Current Issues in Inbound & Outbound Collective … PPTS/8...2017 IFA International Tax Conference Presentation Title 3 1. U.S. Tax Reform -Structuring Acquisitions by Private Equity

Tuesday April 25 & Wednesday April 26 Metro Toronto Convention Centre

Current Issues in Inbound & Outbound Collective

Investment Funds InvestingPanelists

Raffaele Gargiulo – Van Campen Liem (Luxembourg)

John Lorito – Stikeman Elliott LLP (Toronto)

Ron G. Nardini – Akin Gump Strauss Hauer & Feld LLP (New York)

Paul Stepak – Blake, Cassels & Graydon LLP (Toronto)

Moderator: Jack Bernstein, Aird & Berlis LLP (Toronto)YIN Rapporteur: Saam Nainifard, Aird & Berlis LLP (Toronto)

2017 IFA International Tax Conference

Presentation Title

I. Current Tax Challenges for Global Collective Investing1. U.S. developments2. EU global developments

II. Case Study #1

III. Case Study #2

IV. Appendices1. Impact of Anti-Tax Avoidance Directives (ATADs) on Private

Equity Funds2. Impact of UK Brexit on Private Equity Funds3. Impact of new Luxembourg TP rules to Private Equity Funds

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Index

Index


Presentation Title

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1. U.S. Tax Reform - Structuring Acquisitions by Private Equity Funds- Volatility and Uncertainty

I. Current Tax Challenges for Global Collective Investing

o It is likely that U.S. tax reform will have significant impact on the structures usedby private equity funds to purchase, own and/or operate target businesses andon the methods used to value such businesses

o These considerations may need to be taken into account in potentialtransactions in the face of significant uncertainty in the next 18 months (seepotential timelines below) and potential transition rules

o It is expected that many transactions will be on hold until the tax and regulatoryenvironments become clearer


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o Lower corporate tax rates (20% under the U.S. Congress plan and 15%under the Trump plan) and elimination of the corporate AMT are likely tohave the effect of: Impacting pricing of transactions Reducing relative tax benefits of pass-through structures (such as

MLPs) and REITs/RICs (which have significant administrative costs)


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o Elimination of net interest deductions are likely to have the effect of: Reducing the attractiveness of debt financing (including leveraged

blockers) Creating disadvantages for private equity funds that typically use

leverage to fund acquisitions


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o Immediate deduction for capital expenditures (investments in intangibleand tangible assets, other than land) may have the effect of: Significantly increasing in the attractiveness of asset deals Incentivizing the making of serial acquisitions in order to defer tax

o The Destination-Based Cash Flow Tax may have the effect of: Disqualifying U.S. residents from qualifying for the benefits of the

U.S. income tax treaty network Significantly devaluing investments by U.S. persons holding foreign-

currency denominated assets Potentially breaching WTO law Applying differently to different industries, creating winners and

losers (exporters vs importers)


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o One-Time repatriation of foreign profits (with a U.S. tax charge) may havethe effect of: Facilitating additional purchasing activities by enhancing U.S.

multinationals’ access to their foreign cash (although such cash canalso be used for distributions instead)

Creating significant competition for bargain purchases


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o Trump repeatedly promised to eliminate the preferential tax treatment ofcarried interest Some suggest replacing existing carried structure otherwise

applicable to foreign feeders with contingent management fee andtaking the position such income is income from the export ofservices and thus exempt from U.S. tax

Investors to consider potential effect on return from fund, as carriedinterest is an effective deduction against U.S. source incomeotherwise subject to withholding tax on a gross basis—as opposedto management fee which does not provide for a deduction

1. U.S. Tax Reform - Structuring Acquisitions by Private Equity Funds- Carried Interest Alternatives


Presentation Title

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U.S. Feeder

Foreign Feeder

Master Fund Manager

Management agreement

Performance Fee

Management AgreementManagement Fee

GP

Carried Interest

1. U.S. Tax Reform - Structuring Acquisitions by Private Equity Funds- Carried Interest Alternatives


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1. U.S. Tax Reform - Timing of Tax Reform


o The chance that comprehensive tax reform will be enacted retroactive to January 1, 2017, has gonedown The effective dates and transition rules for specific tax reform provisions will be decided de novo by the

current Congress and its tax committees. Precedents and determinations by prior Congresses are in noway binding on the current Congress or tax committees.

Favorable corporate tax rate changes associated with fundamental tax reform not enacted until Augustwould likely be implemented prospectively starting in 2018, and those changes might be phased in overa number of years. This would also likely apply to taxes on imports associated with a border adjustmentmechanism.

Several caveats to the previous point: The first is that a retroactive change in rates (even if associatedwith fundamental tax reform) would become more likely if we happened to experience a recession overthe next 6 months and tax reform became part of a broader economic stimulus plan. There is also agreater chance that provisions impacting a sale or purchase of specific types of assets (as opposed toa broader change in tax rates) could have retroactive effect to the date the provisions were firstproposed in a bill or reported out of committee.

Retroactive rate reductions would also be more likely if the effort to effect fundamental change isabandoned, and a simpler bill involving rate reductions and mild base broadening is enacted. Even inthis context, it would be unusual to have a retroactive rate reduction if enactment is delayed untilAugust or the fall. The chance of a retroactive rate reduction back to January 1, 2017, would increase iftax reform is enacted earlier than August or is part of a stimulus package.

Significant base broadening provisions in either fundamental tax reform or a lighter tax bill would likelybe phased in over several years and are usually accompanied by beneficial transition rules


Presentation Title

o The Council Directive 2016/1164 of July 12, 2016 (“ATAD”) and the amending Directive datedFebruary 12, 2017 (“ATAD 2”) aims at laying down rules against tax avoidance practice thatdirectly affect the functioning of the internal market. They also aim at implementing, at theEU level, base erosion and profit shifting (“BEPS”) recommendations made by theOECD/G20.

o The Directive covers all taxpayers which are subject to corporate income tax in one or moreEU Member States (“MS”) including permanent establishments in one or more MS ofentities resident for tax purposes in a third country

o The ATAD introduces some measures in five specific fields:

The interest limitation rule (article 4);

Exit taxation (article 5);

General anti-abuse rule (“GAAR”) (article 6);

Controlled foreign company rules (“CFC”) (articles 7 and 8); and

Hybrid mismatches (article 9).

o MS have to implement the ATAD Directives no later than January 1, 2019

o “Exit taxation” rule may be implemented until January 1, 2020 and the implementation ofthe “Interest limitation rule” may be postponed until January 1, 2024 unless OECDcountries agree to implement the “Interest limitation rule” before that date

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2. EU global developments - Impact of ATADs on Private Equity Funds



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2. EU global developments – MLI - General information


o On November 24, 2016, OECD adopted the multilateral convention (“MLI”) to implement BEPSmeasures into Tax Treaties of participating jurisdictions

o MLI supplements existing tax treaties by adding new provisions or by modifying or replacingexisting provisions, without amending existing treaties

o Countries have flexibility through opt-in and opt-out mechanisms (except for certain mandatoryminimum standards), as well as alternative provisions

o The MLI will only apply to existing tax treaties that are listed by both contracting states

o Optional MLI provisions: only if the two countries concerned indicate the same choice

o Each country is to notify the OECD (as depositary of the MLI) of:

the specific tax treaties they wish to bring within the scope of the MLI;

the options they have selected; and

the reservations they have made and various provisions of the individual tax treaties that areaffected by these various options and reservations.


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2. EU global developments – MLI - General information - Art. 7: Prevention of Treaty Abuseo Principal Purpose Test (“PPT”): “Notwithstanding the other provisions of this

Convention, a benefit under this Convention shall not be granted in respect of anitem of income or capital if it is reasonable to conclude, having regard to allrelevant facts and circumstances, that obtaining that benefit was one of theprincipal purposes of any arrangement or transaction that resulted directly orindirectly in that benefit, unless it is established that granting that benefit in thesecircumstances would be in accordance with the object and purpose of therelevant provisions of the Convention”

o PPT is the default option (it satisfies the minimum standards)

o Parties may supplement the PPT by opting for a simplified LOB

o Parties may opt out of the PPT and choose a detailed LOB which shouldbe negotiated bilaterally (i.e. it is not included in the MLI provision)

o Parties that choose to bilaterally negotiate a detailed LOB may apply thePPT as interim measure



