Deloitte 2021 M&A Tax Virtual Conference Break-out session France: Management investment’s environment and trends in French deals 03 MARCH 2021 Day 3: Structuring of funds/MEP structures Introduction and Contacts

Alexis Fillinger Partner Paris E-Mail: [email protected]

Alexis is a Tax Partner based in Paris specialised in Share & incentive schemes, as well as investment taxation for individual investors. Alexis provides advice on design and review of Employee/Executive Share schemes and Management Incentive Plans (“MIP”) in the context of M&A and transactions. He has also developed strong skills on and Co-Investments structuring for Private Equity funds. MEP environment and trends in France Day 3: Structuring of funds/MEP structures Key Findings of Private Equity in France

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 4 Day 3: Structuring of funds/MEP structures Instruments used for MEP structuring

Ratchet Mecanism

Strip equity • Ratchet mechanism is an accretive instrument which enables the Managers to • Strip equity is commonly benefit from a greater portion of capital used for the Managers to returns depending on the TRI reached at invest pari passu with the the exit by the Fund fund • Ratche mechanism is structured with • Strip equity is often preference shares or convertible bonds structured with Ordinary shares Sweet equity • Sweet equity mechanism is used in Free shares order enable Managers to benefit from a greater portion of capital returns as they invest proportionally more in equity than the Fund • Sweet equity is often structed with Debt instruments ordinary shares or preference shares combined with debt instruments, the • Debt / assimilated envy ratio being favorable to the instruments are also used in Managers order to achieve the pari passu investment Free shares • Debt instruments are • Free shares are used in order to enable the structured with bonds or Managers to freely acquire their instruments in fixed rate preference the Management package shares • They can be combined with strip or sweet Deloitte 2021 equity as well as ratchet mechanism although 5 it can be challenged by the French tax authorities Day 3: Structuring of funds/MEP structures Evolutions of MEP structuring within a tax and social framework Facts • A Recent case law lead to rethink the structuring of MEP

• Managers from the SAS Groupe Lucien Barrière had invested in share warrants (bons de souscription d’actions or « BSAs ») in 2004 in a context of LBO. The French social authorities challenged the employer on the nature of the share warrants gain and reclassified the gain in employment income Supreme Court decision

Preferential conditions When the purchase of BSA is proposed to executives / employees in consideration of their professional activity and are acquired at preferential conditions, they should be considered as a benefit subject to social security contributions

Links with employment status Based on the investment agreement, the purchase and holding of BSA are subject to the existence of an employment contract / executive 2 office. On that basis, the supreme court considers that it should be viewed as a benefit subject to social security contributions. Triggering event 3 The event triggering a taxable benefit should be its effective availability (e.g. when restrictions on exercise / sale of BSA are unveiled). Key Points

• How to manage existing MEP?

• How to structure future MEP?

• How to manage leaver provisions?

Deloitte 2021 • Social security audit experience Deloitte 2021 M&A Tax Virtual Conference 6 Deloitte 2021 M&A Tax Virtual Conference Break-out session Germany: Dividend Withholding Tax: Draft Act for stricter anti-abuse tests backing the Anti Treaty Shopping Rules 03 MARCH 2021 Day 3: Structuring of funds/MEP structures Introduction and Contacts

Nevin Borucu Partner Munich E-Mail: [email protected]

Half of everything you know will be obsolete in 18-24 months - Moore's Law

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 2 Contents

Overview of Legislation in Germany 4

Current Anti-Treaty Shopping Rules 6 Potential Future Law 11

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 3 Overview of Legislation in Germany

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 4 Overview of Legislation in Germany Reform of withholding tax due to supposed tax avoidance - Overview

04.04.2018 20.01.2021

Circular by the Federal Federal Government Ministry of Finance. issues draft act on the WHT reform WHT reform

24.01.2012 19.11.2020

Circular by the Federal Federal Ministry of Finance Ministry of Finance. issues WHT reform draft bill

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 5 Current Anti-Treaty Shopping Rules

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 6 Current Anti-Treaty Shopping Rules

• German WHT on dividends 26.375% • No WHT on plain vanilla interest • No WHT damage between German companies -> either full credit or CIT/TT fiscal unity Fund

LuxDisregard Master ed for US HoldCo tax

Disregard LuxHoldCoed for US Dividend distribution tax

DisregardGerman ed for US BidCo tax

German Target

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 7 Current Anti-Treaty Shopping Rules General overview

Income from own economic Disregarded for US tax activity of the foreign company Yes

No

non-tax (e.g. economic) shareholder has an Both yes reasons for the chosen adequately furnished DisregardedOR for US tax Structure? business concern?

