Pandemic
Heightens Focus
on Tax for Holding
Companies

The continuing impact of COVID-19 is being felt across many aspects of the business world. Whilst the initial phases of the response focused on immediate issues such as liquidity, attention is now turning to other areas, such as taxation. 

One example is the ability, as a practical matter, to establish and maintain legal and commercial substance for investment holding vehicles in some countries. The effects of the ongoing crisis, together with global and local shifts in taxation and tax authority practices, may give private equity funds reason to review their holding company arrangements.

A Question of Substance

Various jurisdictions in continental Europe operate local dividend withholding taxes and non-resident capital gains taxes. Over recent years, there have been increasing levels of tax authority challenges to non-resident investors seeking to apply double tax treaties and EU tax Directives, to receive exemptions from those taxes.  These challenges have focused on the idea that the holding companies in question do not truly have the necessary beneficial ownership of the underlying dividends or gains. 

Holding companies have been viewed as conduits with limited economic exposure to the underlying investments, or as otherwise lacking legal or commercial substance. Cases have been brought before the European Court of Justice relating to private investment fund structures. A number of taxpayers are or have been subject to European tax authority enquiries in this area.

Moreover, there is a risk that tax authorities in other jurisdictions where fund professionals live and work, or where some of a fund’s other infrastructure is based, will seek to tax the income, profits and gains of asset holding companies, on the basis that substance lies there. 

Establishing Substance: Pre-COVID and Now

Even before the pandemic, establishing substance or tax residence for holding companies in jurisdictions away from the countries where some of the management team and other group operations were based could be difficult. It often relied on making sure that board meetings were held, and key decisions taken, in the places where substance or residence was intended. Travel restrictions due to the COVID-19 crisis have exacerbated the practical difficulties of this approach. With the second wave now accelerating in many countries, it seems likely that those difficulties will continue over the medium and possibly longer term. 

Some short-term accommodation has been made by tax authorities in some countries to mitigate substance and/or residence issues caused by travel restrictions. However, it seems unlikely that there will be a wholesale change in the underlying legislation or case law in these areas.

Tax increases and more stringent clampdowns on tax avoidance and mitigation (in addition to tax evasion) are also on the horizon, if not already in motion. Developments include DAC6, the EU’s new mandatory disclosure regime in Europe for reporting cross-border transactions that meet certain hallmarks perceived as indicating tax avoidance. The OECD has put forward international tax treaty updates that are struggling to address common fund structures. Furthermore, the global focus on tax havens and ‘non-cooperative tax jurisdictions’ is only likely to continue. Together, these steps will encourage domestic tax authorities to gather more data on taxpayers and make far‑reaching investigations. A number of continental European jurisdictions have already shown their willingness to use criminal sanctions in tax cases. 

Considering Options and New Jurisdictions

Against this backdrop, private equity firms may want to consider their ability to maintain substance in the jurisdictions in which they have asset holding companies, or just to plan for increased focus and scrutiny from tax authorities. That may mean thinking about immediate practical steps that can be taken to provide evidence of substance. It may also mean thinking through (and documenting) lines of argument that may be required in response to tax authority enquiries. 

If it proves not to be realistic to maintain substance for asset holding companies in local jurisdictions over the medium or long term, sponsors may end up revisiting other jurisdictions where they have deal professionals and business infrastructure.

One potential candidate jurisdiction could be the UK. It may not work for all, and Brexit remains a risk. However, the UK does have a credible tax regime for holding companies that have a straightforward long‑term equity investment strategy. The UK government also seems to have identified a possible opportunity here. It has recently concluded a consultation on the tax treatment of asset holding companies in alternative fund structures (including private equity, credit and real estate). The aim was to explore the challenges and potential for locating asset holding companies in the UK. The response to the consultation is keenly awaited.

Richard Sultman
Partner

London
T: +44 20 7614 2271
rsultman@cgsh.com
V-Card

Jennifer Maskell
Counsel

London
T: +44 20 7614 2325
jmaskell@cgsh.com
V-Card

Laura Mullarkey
Associate

London
T: +44 20 7614 2249
lmullarkey@cgsh.com
V-Card