Managing tax issues with UK portfolio company debt

The UK tax rules concerning portfolio company debt have become more complex and onerous over the last few years with the introduction of BEPS related measures such as the anti-hybrid rules and the corporate interest restriction. These rules apply in addition to many other long standing UK tax rules such as transfer pricing, the late interest rules and the UK withholding tax regime on interest.

Now that portfolio companies have been through audit and UK corporate tax compliance cycles we are starting to see the effect this additional complexity can have during tax due diligence on transactions. A few specific areas of interest are as follows:

Anti-hybrid rules and the impact of PE fund investors

We previously wrote a brief on how private equity ownership could affect a UK portfolio company’s position under the anti-hybrid rules here. Since the brief was written, we have seen many real life examples where there are winners and losers as a result of how the private equity fund investor analysis and application of the rules play out including some unexpected results.

For example, in several private equity funds, any potential disallowance under the anti-hybrid rules due to ‘bad’ investors is lower than the potential disallowance under the transfer pricing rules. Such portfolio companies that have sufficient capacity for shareholder debt are often then able to take the position that there is no incremental impact of the anti-hybrid rules. However, the process of identifying ‘good’ and ‘bad’ fund investors typically requires coordination with the private equity fund in order to establish whether this position is possible.

However, the anti-hybrid rules have had a significant impact on some private equity funds. For example, funds whose cornerstone investors view the fund itself as opaque for local tax purposes, or where significant fund investment was made by fund-of-fund investors which are themselves hybrid entities, can present challenges in assessing the impact of these rules and can often produce unexpected results. Solutions tend to require case by case analysis so please contact us if you would like to discuss a particular structure.

Common pitfalls we have seen in due diligence

In our experience of tax due diligence, issues with tax compliance of debt occur much more commonly than other areas of tax. There are several pitfalls which we have seen come up as recurring examples which we discuss in the following tax insight article:
Debt and the tax pitfalls of not managing your compliance carefully

Please contact us if you would like to talk through any of these points or if you would like assistance formulating a strategy to deal with these issues on a prospective basis.

James Pratt
Catherine Jones

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