No No

Harmful income Start Start ofthe test at the next shareholder

Yes+ shareholder Yes+ shareholder is a corporation WHT relief of the (next) shareholder is an individual Disregarded for US tax Of the company

No

No WHT refund / Exemption WHT Refund / Exemption

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 8 Current Anti-Treaty Shopping Rules General overview

 Income from own economic activities • E.g. dividends from a German company if actively managed Income from own economic Disregarded for US tax activity of the foreign company Yes • (-) in case of a passive holding

No • Required minimum: • Holding of > 1 companies non-tax (e.g. economic) shareholder has an Both yes reasons for the chosen adequately furnished DisregardedOR for US tax • Real managing functions Structure? business concern? • Actual influence on the business No No • Long-term nature (not only short-term instructions) • Fundamental importance of managerial activities Harmful income Start Start ofthe test at the next shareholder

Yes+ shareholder Yes+ shareholder is a corporation WHT relief of the (next) shareholder is an individual Disregarded for US tax Of the company

No

No WHT refund / Exemption WHT Refund / Exemption

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 9 Current Anti-Treaty Shopping Rules General overview

 Non-tax reasons for the choosen structure • Real anti-abuse test Income from own economic Disregarded for US tax activity of the foreign company Yes • Clarification by the 2018 circular of the Federal Ministry of Finance

No • Overall economic view on the structure and business purpose

non-tax (e.g. economic) shareholder has an Both yes reasons for the chosen adequately furnished OR  Adequately furnished business concern Structure? business concern? • Rather lower requirements No No • 2018 circular of the Federal Ministry of Finance: “non necessary to constantly employ managing and non-managing personnel”

Harmful income Start Start ofthe test at the next shareholder

Yes+ shareholder Yes+ shareholder is a corporation WHT relief of the (next) shareholder is an individual Disregarded for US tax Of the company

No

No WHT refund / Exemption WHT Refund / Exemption

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 10 Potential future law

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 11 Potential future law Outlook

 Economic correlation of business activities:

Economic correlation of • Holding of the German shares must serve a economical function with businessDisregarded activities betweenfor US tax German respect to the other activities of the foreign companies Company and its foreign shareholder Yes • (-) in particular if the economic activity of the foreign company No consists solely of providing support services to one or more subsidiaries (e.g. accounting or legal advice). DisregardedMain-benefit-test for US tax Tax saving is • This correlation must be material in the sense that the economic Tax saving is not main benefit function or origin of the source of income may not only play a main benefit completely subordinate role

 Main-benefit-test? Harmful income • All non-tax reasons must be taken into consideration, including those arising from a group relationship.

Start ofthe test at the next shareholder Yes+ shareholder WHT relief of the (next) shareholder is an individual • Reversal of burden of proof with the foreign company Disregarded for US tax of the company • Link to the definition of the main benefit test within DAC6 Yes+ shareholder is a corporation

No

No WHT Refund / Exemption WHT Refund /Exemption

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 12 Deloitte 2021 M&A Tax Virtual Conference Break-out Session Germany: Reduction of ETR trough interest deduction: tightening of tax audit practice on interest rates and Germany TP practice 03 MARCH 2021 Day 3: Structuring of funds/MEP structures Introduction and Contacts

Nik Nolden Ronny John Director | CFA | Transfer Pricing Director | StB | Transfer Pricing

Deloitte GmbH Deloitte GmbH Wirtschaftsprüfungsgesellschaft Wirtschaftsprüfungsgesellschaft Düsseldorf Leipzig/ Berlin Deutschland Deutschland

[email protected] [email protected] +49 211 8772 2849 +49 341 9927093

Dr. Felix Ebeling Senior Manager | CFA | Transfer Pricing Deloitte GmbH Wirtschaftsprüfungsgesellschaft Düsseldorf/ Köln Deutschland [email protected] +49 211 8772 3191

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 2 Tightening of German tax audit practice on interest rates and Germany TP practice

Please let us know your experience in tax audits of IC loans!

