Private Equity European Bulletin

Transcription

1 Private Equity European Bulletin February 2006 Thin Capitalisation Across Europe

2 UNITED KINGDOM Recent changes to the UK tax regime may deny or defer tax deductions for fi nancing costs on loans made by investors to private equity bid vehicles, and will increase the on-going UK tax burden suffered by investee companies after acquisition. The changes impact in three areas: Loans made by partnerships and other co-investors Previously, the UK thin cap rules treated a partnership fund as transparent with the result that the fund was not caught by the rules. Now, this has changed and persons acting together in relation to a fi nancing of a company will be treated as a single person. Impacts include: > Interests of all investors in a fund will be aggregated. So if the fund controls Bidco, the thin cap rules will apply. > Parallel fund structures will also be caught, with interests aggregated if acting under control of same manager. > Consortium bids likely to be caught in many cases, but will require scrutiny. > Useful to get bank quotes to show that loan comparable to arm's length loan. Zero coupon and other yield roll-up debt The general position remains unchanged where a loan is made by a controlling fund, tax deductions for rolled up interest are deferred until the interest is paid. Exemptions that were previously utilised by funds have effectively been removed, with the result that interest deductions will be deferred (possibly indefi nitely) on many private equity transactions. It may be possible to avoid these rules by using PIK notes. Hybrid debt / equity instruments Cross-border acquisition structures sometimes use hybrid instruments eg. where interest paid on a loan to a UK Bidco is deductible, but the overseas lender receives a tax-free receipt of dividend income. The new rules generally result in the interest no longer being deductible, unless Bidco can demonstrate that UK tax avoidance is not one of the main purposes of the structure. FRANCE The Finance Bill 2006 has deeply modifi ed the French thin capitalisation regime. The new regime will come into effect for fi nancial years starting on or after 1 January 2007 and is expected to impact materially on the structuring of investments in France. The main features of this new regime are as follows: > Scope: The new regime will apply to all debts owed by a French company to group-controlled entities, regardless of where those entities are located (France, EU or outside EU). Loans made by third parties (banks, etc.) should generally remain outside the scope, even if such loans are guaranteed by any entity in the borrower's group. > Disallowance or deferral of the tax deductible interest: - Tax deductible interest will be assessed by application of (i) an interest rate limitation based on market practice, (ii) 1.5:1 debt-to-equity ratio and (iii) a 25% interest-to-operating profi t ratio. - Interest disallowed pursuant to the fi rst limitation will defi nitely be lost for tax purposes. - Interest disallowed under limitations (ii) and (iii) for a given fi nancial year may be deducted in the following fi nancial year or, subject to a yearly 5% reduction, the fi nancial years thereafter. > Safe harbour: Limitations (ii) and (iii) do not apply if the borrower can demonstrate that its own debt-to-equity ratio does not exceed the debt-to-equity ratio of the group to which it belongs. > Exemptions: These may apply under specifi c circumstances (cash pooling agreement, fi nance lease transactions, etc.). > French tax consolidation: Favourable rules apply to a French tax consolidated group which will be deemed to form a single entity for the assessment of the 25% interest-to-operating profi t ratio. > Disallowed interest: This will not be treated as a deemed dividend, so that the French withholding tax exemption that usually applies to interest paid to foreign lenders should remain applicable, despite the non-tax deductibility of the interest at the level of the borrower.

3 GERMANY According to the thin capitalisation rules, fi nancing expenses for certain shareholder loans may be non-deductible and recharacterised as deemed dividends. Withholding tax will arise and may be refunded to certain shareholders. General scope and safe harbour > The rules apply to loans (excluding short term loans) made by a signifi cant shareholder (or related persons), irrespec tive of whether such share holder is tax resident in Germany or not. They do not apply if the aggregate consideration (i.e. total return) on the shareholder loans is less than 250,000 per annum. > A signifi cant shareholder must hold directly or indirectly (e.g. via a partnership), alone or jointly acting in association with other share holders, more than 25% of the capital of the borrower. > Fixed interest will not be treated as a deemed dividend if it can be demonstrated that the loan would also have been made by an inde pen dent party. Further, the rules provide for a safe harbour for shareholder loans where the debt-toequity ratio is 1.5:1 or better. > Safe harbour is provided only for fi xed interest loans; variable interest and hybrid loans are excluded. Loans made by third parties (banks etc.) Loans made by a third party may also fall under the rules. This should only apply to back-to-back fi nancing structures where the signifi cant shareholder (or an entity affi liated thereto) maintains a long-term deposit and (i) such deposit is given as a security for the loan or (ii) the holder of the deposit provides a guarantee for the loan and agrees to restrictions on the disposal or forfeiture of the deposit. The borrower would have to prove by a certifi cate issued by the lender that no backto-back fi nancing exists. Loans made for an intra-group acquisition of shares The thin capitalisation rules disallow the deduction of interest payments on certain loans made for an acquisition of shares from a related party, notably in cases where the lender is a signifi cant shareholder of the acquiring company. ITALY Tax reforms in 2004 introduced two sets of rules limiting the deductibility of interest expense for Italian companies. Thin cap rule The rule provides for the non-deductibility by a borrower of interest on loans received from or guaranteed by qualifi ed shareholders and related parties when the amount of indebtedness of such borrower in a given taxable year exceeds four times its equity. > A qualifi ed shareholder is a shareholder that holds directly or indirectly the majority of the voting rights or at least 25% of the share capital in the borrower. > Companies in which a qualifi ed shareholder holds a controlling interest are considered related parties. > Here equity means the net equity of the previous fi nancial period reduced by (i) unpaid capital; (ii) book value of own shares; (iii) uncovered operating losses, and (iv) a further amount related to the value of participations. Non-deductible interest is treated as a dividend in the hands of the qualifi ed shareholder or related party lender. Banks and other fi nancial companies are not subject to thin cap rules. Assets ratio rule The rule (so called pro rata patrimoniale ) limits the deductibility of interest on loans obtained to fi nance the acquisition of shares qualifying for the participation exemption. If the book value of the investment in subsidiaries qualifying for the participation exemption regime exceeds the net equity, interest deduction will be limited on the basis of a specifi c formula. For this purpose net equity is adjusted to account for unpaid capital and uncovered operating expenses. Impact on private equity investments No exceptions to the rules exist for private equity investments made through Italian companies. However, the above rules do not apply to funds making private equity investments.

4 SPAIN Under the Spanish thin capitalisation rules, interest paid on loans made by non-resident related private equity funds (or other companies or individuals) may be considered dividends and therefore be treated as non-deductible for Corporate Income Tax purposes. > Scope: The thin capitalisation rules apply to interest paid by Spanish resident companies on loans made by non-resident related entities or individuals. Interest paid on loans made by EU related entities or individuals is excluded from this regime (except for entities or individuals resident in a territory listed in Spanish law as a tax haven). A thin capitalisation situation exists when, at any time during the fi nancial year, the net interest-bearing debt, direct or indirect, of a Spanish borrower (other than a fi nancial institution) to non-resident related parties exceeds three times the equity of the Spanish company (excluding the profi t/loss of the current year). This equates to a debt-to-equity ratio that exceeds 3:1. In order to calculate the thin capitalisation of a borrower, both the net interest-bearing debt and the equity shall be taken at their average fi gure over the fi nancial year. > Tax consequences: Interest related to the portion of debt in excess of the 3:1 debt-to-equity ratio shall be deemed a dividend and therefore shall not be deductible for Corporate Income Tax purposes. > Safe harbour: The borrower may submit a proposal to the Tax Administration for the application of a higher debt-toequity ratio. The proposal must show that the same level of indebtedness and similar conditions could be obtained from non-related third parties (except for loans granted by entities or individuals resident in a country or territory listed in Spanish law as a tax haven). Withholding tax As a general rule, interest derived in Spain by non-resident entities or individuals is subject to a fi nal withholding tax at a rate of 15% (possibly reduced by a double taxation treaty). Interest derived by EU residents (not acting in Spain through a permanent establishment and not resident in a tax heaven) is exempt from withholding. SWEDEN General Sweden does not have any tax rules on thin capitalisation and interest is generally deductible without limitations. Case law makes it clear that debt cannot be recharacterised into equity because of a high debt-to-equity ratio. Sweden does not, under its domestic tax laws, impose withholding tax on payments of interest. Sweden has a system for group consolidation for tax purposes which effectively makes it possible to set off interest in a leveraged Swedish acquisition vehicle against profi ts arising in Swedish operating target companies. Since there are no limitations as to the deductibility of interest, the whole acquisition cost can in principle be pushed down to be off set against profi ts of the operating companies. Should the interest exceed the income, losses can be carried forward indefi nitely. The absence of thin capitalisation rules, generous participation exemption rules on dividends and capital gains on shares, and the fact that Sweden does not levy stamp duty or any capital taxes on transfer of shares, makes Sweden an attractive jurisdiction for holding companies. It should be noted that the Swedish participation exemption rules on dividends and capital gains also apply to investments in foreign companies, and that there is no requirement as to the taxation in the state of source. In addition, there is generally no withholding tax on dividends paid by Swedish companies (unless paid to a tax haven etc.). Thus Swedish holding companies are often advantageous even if the target company is foreign. Hybrid debt/equity instruments There are certain limitations as to the deductibility of interest on participating debentures (loans where the interest depends on the profi ts and/or distributions of the borrower) if the lender and the borrower are affi liated. Unless these restrictions apply, interest on hybrid debt is normally tax deductible and not subject to withholding tax. Since dividends from a Swedish entity paid to a tax haven are subject to Swedish withholding tax at a rate of 30%, it may be attractive for a foreign investor to invest through hybrid debt instead of equity. However, there are other structures available to avoid Swedish withholding tax, such as interposing a foreign company.

5 This Bulletin is a joint product of the European Private Equity Group of our network of leading independent firms in France, Germany, Italy, Spain, Sweden and the UK. france Bredin Prat Olivier Assant 130 Rue du Faubourg Saint-Honoré, Paris +33 (0) olivierassant@bredinprat.com germany Hengeler Mueller Peter Weyland Bockenheimer Landstrasse Frankfurt Postfach Frankfurt +49 (0) peter.weyland@hengeler.com italy Bonelli Erede Pappalardo Giorgio Fantacchiotti Via Barozzi, Milano +39 (0) giorgio.fantacchiotti@beplex.com spain Uría Menéndez Christian Hoedl Jorge Juan, Madrid +34 (0) che@uria.com sweden Mannheimer Swartling Peter Alhanko Norrmalmstorg 4 Box 1711 SE Stockholm +46 (0) pa@msa.se uk Slaughter and May Mark Horton One Bunhill Row London EC1Y 8YY +44 (0) mark.horton@slaughterandmay.com