private equity club 2009 - pwc€¦ · pricewaterhousecoopers llp slide 12 conversion of corporate...

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Private Equity Club 2009Facing today, tomorrow and the day after*

*connectedthinking

Asset Management

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Slide 2PricewaterhouseCoopers LLP

Tax: Planning for the 50% income tax and VAT issues on PrivateEquity transactions

Ashley Coups

Private Equity Assurance Leader, PricewaterhouseCoopers LLP

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Tim Hughes

Director, PricewaterhouseCoopers LLP

Darren Docker

Director, PricewaterhouseCoopers LLP

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PricewaterhouseCoopers LLP

Agenda/Contents

Background2009 budgetTypical Adviser / Manager structuresAlternative strategiesMoving the adviserConclusions

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Agenda


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Recap on how a UK based PE executive is taxed

Taxation in the UK depends on two concepts

• Domicile

- UK – taxed in UK on worldwide income and gains

- Non-UK – taxed in UK on the remittance basis

• Residence

- Non-resident

- Not ordinarily resident

- Ordinarily resident

Remittance basis

• £30,000 charge once resident in UK for 7 out of 9 years

Background

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Agenda


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Budget 2009

• From April 2010 income > £150,000 will be subject to income tax at 50% (40% forincome above c£35,000).

• Contemporaneous restrictions in tax deductibility of pension contributions.

• For now, all capital gains still taxed at 18%, but carry shrinking in the short /medium term as the key driver of overall compensation

• UK now as equally uncompetitive as Italy

2009 budget

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Income

• Earned income (i.e. salary and equivalent) as well as investment income (primarilyloan interest).

• But earned income is the most sensitive area. Why?

• Carried interest, and potentially co-investment profits are usually sourced fromgains (18%). Investment income is taxed for UK non-domiciled executives on aremittance basis in many cases – i.e. keep it out of UK, and no UK tax suffered.

• Earned income is subject to UK tax regardless of domicile (though some relief fortemporary residents that carry out some work overseas)

2009 budget

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Agenda


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How UK advisers / managers are structured

• LLPs

• Companies

• Branches of non-UK entity (unusual for admin / PE reasons )

Typical Adviser / Manager structures

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Conversion of corporate to LLP

• Avoids impact of employment related security rules - key to a number of planninginitiatives. Fundamentally changes UK tax valuation verticals.

• No employer’s NIC on a partner’s drawings – annual saving equal to 12.8% ofsalary/bonus equivalent

• Separate legal personality and limited liability while being transparent for taxpurposes

• Increasingly the standard structure for private equity fund managers in the UK

• Can trigger (sometimes) unhelpful tax connection between executives


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Key Consequence of 2009 Budget for UK executives

• Earned income, be it salary and bonus (employees of a company); or fixed andvariable drawings (members of a LLP), taxed in the UK at up to 50%.

• Regardless of domicile status

• What can be done to reduce this earned income if execs are staying in the UK (inthe medium term at least)?


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Agenda


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Three Strategies

• Acceleration

- Bonus (with / without loan back)

- Dividends

- Other (e.g. capital allowances disclaimer)

- Change in accounting date of LLP?

• Restructure compensation character

- Double LLP (the benchmark for UK execs)

- Introduce executive-owned corporate LLP member, and extract profits

- Deliver value for non-doms through shares in offshore GP / Manager

- Dual contracts for non domiciled employees

Alternative strategies

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Three Strategies (continued)

Defer compensation tax point

• Payments through Employee Benefit Trusts

• Unapproved pension plan

• Management fee waiver

• Other (e.g. CFD)


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Personal planning opportunities

• EIS

• VCT

• Gift Aid

• Debt investments

• Negligible value claims

• etc etc


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Double LLP

FUND LPs£1billion

PortfolioCompanies

£20m Fee Structuredas priority profit share (“PPS”)

Member CoManagersLLP

GPLLP

Apportionment of £8minvestment profits(Potentially 18% tax)

PE Executive Partners

Apportionment of £5.8m trading profits(40% tax) 2009/10(50% tax) 2010/11

Cost £6m

Profit share £12m

Assumecosts of£200kFee £11.8m

FUND LPs£1billion

PortfolioCompanies

£20m Fee Structuredas priority profit share (“PPS”)

Member CoManagersLLP

GPLLP

Apportionment of £8minvestment profits(Potentially 18% tax)


Apportionment of £5.8m trading profits(40% tax) 2009/10(50% tax) 2010/11

Cost £6m

Profit share £12m

Assumecosts of£200kFee £11.8m


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Double LLP

• Typical UK / European private equity arrangements

- Annual management fee is paid by the fund to its general partner as a “PriorityProfit Share”.

- GP is a limited partnership or more likely for liability reasons a LLP

- Some (not all) PPS is paid on, as a fee, to a UK advisor formed as a LLP

- (A company is not appropriate as gives rise to valuation issues for employees)

• The Advisor’s fee funds its running costs including arm’s’ length amounts paid tokey executives as a profit share.

• Amounts in excess of the fee are taken out of GP as partnership distributions.These are not taxed until fund makes profits, and then at rates reflecting underlyingcharacter of profits


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Introduce executive-owned corporateLLP member, and extract profits

New CoLtd

TradingLLP

Equity

ProfitShare


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Introduce executive-owned corporate LLP member, and extractprofits

• Company pays tax at 28% (or 21% if a “small company”) not 50%, no socialsecurity

• Loan out of company (close company rules may add more tax) to the shareholders

• Unwind of loan and company on liquidation – effective tax rate either 35% or 41%

• Potential anti avoidance challenges, define commercial role of corporate partner,directors should be other than LLP members.


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Deliver value for non-doms through shares in offshore GP /Manager

FUND LPs£1billion

PortfolioCompanies

OffshoreGP Co


ProfitShare £20m

Fee £11.8m

Shares

ManagersLLP

FUND LPs£1billion

PortfolioCompanies

OffshoreGP Co


ProfitShare £20m

Fee £11.8m

Shares

ManagersLLP


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Deliver value for non-doms through shares in offshore GP /Manager

• Increase return from offshore GP and reduce UK taxable income where the GP isan offshore company and a fee is paid to a UK manager

• Remittance basis of taxation for non-UK domiciled executives allows zero taxextraction of profit from the offshore company

• Subject to transfer pricing analysis


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Dual contracts

• The idea

- Allocation of multiple roles to non-UK domiciled UK resident executives (eitherdual contract or dual partnership interest) where it is possible to clearlysegregate UK and non-UK duties

- If implemented correctly, non-UK domiciled executives will only pay tax onduties performed in the UK

• Disadvantages

• Dual contract arrangement is open to HMRC challenge and difficult to implement

• Dual partnership arrangement is more robust but still open to HMRC challenge


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Payments through Employee Benefit Trusts

Offshore

EBT

Trading

LLP

Members

Co

Loans

to employees

Allocation of

profit

Contribution to EBT


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Payments through Employee Benefit Trusts

• Where Advisor is a LLP, introduce a corporate partner taxed at 21%/28%, and itcontributes its profits allocation to a EBT.

• More straightforward where Advisor is a company

• Loan amounts from EBT to beneficiaries. This can be structured as a tax freeamount (a taxable benefit in kind arises due to absence of interest)

• Taxable when loan is written off – potentially a deferral and “bet” on falling incometax rates. CT deduction only when taxable on exec.

• Not taxed if released on death, loan also diminishes value of UK estate forinheritance taxes

Disadvantages

• This would involve making some LLP members employees of the corporatemember, and this would mean that shelter from ERS rules

• A long term arrangement and not really seen before in private equity


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Unapproved pension plan

• Where Advisor is a LLP, introduce a corporate partner taxed at 21%/28%, and itcontributes its profits allocation to a retirement benefits scheme (EFRBS).

• More straightforward where Advisor is a company

• EFRBS can invest and roll up profit tax free (e.g. co investment?)

• EFRBS subject to UK pension regulation hence can only pay on retirement.

