In a tax efficient holding structure, Parent will usually

be located in a jurisdiction that carries some or all of

the following features:
The tax regime of the jurisdiction offers favourable
treatment/ incentives over the taxation of foreign
dividends;
The jurisdiction does not tax capital gains arising
from the disposal of investment in foreign shares or
assets;
The jurisdiction has a wide network of double tax
agreements with all or most of the jurisdictions
where the operating subsidiaries reside;
Profits can be remitted out of the jurisdiction with
minimal or no additional tax cost; and
There is no tax on the sale by a foreign owner of
shares in an entity set up in the jurisdiction.

Structuring Private Equity Deals in

the Region
Guy Ellis and Iris Cheng, Hong Kong
Private equity investors in the region typically operate
via offshore funds established under tax concessionary
regimes or in countries that impose little or no tax on
the activities of the funds. When making or planning
any investment, two key objectives for a private equity
investor are usually to reduce local and withholding
taxes within the target group after the acquisition and
to establish a structure that would facilitate a future
exit in a tax efficient manner. This article seeks to
explore some common concerns and considerations in
structuring private equity transactions in the region
under this premise.

Other tax issues that would also have to be considered

include:
Does the jurisdiction offer some form of tax relief for
costs, including funding and other transactional
costs, associated with the acquisition and disposal of
foreign investments?
Does the jurisdiction offer some form of tax relief for
goodwill arising from the acquisition of investments?

Typical holding structure

A typical holding structure for regional investments
usually involves the use of one or more intermediary
holding companies.

The Netherlands, for example, has a wide network of

double tax agreements with various Asian jurisdictions
and has been one of the more popular locations for
setting up a holding company for groups operating in
the region. Closer to home, with a reasonably
comprehensive treaty network and the added flavour of
recent changes to the tax regime as proposed in its
latest budget in particular in respect of the proposed
exemption from tax of certain foreign dividends and
other foreign sourced income Singapore may be
considered as a favourable location in which to set up
a regional holding company.
To illustrate the potential tax benefits of using a
suitable holding company, the example below
compares the possible tax consequences on intra-group
dividend between the use of a Singapore holding
company and a holding company incorporated in a tax
haven jurisdiction, say the British Virgin Islands
(BVI), in respect of a group of companies operating
in Singapore, South Korea, Japan and Thailand.

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In the above example, as the British Virgin Islands

does not have an income tax treaty with any of these
jurisdictions, the domestic dividend withholding tax
rates will apply. By using a Singapore holding
company, the investors can potentially reduce their
withholding tax liabilities on dividends repatriated
from the operating entities located in South Korea and
Japan. As the domestic withholding tax rate on
dividends is lower than the rate prescribed by the
Singapore-Thailand double tax treaty, the two holding
companies will give rise to the same withholding tax
consequences in respect of an investment in Thailand.

While commercial factors generally play a significant

role in determining the funding structure in most
transactions, this part will focus on the common tax
considerations in shaping funding decisions in most
private equity transactions:
Are there any regulatory limitations on the level of
debt that can be used in each of the jurisdictions
where the group operates?
Are there different tax rules for deduction or
allowance of funding costs arising from external
borrowings and shareholder loans?
Likewise, are there different tax rules for funding
costs on the acquisition of shares as against the
acquisition of business assets?

As illustrated above, potential tax savings can be

achieved by carefully considering the location of a
holding company. Obviously, this is but a simple
illustration made on broad assumptions. For example,
it has not taken into account potential tax
consequences of other types of fund/profit repatriation,
such as interest, royalties or management fees. Also,
the illustration has not taken into account potential
capital gains tax, if any, on exit. These issues are
explored in more detail below.

Financing the investment

In many private equity transactions, there would
typically be a mixture of shareholder funds and bank
borrowings to finance the investment in the acquired
business. If structured properly, investors can
maximise the tax relief available from the funding
arrangements.

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In most of the jurisdictions within the region, while interest and funding costs (for example front-end fees and other bank
commissions) are typically tax deductible when incurred in the production of taxable income, they are generally subject to
some form of thin capitalisation constraints, which seek to limit the amount of debt that can be applied in funding an
investment. To provide a quick glimpse into the overall thin capitalisation position in the region, the table below provide a
summary of the general deduction restrictions applied in some typical investment locations:

Table 1: Thin capitalisation rules A comparison across the region

Any thin
capitalisation rules?

