BEPS for Asset Management

July 3, 2019 | By Julian Bieber, KPMG in Luxembourg, and Michael Plowgian, KPMG in the United States


This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

Changing the international tax landscape

The Base Erosion and Profit Shifting Project (BEPS Project) by the Organisation for Economic Co-operation and Development (OECD) and the G20 continues to affect the tax landscape for investment funds and asset managers. In particular, the changes instigated by the BEPS Project have affected financing structures and leveraged blockers, as well as the ability of investment entities to claim treaty benefits on cross-border payments.1


Financing structures and leveraged blockers

The BEPS Project included two main actions that affect financing structures and leveraged blockers— recommendations to limit the deductibility of interest expense and recommendations to implement rules that offset the benefits of certain hybrid arrangements.

The BEPS Action 4 Final Report2 includes several recommendations for jurisdictions to limit interest deductions. The recommendations would directly link the entity’s allowable net interest deductions to the taxable income generated by its economic activities. The main recommendation is to limit an entity’s or a group’s net interest deductions to between 10 and 30 percent of the entity’s or group’s EBITDA. In addition, the BEPS Action 4 Final Report states that, as a best practice, jurisdictions may allow an entity to deduct its interest expense up to its proportionate share of its affiliated group’s net third-party interest expense (based on the group’s net interest expense to EBITDA ratio), if that amount is higher than the limitation based on the fixed percentage. The Action 4 Final Report also includes several optional recommendations, including a de minimis rule and a rule for carryforwards of disallowed interest expense or unused capacity and carryback of disallowed interest.

The BEPS Action 2 Final Report3 sets forth recommendations for jurisdictions to offset the tax advantages of arrangements that take advantage of differences in how different jurisdictions treat instruments (e.g., as debt or equity) and entities (e.g., as fiscally transparent or not), as well as differences in the treatment of certain transfers (e.g., securities lending transactions) to achieve double nontaxation, including long-term deferral.

Many jurisdictions have implemented one or both sets of these BEPS recommendations, and others are expected to follow. For example, the United Kingdom enacted interest limitations based on the BEPS recommendations, as well as anti-hybrid rules. European Union Member States are also required to adopt similar rules to be phased in beginning in 2019.4 The United States has also implemented interest deductibility and anti-hybrid rules based on the BEPS recommendations as part of the U.S. tax reform legislation in 2017.

In response, many asset managers have been reviewing their structures to determine the impact of the new rules and modifying acquisition structures where appropriate. In particular, interest deduction limitations are limiting the use of shareholder debt, and in some cases it has become difficult to deduct interest with respect to all third-party acquisition-related debt. The general limitation on deductibility based on EBITDA has caused groups to attempt to spread debt throughout the group to jurisdictions where taxable income is generated in order to obtain the deductions, but jurisdictions also are increasingly enacting safeguards against cashless debt pushdowns and other mechanisms to spread debt throughout the group.

Asset managers, thus, are spending more time understanding intercompany receivables and payables, existing cash levels vis-à-vis normalized working capital, distributable reserves, transfer pricing, and settlement terms. In other words, asset managers increasingly have to design a customized approach for each transaction or structure, taking advantage of a target’s existing profile and the laws of each country, planning entity by entity. In some cases, separate acquisitions of lower-tier subsidiaries have been used to achieve deductibility where local safeguards prevent cashless debt pushdowns. In other cases, different acquiring companies have been formed in multiple jurisdictions to buy a target, with the goal of the acquiring companies each forming a new consolidated group with what were formerly local subsidiaries of the target.

Even with these types of techniques, it may not be possible to deduct all of the acquisition indebtedness, let alone new shareholder debt, and asset managers may consider changing their models to account for the new limitations to ensure appropriate bid prices.

Asset managers of debt funds are also reviewing the impact of the new interest limitation rules. This is of particular importance in the European Union, where the new interest limitation rules of the ATAD apply from January 1, 2019.5 While the impact for entities carrying out pure back-to-back financing activities is expected to be limited in practice (as those entities should not have net interest expense), the situation remains uncertain if an entity holds nonperforming loans, because the ATAD does not provide for a clear definition or guidance regarding what constitutes interest revenue and other economically equivalent taxable revenue and leaves room for interpretation. Asset managers, therefore, are considering alternatives to cope with the uncertainties. The ATAD offers the possibility to exclude from the rule financial undertakings, which includes, in particular, certain alternative investment funds (AIFs).6 We note that Luxembourg has added securitization vehicles covered by EU regulation 2017/2402, which provide for the securitization of credit risk and the subordination through tranching.7

Similarly, asset managers may consider moving away from some of the existing hybrid structures in light of the new rules, as they consider that some of the typical existing structures do not provide much benefit if there is no shareholder debt in place, and the limitation on interest deductibility already reduced the benefit of some of this type of planning. One exception is where a target holding company is in a nontreaty jurisdiction vis-à-vis its subsidiaries. In that case, in order to achieve efficient intercompany financing, there may be a need to have a financing entity in a treaty jurisdiction into which intercompany interest is paid. Hybrid instruments or entities have often been used in those situations, but the new rules make that more difficult. In addition, changes to treaty entitlement (discussed below) also will make that type of planning less effective.

Instead, in many cases, asset managers are now moving toward using entities that are statutorily not subject to tax as long as certain conditions are met (such as the Irish Collective Asset-management Vehicle or ICAV), and other vehicles or instruments not reliant on hybridity to be tax efficient.


Treaty benefits

The other BEPS recommendation that significantly impacts investment structures is the development of rules to prevent abuse of bilateral tax treaties under Action 6 of the BEPS Action Plan.8 A key outcome of this work was the recommendation that treaties include anti-abuse rules, including the so-called “principal purposes test” (PPT), which denies treaty benefits if one of the principal purposes of an arrangement was to obtain those benefits.

The changes recommended as part of BEPS Action 6 were subsequently incorporated in the 2017 updates to the OECD Model Tax Convention on Income and on Capital (the “OECD Model Tax Convention”) and the Commentaries on the Articles of the Model Tax Convention (the “Commentary on the OECD Model”).9 More concretely, the PPT will be included in hundreds of bilateral tax treaties primarily through the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), though it may also be added to treaties through bilateral agreements.10

Governments generally have not issued guidance regarding how they will administer the PPT with respect to investment structures other than regulated funds. The guidance that does exist is limited to the Commentary on the OECD Model, which contains three examples of the application of the PPT to certain kinds of nonregulated investment entities (the “Non-CIV Examples”).

The Non-CIV Examples provide some needed insight into how governments may apply the PPT; however, the examples also raise a number of potential concerns for non-CIV investment entities, because they suggest a narrow view of what non-CIV investment entities can do to satisfy the PPT. Example K is the most advantageous of the examples and suggests that a regional investment platform wholly owned by a single institutional investor can satisfy the PPT even if the regional platform receives a better treaty rate than the institutional investor would have received directly, provided that the platform has significant substance in the jurisdiction in which it resides. Nevertheless, Example K is limited in two important ways. First, the example suggests (especially when read together with Example M, which deals with a multi-investor fund) that a regional platform that is owned by more than one institutional investor would not satisfy the PPT with otherwise similar facts. Second, Example K appears to apply only to the entity that directly employs the relevant employees. That is, other affiliated holding entities in the same jurisdiction that are established by the regional platform for liability or exit purposes may not be able to rely on the substance in the regional platform to satisfy the PPT.

Example L involves a securitization vehicle and concludes that the vehicle satisfies the PPT if the sponsoring bank would be entitled to the same benefits as the securitization vehicle and if the other interests in the vehicle are publicly traded and widely held. While Example L is somewhat helpful, it is very limited and describes a case about which there probably should have been very little doubt even in the absence of the example.

Example M suggests that the application of the PPT to a non-CIV investment vehicle other than those described in Examples K and L depends in part on the treaty benefits to which the investment vehicle’s investors would be entitled if they held the underlying investments directly. While Example M describes a non-CIV investment vehicle that has a significant amount of substance (it “manages” all of the underlying real property investments) and commercial purposes, it also states that the fund “does not obtain treaty benefits that are better than the benefits to which its investors would have been entitled if they had made the same investments directly.” This language suggests that a non-CIV investment vehicle will be required to determine the treaty eligibility of its investors and may need to segregate its investors into different vehicles depending on their treaty eligibility. In other words, Example M may suggest that non-CIV investment vehicles other than regional platforms owned by a single institutional investor may not rely on substance to satisfy the PPT. The “look-through” approach suggested by Example M may be very difficult for some investment vehicle structures to accommodate.

We note that none of the examples describe a non-CIV investment vehicle that does not satisfy the PPT. Thus, it may be possible for some tax authorities to interpret the PPT more expansively and, for example, to treat substance in a jurisdiction as satisfying the PPT. Other authorities may take a more restrictive view. In other words, administration of the PPT is likely to vary significantly among jurisdictions, and differences in administration could lead to considerable uncertainty surrounding the availability of treaty benefits for non-CIV investment vehicles.

At a very high level, the examples indicate that governments are focused on (i) the tax and nontax reasons that a holding company was created, (ii) the tax and nontax reasons the holding company was located in a specific jurisdiction, (iii) what functions or activities the holding company performs, and (iv) whether the investors in the fund would be entitled to similar treaty benefits if they invested directly.

One key question for asset managers, thus, is whether and to what extent a holding company claiming treaty benefits should be able to rely on the functions of an asset manager in determining the functions of the holding company. In other words, can the holding company rely on the “substance” of the management entity?

In general, eligibility for treaty benefits is determined by reference to the characteristics of the person claiming the benefits. For example, a special reduced rate of withholding is provided for dividends if the beneficial owner of the dividends is a company that owns directly at least 25 percent of the capital of the payor.11 The attributes of related entities generally are not taken into account. Similarly, the PPT examples in the Commentary on the OECD Model, including the Non-CIV Examples, focus on the reasons for and the activities conducted by the entity claiming treaty benefits. The examples do not mention activities undertaken by other related entities.