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2. EU global developments – Impact of MLI on Private Equity Funds


o EU countries should only apply the PPT (given the EU compatibility concerns of the LOB)

o The US (and likely Canada) will opt out the PPT and choose for the negotiated detailed LOB

o The treaty eligibility of new and existing holding/financing structures will be impacted

o However, a limited guidance for the non application of the PPT is provided by: OECD Commentary on the PPT Discussion Draft on non-collective investment vehicle (CIV) funds dated January 6, 2017

o Substance has to be enhanced in order to avoid PPT application:

e.g. Centralizing holding functions into a regional or divisional headquarter or investment platform

o There may be interpretive issues with the PPT

o Luxembourg: 65 of 79 treaties signed by Luxembourg are with MLI members and should be affected by the MLI According to the statement made by Luxembourg Prime Minister Pierre Gramegna, all Luxembourg

treaties should be impacted and Luxembourg intends to go beyond the minimum standards

o Netherlands: 68 of 88 treaties signed by the Netherlands are with MLI members and should be affected by the MLI Netherlands intends to implement the MLI measures in its tax treaties as broadly as possible, with a

preference for the inclusion of a PPT as an anti-abuse provision, the amended PE definition andmandatory binding arbitration


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2. EU global developments – Impact of ATADs on Private Equity Funds


Why LuxCo?

o Acquisition and management of a portfolio of private market investments;

o Directors available who know business practices and regulations;

o Skilled multi-lingual workforce;

o Same currency in Luxembourg as in Country X;

o Luxembourg has a good treaty network;

o Luxembourg as a holding company can continue to survive.

Activities in Luxembourg

o Experienced local management, reviews investment recommendations from Fund, approves and monitors investment;

o Treasury function;

o Ensures regulatory compliance wherever it invests;

o Board, appointed by Fund:

Majority Luxembourg resident directors with expertise in investment management;

As well as sponsor team members.

o LuxCo pays tax and files returns in Luxembourg.Opco

LuxCo

PECS

IBL

U.S. Fund

CPECS

WHT WOULDBE 10%

WHT 5%

OpcoOpcoOpcos

Institutional Fund

Non-CIV Funds example

COUNTRYX


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U.S. Sponsor Fund Structure

Foreign FeederForeign Feeder

LLC GP

II. Case Study #1 – Canadian Inbound

Domestic Feeder

Domestic Feeder

Master Fund (Cayman LP)

INVESTMENTS

U.S. Taxables(e.g. U.S. tax residents )

Foreign Investors Tax Exempts


Presentation Title

o Canadian private company, owned by private Canadian resident-owned Canco,engaged in manufacturing business in Canada and other countries

o Operating Subsidiaries (CFA’s) in U.S., Italy, Mexico and China

o Double-dip financing in U.S. through a Luxembourg SARL – with interest-free loan

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Target Structure

Target (CAN)Target (CAN)

Hong Kong Italy U.S. HoldcoCanadian Operations

U.S. OpcoChina

Lux FincoMexico


Interest-free Loan

Interest-bearing Loan


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Acquisition Structure

Lux Holdco

Canadian Acquireco

Target


CFA’s

PE FundPE Fund

Acquisition Financing(related to Canadian

“keep” assets)

Acquisition Financing(related to foreign “distribute” assets)

Amalgamation(to form “Amalco”)

Lenders


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Post-Closing Reorganization (with Bump, but no debt pushdown except Canada)


PE FundPE Fund

Lux Holdco

Hong Kong Italy U.S. HoldcoAmalco

U.S. OpcoChina

Mexico

Lenders

Canadian Operations


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Post-Closing Reorganization (with Bump and debt pushdown)


