Exploring changes in the fiscal environment and their impact on Private Equity 27 January 2004

1. Private Equity Group Exploring changes in the fiscal environment and their impact on Private Equity 27 January 2004 kpmg Private Equity Group

2. Exploring changes in the fiscal environment • The scope for debt push-down in leveraged investments • Investor issues • A trend back to preference shares? • Executives’ share incentives and carried interest • New fund vehicles? • Country summaries • Germany • Netherlands • Italy U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

3. A “typical” leveraged buyout Fund Buffer company, eg Luxco Shareholder loans £25 Institutional ordinaries £9 Management ordinaries £1 Newco 1 Bank/mezzanine £65 Newco 2 Target (£100) U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

4. The scope for debt push-down • Thin capitalisation • Permitted debt/equity ratios come down in Germany to 1.5:1, and limits now also apply to commercial limited partnerships (KGs) • Italy, formerly without formal limitations, has a 3:1 limit from 2004 • Some signs of the UK Inland Revenue getting tougher • Following the Langhorst case, most EU countries are now introducing restrictions for local, as well as foreign, lenders. Spain is the notable exception • All points to climate for ultra-leveraged structures become more hostile • “Churning” • France has long prohibited relief for interest on internal pushdowns. Netherlands, and now Italy and Germany, have followed suit • Efficient tax leverage of secondaries and former family companies becomes more difficult U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

5. The scope for debt push-down (2) • Tax Grouping • Introduced in Italy from 2004 • Netherlands (like UK) now permits tax grouping immediately on acquisition • Marks & Spencer case threatens tax grouping throughout EU, unless the proposed EC grouping directive is revived • Conclusions • Mixed messages, but fund managers may have to accept that leverage will not be entirely tax-effective in future in some European countries • Could this drive a move back to preference shares in MBO structures? U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

6. Investor issues • US Investors • Old issues (Unrelated Business Taxable Income for tax-exempts etc) remain • Non corporates now pay 15% instead of 35% on capital gains and qualifying dividends • Funds are becoming increasingly sensitive to US taxable investor issues eg ‘dry income’ • German investors • Germany joins US and UK as a constituency for whom funds take more care over tax issues • Official view of what makes an ‘asset management’ fund reconfirmed • Funds may now plan short-term holds eg strategic stakes for P to Ps, syndications, through SPVs • Others – dividends and gains generally more favourable than interest U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

7. A trend back to preference shares? • Earlier leveraged deals generally used preference shares to deliver the hurdle return to investors • Use of loan notes now commonplace, due partly to corporate law (redeemability) but also interest deductions enhance cashflows of investee and facilitate increased leverage • It is becoming harder to deduct interest on shareholder loan notes – why give investors taxable, ‘dry’ income, if there is no benefit to the investment? • Investors generally enjoy lower, or no taxation, and on a cash-received basis, on dividends or capital gains U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

8. Executive share incentives • Major new rules in the UK, aimed at abuse of listed company share schemes • Management now automatically assumed to have invested by reason of employment • If “Initial Unrestricted Market Value” (IUMV) of management shares exceeds subscribed price, the excess is subject to income tax and NIC • Manager can either elect to pay tax and NIC on this excess now, or • Pay it on a proportion of the ultimate capital gain • Example • If IUMV is valued at £1.50, and manager subscribes £1, income tax and NIC will apply to 0.50/1.50 of the total gain at exit. U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

9. Executive share incentives (2) • Situation led to discussions between the BVCA and the Inland Revenue, culminating in the “Memoranda of Understanding” (MOUs) • Under the Management MOU, managers can now enjoy CGT treatment (10% minimum rate, no NIC) only if they meet both of the following conditions: • Institutional preference dividend/loan note interest is ‘commercial’, ie exceeds highest third party finance rate borne by investee • Price subscribes reflects the full potential of any ratchet • Example • If management have 10% of ordinary shares, and are entitled to share 10% of institution’s proceeds in excess of 2x investment, they must subscribe 20% of total ordinary equity subscription monies for a 10% holding U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

10. Carried Interest • Major developments in UK and Germany • UK • Fund managers could be taxed on a portion of their carry gains in a similar fashion to management’s shares • A second MOU provides considerable comfort, where carry arrangements are market-standard (20% after 8% hurdle) and entitlement acquired before fund makes first investment • New joiners, or old hands benefiting from reallocation of a leaver’s entitlement, may have an income tax liability, but the principal treatment remains hugely beneficial U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

11. Carried Interest • Major developments in UK and Germany contd • Germany • Finance ministries (Federal and Lander) have for some time been arguing that carry should be taxed fully as professional income, instead of exempted or subject to half-income basis as investment gains • Current official position remains as above but • Rumours of draft law which largely reinstates the original half-income proposition U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

12. Germany – key features • Tough new thin capitalisation rules coming in • Debt/equity ratio being limited to 1.5:1 for all companies (formerly 3:1 for holding companies) • Limits will apply to KG holding structures, previously unlimited • Limits apply to all related party debt (including German) and to third party debt covered by guarantees. Subordination of shareholder debt to senior will for these purposes be a ‘guarantee’ • Restrictions on use of pre-acquisition losses – max 50% of annual profit can be sheltered • 5% of dividends received effectively taxed, by equivalent disallowance of related expenses • Official view of ‘asset management’ fund reconfirmed - average holding 3-5 years, no active management, no fund-level borrowing U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

13. Germany – key features contd Fund Potential fix for guarantees Subordination of loan note to bank debt would be construed as a guarantee for thin cap purposes, but if notes are structurally subordinated into a higher- level company, this is not a guarantee for thin cap purposes Loan notes Newco 1 Newco 2 Bank/mezz Target U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

14. Netherlands – key features • Tax grouping for 95% + subsidiaries • From day one after acquisition • No deduction for interest on debt pushed down through an internal restructuring • Tough new thin capitalisation rules coming in • Debt/equity ratio being limited to 3:1, from 6:1 • Further restrictions may apply where lender has >33% of shares, through deduction deferral rules • But old restrictions on deducting interest relating to loans financing foreign shareholdings have gone • No withholding tax on interest U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT

15. Italy – key features • Tax grouping from 2004 • From first full year after acquisition • Previously had to rely on mergers, or on refund claims for dividend tax credits • New thin capitalisation rules coming in • Debt/equity ratio being limited to 3:1, previously no limit • Can no longer deduct interest on loans to finance foreign shareholdings ie ones which cannot be tax-consolidated with the Italian parent • New anti-avoidance provision to prevent debt push-down by internal restructuring U:\Admin\975\SCI ADMIN ONLY\People\Individual Admin Folders\David Ramsey\PEG Business Plan\PEG business plan 2003-2004.ppt DRAFT