The potential impact of BEPS on Private Equity and the opportunities for the Channel Islands
Since July 2013, the Organisation for Economic Co-Operation and Development has been leading a worldwide review of the international tax framework, in response to growing pressure from tax authorities, governments and the media over tax avoidance by large businesses. This Base Erosion and Profit Shifting (BEPS) agenda is focused on changing the tax rules to ensure that companies pay their ‘fair share’. The changes will affect all global businesses, including those in the Private Equity world. While offshore locations are typically seen as potential targets of the BEPS agenda, for some locations this threat could be turned into an opportunity. Jersey and Guernsey could well be among the territories that are well-placed to help businesses weather the current storm.
What has happened?
Last July, following a call from G20 leaders to fix perceived flaws in the international tax system, the OECD issued a 15-point BEPS Action Plan. The OECD set an aggressive deadline, planning to provide a full response by December 2015. Work has proceeded at an unprecedented pace and the OECD issued the first set of recommendations and guidance papers this September. Although not final, these papers largely represent a consensus view among the OECD and G20 members, as well as a number of other countries, such as India and China.
This has already led to a material shift in the behaviour of tax authorities and there have been a number of unilateral changes in tax rules. In addition, the European Commission has become increasingly active, as seen in the recent state aid investigations into Apple, Starbucks and Fiat. The OECD’s BEPS programme has focused on three main ‘pillars’, which are outlined in more detail below:
Substance – The OECD has several actions focused on ensuring that businesses have the appropriate ‘substance’ (e.g. sufficient numbers of employees with the right qualifications, boards with the right capabilities to exercise their powers, adequate capital to manage the risks attributed to a specific entity, etc.) in any location, but especially where the business is claiming a tax benefit in that location. For example, tax authorities will be challenging whether the relevant activities and Board competencies of regional holding companies or entities justify the level of return being received in those entities.
Disclosure – The OECD has issued recommendations for a country-bycountry report to be provided to all tax authorities in locations where a business has operations. For each country, this report will summarise revenues, taxable profits, employees and other metrics, giving tax authorities an unprecedented level of information on businesses. Some countries, such as the UK, have already formally committed to implementing a country-by-country reporting framework.
Coherence – Here the actions are focused on existing regimes that allow companies to achieve double non-taxation or other benefits due to differences in the domestic tax rules of different countries. In addition, there is a strong push to design rules that will prevent taxpayers taking advantage of favourable tax treaties, both through changes to the treaties and to local laws.
What are the impacts for Private Equity?
The BEPS initiative has put the tax affairs of all companies that operate internationally firmly in the public spotlight. While not directly aimed at Private Equity, the fundamental changes we are seeing in the international tax landscape will affect Private Equity like any other business.
In particular, Private Equity companies should be asking themselves whether they have adequate substance in entities (e.g. GP, AIFM) in relation to the functions that are the most important in driving the value of these operations.
The new disclosure requirements will likewise affect both Private Equity and portfolio companies with global operations. It will be important that information disclosed for these purposes aligns with regulatory filings and other information provided to tax authorities, as there is an increasing level of information sharing between governments and regulatory agencies around the world.
More helpfully, the OECD has acknowledged that certain BEPS actions, such as those focused on treaty abuse, could have unintended consequences on the financial services industry. As part of the ongoing refinement of its guidance, the OECD plans to ensure that collective investment vehicles are not unduly impacted, with a view of releasing policies by next September.
What are the impacts for Private Equity in the Channel Islands?
Despite the increasing scrutiny from tax authorities and ongoing uncertainty about how the OECD’s BEPS recommendations will be implemented, Jersey and Guernsey are well-placed to remain good locations for Private Equity.
The Channel Islands have long had clear and transparent tax systems, without the secret tax rulings and agreements that cause concern and have raised the risk of challenges like the state aid investigations by the European Commission. In addition, by having a comprehensive set of international agreements, Jersey and Guernsey have established a reputation of being fully compliant and cooperative with developing international standards. Although work is still needed to change lingering perceptions of the Channel Islands as a tax haven, the islands are increasingly regarded as some of the more transparent offshore financial centres and are well-placed to align with the OECD’s focus on greater disclosure.
Furthermore, the knowledgeable and experienced local populations, as well as the sizeable operations that many businesses have in the Channel Islands, provide excellent support for the local substance that businesses will increasingly need to demonstrate. Companies that have real substance and clear control of important functions will be in a good position to meet the growing challenges from tax authorities worldwide.
Already, a number of Private Equity businesses based in Jersey and Guernsey are re-evaluating their structures and looking to increase their presence on the island. Although companies may need to work slightly harder to achieve tax efficiency and mitigate reputational risks, the Channel Islands should remain a safe harbour in the midst of the current tax storm.
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