Executive summary

This Alert summarizes tax developments across Europe in the second half of 2024 that are relevant to those involved in private equity, including:

• Budget 2025 and finance bill developments in France and the Netherlands
• Changes to the taxation of carried interest and non-domicile regime in the UK
• Clarifications on transfer pricing rules for intra-group transactions and changes to the interest deduction rule in Germany
• The participation regime for foreign dividends in Ireland
• Withholding tax issues in Poland
• Tax incentives for credit funds in Portugal
• Royalty reporting obligations in Denmark

French government introduces the Draft Finance Bill for 2025

The French Draft Finance Bill 2025 (the Bill) contains various measures. The Bill is being debated by parliament and will likely change before it is enacted in final form. It is expected to be enacted by 21 December. Key provisions that are relevant to private equity (PE) include:

• A temporary, exceptional Corporate Income Tax (CIT) rate for large companies with annual revenues exceeding €1b has been excluded from the Bill for now but could be reintroduced. This contribution could affect investment funds, particularly if the fund holds stakes in French companies with revenues exceeding €1b. Potential consequences include a reduction in the post-tax profits of these companies, lower dividend payouts, a possible decrease in the valuation of investments and, consequently, lower overall performance for the fund and its investors.
• The rate and modalities of a new 8% tax applicable to share capital reductions after a share-buyback transaction realized by large companies headquartered in France are still being discussed. This could lead investment funds to experience lower dividend income, a potential decrease in the valuation of their French holdings and a need to reassess investment strategies. The tax may also increase the administrative obligation and influence the tax efficiency of investments.
• An extended tax-neutral regime that applies to merger transactions following a May 2023 company law reform amends the tax provisions applicable to merger transactions to ensure the neutrality of two new types of restructuring operations made possible by the reform. The amendments could provide investment funds with new tax-efficient restructuring opportunities, facilitate partial demergers without immediate tax consequences and offer more flexibility in transactions within fiscally integrated groups. Additionally, including mergers without share exchange in the special merger regime could make certain acquisitions more financially attractive.
• The Bill corrects some errors in the revised Pillar Two Global Anti-Base Erosion (GloBE) Rules, provides certain clarifications and considers the Organisation for Economic Co-operation and Development's (OECD's) administrative guidance published in 2023.

The rules outlined above are due to take effect on various dates. The Bill is anticipated to be final by 21 December 2024.

UK government announces changes to taxation of carried interest

On 30 October 2024, United Kingdom (UK) Chancellor Rachel Reeves delivered her Autumn Budget. As expected, and as part of the Budget, the Chancellor announced changes to the taxation of carried interest. The changes follow a government "call for evidence" on the regime. (For details, see EY Global Tax Alert,UK Autumn Budget delivers significant tax increases but seeks to plan for the future, dated 31 October 2024.)

With effect from 6 April 2025, carried interest will be taxed at 32% (rather than 28%).

From April 2026, the government intends to reform the carried interest legislation by introducing a revised tax regime that sits wholly within the income tax framework. From that date, all carried interest will be treated as deemed trading income and subject to income tax and Class 4 national insurance contributions (NICs).

It is proposed that the amount of carried interest subject to income tax and Class 4 NICs will be adjusted by a multiplier of 72.5%, where certain "qualifying" criteria are met. This will give an overall effective tax rate of approximately 34%, and this rate is intended to apply to all carried interest returns, regardless of their underlying nature.

The issue of what will constitute qualifying carried interest is subject to consultation until 31 January 2025. The two focus areas for that consultation will be a minimum co-investment requirement and a minimum holding period requirement. The technical practicalities of implementing the regime will be discussed with the industry and draft legislation is expected during 2025.

From April 2026, the government intends to remove the exclusion for employment-related securities from the income-based carried interest rules, ensuring "the rules apply equally and fairly to all recipients of carried interest," which includes both self-employed individuals and employees.

PE houses will want to monitor the changes as the revised tax regime evolves. Although the reforms aim to keep the effective rate on carried interest at a lower rate than on other types of income, the impact of the reforms on the UK's competitiveness (alongside the abolition of non-domicile status and inheritance tax reform) is yet to be seen.