PE FundPE Fund

Lux Holdco

Hong Kong Italy U.S. HoldcoAmalco

U.S. OpcoChina

Mexico

Lenders

Canadian Operations


Presentation Title

o 88(1)(d) bump and distributeo Acquisition financing pushdowno Withholding on dividends (after PUC distribution) Treaty-shopping

o Foreign Affiliate Dumping (FAD) rules 10(f) Ongoing FAD management if distribution of non-Canadian

subsidiaries is not available (because bump not available orotherwise)

o Management incentives Stock options, profits interests (valuation, funding, FAPI issues)

o Taxable Canadian property (TCP) issues if real estate orresource rich

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Discussion Topics



Presentation Title

o Intercorporate Financing Use of a blocker? Canadian thin capitalization rules & BTB “Related” sponsor financing “FinCo” strategy? Interest Free Loan vs MRPS in Luxembourg, ATAD impact Substance requirements in Luxembourg Luxembourg Rulings are exchanged with countries involved

o Foreign tax consequences of amalgamation and subsequentdistribution of shares

o Foreign commercial requirements Need for 2 shareholders in some jurisdictions Timing of transfer of shares

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Discussion Topics (cont’d)



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Post-Closing Structure (without Bump)


PE FundPE Fund

Amalco

Hong Kong Italy U.S. Holdco

U.S. OpcoChina

Lux FincoMexico

Interest-free Loan


Lux HoldcoX?

Canadian Operations

Lenders

Canadian Management


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Post-Closing Structure (without Bump, managing FAD issues)


PE FundPE Fund

Amalco

Hong Kong Italy U.S. Holdco

U.S. OpcoChina

Lux FincoMexico


Lux HoldcoXCanco

Guarantor

Canco GP?Canco GP?

Lenders

Canadian Operations

Interest-free Loan

Canadian Management


Presentation Title

o A U.S. private equity fund with both Canadian andnon-Canadian investors is considering making aninvestment in Target

o The PE fund has AIV rightso Target is a U.S. technology company

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Structure

PE FundPE Fund

III. Case Study #2 – Canadian Outbound

Canadian Investors

Non-Canadian Investors


Presentation Title

United States:

o Initial questions regarding the investment Type of investment across the capital structure of the Target (debt, common, preferred) The U.S. tax classification of the Target (partnership or corporation) The expected composition of the return (dividends and/or capital appreciation on exit)

o Initial questions regarding the investors Is any investor more than 10% of the Canadian aggregator (and, if yes, does any investor

who is a sovereign wealth fund represent 50% or more of the aggregator)? Are the investors eligible for the benefit of an income tax treaty to which the U.S. is a party?

o Based on the above we can determine whether a U.S. blocker is required (in the case of anequity investment in a partnership), whether loan origination risk exists (in the case ofdebt investment if the manager of the aggregator is sitting in the U.S.) and whether anytreaty benefits should be sought after (in the case of a dividend from Target or blocker,same regarding interest with respect to shareholder loans)

o Gain from the sale of shares of U.S. corporations (other than USRPHC) are typically notsubject to U.S. tax for non-U.S. investors

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Discussion



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Target is a Corporation

Canadian/U.S. LP

Canadian/U.S. LP


NewCo(U.S.)

Target(U.S.)

Loan

Canadian Investors

U.S. Investors

Foreign Investors


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Target is a Partnership

Canadian LPCanadian LP


NewCo(U.S.)

Target(U.S.)

Loan

U.S. LPU.S. LP

Canadian Investors

U.S. Investors

Foreign Investors


Presentation Title

The interest deductibility limitation:

o Net excess interest is only deductible up to the higher of 30% of the tax payer EBITDA or an amount of EUR 3M

o MS may: exclude financial undertakings i.e. Financial Institution and insurance Companies from the application of the

“interest deductibility limitation”. An Alternative Investment Fund (“AIF”), such as a PE Fund, as defined in theAlternative Investment Fund Managers Directive (“AIFMD”) qualifies as such.

exclude loans concluded before 17 June 2016 not modified after that date exclude loans used to fund a long term public infrastructure projects where the project operator, borrowing costs,

assets and income are all in the EU (consequently income from long-term public infrastructure projects is excluded) exclude tax exempt income in the computation of the EBITDA carry forward (or carry back) exceeding borrowing costs

o Action required: review financing and consolidation structures and identify AIF vehicles

Exit taxation:

o Exit tax is the difference between the value of assets for tax purposes and their FMV when assets are transferredabroad

o Payment of the exit tax is made in installments deferred over 5 years if assets are transferred to another EU MS

o Deferred tax immediately due in case the transferred assets are disposed of, transferred to NON EU MS or if thetax payer goes bankrupt

o Action required: No particular action required for PE Funds. In majority of EU MS similar legislation already exists.

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1. EU global developments – Impact of ATADs on Private Equity Funds

IV. Appendices


Presentation Title

General anti-abuse rule (“GAAR”):

o NON genuine transactions carried out for one of the main purposes of obtaining a tax advantage are to be ignored

o This substance over form-like clause is present in the Dutch and Lux tax law, e.g. by the concept of Abuse of Law

o Funds often rely on Dutch or Luxembourg SPVs underneath the fund vehicle to benefit from reductions of tax on thebasis of tax treaties and/or EU Directives (such as PSD)

o GAAR can be used by EU source countries (where the invested assets are located) to deny the tax benefits to the fund’sinvestment vehicle (e.g. deny a reduction of wht or capital gain exemption to Lux or Dutch SPVs owned by offshorefunds)

o Local tax authorities will increasingly challenge structures that “lack of economic reality and business rationale”

o Action required: SPVs with little physical presence and minimal personnel need to be revisited

Controlled Foreign Company rules (“CFC”):

o CFC: entity holds directly or indirectly more than 50% in its Sub and Sub is subject to an ETR less than 50% of the entitytax rate

o If a company is treated as CFC, its taxable base will include non-distributed income of its Sub unless CFC carries on asubstantive economic activity supported by staff, equipment, assets and premises, as evidenced by facts andcircumstances. MS may opt not to apply this exception towards third countries, not part of the EEA agreement.

o MS may opt to treat financial undertakings as CFC if 1/3 or less of the entity’s income come from transactions with thetaxpayer or its associated enterprises

o Action required: Review tax rates and identify the vehicles which qualify as an AIF

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1. EU global developments – Impact of ATADs on Private Equity Funds (cont’d)

IV. Appendices


Presentation Title

Hybrid mismatches:

o Carve-out: Rules provided should only apply to “payments”; not for example to provisions recorded

in relation to financing instruments (e.g. Convertible Loans) Payments need to be “deductible”, excluding non-deductible payments from the scope

of ATAD2 (e.g. CPECs redemption in case of exempt income) Interest Free Loans (“IFL”) that lead to deduction and non-inclusion should not be in the

scope of ATAD2 (provided that the IFL is not split into a debt part and an equity part atthe level of the debtor)

If tax relief granted in the payee jurisdiction is solely due to the tax status of the payee –i.e. tax exempt under the law of the payee jurisdiction (e.g. Canadian Pension funds) orthe fact that the instrument is held subject to the terms of a special regime

Jurisdiction use different tax periods and have different rules for recognizing when itemsof income or expenses have been derived or incurred, ATAD2 highlights that thesetiming differences should generally not give rise to hybrid mismatches as long as theincome is included within a reasonable period of time (i.e. within 12 months)

Transfer Pricing adjustments should not fall within the scope of a hybrid mismatch Any adjustments required in accordance with ATAD2 should in principle not affect the

allocation of taxing rights between MS under applicable Double Tax Treaties Hybrid regulatory capital allowed up to Dec 2022. Important for Bank and Insurance

companies which have to be in compliance with solvency ratio.

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IV. Appendices


Presentation Title

Hybrid mismatches (cont’d):

o Hybrid mismatches that result from payments under a financial instrument (as implemented by theUK as from 1 January 2017 – UK anti-hybrid rules)

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IV. Appendices

EXAMPLE 3: HYBRID ENTITY MISMATCH LEADINGTO A DOUBLE DEDUCTION

UK ParentCo

INTEREST

UKCo

USCo

DEEMEDINTEREST

LOAN

USCo

INTEREST

UKCo

EXAMPLE 1: HYBRID ENTITY MISMATCHLEADING TO A DEDUCTION WITHOUT INCLUSION

LOAN

EXAMPLE 2: HYBRID PERMANENT ESTABLISHMENTMISMATCH LEADING TO NON-TAXATION WITHOUTINCLUSION

UKCo

INTEREST

LuxCo

Irish PE

LOAN

Interest paid by UKCo is disregardedfor U.S. tax purposes (tax mismatch -no U.S. income inclusion)