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 3 Tightening of German tax audit practice on interest rates and Germany TP practice German tax audit has several options when analyzing interest rates / estimating the credit rating of the borrower

OECD TPG – Chapter 10 on FT FG Münster Court Decision 7.12.2016 • OECD generally recommends the application of stand • Court decision strictly recommends application alone credit rating (SACR) under consideration of of group rating implicit group support • Appeal against local court decision still pending • Example in para 1.164 sqq of OECD TPG shows adjusted at highest German fiscal court (“BFH” – only rating of A with group rating of AAA and stand-alone these decisions are officially binding to GTA), rating of BBB but often cited by German tax audit • In inbound cases, tax audits rarely use OECD guidance, but BFHrecognize Court OECD Decision guidance 27.2.2019 as interpretation aid “on § 1a AStG-E (from Dec. 2019) request”• Decision of highest fiscal, which was • In 12/2019 German ministry of finance published draft for subsequently repeatedly confirmed novel section on IC Loans and arm’s length interests • Court decision primarily concerns collateral of • Section probably will not become effective soon, but loans for the tax recognition of impairments of administrative letter in same favor expected (i.e. Work in loans by German companies to their foreign Progress) subsidiaries, but only logical, if group support is • Section suggests application of group rating, if tax payer considered to be less relevant, i.e. SACR cannot provide persuasive reasons that another credit rating applicable is applicable (unclear whether OECD concept of passive association would be such reason)

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 4 Tightening of German tax audit practice on interest rates and Germany TP practice Estimation of credit rating of a multinational group entity

Exercise: • Let us assume we have S&P Credit o ….a multinational group with a BBB+ credit rating, Rating Scale and … o …an entity of the group, which has a stand alone BBB+ credit rating of B (flat) BBB BBB- BB+ ? What do you think is the appropriate credit rating to BB assume when deriving the interest rate for the entity, BB- when it borrows funds within the group? B+ B …

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 5 Tightening of German tax audit practice on interest rates and Germany TP practice Estimation of credit rating of a multinational group entity

Answer: S&P Credit Interest rate Rating Scale (USD, 5 Y, Jan … 21) BBB+ § 1a AStG-E and FG Münster … BBB BBB- BBB: ~1% BB+ BB BB- OECD BB: ~3% B+ B BFH 27.2.2019 … B: ~4% …

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 6 Deloitte 2021 M&A Tax Virtual Conference Break-out Session Luxembourg: Debt pushdown under TP angle: debt capacity and yield pricing 03 MARCH 2021 Debt pushdown under TP angle: debt capacity and yield pricing Why Testing of interest rates under TP angle is still important 01  Interest limitation rules (beyond TP) very often limit deduction Fund 02

% S/H Loan  Why Rates shall still be tested/documented 03

under arms length principles Third-party Loan Master LuxCo 04 04  What if the source country considers the rate % S/H Loan on S/H Loan as higher than the arm’s length ? 05 Lux SPVs 04

 What are potential tax consequences? 06 % Equity % S/H Loan 07 Investments

Solution 08

. Continue testing the arms length character to the S/H loans 09

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 2 Debt pushdown under TP angle: debt capacity and yield pricing Building interest rates in a post BEPS environment 01  Bottom-up approach is preferred to build consistency in waterfall of S/H loans Fund 02

 Top-Down approach is preferred to build % S/H Loan 03 consistency with respect to third party funding Third-party Loan Master LuxCo coming from the top 0404 % S/H Loan  Mix of strategies creates tension and potentially irrational situations for Financial Lux SPVs Intermediaries 06 % Equity % S/H Loan 07 Investments

