Private Equity Tax Guide

Private Equity.
*
A guide to Dutch tax aspects
during the deal continuum
Edited by Oscar Kinders
Table of Contents
Contact persons in the Netherlands
Foreword
1.
Introduction
1.
2.
3.
4.
2.
3.
2007 was a special year for the (Dutch) M&A industry

Drivers of M&A activity
Room for improvement within the M&A industry
Tax aspects and private equity
10
10
11
11
Deal Process
15
1.
2.
3.
4.
5.
16
16
17
17
18
Introduction
Pre-deal
Due Diligence
Structuring
Exit
Due Diligence
21
1.
2.
3.
22
22
23
23
23
24
24
24
24
25
25
25
26
26
4.
5.
6.
7.
Private Equity
Introduction
Legal obligations of buyers and sellers
Tax Due Diligence
3.1 General
3.2 Types of tax due diligence
3.2.1 Buy side due diligence
3.2.2 Vendor due diligence
3.2.3 Vendor Assistance
Scope of due diligence
Disclosure to the tax authorities
5.1 General
5.2 Impact on due diligence reports
Focus of tax due diligence for private equity funds
Public to Private Transactions
4.
Typical fund models
29
1.
2.
3.
4.
30
30
30
30
31
31
33
33
34
35
36
36
37
38
38
39
39
39
5.
6.
5.
Tax Structuring of the Deal
41
1.
2.
3.
42
42
44
45
45
45
45
46
47
48
48
49
4.
5.
6.
7.
8.
6.
Key drivers for private equity

Dutch holding structure
Participation exemption on dividends and capital gains
3.1 Income derived from hybrid loans
Limitations on deductibility of interest
4.1 General
4.2 Thin capitalisation rules
4.3 Base erosion rules
Withholding tax on dividends
Substantial interest taxation
Tax grouping
VAT grouping
Deal Financing
51
1.
2.
52
52
52
52
53
54
54
54
54
55
3.
Introduction
Lifetime of a private equity fund
Location for a fund vehicle
Overview of potential fund jurisdictions
4.1 The traditional Dutch limited partnership fund vehicle
4.2 The Dutch Cooperative Association as fund vehicle
4.3 Luxembourg SICAR
4.4 Guernsey/Jersey LP
4.5 Dubai fund LLC/LLP
4.6 Spanish ECR
Typical Anglo-Saxon fund structure
5.1 Substantive requirements and transfer pricing aspects
5.2 Dutch VAT considerations
Commitments and fund flows
6.1 The investors
6.2 The private equity house
6.3 Carried-interest holders
6.4 Fund managers
Introduction
Optimising the financing structure
2.1 Introduction
2.2 Debt servicing capacity
2.3 Debt push-down strategies - financial assistance rules
2.4 VAT considerations
Modelling the cash flow
3.1 Financial modelling
3.2 Assessment of optimal financing
3.3 Structuring the shareholder funds
PricewaterhouseCoopers
7.
Management participation
57
1.
2.
58
59
59
62
62
62
63
64
65
65
66
66
66
67
3.
4.
5.
8.
Share Purchase Agreements
69
1.
2.
3.
4.
5.
70
70
71
71
72
72
73
73
74
74
6.
9.
Introduction
Type of management incentive arrangements
2.1 Share schemes
2.2 Stock option schemes
2.3 Loan arrangements
2.4 Cash-based incentives
Dutch tax treatment of incentive arrangements
3.1 Tax treatment of share schemes
3.4 Cash-based arrangements
3.5 Corporate income tax
Funding
Overview
Introduction
SPA and the phases of the deal process
General content of SPAs
Translation of the outcome of the due diligence into the SPA
Protection from tax liabilities
5.1 Warranties and disclosures
5.2 Indemnities
5.3 Protection from tax liabilities in relation to private equity funds
Purchase price adjustments
6.1 Earn out
Transaction Costs
77
1.
2.
78
78
78
79
79
80
80
80
80
82
3.
4.
Private Equity
Introduction
Purchase costs and corporate income tax
2.1 Restriction on deduction of purchase costs
2.2 Capitalised from what point
2.3 Transaction costs for inclusion in a fiscal unity
Costs related to the issuance of shares
Acquisition costs and VAT
4.1 Recipient of the services
4.2 Recoverability of VAT on transaction costs
4.3 Recharging transaction costs
10. Post-deal services

1.
2.
3.
4.
5.
Introduction
Formalities
2.1 Tax registration of newly incorporated companies
2.2 Tax grouping
2.3 Transaction costs
2.4 Compliance with advance tax rulings
2.5 Compliance with Sale and Purchase Agreement
2.6 Changes in existing legislation
Follow-up tax due diligence issues
Refinancing
Reporting and accounting tax position
11. Transactions Group PwC

1.
2.
3.
4.
5.
6.
Introduction
Integrated, multidisciplinary approach
Sourcing deals
Executing deals
Creating value
Exiting and realising value
Acknowledgments
Appendix I: High-level Dutch tax features
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Introduction
Reduction of the corporate income tax rate
Reduction of the dividend withholding tax rate
The participation exemption regime
Fiscal Unity regime
Net operating losses
Interest deductibility rules
Tax Exempt Investment Fund Regime
Tax treaty network
Value-added tax
Transfer tax on immovable property
Capital tax
Other indirect taxes
85
86
86
86
86
87
87
87
87
87
88
88
91
92
92
93
93
94
95
97
101
102
102
102
103
103
104
104
104
104
104
105
105
105
Contact persons in
the Netherlands
Peter van Mierlo, Managing Partner Transactions Group
E-mail: [email protected]
Telephone: +31 (0)10 407 66 60
Oscar Kinders, Partner M&A Tax

Telephone: +31 (0)10 407 53 48
Ad van Gils, Partner Transaction Services

Telephone: +31 (0)10 407 64 42
Andries Mak van Waay, Partner Corporate Finance

Telephone: +31 (0)20 568 65 09
Wim Holterman, Partner Valuation & Strategy

Telephone : +31 (0)20 568 52 12
Andrew Kruseman Aretz, Partner Human Resource Services

Telephone: +31 (0)20 568 62 51
Alexander Spek, Partner Capital Markets Group

Telephone: +31 (0)20 568 43 20
Private Equity
Foreword
The capital invested by private equity firms in Dutch companies is a factor of major socioeconomic significance. The combined turnover of the Dutch companies wholly or partially
controlled by private equity firms has increased substantially. In the last couple of years
record numbers of large funds have been created, fund sizes have hit record levels and the
velocity of investments in mega-funds has accelerated.
Private equity firms still have abundant capital that needs to be put to work in the coming
years. They are therefore likely to continue to be major players in the global deal arena. In
other words, private equity is here to stay.
The tax implications are sometimes underestimated during the various stages of a private
equity deal. This book describes the tax aspects that may be encountered during the
different stages of a deal in the Netherlands. Each chapter of this book covers a different
stage in the deal and describes the relevant Dutch tax aspects. The book is a valuable
resource for anyone who is confronted with the tax aspects of a deal in the Netherlands.
Gerrit Zalm
Former Dutch Minister of Finance
Private Equity
1. Introduction
Private Equity
1.
2007 was a special year for the (Dutch) M&A industry
Almost every industry is experiencing merger and acquisition activity at the moment.
And 2007 will retain a special place when the story of how mergers and acquisitions reshaped
the economy is told in years to come. By the end of the first quarter of this century, the world will
have come to understand the impact of technological and political developments that are causing
the global marketplace to shrink ever further. The M&A market will have become even more
professional. Private equity will come to be seen as a logical alternative to the stock exchange or
family-owned structures. And people will understand that it makes sense to refocus a company
for a three to seven year period from time to time.
By 2025, a more professional method for diversifying risks in the financial lending market will have
been developed and the credit crunch will be just a distant memory. Rating agencies will be less
powerful in the lending business and their methods of rating certain assets will have improved.
Corporate governance around mergers and acquisitions and around private equity will have
evolved. M&A processes will have become more transparent. Management and shareholders will
have a better understanding of their individual roles in a transaction and society in general will
have a better understanding of what each party ought and ought not to do.
There are a number of specific factors that explain why this year might be viewed as a turning
point in M&A history:
the decision by some larger private equity houses to go public in the first half of the year;
the credit crunch;
the public debate about private equity;
the large number of major private equity deals in the first half of this year (Hema, Norit, Wolter
Kluwer Educatie, SDU and Philips Semiconductors);
the number of large corporate deals in the second half of this year (ABN AMRO, Organon,
Getronics, Numico, NBIC and Grolsch).
Spurred by the credit crunch, but also by the trend of globalisation and technological advances,
corporates have few options but to play the game of catch or be caught. Prices for corporates are
expected to come down, partly due to the decline in the debt multiples that banks are willing to
offer for M&A financing. Synergies will once more become a decisive factor for success in the M&A
game. Corporates are coming to understand the private equity game better and are becoming a
worthier opponent in auctions and other sale processes. Slowly but surely a level playing field for
corporates and private equity will emerge.
2.
Drivers of M&A activity
The world is getting smaller and a lot of companies are struggling to keep up with the pace of
change. Your competitor is seldom from your own country anymore. Nor are your clients. The
demographics in the western world are having an impact on the strategy of companies in many
industries, as are technological developments. Although markets are expanding, the room for
10
alternative strategies is contracting. A position in the top three in its own market seems to be
essential for a company to be able to capture the market potential. Although M&A activity will
always be opportunistic to some extent, one cannot deny the impact of these factors within the
bigger picture.
Although private equity is the new kid on the block in terms of corporate ownership structures,
it has gained enormously in significance in the last five years in the Netherlands. Private equitys
game plan has often been to buy a business that is being privatised or a business unit that no
longer fits into the core strategy of a larger corporate entity. Taking a positive view, one could
describe private equity as the elegant knight saving these businesses from their former owners. A
less positive view might see private equity as an opportunist, an investor that spots an opportunity
and grabs it, making a lot of money along the way.
Either way, private equity serves its purpose in terms of reshaping our economy and bringing focus
to the vision and mission statements of these businesses. At the same time, private equity creates
a certain pull in the transaction world which has an impact on the push resulting from the strategic
reorientation of corporates as the world changes.
3.
Room for improvement within the M&A industry
As already mentioned, corporate governance around transactions should improve in the coming
years since the relevance of transactions for society in general will remain high.
As far as the process is concerned, we feel that managements role during a Management
Buyout needs to be clarified further and the rules relating to delistings in general could be further
developed. Agency costs have become more transparent in a private equity market and accepted
procedures will have to be formulated for dealing with these costs. In our opinion, there is also
room for improvement in the procedures relating to market due diligence, tax due diligence and
the structuring of a transaction. The monitoring of a deal could also improve with better insight
into accounting and its impact on earnings and tighter control of the execution of the acquisition
plan.
4.
Tax aspects and private equity
As regards the tax aspects relating to private equity it should be noted that the tax environment
for Dutch private equity practitioners has changed substantially in recent years. The aim of this
private equity tax guide is to provide some clarity about the current situation. The guide contains
an overview of the various features of private equity transactions, starting with a general overview
of the entire deal process (Chapter 2). The guide then describes several key elements of a deal,
including the due diligence process (Chapter 3), the typical fund models used in practice (Chapter
4), the different methods of arranging management participation (Chapter 7), the broad terms of
share purchase agreements (Chapter 8) and the tax treatment of transaction costs (Chapter 9).
Private Equity
11
The success of private equity is often attributed to the leveraged financing of the transaction
and the associated financial engineering restructuring of a companys balance sheet and the
assumption of high levels of debt without transforming the underlying commercial reality of the
business. Tax plays a key role in the financial engineering. An essential factor in structuring a
private equity deal tax efficiently (see Chapter 5 on the tax structuring of the transaction) is to
ensure that the interest costs can be set off against the operating income so that the tax shield can
be utilised (see Chapter 6 on transaction financing). Chapter 10 describes the post-deal process.
Finally, in Chapter 11 there is an overview of the professional services needed for each element
of the deal.
12
Private Equity
13
14
2. Deal Process
Private Equity
15
1.
Introduction
The focus of a deal is, besides initiating and closing it, also on securing the envisaged return. The
different stages of a deal process can generally be depicted as follows:
Pre-Deal
Due Diligence
Structuring
Exit
The most significant differences between deals in the private equity arena and the traditional
strategic deal-making environment are:
(1) by contrast with most traditional strategic deals, a foreseen and planned exit is inherent to a
private equity deal; and
(2) in a private equity deal there are a number of different stakeholders, all with different roles.
Obviously, these differences will have an impact on the deal process, for example in terms of the
harvesting of deals and the dynamics between the various stakeholders (sponsor, management,
banks etc.).
2.
Pre-deal
The fierce competition that currently exists in the deal market means that deals have to be turned
around quickly. In other words, there are time pressures throughout the deal process, from due
diligence (see Chapter 3) through negotiation, financing and structuring the transaction (see
Chapters 5 and 6) to the ultimate exit. The pricing of a transaction is of course a critical element,
but the overall terms and conditions of a (binding) bid may perhaps be even more important.
To maximise the efficiency and transparency of a deal process and to retain control of the process
in particular the investigation of the target by the potential acquirers the seller can, for instance,
consider performing a vendor assistance or vendor due diligence to enhance the transparency of
the risks and opportunities associated with the target. This benefits not only the seller, by allowing
it to exercise greater control of the process and reducing the risk of disruptions during the process,
but typically also the potential acquirer by addressing relevant issues that will allow the potential
acquirer to limit the warranties and indemnities which are typically broadly defined in a sale and
purchase agreement (see in more detail Chapter 8).
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3.
Due Diligence
A potential acquirer is offered the opportunity to perform a due diligence to assess and validate
the assumptions underlying the proposed deal. In todays highly competitive environment most
transactions are conducted by auction. An auction is initiated by issuing an offering or information
memorandum to potential acquirers. The memorandum, written by the sellers corporate finance
advisers to solicit interest from potential acquirers, provides an overview of the company. Potential
acquirers are invited to tender a bid for the target. In Europe, including the Netherlands, it has
become common practice for the offering memorandum to be supplemented with a so-called
vendor due diligence report. A vendor due diligence report provides an objective and independent
description of the financial, commercial and tax position of the target (see Chapter 3 for a detailed
description). Especially in an auction process, a due diligence performed by the seller will facilitate
a smooth, controlled and more seamless disclosure of the targets value drivers. Accordingly, it
provides added value for all the parties involved in the deal and make it possible to consummate
a deal sooner.
One effect of the inevitable exit strategy of a private equity fund is the emergence of a secondary
buyout market, where one private equity fund sells its portfolio investment to another private equity
fund. A private equity fund is not normally willing to provide extensive warranties and indemnities
for a buyer or to include any post-deal pricing adjustment mechanisms (lock box). By addressing
and settling any of the exposures and risks that were identified in an initial buyout a private equity
fund can take price improvement actions. This will limit the need for lengthy negotiations over
requests for extensive and broadly defined warranties and indemnities in a future secondary
buyout. In other words, the deal process continues even after the closure of a transaction, not
only with respect to exploiting and monetising the identified opportunities but also and perhaps
even more importantly with a view to mitigating any of the identified exposures and risks (see
Chapter 10 for a more detailed discussion of this aspect).
4.
Structuring
The structure of a transaction is obviously of great importance for combining the respective
interests of the various stakeholders. Most buyouts include an incentive for the management.
Incentive schemes can take various forms, but generally include the possibility for management
to co-invest alongside the private equity fund. This may be created by making use of different
equity and equity-like instruments, e.g. common stock, preferred stock, shareholder loans (see in
more detail Chapter 7).
The debt market plays an important role in private equity transactions since leveraging a
transaction is one of the value drivers for private equity because private equity deals are driven
by cash and free cash flow. The debt leverage capacity is typically determined by the security
available to the target business and its expected cash flows (ability to pay interest and repay debt
instruments). Given the debt providers position in the pecking order, extensive documentation
is required and agreements have to be made on issues such as covenants and pay-out policy
Private Equity
17
on dividends to equity providers. The pecking order also influences the acquisition structure.
Besides the acquiring company, one typically encounters various holding and intermediate holding
companies to create so-called structural subordination. This provides additional security for the
debt providers (see Chapter 6 for more details).
Particularly in the last couple of years the fluid debt market has boosted the influence of private
equity in the Dutch and global transactions market. However, with the shorter lifecycles of
financially-engineered structures such as refinancing and leveraged recapitalisations (a leveraged
recapitalisation can best be described as a partial exit strategy whereby an amount of cash is
released to be withdrawn by the equity providers) more emphasis is placed on tax-efficient cash
repatriation and financing strategies since cash may be transferred to the equity providers by
way of either a dividend distribution or capital gain during the lifecycle of a portfolio investment.
As also emphasised with the backlog in the debt market in 2007, the financing, capital and tax
structure is a concern for some private equity funds. The financing, capital and tax structure aims
amongst others to facilitate and enhance any cash flows within private equity fund structures.
A deal process should thus take into account and focus on the effects and efficiencies of the
proposed financing and capital structure to allow for full flexibility for the portfolio investment, the
lender group as well as the private equity fund.
The banks and their investment committee are another important stakeholder in the deal process.
They largely dictate the financing and acquisition structure with a view to safeguarding their
position as debt provider. The terms and conditions of the facilities agreement and debt covenants
(e.g. leverage ratio, interest cover ratio etc.) are thus an important element when designing an
efficient acquisition and financing structure (see Chapter 5 for more details). The deal process
should address the ability of the direct and indirect borrowers to efficiently service any financing
and repayment costs out of their operating cash. In the 2007 backlog on the debt market the
level of comfort required by the banks increased, not only in terms of historic risks but also and
perhaps more importantly in terms of securing the debt servicing/cash repatriation capacity of
the newly established target group. It can typically be assumed that an optimal financial structure
aims to match interest costs on the debt facilities drawn down (in addition to the debt which is to
be refinanced) with the territory targets profits. This aspect will surface during the deal process
when discussing and analysing the debt covenants in the facilities agreement with the debt
providers. A cash flow and tax model will capture and support the proposed financing, including
debt covenants, and capital structure.
5.
Exit
A private equity fund will eventually exit its portfolio investment. Its return will depend on various
value creation factors, such as growth in operating earnings, buy and build strategy, debt leverage,
etc. This value is created from day one and will continue through to exit. The exit strategy is
and should be part of the entire deal process since it is the core of the private equity business.
The transaction structure should retain flexibility with respect to the exit scenario (see in more
detail Chapters 5 and 6). In deciding on the structure and location of the acquisition structure
18
one should therefore consider likely exit routes, such as a trade sale, a secondary buy-out or an
IPO. Considerations include the location of the ultimate holding or IPO vehicle, the tax costs for
(ultimate) investors on disposal and legal issues relating to the remittance of disposal proceeds
back to the private equity fund.
A deal process from inception through to post-deal services (see Chapter 10 for more details)
should encompass every aspect of the deal continuum to extract the full long-term value from
each deal. By approaching the deal process in a transparent, consistent and controlled manner
it will be possible to negotiate more smartly, create a better structure and close the deal more
quickly.
Private Equity
19
20
3. Due Diligence
Private Equity
21
1.
Introduction
Due diligence plays an important role in a wide range of transactions, from management buyouts
of a division of a public company to large-scale leveraged buyouts of large listed enterprises.
Due diligence is not just about uncovering and quantifying contingent liabilities, although this is
obviously an important aspect. A proper tax due diligence is a key ingredient in assessing whether
to proceed with a deal, and if so how to maximise the overall return achieved.
The vast majority of deals fail to achieve targeted returns by not capturing or maximising upside
benefits and by not identifying hidden liabilities and downside risks. A properly conducted tax due
diligence, in conjunction with legal, commercial and financial reviews, should expose these issues
and opportunities and help make the investment a success.
Tax can be a major cost item, but also a rich source of cash flow savings if managed properly.
This applies especially for private equity funds. The tax due diligence should therefore focus on
the impact on the cash flow of the opportunities and issues identified, since cash flow is one of
the most important value drivers for private equity funds.
In the Netherlands, a proper due diligence is also necessary from a legal perspective to ensure
that the agreed allocation of risks (through indemnities, representations and warranties) does not
preclude any claims.
2.
Legal obligations of buyers and sellers
In many non-Dutch territories (Anglo-Saxon jurisdictions, for example) great emphasis is placed on
representations and warranties in determining the post-deal relationship between the buyer and
the seller. In the Netherlands, however, a completely different approach is taken.
Under Dutch civil law, a seller is obliged to disclose (inlichtingenplicht) any information it believes
or ought to believe is of material interest and relevance to the potential buyer. For example, issues
that may have a substantial impact on the purchase price must be revealed. The extent of the
obligation depends on the circumstances. The buyer, on the other hand, is obliged to conduct a
proper, active investigation and make inquiries (onderzoeksplicht) about the object of the sale.
Dutch case law tends to emphasise the buyers obligation, which increases the importance
of the due diligence process or a proper vendor due diligence with reliance in M&A-related
transactions.
Sellers who fail to make disclosure to a purchaser cannot rely on the argument that the buyer did
not adequately meet its duty to investigate. The same applies for sellers who act in bad faith or
are negligent to the extent of actual misrepresentation. Consequently, buyers may successfully
claim under representations and warranties that give rise to contractual liability on the part of the
seller.
22
However, the position of the buyer seems to be weaker in the Netherlands since the buyers
obligation (onderzoeksplicht) appears to weigh more heavily and the scope of warranties is
restricted by the knowledge that a buyer possessed or should have possessed of facts that
contradicted the warranties given by the seller. The law on this point differs substantially from
the principles of common law on due diligence disclosure. Under Dutch law, a buyer who did
not make proper enquiries before agreeing to the sale or had or should have had knowledge of
particular issues may be barred from making claims against the seller under the warranties.
When transacting business deals in the Netherlands, the best policy from a buyers point of view
is to conduct a proper due diligence investigation and require the seller to thoroughly document
material issues.
For a seller, it is imperative to investigate the existence of any circumstances that may fall within
the scope of the sellers general duty to disclose material issues to the buyer.
3.
Tax Due Diligence
3.1 General
In general, whether or not a complete or partial due diligence is required from a tax perspective
depends on whether the transaction involves assets or shares.
In asset deals in the Netherlands, tax liabilities are generally not inherited by a buyer although
a review may still be required for certain specific assets, for example the VAT treatment of real
estate. In share deals, however, all of the target companys tax liabilities generally remain in the
target company and are thus inherited upon a purchase of the shares. Consequently, a tax due
diligence is required.
From the buyers perspective, the quality of information available about a potential acquisition
determines the ultimate success of a transaction. Without ensuring that the businesss financial
statements are realistic a deal may deliver less than first impressions suggest. To ensure an
efficient sales process, vendors need to present their financial information to potential buyers as
transparently as possible. An independent assessment provides potential buyers with certainty
about the business and the nature of its cash flow.
A tax due diligence helps to identify and highlight the elements of the business that are critical for
its future success.
3.2 Types of tax due diligence

The following types of tax due diligence can be distinguished:
Buy side due diligence
Vendor due diligence
Vendor assistance
Private Equity
23
3.2.1 Buy side due diligence

A buy side due diligence should focus not only on assessing and validating the assumptions that
underlie the deal but should also identify opportunities and potential synergies. Depending on the
type of sale, whether it is by auction or a bilateral deal and the phase of the deal (exclusiveness),
buyers are permitted to perform a limited or a more in-depth review. The scope of the review also
depends on the availability of a vendor due diligence prepared by the seller.
3.2.2 Vendor due diligence

A vendor due diligence is basically the same as a buy side due diligence, but for indeterminate
buyers. The scope and approach of such a review should therefore ideally cover all the items that
different types of buyers (financial or strategic) would focus on.
Vendor due diligences have recently become quite popular. One of the reasons for this is that a
vendor due diligence is beneficial for the sales process. One of the biggest advantages is that
sellers know up front what the issues and/or opportunities are and can therefore act upon the
findings before the start of the actual sales process. A vendor due diligence also gives the seller
more control over the sales process by limiting the room to manoeuvre for buyers and thus speeds
up the sales process. Another advantage is that the management of the target company is only
faced with a single, in-depth due diligence process as opposed to several time-consuming due
diligences performed by different potential buyers.
A vendor due diligence should provide the same comfort for potential buyers as their own due
diligence since the vendor due diligence report should be fully scoped and in most cases is
assigned to the buyer upon a successful transaction. Consequently, buyers can save time and
expense that would otherwise be spent on their own due diligences.
3.2.3 Vendor Assistance

A vendor assistance is more or less a lighter version of the vendor due diligence. An important
difference is that the report will not be assigned to the buyer and may therefore provide less comfort
and fewer advantages than a vendor due diligence report. Consequently, potential buyers may seek
more comfort by performing their own in-depth due diligence and would want to include broader
representations and warranties and/or indemnities in the sale and purchase agreement (SPA).
4.
Scope of due diligence
Several factors can influence the scope and performance of a buy side tax due diligence. For
instance, the business in which the target operates can affect which taxes need to be reviewed
or mean that a quick and dirty scan would be sufficient. For example, if the target is a production
company with relatively large number of blue-collar employees one would not expect significant
payroll tax issues given that such employees do not receive remuneration elements (e.g. fringe
benefits) that are likely to yield payroll tax risks. In that case, a quick scan should be sufficient to
assess whether any other payroll tax risks can be expected. VAT and customs duties are, however,
important areas to review when purchasing or selling a manufacturing company.
24
Another factor (as described in section 2) is the legal obligations of buyers and sellers. This is
particularly important in terms of the scope of the due diligence given the increasing popularity of
auctions in the Dutch market in recent years (see Chapter 2). Needless to say, a full-scope tax due
diligence during such an auction may be undesirable in view of the costs if the deal aborts, which
is why the vendor due diligence has become more popular. On the other hand, in most cases the
successful bidder is not allowed to perform a confirmatory due diligence.
5.
Disclosure to the tax authorities
5.1 General
As a rule, a Dutch taxpayer is obliged to provide a tax inspector on request with all data and
information that could be regarded as relevant for taxation and to disclose any books, records
or other data which may be relevant for establishing the facts relevant for the levying of taxes.
This obligation also extends to information held by third parties, with the exception of certain
categories of persons that are exempted by law from the duty to disclose information. Failure to
fulfil this obligation may have adverse implications for the burden of proof in any appeal procedure,
i.e. the burden of proof may shift to the taxpayer.
Under Dutch law, attorney-client privilege applies to legal advice but this statutory privilege
does not extend to tax consulting services provided by tax advisers and accountants. However,
according to a guideline published by the Dutch State Secretary for Finance, a so-called informal
privilege of nondisclosure of information does apply to tax advisers and accountants. This privilege
is intended to provide the same degree of protection for communications between taxpayers and
their tax advisers with respect to tax advice as for communications between a taxpayer and its
attorney under the attorney-client privilege. In other words, the taxpayer does not have to disclose
tax advice it has received or information held by a third party.
5.2 Impact on due diligence reports

Whether or not a tax due diligence report (whether buy side or vendor side) should be disclosed
under the general rule depends on whether such a report falls within the scope of the so-called
informal privilege of nondisclosure.
A tax due diligence report is prepared as part of the process of deciding whether, and at what
price, to proceed with the purchase of a company and to ensure that the valuation of the target
can be fairly ascertained, i.e. that the purchaser gets what he pays for and that the value of his
shares is not unexpectedly depleted by an unforeseen tax liability or cash tax outflow, for example.
One can therefore argue that given its objective a tax due diligence report can be regarded as
relevant for the determination of a tax liability and as such should be disclosed to the Dutch tax
authorities if requested.
Dutch case law, however, stipulates that the principle of fair play limits the extent to which the
Dutch tax authorities can request disclosure of documents if those documents were prepared
for the purpose of providing advice on or discussing a taxpayers tax position. It is questionable
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whether this is also true for documents, including tax due diligence reports, which contain some
factual information if the objective of the document is to provide advice on or to discuss the
tax position of the taxpayer. Parts of documents containing factual information will have to be
disclosed on request. In light of that, it may be advisable to split the report into a factual part and
a part containing the advice or to omit the non-factual parts when providing the report to the tax
authorities.
If, for example, a tax due diligence report forms an integral part of a financial due diligence report
it cannot be argued that the purpose of the whole document is to discuss or provide advice
on the taxpayers tax position. It follows from the case law referred to above therefore that the
recommended best practice is not to include a tax due diligence report in a financial or commercial
due diligence report to preclude the unintended disclosure of a tax due diligence report.
6.
Focus of tax due diligence for private equity funds
The number of auctions has increased significantly in recent years. In this type of sale, particularly
in deals involving private equity, it is more difficult to obtain a broad spectrum of representations,
warranties and/or indemnities to cover the tax exposures (see more detailed discussion in Chapter
8). Consequently, the tax due diligence should focus on the impact of the opportunities and the
issues identified on the valuation and on the cash flows.
Typical cash effects that could have an impact in terms of corporate income tax are restrictions
on the deductibility interest, the application of the participation exemption under which dividends
or capital gains can be received tax neutral and the possibility to carry forward losses to absorb
future taxable profits (see Chapter 5 and Appendix I for further discussion of these issues). One
aspect which may cause future cash effects with respect to value added tax (VAT) that needs to
be considered during a tax due diligence is whether VAT rates, VAT exemptions and the reverse
charge mechanism have been applied correctly. Management participation schemes are another
significant matter that needs to be considered in relation to payroll taxes (see Chapter 7 for more
details). Yet another aspect to be considered in a tax due diligence is whether exemptions with
respect to real estate transfer tax have been claimed correctly, for example for reorganisations.
In relation to customs and excise duties, the correctness of the qualification of imported goods
and whether import and excise duty formalities have been observed needs to be considered.
Finally, it should be noted that any penalties or interest imposed by the tax authorities in relation to
additional assessments imposed could also have an impact on future cash flows. For an overview
of some these Dutch taxes, see Appendix I.
7.
Public to Private Transactions
It should be noted that the dynamics of a public offer are different from a regular LBO. Amongst
others the possibility of a true due diligence investigation is very limited due to non-disclosure
provisions under insider trading rules and no warranties and indemnities can be obtained (see also
26
Chapter 8). In addition, the legal process is complex and time consuming and the role of minority
shareholders like hedge funds may be disruptive.
The Dutch Ministry of Finance has announced new legislation concerning public takeovers (in
implementation of the EU Merger Directive). One of the measures is that a shareholder that jointly
or individually owns more than 30% of the shares in a listed company is required to make an
unconditional public offer for the remaining 70%. Other measures include more severe deadlines
and review of the funding of such public offers.
The following aspects need to be borne in mind when pursuing a public to private transaction.
Although there is no minimum requirement with respect to an acceptance hurdle for a public offer,
in practice a 95% threshold is aimed for as this allows the bidder to employ a forced squeeze-out
of the minority shareholders. The 95% threshold also allows the Dutch bidding entity to apply
the tax consolidation regime. If this 95% threshold is not met, an alternative measure is a legal
merger of the Dutch target company into Bidco (or even an asset deal), subject to legal and
commercial considerations. Note that these alternatives might very well be opposed by minority
shareholders.
A final point to consider with respect to public to private transactions is that the price should be
set clearly and objectively. In that context, a fairness opinion will generally provide an assurance
of independence.
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28
4. Typical fund models
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1.
Introduction
The key taxation issues faced by private equity practitioners in relation to the structuring of private
equity funds are to enhance the tax position, to create an optimal financing structure and funds
flow and to enhance the efficiency and flexibility of future (partial) exits. From a tax perspective, the
funds should be structured with the aim of minimising tax costs on the acquisition of the target,
additional funding, the fund flows and the ultimate exit.
2.
Lifetime of a private equity fund
Investments in unlisted companies are generally made for a period of five years (sometimes
more, sometimes less) and the principal exit routes are through trade sale, secondary buy-out,
management buy-back or an IPO. The long-term nature of the investments and the difficulties in
finding buyers for investment units are such that most private equity funds are of the closed-end
type, which eliminates the need for funds to sell parts of their portfolios to redeem their shares,
and are incorporated for a limited period of time ranging from eight to twelve years. Given the
nature of the return on a private equity investment, which is largely concentrated upon exit, the
cash flow of the fund is usually negative during the first few years.
3.
Location for a fund vehicle
The best jurisdiction in which to locate a fund vehicle will be dictated mainly by legal and tax
considerations. From a tax perspective, the absence of dividend withholding tax (see also Chapter
5) for a tax-free exit option is one of the primary factors in securing an optimal funds flow. In
this context, it should be noted that the Netherlands has a worldwide network of tax treaties,
embracing all EU and OECD member states, Central and Eastern Europe and the Far East, under
which double taxation is avoided. In addition, in 2006 the Netherlands introduced a policy of
gradually reducing the dividend withholding tax. Besides the absence of a dividend withholding
tax, also the absence of an interest and royalty withholding tax and the absence of a capital tax
and stamp duty on the transfer of shares may also influence the decision on the jurisdiction in
which to set up a fund vehicle. Relevant non-tax factors are the legal flexibility of the regulatory
regimes and the responsiveness of the regulators and the capital market.
4.
Overview of potential fund jurisdictions
As already mentioned, tax considerations are important in deciding on the best jurisdiction in
which to locate a fund vehicle. In this respect, it is interesting to see that over the years several
countries have introduced favourable tax regimes as well as specific legal entities that can be
used as a fund vehicle. The following sections highlight the key characteristics of and differences
between some fund vehicles in different jurisdictions. They are:
1. a Dutch Commanditaire Vennootschap (CV);
30
2.
3.
4.
5.
6.
a Dutch Cooperative Association (Coop);

a Socit dinvestissement capital risque (SICAR) in Luxembourg;
a Limited Partnership (LP) in Guernsey;
a Limited Liability Company (LLC) or Limited Liability Partnership (LLP) in Dubai;
a Fondo de capital-riesgo o FCR (VCF) or Sociedades de capital-riesgo o SCR (VCC) in
Spain.
Before looking in detail at how a fund is typically structured in section 5, the following sections
outline the key characteristics of these fund vehicles.
4.1 The traditional Dutch limited partnership fund vehicle

The traditional fund vehicle in the Netherlands is a Commanditaire Vennootschap (CV). This
vehicle is similar to a limited partnership, the traditional venture capital/private equity fund-raising
and investment vehicle known in the US and the UK. The structure of the CV can be either tax
transparent or tax non-transparent depending on the mechanics of the CV agreement. The CV can
be structured as transparent to avoid having a taxable entity in the Netherlands, in which case the
income of the CV is allocated to the partners for the purposes of Dutch tax.
Under Dutch private law, the limited partners in a CV, i.e. the investors, may not perform any acts
of management in respect of the CV. This is to avoid endangering their status as limited partners.
If they perform management activities they run the risk of being qualified as a general partner
and consequently incurring unlimited liability. Because of their unlimited liability, general partners
normally use a limited liability company to cap the liability.
A CV is typically structured as a tax transparent fund vehicle. As such, it is not subject to corporate
income tax or dividend withholding tax. Because a CV is tax transparent, it is necessary to
establish an intermediate holding/acquisition structure that allows access to double taxation
treaties and the EU Parent-Subsidiary directive. Furthermore, such an intermediate holding/
acquisition structure should create flexibility with respect to funding and cash repatriation from
a legal, accounting and tax perspective. In this context, a Dutch BV or Cooperative is a feasible
option for an on-shore holding/acquisition vehicle (see Chapter 5 for more details on the use of a
Cooperative in acquisition structures).
4.2 The Dutch Cooperative Association as fund vehicle

In addition to the traditional CV, the Dutch Cooperative has also emerged in recent years as a fund
vehicle in the Netherlands. Generally three types of Cooperatives should be distinguished. The
differences between these three relate to the liability of the members. These three types are:
1. The Cooperative of which the members are unlimited liable;
2. The Cooperative of which the members liability is limited;
3. The Cooperative of which the members liability is excluded.
Unless the articles of association provide otherwise, the members are fully liable. In addition, the
articles may provide for limited liability or exclude liability for the members.
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Since the Cooperative, like the BV, can benefit from the Dutch participation exemption, dividend
income and capital gains should be tax exempt in the Netherlands. If structured properly, profits
repatriated by the Cooperative to the investors should not be subject to dividend withholding tax
at the level of the Cooperative.
Provided the Cooperative contains sufficient substance in the Netherlands, the Cooperative
should be entitled to the benefits of the tax treaties. The Cooperative should therefore be entitled
to the lower tax rates applicable under the relevant tax treaties with respect to any withholding tax
due on payments of passive income to the Cooperative from another jurisdiction. In addition, the
legal form of a Dutch Cooperative is mentioned in the Annex to the EU Parent-Subsidiary Directive
and it is therefore entitled to the benefits of the directive.
The Cooperative can be funded in several ways. Financing through shareholder debt or equity
should generally not encounter Dutch tax issues. If US investors are attracted, it may be
considered to fund the Cooperative through Preferred Equity Certificates (PEC) and Convertible
Preferred Equity Certificates (CPEC). In addition, since no capital tax is levied in the Netherlands
capital contributions upon incorporation as well as future capital contributions to the Cooperative
do not trigger an upfront tax charge.
Normally, one would expect that the interest in the Cooperative should be assigned to the
business of the investors. This means that the interest in the Cooperative is not held as a free
portfolio investment but as part of the core business of the investors in the fund. The fund itself
should then not be considered as a foreign taxpayer in the Netherlands (see also Chapter 6).
One point to note with regard to the general legal aspects of a Cooperative is that under Dutch
corporate and civil law, the Cooperative is a separate legal entity with its own rights and obligations
and the capacity to legally own assets and conclude agreements. Membership is open to any type
of private equity vehicle. In other words, it is not restricted to individuals and companies and
partnerships may also become members.
There are some provisions of the Dutch Civil Code concerning the terms of the articles of
association of a Cooperative. In general, the Cooperatives articles can be regarded as an
agreement between the members and the Cooperative so there is a lot of flexibility with respect
to their content (e.g. profit allocation and repatriation).
The possibility of issuing different classes of membership rights, i.e. priority rights, preference
rights and alphabet rights, makes the Dutch Cooperative a flexible vehicle.
In addition, when a Dutch Coop is used as fund vehicle, certain regulatory issues may apply. Pursuant
to the Dutch Investment Institutions Supervision Act (Wet Toezicht Beleggingsinstellingen), under
certain circumstances a licence is needed from the Dutch Financial Markets Authority (Autoriteit
Financile Markten or AFM). The primary focus of the AFM is, however, the supervision of investment
funds that are publicly marketed. Since private equity commonly targets professional investors rather
than the public at large, no licence may be required provided certain conditions are met.
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4.3 Luxembourg SICAR

The form of investment company generally used by venture capital and private equity firms in
Luxembourg is the SICAR. The SICAR is commonly set up in corporate form, generally as a
partnership limited by shares (Socit en Commandite par Actions or SCA), to benefit from the
advantages of the tax regime applicable to that type of entity. The general partner owns and
operates the business and assumes liability for the partnership, while the limited partners serve
solely as investors. In a SCA different classes of shares are used to differentiate the interests
held by the general and limited partners and to structure their entitlement to different distribution
rights.
The SICAR is subject to regulation by Luxembourgs financial sector regulator, the Commission
de Surveillance du Secteur Financier (CSSF). Among the requirements are that it must be audited
annually and certain regulatory restrictions may apply to its investments. The SICAR must appoint
a custodian bank which must be a Luxembourg-based credit institution and the law provides for
ongoing light supervision by the CSSF during the life of the SICAR. The subscribed share capital
of the SICAR may not be less than EUR 1 million, it must be fully subscribed and a minimum of
5% must be paid up. The SICAR is subject to a de minimis capital duty on equity subscriptions
(once-off levy of approximately EUR 1,250).
The main tax advantage of the SICAR is that, under certain conditions, the risk capital income
of a SICAR is exempt from tax. The remainder of the income is taxed at approximately 30%.
Additional tax advantages are the absence of dividend withholding tax and (theoretically) access
to Luxembourg tax treaties with respect to income received from jurisdictions where the targets
are located. However, it should be noted that in practice other jurisdictions may question
whether the SICAR is entitled to tax treaty benefits (reduction of withholding tax, etc). General
and limited partners resident outside Luxembourg should generally not be subject to tax on
dividends and capital gains as non-residents of Luxembourg. It should also be noted that, like
in other jurisdictions, substance requirements should be monitored. Very briefly, this requirement
means that the SCA must be managed and controlled from Luxembourg. This involves that the
directors of the general partner vehicle have to travel on a regular basis to Luxembourg and
that Luxembourg-based directors have to be appointed to the board of the general partner who
are genuinely able to scrutinise and potentially reject recommendations made by any advisory
companies (see in more detail section 5.1).
4.4 Guernsey/Jersey LP
In Guernsey and Jersey a limited partnership is commonly used as a fund vehicle. In both
jurisdictions this vehicle is similar to a UK limited partnership. An investment fund structured
via a Guernsey limited partnership is transparent for Guernsey/Jersey tax purposes and from a
Guernsey/Jersey tax perspective the profits of the partnership are allocated to the partners. The
situation may however be different from the perspective of the jurisdictions where the investors are
resident. Since the tax treatment of the investors depends, among other things, on the treatment
of their interest in the Guernsey/Jersey partnership in their resident jurisdiction, this is one of the
considerations for the investors concerned.
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The limited partners, i.e. the investors, must not perform any acts of management in the partnership
if they wish to preserve their status as limited partners. If they perform management tasks they
run the risk of being qualified as a general partner and consequently assuming unlimited liability.
Because of their unlimited liability, general partners commonly use a limited company to cap their
liability.
If an investment fund established in Guernsey is structured with a general partner through a
corporate vehicle on Guernsey, the latter vehicle may qualify for Exempt Company status and
therefore be exempt from Guernsey income tax. To qualify for Exempt Company status, the
beneficial owners of the company must be non-Guernsey residents. The shareholders should
therefore not be resident in Guernsey. Distributions made from an Exempt Company are not
subject to withholding tax.
4.5 Dubai fund LLC/LLP

In Dubai, the fund entity could take the form of a partnership vehicle, such as the Limited Liability
Partnership (LLP), or a corporate vehicle, such as the Limited Liability Company (LLC). As a
partnership vehicle the LLP may offer greater flexibility with respect to fund distributions than the
corporate LLC. At the fund level, the interests of the investors can be separated using different
classes of shares or units. Regulatory issues may require the management company to be situated
in Dubai.
The fund vehicle should be established in the Dubai International Finance Centre (DIFC) in the
United Arab Emirates (UAE), primarily because it will then be able to avail of the UAEs double
tax treaty network. However, it should be noted that in practice it is questionable whether other
jurisdictions will respect the tax-exempt fund vehicles entitlement to tax treaty benefits (reduction
of withholding tax, etc).
The DIFC is a Dubai government-sponsored free zone that was specifically established in 2004 to
operate as an independent capital market. It is not subject to the ordinary commercial rules and
regulations applying to entities registered in the UAE. LLCs and LLPs established in one of the
designated free zones in Dubai, as well as the management company, should generally not be
subject to corporate tax and dividend withholding tax. These free zones provide for tax holidays to
attract business to Dubai. In the free zone, there are no rules prescribing that any of the investors
must be local so all the investors may be resident outside Dubai. If the fund vehicle is established
in such a free zone it should not be subject to either corporate tax or capital duty and the foreign
investors, whether corporate or individual, should also not be subject to tax.
34
4.6 Spanish ECR

Venture capital entities in Spain are known as Entidades de Capital Riesgo (ECR). There are two
specific types: the Venture Capital Fund (Fondo de Capital-Riesgo o FCR) and the Venture Capital
Company (Sociedades de Capital-Riesgo o SCR).
The minimum share capital of a Venture Capital Fund (VCF) is EUR 1,650,000 and of a Venture
Capital Company (VCC) it is EUR 1,200,000 (in 2007). There is a special tax regime that only applies
to the income derived from investments by these entities within the Compulsory Investment Ratio
(CIR). This CIR is 60% of the total income. In other words, 40% of the investments can be in assets
that do not comply with the CIR.
Dividends received by a VCC or VCF are tax exempt and capital gains are exempt for 99%, i.e.
they are effectively taxed at approximately 0.30%. Spanish VCCs and VCFs do not pay capital
duty on incorporation or on subsequent capital contributions. The main tax advantages for
non-resident investors are that capital gains and dividends received are not taxable in Spain and
are free of withholding tax (irrespective of the percentage and period of the shareholding, unless
the recipient is resident in a tax haven).
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5.
Typical Anglo-Saxon fund structure
A typical fund structure and the relevant inflows can be depicted as follows:
Typical fund structure
PE House
Carried interest holders
Carry
vehicle
Investors
(1) Capital
(2) Loan
Advisory
Company
Management
Company
Advisory fee
Advice
(1) Capital
Fund
(3)
HoldCo (1)
Junior debt
HoldCo (2)
Senior debt
Mezzanine debt
(1) Nominal capital contributed to the fund by

investors and carried interest holders
(2) Investors loans made to the fund
Investments
(3) Proceeds from targets (dividends/capital gains)
5.1 Substantive requirements and transfer pricing aspects

As general partner of the fund, the management company usually subcontracts with advisory
companies. To ensure that the management company (being the general partner), which is
typically located and active in a low-tax jurisdiction, does not become taxable as a non-resident
in the country where the advisory companies are located, the general partner should not carry on
its enterprise in those jurisdictions through a Permanent Establishment (PE). If the management
company carries on its enterprise in other jurisdictions through a PE it could be liable to tax as
a non-resident for the profits attributable to the PE. Generally, to avoid having a PE the general
partner should pursue activities in that capacity only in the jurisdiction where it is located. Hence,
fund decisions regarding investments should be taken in the low-tax jurisdiction where the
management company is located.
36
There could be a substantive requirement in the jurisdiction where the general partner resides
provided that the management company has to have genuine decision-making capacity.
Depending on the eventual structure of the fund, the advisory company may be connected to the
general partner for transfer pricing purposes (e.g. through common shareholders). In such case,
the arms length nature of the remuneration paid by the general partner to the advisory company
should be respected (i.e. it should be in line with the market). What arms length remuneration is,
depends on who performs the Key Entrepreneurial Risk-Taking (KERT) functions and where they
are performed.
5.2 Dutch VAT considerations

As far as the implications for Dutch VAT are concerned, it should be noted that in principle an
advisory fee charged by an advisory company in the Netherlands to a general partner in a low-tax
jurisdiction, typically Guernsey or Jersey, may be subject to VAT in the Netherlands (depending
on the exact scope of these services, see in this respect also Chapter 9). However, the reverse
charge mechanism applies to advisory fees. Hence, if the fees are charged to an entity established
outside the EU the place of supply is where the recipient is established. Consequently, the Dutch
advisory company is not liable to account for VAT on the fees charged, but the management
company should in principle make a self-assessment for VAT for the fees in accordance with local
VAT law (if a VAT system is in place).
Another point to note is that management fees charged by a Dutch management company are
in principle liable to Dutch VAT. If the management company is not resident in the EU, VAT can
in principle be reclaimed with a VAT refund request pursuant to the 13th Directive. This is to the
detriment of the cash flow but can be mitigated if the contract and activities of the Dutch company
are structured properly.
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6.
Commitments and fund flows
With respect to the income flows within the fund it should be noted that the commitments of the
participants to the fund vary depending on their role within the structure. Generally, the outflows
of a fund can be depicted as follows:
Typical funds flows
PE House
Carried interest holders
Management fee
Advisory services
Management
Company
Advisory
Company
Advisory fee
Advisory
services
Carry
vehicle
Investors
(3) Profit
(3) Carried
interest
(1) Priority profit
share
(2) Loans and

hurdle
Fund
(Proceeds from targets)
Investments
(1) Priority profit share paid to general
partner to cover set-up costs and
annual management costs
(2) Loans and hurdle return paid to investors
(3) Remaining profit split between
carried interest holders and investors
The key participants in the fund, together with the related commitments/outflows, are described
below.
6.1 The investors

Generally speaking, but not limited to, the commitments by and outflows to the investors (being
the limited partners in the funds limited partnership) are as follows:
The investors contribute capital to the fund;
The investors make commitments to provide interest-free loans to the fund once suitable
investment opportunities have been identified; and
38
The investors receive a preferred return on their loans to the fund (hurdle rate) and share profits
in excess of that return with the carried-interest holders.
6.2 The private equity house

The commitments by and outflows to the private equity house are as follows:
The principal role of the private equity house is to identify investments, appraise investment
opportunities, negotiate the terms of those investments, monitor the investments, create added
value by an active involvement in the management of the investments and oversee the exit from
them; and
The private equity house receives a priority profit share from the fund to cover initial set-up
costs and an annual management fee.
6.3 Carried-interest holders

Carried-interest holders may be individuals who are partners in the fund (either directly or through
a carry vehicle) as well as employees or directors of the management company or an associated
company. These individuals contribute nominal capital to the fund for their carried interest in the
fund. Until the loans of the investors have been repaid and the preferred return has been made
to the investors, the carried-interest holders are considered to have a profit-sharing ratio of 0%.
Once the loans and the preferred return have been paid, i.e. once the hurdle has been reached,
the profit-sharing ratio changes and the carried-interest holders typically receive 20% and the
investors 80%. Taxation of the carried interest is one of the concerns to be addressed for Dutch
resident fund managers.
6.4 Fund managers

The fund managers are entitled to contribute a limited amount of equity to the fund, which entitles
them to share in the profit available after repayment of the hurdle interest on the investors
loans. The profit attaching to the equity share in the fund can produce attractive returns due to
subordination of the fund manager to the other investors. Besides the acquisition and recycling
process, the private equity managers will divide their time between managing the funds by
assisting, advising and monitoring their portfolio companies on the one hand, and managing
relations with their investors and the capital market in general on the other.
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40
5. Tax Structuring
of the Deal
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1.
Key drivers for private equity
Private equity firms aim to realise a high return on investment, typically by pursuing a value-added,
active management strategy. In a cash-flow driven and competitive private equity market, tax
is increasingly regarded as a key value driver. The tax efficiency of acquisition structures is of
paramount importance for enhancing the cash-flow position of a private equity funds portfolio
companies, but perhaps even more importantly for enhancing the efficiency and flexibility of future
(partial) exits.
Exotic jurisdictions and tax havens are still used as locations for private equity funds but are
fading in importance as locations for investment or acquisition vehicles. The current trend is for
private equity to move their investment or acquisition companies to onshore locations, such as the
Netherlands and Luxembourg, for tax-related and other reasons. These companies are then used
as a platform for their pan-European and, to a lesser extent, global buyouts.
Key drivers of the deal structure will be the desire to secure the maximum legal flexibility with
regard to aspects such as acquisitions, decision making, the exit and minimising the tax leakage
throughout the investment, and particularly upon an exit. The proceeds from the management of
the portfolio companies (in the form of capital gains, dividend or interest income) should accrue
to the investors in the most tax-efficient way. Consequently, the after-tax costs of each type of
financing will be a key factor in the choice of acquisition structure. Deduction of interest costs can
effectively reduce the cost of that finance for the group and thus ultimately the cost of the final
return on the investment.
The following items will typically be relevant in the deal structuring process:
selection of a suitable local acquisition vehicle;
selection of the most favourable jurisdiction for an acquisition and financing company;
assessment of the transaction costs and the tax treatment of those costs (for more detail see
Chapter 9);
assessment of tax-efficient management participation (for more detail see Chapter 7);
selection of a tax-efficient financing structure;
preparation of a cash-flow model ensuring efficient debt servicing;
ensuring a tax-efficient exit for the investors.
2.
Dutch holding structure
A holding company acting as the funds acquisition vehicle is a common feature of acquisition
structures.
The Netherlands good infrastructure makes it a popular location for head offices of multinationals.
In addition, many international companies have an operating subsidiary in the Netherlands to
take advantage of the countrys central geographical situation as a gateway to the European
market. From a tax perspective, one of the requirements for setting up a holding company in
42
the Netherlands is that the company must have a genuine substantial presence in the country
(i.e. personnel, buildings, etc.). Many international companies already meet this requirement
of a substantial presence for tax purposes since they have their head offices and operational
subsidiaries in the Netherlands.
The Dutch holding regime is popular due to its full participation exemption rules, the countrys
extensive double taxation treaty network and the fact that, with a proper structure, no (dividend)
withholding taxes have to be paid on distributions or repayment of debt (see section 5 and
Appendix I for more details).
For private equity funds, which often have to make deals in a short period of time, another aspect
that makes the tax climate attractive for a holding company is a tax authority that is able to
cooperate at short notice. A tax authority that is accessible and works quickly helps dealmakers
to eliminate tax risks and avoid discussions afterwards. In this respect, it is of importance that
negotiations with Dutch tax inspectors tend to be informal, by way of consultation, rather than
taking place in a climate of litigation and penalties, as is commonly the case in most Anglo-Saxon
countries.
There are some specific Dutch tax and legal regulations that have an impact on the Dutch
acquisition finance practice.
The most important legal provisions that impact on Dutch deal structuring and financing are:
financial assistance rules (for more details see Chapter 6);
rules with respect to corporate interests; and
insolvency law.
The most important Dutch corporate income tax regulations in this respect are:
limitations on the deductibility of interest;
taxation of dividends and capital gains for individual shareholders with a substantial interest
and certain corporate shareholders in situations where no tax treaty is applicable.
The challenges posed by these legal rules can be managed by adopting the proper structure.
Foreign private equity houses which actively manage their investments face less risk of potential
liability as a foreign taxpayer in the Netherlands. Interest deduction restrictions can be mitigated
in such a way that sometimes shareholder loans from private equity funds may be deductible for
Dutch corporate income tax purposes.
The constraints mentioned above are therefore limited, assuming a suitable tax structure is also
feasible from a commercial and legal perspective. This is generally the case for private equity
transactions.
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The Dutch tax system contains some interesting features (see Appendix I for more details). They
include:
full participation exemption on dividends and capital gains;
interest relating to the external acquisition of shares may be tax deductible in most cases with
proper structuring;
no withholding tax on interest and royalties;
withholding tax on dividends can be avoided by means of proper structuring;
a wide network of tax treaties concluded with all industrialised countries worldwide.
Sections 3 to 6 describe some of the Dutch tax regulations one encounters while structuring a
deal in more detail.
3.
Participation exemption on dividends and capital gains
The Netherlands applies a so-called full participation exemption. When the conditions for the
participation exemption are met, all dividends and capital gains of substantial shareholdings are
fully tax-exempt. Ever since 1893 the Dutch tax legislators have adhered to the principle that
distributions between corporations should not be taxed twice.
Two tests have to be met to qualify for the full participation exemption:
1. an ownership test, to control that the holding requirements are fulfilled; and
2. an assets test, which establishes that the participation can be regarded as active.
1. Ownership test
The ownership test is passed if the taxpayer holds at least five percent of the nominal issued share
capital of a company with a capital divided into shares. Furthermore, the ownership requirements
are fulfilled if a taxpayer holds five percent of the participation interests in a joint account fund, is
a member of a Cooperative Association or is a limited partner participating for at least five percent
in the profits realised by an open CV (a Dutch limited partnership that is treated as a company
for Dutch tax purposes).
2. Asset test
The asset test is passed if the company in which the shareholder has an interest can be regarded as an
active company. If more than 50 percent of the assets of the participation consist, directly or indirectly,
of portfolio investments it is regarded as a passive participation (for more details see Appendix I).
If the assets test and the ownership test are passed, the participation is regarded as active and
the participation exemption applies. Whether or not the active companys profits are subject to
tax is then irrelevant for the application of the Dutch participation exemption, by contrast with
other European countries where such a subject-to-tax requirement is commonly applied. In this
respect, it should be noted that the absence of a subject-to-tax requirement for active companies
under the Dutch participation exemption does provide for structuring opportunities with respect
to companies which are not subject to tax.
44
It is also important to note that the Dutch tax authorities are willing to provide advance confirmation
that the participation exemption will apply to a given interest held by a Dutch holding company.
3.1 Income derived from hybrid loans

If an investment qualifies for the participation exemption, income derived from hybrid loans
receivable from such a subsidiary could also be covered by the participation exemption. This
creates planning opportunities if the interest paid on hybrid loans is deductible in the source
country.
4.
Limitations on deductibility of interest
4.1 General
The Dutch Corporate Income Tax Act provides for a couple of possible restrictions on the
deductibility of interest paid to related parties. The most important ones are the thin capitalisation
rule and the anti-base erosion rule. Apart from these rules, interest deduction restrictions may also
apply if debt is classified as equity for Dutch tax purposes, i.e. so-called hybrid loans.
Interest expenses should also meet the arms length standard. If interest is paid to a bank or
another third party (without guarantees from group companies) the arms length standard will
normally be met. The interest rate charged by a third party is often used as a benchmark to
determine the interest rate on related party debt (i.e. to determine whether the interest rate on
related party debt meets the arms length standard).
For Dutch corporate income tax purposes, related parties are generally considered to be
companies or individuals that have a direct or indirect interest of at least one-third in the Dutch
taxpayer or in companies in which the Dutch taxpayer has an interest of at least one-third.
Companies and individuals are also considered related parties if the Dutch taxpayer and another
company have a direct or indirect shareholder that has an interest of at least one-third in both the
taxpayer and the other company.
If a related party provides guarantees to a Dutch taxpayer in relation to third-party borrowings,
the implications should be carefully reviewed. Third-party debt may be requalified as related-party
debt unless, for instance, the borrower can demonstrate that it could have obtained the debt on a
stand-alone basis. Typically, this would be demonstrated using cash flow models showing that the
company can service its debt, including interest payments. Consequently, guarantees provided to
obtain better terms, i.e. a lower interest rate, should not cause any harm.
4.2 Thin capitalisation rules

Dutch thin capitalisation legislation limits the deductibility of interest payments in the event that a
company is excessively financed by means of debt. Whether a taxpayer is excessively financed by
debt is determined by comparing its debt and equity. A company is considered to be excessively
financed by debt to the extent that its average debt exceeds three times the average amount of
its equity, the so-called fixed ratio criterion.
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The thin capitalisation legislation is only applicable if the taxpayer is part of a group as defined in
the Dutch Civil Code (Burgerlijk Wetboek). A group is defined as an economic unity in which legal
persons and companies are organisationally connected. In practice, this means that companies
constitute a group if one company is essentially in control of the other.
The non-deductibility of interest payments is maximised at the balance of interest payments owed
to related parties and interest received from those parties. Hence, the thin capitalisation provisions
will not limit the deductibility of interest payments if a company has exclusively arranged external
loans.
Apart from the fixed ratio criterion, the Dutch taxpayer can elect to apply the group debtto-equity ratio based on the groups consolidated financial statements. Again, for Dutch tax
purposes the concept of a group is based on the definition of group in the Dutch Civil Code. The
consolidated accounts could be used as evidence of the existence of such a group. This ratio
provides companies with flexibility, for example in situations where the debt financing position of
a certain industry is relatively high.
Although, according to Dutch private law standards, private equity funds generally belong to a
group they are not usually obliged to consolidate their investments because they have an explicit
exit strategy. Consequently, the highest level of group consolidation, according to the Dutch Civil
Code and therefore for the purposes of Dutch thin capitalisation rules, normally starts with the
acquisition holding company directly below the fund. The group ratio therefore includes all debt
provided by the fund and external sources on a consolidated basis at that holding company level.
If the Dutch (intermediate) holding companys debt-to-equity ratio is similar to or better than the
groups, which is the case if the Dutch holding company heads the group, interest should not be
subject to Dutch thin capitalisation rules.
4.3 Base erosion rules

As in the case of the Dutch thin capitalisation rules, the base erosion rules only disallow interest
paid to related parties, i.e. if the debt is used to finance certain tainted transactions (such as
dividend distributions, a repayment of capital and the acquisition of or contribution of capital to a
subsidiary). Interest paid on genuine third-party debt should be deductible.
In addition, even if interest is paid to related parties on loans to finance a tainted transaction, the
interest should still be deductible provided that both the transaction and its financing are based
on sound business principles. That might be the case, for example, when group debt is eventually
financed outside the group and there is a direct relationship between the related party debt and
external debt. A direct relationship is mainly determined on the basis of the terms, the repayment,
the remuneration and the magnitude and duration of the loans.
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5.
Withholding tax on dividends
Dutch dividend withholding tax is imposed on dividends distributed by Dutch tax-resident

companies. In principle, the tax rate is 15%.
No tax is withheld if a Dutch company distributes dividends to a company in another EU member
state when the EC Parent-Subsidiary Directive (No. 90/435/EEC) is applicable. The ParentSubsidiary Directive applies if the following conditions are met:
1. both companies have one of the legal forms mentioned in the annex to the directive;
2. at the time of the distribution the parent company has held at least 25 percent of the par value
of the paid-up capital in its subsidiary for an uninterrupted period of one year;
3. both companies are subject to a tax on profits, without the option of an exemption or an actual
exemption;
4. neither company is deemed in their respective country of residence to be resident outside the
EU on the basis of a tax treaty concluded with a third State.
Generally speaking, the Dutch dividend withholding tax is reduced under tax treaties to 10, 5 or 0
percent for dividends from a participation that exceeds a certain threshold. The Netherlands has
concluded tax treaties with more than 80 countries worldwide. With this extensive treaty network,
the Netherlands is a preferred location to establish holding and financing companies.
In recent years, the Dutch Cooperative Association has gained in popularity. One of the reasons
for this is the inclusion of the Dutch Coop in the EU Parent-Subsidiary Directive since 2003. One of
the main characteristics of the Dutch Coop is that Dutch dividend withholding tax does not apply
to distributions by the Coop to its participants, provided the articles of association of the Coop
are properly structured. The Netherlands is a particularly interesting location for some transatlantic
and pan-European private equity funds entering the European market, and to a lesser extent for
structuring global investments.
Simplified Dutch Coop Structure
Fund
Fund jurisdiction
Tax free repatriation of proceeds
The Netherlands
Dutch Entity
Tax exempt dividends under participation
exemption
Target jurisdiction
Target
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The structure shown before is a simplified example in which a private equity fund uses the benefits
of a Dutch Coop to ensure tax-free distributions to the fund.
6.
Substantial interest taxation
The income a corporate shareholder receives from a substantial interest in a Dutch company is
subject to corporate income tax unless that interest forms part of the assets of the shareholders
business enterprise. The income from a substantial interest includes not only dividends received
and capital gains realised but also income and gains from loans to a company in which a
substantial interest is held.
A non-resident entity has a substantial interest in a company resident in the Netherlands if, directly
or indirectly, it:
a. owns at least five percent of the issued share capital of that company;
b. has rights to acquire shares representing at least five percent of the issued share capital of that
company; or
c. has profit-sharing certificates relating to at least five percent of the annual profits of that
company or at least five percent of its liquidation proceeds.
The rights of enjoyment to shares or profit-sharing certificates as well as participations in mutual
investment funds can qualify towards holding a substantial interest.
Private equity funds will generally be protected from substantial interest taxation if their investment
forms part of the assets of a business enterprise of the fund. In this respect, active management of
the investments is regarded as a business enterprise. In general, private equity funds do actively
manage their investments and this constitutes part of their business activities. It is therefore
possible, and is common practice, for private equity funds to obtain an advance ruling from the
tax authorities confirming that substantial interest taxation is not applicable.
7.
Tax grouping
Under certain conditions a parent company may be taxed, together with one or more of its
subsidiaries, as a group (see in more detail Appendix I). For corporation tax purposes, this means
that the subsidiaries are deemed to have been absorbed by the parent company.
The main advantage of group taxation is the possibility to offset interest on acquisition debt
against the operating profits of the target companies. Other advantages are that the losses of one
company can be set off against the profits of another group company and that fixed assets may
in principle be transferred tax-free from one group company to another.
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8.
VAT grouping
In addition to corporation tax grouping, VAT grouping is also possible in the Netherlands provided
that certain criteria are met.
Dutch companies that have a financial, economic and organisational link can in principle be joined
in a VAT group (at the request of the companies themselves or at the discretion of the Dutch tax
authorities).
The main administrative benefit of VAT grouping is that transactions between companies in the VAT
group fall outside the scope of Dutch VAT. Furthermore, the right to recover input VAT in relation to
residual/general costs is determined on the basis of the external activities of the companies in the
VAT group. As a result, the VAT taxable activities of the operating companies can have a positive
effect on the input VAT recovery position of the holding company compared with the input VAT
recovery position of the holding company on a stand-alone basis.
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6. Deal Financing
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1.
Introduction
Financial institutions are important stakeholders in driving successful large buyout operations by
private equity houses. In the typical buyout, a mix of financial institutions is brought together to
raise the funds required.
Most of the larger financial institutions in the Netherlands have dedicated leveraged finance
teams, which underwrite and syndicate a single transaction with various forms of debt including
senior, mezzanine and high-yield debt, bridging finance and working capital facilities. These teams
are highly active in local and international buyouts. Besides the Dutch financial institutions, there
are UK and continental European leveraged finance teams as well as mezzanine and intermediate
capital houses active in the Dutch private equity market.
This section discusses some of the instruments that can be used and how the financing can be
organised between the debt and equity providers.
2.
Optimising the financing structure
2.1 Introduction
In a Leveraged Buyout (LBO), the correct mix of debt and equity providers is assembled to serve
the objective of minimising the cost of capital.
Every financing instrument has a rate of return according to its risk profile. The risk profile is
determined by a combination of the ranking of the different financial instruments, the level of
security and additional conditions. The risk profile varies from senior financing to junior financing,
mezzanine instruments and equity, which for private equity investors generally consists of ordinary
shares, preference shares, shareholder loans or a combination thereof.
Subordination is used to reflect the different risk profiles between and amongst the different
categories of the financial instruments. In the event of a companys liquidation debt providers
are in a similar position to the other creditors of the company, whereas the equity providers are
subordinated to these creditors and thus face a higher risk.
Subordination can
agreement) or by
between the senior,
subordination) (see
be organised either contractually amongst the creditors (inter-creditor

inserting multiple intermediary companies to reflect the subordination
junior and mezzanine debt providers in a multi-tier legal structure (structural
the illustration in Chapter 4.5).
2.2 Debt servicing capacity

In a LBO, the appropriate proportion of each type of financing greatly depends on the type of
business of the target and the debt servicing capacity of its free cash flow.
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A companys debt servicing capacity typically sets the limits to the amount of debt the company
can attract. If the debt servicing limits of senior (and junior) financing have been reached, in
combination with additional securities, a company will have to look for other sources of financing,
such as high yield (junk) bonds, mezzanine financing or equity.
The limit of what financial institutions are prepared to lend is determined by a multiple of EBITDA.
High multiples reflect favourable lending and market conditions and permit higher deal prices.
It goes without saying that the rate of return on the financing as such (spreads over LIBOR or
EURIBOR for example) also has a direct impact on the debt multiples (i.e. more debt can be
serviced as the rate of return decreases).
In the period 2003-2007 the amounts raised by private equity funds reached steadily higher record
levels, resulting in higher debt multiples, higher prices and a very competitive debt and private
equity market, which led to lower returns for the debt providers and even a softening of the lending
conditions. These factors meant that private equity investors were forced to struggle to meet their
targeted return, for example by adopting a buy and build strategy or by streamlining a targets
business model.
2.3 Debt push-down strategies - financial assistance rules

