Joint Letter to OECD on BEPS Tax Treaties Action Plan
Re: Unintended Consequences of the BEPS project on Private Equity and Venture Capital
Date: November 8, 2016
On September 21-22, 2016 the venture capital and private equity industry associations from around the world met in Vancouver, British Columbia, Canada for the sixth annual Global Venture Capital Congress (GVCC). The GVCC represents industry stakeholders on six continents and we estimate that together we cover more than 80% of the global venture capital and private equity industry by assets under management.
A prominent topic at the Congress was a collective concern regarding unintended consequences for the global venture capital and private equity industry from the OECD’s Base Erosion and Profit Shifting (BEPS) project. While our delegations welcome the work that is being undertaken to tackle tax avoidance and evasion that exploit gaps and mismatches in tax rules, we share significant apprehension on the potential policy responses being discussed as part of Action 6 on “Preventing Treaty Abuse in Inappropriate Circumstances.” The potential solutions being consulted on as part of Action 6 include some that would not be appropriate for the industry given its characteristics, and would be disproportionate given the very low risk of treaty abuse inherent in our industry. If the OECD’s proposals are implemented as currently proposed, it would severely impact the ability of venture capital and private equity funds to raise money from investors and invest in companies internationally. It is critical to venture capital and private equity funds that they can operate effectively cross-border and continue to contribute to global economic growth.
It is important for the OECD to recognize the following:
Private equity and venture capital funds by their very nature are unlikely to be used as vehicles for tax avoidance and deferral. Existing regulatory frameworks (i.e., those that require a fund manager to be regulated) and due diligence procedures (such as the requirements under CRS and FATCA) demonstrate that the private equity funds model presents a very low risk of treaty abuse. Secondly, deferring distributions would negatively impact the fund’s internal rate of return, a common measure of performance for the private equity industry. There is a commercial incentive to distribute to investors as soon as practical the amounts received from realised investments rather than defer income. In addition, proceeds received by a fund or a subsidiary holding company in connection with a disposition of an investment generally are required to be distributed promptly to investors in any event. These funds do not provide the opportunity for taxable investors to defer tax.
The OECD’s current proposals to allow venture capital and private equity funds and their investors to receive the treaty benefits to which they are entitled are unworkable. Specifically, the Limitation On Benefits (“LOB”) provision calls for a number of objective tests which many private equity and venture capital funds (and any holding company owned by the funds) may not meet – not because their investors are not entitled to such treaty benefits – but because of the inherent nature of such funds with investors and holding companies being located in different jurisdictions. Additional solutions are needed under the LOB provision. These solutions need to be appropriate for the industry and not lead to either double taxation nor a significant compliance burden for our investors (many of which are non-taxable entities like state pension plans, sovereign wealth funds, development finance institutions, charitable foundations and university endowments) and fund managers. They also need to ensure that an investor that invests through a fund structure is left in the same position economically as if they had invested directly into an asset.
It is apparent that the private equity and venture capital industry is not the intended target of these rules, but measures that are designed for other structures risk negatively impacting the global transactional nature of our industry. Implementing the Action 6 proposals as currently drafted could cause investors in venture capital and private equity funds to be subject to taxation which is not consistent with their substantive treaty position, with the process for investors to claim their entitled treaty benefits being cumbersome and laborious. The proposals will reduce returns to investors by subjecting them to double (or undue) taxation, making the asset class overall less attractive. In turn, this is likely to reduce the pool of capital available for business investment.
We urge the OECD to consider adopting provisions acknowledging the existing regulatory framework within the venture capital and private equity industry as adequate and exempt fund managers from unnecessary compliance burdens that reduce the attractiveness of the funds industry for investors.
Thank you for your consideration.