Today New City Initiative is comprised of 43 leading independent asset management firms from the UK and the Continent, managing approximately £500 billion and employing several thousand people.
Published by Charles Gubert
Base Erosion and Profit Shifting (BEPS) is the latest tax initiative to impact the financial services industry following the US Foreign Account Tax Compliance Act (FATCA), its UK variant – “The Son of FATCA” and the Organisation of Economic Co-operation and Development’s (OECD) Common Reporting Standard (CRS).
Like CRS, BEPS is an OECD-led initiative first unveiled in 2014 and it is designed to clamp down on cross-border double non taxation and treaty shopping by multinational corporations. While the OECD cannot introduce legislation per say, it does carry political clout and a number of countries will take note of it.
BEPS will affect fund managers despite this not being the original objective of the OECD. Given its scope and ambition, many market participants assumed BEPS would be put on the backburner, unlikely to have a major impact on financial services for quite a few years. These market participants have been proven wrong.
BEPS has come into fruition remarkably quickly and it is going to be presented to the G20 finance ministers in October 2015. The initiative has a lot of political backing behind it, so a change of heart about implementing BEPS by national tax authorities looks unrealistic. An action plan is likely to be published at the end of the year meaning implementation could occur as early as 2016 or 2017. This is not long for financial institutions to prepare for BEPS.
Of the 15 action point plan being proposed by BEPS, several stand to impact fund managers. Action 6 is designed to prohibit treaty shopping or treaty abuse where a financial institution will structure their business to take advantage of tax treaties as a mechanism to reduce their tax bill. BEPS introduces a Limitation of Benefits (LOB) rule, which is likely to restrict treaty shopping. Another action point in BEPS is its stricter interpretation of permanent establishment, which would force financial institutions to have a substantive presence in the jurisdictions in which they are structured.
This matters to fund managers. A number of hedge funds or private equity funds will domicile their funds in tax efficient, offshore jurisdictions such as the Cayman Islands, British Virgin Islands (BVI), Bermuda, Jersey or Guernsey. Others will structure businesses in onshore jurisdictions such as Ireland, Luxembourg or The Netherlands as these countries also offer tax efficiencies. Any funds or special purpose vehicles domiciled in tax efficient jurisdictions benefiting from reduced tax on income or dividends should be concerned.
If a manager does not have investors or little/if any investments in these tax efficient jurisdictions, they could face scrutiny from tax authorities. Fund managers will now need to demonstrate meaningful substance in those countries to mitigate this risk.
While a number of firms will argue they manage capital on behalf of geographically diverse investors – and need to pool this capital into funds based in “tax neutral” jurisdictions, this is unlikely to convince national regulators to change course, particularly given the political backdrop. Some jurisdictions – notably Guernsey and Jersey – both of whom are home to sizeable private equity communities highlight senior personnel do reside there. They argue this should satisfy the authorities should they question managers’ substance in these jurisdictions.
BEPS does, however, distinguish between Collective Investment Vehicles (CIVs) and non-CIVs. The former are regulated fund vehicles such as UCITS, while non-CIVs are comprised of alternative investments such as hedge funds and private equity. CIVs will attain better treatment under BEPS than non-CIVs.
However, the OECD has made no reference as to whether alternative investment fund managers (AIFMs) regulated under the Alternative Investment Fund Managers Directive (AIFMD) are classified as CIVs or non-CIVs. Critics point out AIFMD is regulation and AIFMs are regulated, and as such should be afforded the same benefits as CIVs. Again, whether this request is granted is a big unknown. The OECD has yet to make public its stance.
The implication of BEPS should not be underestimated. As with previous tax initiatives, it is likely to prove extremely complicated and expensive. Some countries have already introduced their own variants of BEPS. The UK’s Diverted Profits Tax (DPT), which is part of the 2015 Finance Bill, requires firms to pay 25 per-cent on any profits that have been diverted to lower tax jurisdictions. The UK rules are extraterritorial and impact US parent companies with UK subsidiaries. Australia has said it could push for a DPT initiative as well. It is inevitable other countries will follow suit. If an un-harmonised approach to DPT is adopted, this could lead to widespread uncertainty for fund managers.