debt.

55


Attachment IV: UK (Jonathan S. Schwarz) UK Resident Investors’ Preferences: Corporate

Financing Interest generally deductible

Income stream Dividends exempt

Interest taxable

Rental income taxable

Disposal Shares of Luxco/Propco taxable (unless trading when substantial

shareholding exemption may apply)

Rental property taxable

Preferences Shares in Luxco/Propco

56

Attachment IV: UK (Jonathan S. Schwarz) UK Resident Investors Preferences: Pension Scheme

Financing cost Non-deductible (except cost of earning rental income)

Income stream Dividends exempt Interest exempt Rental income exempt Profit on trade in real estate taxable

Disposal Shares in fundcos or propcos exempt Rental property exempt

Preferences Debt where interest deductible by GerFund or Luxco/PropCo Dividends where UK-DE Treaty exempts (Art Corporate vehicle (LuxCo/PropCo to minimise real estate trade

risk)

57

Attachment IV: UK (Jonathan S. Schwarz) UK Resident Investors Preferences: Individual

Financing Interest only deductible to earn rental income

Income stream Dividends taxable Interest taxable

Rental income taxable

Disposal Shares of Luxco/Propco taxable Rental property taxable

Preferences Transparent to minimise corporate/shareholder double taxation Shares in Luxo to facilitate change in portfolio without disposal Non-domiciled residents flexibility of vehicle

Problems

Differences in amortisation of capital expenditure between UK and DE results in mismatching profits.

Anti-deferral regimes unless no tax avoidance purpose

58

Attachment V: Action 6 BEPS (Albert Collado) Table of contents

1.Action 6 BEPS: Preventing Treaty Abuse

2.EU considerations

3.Cross-border funds 'investments – a Spanish perspective

Annex I: Recent Court Cases on Anti-abuse of the P/S Directive in Spain.

59

Attachment V: Action 6 BEPS (Albert Collado) Preventing Treaty Abuse

Precedent work: The OECD 2010 report “The granting of Treaty Benefits with Respect to the Income of CIV” and subsequent Commentaries to MCOCDE

Scope of the report: widely-held funds (CIV), including “master” and “feeder” funds that are part of “funds of funds”.

The function of CIV as an investor´s pooling vehicle, seeking economic efficiency and other advantages (risk diversification, professional management, liquidity, etcetera).

Is CIV a person, a resident of a Contracting State, a beneficial owner?

The principle of “tax neutrality”

Recommendation to clarify treatment into Tax Treaties (i.e. Germany-Ireland DTT defines tax treatment of Irish UCITS and Common Contractual Funds (CCFs).

60


Action 6: Working timetable:

Report finalized in June, presented to G20 on 16 September 2014

Follow-up work on BEPS Action 6: Public discussion draft issued 21 November 2014.

Comments on discussion draft published January 12 and OECD public consultation meeting: January 22.

New draft expected March 2015.

Final delivery deadline: September 2015

61


Action 6 called for work to be done to:

Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.

Clarify that DTT are not intended to be used to generate double non-taxation.

Identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country.

Proposed measures:

A General Anti-Abuse Rule (GAAR)

Limitation on Benefits (LOB) provisions

Specific Anti-Abuse Rules (dividend holding period, dual resident companies, immovable property companies, etcetera).

Clarification in the preamble that DTT are not intended to be used to generate double non-taxation.

62


A General Anti-Abuse Rule: the Principal Purpose Test (PPT)

Guiding principle: current 9.5 Commentary (main purpose test)

The PPT rule:

“If a resident of a Contracting State is neither a qualified person pursuant provisions of paragraph 2 nor entitled to benefits with respect to an item of income under paragraph 3 of this Article, the competent authority of the other contracting State shall nevertheless treat that resident as being entitled to the benefits of this Convention, or benefits with respect to a specific item of income, if such competent authority determines that the establishment, acquisition or maintenance of such person and the conduct of its operations did not have as one of its principal purposes the obtaining of benefits under this Convention.”

63


The New LOB provisions

U.S. Model

Definition of “qualified person” for the purposes of application of the Treaty. Examples:

An individual resident in the other Contracting State.

A company engaged in an active conduct of business, other than the business of managing investments for the resident´s own account, unless these activities are banking, insurance or securities activities carried out by a bank, insurance company or securities dealer.

Companies that are at least 50% owned by residents of the same State and satisfy 50% base erosion test

Certain publicly-listed companies.

Charitable organizations and pension funds.

[Certain Collective Investment Vehicles] to be developed.

64


The New LOB provisions (cont)

Optional derivative benefits clause:

At least 95% of the aggregate voting power and value of the shares is owned, directly or indirectly, by seven or fewer persons that are equivalent beneficiaries; and

Less than 50% of the company´s gross income, as determined in the company´s State of residence, for the taxable year is paid or accrued, directly or indirectly, to persons who are not equivalent beneficiaries, in the for of payments that are deductible for the purposes of the taxes covered by this Convention in the company´s State of residence.

65


Comments on Follow-up Work (January 12, 2015) – IBA Working Group comments:

General comment: CIV and non-CIV fund structures are aimed at achieving tax neutrality: granting to investors the same tax treatment that would have applied had they directly invested.

LOB provisions:

CIV (widely held):

They should be considered “qualified person” for LOB provisions, as CIVs are not typically established to obtain benefits of the treaties.

The discretionary relief provision is not a predictable outcome. The group of persons / entities potentially qualifying for the benefit of the treaty is too narrow.

LOB provisions will hinder the development of cross-border international funds:

o More administrative burden (impossible to follow a look-through approach).

o EU compatibility? The position of the EU Commission.

Intermediate vehicles used by CIV should follow CIV treatment provided they are controlled by CIV.

66

Attachment V: Action 6 BEPS (Albert Collado) Preventing Treaty Abuse Comments on Follow-up Work (January 12, 2015) – IBA Working

Group (cont.):

LOB provisions (cont):

Alternative funds / private equity funds:

If widely held, follows CIV approach.

If closely held, proposal to treat the fund as “qualified investor” provided that at a certain date (i) it is owned for at least 50% by investors which will be entitled to treaty benefits if they had invested directly in the source country (“equivalent beneficiary concept”) and (ii) at least 50% of the fund profits are paid or accrued to such investors.

PPT rule

Need to adapt the rule to be applicable in situations of actual Treaty abuse and never for an entity that has substance.

The use of conduit companies is not necessarily tax driven (pay attention to other factors – limitation of responsibility of the fund, facilitating co-investment strategies, facilitating external financing, investment protection, centralizing holding and administrative functions, etcetera).

67

Attachment V: (Albert Collado) EU considerations

Withholding tax refunds for CIVs

Freedom of movement of capital and CIVs.

ECJ cases provide for non discrimination between tax treatment in connection with withholding tax refunds for foreign CIVs compared to domestic CIVs:

Aberdeen Property Fininvest Alpha Oy (C-303/07), June 18, 2009 provides for same treatment in case of a Luxembourg SICAV vs. a domestic Finish CIV.

Santander Asset Management SGIIC SA (joined cases D-338/11 to C-347/11), May 10, 2012 and Emerging Markets Series of DFA Investment Trust Company (C-190/12), April 10, 2014 provides for same treatment of foreign funds (third countries) vs. EU funds in a comparable situation and restriction is not capable of being justified by reasons of public interest (based on tax treaty exchange of information).

68

Attachment V: (Albert Collado) EU considerations

New GAAR P/S Directive (Council Directive (EU) 2015/121 of 27 January 2015):

“2. Member States shall not grant the benefits of this Directive to an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part.

3. For the purposes of paragraph 2, an arrangement or a series of arrangements shall be regarded as not genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality.

4. This Directive shall not preclude the application of domestic or agreement-based provisions required for the prevention of tax evasion, tax fraud or abuse.”

C-196/04 - Cadbury Schweppes and Cadbury Schweppes Overseas ECJ case and new anti-abuse rule.

Recommendation of EU (December 2012) on Aggressive Tax Planning. Introduction of a common GAAR.

28 November 2014 join letter of the finance ministers of France, Germany and Italy to EU tax Commissioner Pierre Moscovici, asking the Commission to propose a comprehensive EU Directive to counter BEPS.

69

Attachment V: Spain (Albert Collado)

Cross-border funds’ investments and tax audits in Spain

Focus on base erosion derived from debt push downs:

The beneficial ownership approach.

Spanish domestic GAAR approach.

Extensive application of anti-abuse rule on P/S directive on dividends

Future trends:

PE issues derived from managing activities in Spain (debt collection – distressed investments- and investment management).

Spanish domestic GAAR approach (art. 15 LGT – fraus legis- and art. 16 LGT – sham transaction).

BEPS Action 6

70

Attachment V: Spain (Albert Collado) Use of intermediate Spanish sub-holding (new 2015)

Issues to consider:

Dividends exempt under P/S Directive

Business reasons behind existence of Dutch parent / substance.

Limitations on deductibility of interest / anti-hybrids.

Capital gain exempt if divestiture at Spain SPV level (new 2015)

Limitations on deductibility of interest / anti-hybrids:

30% EBIDTA

Target Co’s EBIDTA not included during 4 years, subject to specific safe harbor rules.

