Funds (Session report from the 11th Annual IBA Finance and Capital Markets Tax Virtual Conference 2022)

Thursday 5 May 2022

Rui Hui Simone Hong

Chiomenti, Milan


Report on a conference session at the 11th Annual IBA Finance and Capital Markets Tax Virtual Conference 2022

Session Chair

Brenda Coleman Ropes & Gray, London


Paolo Giacometti Chiomenti Studio Legale, Milan

Thierry Lesage Arendt & Medernach, Luxembourg

Ailish Finnerty Arthur Cox, Dublin

Rafael Calvo Salinero Garrigues, Madrid

Ron Nardini Vinson & Elkins, New York


The panel discussed current tax issues and recent developments in fund structuring and new trends in investment strategies.

A new set of rules: European Union directive implementing Organisation for Economic Co-operation and Development (OECD) Pillar 2 and Anti-Tax Avoidance Directive (ATAD) 3

The panel started with Thierry Lesage discussing how Pillar 2 and the recent EU directive may be applied in the funds' context. Regarding the implementation of Pillar 2 in Europe, it was specified that a directive was proposed to have a more coordinated approach and to comply with certain European law principles. Subsequently, an example was provided of how Pillar 2 is going to work to ensure an effective tax rate of 15 per cent: having a Luxembourg entity as the ultimate parent company. Then, Lesage provided an overview of the general provisions of the draft of the directive implementing Pillar 2 in Europe, focusing on exclusion rules, which are not applicable in certain circumstances (eg, in the case of a joint venture).

Moving on to ATAD 3, Lesage confirmed that it will have an impact on fund structuring, and then focused on the applicable carve-out. However, he specified that various criticisms have been raised by the funds industry. For example, it has been highlighted that there are still general problems regarding scope and key definitions that need to be clarified to make the directive enforceable. Given the various issues, Lesage concluded that whether the directive will be adopted in the current form is uncertain and it will be very unlikely to meet the timeline.

Trends and development of Irish vehicles used for fund structuring

Ailish Finnerty started by giving an overview of typical Irish structures for private equity investment, typically structured using a Section 110 company or qualifying investor alternative investment fund Irish collective asset-management vehicle (QIAIF ICAV). In this regard, after a general description of the two types of vehicles, it was specified that a Section 110 company (unregulated entity) is easier to establish, but requires careful structuring to achieve a tax-efficient outcome. On the other hand, a QIAIF ICAV (regulated entity) is more expensive to establish and maintain, but has the benefit of being tax-exempt in Ireland.

Consequently, the discussion moved to an overview of recent developments that have impacted the Section 110 company type of structure. In this regard, the discussion was about anti-hybrid rules, specifying that the deduction of proper participation notes is denied in certain cases, as they are treated as an equity type of instrument.

In addition, concerning associated enterprises and for corporate benefit purposes, it was specified that Section 110 companies are typically held in a charitable trust, where they are consolidated with the noteholder. Subsequently, Finnerty discussed interest limitation rules that applied from 1 January 2022, focusing on exemption cases, and providing examples of the definition of interest. Given that such vehicles achieve a tax neutrality outcome by taking the deduction of proper participation notes, it seems that this rule will have a big impact.

Then, the discussion moved to the QUAIF ICAV (generally eligible for treaty benefits). Finnerty highlighted that this is also a very tax-efficient type of structure, considering that it can also hold non-financial assets, compared with the Section 110 company, which cannot. However, after providing an example of the operating structure, she highlighted that it is a more complex structure, but no less tax efficient.

Finally, Finnerty concluded that recent tax developments may have an impact on the use of vehicles in the EU and funds context, mentioning ATAD I and II, the Unshell directive, Pillar 2, debt-equity bias reduction allowance (DEBRA) and base erosion and profit shifting (BEPS)-related initiatives.

Recent developments in the United Kingdom

Brenda Coleman introduced the new UK qualifying asset holding company regime, which aims to make the UK a more attractive location to set up and manage funds. She explained that such a regime aims to recognise circumstances in which intermediate holding companies are used to facilitate the flow of capital, income and gains between investors and underlying investments. It was specified that it may be particularly attractive for debt funds where there is already substance in the UK and the will to get access to treaty benefits, and it is currently outside ATAD III, but in the future, the EU may issue additional proposals to tackle non-EU shell entities. Furthermore, Coleman explained that such a regime will probably work in general how it currently works in Luxembourg.

Focusing on private equity funds, Coleman mentioned that they also have the scope to work efficiently. In particular, considering the characteristics of such a regime, the aim of acquisition structures is often to put debt into non-asset holding companies (AHCs) to utilise group relief for interest deductions. Moreover, Coleman specified that there are no restrictions on the percentage ownership or holding period required to benefit from the participation exemption (hence, no gain on disposal), so it is a good structure for venture capital.

Coleman concluded the discussion by specifying that a way to repatriate capital is the repurchase of shares that get capital gain tax treatment for UK carry holders, confirming that it is a very attractive regime where there is substance in the UK.

Taxation of funds in Spain

Rafael Calvo Salinero talked about the context of the taxation of funds in Spain. He introduced the topic by first making a distinction between the treatment of domestic funds and foreign funds tax.

