Part 4: Private Equity
We are coming to terms with the Tax Cuts and Jobs Act, the most substantive change to US tax legislation since 1986. The broad intent was to reduce taxes for both individuals and corporations, yet the American abroad may not achieve this.
In a series of articles by our London-based Private Client US Tax Advisory team we consider the recent US Tax reform through the eyes of the American abroad. In this fourth instalment, we look at the impact of US tax reform on private equity investors in non-US funds.
The article series is also being featured in eprivateclient
Carried interest held by US taxpaying individuals will no longer qualify for long-term capital gains treatment unless the underlying investments are held for three years or more. Moreover, anti-avoidance legislation is to be introduced to counteract any attempts to forestall the introduction of these rules.
Profits of non-US subsidiaries
The reforms also set out a complex set of measures designed to tax un-repatriated profits of foreign subsidiaries of US companies.
There is a one off ‘transition tax’, which charges US investors on historic un-repatriated portfolio company profits, as well as some controlled foreign company (CFC) style rules around ‘global intangible low-taxed income’ (GILTI) which can result in ongoing annual dry tax charges on certain portfolio company profits. Both rules can also apply alongside the existing CFC rules.
The results are counterintuitive but, as currently drafted, the ownership provisions in these rules can yield some unexpected transition tax and ongoing CFC/GILTI inclusions for US taxable investors with more than a 10% economic interest in a fund. The two main scenarios in which this can occur are:
- Where the fund has a US portfolio company and >10% US individual investor
- Where the fund has both a >10% US corporate investor and a >10% US individual investor
In the worst case, scenario 1 can result in transition tax on the US investor’s economic share of 2017 non-US portfolio company earnings at rates of up to 17.5% and also ongoing CFC/GILI ordinary income inclusions at ordinary income rates of up to 37%.
In scenario 2, the CFC/GILI point falls away to the extent that the portfolio investments are not CFCs but the transition tax point remains.
It is possible that there could be further refinement to these rules and there are also potential mitigation options which need to be worked through case by case. For example, potential restructuring of portfolio investments into US corporations may mitigate the impact of the CFC/GILTI provisions in some cases. However, the net effect of these rules is that there should be more non-US corporations which become US CFCs.
The first step is to identify potential issues and we would recommend that General Partners review their investor base fund by fund to see whether or not they could be affected. The Transitions tax and decisions whether or not to elect to pay any tax due by instalments required action before 15 June 2018.
BDO’s Private Client US Tax Advisory team, based in London, comprises dual qualified US UK tax professionals experienced in the international taxation for ‘US-connected’ clients:
- US citizens living abroad
- Foreign nationals moving to US or with investments in the US
- Businesses looking to expand into or out of the US
For more information visit our US Tax Advisory webpage or get in touch with one of the team directly: Mark Walters, Andrew Harrison or Nitin Naik
Read further articles on US Tax Reform for Private Clients