| Competition in funds industry |
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| The recent KPMG UK report on the impact of taxation on the competitive position of the UK as a centre for funds administration and domicile raises issues for Ireland also : do the tax disadvantages cited by the report have any echo here? : are there opportunities for Ireland in the growth areas identified in the report?: are we complacent about Luxemburg as a competitor and the threat from the UK if it remedied its tax problems? |
The KPMG UK report
The report was published in October 2006 by the Investment Management Association.The report was prepared by KPMG UK. It concerned the impact of the UK’s tax regime on the competitiveness of the UK as a centre for administration and domicile of all forms of collective investment entities ie funds in their widest sense.
The report concluded that Luxemburg and Ireland were growing as funds centres significantly faster than the UK in the period 1991 to 2005. The principal strength of the UK fund management industry – the large domestic market for funds in the UK – was being eroded in recent years as offshore funds took a larger share of that market.
The report found that managers’ perceptions of the taxation regime, both in its rules and administration, and of the regulatory regime were the key factors which influenced the domicile of new funds. The perception by managers of the taxation regimes in Luxemburg and in Ireland were more favourable than their perceptions of the UK tax regime across most fund types. For many managers, the UK was not a competitive location for domiciling funds.
Comparison of tax regimes by managers
One of the most interesting findings regarding the manner in which fund managers evaluate a tax regime is that the technical features are not the most important factor for them. Managers of alternative or progressive funds valued especially the ability of regime to offer a clear and certain approach and a stable environment. The quality of relationships with Revenue authorities, and of consultation with and understanding of the industry by them was an important factor. This was seen as a key weakness in the UK, in contrast to Ireland or Luxemburg.
It might be reasonably inferred from the report that where Revenue authorities are focused largely on domestic tax concerns, including anti avoidance and anti evasion in the context of domestic taxpayers, they are not likely to have a tax regime that will have the transparency and simplicity which an internationally focused fund industry requires.
The report also highlights the choice between a gross or tax free regime for funds with one which imposes domestic tax but allows for credit for foreign withholding taxes. In some cases, depending on the pattern of investment, the taxation with credit system can result in a lower overall tax cost for a fund. However this advantage in some cases is outweighed in the judgement of most managers by the reaction of retail customers, to whom it is attractive for a fund to correctly claim it is ‘tax free’ at fund level, and who have little appreciation of the complexities of withholding taxes on fund income.
When KPMG prepared a report on the development of a funds industry in Ireland many years ago, the same debate occurred but fortunately the key KPMG recommendation, to listen to the customer, who wanted a gross fund, and not try to second guess the customer, was adopted. The current report notes the declining significance of withholding taxes, especially across the EU, as further reinforcing the advantages of the gross fund model.
So all is well for Ireland?
The conclusions of the KPMG UK report, that Ireland and Luxemburg are more attractive currently than the UK as a fund location may seem comforting to Ireland. It is true that the report recommends several steps which would make the technical aspects of the UK tax regime more competitive for funds. But the report also states that perceptions of an unsympathetic Revenue, prone to act without prior consultation in a fashion that impacts on funds, can linger for years after attempts are made to mend fences with the fund industry.
But, implicitly,there is a warning there for Ireland. There has been outstanding cooperation between Revenue, regulatory authorities, and the industry in Ireland in the development of new products and vehicles. This is exemplified by the development of the Common Contractual Fund and in a wider context, by the design and updating of the Irish securitisation regime, to mention but two concrete examples. But there also have been instances of tax measures being introduced in Ireland which impacted the funds industry unfavourably and which showed little understanding of its needs. The introduction of the eight yearly deemed disposal of assets attributable to domestic unit holders is one example, and the abolition of the remittance basis ( relevant to seconded expert staff ) is another example. A good reputation was hard earned, but can be more easily lost by such behaviour than it can be subsequently restored in the perception of an international audience.
