Legal & Regulatory Bulletin

The OECDs International Tax Avoidance

Project and Private Equity
By Stephen Pevsner and Laura Charkin, Tax Partners, and Andrew Pollock, Trainee Solicitor, King &
Wood Mallesons LLP

The OECD, backed by the G20, has been working on an

initiative to crack down on tax avoidance by multi-national
companies since July 2013 under its so-called base erosion
of profits (or BEPS) project. While aimed principally at
international profit allocation and repatriation by multinationals, its potentially broad scope means that it has
caused a stir in the wider private equity industry with fears
that the consequences of the project could be damaging for
funds and their investors.
The aim of the project overall, elaborated on by a paper
issued by the OECD in March 2014, is to create a generally
accepted set of international tax rules, particularly by
adopting a consistent approach to double tax treaties and
their implementation, to address concerns that taxpayers
are able to avoid paying their "fair share" of tax in the
appropriate jurisdictions where the economic activities that
generate the profits are carried out and the value is created
by moving their profits to low tax jurisdictions.
The OECD has identified 15 action plans, each dealing
with a perceived weakness in the international tax system.
Of these, four are likely to be of particular interest to the
private equity industry:
(i)

Preventing Double Tax Treaty Abuse Action Plan 6;

(ii) Assessment of What Should Constitute a Permanent

Establishment Action Plan 7;
(iii) Limiting Interest Deductions Action Plan 4; and
(iv) Addressing Hybrid Mismatch Arrangements
Action Plan 2.

The OECD published consultation papers on Action

Plans 2, 6 and 7 in September and are starting to discuss
Action Plan 4, with a view, in each case, to finalizing their
recommendations in 2015.
The action point which has had the most focus to date
from the private equity industry has been the double
tax treaty proposals. Put simply, the OECD wants to stop
taxpayers using intermediate vehicles inappropriately to
bridge the gap on payments between residents of two
countries which do not have a double tax treaty with each
other in order to reduce the tax (generally withholding tax)
due in the source country of the payment. For instance, a
taxpayer located in Country A may be able to reduce or
even eliminate tax on income generated in jurisdiction B in
circumstances where there is no double tax treaty between
Countries A and B by paying and receiving the income
through an entity in Country C which does have a double
tax treaty with Country B. If jurisdiction C does not apply
withholding tax on outbound payments under its domestic
law or if it does have a double tax treaty with Country A,
the taxpayer may be able to receive the payment without
suffering the Country A tax that it would have suffered had
it received the payment directly.
The emerging market private equity industry does use
intermediate vehicles, but typically for different reasons to
those in respect with which the OECD has raised concerns. For
example, a fund which has investors from, and itself invests
in, a wide range of countries might save itself a compliance
burden by holding investments through a central treatyeligible structure. The concern in this area was, however,

that the initial approach taken in the proposals for the "antiabuse" terms to be included in double tax treaties included,
as one alternative, a standard limitations of benefits
provision, which presupposes that the (treaty jurisdiction)
Country B entity has a relatively simple set of shareholders
(or owners). These proposals, if adopted, would have made
it unlikely that any private equity fund would be able to
rely on what would otherwise be treaty eligible investment
vehicles to minimise the withholding taxes on their receipts.
This would be so even where all (or a large majority) of the
fund's investors were themselves tax exempt or eligible for
treaty relief, as is often the case. This would undermine the
central tenet of private equity fund investments, that the
investors should not be any worse off in tax terms than if
they had invested directly.
After engagement with the OECD on this, the OECD have
recognized that they had not taken the particular structures
of private equity funds into consideration when crafting
the proposals. Industry bodies are now engaging with the
OECD in this regard, and further proposals on how the
abuse principle might apply to private equity funds are
expected in the early part of 2015. The OECDs September
paper recognized that policy considerations will need to
be addressed to ensure that the new rules do not unduly
impact collective investment vehicles and other funds and
makes it clear that this is an area which requires further
work. It is likely that the OECD's final recommendations will
include various options for defining the ways in which the
new rules will apply to fund vehicles.
While of less immediate importance, the other action
plans on ensuring that the current OECD Model Tax Treaty
approach to permanent establishments does not allow
the artificial avoidance of PEs and the local jurisdiction tax
that goes with them and on investment company interest
deductions will also be of interest to the industry. While
the latter might affect the effective tax rate of a fund's
investments, the former might lead to structural changes
being required to a fund's management arrangements, if
the current arrangements might result in profits of the fund
and/or the investors being brought into the scope of tax in
a wider range of jurisdictions.

2015 EMPEA

The emerging market private

equity industry does use
intermediate vehicles, but
typically for different reasons
to those in respect which the
OECD has raised concerns.

Although, as stated, the final proposals are unlikely to

be known under mid to late 2015, what is clear from the
materials and discussions so far is that the BEPS project
will have a long lasting effect on the tax arrangements and
consequences for private equity funds across the industry.
It is extremely important that the industry bodies and other
interested parties remain (or get) engaged in the process
of discussions with, and responses to, the OECD and local
governments and tax authorities to try to ensure that
the particular characteristics of private equity funds are
fully considered before any decisions are taken that could
operate as a deterrent to investors with the overall adverse
effect on investment and development that would result.

About the Authors

Stephen Pevsner is a Tax Partner at
King & Wood Mallesons LLP

Laura Charkin is a Tax Partner at

King & Wood Mallesons LLP

Andrew Pollock is a Trainee Solicitor at

King & Wood Mallesons LLP