The Wealth and Asset Management sector has well-established routines for all aspects of its business, from sourcing investors to managing individual investments. Unfortunately these well-travelled roads are now being increasingly blocked or detoured by tax changes. This is happening at a multi-lateral level (Base Erosion and Profit Shifting (BEPS), EU Anti-Tax Avoidance Directive (ATAD), the Multi-lateral Treaty initiative[1]), and at a national level (US tax reform, withholding taxes changes, audits by tax authorities or even individual tax inspectors). In this article, we’ll examine the new global tax environment to see if there is an approach that can be used to find alternate commercial routes for the sector.
The new global tax environment will challenge the Wealth and Asset Management industry. Traditional access routes to investors and investments are being affected by changes to global tax treaties, by ATAD and by other developments like US tax reform, Brexit and innumerable local tax developments. These will test traditional operating models and may result in unanticipated and unintended tax outcomes – for both asset managers and their investor base. How do wealth and asset managers deal with such major, far reaching and unprecedented change?
For the Wealth & Asset Management sector, a common solution is to put more substance – including people – into countries where these tax changes may impact. Our view is that an analysis requires a more holistic view, and putting people in certain locations is not the only answer.
There is actually a fair degree of technical robustness in many current market practices in the Wealth & Asset Management sector. Efficient market processes, commercial, operational regulatory and economic requirements have created business models which, in many cases, reflect the best way for asset managers to carry on their business. They may need to use different jurisdictions for different types of funds for their investors. They will have different distribution channels for their products. They will have different investor profiles and will need both back, middle and front office in different locations to match those needs. There are, therefore, commercial imperatives in how they work that explain the need for their multi-jurisdictional models.
Looking at client businesses location by location or entity by entity is not the optimal approach. Instead, our approach is to look at businesses more holistically as ‘value chains’. We follow the logic of what the value chain analysis/asset strategy is and see what that leads to throughout the entire business of the asset manager.
There can be too much focus on what is happening in a particular jurisdiction – for example, Luxembourg or Ireland – in isolation. This is borne out by the recent German treaty-shopping case, where the ECJ commented that “the fact that the economic activity of a non-resident parent company consists in the management of its subsidiaries or that the income of that company results only from such management cannot per se indicate the existence of a wholly artificial arrangement which does not reflect economic reality.” Indeed, the ECJ requires an assessment of the relevant situation on a case-by-case basis, “based on factors including the organizational, economic or other substantial features of the group of companies to which the parent company in question belongs and the structures and strategies of that group.”
Every asset manager will have their own unique value chain and their own unique investment strategy. This spans the chain from sourcing investors down to managing individual investments. There can be no one-size-fits-all. Subjective factors will determine where substance should be and what the purpose is of different entities in different locations.
This value chain analysis is not just an economic analysis but must also take into account the effect of legal, accounting, regulatory and practical factors that drive decisions as to location and structure.
When you apply that value chain analysis, then lots of market practices make sense. For example: you may have a management company in the UK and a fund in Ireland. You might look just at that fund and say, where is the substance in Ireland? But if you look at the full value chain, you can see that Ireland performs a particular (limited) role in that chain and the substance etc., should follow that logic – i.e. there is no need/logic for significant management in Ireland. Another example might be that you have established a management operation in Ireland which manages various fund ranges in Ireland and Luxembourg. Here you would expect to see more substance in Ireland.
However, there are mechanical rules – in particular anti-hybrid rules[2] – that will mechanically and probably unexpectedly impact on asset managers and their fund ranges. There is no alternative but to look at the rules and apply them to client structures. This is already happening in the UK, due to their anti-hybrid rules. Obviously, legal factors such as the OECD examples around BEPS and EU case-law can also be layered over purely subjective client choices as to location.
Therefore in addition to a value chain analysis, asset managers should conduct a second, more mechanical, analysis. This should encompass anti-hybrid, interest limitation, BEPS tax changes, and examine how they might impact.
Our advice is to treat every investment structure as a unique value chain, including: sourcing investors, day-to-day management of underlying investments, receiving money from investors and returning to them with the ultimate outcome of the investment strategy. Every entity, step and person, has a role in this process. This ensures that the new environment has not generated any weak links in the value chain.
Ultimately, the understanding and insights provided by this approach can help to guide asset managers through the new global tax landscape.
[1] As of 8 August 2019, 89 jurisdictions have signed the MLI with a further 5 indicating their willingness to sign
[2] Anti Hybrid Rules will be effective in Ireland from 1 January 2020 and anti-reverse hybrid rules will be effective from 1 January 2022
See below a video about EY’s Value Chain Analysis tool and click here for more information.
