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The Netherlands: The impact of BEPS on private equity

On March 14 2014, the OECD released a discussion draft on treaty abuse under its Action Plan on Base Erosion and Profit Shifting (BEPS). Marc Sanders of Taxand provides guidance on the BEPS project’s impact on the private equity sector.

BEPS is a reaction to the discussion in politics and the press on perceived treaty abuse by multinationals. The intention is that in September 2014 final proposals will be published on the various BEPS actions.

The document contains proposed tax treaty provisions and related commentary together with proposed domestic law provisions to address potential treaty abuse. The recommendations include incorporating in tax treaties both a specific anti-abuse rule limitations on benefits (LOB) similarly found in US tax treaties and a general anti-abuse rule similar to the main purpose test found in UK tax treaties.

The tax profile of private equity

Investors into private equity funds are typically pension funds, family offices, insurance companies, banks, sovereign wealth funds, not-for-profit organisations, educational endowment funds, charities, and other investment funds in a broad range of jurisdictions. Many of these investors can, in general, benefit from tax treaties in their jurisdictions of residence. From a tax perspective, it is therefore important that the structure of the fund is tax neutral for the investors. The pooling of the investments through the fund entity should not trigger additional tax for investors when compared with a situation in which the investors would have invested directly.

Private equity funds typically invest in companies in multiple jurisdictions, to diversify risk and maximise investment opportunities. It is therefore critical to private equity funds that they can operate effectively cross-border and tax is not a barrier to invest into another country. The funds use holding companies to avoid any double taxation.

Holding companies are also necessary for private equity funds for reasons other than tax such as being able to structure the acquisition of a target through an appropriate legal system, obtaining financing for the acquisition and implementing a suitable management structure.

BEPS is largely focused on multinationals. However, private equity operates very differently from multinationals. Many of the issues the private equity industry faces with the proposed changes are because the document does not (yet) consider the position of collective investment vehicles (CIVs). It is clear from previous OECD publications that the OECD is aware of the particular challenges faced by CIVs in relation to treaties. During a webcast by the OECD on May 26 it was stated that the tax position of CIVs should be taken into account but no details were provided.

Limitation on benefits rule

One of the proposed measures is that all tax treaties should include a LOB rule. The origin of this rule stems from tax treaties concluded by the US. To benefit from a treaty, a qualifying person should meet one of several detailed tests under the LOB rule such as the stock exchange test or the active trade or business test. Experience shows that the LOB rule is often a very complex and detailed rule that creates a significant burden on taxpayers. The specifics of the LOB rule are such that we could have filled this edition easily with further details. The fact is that the LOB test includes many subjective and complicated definitions which are left open for interpretation by tax administrations in each jurisdiction. This can only lead to increased uncertainty for private equity funds.

Furthermore many private equity investment funds, their holding companies and even the companies they invest in may not meet the LOB test because:

  • the fund, their holding companies and investee companies will not be listed on a stock exchange and will therefore not meet the stock exchange test;

  • neither the fund nor the holding companies will in general be treated as carrying on an active trade or business under the definition of the current LOB test; and

  • the derivative benefits test proposed is very narrow. Given that many private equity funds raise funds from a broad range of jurisdictions, it will rarely be the case that 50% or more of the investors in the fund are resident in the same jurisdiction as the fund or holding company. From a practical perspective it is also important to note that it will be very difficult to establish the treaty status of the investors in the fund. Even where the ultimate beneficiaries can be identified, it will often not be possible for the fund to establish their treaty status.

Therefore there is a good chance that the fund and its holding companies cannot benefit from treaty benefits if a LOB rule is included in tax treaties as now proposed by the OECD. It is likely that all investors would, however, qualify for treaty benefits if the investors in the private equity fund would have invested directly. This demonstrates that the proposed LOB rule affects many CIVs and their holding companies. Furthermore the LOB test will create a significant additional administrative burden on the funds to review whether they and their holding companies can qualify

For a number of reasons, private equity funds frequently use (holding) companies in locations such as Luxembourg or the Netherlands. An analysis of the LOB provisions applied to these types of structures shows that limiting access to a treaty primarily by reference to the various LOB tests poses particular challenges for businesses based in small open economies. Most private equity owned companies that operate in these countries, for example, have foreign owners and draw upon foreign sources of finance. This will make it more difficult to qualify under the LOB test.

During the May 26 webcast the OECD said it will provide some flexibility for countries to implement the LOB rule as they see fit. No details are available at the moment, however. Although flexibility is welcome it may also create further complications if countries implement the LOB rule differently.

Main purpose test

Also included in the draft proposals is the inclusion of a general anti-abuse rule (main purpose test) designed to address other forms of treaty abuse that would not be covered by the LOB provision. The test is whether it is "reasonable to conclude" that obtaining a treaty benefit was one of the main purposes of the arrangement or transaction.