Indeed, Spanish funds can benefit from a special tax regime. On the other hand, foreign funds are generally taxed and do not benefit from a special tax regime (only EU undertakings for the collective investment of transferable securities (UCITs) are subject to special corporate tax at one per cent). However, various claims to the Spanish courts resulted in the Spanish Supreme Court granting refunds to foreign funds, treating them equally with domestic funds (however, such treatment is not provided in the Spanish tax law).

In relation to foreign Private Equity funds, Calvo Salinero specified that they are normally subject to the general rule (except in cases in which double tax treaties or EU benefits are applicable). He also highlighted that recent trends have seen funds increasingly treated as transparent.

Investment schemes in Spain are generally structured through an intermediate holding company in Europe (generally in Luxembourg). In this regard, it was mentioned that there is increasing scrutiny of anti-abuse regulations and the need to comply with three pillars: (1) good business reason; (2) substance; and (3) be the beneficial owner.

Historically, private equity funds have focused on equity divestments, therefore relying on capital gains (not being subject to tax under domestic law). On the other hand, the most recent trend has been minority investment in big listed companies, and therefore dividend exemption has become very relevant.

The discussion concluded with a brief focus on real estate companies in Spain, highlighting heavier discrimination for such entities. A capital gain exemption for EU and European Economic Area (EEA) investors does not apply to shareholdings in Spanish real estate entities. This is the reason that structuring real estate investments is seen very often through a Spanish holding company.

Italy: how funds are typically invested in Italy

Paolo Giacometti talked about the structuring of investments in Italy and related tax issues from the perspective of Italy as the target jurisdiction for investments. In this regard, he highlighted that most Spanish tax issues are very similar in Italy.

Then, Giacometti identified the main issues in repatriation and disinvestments, which may differ depending on the type of fund (withholding tax on dividends for UCITs; repatriation and exit strategies for private equity; and capital gains on disposal of assets for real estate funds). However, Italy provides several exemptions under certain conditions. In fact, Giacometti highlighted that it is very important to structure the investment in a tax-efficient way, but also to avoid any challenges by tax authorities, which have been very aggressive in recent years.

Then the discussion moved into the detail of UCITs, where the changes compared with past years were highlighted (now EU UCITs are fully exempt from domestic withholding tax), specifying, however, that discrimination remains for non-EU funds (including UK funds).

In addition, Giacometti also mentioned a very interesting decision in which, for the first time, the competent court decided that a Luxembourg société d'investissement à capital variable (SICAV) is entitled to tax refunds.

With reference to private equity funds (generally not entitled to benefit from exemption), Giacometti pointed out significant issues with the recognition of the transparency of the structure for Italian tax purposes. Indeed, subject to certain conditions, Italian tax authorities shall recognise the transparency of the foreign entity, but from a practical standpoint, it seems that Italian tax authorities are quite reluctant to recognise it.

In relation to investment structures, Giacometti pointed out that, typically, investments are structured through an intermediate European holding company. An important Italian milestone is that, as of January 2021, qualifying alternative investment funds (AIFs) benefit from a domestic exemption. In such a case, the use of an intermediate company may not be necessary, removing the risk of challenges made by tax authorities. Then Giacometti concluded the discussion by highlighting increasing trends in the use of these AIFs, including as sub-funds of non-alternative investment fund manager (AIFM) compliant master funds.

Tax challenges associated with the latest investment strategy trends

The last topic that the panel focused on related to the latest investment trends and related tax issues. Ron Nardini first illustrated that the investment strategies of funds are now focused on loan origination, real estate, infrastructure, shipping and aircraft, digital currency and investment in the entertainment industry.

With reference to loan origination, Nardini mentioned that credit funds now invest in units of both the debt and equity of the borrower. He specified that, in this case, tax issues, specifically in the United States, are identified within the origination of loans that may create a taxable nexus in the US. However, it was specified that, in the US, interest barrier rules do not apply, and the typical structure uses a mutual fund in a treaty jurisdiction (generally the Irish ICAV). He also pointed out that US mutual funds are not popular because they are designed for funds going public and are therefore not very efficient for private equity funds.

In relation to real estate, Nardini highlighted the popular trend (albeit not very efficient from a tax perspective), which mainly focuses on different types of asset classes (eg, warehouses for industrial activities, multi-family houses for short-term renting and movie studios related to the entertainment business).

With reference to infrastructure, it was pointed out that trends increased exponentially, also thanks to the strong support of governments. In this regard, relevant opportunities are connected to energy transition and decarbonisation, which includes renewable energy, storage facilities and digital infrastructure.

Another relevant investment trend is related to digital currency. In this regard, Nardini confirmed that, to date, the digital currency asset class is very challenging and tax legislation is not substantially developed yet, even in the US.

A very popular recent investment trend is related to shipping and aircraft. In such a case, an important issue raised by Nardini is related to aircraft flying from/to Russia in light of the sanctions in force, which may create tax issues.

With reference to the entertainment industry, Nardini pointed out that a very tax-efficient structure is necessary for such types of investments because royalties are taxed on a gross basis.

The last popular asset class was identified in secondary funds, which, according to Nardini, are particularly appealing to managers because they allow them to gain time to increase value in underlying portfolio companies. In this regard, Nardini specified that this may create various tax issues because the tax composition may differ from the buyer or seller perspective.