31 August 2016

AIC: PwC on private equity deals in the new international tax environment

Like the American Investment Council, PwC is actively advocating on behalf of the PE industry by submitting comment papers and recommendations to the OECD addressing the BEPS proposals.

The changing tax landscape has created a plethora of tax risks and opportunities that can have a material impact on deal valuations. The international tax landscape is on the cusp of a significant change, spearheaded by the OECD-led Base Erosion and Profit Shifting (“BEPS”) project. Whilst the private equity (“PE”) industry is not the primary focus of the BEPS initiative, it will be impacted by these developments and in some cases may suffer from unintended consequences.

Like the American Investment Council, PwC is actively advocating on behalf of the PE industry by submitting comment papers and recommendations to the OECD addressing the BEPS proposals. Although not all proposals have been finalized, what is clear is that these changes will impact the pricing, valuation and risk profile of existing and future transactions. That said, there are still opportunities on the horizon as those fund managers best equipped to navigate the shifting landscape and myriad changes will enjoy a natural competitive advantage over those who are more reactionary.

While it may take considerably longer for the full impact of these changes to materialize in practice, there are indications that the BEPS project and related developments are already leading to a material shift in the behavior of tax authorities. In addition to the changing behavior of global tax authorities, we are seeing real legislative change, inspired in some cases by the BEPS proposals, such as the introduction of the diverted profits tax in the UK in its 2015 Finance Bill, anti-hybrid rules, and more recently, the EU Member States’ political agreement on the Anti-Tax Avoidance Directive (“ATAD”) which is due to become effective in the Member States in 2019, to name a few. This shift will impact all aspects of the deal, including how deals are sourced, how they are structured, the related compliance, and ultimately the internal rate of return (“IRR”) of the transaction. In short, BEPS will have implications which are much broader than just tax.

Tax planning within a PE fund that was effective when investments were initially structured may no longer deliver the intended results. To the extent an exposure crystallizes, this could adversely impact the investors, future management fees and returns/carry earned by the PE fund’s GP, not to mention the reputational impact for the PE manager, an outcome which could have broader consequences.

There will also be greater challenges in determining the correct effective tax rate for a portfolio company to be included in the deal model as a result of BEPS. PE managers eager to protect their investments should look to engage with their multi-national portfolio companies to help them to navigate the greater risk and uncertainty in a post-BEPS world. Further, PE managers should be aware that there may potentially be a greater risk of unrecorded liabilities in target companies as a result of potential future BEPS related challenges.

Full press release

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