• (Unlike EBT) Treaty protection from UK tax on receipt of distributions from EFRBSpossible, UK company gets a tax deduction at that point

Disadvantages

• Depending on anticipated retirement this is a more long term arrangement and notreally used previously in private equity


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Waiver of management fees to commute co-investmentobligations

• There is still some discussion between advisers of whether this “works” in the UK

• Only possible where adviser is a LLP because of value of investment made onbehalf of executive

• Risk of treatment of co-investment as a disguised service fee.

• But possibility of non taxation of amounts eventually received as a return of basis.


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Agenda


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Leaving the UK

Move the UK manager to a more tax favourable jurisdiction

• Becoming non-UK resident:

- Full time employment abroad for at least one full tax year; or

- Leave permanently (or for at least 3 years)

• AND, once departed visits to the UK must

- Total less than 183 days in any tax year

- Average less than 91 days per tax year

The jurisdiction to which the manager is moved needs to be consideredcarefully…

Moving the adviser

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Leaving the UK

Tax issues to consider

• Residence requirements

• Income tax rates

• Capital gains tax rates

• Social Security rates

• Treatment of carried interest

• Tax on exit

• Direct tax rates for manager

• Issues for investors – permanentestablishment, etc

• Indirect taxation

Practical issues to consider

• Regulatory requirements

• Investor perception

• Cost of living

• Schools

• Infrastructure

• Red tape

• Transport

• Language

• Office space

• Housing

• Weather (!)

Moving the adviser

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Summary

Luxembourg

InvestorsIndirect taxationof manager

UK

Switzerland

Netherlands

Monaco

Ireland

Channel Islands

Direct taxation ofmanager

CarryEmployeetaxation

Moving the adviser

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Agenda


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Conclusions

• UK tax environment deteriorating for execs whose comp has a significant earningscomponent.

• There are acceleration, deferral and re-characterisation opportunities.

• Is it practical for existing funds to use these opportunities?

• Will HMRC narrow capital / income differential?

• Or change law on “PPS”?

• If US changes the game on carried interest, will UK fall into line?

• Is emigration a practical answer?

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Stephen Morse

Partner, PricewaterhouseCoopers LLP

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Agenda

• Focus on deal fee VAT recovery• What are HMRC doing?

• Case law analysis

• What should you be doing?

• Other key issues• Offshore funds

• Partial exemption

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Deal fee VAT recovery

How much VAT on deal costs is recoverable?

HMRC taking a very aggressive approach

Numerous enquiries and assessments

Ongoing litigation NB so-called ‘test cases’

All have a similar tone / consistent approach

PE backed and ‘mainstream’ M&A

Portfolio approach by HMRC

NB potential negative impact on the PE House from HMRC’s wider challenge

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Taxpayer can recover so much of its input tax for the period that is attributable totaxable supplies

Input tax is VAT incurred on the supply to the taxpayer of goods or services used or tobe used for a business purpose

Substantial body of case law:

Redrow

Loyalty Management

Town and County Factors

Eagle Trust

Poladon

Mono Global

Telent

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What should you be doing?

Review structures used

- Assemble / retain all relevant paperwork: is it all in order?

- Supporting evidence / ‘gaps’?

Care in responding to HMRC

- Take the initiative

Protect your position

- Alternative claims?

Proactive VAT management on current / future deals

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Other key VAT issues

Offshore funds

- HMRC attack: VAT technical and ‘anti-avoidance’

- PwC’s view

- What you should do

Partial exemption

- New Standard Method

- Overrides

- PwC’s view

- What you should do

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This publication has been prepared for general guidance on matters of interest only, and does not constituteprofessional advice. You should not act upon the information contained in this publication without obtaining specificprofessional advice. No representation or warranty (express or implied) is given as to the accuracy or completenessof the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP,its members, employees and agents do not accept or assume any liability, responsibility or duty of care for anyconsequences of you or anyone else acting, or refraining to act, in reliance on the information contained in thispublication or for any decision based on it.

© 2009 PricewaterhouseCoopers LLP. All rights reserved. ‘PricewaterhouseCoopers’ refers toPricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) or, as the context requires, thePricewaterhouseCoopers global network or other member firms of the network, each of which is a separate andindependent legal entity.

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