Solution 08

. Segregation of flows + alignment of terms on the waterfalls 09

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 3 Debt pushdown under TP angle: debt capacity and yield pricing Debt and equity funding – Debt capacity analysis Topic Key Chart Jurisdictions notes 01 Many countries have Debt:Equity safe harbour ratios. Some examples include: Thin capitalisation rules 02 - Turkey: 3:1 Debt:Equity minimum requirement - Switzerland: Minimum Debt:Equity requirement for 03 0% each asset class i.e. investments can be 70% debt funded 40% - South Korea: 2:1 Debt:Equity minimum requirement 60% 04 - South Africa: Min 20% equity minimum requirement No thin 04 Minimum equity Thin capitalisation - Russian: 3:1 Debt:Net Asset minimum requirement requirements/ capitalisation rules/ general - Mexico: 3:1 Debt:Equity minimum requirement prescriptive asset rules arm’s length 05 ratios - Japan: 3:1 Debt:Equity minimum requirement principle - Denmark: 4:1 Debt:Equity minimum requirement - China: 2:1 Debt:Equity minimum requirement - Canada: 1.5:1 Debt:Equity minimum requirement in Minimum equity requirements some cases - Brazil: 2:1 Debt:Equity minimum requirement

It should08 be noted many countries also have EBITDA 0% rather than Equity linked limitations. 46% 54% 09 Many countries have a legal minimum equity requirement for example Switzerland, Sweden, Russia, Norway, Italy, Germany, US, UK, Belgium and Argentina. This typically relates to the equity on incorporation.

Minimum No minimum Minimum equity However, many countries also monitor equity levels and equity equity requirements where for example a entity falls into a negative equity requirements requirements. exist. position additional action is required. Such counties include Finland, Denmark and Turkey. Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 4 Some counties do not have set rules but a minimum level of equity is expected for example Singapore and Austria Debt pushdown under TP angle: debt capacity and yield pricing Debt capacity analysis – Various Methods 01 Solution Industry OECD Compliance Economic Required data rationale 02 Peer analysis / Loan to Value (LTV) Real Estate ●●● ●● ● The method is based on the identification of comparable transactions to benchmark them under the angle of Loan to Value (LTV) and determination of the maximum debt based on this benchmark 03 Peer analysis / Covenants All ●●● ●●● ●● The method is based on searching for comparable transactions to define financial/covenant ratios. The financial covenants observed are used to determine the arm’s length debt-to-equity ratio. 04 Peer analysis / Financial ratios All ●●● ●● ●● 04 The method is based on the identification of Peers and observation of financial ratios of the Peers to build a benchmark. 05 Expected loss (EL) AI Debt ●●● ●● ●●● It consists of checking the risk attached to an investment (credit risk) and based on its probability of default, assessing the minimum equity that the entity making the investment should have to face the said risk. 06 Cash Flow Forecasts (CFF) All ●●●● ●●●● ●●●● The method consists of modelling expected cash flows from the specific investment and the risks attached thereto to test the ability to serve the debt 07

Message 08

. Test the amount of debt before the actual establishment of arm’s length rate . Safe harbor / Rules of thumb debt to equity ratios under pressure 09 . Multiple approaches to economic analysis for the arm’s length debt to equity

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 5 Deloitte 2021 M&A Tax Virtual Conference Break-out Session Luxembourg: Holding companies and VAT: navigating the puzzle of CJEU Jurisprudence 03 MARCH 2021 Break out sessions – Holding companies and VAT– Introduction and Contacts

Cédric Tussiot Tomas Papousek Partner Director Luxembourg Luxembourg E-Mail: [email protected] E-Mail: [email protected]

Marcus Sauer Bérenger Richard Director Director Düsseldorf Paris E-Mail: [email protected] E-Mail: [email protected]

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 2 Contents

CJEU case-law on input tax deduction right 4

Luxembourg aspects 8

German aspects 10

French aspects 13

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 3 CJEU case-law on input tax deduction right

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 4 Day 3: Holding companies and VAT CJEU case-law on input tax deduction right on transaction costs – involvement in management Landmark Cases:

Polysar v Netherlands (C-60/90), 20 June 1991 Pure holding companies: no intervention in the management of subsidiaries except the exercise of shareholder rights  not taxable persons

Cibo Participations SA v France (C-16/00), 27 September 2001 The involvement of a holding company in the management of companies in which it has acquired a shareholding constitutes an economic activity (…) , where it entails carrying out transactions which are subject to value added tax (…), such as the supply by a holding company to its subsidiaries of administrative, financial, commercial and technical services.