UK government to abolish non-domicile status from April 2025

The UK government confirmed in the UK Budget on 30 October 2024 that it will abolish the non-domicile regime from April 2025. It did not announce any new fundamental changes.

A foreign income and gains (FIG) regime based on residency will apply from April 2025. New arrivals to the UK will not be taxed on FIG for their first four years of UK tax residence.

Individuals who have been tax residents in the UK for more than four years, as of 6 April 2025, will become subject to tax on their worldwide income and capital gains.

A temporary repatriation facility will be available from April 2025 for three years to enable non-domiciled individuals to remit accumulated FIG to the UK at a reduced tax rate (12% for the first two years and 15% for the final year).

A new residence-based system will also be introduced for Inheritance Tax (IHT). An individual will be a "long-term resident" and therefore within the scope of IHT where they have been UK tax resident for 10 out of the previous 20 tax years. From that point, all worldwide assets will be in scope, with a maximum IHT tail of 10 years for non-UK assets on exit from the UK. There is a limited form of tapering for those individuals who have been UK tax residents for between 10 and 20 years and who subsequently leave the UK.

This will include a limited form of grandfathering for excluded property trusts settled before 30 October 2024.

The non-domicile regime has been a driver in attracting senior asset managers to the UK. The new FIG regime will increase the tax burden on non-domiciled individuals and could act as a disincentive to relocate to the UK.

Netherlands releases key budget developments for 2025

In September 2024, the Dutch government released its budget plan for 2025. The proposals are subject to parliamentary proceedings and may, therefore, change. Enactment is expected in December. Highlights of the current proposals follow.

New group concept for the Withholding Tax Act 2021

The conditional withholding tax (CWHT) rules only apply to payments between affiliated entities. A cooperating group of entities may also qualify as affiliated. In practice, this definition is unclear, resulting in legal uncertainty. The Dutch government has proposed that a new definition of "cooperating group" will be introduced in the CWHT (referred to as a "qualifying unit"). This proposed change is expected to further restrict the application of the CWHT rules to perceived abusive structures. It is specifically relevant for dividend and interest payments in PE structures. It is possible to obtain certainty in advance through a tax ruling on the non-application of the CWHT rules.

Generic interest deduction limitation rule — increase of the maximum interest deduction percentage

Currently, the earnings stripping rule restricts the deduction of net interest expenses exceeding the higher of €1m or 20% of fiscal earnings before interest, taxes, depreciation and amortization (EBITDA). This threshold applies per taxpayer.

Increasing the 20% threshold to 24.5% of fiscal EBITDA is proposed. Earlier announced changes to the earning stripping rule focusing on real estate businesses with real estate leased to third parties have been withdrawn during the proceedings.

Other key measures

The proposals also include a reduction of the highest "Box 2" personal income rate from 33% to 31%. This is relevant for management equity plan participants (holding their interest via a pooling vehicle or personal holding company). Other measures include (i) the reversal of the abolition of the dividend withholding tax repurchase facility, (ii) Pillar Two clarifications, (iii) changes to the debt cancellation income relief, (iv) amended real estate transfer tax (RETT) rates and (iv) updates to the beneficial expatriate tax regime.

German tax authorities clarify tightened transfer pricing rules on intra-group transactions and reduce transfer pricing documentation requirements

The enacted Growth Opportunities Act (Chancing) has implemented tightened transfer pricing rules addressing financing transactions with related parties. On 14 August 2024, the German Federal Ministry of Finance updated the administrative guidelines for these regulations. Generally, the debtor, as part of the new debt capacity and business function test: (i) must credibly show that the debt can be serviced (e.g., cashflow calculation including follow-up financing regarding interest and repayment) and that the liability can be repaid as agreed; and (ii) must prove that the debt is economically required and in line with the purpose of the business of the debtor. If this is not possible, the borrower can prove that the interest paid does not exceed an interest rate that an external lender would have agreed to, considering the group rating. Arm's-length interest rates for related parties' debt are determined using the comparable uncontrolled price (CUP) method. Low-function and low-risk finance companies are allocated a cost-plus return.

The draft provides a grandfathering clause for existing debt and expenses incurred up to 31 December 2024 that are based on financing relationships that were agreed and disbursed before 1 January 2024. Further details were added in the extended German Annual Tax Act 2024. If affected financing relationships are significantly changed after 31 December 2023 and before 1 January 2025, the tightened transfer pricing rules do not apply to expenses incurred before the significant change.

The Fourth Bureaucracy Relief Act (BEG IV) eases the requirements for transfer pricing documentation from 1 January 2025. For tax audits, only a transaction matrix, the master file and records of exceptional business transactions must be provided. Individual records are only necessary at the specific request of the auditor.

Germany imposes stricter interest deduction rules and updates equity-ratio escape

The Secondary Credit Market Promotion Act (abbreviated KrZwMGEG for "Kreditzweitmarktförderungsgesetz") has restricted the interest deduction in Germany. The amended provision is applicable for financial years beginning after 14 December 2023 that did not end before 1 January 2024. Further, the requirements for the equity-ratio escape were adjusted. The equity escape clause provides an exception to the interest deduction limitation rule where, broadly, the company's equity ratio equals or exceeds that of the group. For the application of the equity-ratio escape, the definition of the term "group" has been adjusted. Since the extended group definition has been removed, the practical relevance of the equity-ratio escape should have increased. Modifying the equity-ratio escape has also resulted in changes to the definition of harmful shareholder financing. Accordingly, the remuneration for debt capital from individual qualifying shareholders must be cumulated when examining the 10% threshold for harmful shareholder financing. The effects of these adjustments must be considered accurately from the outset when setting up corporate structures.

According to the updated "interest barrier" decree (draft dated 9 October 2024), expenses for interest swaps, commitment interest, guarantee commissions, arrangement fees, agency and security agency fees and fictitious interest will be considered interest expenses from a German tax perspective (i.e., interest deduction restrictions apply).          

Ireland introduces participation exemption for foreign dividends

The Irish Finance Bill 2024 (the Bill) introduces legislation to implement a new simplified method of double tax relief through a corporation tax exemption for qualifying foreign dividends and other distributions (the participation exemption for foreign dividends). (For background, see EY Global Tax Alert, Ireland Budget 2025 / An overview for international investors, dated 4 October 2024.)

The exemption will apply where an Irish parent company receives a qualifying distribution from a qualifying foreign subsidiary on or after 1 January 2025 and a claim is made in the relevant tax return for the period in respect of all qualifying distributions.

Before the Bill, Ireland had generally only operated a "tax and credit" approach to dividends that Irish companies received from non-Irish resident companies. Where an Irish parent company does not opt to claim the new participation exemption, the existing tax and credit measures will continue to be available.

The conditions that must be satisfied to claim the exemption are detailed. However, in general, a dividend should be exempt in the following circumstances:

1. An Irish parent holds at least 5% of the subsidiary throughout a 12-month period.
2. The subsidiary pays the parent a dividend on or after 1 January 2025 during the 12-month period.
3. The subsidiary is tax-resident in an European Economic Area country or a country with which Ireland has a tax treaty.
4. The dividend is paid out of the subsidiary's profits, which have been recognized in its profit and loss account.
5. If condition 4 is not met, the dividend is paid out of the company's assets, and a hypothetical sale of the company's shares would qualify for the existing exemption for capital gains on the disposal of shares.

It is anticipated that further consideration will be given in 2025 to expanding the geographic scope of the participation exemption and introducing a foreign branch exemption.

The addition of the participation exemption is a welcome development that should simplify the repatriation of profits. However, one must carefully consider the conditions to ensure the exemption applies, including managing the timing of dividend payments.

Poland withholding tax issues present growing challenge

Although what constitutes a "beneficial owner" and "genuine economic activity" have not changed, the Polish tax authority seems to be issuing more taxpayer-unfavorable withholding tax (WHT) opinions and WHT refund denials. For example, some decisions contend that the recipient of payments subject to WHT in Poland does not have the right to freely dispose of the funds; others describe the entire structure as artificial.