Consistent with this basic mode of treaty analysis, informal discussions with OECD and government representatives suggest that an entity claiming treaty benefits should not rely on activities undertaken by another entity to satisfy the PPT, particularly if that other entity is resident in another jurisdiction. Rather, the entity claiming treaty benefits should be able to carry out through its staff the purposes for which it was established.

In light of this general principle, asset managers are exploring co-employment or employee leasing arrangements to increase the functions of the holding companies, and bringing in additional staff to perform those functions. On the Luxembourg market, asset managers may use global employment contracts (GECs). A GEC is an employment contract that governs the relationship between one Luxembourg-based employee and several Luxembourg employers (i.e., the Luxembourg holding companies). Under a GEC, the employee alternately works for and on behalf of the employers (that are part of the GEC); the employee’s duties may vary over the time depending on the business needs of each employer, and the employee is paid by one employer on behalf of all the employers. The GEC, thus, may allow asset managers to ensure that each entity has the appropriate staff to carry out its purposes and functions, while remaining sufficiently flexible.

Similarly, asset managers may attempt to address the PPT by documenting the purposes for which the entity is established, and ensuring that it has the ability to carry out those purposes. For example, if the holding company is to evaluate and approve investments, it should have officers or directors with the skills and experience to carry out those functions. If the holding company is to serve a financing or cash management function, it should have the staff and the assets necessary to carry out those functions.

Asset managers may also consider whether and to what extent the treaty eligibility of the ultimate investors affects the eligibility of the holding company. Example K explicitly states that the holding company gets a better treaty rate than the ultimate investor (one institutional investor) would get if it invested directly, and concludes that the PPT is not violated. On the other hand, Example M looks at a more typical fund structure that includes multiple institutional investors and states that the holding company does not receive a better treaty benefit than any of the institutional investors would have received if they had invested directly. Example M, thus, suggests that the treaty eligibility of investors is a factor in evaluating whether a holding company satisfies the PPT. Asset managers, thus, may focus more attention on making sure that they can document the treaty eligibility of their investors; however, until jurisdictions issue guidance regarding how they will administer the PPT, we do not expect that asset managers will change fund structures based on treaty eligibility of the investors.

The OECD continues to work on issues of treaty eligibility of investment funds, and there is some hope that additional guidance will help clarify some of the issues raised above. Ultimately, however, the jurisdictions implementing the PPT must issue guidance regarding how they will administer the PPT, and we expect that that guidance will further change how asset managers structure and manage their investment structures.



The OECD/G20 BEPS Project and the tax law changes it has inspired have fundamentally changed the international tax landscape for asset managers and investment funds. Jurisdictions continue to implement restrictions on the deductibility of interest and to negate the benefits of hybrid arrangements. In addition, the PPT will change the ability of investment entities to claim treaty benefits. Asset managers are making changes to deal with these measures and will need to continue to monitor these changes as global tax reform continues.


[1] The BEPS Project also has led to several other recommendations that may affect asset managers and funds, but are beyond the scope of this article.

[2] OECD (2015), OECD/G20 Base Erosion and Profit Shifting Project, Limiting Base Erosion Involving Interest Deductions and Other Financial Payments, Action 4: 2015 Final Report.

[3] OECD (2015), OECD/G20 Base Erosion and Profit Shifting Project, Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report.

[4] Under the Anti-Tax Avoidance Directive (ATAD) EU 2016/1164 of July 12, 2016, articles 4 and 9.

[5] Ibid., articles 4 and 11.

[6] AIF managed by an alternative investment fund manager as defined in point (b) of Article 4(1) of Directive 2011/61/EU or an AIF supervised under the applicable national law.

[7] Law of December 21, 2018 transposing the ATAD in Luxembourg.

[8] See OECD (2013), Action Plan on Base Erosion and Profit Shifting, BEPS Action Plan, available at

[9] OECD, Model Tax Convention on Income and on Capital: Condensed Version 2017, available online at The OECD Model Tax Convention is used as the foundation for many bilateral tax treaties, especially those between OECD members. See Pasquale Pistone, General Report, in The Impact of the OECD and UN Model Conventions on Bilateral Tax Treaties 2 (Michael Lang et al. eds., 2012). Many courts use the Commentary on the OECD Model to interpret the meaning of their bilateral treaties based on the OECD Model Tax Convention. See, e.g., National Westminster Bank PLC, FedCl, 99-2 USTC ¶50,654, 44 FedCl 120, 125 (1999) (“explanatory material in the OECD Document is appropriate for use in divining probable intent of countries adopting treaties based thereon”); see also J. Avery Jones, The Effect of Changes in the OECD Commentaries after a Treaty is Concluded, 56 Bull. Int’l Fiscal Documentation 3 (2002).

[10] The PPT, as included in the MLI, provides:

Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement. MLI, Art. 7(1).

[11] See OECD Model Tax Convention (2017 version), Art. 10(2).