Structures and strategies for private credit funds
France Johnson
K&L Gates, Charlotte
Report on ‘Private Credit Funds Structuring Considerations’, a session at the 25th Annual IBA/ABA US and Europe Tax Practice Trends conference in Amsterdam.
Thursday 10 April 2025
Session chairs
Thierry Lesage Arendt & Medernach, Luxembourg
Gal Shemer Kirkland & Ellis, London
Speakers
Christine Fauroux Ardian, London
Ailish Finnerty Arthur Cox, Dublin
Caleb McConnell Simpson Thacher & Bartlett, London
Jan Neugebauer Arendt & Medernach, Luxembourg
Veronika Polakova Debevoise & Plimpton, London
Adam Tejeda K&L Gates, New York
Introduction
Gathering legal experts from the United States and across Europe, the panel convened to discuss structuring considerations, strategies and other emerging issues relevant for private credit funds.
Panel discussion
Co-chair Gal Shemer began the discussion by inviting the panel to compare and contrast various European vehicles commonly used in private credit funds. Setting the stage, Caleb McConnell explained that: ‘Given the fundamental role for a tax fund structure is to at least deliver to your investors the same tax treatment that they would get if they had invested in the asset directly, and possibly get a better result, one of the most important questions when structuring credit funds is where the lending platform is going to be best.’
Emphasising that ‘no one size fits all’, McConnell noted that determining a fund’s structure is fact dependent, taking into consideration factors like treaty entitlement. McConnell then introduced the ‘new kid on the block’, the UK qualifying asset holding company (QAHC), which he reported to be a promising vehicle for treaty analysis so long as the beneficial ownership requirements can be substantiated.
Speaking from an industry perspective, Christine Fauroux highlighted how fund managers must balance the ‘commercial tension’ between qualifying for certain vehicles and pursuing ‘important investment opportunities’. For example, achieving a congruent ownership threshold to qualify for a certain vehicle can be difficult if the pool of potential investors is diverse. She also noted that straying from previous structures to use new or ‘relatively untested’ vehicles can be difficult to justify both internally administratively and externally to investors, potentially complicating or prolonging fundraising.
Turning to Luxembourg and Irish vehicles, Jan Neugebauer described the flexibility provided by Luxembourg’s société à responsabilité limitée (SARL), société en commandite spéciale (SCSp) and securitisation vehicle (SV), while Ailish Finnerty offered Ireland’s Section 110 company, Irish collective asset-management vehicle (ICAV) and investment limited partnership (ILP) as alternatives. Specifically, Finnerty indicated that, ‘in terms of the Irish Section 110 […] Ireland has a strong treaty network [and] there is a lower risk of beneficial ownership or substance challenges with it’. On the other hand, ‘the Irish ICAV is a regulated platform and there may be more question marks around its treaty entitlement’.
The panel then shifted to discussing US tax issues involved with activities undertaken by private credit funds, including the risk of generating income for non-US investors that is effectively connected with a US trade or business (effectively connected income or ECI). ECI can be triggered by loan origination activities, debt modifications and certain delayed drawdown facilities.
Veronika Polakova explained that not only does ECI expose non-US investors to a tax return filing obligation in the US, it subjects a non-US investor to federal tax on its net income at the same rates as US taxpayers (ie, up to 37 per cent for individuals and 21 per cent for corporations) as well as potential state and local taxes. Polakova noted that the determining of whether a non-US investor is engaged in a US trade or business is a ‘factual analysis that requires looking at the type and the frequency of the activities that the non-US investor is engaged in’. Adam Tejeda stated that: ‘While we do not have a lot of guidance as to what exactly gets over the line, a fund that is originating 100 loans per year in the United States is clearly going to be engaged in US trade or business, but the market practice says three to five loans per year generally should not qualify as being engaged in a US trade or business.’
Polakova introduced four strategies commonly utilised to mitigate ECI in this context:
- using a levered blocker;
- implementing a season-and-sell arrangement;
- relying on a treaty-based structure; and
- using a real estate investment trust (REIT) fund.
Providing an overview of each, Polakova highlighted that:
‘The simplest structure to implement is the levered blocker structure, but the downside of it is that it comes with some tax leakage. The second season-and-sell structure comes with some operational burdens and restrictions where the sponsor has to be willing to follow certain guidelines in making its investments. The third structure relies on treaty eligibility by a fund vehicle that the sponsor sets up or relying on treaty benefits that the investors in the fund are entitled to. The last structure involves a real estate investment trust in the US that is appropriate in certain real estate contexts.’
Polakova and Tejeda then provided a detailed description of each alternative structure alongside visual depictions.
Tejeda emphasised that, while there is little to no tax leakage in a season-and-sell structure, economic leakage could result from the need to comply with strict tax guidelines, involve an independent investment professional and undertake regular appraisals. Polakova also noted that a key concern in treaty structures is whether a manager, as the agent, can be considered ‘independent’ of the investor, as the principal, such that its permanent establishment is not attributed to the principle. Two components are involved in this analysis: whether the agent is (1) economically independent and (2) legally independent.
Tejeda explained that, in demonstrating an agent’s economic and legal independence, ‘the [treaty structure] works better for sponsors that are well established and manage multiple products’ compared to ‘first-time managers who may have a harder time establishing that this is their true business and that they’ve been doing it for a period of time’. Tejeda also pointed out other treaty eligibility hurdles, such as establishing residence, qualifying under the limitation on benefits provisions, and complying with anti-treaty shopping and base erosion prevention efforts. Wrapping up the overview of alternative structures, Tejeda briefly mentioned that ‘a REIT fund is an iteration of a levered blocker that is a bit more efficient for real estate and certain debt structures.’
Before concluding, McConnell previewed new proposed UK regulations that would classify all carried interest as ‘trading income’, which is deemed a profit of a trade carried on in the UK and subject to a maximum rate of 47 per cent. This emerging issue presents administrative complexity and compliance costs, impacts treaty analysis and could act as a potential deterrent to UK-based managers, as noted by McConnell and Fauroux.
As discussed by the panellists, the possible structures for private credit funds are dynamic and complex, involving key factual drivers such as where the lending vehicle should be organised, the composition of the investor base and the overall strategy and goals of the fund. Careful planning and analysis are important to optimising tax planning and minimising uncertainty as this global industry continues to evolve.