LBOs: Tighter fiscal regulation ahead

The governments of Sweden, France, the UK and Belgium are looking to replenish their coffers and seem to have found a hidden treasure trove in private equity. Recent controversies have encouraged them to swing their axes at the rich, but with public companies already sailing rough seas, they are currently looking to cut tax avoidance and interest deductibility for private equity firms.

"It makes a good story for the public," confirms Linklaters banking partner Annette Kurdian, adding that private equity firms are often perceived as secretive and not paying enough tax.

Tax partner Elizabeth Conway, also from Linklaters, finds it interesting to see the same developments in several jurisdictions at the same time, and concurs that private equity is being specifically targeted in some areas.

In France, for example, proposed legislation aims to change the way the tax authority treats holding companies. The draft, adopted by the National Assembly, stipulates that tax deductibility on financial charges will only apply to French holding companies with domestic shareholders. On the other hand, if a French newco was controlled by a fund manager based in the UK, it would no longer be subject to tax deductibility. "The target here is clearly LBOs by private equity houses," Conway points out.

Similarly, the government of Sweden - a country that has enjoyed a more liberal business climate over the last few decades - has signalled tougher tax rules for private equity. Its minister for finance had previously criticised tax shields, created by shareholder loans from companies set up in tax havens, when a media firestorm hit private equity involvement in tax-funded welfare companies.

The Swedish authorities are considering drafting legislation by 2012 to come into effect by 2013, but buyout house Altor has already taken steps to preserve its reputation by converting a shareholder loan in pharmacy chain Apotek Hjärtat to equity. The move will return some SEK 16m per annum to the taxman and is believed to have a non-negligible effect on returns.

In the UK, the General Anti-Avoidance Rule (GAAR) is more inclusive in terms of aggressive tax planners. The problem is, however, that nobody seems to know when tax planning gets aggressive. Conway illustrates the industry sentiment by explaining that while some people argue a Luxembourg holding company counts as aggressive tax planning, others regard it as common practice: "At the moment, we do not really know where the line will be drawn, and it is causing uncertainty."

Kurdian stresses that the proposed changes may put pressure on portfolio companies' financial covenants. "Obviously, the financial model was constructed on the basis of a tax shield being in place. While this will be taken into consideration for new deals, it is possible that present companies will have a harder time."

Conway and Kurdian also highlight the possibility of private equity houses looking into jurisdictions that are more lenient on tax planning. "But you have to wonder how long it will take for this thing to catch on in other European countries," notes Kurdian.

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