Tax reforms focus on the substance of holding companies and treatment of carried interest

Fundamental changes to the international tax framework are having an impact on deal structures, modelling and financial cash flows. And there are further developments on the horizon.


There has been a major shift in international tax policy in recent years, with greater levels of collaboration between tax administrations than ever before. Private capital firms have already wrestled with changes to treaty rules and, in particular, with the EU’s implementation of the OECD/G20 BEPS project through the Anti Tax Avoidance Directive (ATAD 1) and ATAD 2, which amends ATAD 1 by introducing tighter rules around so-called “hybrid mismatches” (structures that exploit differences in the tax treatment of entities or instruments across jurisdictions).

And there is more to come, with developments on the horizon that seek to modernise the international framework and respond to growing public and political concerns about tax avoidance. These changes will have a tangible impact on deal structures, modelling and cash flows.

Traditional ways of structuring deals to optimise the tax treatment may no longer be as effective. This will not only impact newly implemented structures, but also those that are already in place.

OECD rules, proposed EU directive and ‘Danish cases’ prompt shift away from intermediate entities

Developments such as (i) the OECD/G20 pillar two rules for a global minimum rate of tax, (ii) the proposed EU directive requiring intermediate entities to have sufficient substance (Unshell/ATAD 3) and (iii) ECJ case law looking into beneficial ownership (the so-called Danish cases) are all addressing the importance of substance (both economic and organisational) with respect to holding companies.

Governments on the lookout for additional revenue – including in the Netherlands and Belgium - have also had carried interest in their sights. Changes to the tax treatment of carried interest and management incentive plans are having an impact on remuneration packages (where cash bonuses are increasingly preferred over equity stakes) as more tax administrations consider amending their rules in this area.


Firms need to anticipate the impact of international tax changes and adapt their deal structures to prevent unexpected tax consequences further down the line.

For instance, the OECD/G20 pillar two rules only apply to groups over a EUR750 million revenue threshold, where who is in a “group” is tested by accounting consolidation. Keeping separate investments under different holdcos may help minimise exposure.

If a target falls within pillar two or is relying on particular tax incentives or deductions that may not be respected for pillar two purposes, it’s crucial to ensure this is factored into financial modelling.

Appropriate elections and analysis of exemptions can help minimise tax and compliance burdens

These rules have not yet taken effect so current financial statements will not reflect the impact that being within pillar two will have. Making appropriate elections and determining if any exemptions or safe harbours apply may also improve your tax position and reduce compliance requirements.

Investing directly in target jurisdictions may become more common but may give rise to different challenges that will require alternative deal structures.

Cash bonuses may, in some cases, be preferred over taking an equity stake to navigate greater taxation of carried interest and management incentive plans.

Building in appropriate contractual protections can also help manage potential tax liabilities that may arise as a result of the various tax changes. There remains considerable uncertainty in relation to some of the rules that are being introduced. Deciding who should bear these new tax risks will be the subject of potentially complex negotiations. Ensuring these international tax developments are taken into account early on in the planning of a transaction is therefore crucial. 

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This content was originally published by Allen & Overy before the A&O Shearman merger

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