| Tax and the Irish investment funds industry - a time of challenge and opportunity |
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| As the new Taoiseach opens the door for funds service providers to outsource to Northern Ireland, Seamus Hand and Ted McGrath look at some of the tax related opportunities and challenges facing the investment funds industry in Ireland. |
Ireland continues to advance its position as one of the key European ‘centres of excellence’ for the investment funds industry with, for example, a staggering one third of global hedge fund assets now serviced here. European Fund and Asset Management Association statistics show that while most of our European competitors suffered a net outflow of investment funds in 2007, Ireland showed a net inflow putting net assets over 12% up on the previous year. However there are potential challenges on all fronts and we need to remain vigilant to the risks that these raise and bold in our continuous pursuit of innovation in an industry
where we are truly regarded as a market leader.
Pension Pooling
In recent years, Ireland’s tax transparent common contractual fund (‘CCF’) has continued to develop its prominent market position as an institutional pooling vehicle, particularly, in the pensions pooling arena.
Now, a number of large multinationals are considering the possibility of a pan-European pension fund and some have already been established in Ireland. Although the location in which the pension fund itself is established need not be the same as that of a pooling vehicle, it seems logical for the two to be in the same jurisdiction where it is efficient to do so.
It is not surprising therefore that Ireland’s main competitors for such business are other jurisdictions that have established cross-border asset pooling vehicles, in particular Luxembourg. However the Netherlands and Belgium are making efforts to challenge Luxembourg’s and Ireland’s dominant positions with their new pension vehicle regimes, the Organisme de Financement de Pensions (‘OFP’) in Belgium and the Dutch Fons voor Gemene Rekening (‘FGR’) in the Netherlands.
A recent decision by the US Department of Labor paves the way for multinationals to pool their US pension assets in vehicles such as the CCF which was previously thought not possible under the US Employee Retirement Income Security Act (‘ERISA’). In addition, the recent recognition by Australia of the tax transparency of Irish CCFs for double tax treaty purposes is a welcome clarification. Ireland needs to maximise these opportunities.
UK market opportunity
The tax treatment of UK investors in offshore funds is largely dependent on whether the fund has ‘UK distributor status’. A key test is for the fund to distribute at least 85% of its income each year. Broadly, if it does, UK investors are subject to capital gains tax on disposal of their interest instead of income tax (at 40%), a much more favourable outcome since the reduction of the applicable UK CGT rate to 18% earlier this year.
Meanwhile, draft regulations have been issued which intend to allow an offshore fund to report its profits, and not have to distribute them, to benefit from the CGT treatment. In principle, this seems like a positive development which has the capability of reducing the administrative costs and burden associated with obtaining UK Distributor Status. It should open up the offshore market for tax efficient UK investment (including Irish funds). Nonetheless, the jury is still out as to the final impact, as only time will tell whether the reporting requirements prove less burdensome for the funds concerned than distribution of the funds. (Could it be a first step on the road to more detailed UK Tax reporting?).
There are also some opportunities for Irish funds resulting from the change in the UK treatment of non-UK dividends, whereby UK investors now receive a notional credit previously only available on
UK dividends.
EU Savings Directive
A recent report by the European Commission has raised concerns that the EU Savings Directive is being circumvented through the use of intermediate investment vehicles not caught by the reporting requirements or the use of investment products whose income falls outside the definition of interest payment covered by the Directive.
Mechanisms suggested to address these concerns include further look-through reporting of beneficiaries of interest payments and asset distributions comprising interest, listing of financial products which can be equated with debt claims, extension of reporting to dividends and capital gains and to income obtained through non-UCITS (largely excluded to date).
Fund administrators should be mindful that this could result in major modifications to their systems and processes, posing challenges in the years ahead.
VAT
Ireland has been progressive in developing one of the more commercial European VAT regimes in the area of fund management. The scope of the services to which VAT exemption applies is defined more broadly and VAT exemption applies to the management of a wider range of funds than in some other EU States. The VAT recovery entitlement for Irish fund administrators is also applied in a practical and beneficial way.
As a result, our interpretation of EU law in this area has been confirmed as being correct by a number of EU judgements. However EU cases have, in some instances, prompted countries such as the UK and France to bring their regimes in line, thus making them more competitive. Furthermore, more formal harmonisation is on the horizon with European Commission proposals to amend EU wide VAT legislation on funds and funds management as part of their wider review of VAT and financial services. We need to be cognisant of this continual levelling of the playing field.