The LOB test and the main purpose test are not presented as being mutually exclusive. It is proposed that the LOB measures would have primary effect in limiting the potential for inappropriate use of the treaty but that the additional main purpose test could have effect even if a taxpayer met the tests for treaty entitlement set out in the LOB provisions.

The challenge of the main purpose test is that it is subjective and that tax administrations in different jurisdictions can form a different view on the interpretation of the provisions and the implemented structure. The potential to fail this test is relatively high because the test is very broad. For private equity funds it is also more difficult to establish the aims and purposes of all the investors in the fund. This will therefore also lead to increased uncertainty for a private equity fund and its holding companies.

Conclusions on the proposed LOB and main purpose test

The inclusion of a LOB and main purpose test will create additional uncertainty and administrative burden for multinational companies and especially private equity funds. At the moment it is not clear how the final proposals of the OECD will look and whether these proposals will be implemented at all. The OECD does however seem to pursue the direction in the draft document. Hopefully the OECD will reconsider the tax position of CIVs, take the significant criticism on the proposals into account and provide detailed commentary on the new rules. This may eliminate some of the burden for the private equity industry.

Other developments

A lot of companies and private equity funds are facing questions from tax administrations on their tax structures and especially the substance of their structures. The tax administrations increasingly demand economic rationale behind international tax planning structures. Recent high profile court cases in a number of countries are a result of this increased scrutiny. We refer, for example, to the recent court cases in Denmark on beneficial ownership and the Vodafone case in India.

The developments on the definition of beneficial ownership are also important, as are the continuing discussions in the EU on tax planning and potential changes to the EU parent-subsidiary directive. A number of countries have already implemented local anti-abuse rules which sometimes override tax treaties. An example is the German rules on foreign holding companies. Although the proposals by the OECD get the most attention, the proposals at EU level or local anti-abuse rules may be implemented quicker and with more effect, particularly if the OECD fails to achieve agreement on the various proposals.

Actions private equity firms can take

These different developments in recent years have resulted in a new environment where private equity structures should be implemented with sufficient substance and business purposes. Private equity funds therefore need to adapt to the new environment and reconsider their standard structures.

A cookie cutter approach should not (or no longer) be taken, especially considering the fast changing rules. The necessary substance in the structure should be tailored to the business strategy and the tax requirements of the source jurisdiction and the treaty. Fund managers should perform a cost/benefit analysis on establishing the necessary substance at a holding company. An empty letter box company in a tax haven may seem a cost efficient solution but often proves costly in the long term.

Setting up or maintaining holding or finance companies in a jurisdiction without proper allocation of substance (functions, risks, employees, decision-making powers and assets) should be avoided. This should, however, not prevent companies from engaging in tax planning strategies. Tax planning will remain possible as long as countries compete to attract investments through beneficial tax regimes. The tax planning strategy should, however, be aligned with the business strategy of the company/fund and sufficient substance should be present.

Actions that private equity funds are taking are, for example, that they no longer use a separate acquisition/holding company for each acquisition (often in different jurisdictions) but use a very limited number of holding companies in a single jurisdiction. These holding companies do have sufficient substance including relevant employees and resident managers/directors.

A number of private equity funds are also on-shoring their funds from typical offshore locations such as Bermuda, BVI and Jersey to onshore locations such as Luxembourg and the Netherlands. The tax and legal benefits found in offshore locations are often also available in onshore locations due to specific tax and legal regimes. The main benefit of having the fund, management and holding companies in a single onshore location is that it is much easier to have sufficient substance and business purposes for the structuring through that location. Centralising the location of the fund, management company and/or holding companies will also create cost efficiencies. Jurisdictions that can be considered in this regard should have a proper infrastructure (workforce, transportation, advisers and an attractive and cost efficient living environment), a stable economy and political climate, an attractive tax regime and a large treaty network.

Overall private equity managers and their tax advisers should take these developments into account when designing and evaluating their structures. Burying one's head in the sand and relying on structures that worked 10 years ago may result in unwelcome attention from the tax administrations.



Marc Sanders


Tel: +31 20 435 6400

Marc Sanders is a partner at Taxand Netherlands and specialises in M&A transactions and international taxation. Clients include private equity funds and multinationals. Marc frequently works on (vendor) due diligence projects and tax structuring for M&A deals.

Marc graduated in Tax Law from the University of Amsterdam in 1999 and joined Deloitte on Aruba in the Caribbean. In 2000 he joined the International Tax department of Arthur Andersen in Amsterdam where he worked in the Technology, Media & Telecom team with a focus on international corporate income tax planning.

During 2002-2003 Marc was seconded to a major European cable company, where he was the interim tax manager for the content division. Marc worked at the Dutch desk of Deloitte in New York in 2006/2008 where he assisted US clients with tax planning and M&A advice.

As of 2009 Marc has been a partner at Taxand Netherlands, the only independent Dutch tax firm with global coverage.

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