Substance at Spanish SPV

Luxembourg

Spain

Target Co 2

Spain

Non-EU

Lux Co

(1 or 2 tier)

Dividend

Capital gain

SPV

Spain

PE

fund

Loan

Fiscal Unity

Target Co 1

Spain

Target Co 3

Spain

71

Attachment V: Spain (Albert Collado) Use of partnerships or direct investment in club deals

Issues to consider:

Flexible structure to directly invest in Target Co. (qualifying investors) or through intermediate structures:

To avoid potential treaty-shopping issues.

To ensure intermediate taxes are credited by investors in their respective jurisdictions.

To allow controlling power by general partner. Target Co

Spain

Partnership

Lux Co

Spanish

investors

EU / DTT /

Pension

Funds

Other

investors

72

Attachment V: Spain (Albert Collado) RECENT COURT CASES ON ANTI-ABUSE: P/S DIRECTIVE

73

1.- Parent-Subsidiary Directive and court cases on anti-abuse situations

Background information: anti-abuse clause included in the Spanish rule transposing the PSD.

Exemption from withholding tax is denied if the parent is controlled (directly or indirectly) by natural or legal persons with their tax residence outside the EU.

Unless: Parent performs an economic activity which is related

with the Spanish subsidiary’s activity; or

Parent’s activity consists in the direction and management of the subsidiary, with the corresponding human and material means; or

Parent’s incorporation responds to valid economic reasons different from the enjoyment of the PSD benefits.

74

2.- Aromatics cases (Supreme Court 4 April 2012, 21 March 2012 and 22 March 2012)

Spanish sub pays dividends to EU parent (tax resident in NL) with non-EU controlling shareholders.

Parent’s seat had been transferred from another jurisdiction (Bermuda).

Court’s view: none of the three exceptions to the application of the anti-abuse clause was applicable. No relation between activities of parent and

sub. Parent performed an activity consisting on

providing R&D support to its sub, which was engaged in a manufacturing activity.

Subsidiary was not managed by the Dutch parent. Parent had employees but no evidence of

services rendered (no management fees charge).

Transfer of holding’s seat to the Netherlands: main purpose was enjoying the benefits of the PSD No analysis of commercial and business

arguments posed by the taxpayer.

Non-EU

NL

Spain

Bermuda

dividend

NON-EU

CO

NL CO

SPANISH

CO

75

3.- Pilbrico case (TSJ Asturias 11 April 2011)

Spanish resident company distributes a dividend to its EU parent (resident in Luxembourg), which is controlled by non-EU residents.

Court’s view: same reasoning as in Aromatics: None of the three exceptions to

the anti-avoidance rule was applicable: Parent company had no

economic activity

No daily and constant involvement in the subsidiary’s management

No valid economic reasons for its settlement in Luxembourg, beyond the enjoyment of the PSD

Non-EU

Lux

Spain

USA

dividend

NON-EU

CO

LUX CO

SPAIN CO

76

4.- RHI Cases (Central Economic-Administrative Court –TEAC- 14 June 2007 and National Appellate Court 25 November 2010)

Spanish company distributes a dividend to EU parent, (NL resident). Ultimate controlling shareholders of NL parent cannot be identified because top tier corporate shareholder is an Austrian listed company.

TEAC considered that the anti-avoidance clause made no exceptions for listed companies and thus, PSD benefits could not apply if ultimate owners could not be identified as EU tax residents.

National Court revoked the previous decision. Conclusion: application of the anti-abuse rule should be restrictive (cases where there was an evidence of an abusive conduct but not as a general rule). Dutch company was held by several layers of

(active) EU resident companies. Therefore, the establishment in NL did not seem to respond to a fraudulent intention.

The anti-abuse provision should not be applied.

Germany

NL

Spain

dividend

Austria

LISTED

AUT CO

EU or

non-

EU?

NON-EU EU

GERMAN

CO

NL CO

SPAIN CO

77

5.- Conclusions

Very restrictive approach by tax authorities (narrowing the scope of the PSD to a considerable extent).

Holding parent companies: Active involvement in the management of the subsidiary’s

activity (not of the holding’s participation) is required.

New wording of the anti-abuse clause applicable as from 2015: Exemption from withholding will not apply if controlling

shareholder is not an EU/EEA resident, unless the incorporation and activity of the subsidiary responds to valid economic and business reasons (VBR).

Compatibility with EU Directive (current and prospective wording)

78

new challenges in obtaining interest deduction and in ... · or hybrid financing . beps initiatives...

Documents