EMPEA Guidelines – 3
3. Clear, consistent and internationally competitive taxation
Markets optimal for private equity investment also feature tax systems that promote the long-term growth of capital and allow foreign and domestic private equity investors to pool their capital in an investment vehicle. Key features of such tax systems minimize the risk of onerous treatment of foreign investors, e.g., protection from additional or double taxation at the level of the vehicle or on distributions by the vehicle as well as certainty with respect to the local tax liability. Tax filing obligations in such systems are not unnecessarily onerous and there are minimal delays in refunds of withholding tax where a country agrees not to exercise its taxing right in respect of payments to, or on disposals by, foreign investors.
Specific aspects of tax systems that accomodate the private equity investment model include:
3.1 – Flow through taxation of investment vehicles and certainty with respect to local tax liability
- In many jurisdictions, private equity investments are made through investment vehicles that are not themselves taxed, such as limited partnerships. Investors who are limited partners are taxed on their share of income and capital gains generated by the limited partnership (whether or not any distributions are made to limited partners).
- Allowing for such taxation avoids an element of double taxation of profits, thereby promoting specialized and professionally managed capital pools, providing diversification benefits to investors and providing certainty for investors with respect to taxation.
- It should be clear to foreign investors whether they are subject to local taxation in respect of any activity or investment (subject to any treaty relief), the applicable rates of taxation and the method of calculating the tax liability.
3.2 – Limitation of the potential for double taxation of foreign investors
Measures that will reduce the likelihood of double taxation for foreign investors include:
- Application of anti-avoidance rules (e.g., anti-treaty shopping rules) in a manner that can be understood and predicted by private equity investors;
- A clear and consistently applied set of requirements for claiming treaty benefits and a streamlined process for foreign investors to claim withholding tax refunds or withholding tax exemptions, including avoiding the requirement that foreign investors with a multitude of beneficial owners (e.g., pension plans) produce unnecessarily extensive information about their ultimate beneficial owners in order to claim such refunds or exemptions;
- Not treating foreign investors as having a taxable presence in a country unless it is established that they are carrying on business in that country through a permanent establishment, as defined in the OECD Model Tax Convention and the Commentary to the Model Tax Convention;¹
- Consistency with the OECD’s interpretation in application of the provisions of their double tax treaties (e.g., in determining the source of capital gains and investment income so as to allow the proper functioning of the double taxation treaty network);
- Establishing rates of withholding taxes on interest and dividends paid to foreign investors that are no higher than the OECD average;²
- Treatment of foreign-established and domestic-established limited partnerships as tax transparent vehicles for domestic tax purposes and for purposes of applicable double tax treaties;³
- In cases where investments pass through a tax transparent vehicle located in a third country, application of the tax treaty between the country in which the investment is located and the foreign investor’s country of residence; and,
- Attribution of capital gains and investment income arising from investments to the jurisdiction of the foreign investor rather than the jurisdiction in which assets are located, or where assets are managed (i.e., a safe harbour rule for income and capital gains arising from portfolio investments or as a result of investment managers’ decisions made in the jurisdiction in which the assets are located).
3.3 – Other tax issues for consideration
- Countries seeking to encourage private equity investment should consider whether domestic tax rules discourage or impede domestic investors from pooling their capital with foreign investors.
- Countries should assess whether foreign investors are subjected to taxation that is more burdensome than the taxation to which local investors in the same circumstances are subject.
- If a stamp duty regime applies, ensuring that securities that are substantively similar in nature are treated the same for stamp duty purposes so as to avoid creating a bias for or against the transfer of securities of a particular form;
- Abolishing the taxation of unrealised gains and other forms of ‘phantom income’;
- Avoiding using import duties as a tool to reduce the price competitiveness of imported goods;
- Providing a stable and predictable duty regime to facilitate the accurate forecasting of supply and demand;
- Ensuring the existence of a comparatively competitive and user-friendly regime of corporate taxation;
- Ensuring that methods of assessment for corporate taxation are transparent, predictable and include standard reliefs;
- Ensuring that foreign investors can obtain binding tax rulings, which afford certainty in regard to the manner in which investments are taxed;
- Consistently applying ‘transfer pricing’ and other similar rules with respect to the deduction of royalties, interest, management fees and other deductible expenses incurred by portfolio companies,
- Not imposing significant import duties on equipment imported for the purpose of capital investment; and,
- Providing for depreciation and amortisation deductions for wasting assets, goodwill and intangibles in line with OECD norms.⁴
¹OECD Model Convention with Respect to Taxes on Income and Capital, 2003; 2010 Update to the Model Tax Convention
²OECD Model Convention with Respect to Taxes on Income and Capital, 2003
³OECD Tax Database, Section C Corporate and capital income taxes
⁴OECD Model Convention with Respect to Taxes on Income and Capital, 2003
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