OECD-led tax changes are around the corner

Private investment fund managers must get up to speed now with OECD-led measures to tackle international tax avoidance and get ready for potential closer scrutiny of tax affairs, tighter tax laws and searching questions from investors.

The OECD released its final Base Erosion and Profit Shifting (BEPS) package for reform of the international tax system last year. It was the culmination of a long-running consultation to tackle perceived corporate tax abuses on a global scale.

Against that backdrop, ensuring that the BEPS measures are implemented appropriately and do not have unintended consequences for private investment fund managers and their investors, such as pension funds and insurers, is a top priority for Invest Europe. But fund managers also need to educate themselves about the OECD measures now in order to understand how they may affect their operations and relationships with investors. I anticipate it will be a hot topic for discussion when I attend the CFO Forum in Munich on May 24/25.

Two key measures within the OECD package have the greatest potential impact on private investment funds and their portfolio companies. The first is Action 6 which deals with treaty abuse and access to bilateral tax agreements. This action still needs clarification from the OECD – primarily on how the proposed measures restricting access to tax treaties should affect funds which are “non-CIVs” i.e. funds, including alternative investment funds, which fall outside the OECD’s collective investment vehicles definition. Most recently, the OECD has received some 500 pages of responses from interested parties, indicating the level of interest in this aspect of the Action 6 proposals. We can expect the OECD to publish its response and recommendations sooner rather than later, as it intended to complete its work in the first part of 2016.

The second point is Action 4 on deductibility of interest. Currently, different countries take different approaches to restricting deductions for interest: some countries already limit net interest deductions to a fixed proportion of company EBITDA, while others may use arm’s length tests or other methods to limit excessive deductions. The aim of Action 4 is to harmonise international standards in this area, with the OECD recommending an approach based on a fixed ratio (between 10% and 30%) of EBITDA. There are other BEPS actions that may impact some firms or investment structures depending on their particular fact patterns – including Action 7 on permanent establishment, Actions 8-10 on transfer pricing and Action 2 on hybrids.

For the BEPS recommendations to become a reality, each country which intends to take part in this push to modernise the international tax landscape now has to construct its own legal framework that reflects the OECD’s guidance. This will take time and while there are uncertainties around the extent to which the proposals will be implemented by certain countries, the political momentum in other countries means managers should not expect foot-dragging or delay.

The European Union is working on its own Anti Tax Avoidance Package (ATAP), with the Commission proposing a directive to coordinate tax approaches across its 28 member states. Interested parties are waiting to see how it will be received by member states. Meanwhile, the OECD is proposing a multilateral instrument that could alter all tax treaties at a stroke and avoid years of individual treaty negotiations. So, alongside a general shift in the standards by which tax planning is judged, significant changes to tax laws could be just around the corner and fund managers need to review these potential changes now to evaluate the effect they may have on the way their funds and investments are structured.
It is not only the potential for change in tax laws that firms need to prepare for. Many investors are delving deeper into the tax affairs of the funds in which they invest. They want reassurance that funds are compliant and transparent in their tax dealings. They also want to know that fund managers are aware of the potential effect of BEPS measures on their funds and investments, and are considering how to manage the impact, if any, on returns.

Some larger fund managers with in-house tax operations and legal teams are already preparing for potential new tax rules, but all managers also need to get up to speed on BEPS. By doing so, they can be ready to adapt swiftly to tax-related changes while reassuring investors that they are employing best practice in this changing tax landscape.

Catherine Sear is Partner at Proskauer and a speaker at this year's Invest Europe CFO Forum.