International tax adds extra complexity for PE funds considering holding companies
Tax planning for private equity (PE) funds presents unique challenges and opportunities, due to the (at times) competing tax priorities of the PE fund, its investors, and its portfolio investment companies. The tax priorities of the affected stakeholders have only grown in complexity because of the daily upheaval in tax legislation being enacted across the globe.
A critical aspect of tax planning for PE funds presents itself when a PE fund acquires a portfolio investment company. Acquisition structuring is complex, and getting the “right” structure in place is critical to facilitate tax efficiencies going forward. An ill-conceived tax structure not only leads to inefficiencies in tax but also can present business and operational challenges.
One of many significant decisions to be made as part of acquisition structuring is whether to utilize a holding company when acquiring a target company and, more importantly, the jurisdiction of such holding company. The utilization of a holding company in a tax structure can streamline cash repatriation to investors, repayment on debt financing, and cash deployment throughout the portfolio investment structure. It can also, in certain instances, provide additional tax benefits, such as reduced withholding tax rates on various payment flows and reduced tax on exit.
It is critical that holding company structuring occur in conjunction with acquisition structuring. Interposing a holding company post-acquisition only increases the complexity of a company’s tax structure and is often more difficult to effectuate once the structure has been formed.
Where to form a holding company is a complex decision and depends on various factors including the location of the target portfolio company and the objectives of the PE fund and its investors. Depending on the circumstances, forming a holding company in the same jurisdiction as the target portfolio company may be prudent, while at other times it may be ill-advised.
Numerous countries have enacted tax policies to incentivize stakeholders to establish their holding companies there. When choosing a holding company jurisdiction, consider the following.
PE funds may want earnings generated from the underlying portfolio investment to be distributed to its investors. Dividend distributions are a valuable tool for repatriating earnings to shareholders but may also present tax leakage consequences. If the payor’s country levies withholding tax on dividend payments, the tax cost may be permanent. For example, U.S. tax exempt investors will be adversely impacted by withholding taxes because generally speaking, such distributed earnings would not be subject to tax in the U.S. Taxable investors may be able to claim a credit for the withheld tax, but this is dependent on numerous factors and complex calculations.
There are limited jurisdictions that provide a 0% withholding tax on dividend payments, such as the U.K. If a holding company can’t qualify for treaty benefits (see discussion below), forming a holding company in a jurisdiction with no withholding tax on dividend payments may be prudent.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
Strategic Tax Issues for Capital Markets
InsightWhat would the Inflation Reduction Act mean for carried interest taxation?Robert Richardt, Moshe BidermanThe proposed legislation would adjust holding periods, transfer rules, and other aspects of taxation of carried interest. Read more.
InsightN.Y. case: Vacation home not a permanent place of abodeLance Rothenberg, Corey L. RosenthalThe recent decision around a taxpayer’s statutory residency may open the door for others to argue the same, under similar facts.
InsightNew California budget offers tax relief: Refunds, credits, and moreTed Tourian, Marietta Probst, Krista SchippRead about key refunds, credits, grants, and other tax provisions in California’s latest budget, including changes to cannabis taxation.
InsightRetaining LIHTC leadership – Why succession planning mattersMatthew BarcelloHow does an organization “download” the depth of experience to the next generation of Low-Income Housing Tax Credit leaders? Read our recommendations.