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Thursday, 18th April 2024 |
| Funds and foreign taxes - is the tax refundable? |
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| Recent media reports suggested that funds suffered billions of euros of withholding taxes on their income, which they could avoid or have refunded to them. However, the position is more complex than media headlines might suggest, Brian Daly writes, and in some cases this tax is unavoidable. |
BBillions wasted?
Recent media reports suggested that funds suffered billions of euros of withholding taxes on their income, which they could avoid or have refunded to them. The position is more complex than media headlines might suggest.
Most funds which are based in Ireland invest a large proportion of their assets in overseas shares and securities, or in some cases even property. Income from foreign investments is in principle potentially liable to foreign taxes. The forms of income which a fund normally obtains - interest and dividends principally - are frequently subject to withholding tax before payment to the fund. These withholding taxes are imposed under the domestic laws of foreign states. Ireland too has withholding taxes on similar income paid from Ireland to non-residents. There is nothing unusual about this.
Funds and tax treaties
One of the advantages of location in Ireland by a fund is that Ireland has a decent range of double tax agreements. One of the functions of a good double tax agreement is to eliminate or reduce taxation in the country from which income is sourced, and to confine the principal taxation liability to the country in which the fund is resident.
Most funds in Ireland are “gross funds”. Such funds are subject to taxation on disbursement of their funds to certain unit-holders, or on sale of units by certain unit-holders rather than at the point of receipt of income. In an ideal world, a fund would be protected from withholding taxes in the countries from which it sources its income, and would be exposed to tax only in Ireland, which does not charge tax until disbursement in the case of certain unit-holders.
The reality is different to the ideal. One obvious problem is that Ireland’s double tax agreements do not eliminate withholding taxes even where they have application. Particularly on dividends, they frequently do no more than limit the rate of withholding tax, but do not reduce it to zero.
There is a more pervasive and fundamental obstacle to funds benefiting from treaties. Some states with whom Ireland has double tax agreements experience confusion in the application to Irish funds of the double tax agreements.
The wording of some treaties can be a source of this confusion. For the most part, only “residents of” one or other of the treaty states may obtain the benefits of a double tax agreement. That is not a universally true statement but it is valid as a broad generalisation, particularly with regard to withholding taxes.
“Resident of a contracting state” is typically defined as “any person who, under the law of that state, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature” - Because the taxation regime for gross funds in Ireland may differ from the taxation system in overseas countries some treaty states have difficulties in applying this definition to a gross fund.
Typically, where a payment has suffered a withholding tax and a fund wishes to obtain a refund of that tax, the foreign state will require a certificate from the Irish Revenue which will usually have to confirm that the fund is liable to tax in Ireland. The Irish Revenue are happy to confirm that the fund is resident in Ireland for tax purposes and subject to Irish tax law.
When the funds regime was first developed for the IFSC, KPMG carried out a survey and consultation exercise involving the major players internationally in the funds industry. A key issue addressed was the dicussion in relation to the benefits of an Irish tax only at point of disbursement to certain unitholders in Ireland (ie a gross fund) accepting the potential issues it posed regarding foreign withholding taxes, and the standard taxation regime in Ireland with less confusion in relation to foreign withholding taxes. The Funds sector then strongly favoured the adoption of the gross fund regime. That feedback helped to determine the current tax treatment of funds in Ireland.
That original consultation exercise involving KPMG and the Funds industry was also the genesis of KPMG’s Annual Survey Of Taxation And Regulation Of Funds Worldwide, which is available from www.kpmg.ie or on CD on request. The 2004 edition is due for publication shortly.
A second problem can arise in that some funds are organised as trusts, or in the case of a common collective fund, as a contract. Some foreign states would regard such entities as transparent both as a matter of general law and as a matter of tax law. In such a case some foreign states might regard the unit holders as the beneficial owners of the income in question, in proportion to their unit holdings in the fund. Where the unit holder is Irish resident, the foreign state will usually permit that individual unit holder to avail of the treaty. But where a fund has many unit holders, this can make the claiming of a refund of a withholding tax economically unprofitable.
Not all unit holders in an Irish fund will be Irish resident in any event. In such a case a non resident unit holder may be regarded by the country imposing the withholding tax as entitled to benefits under a third country treaty eg that between the USA or UK and the country imposing the withholding tax.
This further increases the complexity of an attempt to claim a withholding tax in such circumstances. If the unit holders are themselves a gross fund or entity in their country of residence, the complexities spiral.
Many funds are organised in a corporate form. Such funds are not regarded as transparent and their issues relating to withholding tax are confined to the issue of whether or not they meet the definition of “residents of a contracting state” in the relevant treaty.
How to avoid foreign tax costs
This explains why source country taxation in the form of withholding taxes represents a dead weight cost for the funds industry worldwide. But all is not gloom. Despite the problems presented, many countries do provide refunds of taxes to funds. It is not always worthwhile for a fund to pursue refunds where the amounts involved are small in relation to that fund. In order to pursue a refund it is usually necessary to fulfil detailed requirements regarding documentation, claim forms, certificates etc. The requirements differ from country to country.
A fund has to weigh up the cost of foregoing a refund against the cost of administering a claim for a refund. KPMG is able to help funds in that its worldwide network enables it to advise on the documentation requirements in various overseas countries and to provide access to copies of forms etc. It is also able to provide advice on whether or not it is worthwhile pursuing claims with a particular country, having regard to their attitude to entitlement of funds to treaty benefits and the speed (or lack of it) in processing refund claims. With the benefit of such advice and assistance, a fund can make a rational decision on the refunds of withholding tax which can be profitably pursued.
Funds will never achieve a situation of paying no tax anywhere. Withholding taxes are likely to remain a net cost for funds in many countries and the most a fund can hope to do is to make informed decisions on how to minimise the cost. |
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| Article appeared in the May 2004 issue.
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