Third International Tax Dialogue Global Conference Financial Institutions and Instruments - Tax Challenges and Solutions

1. Third International Tax Dialogue Global Conference Financial Institutions and Instruments - Tax Challenges and Solutions Private Equity and Hedge Funds: The Tax Challenge Beijing, October 26-28, 2009 Marcello Distaso Baker & McKenzie Amsterdam

2. Everything starts from the Fund… • Different structures • Different categories bearing a different interest: Investors, Fund Managers, Sponsors • Common scope: maximizing the IRR 2

3. Private Equity Fund – Basic Structure Investors GP Fund SPV Target 3

4. Hedge Fund – Basic Structure Domestic Investors Foreign Investors Feeder Fund Feeder Fund GP Master Fund Investment 4

5. Different Categories of Issues • Legal issues: flexible and ‘water proof’ documentation • Regulatory issues: acceptable regulatory environment • Tax issues: any tax paid at the level of the Fund represents a cost that reduces the IRR 5

6. Tax Objectives for Investors • Tax neutrality of fund vs direct investment in Targets • Avoid/defer taxation until distributions from the Fund • Minimize tax ‘leakage’ on Fund’s distributions • Fund structure should be flexible enough to allow each Investor to organize its own (tax) planning 6

7. Tax Objectives for Fund Managers • Efficient tax planning of the carried interest remuneration (i.e. capital gain/dividend vs employment income qualification) • Avoid/defer taxation until distributions from the Fund • Minimize tax ‘leakage’ on Fund’s distributions • Avoid personal tax liabilities in the target jurisdictions 7

8. Pension Funds US Investors CH Investors EU Investors Special LP Other Investors Fund L.P. Carried interest GP Fund Manager Management Fee Economic ownership of shares in Holdco Equity Legal title to shares in GP of the Fund SPV Equity Local Bidco Bank Loan Target Tax consolidation/merger 8

9. Tax issues at Target level • No local taxation: (i.e. interest and dividend withholding tax and capital gain tax) in the country of the Target Companies – Need for SPVs to guarantee ‘treaty protection’ • Possibility to implement efficient debt-push-down on the bank leverage (e.g. tax consolidation or merger) • Possibility to minimize the tax exposure of effective management of the Fund in the target jurisdictions and the presence of a taxable permanent establishment 9

10. Fiscal Transparency • Advantages • no double tax charge • distributions retain character of underlying income/capital gains • fund cannot be a tax resident of any country • flow-through of foreign tax credits for taxable investors • Disadvantages • Not harmonized concept: different definitions • PE risk for partners in investee company and/or investment manager country • fund not entitled to double tax treaty benefits • immediate income/gain recognition by taxable investors 10

11. Fiscal Transparency Investor Treaty country (low tax) Feeder Tax Haven Partnership Treaty country (low tax) SPV Investee country Investee Company 11

12. Debt push-down: base case Debt is pushed down to the NL/Lux SPV with a loan and to Target through a merger or a tax consolidation: the interest expense can finally be deducted against the operating profit of Target Possible impact of local thin cap and anti abuse rules: no initial leverage at the level of Bidco, but subsequent third party debt at the level of the Target that pays capital or dividend to NL/Lux SPV Fund 1 Fund 2 Equity/ Debt NL/LUX SPV Equity Bank debt Bidco Bank debt TARGET Merger / tax consolidation 12

13. Tax issues at SPV level • No taxation on dividend income or cap. gains • No incremental taxation (i.e. dividend withholding tax or local cap gain tax on the distributions of the SPVs to the Fund • No indirect taxation (i.e capital or stamp duty) on the equity funding of the SPVs • Usual suspects: NL, Lux, BE, Cyprus. Dutch Coop is currently ‘hot’… 13

14. Tax issues at Fund level • No taxation on proceeds deriving from Targets or SPVs: tax transparency or full exemption • No incremental taxation (i.e. any WHT or local tax) on the distributions of proceeds to Investors • No local tax compliance for Investors • Possibility to avoid the VAT incremental cost for the Fund re the management fees and the advisory fees 14

15. Carried Interest • Carried interest: an interest in the fund which entitles the holders to participate in the (super) profits of the fund once any preferred returns have been paid to the investors • Carried interest holders: individuals who are “partners” in the fund (either directly or through a carry vehicle) and potentially employees or directors of the management company or associated companies • Carried interest holders often contribute only nominal capital to the fund for their carried interest in the fund 15

16. Carried Interest • Concerns: low investment and important upside potential • Traditional discussion: capital gains taxation versus “employment” income • Jurisdictions without specific guidance – jurisdictions with specific guidelines (e.g. UK) 16

17. The life of a fund tax lawyer can be difficult… Pension Funds US Investors CH Investors EU Investors Special LP Other Investors Fund L.P. Carried interest GP Fund Manager Management Fee Economic ownership of shares in Holdco Equity Legal title to shares in GP of the Fund SPV Equity Local Bidco Bank Loan Target Tax consolidation/merger 17

18. Thank You!! marcello.distaso@bakernet.com Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm.