The impact of ATAD II on real estate asset managers

On 29 May 2017, the EU Council approved Directive 2017/952/EU (ATAD II or the “Directive”), which amended ATAD I. The ATAD II aims to extend the scope of ATAD I for hybrid mismatches involving non-EU countries.

As with any EU directive, the measures of ATAD II first need to be implemented into each EU Member State’s domestic tax legislation. Expectation is that EU Member States are able to introduce domestic legislation for ATAD II to be applicable as of 1 January 2020 (except for reverse hybrid mismatches, which may be applicable with a delay, as of 1 January 2022). The full impact of ATAD II has to be addressed upon transposition in domestic tax law by each EU Member State—only a few have initiated this transposition process at time of going to press. 

However, it is expected that ATAD II will have a significant impact on how real estate alternative investment funds, and its investments, will be structured.

4 Things to look out for as a real estate asset manager:

1. Hybrid instruments and hybrid entities

As per the Action 2 Report, the different tax qualification of a debt instrument between the lender and borrower states may lead to a hybrid mismatch outcome and result in denial of the related deduction in payer jurisdiction (primary rule). The same mismatch situation may arise in the case of such a debt instrument attributed to an investor in a tax transparent investment (fund) vehicle, should the investor qualify the instrument differently from the payer jurisdiction.

A hybrid mismatch may also occur when the qualification of an entity considered as tax transparent in one jurisdiction, but considered as opaque from the other jurisdiction’s perspective, leads to a discrepancy in the tax treatment of any payment made.

If left unchecked, these may create unintended deductibility concerns within a fund holding structure (in particular regarding the internal [shareholder] financing), or create an additional layer of taxation at fund/investor level.

In light of this, fund managers will need to consider, identify and monitor their investor base. This is not a one-time only exercise, but goes hand-in-hand with continuous monitoring activity (beyond tax).

It should not be a well-intended exercise to identify the implications of correct feeder/blocker vehicles within a structure, but instead should be considered as part of the ongoing operational aspects of an investment fund.

2. The “acting together” concept

Hybrid mismatch may arise between associated enterprises meeting a 25-50% participation threshold.

Therefore, one might think that the hybrid mismatch rules may be of less concern to widely-held, collective investment vehicles. However, given the “acting together” concept, there could be an impact on the alternative investment fund industry at fund level. Since this concept may group investors whose investments are managed under a common mandate (e.g. same class of investors) or who are partners in an investment partnership, it may bring them back within the scope of the hybrid mismatch rules.

Until there is further clarification via the domestic implementation of the Directive, it remains uncertain as to how to interpret the “acting together” concept within the alternative fund industry and its implications.

3. Reverse hybrid and imported mismatches

Although there is a carve-out reference to collective investment vehicles within the Directive, it remains unclear as to whether this refers to regulatory supervision only, or if semi- or unregulated products are covered as well (provided they are managed by an authorized investment manager who is then subject to supervision).

It may well only refer to UCITS and completely exclude so-called non-CIV products–like most alternative investment funds.

4. Investor relations

Identifying sources of possible hybrid mismatch cases is one issue arising from the various hot topics circulating around the implications of ATAD II. However, how to manage investor relations in this respect is even more difficult.

Fund managers and advisors should actively work together to assess the possible ATAD II implications to investors, and address the related safeguards included in the relevant fund documentation (e.g. a clawback clause in the fund documentation or a questionnaire in the subscription booklet).

The ATAD II items are raising challenges both at fund level and from an investment structuring perspective. Asset managers now need to carefully consider the type of fund products and structure, in line with their investor base, to remain attractive whilst adapting their operational model to comply with the recent regulations arising from BEPS.

The impact of the hybrid mismatches need to be assessed on a case-by-case basis. Timing will be of the essence as the parameters of the Directive will be applicable as of 1 January 2020 (with an exception for 2022 for reverse hybrid mismatches). For this reason, the implications of ATAD II will be immediate and will affect the practice as from fiscal year 2020 onwards.

A more detailed version of this article is available in the Reflexions magazine.