While the KPMG UK report uses Ireland and Luxemburg as benchmarks against which to judge the UK regime, it is noticeable that Luxemburg could be argued from comments in the report to have an edge over Ireland. This is so notwithstanding that the basic tax regime for funds is fundamentally the same in both jurisdictions – broadly a gross fund model for non residents.
This perception by managers is borne out to some extent by the statistics cited in the report which show Luxemburg ahead of Ireland in value of assets in funds managed, especially in retail UCITS. Ireland has a lead in alternative funds, which is reflected in a better rating for Ireland from the managers of such funds. This lead by Luxemburg may merely reflect ‘first mover’ advantage especially in the area of retail funds but it is worrying that the lead in assets managed in retail funds is reflected in perception by managers of such funds, something which is less easy to put down to Luxemburg being in the market before Ireland.
At present alternative funds are seen as the main growth area but there is evidence that the cross border sales of retail funds are at last beginning to grow, including into the UK which traditionally resisted them. Ireland should pay attention to its competitive position vis ? vis Luxemburg in that retail area.
One table in the report is striking. It compares various features of the taxation of funds in the three competing jurisdictions. The table shows a simple statement for Luxemburg – exempt from tax. According to the report that is the preferred statement that UK managers find they can sell to their retail unit holders. But in relation to Ireland, that simple statement is not made. Instead there is a sentence explaining the basic exemption as limited by the eight yearly charge on gains and how this charge does not affect non resident unit holders. This is the complexity the UK managers of retail funds make clear they don’t like to face – it is stated in the report that managers consider time spent explaining a tax regime and why it does not adversely affect the foreign unit holder as time wasted. Anyone reading the report to this point and having understood what the interviewed fund managers were saying when they stress the importance of the simplicity of the gross fund, and its predominant attraction to potential retail unit holders, will see that Ireland has managed to throw away one of its principal attractions for a retail fund. Of course the point is less important to funds aimed at more sophisticated investors.
The eight yearly charge was introduced solely for domestic unit holders. It is applied on a self assessment basis for overseas funds e.g. those in Luxemburg. But in a misguided effort to avoid some collection costs it is imposed on Irish funds (which are overwhelmingly held by non residents) as a direct tax charge. This is an example of purely domestic concerns (of almost no importance even in a domestic context) being allowed to cause potential damage. The KPMG report emphasises that consultation and understanding of the needs of a cross border industry is the key feature that fund managers seek in selecting a long term location for funds. It is seen as insurance against future mistaken changes. Such consultation was our strength in the past but we may have become complacent in that area in recent years.
Opportunities?
The KPMG UK report points out that ‘the potential business efficiency of co-locating funds and investment managers cannot be disregarded. Hedge fund managers are particularly flexible in this regard, with no compelling reason to locate in any particular location, including the UK’.
Ireland successfully created a fund management industry. Is there a chance, if we seriously apply ourselves to it, to create an international investment management industry also? Ireland already has a domestic investment management industry which proves it is not beyond us. We may be entering a period of flux in the location of investment management which could be a once off opportunity for Ireland. But any attempt to achieve a major break through in this area would require us to be an attractive jurisdiction for seconded high earning staff. This point was made also in a 2004 report prepared for the IDA. How silly the damage done last year to our remittance basis now looks. It was another example of a narrow domestic focus by decision makers damaging an internationally focused sector.
While noting the lead enjoyed by Luxemburg and Ireland as locations for more complex alternative funds (hedge funds, property funds, funds using derivatives etc) the report states ‘there is as yet no clear domicile of choice’. It suggests that that prize is still to play for and that the UK, were it to get its act in order, was still there with a chance to be that domicile of choice. If that is so, then surely it is still possible for Ireland to grasp the prize instead? A start to that would be to review the errors of the 2006 budget and ensure that consultation is strengthened and made real. |
Ted McGrath is a director at KPMG.
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| Article appeared in the January 2007 issue.
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