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

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1 Asset Management Private Equity Club 2009 Facing today, tomorrow and the day after* *connectedthinking 1

2 Tax: Planning for the 50% income tax and VAT issues on Private Equity transactions Ashley Coups Private Equity Assurance Leader, Slide 2 2

3 Tax: Planning for the 50% income tax and VAT issues on Private Equity transactions Tim Hughes Director, Darren Docker Director, Slide 3 3

4 Agenda/Contents Background 2009 budget Typical Adviser / Manager structures Alternative strategies Moving the adviser Conclusions 4

5 Agenda Background 2009 budget Typical Adviser / Manager structures Alternative strategies Moving the adviser Conclusions 5

6 Background 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 Slide 6 6

7 Agenda Background 2009 budget Typical Adviser / Manager structures Alternative strategies Moving the adviser Conclusions 7

8 2009 budget Budget 2009 From April 2010 income > 150,000 will be subject to income tax at 50% (40% for income 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 Slide 8 8

9 2009 budget Income Earned income (i.e. salary and equivalent) as well as investment income (primarily loan interest). But earned income is the most sensitive area. Why? Carried interest, and potentially co-investment profits are usually sourced from gains (18%). Investment income is taxed for UK non-domiciled executives on a remittance 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 for temporary residents that carry out some work overseas) Slide 9 9

10 Agenda Background 2009 budget Typical Adviser / Manager structures Alternative strategies Moving the adviser Conclusions 10

11 Typical Adviser / Manager structures How UK advisers / managers are structured LLPs Companies Branches of non-uk entity (unusual for admin / PE reasons ) Slide 11 11

12 Typical Adviser / Manager structures Conversion of corporate to LLP Avoids impact of employment related security rules - key to a number of planning initiatives. Fundamentally changes UK tax valuation verticals. No employer s NIC on a partner s drawings annual saving equal to 12.8% of salary/bonus equivalent Separate legal personality and limited liability while being transparent for tax purposes Increasingly the standard structure for private equity fund managers in the UK Can trigger (sometimes) unhelpful tax connection between executives Slide 12 12

13 Typical Adviser / Manager structures Key Consequence of 2009 Budget for UK executives Earned income, be it salary and bonus (employees of a company); or fixed and variable 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 (in the medium term at least)? Slide 13 13

14 Agenda Background 2009 budget Typical Adviser / Manager structures Alternative strategies Moving the adviser Conclusions 14

15 Alternative strategies 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 Slide 15 15

16 Alternative strategies Three Strategies (continued) Defer compensation tax point Payments through Employee Benefit Trusts Unapproved pension plan Management fee waiver Other (e.g. CFD) Slide 16 16

17 Alternative strategies Personal planning opportunities EIS VCT Gift Aid Debt investments Negligible value claims etc etc Slide 17 17

18 Alternative strategies Double LLP Apportionment of 8m investment profits (Potentially 18% tax) PE Executive Partners Apportionment of 5.8m trading profits (40% tax) 2009/10 (50% tax) 2010/11 Cost 6m Managers LLP Fee 11.8m Member Co Assume costs of 200k Profit share 12m GP LLP FUND LPs 1billion 20m Fee Structured as priority profit share ( PPS ) Portfolio Companies Slide 18 18

19 Alternative strategies Double LLP Typical UK / European private equity arrangements - Annual management fee is paid by the fund to its general partner as a Priority Profit 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 to key 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 underlying character of profits Slide 19 19

20 Alternative strategies Introduce executive-owned corporate LLP member, and extract profits Equity New Co Ltd Profit Share Trading LLP Slide 20 20

21 Alternative strategies Introduce executive-owned corporate LLP member, and extract profits Company pays tax at 28% (or 21% if a small company ) not 50%, no social security 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. Slide 21 21

