"The theme of substance remains a key topic of discussion in the alternative investment industry"
"A key mission of BEPS is to align taxation with the jurisdiction of economic activity and value creation"

Under the Regulatory and Political Microscope: Real Estate and Private Equity Fund Structures

08 Aug 2016

With the constant onslaught of compliance requirements and regulation from various local, national and international bodies and governments all over the world, the theme of substance remains a key topic of discussion in the alternative investment industry.

The Organisation for Economic Co-Operation and Developments (OECD's) Base Erosion and Profit Shifting, or more commonly termed BEPS, has really shone a light on the concept of substance and the location of investment entities in so-called preferential tax jurisdictions.

A key mission of BEPS is to align taxation with the jurisdiction of economic activity and value creation. The OECD is pushing to revamp existing harmful tax practices with a priority on regimes to be strengthened in order to realign taxation of profits with the substantial activities that generate them.

In order to address this, action point five of the 15 set out in the initial Action Plan; is designed to counter harmful tax practices more effectively, taking in to account transparency and substance by substantially increasing cross-border corporation between tax authorities and substance analysis.

The OCED has proposed some significant changes to the rules regarding whether an entity or company has a permanent establishment, and as a result, a taxable presence in an overseas territory. Despite the fact that the initial objective of Action Point 5 was aimed at addressing the apparent  manipulation of internet selling and commissionaire arrangements, given the very loose terminology there could potentially be wider implications for real estate and private equity fund structures, especially those with entities domiciled in multiple jurisdictions.

The new recommendations from the OECD seek to enhance and increase the definition of when a permanent establishment is created, such as; when an agent “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise.” Within this context, private equity and real estate managers, in particular those using various special purpose vehicles will need to consider this definition carefully and whether tax authorities will look at actions across individual special purpose vehicles or across the fund as a whole.

To add an additional layer of complexity to the process, the OECD has no authority to implement law and as a result the onus will be on the individual member states to decide on how best to amend their existing tax treaties. This could potentially result in inconsistency being adopted from one member state to the other.  Whilst the OECD has acknowledged that the funds industry will need to be looked at in some detail in order to identify the most appropriate course of action, it remains to be seen what, if any, exclusions will be allowed by individual states to fund structures. Regardless of the outcome, there will continue to be a focus on private equity and real estate managers to ensure that the existing operating models are fit for purpose and that they adhere to substance requirements across the full fund structure.

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Global Head - Alternative Investments