As with most corporate transactions, tax is a key component in determining the ultimate structure and operation of a joint venture. Here we summarise some of the key tax considerations when structuring a joint venture and then managing the joint venture on an ongoing basis.
Structuring the joint venture
One of the primary goals in structuring a joint venture is to ensure that it is set up in a tax-efficient way so as to minimise tax leakage on any profits made. We illustrate these principles by reference to a joint venture in the form of a corporate entity (rather than a partnership) with corporate shareholders, as opposed to individuals. If a partnership (or limited partnership or limited liability partnership) is chosen for the joint venture vehicle, different tax considerations will apply, as in many cases the vehicle will then be tax transparent.
Extraction of profits
One of the key considerations for shareholders is how they are able to extract profits from the joint venture, and the tax treatment of any such receipts. The JV company will be subject to tax on its own profits and so there will be leakage at the level of the JV company. It will then need to distribute any such amounts to its shareholders (generally either through a repayment of any debt financing, or through the payment of dividends). Such distributions can also give rise to tax leakage in the form of withholding taxes or tax on receipt by the relevant shareholder.
The withholding tax position will depend on where the JV company is tax resident. For example, if the JV company is tax resident in the UK, withholding tax may arise on the payment of any interest (subject to various exemptions and the potential availability of relief under the relevant double tax treaty) and any royalties. There is no UK withholding tax on dividends.
The tax treatment of the distributions in the hands of the shareholders will depend on where the shareholder is tax resident. For example, if the shareholder is also tax resident in the UK, it is unlikely to pay any tax on the receipt of dividends or the repayment of the principal element of any loan. However, tax liabilities may arise in respect of any interest or royalties.
It is therefore important to consider the tax position of both the JV company and the shareholders early on in the process of establishing the joint venture to ensure that the financial modelling accurately reflects the tax position of each shareholder.
Transfer of assets into the JV company
The transfer of assets by a shareholder into the JV company may be treated as a disposal of such assets and therefore may give rise to tax liabilities. There are a variety of potential tax charges that can arise on the transfer of assets into a JV company. For example:
- A tax liability may arise on any chargeable gains made by such shareholder on disposal of an asset to the JV company.
- A tax liability may arise on the disposal by a shareholder of any trading stock.
- A transfer tax (such as stamp duty / stamp duty reserve tax in the UK) liability may arise if the shares in entities are transferred to the JV company.
- A transfer tax (such as stamp duty land tax liability in the UK) may arise if land is transferred to the JV company.
- A VAT liability may arise if individual assets are transferred which do not constitute a ‘transfer of a going concern’.
There are a number of potentially relevant reliefs which could be used to mitigate the impact of any such tax liabilities. However, the availability of the relevant relief(s) will need to be considered in detail based on the specific facts and circumstances existing at the time of the proposed transfers. In addition, some of the direct tax liabilities may be mitigated if the shareholder has relevant losses available to set against any profit / gain arising from the transfer of assets into the JV company.
Early identification of relevant assets to be transferred into the JV company will ensure that the tax treatment can be determined and factored into the economics of the transaction.
Ongoing tax matters
Shareholders will wish to ensure that the joint venture is not adversely impacted by tax issues relating to other shareholders. As a result, the joint venture documentation typically includes two sets of tax protections – one set relating to pre-completion matters (which may be dealt with under specific agreements between the JV company and the relevant shareholder) and one relating to post-completion matters (which are typically dealt with in the JV agreement itself).
The extent of any pre-completion protections will largely depend on whether there is a transfer of a business into the JV company (such that a majority of the historical tax risk will usually remain with the transferring shareholder), or a transfer of operating entities (where a broader range of tax protections is more suitable due to the JV company inheriting the tax history of such entities), as well as the negotiating position of each relevant shareholder. The goal of any such protections is to ensure that the JV company remains untainted by any pre-completion tax matters so that the shareholders only share in the post-completion profits or losses of the JV company. The protections for pre-completion matters are based on the protections found in typical share and asset sales and so are not considered further here.
The post-completion matters will be dealt with in the JV agreement and will typically look to protect the JV company going forward, while also looking to address procedural matters as between the shareholders.
Some of the key post-completion matters are summarised below.
It is likely that the shareholders will want to be able to have the power to extract any losses arising to the JV company in order to be able to use them to shelter other profits arising to such shareholders. It is therefore necessary to consider the protections to be included in the JV agreement to ensure that the extraction of such losses is not detrimental to the JV company. This is typically achieved by requiring the relevant shareholder to make a cash payment to the JV company in return for the use of some or all of the losses. There are also various mechanical provisions which should be included to ensure that it is practically possible for there to be such an extraction of losses.
In addition, if the shareholders have existing losses within their groups, it is often beneficial to include provisions in the JV agreement which allow the shareholders to surrender such losses into the JV company in order to offset any profits arising to the JV company. As with the extraction of losses, any such surrender will typically be in return for a cash payment by the JV company and there will also be various mechanical provisions incorporated to achieve this.
Joint venture arrangements may involve the ongoing supply of goods and/or services by one or more of the shareholders to the JV company. Where this is the case, depending on the shareholdings of the relevant shareholder(s), it may be necessary to consider and apply transfer pricing rules to any such arrangements.
There are often specific provisions included in the JV agreement which deal with a situation where subsequent transfer pricing adjustments are made by a tax authority to transactions between the JV company and its shareholders. Broadly, these provisions seek to ensure that the economic impact of any transfer pricing adjustment is equalised between the JV company and the relevant shareholder(s). The objective is to insulate the JV company from any transfer pricing adjustment.
Secondary tax liabilities
As the shareholders will typically have material equity interests in the JV company, the potential for secondary tax liabilities for the JV company exists (i.e. where one person is made responsible for tax liabilities which are primarily attributable to another person). The JV agreement therefore typically includes specific provisions which ensure that the cost of such secondary liabilities is borne by the shareholder who was primarily liable for such tax.
It may also be necessary to consider whether the JV company could fall within a shareholder’s tax consolidation either as a matter of law (such as the corporate interest restriction group) or by election (such as in the UK, a VAT group). If so, protections will need to be included to ensure that the JV company is not prejudiced.
Management of tax affairs
As a minimum, each shareholder will wish to ensure that it has access to such underlying information concerning the JV company as it needs in order to comply with its own tax compliance obligations. In addition, if the JV company will not have its own tax function, it will be necessary for the shareholders to agree how the day-to-day tax compliance of the JV company will be managed.
Certain shareholders may also have specific requirements as to how the JV company operates from a tax perspective (e.g. compliance with published tax strategies etc.) in which case, these will need to be specifically documented in the JV agreement.