In the Netherlands there is the concept of tax consolidation, which solely from a Dutch tax
perspective means that there is no need to push debt down to Dutch target level (see Chapter
5 for more details). In a typical LBO deal this situation is however different, as legal and banking
considerations (for example the use of targets assets as security to agree on more favourable
lending conditions and a lower rate of return) outweigh tax reasons. Moreover in a vast majority of
the LBO deals there are also non-Dutch companies involved.
Typical debt push-down strategies involve the use of
(i) leveraged dividends or capital repayments, and
(ii) a local holding company in combination with tax consolidation or subsequent legal merger.
The decision to use and the feasibility of a particular debt push-down strategy depends heavily
on legal (see below), financial, commercial and tax considerations.
In considering the appropriate debt push-down strategy in the Netherlands (and in most other
countries), so-called financial assistance rules have to be taken into account. These financial
assistance rules are laid down in the Dutch Civil Code and restrict the ability of a target company,
or subsidiaries of the target company, to guarantee, underwrite or support a third-party purchase
of its shares. However, to the extent that the loan does not exceed the freely available distributable
reserves (vrij uitkeerbare reserves) and the articles of association permit such a loan it does not fall
within the scope of the financial assistance rules.
Clearly, therefore, in a typical buyout situation where the financing is to be secured by the assets
of the target group and where there is a commercial, legal and/or tax need to push debt down into
the target structure the financial assistance rules should be closely monitored.
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A commonly used structure in the Netherlands that circumvents the financial assistance rules is
the use of an upstream legal merger between the target and the acquiring company as surviving
entity.
2.4 VAT considerations

The provision of financing (interest-bearing loans) in principle qualifies as a VAT-exempt activity.
As a result, debt push-downs via the Netherlands might have an impact on the input VAT recovery
right of the Dutch companies in a structure. Input VAT in relation to interest-bearing loans provided
to recipients established in the EU cannot be recovered. However, input VAT relating to interestbearing loans granted to non-EU recipients is recoverable (for more details see Appendix I).
In view of this, the VAT consequences of financing activities should be closely monitored.
3.
Modelling the cash flow
3.1 Financial modelling

The debt multiples offered and the terms of various debt instruments used in a buyout (redemption
period, yield, covenants and securities) are closely related to the modelling of the expected rate of
return and the related future post-tax cash-flow (debt servicing capacity). Modelling the expected
return and cash flow is therefore a key step for the providers of both equity and debt in a LBO deal
structure. In this context, a detailed analysis of the tax line (taking into account the new financing
and capital structure) is essential.
In the larger UK-driven LBOs such tax line analysis is common practice, and there is clearly also
a growing tendency among banks in the Netherlands to require a more detailed analysis of the
underlying tax assumptions.
The terms sheet of the various debt instruments is negotiated by the private equity house. The
terms of the bank financing are by definition negotiated at arms length, but the terms of the
shareholder instruments should be properly substantiated for tax purposes.
3.2 Assessment of optimal financing

Based on the outcome of its due diligence investigation(s) and after analysing the business plan
and running a financial model on projected returns and cash flows, the private equity house
intensifies the negotiations on the terms sheet of the debt package with various potential financial
institutions. On that basis, and bearing in mind the anticipated bid price for the shares in the
target, an assessment is made of the sources and uses needed to complete the share transaction,
including the refinancing of existing debt and the payment of transaction costs including financing
expenses (see Chapter 9 for more details).
The importance of the target having an optimal tax line, for example via the effective tax
deductibility of interest on shareholder and bank debt, for the value of the target arises from the
fact that the value of the target is the discounted value of its post-tax cash flows. Thus the benefit
54
of a reduced tax position is an improved cash position to service, inter alia, the bank debt and
future (CAPEX) investments.
3.3 Structuring the shareholder funds

The equity financing of private equity houses generally comprises loan stock, which can take the
form of shareholder loans (possible tax attribute as well as flexible cash repatriation instruments)
and ordinary shares and/or (occasionally) preference shares.
The ultimate return for the private equity house then comes from the (accrued) fixed rate of return
on the shareholders loans or preference shares and the gain (or loss) on the ordinary shares at
the time of exit.
The return on the shareholder loans (and preference shares) has to be considered given its
pre-eminently affiliated nature. For tax purposes, therefore, it is advisable to substantiate the
arms length nature of the remuneration of the instruments, for example with a loan pricing
benchmark study. Fundamental to the success of a LBO is the buy-in of existing management (or
owners of the business) or of a newly recruited management team. Note that in the latter case,
that the management investment scheme has implications not only for corporation tax but also for
payroll tax (as described in the next chapter).
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7. Management
participation
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1.
Introduction
The incentivisation and motivation of either existing owners of the business, existing management
or new, incoming management is a fundamental element in the vast majority of buyout deals. The
underlying assumption is that the managements performance is a vital element that can either
make or break the deal. Consequently, in almost every transaction management is required to
invest alongside the private equity house in order to align their interests with those of the private
equity house in seeking growth in the value of the business and to motivate them to achieve the
goals defined in the business plan.
Since the costs involved in a management participation arrangement are generally significant for
a private equity house, the financial implications of these incentive arrangements must be clearly
understood and properly managed:
from the point of view of management to ensure that the reward is market competitive, tax
efficient, supportive of value-creating behaviours and the risks are well understood and
managed;
from the point of view of the company to ensure that costs are controlled (often these incentive
arrangements fall under the scope of international accounting standards), dilution and cash
flow effects are properly managed, financing risks are optimally managed and the incentive
arrangements are sufficiently robust and challenging.
The following factors are also relevant in selecting a management incentive arrangement:
The target group (Tier 1 management and/or Tier 2 management) and the purpose (retention
/ incentivisation / investment) of the participation;
Alignment with the business strategy of the company and the reward strategy of the company/
acquisition target;
The tax implications for both the company and the participant (corporate and income tax
consequences);
The funding of the arrangement;
The legal framework/corporate structure (i.e. employment law, prospectus requirements,
maintenance, etc.); and
Accounting and governance consequences.
Furthermore, significant commercial and reputation advantages can be gained from proactive
communication of the objectives and outcomes of the management participation with other
stakeholders (i.e. Works Council, other personnel and the general meeting of shareholders).
The most commonly used types of management incentive arrangements are outlined in Section
2. In Section 3, the Dutch tax implications for management of the various incentive arrangements
are described. Section 4 summarises some other considerations. Section 5 discusses the main
points that private equity houses need to consider in the implementation of management incentive
arrangements.
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2.
Type of management incentive arrangements
The management incentive arrangements in a transaction environment can generally be divided

into four different types:
Share schemes;
Stock option schemes;
Loan arrangements; and
Cash-based remuneration.
Bear in mind that every transaction is different in terms of the corporate structure, financial
engineering and preferred management participation. The above list is therefore not exhaustive
but merely an overview of the most common management incentive arrangements.
2.1 Share schemes

Co-investment
For Tier 1 management, a co-investment or share incentive arrangement is generally implemented.
In such an arrangement the manager purchases, possibly at a discount, a shareholder interest. An
investment in advance is required of the participants (financing) and the financial risks ensure there
is a real alignment of interests between the participant and the private equity house (retention).
Furthermore, these types of schemes can generally be structured in a tax-efficient manner for the
participant.
Restrictions
There are almost always conditions attached to the management participation. The most
commonly employed restrictions are (i) a continued employment requirement (good and bad
leaver provisions), (ii) restrictions on the transfer of shares and (iii) terms giving the management a
right or obligation to sell if the other investors exit (the so-called drag and tag-along rights).
Leverage in the structure

Additional leverage is generally created for management in the financial structure of the
transaction. Leverage can be created by investors partly investing in fixed-return instruments
such as preference shares, loan notes or shareholder loans. Since management invests solely or
primarily in common equity, leverage is created but there is also more risk.
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Preference shares and shareholder loans have a fixed return so any excess in value created upon
an exit is allocated to the common equity, a part of which ultimately flows to management. This
is why such schemes are referred to as sweet equity. The figure below provides an illustrative
example.
Shareholder Value
Shareholder Value
Illustrative example of sweet equity
Sweet Equity
Additional financing PE House
(Subordinated debt. preferred shares, etc)
Entry
Time
The enterprise value

growth is driven primarily
by improved business
performance e.g. EBITDA
growth & multiplier effect;
The equity value growth is
driven via a combination of
increase in enterprise value
and debt repayment.
Exit
Ratchet schemes and reverse ratchets

Ratchet schemes are commonly used to motivate management in private equity deals. A ratchet
scheme provides for an additional pay-out to management dependent on the companys future
performance or the investment multiple achieved by the private equity house. A ratchet scheme
can be implemented in many different ways. For example, it can provide not only for the automatic
multiplication of certain shares but also for the option of converting shares into another class of
shares or of converting convertible bonds/preference shares held by management into common
shares. Payments under a ratchet scheme are generally considered to be taxable income for
management.
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For tax purposes, a more favourable structure in the Netherlands is to provide that the
managements stake in the shareholding will decrease if the company underperforms (a so-called
reverse ratchet scheme). Again there are numerous ways to structure this. See the figure below
for an example of a reverse ratchet scheme.
Illustrative example of a reverse ratchet
Entry
Ratchet
Time
10%
Exit
15%
IF IRR > 25%

Management Participation
Reverse Ratchet
15%
10%
IF IRR < 25%
To begin with, the private equity house holds 85% of the shares and management 15%. The
reverse ratchet scheme provides that the target rate of return is 25% (i.e. on exit the private equity
house should receive an IRR of 25% on its total investment in the target company). Lets say that
on exit the IRR for private equity is only 20% on its total investment. Under this ratchet scheme,
the number of shares of the private equity house will automatically multiply by 1.2. Since the IRR
is only 20% its number of shares has to be multiplied by 1.2 in order to achieve its target return of
25%. Consequently, the overall performance causes managements participation to decline from
15% to 10% and private equitys stake to increase from 85% to 90%.
Growth shares / Hurdle shares / Flowering shares

Another way of creating leverage is by granting management the option of investing in a separate
class of ordinary shares. The new class of shares only entitles its owners to profit from the future
growth in the value of the company from the date the shares are issued. These are therefore called
growth shares. In economic terms, these growth shares can be compared with an option right and
they are therefore priced as such. Growth shares allow management to purchase a larger stake
than they could have acquired if they had to invest in common shares.
Membership interests (participation in a Dutch Cooperative)

In many recent deals PE houses have used a Dutch Cooperative Association (Dutch Coop) as the
acquiring entity. The Dutch Coop is a separate legal entity under Dutch law, with its own rights
and obligations and with the capacity to legally own assets and conclude agreements. The Dutch
Coop does not have a capital divided into shares (see in more detail Chapter 5).
It is possible to issue different classes of membership rights, i.e. priority rights or preference rights,
which makes the Dutch Coop highly flexible from a legal perspective and attractive for PE houses.
Management can be offered the opportunity to invest in a membership interest. Generally, the tax
treatment will be the same as with an investment in shares.
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Other possibilities
One can of course structure management incentive arrangements by (i) combining the
aforementioned elements, (ii) creating hybrid arrangements or (iii) using alternative types of shares,
such as performance shares, matching shares and/or deferred shares. Every case therefore
requires detailed analysis and careful structuring.

Stock option schemes are not often implemented for Tier 1 management in Europe since they do
not provide for an up-front investment and are not felt to be tax efficient. However, stock option
schemes remain popular as an incentive instrument for Tier 2 managers in a deal environment.
Basically, with a stock option scheme the company gives the participant a right to acquire shares
in the company during a fixed period at a predetermined price. There is little or no up-front
investment required from the participant (leverage) and inserting a restriction period can intensify
the relationship with the company (vesting). Furthermore, performance targets can be attached
to the grant and exercise of the option (aligning interests). Finally, in principle no favourable tax
treatment can be achieved by implementing such a structure and stock option schemes generally
trigger accounting charges for the company.

A loan arrangement can also be used for Tier 1 management in the framework of an acquisition.
An example of such an arrangement is the loan note, in which the interest payment on the loan
is deferred and can, for example, be made contingent on the future results of the target (earn-out
arrangement). The best known loan arrangement is the convertible bond, in which a loan is
provided by management to the company with a right of conversion to shares attached (option).
However, there are other cash-based loan arrangements, such as profit participating loans (PPL).
A PPL is provided by management to the company and provides for a return equal to a certain
increase in the value or earnings of the company. The Dutch tax treatment of the PPL is still open to
discussion. Following the abolition of the deductibility of share-based arrangements for corporate
income tax, the popularity of cash-based exit arrangements has increased. For more information
about the corporate income tax consequences of the various schemes, see section 3.5.
2.4 Cash-based incentives

With the exception of exit and completion bonuses, long-term cash-based incentives are rarely
employed for Tier 1 management in a transaction environment. Retention bonuses are sometimes
paid, but these generally relate to the compensation structure (settlement or replacement of
existing bonus arrangements) and are not linked to the transaction.
The completion bonus is intended to reward management for their additional efforts in the deal
process and to ensure their alignment with the sellers interest until the closing date or shortly after
(milestones). In addition, where management is invited to invest the completion bonus can then
also be used to facilitate this investment. Payment of the completion bonus is generally subject to
closure of the deal, sometimes within a specified time frame.
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Cash-based incentives implemented for the benefit of Tier 2 management are generally
arrangements in which the payout and/or the benefit is dependent on the investment multiple
realised by the investors. These are known as exit ratchet arrangements. Additional performance
criteria can be attached to maximise the retention and motivation effect. Exit ratchet arrangements
do not require complex legal structuring but are in principle fully liable to Dutch taxation at the
time of payment. Other cash-based incentives commonly introduced for Tier 2 management are
Stock Appreciation Rights (SARs), which are economically similar to option rights and can be
settled in either shares or cash (for example at exit) and Restricted Stock Units (RSUs), which are
instruments that are also economically similar to shares.
3.
Dutch tax treatment of incentive arrangements
Assumptions
Having briefly outlined the main characteristics of the various management participation and incentive
arrangements, the basic income tax and social security consequences for management that may
arise (i) at acquisition, (ii) during the lifetime of the investment and (iii) at exit are outlined below.
Please note that for the purposes of clarity several assumptions have been made. These are:
the manager qualifies as a Dutch resident throughout the holding period of the investment;
the manager is not a managing or statutory director of the company;
the manager holds the shares as assets in a private capacity and not via a personal holding or
other investment vehicle;
the manager acquires shares in a non-listed company.
Substantial interest shareholding

Another assumption made is that the manager does not hold a so-called substantial interest
(Box 2) for tax purposes. Under the Dutch Personal Income Tax Act of 2001, an individual holds
a substantial interest in a company if he or she owns, directly or indirectly, at least (i) 5% of the
issued and paid-up share capital and/or 5% of the voting shares in that company, or (ii) at least 5%
of the issued and paid-up share capital and/or 5% of the voting shares of any class of shares or
(iii) is entitled to 5% of the annual profits and/or 5% of the proceeds at liquidation. All income from
a substantial interest is taxed at a maximum flat rate of 25% and is calculated as the aggregate
amount of:
the distributions (i.e. dividends) made on shares or certificates that are part of the substantial
interest (regular gains), reduced by the deductible expenses; and
the profits realised upon disposal of shares or certificates that are part of the substantial interest
or upon disposal of part of the rights pertaining to these shares and certificates (capital gains),
reduced by the deductible expenses.
Please note that if the manager already owned shares in the company concerned these shares
will also form part of the substantial interest as of the moment a substantial interest is acquired.
Should you want to avoid creating a substantial interest it is worth considering structuring the
participation through a special vehicle or providing management with a combination of shares and
other instruments such as options and/or profit participating loan arrangements.
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3.1 Tax treatment of share schemes

At acquisition
In general, where management directly purchases equity this should in principle not trigger any
Dutch tax implications at acquisition as long as the transaction is considered to be at arms length.
In this context, the Dutch tax authorities focus on whether the equity has been purchased at a
discount given (i) the time that has passed between the transaction date and the participation of
management, (ii) the leveraged structure of the investment (the so-called envy) and (iii) the pricing
of all other instruments in which the PE house invests (preference shares, loan notes, etc.).
Furthermore, if the shares are restricted and/or good and bad leaver provisions are attached to the
shares this may jeopardise their investment nature for Dutch tax purposes. It is generally accepted
practice in the Netherlands to consider participation by management in shares as an investment
for tax purposes (Box 3), regardless of whether good and bad leaver provisions are attached. This
is based on the understanding that shares are generally independent financial instruments that are
commonly traded in the market. However, on the basis of the wording of the attached good and bad
leaver restrictions, the financial risks for management are minimal, the shares may be regarded as
being linked to the employment. In that case, any gains realised with such shares could be regarded
as income from employment, which is taxable at a maximum rate of 52% (2008). Whether that
actually happens will depend on the nature and severity of the restrictions. Generally, this situation
can be avoided by careful structuring of the leaver provisions attached to the investment.
Discount
The value of the management shares is affected by the nature of the rights attached to them. In
practice, one has to consider each of the restrictions attached to the shares (bad leaver provisions,
blocking period, illiquidity, etc.) to establish the fair value. There are some general rules of thumb
that can be applied in this context. For example, if a blocking period is applicable it may be
possible to reduce the value of the shares by negotiating a discount (i.e. a value depreciating
factor) on the fair market value of the shares with the Dutch tax authorities.
During the holding period/at exit

If the purchase of the management participation is regarded as an investment, the average fair
value of the investment is subject to an effective annual imputed net wealth tax of 1.2%. However,
actual gains realised with the shares (capital gains, dividends, etc.) are not subject to tax.
Membership interests (participation in a Dutch Cooperative)

An important consideration with respect to investing through a Dutch Coop (see Section 2 for
more information about the Dutch Coop) is whether the participation in the Dutch Coop qualifies
as an investment. If so, it will be treated in very much the same way as described above for
share scheme arrangements. It is important to carefully assess whether, based on its articles of
association, the Dutch Coop should be regarded as a transparent entity for income tax purposes
or whether it operates as an independent entity with its own legal personality. The managements
participation should therefore be clearly linked to their membership interests rather than to
contractual arrangements.
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For the purposes of the rules on substantial interests, the membership interests in a Dutch Coop
should be treated as similar to a profit right. This implies that as long as the different classes of
membership interests together do not entitle the manager (i) to 5% of the annual profits and/or
(ii) to 5% of the proceeds at liquidation and/or (iii) to 5% or more of the total voting rights in the
Dutch Coop, no substantial interest holding should arise.
Ruling practice
In view of the significant differences in terms of taxation depending on whether the incentive
arrangement is deemed to be investment or employment income, it is worth considering obtaining
up-front certainty by requesting an advance ruling from the Dutch tax authorities. In such ruling
procedures the investment nature of the participation, if properly structured, is generally accepted.
The Dutch tax authorities focus mainly on the valuation of the shares. It is therefore recommended
that supporting documents are provided, preferably prepared by an independent valuation expert.
Ratchets
Reverse ratchet and ratchet arrangements are likely to have different tax implications in the
Netherlands. Lets say management buys 10% of the equity for a sum of EUR 1 million. Upon exit
after five years, this 10% is worth EUR 3 million. Under a ratchet arrangement, management will
receive an additional stake of 5% because the private equity house has achieved its IRR of 25%.
Managements total stake of 15% is worth EUR 4.5 million. The gain that should be attributed to
the additional 5% equity is likely to be taxed as income from employment, which means that if a
ratchet scheme is used the total taxation amounts to approximately EUR 750,000 (EUR 1.5 million
x 52%). The effective gain for management is therefore EUR 2.75 million (EUR 4.5 million minus
EUR 1 million minus EUR 750,000).
Should the management arrangement be structured as a reverse ratchet, the initial purchase price
would amount to EUR 1.5 million and the total gain of EUR 3 million is tax exempt. Therefore,
this structure yields an extra EUR 250,000 in profit for management. However, the managements
investment risk must be managed carefully.

Participation by means of a stock option scheme will give rise to a charge for income tax and
social security contributions at the date of exercise. The taxable benefit is equal to the difference
between (i) the fair market value of the underlying shares at the exercise date and (ii) the actual
exercise price paid by the participant (the spread). The spread is treated as employment income,
which is taxed at a maximum rate of 52% (2007).
It can be argued that options that are purchased at fair value should be regarded as an investment
and that gains realised with such options are free from Dutch tax. The Dutch tax authorities are
generally unwilling to accept this position unless the options can be freely transferred or sold.

Where management participates in the target company by means of a loan arrangement, the
wording and valuation of such arrangement are key to determining the Dutch tax implications. If
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sufficient economic substance exists and the leaver and transferability provisions attached to the
arrangement are not too onerous, the loan may be regarded as an investment. However, since it
is non-transferable, one could take the position that the loan arrangement should be split into two
elements, with part of the return being qualified as an investment return and the return above this
normalised return being regarded as employment income.
3.4 Cash-based arrangements

Cash-based arrangements are taxed as employment income at the date of payment at a maximum
rate of 52% (2007).
3.5 Corporate income tax

On 24 May 2006, new draft legislation in the Netherlands proposed the abolition of the Corporate
Income Tax deduction (CIT deduction) for employee stock options, comparable rights (e.g. warrants
and convertible bonds) and employee shares. Under these rules, a CIT deduction is not available
for new grants of employee stock options, comparable rights (e.g. warrants and convertible
bonds) and share awards that vest on or after 1 January 2007. The Minister of Finance confirmed
that in principle the costs of incentive arrangements settled in cash would still be deductible for
CIT purposes. Therefore, to qualify for CIT deduction, the selected incentive arrangement should
in principle be structured as a cash-settled arrangement.
4.
Funding
Management will not always have the financial resources to make the investment in the target
that the private equity house requires. A bank or the private equity house itself can provide
management with funds to make the requisite investment or to pay the income tax due on the
stock options in the form of either an interest-bearing loan or an interest-free loan.
Interest-bearing loan
If an interest-bearing loan is provided the manager has to pay annual interest on the loan. In
determining the appropriate interest rate, the company could apply market interest rates or the
standard annual interest rate as set by the Dutch tax authorities (4.7% for 2007). Please note
that this standard interest rate is adjusted annually and parties are free to decide whether (i) the
annual interest will be payable annually or (ii) will accrue to the principal of the loan. If the annual
interest rate is equal to or higher than the standard annual interest rate set by the Dutch tax
authorities, this should not result in a taxable benefit for Dutch wage tax purposes. Therefore,
under such an arrangement, the effective annual costs for the employee would be equal to the
interest payable to the company.
Interest-free loan arrangement

An interest-free loan constitutes a taxable benefit. The fact that no interest is paid on the loan
provided to a manager/employee is deemed to be a benefit in kind and should be reported
annually in the companys local Dutch payroll administration. The taxable benefit is again based
on the standard interest rate as set by the Dutch tax authorities. In order to determine the taxable
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benefit of the loan, a 4.7% annual interest rate (2007) will be attributed to the value of the interestfree loan and will be taxed at a maximum of 52% (2007). The participant will therefore pay tax at
an effective rate of 2.44% annually.
Completion bonus
As already mentioned in section 2.4, completion bonuses are often used to fund the managements
participation.
5.
Overview
To sum up, the initial considerations in selecting the appropriate participation arrangement are
the target group (i.e. Tier 1, Tier 2 or an even broader group) and the purpose of the incentive
arrangement (i.e. alignment, retention or incentivisation). Once these basic underlying principles
have been identified, the structure of the participation can be determined on the basis of the
corporate structure of the transaction and the tax implications for both management and the
company. In addition to careful structuring of the documentation, the valuation of the instruments
is crucial for Dutch tax purposes and is determined by the transaction structure, the amount of
the investment and the likely pay-out. Consideration should also be given to the tax, legal and
financial (accounting) implications of the participation structure selected. Finally, communication
tools may help management to fully understand and appreciate the implications of the design and
structure of their participation in the investment and how their total reward package establishes a
link between reward and performance.
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8. Share Purchase
Agreements
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1.
Introduction
One of the most essential aspects of a share deal is the Share Purchase Agreement (SPA). The
SPA documents the binding terms of the transaction, such as the parties involved in the share
deal, the purchase price, the closing date, warranties and/or indemnities by the seller and/or the
purchaser. Essentially, the SPA is a mechanism for allocating risks between the parties in a share
deal. Therefore, all matters that are of relevance to either the seller or the purchaser should be
documented in the SPA.
2.
SPA and the phases of the deal process
The simplified model below shows the various phases and actions in a deal process. The remainder
of this chapter discusses these phases and actions in relation to the terms of the SPA .
Action
Signing
Phase
Pre-signing
Completion
Post-signing/Pre-completion
Post-completion
Deal Process
Pre-signing phase: during the pre-signing phase the purchaser can decide not to proceed with
the deal without penalties, for example in light of the outcome of the due diligence.
Signing: the date on which sellers and purchasers agree on the sale and purchase of the shares
in the target company in accordance with the conditions set out in the SPA.
Post-signing/Pre-completion phase: during this phase, also known as the straddle period, the
purchaser cannot walk away from the deal unless specific clauses have been inserted in the
SPA, and generally a penalty is due. This phase of the deal typically involves fleshing out the
conditions in the SPA and securing approval from authorities, competition bodies [in the
Netherlands being the Nederlandse Mededingings Autoriteit], works councils, etc.
Completion (or closing): at the time of completion (or closing), all the transactions that have to
take place to finalise the share deal are carried out (such as the signing of the deed of transfer
of the shares, the payments that need to be made by the purchaser to the seller, etc.). From
this moment the purchaser is the owner of the shares to which the SPA relates.
Post-completion phase: after completion the deal cannot be cancelled; only a final pricing
adjustment can be made in accordance with the pricing mechanism that was agreed in the
SPA.
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3.
General content of SPAs
SPAs generally include the following clauses:
Definitions: the key definitions that are used throughout the SPA;
Sale & Purchase: this section defines what is being sold and who the sellers and the purchasers
are;
Consideration: this section defines the purchase price. The purchasers interest at the time of
the SPA is to pay what he is willing to pay based on the information available at the time of the
acquisition. However, some aspects of the target company and its subsidiaries may still be
uncertain at the time the SPA is signed. Deferred compensation is then negotiated to cater for
these uncertainties at closing. Various methods of adjusting the purchase price that might be
included in the SPA will be discussed briefly below;
Warranties and Indemnities: this section sets out the financial exposures of the target company
and its subsidiaries that are covered by warranties and/or indemnities (see below for a more
extensive discussion of warranties and indemnities);
Completion/closing: this section stipulates when the shares will actually be transferred from the
seller to the purchaser and describes the actions that have to be taken at that time to complete
the share purchase;
Post-completion or straddle period restrictions: this section sets out the restrictions on the
activities that the seller can carry out without the prior written consent of the purchaser.
4.
Translation of the outcome of the due diligence into the SPA
The due diligence (see Chapter 3) reveals information for a purchaser regarding various legal rights
and obligations and (potential) historic exposures of the target company and its subsidiaries. For
example, possible future penalties imposed in relation to transactions prior to completion for
which taxes had to be paid but were not reported or paid to the tax authorities may have an impact
on the value of the target and should consequently affect the purchase price. The same applies
for future tax liabilities that might arise from the period prior to the completion but that have not
yet been accounted for by the target company and its subsidiaries. For example, if the company
has not applied the correct VAT rates or the correct VAT qualification to certain costs, VAT may be
due as yet together with penalties and late payment interest.
Consequently, the buyer may decide not to proceed with the share deal because the potential
exposure is too great. Whether the buyer will incur a penalty depends on the phase of the deal
process when this occurs. Alternatively, the parties can negotiate to cover the risks with:
Disclosures (exceptions to the warranty) that are accepted by the purchaser without a price
adjustment;
Disclosures that are accepted by the purchaser in return for a price adjustment;
Warranties and penalties to be included in the agreement;
Indemnities.
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5.
Protection from tax liabilities
Possible exposure of the target company and its subsidiaries arising from the period prior to
completion can be covered by warranties or indemnities. The following sections briefly describe
the differences between the two.
5.1 Warranties and disclosures

Warranties
A warranty is a statement by the seller that the business it is selling corresponds with the
information it provided to the buyer and which caused the buyer to decide to purchase the
shares at the price that was agreed. In general, a warranty only covers a specific fact relating to
the target company and its subsidiaries. If the statement proves to be false, the buyer can claim
financial compensation for damage arising from the provision of incorrect information. Warranties
are necessary because the law provides little protection for a buyer with respect to the assets and
liabilities of the target company.
However, the protection from tax liabilities is limited by a number of factors. First, a warranty is
subject to time constraints. In this respect, the buyer needs to make sure that the warranties only
lapse several months after the expiry of the statute of limitation period in order to ensure that he
will be able to recover any tax exposure during the entire period during which the exposure may
arise. Second, the seller can limit liability by fixing a maximum amount for claims. Third, warranties
can be limited by disclosures by the seller.
Disclosures
A buyer cannot sufficiently rely on warranties without disclosure of the documents and other
relevant information pertaining to the specific SPA warranty. Such disclosure is usually provided
through a Disclosure Letter.
Inadequate disclosure may expose a seller to a claim under a warranty in the SPA. Furthermore,
the negotiation of the Disclosure Letter can serve as a mechanism to eliminate nasty surprises for
the buyer before he commits to the purchase.
Depending on the wording of the SPA, the seller may not be liable for any fact or circumstance
that:
was mentioned in the Disclosure Letter;
was identified by the purchaser during the due diligence process;
was included in information in the data room.
The buyer must therefore conduct very thorough research since he will not be able to recover
financial damages at any time.
Furthermore, the seller cannot be held liable for damages if the claim arises from any action or
omission of the purchaser after completion (for example, contacting the tax authorities).
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5.2 Indemnities
By contrast with a warranty, an indemnity requires the seller to make payments to the buyer
if, after completion, the target company and/or its subsidiaries become liable for specific
unforeseen tax liabilities in connection with matters that arose prior to completion. In that case
the amount of tax that has to be paid by the target company or one of its subsidiaries will exceed
the amount that was provided for and the shares in the target company will prove to be worth
less than the buyer originally thought. The amount that the buyer can recover is on a euro for
euro basis.
In certain respects, however, an indemnity is inadequate. An indemnity covers a buyer for
unexpected tax liabilities that may arise during an agreed period. However, it is also possible that
a seller has claimed an exemption, relief or performed a transaction in the past that may result in
a future tax liability (i.e. a post-completion tax liability). Such a tax charge does not relate to the
period covered under a tax indemnity so those items should be covered under a tax warranty. A
tax indemnity may be inadequate with regard to the following items:
Exemptions claimed in the past if they may be reversed in future years;
So-called tainted transactions within a fiscal unity that may limit the flexibility of a buyer;
Disputes with the tax authorities;
Compliance aspects in general (i.e. items that have an impact on the companys future tax
position).
5.3 Protection from tax liabilities in relation to private equity funds

Indemnities and the sale of shares by private equity funds
Unexpected tax liabilities that arose prior to completion and which are covered by tax indemnities
in the SPA can have a significant impact on the purchase price after completion. As private equity
funds are typically driven from a return on investment/cash-flow perspective, in principle they
cannot pay for any historical tax liabilities that arise from a target whose shares have been sold
by a private equity fund, as the return on investment is settled on the exit and claims cannot
be recovered from the private equity fund afterwards. Private equity funds are therefore usually
unwilling to provide the purchaser with any indemnities in the SPA but instead aim to negotiate to
transfer all historical tax with the shares that are sold. In this respect, they may rather grant the
purchaser a discount on the purchase price than maintaining uncertainty about whether any future
payments of tax liabilities may impact their return on the investment which has normally already
been distributed to the investors.
Indemnities and the purchase of shares by private equity funds

Nevertheless, when private equity funds purchase shares in a target company they usually
negotiate to have tax indemnities included in the SPA, since private equity funds are - again
from a return on investment/cash-flow perspective - unwilling to account for any tax liabilities
that arise from the period prior to completion (i.e. the private equity funds do not want the return
on their investment to be affected by tax liabilities that arise from the period during which the
target company was controlled by other parties). Again, if the seller is a private equity fund (i.e. a
secondary buy-out) it will be difficult for a buyer to negotiate any indemnity.
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6.
Purchase price adjustments
6.1 Earn out

As already mentioned, the SPA can also include mechanisms to determine adjustments to the
purchase price after completion. An earn-out clause refers to deferred compensation (in cash
or in stock) based on the future results of the target when the seller continues to operate for a
certain period after the sale. Such clauses are particularly effective in motivating the vendor after
the sale. They may also be tax-efficient for the sellor, since a price adjustment after the sale still
qualifies as a capital gain on shares which may be tax-exempt for the sellor (and non-deductible
for the vendor).
The share purchase agreement can also provide for adjustments to the purchase price depending
on a number of contingencies, such as the result of a post-closing audit of the accounts, the
outcome of a material piece of litigation or the receipt of a tax assessment.
In this context, a deferred payment can offer protection for the purchaser when it is linked to
contingencies that might affect the value of the acquired company.
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9. Transaction Costs
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1.
Introduction
The acquisition of a business generally involves substantial transaction costs, ranging from legal
fees for the purchase agreement to the charges invoiced by banks for providing debt financing.
Different transaction costs are treated differently for tax purposes. Some costs are tax deductible,
others are not. The extent to which the VAT on these costs can be recovered is also important.
2.
Purchase costs and corporate income tax
2.1 Restriction on deduction of purchase costs

Current legislation on the participation exemption states that costs relating to the purchase of a
participating interest are not deductible for corporate income tax. Selling costs associated with the
disposal of a participating interest are excluded from deduction as well. The legislature has stated
that purchase costs are all costs that a taxpayer has to incur to achieve its intended holding in
a participating interest.
However, this does not mean that all costs incurred in relation to an acquisition are covered by the
restriction on deduction, since a distinction can be made between purchase costs and financing
costs and corporate expenses. The latter cost categories are typically tax deductible, even if they
are related to a transaction.
Purchase costs
Purchase costs are not deductible and have to be capitalised, which increases the cost of the
participating interest. Any subsequent downward revaluation or disposal of the participating
interest is covered by the participation exemption, which excludes the costs from the taxable profit.
Capitalised acquisition costs will effectively only lead to a deduction if the purchased participating
interest is dissolved (by application of the liquidation loss rules). Examples of purchase costs
include fees charged by external advisers to draw up the purchase agreement and the fee paid at
the end of the transaction to an intermediary in connection with a successful acquisition.
Financing costs
Financing costs are generally tax deductible. They relate mainly to debt drawn to finance the
acquisition. Examples of financing costs are interest payments (see also Chapter 5) and handling
and arrangement fees paid to the entity which has successfully arranged the financing.
Corporate expenses
Corporate expenses are generally tax deductible. Corporate expenses can be defined as the
normal costs of running a company. They are costs that would be incurred even if no participating
interest were to be acquired in a given year. Examples of corporate expenses are incorporation
costs, Chamber of Commerce fees and the costs of preparing the consolidated balance sheet.
Some costs are not easy to classify. They include the costs of a due diligence review (see Chapter
3) or advice on the tax structure (see Chapter 5). Since banks use such reports when assessing the
78
creditworthiness of the future debtor some or all of these costs can be attributed to the financing
of the transaction and can be deducted. A formula that could be used for the allocation of the
costs is the proportion of the acquisition that is financed with debt. Note that the allocation of
costs that do not clearly fall into one or other of the above categories ultimately depends on the
circumstances of the actual case. According to the circumstances of a particular case it will be
possible to allocate more or less of the costs to the deductible financing costs.
In view of the different tax treatment of the
distinguish in the costs and invoices between
the transaction (financing costs), costs which
(corporate expenses) and purchasing costs.
according to these categories.
various types of cost, it is always important to

expenses and activities associated with financing
would be incurred irrespective of the transaction
It could be useful to break down the invoices
2.2 Capitalised from what point

Apart from being able to identify the different types of transaction cost (purchase costs, corporate
expenses and financing costs), it is also important to know from what point in the transaction
process certain costs are no longer deductible. It is conceivable that costs which would be classified
as generally non-deductible purchase costs according to the above guidelines are nevertheless
deductible because of the period when they were incurred. An example is costs connected with
due diligence reports prepared during a bidding process for a possible acquisition.
Current case law on the treatment of costs states that the question of whether costs should be
capitalised or may be deducted has to be answered in light of the information available at the time
they were incurred. It is important in this context to establish the precise status of the acquisition
process at every moment that costs are incurred. A substantial portion of the costs may still be
deductible if there is a sound analysis.
2.3 Transaction costs for inclusion in a fiscal unity

According to Dutch tax literature, the non-deductible category of purchase costs could still be
deductible if the acquired company joins a fiscal unity with the acquiring holding company from
the acquisition date.
Deductibility depends on whether, from a tax perspective, a participating interest relationship
continues to exist with the target after it has been included in the fiscal unity. The wording and
history of the law shows that no such participating interest relationship exists after the companies
are joined. From a tax viewpoint, with the inclusion of the target in the fiscal unity it is not the
interest in the subsidiary but the subsidiarys assets and liabilities that are included in the parents
balance sheet. For tax purposes, the transaction is similar to an assets-liabilities transaction
and so it could be argued that if the companies are immediately joined there is no identifiable
participating interest. One could argue that the purchase costs would then be deductible. This
subject has not been tested in the tax courts so there is no certainty on this point.
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3.
Costs related to the issuance of shares
The main criteria for judging the deductibility of costs relating to the issuance of shares relate
to the nature of the costs. Should the commission ultimately paid to the banks (underwriter)
be associated with financial services commission (i.e. intermediary services and insurance of
placement with the public) then these costs would be accounted for in the issuing company. The
fees will in that case be paid out of the proceeds of the issuance. It is therefore arguable that these
costs should be tax deductible.
Alternatively, the commission may be associated with the right of the banks to issue/sell the
shares of the issuing company. This situation would be comparable to the bank having a put
option. In such a scenario, the issuing company renounces part of the proceeds from the issuance,
effectively reducing the proceeds for the issuing company. Accordingly, the costs relating to the
issuance are treated as a non-deductible discount on the gross proceeds and thus the costs
should not affect the entitys taxable result.
The underwriting agreement is a very important source of information for the Dutch tax authorities in
determining the tax treatment of the costs. To safeguard the deductibility of the costs it is therefore
important to consider the tax consequences when drafting the underwriting agreement.
4.
Acquisition costs and VAT
The treatment of acquisition costs for VAT depends very much on the specific circumstances of
the individual case. There are, however, some basic principles with regard to the recoverability and
possible recharge of transaction costs and the VAT due on them.
4.1 Recipient of the services

From a Dutch VAT perspective it is very important to determine which company is the recipient
of the service. In that context, it is strongly recommended that during the structuring process,
when the optimisation of the structure takes place, it is determined which company is/should be
regarded as the recipient of the services and to ensure that engagement letters reflect this position
or are assigned/novated to the recipient accordingly.
4.2 Recoverability of VAT on transaction costs

The principal rule is that there is no deduction of VAT without VAT entrepreneurship and VAT
taxable activities. Furthermore, in the Netherlands there is a use and enjoyment rule which
provides that non-entrepreneurs are liable for self-assessment for Dutch VAT on services from
non-EU service suppliers if the services are deemed to have been used and enjoyed in the
Netherlands.
It is therefore important in cases where an acquisition holding company, which is generally newly
incorporated, is used to consider the details of the VAT entrepreneurship and the VAT treatment of
the different types of costs that will be incurred well before the actual acquisition takes place. A
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holding company is only regarded as an entrepreneur for VAT purposes if it has economic activities
in addition to merely holding the participating interest. Economic activities would for instance be
the provision of management services by the acquisition holding company for the target.
It is generally also possible to obtain the status of VAT entrepreneur by recharging costs through
a cost-sharing agreement. Consideration could also be given to forming a VAT group between the
acquisition holding company and the target companies.
If the holding company qualifies as a VAT entrepreneur, self-assessed input VAT on invoices
issued to the holding company can generally be recovered. As a general rule, transaction costs
(purchasing and selling) form part of the residual/general costs of the holding company with
respect to determining the recoverablility of the VAT on those costs. General costs are normally
recoverable for VAT purposes on a pro rata basis, the percentage being calculated over the
turnover on taxable supplies in relation to the total turnover of the holding company.
The figure below illustrates the VAT recoverability in different holding company situations.
Function:
acquisition and
holding of
shares in target.
Passive holding company

=
no VAT entrepreneur status
BidCo NL
Active holding company
=
VAT entrepreneur status
Function:
acquisition/holding
of shares in target.
In addition thereto providing
management services
and/or the oncharging of
costs to the target.
No VAT recoverability
BidCo NL has both taxable

and non-taxable activities
Pro rata VAT

recoverability
BidCo NL has only

taxable activities
100% VAT
recoverability
Substance through:
management agreements
cost sharing agreements
While general costs in principle lead to a proportional entitlement to recovery, this is often not the
case for costs connected with the financing of the acquisition.
These financing costs and financing activities are generally VAT exempt and do not create an
entitlement to deduction (see Chapter 6 on this point). The fact that providing financing is VAT
exempt may also be relevant in the situation where the holding company not only provides
management services but will also grant interest-bearing loans to the target. As indicated above,
the percentage of the holding companys turnover that arises from VAT-exempt services (the
supply of group financing) can increase and might have an adverse effect on the companys
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position in terms of recovering input VAT since in principle the part of the VAT on the transaction
costs directly attributable to the VAT-exempt financing activities cannot be recovered unless the
financial activities are performed for non-EU established recipients. The VAT-exempt activities
might also impact on the input VAT recovery in relation to general costs which cannot be attributed
to either VAT-exempt or VAT-taxable activities.
4.3 Recharging transaction costs

The invoices of the various service providers are usually sent to the company that concluded the
agreement with them. Depending on which company ultimately benefits from the service and
qualifies as the recipient of the service (see our comments above), part of the transaction costs
may be passed on to different group companies (see our comments about the use and enjoyment
rule). The costs that can be passed on include financing costs and legal fees for setting up the
holding company structure.
Since the passing on of different types of costs can have different VAT consequences, it is
important to consider aspects such as whether the various costs should be passed on separately
instead of as a bulk of costs. Furthermore, to avoid VAT leakage it is also important that the
company the costs are passed on to is also entitled to recover input VAT it incurs when recharging
transaction costs.
As already mentioned, the supply of VAT-exempt activities can have an adverse impact on the
suppliers input VAT recovery position. Hence, when recharging costs associated with VAT- exempt
(banking) services the impact on the input VAT recovery position of the recharging entity should be
closely monitored. An alternative might be for the bank to send its invoice directly to the relevant
group company. This would mean, however, that the banks original agreement with one company
has to be replaced by an agreement with the group company that is invoiced or alternatively
that the original contract should contain a novation clause or be assigned to the relevant group
company.
Acquisitions generally involve substantial transaction costs. The CIT and VAT implications of
the costs should therefore be considered carefully since proper treatment of acquisition costs
may lead to a fair result on which part is or is not tax deductible. It is important to consider the
acquisition costs at an early stage of the structuring process. To reduce risks and prevent VAT
leakage it is advisable to keep proper records of the costs associated with the transaction and to
address the topic of VAT entrepreneurship and VAT recoverability in good time.
82
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84
10. Post-deal services
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85
1.
Introduction
Following completion of the deal, the envisaged tax efficiencies of the acquisition structure have
to be realised and sustained and unforeseen tax leakage has to be avoided. This means that tax
formalities must be observed in good time and management must have a clear understanding of
the legal and tax structure that was employed. With a view to the future exit, it is also important
to address any issues that were identified during the tax due diligence in a timely fashion and to
optimise the tax compliance position of the target companies.
2. Formalities
2.1 Tax registration of newly incorporated companies
When new companies are incorporated they have to be registered with the tax authorities in their
respective jurisdictions. It is important to arrange their registration soon after completion of the
deal to ensure that the companies are recognised by the tax authorities and become part of the
regular compliance process (e.g., issuance of assessments and tax returns, extension of filing
dates, etc). Early registration will also facilitate the processing of a request for an advance tax
ruling or a tax grouping.
In the Netherlands, registration for corporate income tax and wage tax purposes is generally
a formality. However, attention must be paid to the information provided in relation to the VAT
registration. As discussed in chapter 10, VAT on acquisition costs can only be reclaimed if the
claimant qualifies as an entrepreneur for VAT purposes at the moment of tax registration.
2.2 Tax grouping

If the intention is that the acquisition and target companies will form a tax grouping for corporate
income tax purposes in their respective jurisdictions of tax residence, a request must generally be
submitted to the tax authorities within a certain timeframe.
In the Netherlands, such a request must be submitted to the tax authorities within three months of
the acquisition of the legal and beneficial ownership of the target companies. If the request is not
submitted in time it will not be possible to use part of the profits of the target companies to offset
the transaction and financing costs to the extent that such costs are deductible.
Furthermore, a tax grouping can generally only be established if certain requirements are met on
a permanent basis. It is therefore important to closely monitor compliance with the requirements
following completion of the deal. See Chapter 5, Section 7 for an overview of the requirements that
must be complied with to establish a tax grouping for Dutch corporate income tax purposes (e.g.
effective management and control of the companies must be situated in the Netherlands, 95%
legal and beneficial shareholding threshold, concurrent financial years, etc).
If the acquisition and target companies would also like to form a tax grouping for VAT purposes
a separate request must be submitted to the relevant tax authorities. In addition, if the target
86
companies were part of a Dutch or foreign tax grouping with the seller, another request must be
submitted to cancel such tax grouping with respect to the acquired target companies.
2.3 Transaction costs

Following completion of the deal, the transaction costs must be charged to the appropriate
acquiring companies and may then be charged on within the group. We refer to our comments
in Chapter 9. This process must be monitored closely to mitigate the risk of any unnecessary tax
leakage.
2.4 Compliance with advance tax rulings

If the tax treatment of the acquisition structure has been agreed in advance with the tax authorities
and an advance tax ruling has been issued, it is essential that the facts and circumstances on
which the ruling was based do not materially change following the completion of the deal. For
example, if the ruling request describes the funds decision-making process it is essential that
the actual decision-making process corresponds with the facts and circumstances presented
in the request. If the actual situation differs from the facts and circumstances as presented the
advance tax ruling may be void, in which case there is no agreement on the tax treatment of the
acquisition structure. Therefore, the tax authorities must be informed as soon as possible if it
becomes apparent that the facts and circumstances will change following the conclusion of the
advance tax ruling.
Furthermore, advance tax rulings generally apply for a fixed period of time. If the rulings expire
prior to exit it is important to renegotiate the rulings in good time.
2.5 Compliance with Sale and Purchase Agreement

The sale and purchase agreement generally contains provisions regarding the allocation of tax
compliance responsibilities between the seller and purchaser prior to and after completion of
the deal. The sale and purchase agreement may also prescribe other obligations for the seller
and purchaser. It is therefore important to carefully review the sale and purchase agreement and
determine internal responsibilities following the completion of the deal to ensure that the sale and
purchase agreement is executed correctly.
2.6 Changes in existing legislation

In principle, the tax treatment of the acquisition structure is based on the laws that are effective at
the time of the transaction. However, tax legislation changes regularly, in most jurisdictions even
annually, and it is therefore essential to monitor such changes closely following deal completion.
3. Follow-up tax due diligence issues

Tax warranties and indemnities are generally limited in their duration and can only be relied upon if
the seller is informed of an alleged breach of a warranty or indemnity within a certain timeframe. To
avoid losing its entitlement to invoke a tax warranty or indemnity, it is important for the purchaser
to address tax issues that were identified during the tax due diligence in a timely fashion. Some
Private Equity
87
tax issues may require further analysis in order to get a better understanding of the actual risks
involved, while for others agreements may have to be reached with the tax authorities. See Chapter
3 for a discussion of the issues that are typically investigated during a tax due diligence.
Besides ensuring that tax warranties and indemnities can be invoked, addressing the tax issues
identified in the due diligence issues also helps clear away any tax obstacles to a smooth and
efficient exit.
4. Refinancing
As described in chapter 7, banking or legal requirements may make it necessary to refinance
existing debt or effectuate debt push-downs in the acquisition structure after completion of the
deal. These refinancing processes need to be implemented in accordance with the transaction
documentation whilst maintaining the envisaged tax benefits of the acquisition structure.
5.
Reporting and accounting tax position
Following completion of the deal, the acquisition and target companies must adopt new reporting
and accounting policies. This involves, inter alia, establishing appropriate reporting lines and
assessing existing IT systems in order to determine their compatibility with the shareholders IT
systems to ensure efficient reporting of financial and management information.
In todays business environment, companies also need to remain in control of their tax position
and have a clear understanding of their tax weaknesses. Establishing new reporting lines may
present a good opportunity to establish and implement a so-called Tax Control Framework.
A Tax Control Framework basically entails establishing clear tax reporting lines, which is
particularly important because the tax position is based on input from several departments within
the organisation. Implementing a Tax Control Framework may therefore significantly mitigate the
risk of weaknesses in the tax position, which is obviously also important from the point of view
of a future exit.
A Tax Control Framework also enables companies to improve the effectiveness of their tax
function and strategy since potential tax issues can be addressed at an earlier stage and the tax
position can be managed proactively.
In relation to the Tax Control Framework and the tax position of companies in general, special
attention should also be paid to compliance with the transfer pricing regulations in the various
jurisdictions involved. Transfer pricing is high on the agenda of the tax authorities in the
Netherlands and other countries and is generally identified as a risk during tax due diligences.
Describing and documenting the transfer pricing processes should therefore be a high priority
following deal completion.
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90
11. Transactions Group

PwC
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91
1.
Introduction
Technological changes, globalisation, deregulation and the ageing of the population. These trends
are forcing corporations into a strategic reorientation. This results in acquisitions, disposals,
alliances and capital market transactions. The focus of these transactions is on value maximisation
and risk minimisation. PricewaterhouseCoopers (PwC) aligns its transaction-related services with
the private equity deal continuum: from development and implementation of strategy to the
implementation of change; from corporate finance and valuation to accounting and structuring.
2.
Integrated, multidisciplinary approach
Transactions are looked at from various angles: from financial and commercial to fiscal and HR
aspects to ICT and operational aspects. An integrated, coherent approach is the solution to
the ultimate goal of risk minimisation and value maximisation. PwCs Transactions Group offers
various integrated services to optimise value for PE houses.
Capital markets
Global capital markets
Dutch capital markets
IFRS implementations
92
Ac
qu
ire
/
Re
re
a
te
ea
Cr
HR Transaction Services
HR due diligence
Pension due diligence
Management support
re &
e
ctu
rt u valu
s ise
l
Int
egr
ate
l
tro
Manage & con
M&A Tax
Tax due diligence
Tax structuring
Tax Modelling
SPA Advice
Fund Structuring
Post Deal Services
Corporate Finance
Investment banking
Deal flow generation
Management advisory
Strategy evaluation
iness Lifecycl
e
Bus
Im
pro
ve
performance
Transaction Services
Financial due diligence
Commercial due diligence
Operational due diligence
Synergy reviews
IT due diligence
Completion accounts
SPA advice
Valuation and Strategy

Valuation services
Economic advisory
Purchase price allocation
PwCs Transactions Group (TG) pursues a multidisciplinary approach and employs more than 250
professionals from our Assurance, Tax and Advisory service lines. The TG supports private equity
from multiple angles throughout the deal continuum:
Pre-Deal
3.
Due Diligence
Structuring
Exit
Sourcing deals
Corporate finance and investment banking

Private equity houses are always searching for new opportunities. PwCs specialist private equity
team assists private equity houses in this process. Our Corporate Finance specialists have a
detailed insight and broad knowledge of the markets and work closely with the firms industry
experts. Our Corporate Finance services include initiation of the transaction, valuations as well as
structuring and arranging financing of the transaction and management participations.
4.
Executing deals
Due diligence
Our Transaction Services specialists help private equity houses to assess a prospective acquisition
with financial, commercial and operational due diligence advice. Prospective purchasers want an
independent opinion on the target, including the identification of opportunities and risks, upsides
and downsides and the value drivers of the target. Private euity houses use financial, commercial,
operational and strategic information in their assessment of the target. Our due diligence
specialists assist private equity houses in this analysis and are highly experienced in private equity
transactions, resulting in a greater likelihood of a successful transaction.
Our commercial due diligence specialists extend the due diligence procedures to the market and
commercial environment in which the target operates. What is the industry and what position
does the company hold in this market? What is the targets potential in the light of market
developments? A thorough assessment of the potential of a target is almost impossible without a
detailed understanding of the market environment.
PwCs M&A tax specialists assist private equity houses in the taxation due diligence process
during the acquisition process (see in more detail Chapter 3). The taxation due diligence focuses
on identifying risks and opportunities in the areas of corporation tax, dividend withholding tax, VAT,
wage tax and local taxes. Our tax specialists also assess the taxation structure and form initial
views of potential taxation structures going forward.
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93
Our HR Transaction Services team assesses the human resource risks and opportunities of the
target, including remuneration and retention strategies and pension due diligence. Our IT due
diligence specialists assess the information technology platform as well as the scalability of the
IT organisation.
SPA advice and completion accounts

The outcome of due diligence procedures will often be reflected in a Sale and Purchase Agreement
(SPA, see also Chapter 8). Our transaction specialists assist buyers in the financial and fiscal
aspects of the SPA, such as fiscal warranties and closing mechanisms. Our transaction services
specialists assist PE houses with the review of completion accounts with a view to minimising
post-deal cash flow exposures.
Management advice and participations

In many PE transactions management will participate in the company going forward (a so-called
MBO). For most managers this is a significant and important step in their relationship with the
company. This requires careful planning from fiscal (see in more detail Chapter 7), legal and
financial perspectives. Our management advisory role encompasses independent advice for
management in complex buy-out situations as well as fiscal structuring of the management
participation.
Deal translation
The closing of the transaction is followed by the accounting treatment of the transaction in the
financial statements of the target or Newco. PE houses should at this stage consider what the
optimal treatment of the acquisition is and which GAAP to use. If an exit through an IPO is being
considered, companies may wish to move to IFRS or US GAAP at an early stage. Our deal
translation specialists identify the potential accounting issues and treatments prior to the closing
of the deal and assist PE houses in the implementation following the closing, including purchase
price allocation. PwCs valuation and strategy specialists assist companies in the valuation of the
tangibles and intangibles required for purchase price allocation under the various GAAP.
Economics
The specialists in PwCs Economics group focus on analysing economic, political and strategic
issues. Particularly important are competition aspects, such as approval by the Netherlands
Competition Authority (NMA). Our specialists build a case with analysis underpinning and
supporting NMA approval requests.
5.
Creating value
Fiscal structuring
During the third period of the investment life cycle of a PE investment the focus will be on the
implementation of the transaction, integration and performance improvement (creating value).
The fiscal due diligence has laid the basis for identifying the optimal fiscal structure. Our fiscal
structuring specialists assist PE houses in setting up an optimised fiscal structure (see in more
94
detail Chapter 4), including maximising interest deductibility, minimising effective tax rates and tax
efficient cash and dividend streaming (see in more detail Chapter 5 and 6).
Operational due diligence and post-deal services

An acquisition calls for a serious investment from key stakeholders in the company. Attention
is often devoted mainly to the closing of the transaction. However, a thorough post-transaction
operational plan is equally important. Our operational due diligence experts analyse the operational
(and synergy) assumptions and improvement potential underpinning the deal. Our specialists are
experts in the translation of operational assumptions to cash flow and ultimately the deal value
and exit opportunities.
More and more PE transactions involve carve-outs from global organisations. Our carve-out
specialists assist PE houses with the identification of carve-out issues and the implementation
and the effectuation of the carve-out.
6.
Exiting and realising value
Corporate finance and investment banking

PE houses have various exit opportunities such as IPOs, trade sale and secondary or
tertiary buy-outs. PwC offers various services to assist PE houses in pursuing the best exit
opportunities.
Our corporate finance specialists assist PE houses throughout the process of identifying the
optimal exit strategy and identifying prospective purchasers.
Capital market transactions

IPOs are laborious and time-consuming projects with processes that are becoming more and
more complex. Shareholders, investment bankers and regulators place increasing demands on the
transparency and on the quality of the communication in general, and of the offering memorandum
in particular. Our capital market specialists provide pre-IPO assistance including restatements into
IFRS or US GAAP as well sponsoring due diligence services.
Vendor due diligence

More and more transactions with deal values higher than EUR 50 million are accompanied by
a vendor due diligence report. The Vendor Due Diligence (VDD) is an independent full-scope
due diligence that focuses on financial, commercial, operational, taxation, IT and HR matters.
It provides vendors and prospective purchasers with a detailed impression of the risks and
opportunities of the target. Detailed analyses will highlight potential blinds spots at an early stage
and support vendors and prospective purchasers in their decision-making process.
Private Equity
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96
Acknowledgments
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97
Every aspect of a private equity deal represents an independent subject to which experts devote
their careers. Consequently, this Private Equity Tax Guide describing all the aspects of a deal was
a team endeavour. The following persons made valuable contributions to the overall effort that was
required to produce this book.
Guido Doeve, M&A Tax partner
Hans Seeling, M&A Tax partner
Jochem Veltman, M&A Tax partner
Roland Brandsma, head of the Tax Technical Office Netherlands
In addition, we would like to express our gratitude to the following experts for their input to specific
chapters.
Bart Weijers
Brenda Mooijekind
Elmo Ferrier
Frank Grizell
Gijs Fibbe
Harmen Rosing
Janet Visbeen
Johan Ypma
Jos Boerland
Machiel Visser
Mark Apeldoorn
Martijn Breen
Pauline van Altena
Peter Josten
Remco van Daal
Ren van Ede
Saskia Hadewegg Scheffer
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100
Appendix I: High-level
Dutch tax features
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1.
Introduction
Historically, the Netherlands has owed its reputation as a location for finance, holding and
distribution companies not only to its geographical position and infrastructure but above all to
its beneficial tax system. Appealing aspects for foreign investors include the Dutch participation
exemption, under which both dividends and capital gains are fully tax exempt. Other traditional
features were and still are the absence of withholding tax on interest and royalties and a worldwide
network of tax treaties encompassing all EU and OECD member states and most countries in
Central and Eastern Europe and the Far East, under which double taxation is avoided.
For private equity funds, where deals are often made in a short period of time, an attractive tax
climate also depends on a tax administration that is able to cooperate at short notice. A tax
authority that is accessible and works promptly helps dealmakers to eliminate tax risks and avoids
discussions afterwards. In this respect, it is of importance for Dutch private equity practitioners
that negotiations with Dutch tax inspectors tend to take the form of informal consultation.
As of 1 January 2007 significant changes were made in the Dutch corporate income tax regime and
to several other taxes. The amending legislation was initiated because of the Dutch governments
desire to create a competitive tax regime in a pan-European perspective. The Netherlands also
extended the existing treaty network with newly concluded treaties in 2007.
The following sections describe these developments and a number of the business taxes which
can be of relevance to private equity funds.
2.
Reduction of the corporate income tax rate
The standard rate of corporate income tax, which had already been reduced from 31.5% to 29.6%
in 2006, was further reduced to 25.5% with effect from 1 January 2007. The aim of the reduction
is to attract more investment from foreign multinationals and also deter those multinationals that
currently reside in the Netherlands from migrating to a better tax environment.
3.
Reduction of the dividend withholding tax rate
The dividend withholding tax rate was reduced from 25% to 15% with effect from 1 January
2007. This should reduce the administrative burden for companies and shareholders as many
shareholders will no longer be required to apply for a reduction from the general rate of 25% to
the more common 15% treaty rate. With careful structuring, the dividend withholding tax can even
be reduced to zero.
However, under most of the Netherlands eighty tax treaties, dividend withholding tax is reduced
even further or even mitigated altogether (see section 9). In addition, it should be noted that the
Netherlands does not levy an interest and royalty withholding tax.
102
4.
The participation exemption regime
Since 1 January 2007 the participation exemption applies consistently to shareholdings of 5% or

more unless the shareholders interest is a portfolio investment in a company that is subject to
a tax rate that is not considered adequate (adequate being an effective tax rate on profits equal
to at least 10% over a taxable base according to Dutch tax standards). This is measured at the
level of the company itself, unless the company heads a tax consolidation group, in which case
the consolidated effective tax rate applies. For Dutch portfolio investment subsidiaries that do not
meet the 10% test, a tax credit method applies rather than a tax exemption.
It is very important to bear in mind that whether or not a shareholders interest in a company
constitutes a portfolio investment is determined solely by the assets of that company, including
its own goodwill and other intangibles. For example, if the companys consolidated assets are
predominantly free portfolio investments or consist predominantly of assets used for passive
group financing activities (e.g. group loans), the shareholders interest will in principle be regarded
as a portfolio investment. A distinction is made in this respect between portfolio investments held
by a company in the course of its business and free portfolio investments. Only the presence of
free portfolio investments can lead to qualification as a portfolio investment subsidiary. Portfolio
investments held by a company in the course of its business (for example, as security for insurance
obligations) are qualified as good assets. In determining a companys consolidated assets the
companys liabilities are not taken into account. In other words, loans from and advances to
subsidiaries and lower-tier subsidiaries cannot cancel each other out.
The participation exemption will however apply to a participation in a subsidiary whose
consolidated assets consist for at least 90% of real estate.
For a portfolio investment shareholding that does not fall under the scope of the participation
exemption, double taxation will be avoided by applying the tax credit method, unless the portfolio
investment shareholding is effectively not subject to tax at all. For EU shareholdings there is the
option of crediting the actual underlying tax.
5.
Fiscal Unity regime
A parent company and its Dutch-resident subsidiaries (of which the parent owns at least 95%
of the shares) may, under certain conditions, file a tax return as a single entity (fiscal unity),
which means not only that all intra-group transactions are ignored but also that intra-group
reorganisations can take place without tax consequences. However, if the group breaks up a
recapture may take place. Group taxation is available for companies whose place of effective
management is in the Netherlands, both for Dutch tax and treaty purposes.
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6.
Net operating losses
From 1 January 2007 tax loss carry-back is available for one year. Tax loss carry-forward is limited
to nine years. This also applies for start-up losses.
Complex rules may prohibit the utilisation of net operating losses after a change of 30% or more of
the ultimate control in a company. Furthermore, there are limits to the possibilities of loss utilisation
for holding/finance companies. Companies carrying out significant other activities (with 25 or more
employees) are in principle unaffected by these loss relief restrictions.
7.
Interest deductibility rules
A number of interest deductibility rules exist in the Netherlands which change regularly. Careful
structuring is needed to secure the optimal effective tax rate in accordance with these rules.
8.
Tax Exempt Investment Fund Regime
A new investment fund regime was introduced in the Netherlands in 2007. New legislation
created an exempt investment fund regime that entered into force on 1 August 2007. The main
characteristics of the new regime are that investment funds that are subject to it are exempt from
corporate income tax and are not subject to dividend withholding tax. The bill was prompted by
the Dutch governments desire to create a competitive tax regime for investment funds and to
attract more investment funds to the Netherlands.
9.
Tax treaty network
The Netherlands has a worldwide network of approximately 80 tax treaties, including treaties with
all EU and OECD member states and most countries in Central and Eastern Europe and the Far
East, under which double taxation is avoided. This network is steadily expanding. In 2007 the
Netherlands concluded new treaties with Jersey (on the exchange of information relating to tax
matters), the United Arab Emirates (to avoid double taxation on income) and Bahrain (to exempt
tax on income and profits derived from international air transport). These treaties have not yet
entered into force. The tax treaty with Barbados to avoid double taxation on income concluded in
2006 will be applicable as of 1 January 2008.
10. Value-added tax

Known in Dutch as BTW (Belasting over de Toegevoegde Waarde), VAT is payable on sales of
goods and on services rendered in the Netherlands, as well as on the importation of goods and
on the intra-European acquisition of goods. There are three tax rates.
104
Main tariff
Reduced tariff on certain prime necessities
Special tariff, applicable mainly to intra-European Union supplies, exports,
imports stored in bonded warehouses, services rendered in connection
with the above and certain other services
19%
6%
0%
The following are exempt from tax:

1. The supply of immovable property two years after putting it into use and lease. However, if
the lessee uses the immovable property for 90% or more for input VAT-deductible purposes,
the lessor and lessee may opt for VAT to be charged on the rent, in which case the lessor may
deduct the VAT charged in respect of the property.
2. Medical, cultural, social, and educational services.
3. Services provided by banks and other financial institutions in connection with payment
transactions and the granting of credit facilities.
4. Insurance transactions.
5. Transactions in shares.
11. Transfer tax on immovable property

Acquisition of economic or legal ownership of immovable property in the Netherlands is subject
to a transfer tax of 6% of the market value; some exemptions are available.
12. Capital tax

In order to attract more foreign investment, capital tax was abolished as of 1 January 2006.
13. Other indirect taxes

Insurance tax of 7% is payable on insurance premiums if the party taking out the policy is a
resident of the Netherlands or if the insured object is in the Netherlands. Several exemptions are
available.
Municipalities impose immovable property tax on the owners of the immovable property. The rates
vary from one municipality to another. The taxable basis is the market value of the immovable
property. Please note that the (assessment of the) value as of 1 January 2007 is also of importance
for corporate taxation since that value may limit the amount of depreciation.
Excise duties are levied on certain consumer goods (e.g., cigarettes, cigars, mineral oils, alcoholic
products, etc.). No excise duties are levied if the goods are used solely as raw materials and duties
are refundable if an article is exported.
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105
2007 PricewaterhouseCoopers. All rights reserved. 2007.11.01.28.85
At PricewaterhouseCoopers Nederland, over 4,600 professionals work together covering

various disciplines: Assurance, Tax and Human Resource Services, and Advisory. On
the basis of our corporate philosophy, Connected Thinking, we provide sector-specific
services and seek novel solutions. Not only for large national and international companies,
but also for medium-sized and smaller businesses as well as for government entities and
non-profit organisations.
As an independent part of a worldwide network comprising 146,000 colleagues in 150
countries, we can rely on extensive knowledge and experience which we share with each
other, with our clients and with their stakeholders. We seek unexpected angles, make
surprising connections, feel involved and work together from our strengths.

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Private Equity.

2007 was a special year for the (Dutch) M&A industry

Typical fund models

Tax Structuring of the Deal

Key drivers for private equity

Share Purchase Agreements

10. Post-deal services

11. Transactions Group PwC

Oscar Kinders, Partner M&A Tax

Ad van Gils, Partner Transaction Services

Andries Mak van Waay, Partner Corporate Finance

Wim Holterman, Partner Valuation & Strategy

Andrew Kruseman Aretz, Partner Human Resource Services

Alexander Spek, Partner Capital Markets Group

2007 was a special year for the (Dutch) M&A industry

Drivers of M&A activity

Room for improvement within the M&A industry

Tax aspects and private equity

Legal obligations of buyers and sellers

Tax Due Diligence

3.2 Types of tax due diligence

3.2.1 Buy side due diligence

3.2.2 Vendor due diligence

3.2.3 Vendor Assistance

Scope of due diligence

Disclosure to the tax authorities

5.2 Impact on due diligence reports

Focus of tax due diligence for private equity funds

Public to Private Transactions

4. Typical fund models

Lifetime of a private equity fund

Location for a fund vehicle

Overview of potential fund jurisdictions

a Dutch Cooperative Association (Coop);

4.1 The traditional Dutch limited partnership fund vehicle

4.2 The Dutch Cooperative Association as fund vehicle

4.3 Luxembourg SICAR

4.5 Dubai fund LLC/LLP

4.6 Spanish ECR

Typical Anglo-Saxon fund structure

Typical fund structure

Carried interest holders

(1) Nominal capital contributed to the fund by

(3) Proceeds from targets (dividends/capital gains)

5.1 Substantive requirements and transfer pricing aspects

5.2 Dutch VAT considerations

Commitments and fund flows

Typical funds flows

Carried interest holders

(2) Loans and

(Proceeds from targets)

6.1 The investors

6.2 The private equity house

6.3 Carried-interest holders

6.4 Fund managers

Key drivers for private equity

Dutch holding structure

Participation exemption on dividends and capital gains

3.1 Income derived from hybrid loans

Limitations on deductibility of interest