Larentia + Minerva and Marenave Schiffahrts (C-108/14) / Marle Participations (C-320/17) Can a holding company recover VAT incurred in relation to input supplies connected with the purchase of shares in subsidiaries, if that holding company subsequently provides various taxable services to those subsidiaries?

• Where the holding company will • Where the holding company will not • Clarification of the concept of involve itself in the management involve itself in the management “involvement in the management”: (active) of all of the subsidiaries it (passive) of all of the subsidiaries it extension to all economic acquires, it is in principle entitled to acquires, only part of the input VAT transactions. recover input VAT incurred on incurred on transaction costs may transaction costs in full, unless it be recovered (i.e. an apportionment makes exempt supplies (in which must be made to reflect economic case appropriate partial deduction vs non-economic activity). method must apply).

 Ability to substantiate the active involvement in the management of the subsidiaries will remain a key element in practice;

 Economic consistency between the amount of transaction costs and the annual aggregate fees charged by the holding company is most likely to still be tested by number of tax authorities across EU. Important remarks

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 5 Day 3: Holding companies and VAT CJEU case-law on input tax deduction right on aborted deal costs – concept of exclusive reason Ryanair (C-249/17) Ryanair made a formal bid with the aim of acquiring the entire share capital of Aer Lingus, but acquired slightly less than 29% and had to abandon the acquisition for competition reason. In connection with the takeover bid, Ryanair availed itself of services subject to VAT. Ryanair claimed that VAT as deductible input tax.

Should a company be entitled to deduct A company, (…), which intends to acquire all the shares of another input VAT incurred on the professional company in order to pursue an economic activity consisting in the costs incurred in the context of a takeover provision of management services (…)” subject to VAT has “(…) the right bid, even if the transaction is aborted and to deduct, in full, input VAT paid on expenditure relating to consultancy ultimately the intended taxable supply of services provided in the context of a takeover bid, provided that the management services is not carried out? exclusive reason for that expenditure is to be found in the intended economic activity”.

C&D Foods (C-502/17) C&D Foods provides management and IT services subject to VAT only to Arovit Petfood. C&D Foods supported costs in connection with the envisaged but aborted sale of shares owned in Arovit Holding and Arovit Petfood. Danish authorities refused the deduction of the VAT because the services were not provided to C&D Foods (?) and lack a sufficient link with the taxable activities of C&D Foods

Could a holding company deduct VAT on The exclusive reason of the disposal of the shares was to use the costs in connection with the sale of an proceeds of that sale to settle the debts owed to the proprietor of the envisaged but aborted sale of a (sub- Arovit group. The VAT on expenditures in connection with the sale subsidiary) to which the holding company (auditors and lawyers fees) is not deductible. supplies management and IT services that are subject to VAT?

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 6 Day 3: Holding companies and VAT CJEU case-law on input tax deduction right on aborted deal costs – addition of actual use concept Sonaecom (C-42/19) Intending to invest in a new business segment, a holding company acquired consultancy services relating to market studies to potentially acquire shares in a telecommunications provider. Also, the holding company paid a taxable commission to a bank that helped put together and guarantee the placement of a private issuance of bonds. The VAT at stake was around €1 million. However, while the fundraising via the bond issuance was successful, the share acquisition was not completed and the holding company made the capital obtained available by issuing the bonds to the group’s parent company via a loan.

Should a holding company be entitled to Reaffirming its past stance on this matter, the CJEU held that an active deduct the input VAT incurred concerning holding company is entitled to deduct input VAT paid on consultancy consultancy services in relation to an services incurred regarding the acquisition of shares in another acquisition of shares that had not been company, even if the acquisition did not take place. Therefore, the Court completed) confirms that a company can recover VAT on costs relating to a failed or aborted acquisition of shares in another company—as long as, based on objective elements and evidence, the former has or had the intention to provide the latter with taxable management services.

The Court confirmed that, in these circumstances, whilst the intention was to make taxable supplies of management services that, in principle, would have been entitled to an input VAT deduction right on related Should a holding company be entitled to costs, here the company actually granted a loan to its parent company. deduct the input VAT incurred concerning Since the provision of a loan is an exempt supply under the VAT the commission for organizing and putting Directive, the company was not entitled to reclaim the input VAT together a bond loan that was ultimately incurred on the bank’s commission. transferred to the parent company of the group? Therefore, the Court refused the company’s input deduction right regarding the VAT incurred on the bank’s commission because the actual use of the funds raised did not entitle to an input tax deduction right. This ruling brings another consideration to be analyzed when dealing with the input VAT deduction right of holding companies, apparently enforcing an effective use over an intended use, according to which the “exclusive reason” test is now paired with an “actual use” test in tandem

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 7 Luxembourg aspects

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 8 Day 3: Holding companies and VAT CJEU case-law on input tax deduction right on transaction costs – Luxembourg aspects

Per the current CJEU case-law, where Lux BidCo would post-acquisition start providing management service, it should be entitled to recover the VAT it incurrs on the costs relating to the acquisition of the shares of the Target. The Luxembourg VAT authorities are currently challenging the input tax deduction right in these cases arguing that taxpayers need to show the direct link between the transaction costs and the management services (and that such transaction costs do not related to the holding of shares or financing, if any).

A straight recharge of costs (if properly documented) may help in some cases.

Transaction costs in relation to the acquisition Sale of shares of Target Service of shares Lux BidCo Vendor providers

Management services / Management services recharges of transaction provided by Lux BidCo to costs by Lux BidCo to Target post-acquisition Target post-acquisition

Target (OpCo)

Attention should be paid whether the management services provided / recharges of transaction costs to Target do not attract irrecoverable VAT locally, which could ultimately lead to an increase of the final VAT cost of the whole structure

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 9 German aspects

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 10 Day 3: Holding companies and VAT Certain German VAT aspects

Consultancy agreement is concluded with investor and the service provider is raising its invoice to the investor. Investor will then recharge the consultancy fee directly to BidCo

Consultancy Consultancy agreement agreement Service Service Investor Investor provider provider Invoice for consultancy services

Invoice for New consultancy consultancy agreement services Recharge of consultancy fee

BidCo BidCo

Consultancy agreement is concluded with investor given that BidCo is generally only established Alternatively, once BidCo is established, service before the actual acquisition. provider enters into consultancy agreement with The invoice is, however, raised to BidCo BidCo directly or investor novates the consultancy agreement to BidCo. The invoice would then be issued directly by service provider to BidCo

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 11 Day 3: Holding companies and VAT Certain German VAT aspects

Establishment of a VAT group

Transaction costs in Sale of shares of relation to the Targets Service acquisition of shares BidCo Vendor providers

Management services provided by Lux BidCo to Target post- acquisition Target 1 Target 2

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 12 French aspects

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 13 Day 3: Holding companies and VAT Certain French VAT aspects

The French Administrative Court has transposed the Larentia + Minerva principles in its decision from 2016

According to guidelines published by the French tax authorities acquisition costs incurred by a mixed Holdco receiving dividends (outside the scope of VAT) and VAT taxable revenues are considered as deductible general expenses – without consideration of the dividends received – irrespective whether the HoldCo is involved or not in the management of the Target

Reminder: If HoldCo also receives incomes in the scope of VAT but VAT exempt (e.g. loan interests), the deduction of VAT on acquisition costs must be limited in proportion to the ratio of VAT deduction (Coefficient de Taxation Forfaitaire or « prorata »)

Several situations in the structuring of the acquisition costs may lead to a challenge of the recovery of VAT on said costs • The acquisition costs are not invoiced to BidCo, but to another entity of the Group (TopCo, Targets directly, etc.) • The supporting engagements with the suppliers are not concluded with BidCo, but with other entities of the Group (generally TopCo) Practical recommendation • If the agreements are concluded with TopCo, invoices must be raised to the attention of TopCo, and the costs recharged by TopCo to BidCo with support of a dedicated agreement • Point of attention: TopCo must be dully activated to avoid an adverse VAT cash impact

Specific situation of TopCo providing services to Targets • A TopCo can deduct input VAT on expenses incurred for the preparation of a deal made by a sub-holding, provided that the TopCo can demonstrate that it is the only company of the Group that provides taxable services to the Targets • In this situation, the preparatory expenses are considered as deductible general expenses at the level of the TopCo (deduction in proportion to the prorata of TopCo)

Direct and exclusive relationship between TopCo and the subsidiaries is difficult to demonstrate in practice

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 14 Deloitte 2021 M&A Tax Virtual Conference Break-out Session Luxembourg: Impact of the investment strategy on the income classification at the level of the platform 03 MARCH 2021 Day 3: Structuring of funds/MEP structures Breakout on the investment strategy of debt funds and income classification

Philippe Lenges Jeremy Pages Partner Senior-Manager (Lux) Audit & Assurance Accounting & Reporting Advisory

[email protected] [email protected] +352 621500078 +352 661250512 +352 451452414 +352 451453863

Ben Toussaint Tax partner & (Lux) debt leader Luxembourg

[email protected] +352 621568027 +352 451452890

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 2 Contents

Investment strategies of private debt funds and usual Luxembourg structures 4

Related tax implications 6

Challenges of capturing properly the investment strategies and translate them into the financial statements 9

Options available from an accounting perspective 11

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 3 Investment strategies of private debt funds and usual Luxembourg structures

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 4 Day 3: breakout on the debt investment strategies and income classification Investment strategies and Luxembourg structures

• The different investment strategies usually considered are the following: direct lending; mezzanine; ; distressed and . • These investment strategies would translate into different kind of structures in Luxembourg. • There is a need to setup the right architecture and platform to allow for an appropriate tracking of the specific return on the asset class at stake. • Some examples below:

Investors Investors Investors

Dutch Lux Notes Lux AIF Stitching AIF Debt Debt Notes funding funding Master Luxco Debt Lux Lux funding Lux SPVs SV SV

Lux SPVs

Equity kicker / options Loans / warrants

Borrowers

Discounted Distressed Enforced or distressed assets assets debt

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 5 Related tax implications

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 6 Day 3: breakout on the debt investment strategies and income classification Typical tax considerations generally speaking

Purpose is to introduce a limitation to the tax deductibility of any “exceeding borrowing costs” to 30% of the taxpayer’s tax-based EBITDA subject to certain de minimis rules (€3m) and certain carve-outs (AIFs, certain SVs, etc.). Purpose is to prohibit the deductibility of expenses Interest incurred within the context of EU transactions/structures limitation whereby the differences in the legal characterization of a financial instrument or entity result in a double deduction or a deduction without inclusion. Purpose is to introduce a rule according to which non-genuine arrangements put in place for the main purpose (or one of the main purposes) Anti- of obtaining a tax GAAR / advantage that defeats hybrids the object or purpose of B.O the applicable tax law should be ignored. B.O is about checking whether the recipient of the income has full authority on the income and is the economic owner.

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 7 Day 3: breakout on the debt investment strategies and income classification Typical tax considerations depending on the cash flows

Investors Investors

• The main consideration at stake is the interest Dutch limitation restrictions Lux Notes of the ATAD 1 AIF Stitching Directive which Debt applies across the EU. funding Master • Back-to-back lending • The main consideration Luxco position not impacted at stake is the interest Debt by interest limitation Lux limitation restrictions:: funding rules. SV impacts would depend on the types of income • Considerations should to be received (discount be given to the income Lux SPVs unwind or capital gains not qualifying as on NPLs). interest or equivalent • Typical cash flows: interest Equity kicker / options income. • Tax qualification of the • Typical cash flows: Loans and principal / warrants payments under the interest and repayment. notes would also be principal • Exception return relevant repayment. Borrowers such as capital • • Exceptional return gains e.g. upon Access to DTT or EU such as dividend on enforcement. Distressed Directives would also be a relevant in the light of the equity kicker or debt gain on the option / recent developments warrants. (PPT and ECJ case law). An intermediate SPV might be required. • Acquisition of existing debt which could either be discounted or distressed. • Importance of the investment strategy: investment vs. trading. • Accounting methodology applying under local GAAP to the discount unwind / capital gains should be discussed beforehand. • Tax treatment of the discount unwind could vary depending on the jurisdiction of the structure but in all cases subject to ATAD 1: in Luxembourg, accounting approach & economic approach would be developed.

