Young Ran (Christine) Kim (Cardozo; Google Scholar), International Tax Implications for Private Equity Investments, in Research Handbook on the Structure of Private Equity and Venture Capital (Brian Broughman (Vanderbilt; Google Scholar) & Elisabeth de Fontenay (Duke; Google Scholar) eds., forthcoming 2025). :
Private equity funds (PEFs) have continuously grown over the last couple of decades, making up a “quarter of global M&A activity and as much as half of the leveraged loan issues in the capital markets” (Talmor and Vasvari, 2011, 3). Its popularity is due to the fact that it allows access to capital not available on the public markets. However, discourse on private equity tax is still limited to domestic matters. There is scant research analyzing international tax aspects of PEFs’ cross-border investment, despite the dramatic increase in international capital flows. Indeed, PEFs invest all over the world. American private equity firms were in charge of 32% of international buyout investments between 2003 and 2007. During the same period, 34% of the investments from the European private equity market were deployed in nondomestic countries (Talmor and Vasvari, 2011).
PEFs eliminate entity-level taxation by using pass-through entities. They further minimize their investors’ tax liability by taking the position that profits distributed to both general partners (GPs) and limited partners (LPs) are passive portfolio investment income and taxed preferentially. The taxation of carried interest at low capital gains rates is likely the most infamous loophole. This Chapter critically analyzes the nature of PEF investment in the cross-border context—whether it is active investment or passive portfolio investment—and discusses the international tax implications. If the nature of PEF investment is active as opposed to the traditional wisdom, the primary tax jurisdiction to levy tax on PEFs’ cross-border income, especially carried interest, would be changed.
This Chapter further proceeds to the pass-through taxation that investors in PEFs aim to accomplish. Fund investment, or indirect investment, does not entail entity-level taxation domestically, so investors enjoy “tax neutrality” between direct and indirect investments made within a country. In contrast, when investments are made across borders, tax neutrality cannot be guaranteed because current international tax regimes are built upon bilateral tax treaties and lack pass-through tax rules for multinational fund investment schemes. This may put investors in a worse tax position than had they invested directly (i.e., over-taxation). In response, investors have created many strategies to reduce tax liabilities internationally when investing indirectly. Sometimes those strategies enable investors to pay even fewer taxes than they would with a tax-neutral benchmark (i.e., under-taxation). This Chapter considers how to achieve tax neutrality goals in the cross-border PEF investments.
Editor's Note: If you would like to receive a daily email with links to tax posts on TaxProf Blog, email me here.
