Insights
We are proud to be named a West Coast Regional Leader for 2024


What U.S. private equity funds need to know about EU Directives
ARTICLE | September 13, 2023
Authored by RSM US LLP
U.S. private equity (PE) funds that invest in foreign portfolio companies should stay abreast of two key EU Directives designed to combat perceived tax avoidance achieved through hybrid mismatch arrangements and shell companies.
The Anti-tax Avoidance Directive II (ATAD II) and Unshell Directive (ATAD III) add complexity to achieving tax benefits in existing structures and potential accounting and compliance costs to tax reporting requirements. While this tax legislation sets goals for all EU countries to achieve, it is up to individual countries to devise their own laws on how to achieve them. Below are answers to frequently asked questions about these new Directives.
ATAD II: Hybrid mismatch rules
Who does it affect?
The Directive can affect U.S. PE funds that have set up tax structures to take advantage of the different tax classification and treatment of entities and cross-border payments in two or more jurisdictions.
What is the purpose?
ATAD II is intended to counteract tax advantages arising from certain so-called hybrid features that may exist in any given structure. One such feature is a hybrid instrument treated as debt in one jurisdiction but equity in another jurisdiction. Another is a hybrid entity treated as tax-transparent in one jurisdiction and tax-opaque in another, resulting in double deductions, deductions without income inclusion, imported mismatches and disregarded transactions.
When did it go into effect?
ATAD II was generally applicable to tax years starting on or after Jan. 1, 2020.
What are the potential tax consequences?
PE funds with hybrid entities (such as foreign corporations treated as disregarded entities for U.S. income tax purposes) may forfeit certain deductions on intercompany payments where there is a deduction on one side and no income inclusion on the other. Deductions may also be lost when a double deduction is available as could be the case with hybrid entities.
What actions could PE funds take?
PE funds should review their existing operating structures which could be tax inefficient because of the introduction of these rules. PE funds should also carefully consider the usage of hybrid entities and instruments in their tax planning. Not recognizing the impacts of ATAD II could drive down the value of the investment due to increased tax costs and tax reserve accruals and uncertain tax positions.
ATAD III: The Unshell Directive
Who does it affect?
This Directive targets PE funds that have set up holding companies without any substance (i.e., shell companies) to hold their non-U.S. portfolio companies. Under current or proposed tax planning, funds may be looking to repatriate cash from their foreign portfolio companies to the United States.?In a typical PE fund structure, we may see one or more holding companies between the U.S. and foreign portfolio companies in order to take advantage of reduced withholding taxes.
What is its purpose?
ATAD III is intended to provide substance requirements for shell companies to prevent their misuse for tax purposes. Examples of misuse include reducing withholding taxes by qualifying for the EU Parent-Subsidiary Directive and the Interest and Royalties Directive or one of the income tax treaties.
When does it go into effect?
Draft ATAD III Directive is currently with the European Council for further consideration. However, the target date for implementation of Jan. 1, 2024, along with the look-back period of two years, seems to have not changed as of the date of this article.
What are the potential U.S. and EU tax consequences?
Where taxpayers are not expected to meet the minimum substance tests, they may be denied the benefit of the EU Parent-Subsidiary and the Interest and Royalties Directive or one of the income tax treaties and be subject to higher withholding tax rates and other adverse tax consequences.
What actions could PE funds take?
Funds should review each country’s substance requirements, and take appropriate action. For example, they might hire local employees or hold in-person board meetings or other substantive activities within their holding companies. Otherwise, holding companies might not be able to obtain a tax residency certificate for subsidiaries to reduce or eliminate withholding taxes, which could affect their ability to repatriate cash. It could also reduce the fund’s value. Consult a tax advisor to review any potential tax structuring or planning in the EU, as well as any tax structures currently in place.
As ATAD II and III emerge as tax focus areas for the EU, PE funds can expect greater scrutiny of their holding structures. RSM’s international tax practice is well-versed in navigating the multiple variables that affect planning for these directives and can work with funds to stay informed and prepared.
Let’s Talk!
You can call us at +1 213.873.1700, email us at solutions@vasquezcpa.com or fill out the form below and we’ll contact you to discuss your specific situation.
Required fields are marked with an asterisk (*)
This article was written by Mark Strimber, Lynn Ellenberg and originally appeared on 2023-09-13. Reprinted with permission from RSM US LLP.
© 2024 RSM US LLP. All rights reserved. https://rsmus.com/insights/industries/private-equity/what-us-private-equity-funds-need-to-know-about-eu-directives.html
RSM US LLP is a limited liability partnership and the U.S. member firm of RSM International, a global network of independent assurance, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.com/about for more information regarding RSM US LLP and RSM International.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

Vasquez + Company LLP has over 50 years of experience in performing audit, tax, accounting, and consulting services for all types of nonprofit organizations, governmental entities, and private companies. We are the largest minority-controlled accounting firm in the United States and the only one to have global operations and certified as MBE with the Supplier Clearinghouse for the Utility Supplier Diversity Program of the California Public Utilities Commission.
For more information on how Vasquez can assist you, please email solutions@vasquezcpa.com or call +1.213.873.1700.
Subscribe to receive important updates from our Insights and Resources.