Funding business innovation and growth through private equity should have little to do with the corporate structures of multinationals, nor the dark world of money laundering and terrorist financing. Yet with the industry being susceptible to money laundering risks, global rules on these areas have had their impact on PE funds. Hence why Pieter Leguit, a partner in the asset management and investment funds group with Simmons & Simmons Luxembourg, welcomes proposed EU legislation to further harmonise rules on anti-money laundering.
Level playing field
“The proposals would further level the playing field across Europe, and should have a considerable beneficial impact in Luxembourg,” Mr Leguit said. He highlighted how interpretations of AML rules by legislators and regulators still vary from country to country, and this can complicate matters for fund managers that operate cross-border. The proposals include a fully fledged EU regulatory body devoted to AML/CFT. “A unified pan-EU regime will help the Grand Duchy maintain its leadership position,” he added.
Similarly with tax. Private equity backs startups, growth companies and the like, yet these funds that channel this funding cross border can get snagged by rules seeking to reduce the ability of multinationals to move earnings around the world to minimise their tax bills. Hence why PE funds (especially cross-border Luxembourg-based funds) must frequently deal with the side effects of the OECD’s Base Erosion and Profit Shifting (“BEPS”) project. These rules have been implemented into European law via the two anti-tax avoidance directives ATAD 1 and ATAD 2.
ATAD impact on PE
“One of the ATAD provisions which had the most impact on PE structuring is the anti-hybrid mismatch rules,” said Pierre-Régis Dukmedjian, head of tax at Simmons & Simmons Luxembourg. These hybrid mismatches derive from different qualifications in different jurisdictions as regards the use of financial instruments and entities. “For example, a hybrid mismatch can occur when a Luxembourg partnership is considered tax transparent in Luxembourg and tax opaque in the investor jurisdiction. Interest payments to the Luxembourg partnership can then trigger a tax deduction with no taxation of said interest received by the partnership nor at the level of the investors.
One of the ATAD provisions which had the most impact on PE structuring is the anti-hybrid mismatch rules.
The application of ATAD 2 rules may increase the cost of the structure with an impact on the return,” Mr Dukmedjian explained. “There are options to ensure that different investors with different tax profiles can be dealt with in parallel, so that costs of the new rules only fall on those who are directly affected,” he added.
Drivers of fund structuring
Thus tax can be one of the drivers of the decision around which vehicle to use. “The basics remain the same: managers decide which investors they wish to target and how, and the structure is chosen accordingly,” Mr Leguit said. The country of residence and sophistication of investors, the type of assets to be held, and the location of the assets are the main drivers for decisions about structuring.
The basics remain the same: managers decide which investors they wish to target and how, and the structure is chosen accordingly.
At investor level, there might be a preference to invest in a tax transparent entity (partnership) vs a tax opaque entity (corporation). The general aim is to have the fund structure as neutral as possible from a tax perspective, knowing that the investors and companies in which the fund invests are generally already taxed.
Flexibility is key
“It is possible to enable ATAD 2-sensitive investors to invest through a separate vehicle,” said Mr Dukmedjian. As well, structuring itself has evolved, with ATAD 2 influencing whether a partnership or corporation form of the fund is most appropriate for these specific investors. Alternatively feeder funds and other structuring processes may be used, techniques which have been used for a while for regulatory or commercial reasons.
Each time European and international bodies consider global changes to tax and regulatory frameworks, worries emerge about whether successful cross-border systems will be disrupted, and the private equity sector is no exception. Yet the wealth of experience of managing business cross-border in the Grand Duchy enables these hurdles to be navigated with minimum disruption.