The UK’s decision to limit the tax deductibility of debt in its April Budget announcement was a direct result of the OECD’s agenda on base erosion and profit-shifting under a G20 mandate on tax standards. The intergovernmental body is expected to propose standards to tackle tax treaty abuse in 2017, the same year that the much-maligned directive for instituting a single European market for alternatives managers – AIFMD 1 – will also be up for review.
You’re a voice for the industry. What’s the industry most concerned about?
On the tax side, it’s the work the OECD is doing on tax treaties, double tax treaties. So the exam question for our industry is: “What level of access will the private equity industry, investors and funds still have to the tax treaty network?”. Because if you don’t have access to the network, if you can’t benefit from those arrangements set out in tax treaties, the risk is that you’ll end up paying tax twice. In particular, we’re worried that funds will end up being taxed and then limited partners [investors] will pay tax on the returns that come to them, and you won’t be able to offset the tax that’s paid by the fund against your individual LP tax bill from your domestic tax authorities.
In what jurisdictions do you expect this to be a problem?
It would be a problem everywhere. If fund structures are no longer able to qualify for tax treaties, then it doesn’t matter where the fund is located if you design your tax treaty rules in such a way that in OECD-speak they’re called ‘non-CIVs’ [non-collective investment vehicles]. You’re going to end up with a danger of double taxation, or you end up with a massive compliance burden where you’re technically able to access the tax treaty network but the information you have to provide, the audit trail you have to be able to show to the tax authorities, becomes so extensive that you raise the cost of doing business quite dramatically.
What are industry’s concerns when it comes to the OECD’s [work on] tax treaties? What’s the thing they fear most?
I think the thing that people fear most is a massive increase in the cost of compliance; that the OECD will not try and exclude entirely private equity and venture capital firms from the tax treaty network, they won’t say there are no circumstances in which a private equity firm can use tax treaty benefits. Instead, what we will find is that the way you get access to that network is by providing such detailed information about your investor base that the compliance cost – either for the LP or general partner [private equity firm] or possibly both – will ramp up enormously.
When will a decision be made [on tax treaties] and what is a realistic outcome?
In terms of timing, it’s very, very difficult to say. The relevant OECD working parties have been saying for the best part of 18 months now that a final decision is imminent, and then another deadline passes. Early next year is probably what we’re now hearing is the timetable that the relevant committee will sign off on some proposals. Whatever they come up with then has to actually be implemented, and that is either going to be done by the negotiation of a multilateral instrument – so a big new tax treaty at the global level, which is a mammoth undertaking – or the new rules will be implemented by individual countries when they revisit their tax treaties.
Is that the biggest issue facing European private equity?
Certainly on the tax side that’s the biggest issue. Other issues obviously include the operation of the Alternative Investment Fund Managers’ Directive, the possible review of the directive next year – that’s potentially an enormous issue for the industry. If you just think back to how big AIFMD 1 was back in 2008/9/10, any revision to it would inevitably raise similar questions.
We’ve had the announcement that Theresa May is going to trigger Article 50 by March. What’s the significance for the industry? Do you think that’s going to have a knock-on effect on how AIFMD is handled?
One of the most contentious issues in AIFMD, and actually a lot of financial market legislation, is always: “How do you give access to non-EU jurisdictions to the EU market?” That was one of the big issues in AIFMD 1, even without Brexit. It would be a big issue in AIFMD 2. Brexit only turbocharges that question, because if we’re in a position 12 months from now where we’re reopening AIFMD and looking again at the rules on third-country access, everybody is going to be thinking a year from now, two years from now, the UK will be a third country. There’s a Brexit dimension now to what were always quite sensitive and quite complex discussions.
So what’s the next step?
The current directive, AIFMD 1, sets a timeline of summer next year for the European Commission to review the whole thing.
Honestly, I don’t think the Commission have yet made a decision on whether they want to undertake a review or not. There are good reasons not to: Brexit is probably one of them. The fact that actually we don’t have that much experience of the operation of AIFMD 1 yet – it’s only a couple of years old, quite a few member states transposed it into domestic law late (in Poland for example the relevant national legislation only entered into force this year) – it’s actually quite difficult to form a view.
I think there’s a definite possibility that the Commission will decide, for Brexit reasons and for those other reasons I mentioned, to delay it and give themselves longer or to do a review that concludes they’ve looked at it, they don’t have enough evidence, they’ll hold off and come back to it a little bit further down the line.
We’ve had a couple of [Brexit] lobbies emerge… financial lobbies campaigning for a good deal for the industry. [Has Invest Europe] been involved in talks? Have you been consulted?
Frankly all three of the European institutions, Council, Commission and Parliament, have a role. Once Article 50 is triggered – and once there is a process up and running – I’m sure we will want to be speaking to representatives of all three of those bodies, at both the technical level and the more political level. But it’s way too early for any of that, and frankly until Article 50 is triggered, the appetite from the EU of having those kinds of conversations is going to be fairly limited.