How should PE investors and rollover participants view the issue of blocking companies? The Blockers Tax Guide illustrates the U.S. consequences of operating income tax and transferring a blocker, at home or abroad, in several common scenarios. 1 The purpose of this guide is to describe in a general way the tax consequences of different blocking structures in the United States. It does not recommend a particular structure. The structure of each fund investment in the U.S. must be on a case-by-case basis and depends on the specific facts of the agreement. Foreign taxpayers should consult with the U.S. tax advisor at an early stage to discuss a U.S. investment project.
In a previous article titled “Rollover Equity Transactions 2019,” we discussed the various business and tax issues related to transactions with private equity (PE) buyers, who integrate target private equity transactions into their leverage buyback (LBO) transactions. Here, we dive deeper into the impact when some PE investors invest in target companies through blocking companies. Blockers are an integral part of international tax planning, especially for inbound transactions involving foreign persons in U.S. companies. Blockers are U.S. or foreign companies that are considered businesses for U.S. income tax purposes. When they are established in the United States, they are normally created as crown corporations.
On the other hand, offshore blockers can activate the box in Regs. § 301.7701-3 to choose their classification for federal tax purposes, or they may be classified as businesses according to the standard rules according to the rules of the Department of Finance. In summary, rollover participants (and other pe investors) are generally informed that there are the following requirements with respect to blocking companies: (i) certain investors (foreign and tax-exempt investors) invest through blocking companies; (ii) if the capital of the target company is ultimately sold in a sale process three to seven years later, the sale process will be the sale of Blocker Corporation shares (iii) the investors of blocking companies are associated equally (in proportion to the indirect equity participation of the portfolio company) in the proceeds of the sale, by ignoring a differentiation of the purchase price of the shares held by the company by blocker. A reasonable question is why pe companies cooperate with requests from foreign and tax-exempt investors when structuring an LBO with blocking companies puts other PE investors and scooter participants in a less favorable position? Finally, with regard to foreign investors who invest through blocking companies, one factor is that they may be taxable in their home country on the profits generated by the sale of their blocking shares. For example, if blocking shares held by a Canadian resident are sold, the Canadian investor may flee the United States.