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 8 Challenges of capturing and translating

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 9 Day 3: breakout on the debt investment strategies and income classification Accounting: financial fixed asset, investment or held for trading

INVESTMENTS

FINANCIAL FIXED ASSETS = all the other financial assets A STRATEGY AFFECTING are considered as current = Intend to serve the activity of the company on a long-term THE ACCOUNTING The classification HELD FOR basis (i.e. more than 12 months) TRADING does not exist under TREATMENT LUX GAAP. It is embedded in the INVESTMENTS classification

Cost less permanent value Lower of cost or market Then All assets first recognized at Then reduction (i.e. value acquisition cost, including Or adjustments in case of a any direct attributable costs Fair Value Through Profit or Loss durable depreciation) if held for trading purpose

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 10 Options available from an accounting perspective

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 11 Day 3: breakout on the debt investment strategies and income classification Accounting: options available in Luxembourg

HOW TO ACCOUNT FOR THE CASH COLLECTED ON THE PERFORMING OR NON-PERFORMING LOANS: COST REDUCTION, INTEREST INCOME OR CAPITAL GAIN ?

New Fund ‒ Loans purchased at a discount: cash collection = interests + acquisition cost + expected additional amount based on the anticipated future cash flows Lux Sarl / SV PURE LUX SUBSTANCE • Lux GAAP GAAP ‒ Expected additional amount based OVER FORM accounting or on the anticipated future cash flows = PRINCIPLE IFRS. interest income or capital gain ?

‒ LUX GAAP Debt ‒ After initial recognition, nothing in the General Accounting Law, but assets more information provided in the Banking Accounting Law and Former Investments at a discount “Banking Bible” published by the CSSF price in: ‒ Alternative options = Substanceover formprinciple • Either performing As per CNC => Follow the IFRS or another EU nationalGAAPs loans;  Different measurement approaches might be allowed: cost recovery • Or Non-Performing method, effective interest rate (EIR) method or fair value (for loans that could be investment entities) combinedwith EIR method secured or unsecured. ‒ The Effective Interest Rate (EIR) method applies differently between performing and non-performing loansas per the IFRS: ‒ EIR approach – Purchasedperforming loans ‒ Credit adjustedEIR approach– Purchased non-performing loans Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 12 Day 3: breakout on the debt investment strategies and income classification Accounting: practical considerations

Any accounting policy change needs to Accounting policy changes – in practice be duly justified and explained in the follow IAS 8 requirements notes

LUX GAAP = Prudent principle that Attention to the accounting treatment of might lead to different treatments Practical changes in the expected cash flows between performing loans and non- (especially for NPL) and/or changes in the performing loans (secured or not) considerations contractual terms

Accounting policy needs to be applied on a Cherry-picking not allowed consistent and permanent manner

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 13 Day 3: breakout on the debt investment strategies and income classification Take away

Accounting policy needs to be Taking into account the investment applied on a consistent and strategy when setting-up the permanent manner with structure 01 03 appropriate disclosures

Accounting policy needs to be Consider both the accounting and applied on a consistent and tax qualification of your cash flows permanent manner with 02 in a post ATAD environment 04 appropriate disclosures

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 14 Day 3: breakout on the debt investment strategies and income classification Take away

Do you think that an accounting policy change might help you to better reflect the economic substance of cash collected on performing and non-performing loans?

A. YES B. NO C. NEED TO INVESTIGATE MORE

Deloitte 2021 Deloitte 2021 M&A Tax Virtual Conference 15