PwC On Private Equity Deals In The New International Tax Environment

Doing Private Equity Deals In The New International Tax Environment: What PE Deal Teams Need To Know
By: PwC

The changing tax landscape has created a plethora of tax risks and opportunities that can…

Doing Private Equity Deals In The New International Tax Environment: What PE Deal Teams Need To Know

By: PwC

The changing tax landscape has created a plethora of tax risks and opportunities that can have a material impact on deal valuations. The international tax landscape is on the cusp of a significant change, spearheaded by the OECD-led Base Erosion and Profit Shifting (“BEPS”) project. Whilst the private equity (“PE”) industry is not the primary focus of the BEPS initiative, it will be impacted by these developments and in some cases may suffer from unintended consequences.

Like the American Investment Council, PwC is actively advocating on behalf of the PE industry by submitting comment papers and recommendations to the OECD addressing the BEPS proposals. Although not all proposals have been finalized, what is clear is that these changes will impact the pricing, valuation and risk profile of existing and future transactions. That said, there are still opportunities on the horizon as those fund managers best equipped to navigate the shifting landscape and myriad changes will enjoy a natural competitive advantage over those who are more reactionary.

While it may take considerably longer for the full impact of these changes to materialize in practice, there are indications that the BEPS project and related developments are already leading to a material shift in the behavior of tax authorities. In addition to the changing behavior of global tax authorities, we are seeing real legislative change, inspired in some cases by the BEPS proposals, such as the introduction of the diverted profits tax in the UK in its 2015 Finance Bill, anti-hybrid rules, and more recently, the EU Member States’ political agreement on the Anti-Tax Avoidance Directive (“ATAD”) which is due to become effective in the Member States in 2019, to name a few. This shift will impact all aspects of the deal, including how deals are sourced, how they are structured, the related compliance, and ultimately the internal rate of return (“IRR”) of the transaction. In short, BEPS will have implications which are much broader than just tax.

Tax planning within a PE fund that was effective when investments were initially structured may no longer deliver the intended results. To the extent an exposure crystallizes, this could adversely impact the investors, future management fees and returns/carry earned by the PE fund’s GP, not to mention the reputational impact for the PE manager, an outcome which could have broader consequences.

There will also be greater challenges in determining the correct effective tax rate for a portfolio company to be included in the deal model as a result of BEPS. PE managers eager to protect their investments should look to engage with their multi-national portfolio companies to help them to navigate the greater risk and uncertainty in a post-BEPS world. Further, PE managers should be aware that there may potentially be a greater risk of unrecorded liabilities in target companies as a result of potential future BEPS related challenges.

The key BEPS actions which are relevant for the PE managers are related to Hybrid Mismatch Arrangements (Action 2), Interest Deductibility (Action 4), Treaty Abuse (Action 6), and Permanent Establishment (Action 7).  There will be significant changes in each of these areas.

For example, hybrid arrangements, addressed in Action 2, are often utilized in the PE industry.  These may include CPEC (convertible preferred equity certificates) and PEC (preferred equity certificates) arrangements which are often utilized when structuring through Luxembourg as well as entities treated as partnerships in certain jurisdictions but corporations in others. Additionally, certain jurisdictions have already enacted legislation in line with Action 2 (e.g. the U.K.), which could potentially impact elections under the U.S. ‘Check the Box’ regime. PE managers should evaluate and in some cases restructure current hybrid arrangements to mitigate the risk of incremental tax leakage within their fund structures.

Further, double tax treaties, covered by Action 6, play an important role in PE fund structures as they preserve tax neutrality for investors who themselves would often be entitled to treaty benefits. The revised treaty anti-abuse rules address treaty shopping, which involves strategies through which a person that is not a resident of a particular country attempts to obtain the benefits of a tax treaty concluded by that country. More targeted rules have been designed to address other forms of treaty abuse by adding to the OECD Model Tax Convention provisions such as a Limitation on Benefits clause and/or a Principal Purpose Test. The OECD perceives double tax treaties to be a significant source of double non taxation – by the multinational companies –  and the changes proposed could result in denial of tax treaty benefits for fund structures materially impacting the tax cost of future exits or distributions.

For each of these initiatives, PE funds will need to carefully consider their acquisition structures for potential current and future exposures and plan for a future in which governments are more coordinated and aggressive in challenging investment structures historically employed by PE managers.

Key Takeaways For Deal Teams

  • Assess BEPS impact on transaction risk, structures, and deal value
  • Build sustainable structures by focusing on operational substance
  • Effectively manage potential tax leakage in transaction models
  • Avoid reputational risk by being on top of these developments
  • Elevate tax matters during transaction


Authors: Oscar Teunissen, Global International Tax Asset Management Leader, PwC; Thomas Groenen, Principal, International Tax Asset Management, PwC; Danny Stolp, Principal International Tax Asset Management, PwC; Keith Clarke, Director, International Tax Asset Management, PwC

PwC is a Tier-Two Associate Member of the American Investment Council

The opinions expressed in this article do not necessarily reflect the views of the American Investment Council