UK anti-hybrid rules deny UKCointerest deduction

UKCo pays interest to non-trading IrishPE

Tax mismatch: no Irish income inclusion(non-trading PE) and no Luxembourgincome inclusion (double tax treaty)

UK anti-hybrid rules deny UKCo interestdeduction

UKCo pays interest to UK ParentCo

USCo deducts interest actually paidby UKCo for U.S. tax purposes -double deduction

UK anti-hybrid rules deny UKCointerest deduction


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IV. Appendices

USCo

EXAMPLE 4: IMPORTED MISMATCH DEDUCTIONWITHOUT AN INCLUSION

Dutch BV

UKCo

INTEREST

INTEREST LOAN

LOAN

U.S. Investors

PEC/CPECS

EXAMPLE 5: IMPORTED MISMATCH DEDUCTION WITHOUT ANINCLUSION

Others

CayCo

LuxCo

UKCo

IBLINTEREST

INTEREST

Interest received by LuxCo is included in its taxable basis –No mismatch

PECs interest or CPECs premium paid by LuxCo to CayCoare no included in CayCo and/or U.S. Investors taxablebasis - "imported" tax mismatch

UK anti-hybrid rules deny UKCo interest deduction

UKCo pays interest to Dutch BV – no direct tax mismatch asincome inclusion in Dutch BV

Dutch BV pays interest to Dutch CV - "imported" tax mismatchas no income inclusion in Dutch CV and/or USCo

UK anti-hybrid rules deny UKCo interest deduction

Dutch CV

Hybrid mismatches (cont’d):


Presentation Title

o Art. 50 of the Treaty on EU has been invoked on March 29, 2017. Two years for the exit

o ECJ Cases: MS must comply with the Treaty on the Functioning of the EU (TFEU)provisions on free movement of goods, persons, services and capital (thefundamental freedom). If UK does not negotiate a position similar to the EEA States,UK will not be bound by ECJ case law and would not bound to comply with thefundamental freedoms.

o EU State Aid: UK will no longer be subject to “state-aid rules” as per Art. 107 of theTFEU. UK could adopt more favorable (tax) regimes to encourage inboundinvestments.

o Tax directives: Parent Subsidiary Directive: Many MS apply the domestic participation exemption only

to EU/EEA MS. UK Dividends may be taxed in some EU/EAA jurisdictions. Interest and Royalties Directive: UK law foresees 20% WHT on interest and royalties

which could be reduced to a lower rate if a treaty is applicable Merger Directive: mergers, de-mergers, transfer of assets, exchanges of shares and

transfers of the registered office of SE or SCE between MS could no more be carriedout without direct tax consequences

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2. EU global developments - Impact of UK Brexit on Private Equity Funds – tax angle

IV. Appendices


Presentation Title

o More detailed comparability analysis with substance over form approach

o Equity at risk to be determined through a credit default loss computation

o Safe harbor rules: If the entity is comparable to banks and similar financial entities, the minimum equity at risk required is

10% and the entity should realize an after tax margin of, at least, 1% of the financing granted Intermediary Companies (low risk profile) should have minimum equity at risk and should realize an

after tax margin of, at least, 2% of the financing granted These thresholds could be modified by the Luxembourg tax authorities based on market conditions

o APA granted by the Luxembourg tax authorities before 1 January 2017 are not valid as from fiscalyear 2017

o SUBSTANCE requirements:

o Luxembourg companies engaged in intra-group financing activities must have an adequate level ofsubstance in Luxembourg: The majority of directors/managers should be (professionally) resident in Luxembourg and should be

properly qualified in relation to the activities performed by the company The company has to have qualified employees to control the transactions performed. However, such

functions may be outsourced to third parties to the extent that they have no significant impact on thecontrol of the risk. In our opinion, such activities may also performed by the managers/directors of thecompany (it is still debatable in the market).

The key decisions must be physically taken in Luxembourg

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3. EU global developments – Impact of new Luxembourg TP rules to Private Equity Funds

IV. Appendices

Documents

Current Issues in Inbound & Outbound Collective … PPTS/8...2017 IFA International Tax Conference Presentation Title 3 1. U.S. Tax Reform -Structuring Acquisitions by Private Equity