Details/remarks

Australia

A safe harbour level of total debt at 75% of Australian assets is

available, although specific rules may apply for financial institutions.

China

Equity level is governed by the minimum registered capital depending on

the size of investment.
Total investment between US$10 and US$30 million would have a
minimum registered capital of higher of US$5 million or 40% of the total
investment.
Total investment over US$30 million would have a minimum registered
capital of higher of US$12 million or 33 1/3% of the total investment.

Hong Kong

While Hong Kong does not have thin capitalisation rules, there are
stringent conditions for the deductibility of interest, which may effectively
restrict the use of overseas debt finance.

Indonesia

Currently, there are no prescribed debt/ equity ratio limits, although a

minimum debt to equity ratio may be imposed through the foreign
investment regulatory approval process.

Japan

The thin capitalisation rules currently permit the use of a ratio higher than
3:1, although other conditions may still need to be satisfied.

Korea

Foreign controlling shareholder debt/ equity ratio of 3:1 is generally

acceptable for tax purposes, although specific rules may apply for
financial institutions.

Malaysia

While there are no thin capitalisation rules, a debt/ equity requirement

may be imposed by the Malaysian Central Bank for exchange control
purposes.

New Zealand

Generally, total interest-bearing debt/total asset ratio should not exceed

75% and 110% of the worldwide group debt percentage.

Philippines

While there are no thin capitalisation rules, a debt/equity requirement

may be imposed by other regulatory agencies, e.g. when the taxpayer
seeks to apply for a special licence or tax concessions.

Singapore

While there are no thin capitalisation rules, the tax authorities may
disallow interest to the extent not used to finance assessable operations.

Taiwan

While there are no thin capitalisation rules, the minimum equity capital
required for a company limited by share is NT$1 million.

Thailand

While there are no thin capitalisation rules, a debt/ equity requirement

may be imposed by other regulatory agencies, e.g. when the taxpayer
seeks to apply for tax concessions under the Investment Promotion Act.

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Exit strategy

While not all jurisdictions have specified rules and/or

safe harbours prescribing the level of allowable debt
as a proportion of total business assets, in most cases
some form of restrictions do apply over the amount of
deductible funding costs. Investors who look to
maximise their tax benefits from debt financing should
therefore carefully consider the implications of these
restrictions in planning their investment in the region.

Apart from the above concerns, private equity

investors in the region are usually particularly
concerned to structure their investments in ways that
allow a degree of flexibility on exit, usually in the
form of a trade sale or possibly through an IPO.
Certain structures can be put in place to ensure that
the capital gains tax and/or other transactional tax on
the exit is minimised.

A further question to consider regarding funding

arrangements is whether there are withholding tax
requirements on interest payable by the operating
entities to a foreign parent or a related party resident
in a foreign jurisdiction. As it is possible that some, or
all, of the withholding taxes chargeable on interest
will not be creditable against income taxes payable
by the recipient, consideration needs to be given to
the withholding tax requirements of each jurisdiction
and potential protection under existing double tax
treaties.

One common technique is the use of a holding

vehicle set up in a tax haven jurisdiction. When the
investment is to be sold, the tax haven company can
be sold instead of the underlying investment.
By way of illustration, in example 2 below, using an
offshore holding vehicle in a tax free jurisdiction can
potentially mitigate tax liabilities on capital gains
arising from the sale of the investment and provide
flexibility on stamp duty planning.
As one will notice from this example, some double tax
treaties may also provide protection against capital
gains tax imposed by the jurisdiction where the
operating entities are resident.

Other profit/fund extraction

While not going into detail here, there are other
planning opportunities in structuring the repatriation of
profits from an investment. For example, the operating
entities can repatriate profit by way of payments in
relation to the use of intangibles or management/
shared services fees. Where properly structured, these
arrangements may help to reduce the net tax cost of
the business.

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Concluding remarks
This article has explored some common considerations
in structuring private equity transactions, including
some points of particular relevance to investments in
the Asia Pacific region.
A word of caution may however be warranted. As
mentioned above, by carefully considering the
location of the holding company and the form of
profit/fund repatriation, substantial tax savings can
potentially be achieved. Nevertheless, with
increasing scrutiny by the tax authorities on treaty
shopping and tax avoidance cases, due care has to be
exercised in balancing tax efficiency and commercial
substance in planning a suitable investment structure.

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