This trend results from the increasingly robust policies of the Polish tax authority regarding WHT preferences. It is becoming increasingly difficult to demonstrate that commonly used structures in which holding companies with minimal assets performing management activities can be considered the beneficial owners of the received payments. The following characteristics in a holding company tend to indicate that the holding company's activities are purely passive, involving only the formal holding of shares in companies and the transfer of funds to the beneficial owner:

• A lack of personnel or the employment of minimal personnel based on part-time contracts
• A lack of dedicated office space, even in situations where a small office space is shared with several other, often related, entities
• The absence of a clearly defined role for the holding company within the structure, particularly if there is no active role in reinvesting received funds

Additionally, the tax authorities do not always consistently interpret the condition that a holding company should be subject to income tax on all its income, regardless of where it is earned. Considering this, the condition is not met in cases where existing tax losses are utilized.

Given the above and the fact that the pay and refund mechanism may negatively impact cash flows (e.g., lengthy tax refund procedure, need to draw up a detailed application, risk of no tax refund), an increasing number of PE entities may be considering changes to their investment structures in Poland.

Taxpayers and investors in Poland should verify their current structures in terms of WHT efficiency. If necessary, a complete reorganization of the structure in Poland could be considered to minimize the WHT burden.

Portugal introduces tax incentives to boost investment in capital market

A new regulation, entering into force in Portugal in June 2024, introduced a significant tax reform aimed at boosting investment in the capital market (Law no. 31/2024). This legislation derives from a milestone established with the European Commission within the Recovery and Resilience Plan for Portugal. It may have an important impact on the national economy, promoting the diversification of sources of financing alternative to traditional bank lending, as well as financial stability and sustained economic growth. (For background, see EY Global Tax Alert, Portugal adopts tax incentives for capital market development and non-financial companies' capitalization, dated 8 July 2024.)

Among other relevant measures, this new legislation approves the tax regime for Alternative Investment Vehicles (AIVs) focused on credit (either the granting of credit or acquisition of credits originated by bank financing and commonly known as "Loan Funds"). This tax regime had been eagerly anticipated by the market with high expectations, mainly as the regulatory regime for Loan Funds had already been approved in 2019.

The new law provides that Loan Funds are subject to the tax regime previously restricted to Venture Capital Funds (VCFs), under which income of any nature obtained by AIVs set up according to the Portuguese Law, is exempt from CIT. For Loan Funds, this exemption mainly covers interest or gains with the assignment of credits. The tax regime also covers income obtained by participants of Loan Funds, foreseeing a full exemption on income distributions or gains with the disposal or redemption of the participation in the Fund for nonresident participants.

The new law also extends the favorable tax regime, described above, to corporate AIVs, either VCFs or Loan Funds, but not to contractual funds. This removes the uncertainty that previously arose in this respect.

The new tax regime represents an important milestone for funding emerging and high-growth potential sectors. It opens the door for interesting and tax-efficient alternatives to structuring debt transactions for Portuguese companies, encouraging innovation and competitiveness in the market, notably for industries where access to traditional credit sources has been significantly impacted due to the recent financial crisis.

Denmark introduced new reporting obligation on royalty payments

On 1 July 2024, Denmark introduced a new reporting obligation for all companies making royalty payments to nonresident recipients. This measure aims to increase tax transparency and compliance. This new rule applies irrespective of whether the recipient is subject to Danish taxation. It marks a significant shift in Denmark's approach to monitoring cross-border financial flows related to intellectual property (IP).

All royalty payments to nonresidents must be reported to the Danish tax authorities, regardless of the recipient's tax status or whether they are affiliated with the payor.

The reporting requirements for royalty payments differ based on company size. Large companies must submit their reports by the last banking day of the month in which the royalty payment is made or accrues. In contrast, small companies must submit their reports no later than the tenth day of the month following payment of the royalty. A company qualifies as "small" if its annual labor market contributions do not exceed 250,000 Danish kroner (DKK) or its salary withholding tax payments are less than DKK1m per year. These thresholds ensure that smaller businesses are subject to less-immediate reporting pressure than larger entities, though the obligation remains the same for all.

This new obligation aligns Denmark with global initiatives to combat tax avoidance, especially through profit shifting via IP transactions. It also ensures that all royalty payments are properly documented and taxed where necessary.