Competitor Threats
With our flexible Qualified Investor Fund (‘QIF’) regime offering 24 hour authorisation, Ireland has become a strong competitor to traditional offshore locations as a domicile of choice for hedge funds, where key requirements are favourable tax regime, flexibility, speedy authorisation and good fund servicing.
However, Luxembourg has developed a new flexible Specialised Investment Fund (‘SIF’) Law which may now pose a challenge in this area, while Jersey and Guernsey are continually focussing on flexibility, with Jersey launching an unregulated fund last February and Guernsey soon to follow. The Isle of Man has also made favourable changes.
In the funds industry generally, the UK Treasury seems to be currently committed to addressing the fact that the UK’s competitiveness had lagged behind other locations, in particular Luxembourg and Ireland, and this is also resulting in a number of initiatives to improve the domestic UK offering.
For example, it is proposed to make the new UK Fund of Alternative Investment Funds (‘FAIF’) more attractive to UK tax exempt and foreign investors by allowing for election for direct taxation of investors instead of the FAIF. A possible simplification of certain anti-avoidance measures relating to qualified investor schemes and improvements to rules governing investment trust companies to deliver tax efficient pooled investments are on the horizon. A more favourable tax regime has also been introduced for the new Property Authorised Investment Funds (‘PAIFs’) which provide alternatives to UK Real Estate Investment Trusts (‘REITs’).
2008 Finance Act
As can be seen there are plenty challenges which are beyond our control and therefore we should be trying to ensure that we do not inadvertently add to these challenges through unnecessarily burdensome domestic legislation.
Obligations placed on Irish funds, in 2006, to operate tax in respect of 8 year deemed disposal provisions for Irish investors, were misguided and resulted in a disproportionate administrative burden given the fact that the overwhelming majority of investors were non Irish residents.
The 2008 Finance Act has gone some way towards alleviating the practical burden by putting the obligation on a self-assessment basis for funds with a small proportion of Irish taxable investors. This is helpful in restoring the industry’s competitive position in this regard. However, the two years, from the introduction of the original provisions to introduction of the provisions alleviating the burden, demonstrate the efforts involved in highlighting the industry challenges. While the fact that we can mitigate the impact of such provisions is testament to the strong relationship between all the industry stakeholders, our industry would be much better served if we were spending this time looking forward with innovative ways to deal with new challenges.
It is welcomed that the Finance Act extended provisions allowing for the tax-efficient reorganisation and amalgamation of Irish fund structures to the reorganisation of sub-funds of an umbrella fund into a new umbrella fund even if not all of the sub-funds are part of the restructure. These, along with the new measures providing relief from stamp duty on certain reconstructions and amalgamations of investment undertakings, are important given the current industry focus on rationalisation.
Outsourcing to Northern Ireland
The new Taoiseach, along with the Stormont Finance Minister Peter Robinson, recently announced welcome plans to relax the Irish requirements for a minimum level of administration activities of funds to be carried on in the Irish State, in order to facilitate outsourcing of the activities concerned to Northern Ireland.
No regulatory pronouncement has been made on the detail of how the initiative will be implemented but the announcement lays a framework for a Northern Irish labour supply to ease capacity constraints of the Irish funds servicing industry as it strives to maintain its dominant position.
The proposal will not alter in any way the tax position in either Northern Ireland or the Republic though outsourcing will bring its own tax challenges in terms of dealing with the tax risks and obligations of another jurisdiction, including transfer pricing.
Conclusion
Both the Department of Finance and the Financial Regulator have consistently been responsive to the funds industry needs to date. However as can be seen from the snapshot of developments mentioned above, the competitive tax and regulatory environment is continuously changing. Some say one of the biggest future threats will be from Eastern European countries, in particular Poland which is gaining a wealth of expertise from connections with Ireland and the UK.
Just as Luxembourg would never have envisaged Ireland taking such a market share 20 years ago, there are plenty jurisdictions waiting in the wings should Ireland not remain on top of its funds game. |
Seamus Hand is a tax partner and Ted McGrath is a tax director in KPMG.
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| Article appeared in the June 2008 issue.
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