22 Alternative strategies Deliver value for non-doms through shares in offshore GP / Manager PE Executive Partners Managers LLP Shares Fee 11.8m Profit Share 20m Offshore GP Co FUND LPs 1billion Portfolio Companies Slide 22 22

23 Alternative strategies Deliver value for non-doms through shares in offshore GP / Manager Increase return from offshore GP and reduce UK taxable income where the GP is an offshore company and a fee is paid to a UK manager Remittance basis of taxation for non-uk domiciled executives allows zero tax extraction of profit from the offshore company Subject to transfer pricing analysis Slide 23 23

24 Alternative strategies Dual contracts The idea - Allocation of multiple roles to non-uk domiciled UK resident executives (either dual contract or dual partnership interest) where it is possible to clearly segregate UK and non-uk duties - If implemented correctly, non-uk domiciled executives will only pay tax on duties 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 Slide 24 24

25 Alternative strategies Payments through Employee Benefit Trusts Members Allocation of profit Co Loans Contribution to EBT to employees Trading LLP Offshore EBT Slide 25 25

26 Alternative strategies Payments through Employee Benefit Trusts Where Advisor is a LLP, introduce a corporate partner taxed at 21%/28%, and it contributes 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 free amount (a taxable benefit in kind arises due to absence of interest) Taxable when loan is written off potentially a deferral and bet on falling income tax rates. CT deduction only when taxable on exec. Not taxed if released on death, loan also diminishes value of UK estate for inheritance taxes Disadvantages This would involve making some LLP members employees of the corporate member, and this would mean that shelter from ERS rules A long term arrangement and not really seen before in private equity Slide 26 26

27 Alternative strategies Unapproved pension plan Where Advisor is a LLP, introduce a corporate partner taxed at 21%/28%, and it contributes 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 EFRBS possible, UK company gets a tax deduction at that point Disadvantages Depending on anticipated retirement this is a more long term arrangement and not really used previously in private equity Slide 27 27

28 Alternative strategies Waiver of management fees to commute co-investment obligations 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 on behalf 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. Slide 28 28

29 Agenda Background 2009 budget Typical Adviser / Manager structures Alternative strategies Moving the adviser Conclusions 29

30 Moving the adviser 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 considered carefully Slide 30 30

31 Moving the adviser Leaving the UK Tax issues to consider Practical 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 permanent establishment, etc Indirect taxation Regulatory requirements Investor perception Cost of living Schools Infrastructure Red tape Transport Language Office space Housing Weather (!) Slide 31 31

32 Moving the adviser Summary Channel Islands Employee taxation Carry Direct taxation of manager Indirect taxation of manager Investors Ireland Luxembourg Monaco Netherlands Switzerland UK Slide 32 32

33 Agenda Background 2009 budget Typical Adviser / Manager structures Alternative strategies Moving the adviser Conclusions 33

34 Conclusions UK tax environment deteriorating for execs whose comp has a significant earnings component. 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? Slide 34 34

35 Tax: Planning for the 50% income tax and VAT issues on Private Equity transactions Stephen Morse Partner, Slide 35 35

36 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 36

37 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 Slide 37 37

38 Deal fee VAT recovery Taxpayer can recover so much of its input tax for the period that is attributable to taxable supplies Input tax is VAT incurred on the supply to the taxpayer of goods or services used or to be used for a business purpose Substantial body of case law: Redrow Loyalty Management Town and County Factors Eagle Trust Poladon Mono Global Telent Slide 38 38

39 Deal fee VAT recovery 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 Slide 39 39

40 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 Slide 40 40

41 Questions This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law,, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any 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 All rights reserved. PricewaterhouseCoopers refers to (a limited liability partnership in the United Kingdom) or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. 41

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

Private Equity Club 2009 Facing today, tomorrow and the day after* Facing today, tomorrow and the day after* *connectedthinking PwC Tax the latest thinking on structuring, VAT and other developments Ashley Coups Private Equity Assurance Leader, Private Equity Club Slide