Clarity on how the OECD Base Erosion and Profit Shifting (BEPS) framework will affect asset managers is limited by the sheer breadth of the project and the fact that the final details have yet to be confirmed.
As the BEPS initiative, which focuses on strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations, is a collaboration between more than 100 countries and jurisdictions progress on reaching practical measures has understandably been slow.
One area, for example, in which the proposed changes might not be easily applied is the use of treaty-entitled special purpose vehicles (SPVs) as a means of investing in underlying assets.
The new so-called principal purpose test, which is likely to be adopted into many double tax treaties as a result of BEPS, will create doubt around the future availability of treaty relief for these vehicles.
A further source of uncertainty is the timing and manner of BEPS implementation by individual countries.
ASSET MANAGEMENT IMPACT
The key elements of the project for the asset management community is Action 15, Multilateral Instrument (including the provisions intended to implement BEPS measures without needing to renegotiate individual treaties) and Action 6, Prevention of Treaty Abuse, according to Northern Trust global head of tax product, Rebecca Wilmott.
A multilateral instrument is a standalone document with provisions that will apply to the covered double tax treaties. It will result in some added complexity as asset servicers will be required to verify the status of relevant double tax treaty provisions with reference to the implementation of the instrument by contracting parties.
Action 6 is aimed at preventing the granting of tax treaty benefits in inappropriate situations to address potential treaty abuse. This will have the greatest impact on the funds industry, says Wilmott.
“To achieve this, proposals include implementing a limitation on benefits article, per the US Model Treaty, along with a principal purpose test,” she says.
Paul Hale, managing director, global head of tax affairs at Aima highlights three aspects of an asset manager’s business that will determine how it is affected by BEPS: where the business is established, the structure of its funds and the funds’ investments.
“If a US or UK manager is established within one jurisdiction only, with no operating affiliates, BEPS has little additional effect – even if it is managing funds in Cayman or Ireland,” he explains.
“The business will continue to make sure it complies with domestic tax rules aimed at ensuring it recognises a full taxable profit in the home jurisdiction. If it has branches or affiliates in other jurisdictions, BEPS may have tightened up applicable transfer pricing rules, for example, but I doubt that it is a significant change for most.”
For asset managers, one of the key points of BEPs is transfer pricing, suggests BDO transfer pricing & international tax partner, Anton Hume.
“Fund managers outsourcing functions such as investment management advice and fund distribution administration will often occur between related parties,” he says.
“Tax authorities will pay close attention to whether the arm’s length principle is followed – meaning that the prices and other terms and conditions agreed between related parties need to be the same – or at least similar – to what unrelated third-parties agree or would have agreed under the same or similar circumstances.”
Hume warns that fund managers should be aware that some of the structures they have used in the past are now at greater risk of being disregarded due to not being considered arm’s length, especially contractual allocations of risk that lack economic substance.
“Nonetheless, recent experience indicates that different tax authorities still have different – and often diverging – views about the basis on which income from investment management activity in an intra-group context should be taxed and how the arm’s length principle shall be applied in practice,” he adds.
“This places greater emphasis on being well prepared to support and defend your transfer pricing policies.”
For the largest businesses, there will be country-by-country reporting. While this is largely a compliance issue as far as the business is concerned, it will come with a cost in terms of staff time and professional fees.
New country-by-country reporting requirements for large asset managers already require substantial resources to be applied to the analysis of financial data and the preparation of new financial information that will need to be supplied to tax authorities, observes Mark Stapleton, a London-based international tax partner with Dechert.
This, in turn, is expected to lead to greater enquiries by those tax authorities. Hale notes that BEPS may reduce the efficiency of industry- standard fund forms such as master-feeder funds, since the introduction of measures into tax treaties that seek to restrict their benefit (whether by a principal purpose test or limitation on benefits provision) will encourage funds to have greater regard to the nature of their investor base, leading to parallel fund structures to cater for entitled and non-entitled investors.
“Allied to this is the use by funds that might not otherwise qualify for tax treaty benefits, of special purpose companies – for example, in Ireland or Luxembourg – to access tax treaties or domestic tax benefits,” he says.
“This will generally be harder, although in some cases tax authorities may be more willing to accept legitimate entitlements to alternative investment funds.”
In addition, asset managers need to be aware of issues relating to funds’ investments. Will the BEPS measures materially affect the profits of multinational enterprises? Hale suspects not, given the interaction with US tax in most cases (so it is the US tax take that bears the burden).
“US tax reform may prove to be more important in the long run, as a substantial reduction in the US corporate income tax effective rate would put pressure on US multinationals to reduce their overseas tax rates to the same figure,” he adds.
“BEPS will affect the nature of instruments that funds invest in, particularly if they are to any extent a hybrid of debt and equity.”
The application of such tests in the context of common investment vehicles (CIVs) has attracted particular attention given the likely complexity and administrative burdens. The funds industry has sought to ensure that CIVs will be able to continue to rely on tax treaties, where appropriate.
Wilmott suggests that the introduction of such proposals may well result in a reduction of treaty benefits for some CIVs and an increase in administration requirements for asset servicers.
As a result, the wider concern is that in order to meet requirements markets may be forced to move away from their up-front basis towards reclaims, which may result in loss of fund usage over time for institutional investors.
Stapleton recommends asset managers review existing fund structures that rely on treaty benefits to avoid the loss of these benefits and unexpected additional taxation of income or profit flows from underlying fund assets.
“They should analyse their footprint in jurisdictions where deal sourcing, marketing and distribution is undertaken to establish whether changes should be made to avoid any new risk of the creation of a taxable presence in those jurisdictions,” he says.
“They should also consider the potential impact of the current UK and forthcoming EU anti-hybrid and interest deduction limitation rules on existing fund and financing structures.”
According to Martin Shah, corporate tax partner at Simmons & Simmons, costs may arise where it is considered necessary to establish additional substance in a particular fund or investment vehicle jurisdiction.
“This substance may result in the need to recruit additional headcount, to establish a greater physical presence in the jurisdiction in question or to rationalise and consolidate the structures through which investments are made,” he concludes.
Anton Hume suggests that any analysis of whether managers are adequately placed to deal with current and future transfer pricing challenges should address the following: