Using Tax Transparent Funds to improve efficiency

Common Contractual Funds and why you should consider them

For Professional Clients only Using Tax Transparent Funds to improve investment efficiency // Page 2 Executive summary

For both investors and managers exploring tax transparent funds, and specifically Common Contractual Funds (CCFs), is critical for two key reasons:

• Investors could be losing valuable basis points on their funds’ performance • Managers should launch CCFs to avoid their tax exempt clients losing money

Tax efficiency of pooled funds has been neglected Expertise needed to create a Both large and small institutional investors continue to use Making a fund tax transparent is a complex process which requires pooled funds to implement their portfolio strategies. But until tracking dividend income as well as applying the relevant tax now few have considered whether these funds have been built treaties to the right investor. Technological developments have to be withholding tax efficient. A number of trends will make made it easier but expertise is required to make sure this can be investors pay greater attention to the impact of tax drag on done without falling foul of tax laws. performance. These include the increasing use of passive funds and the growth of auto-enrolment. AMX provides a new route to accessing TTFs By using AMX, the institutional platform, to access tax transparent Removing withholding tax improves returns CCFs, investors and fund managers no longer have to go to the Different European jurisdictions have developed specific hassle of setting up their own management company and fund. structures which can be used to provide a Tax Transparent Fund And it’s now possible for individual schemes, as well (TTF). An example of such a TTF is the Irish domiciled Common as multinational firms, to take advantage of Tax Transparent Contractual Fund (CCF). The fund has no legal personality Funds. Tax returns need to be tailored for the jurisdictions of and therefore allows a ‘look through’ to the tax status of the the different investors. AMX can offer trustees peace of mind to underlying investor for the purpose of withholding tax on dividends. ensure tax reclaims are being correctly administered; the platform The advantages of using a global equity fund which minimises provides operational oversight of the tax services provided by the withholding tax can be significant. It can boost the performance administrator through the use of robust technology and expertise. of a fund by as much as 100 basis points and around 30-40bps on average1 , for tax exempt investors such as pension funds.

1 Irish Funds – Common Contractual Funds: The Tax Efficiency in Asset Pooling, June 2015

Using Tax Transparent Funds to improve investment efficiency // Page 3 Using Tax Transparent Funds to improve investment efficiency

1 Pooled funds – a useful tool for institutional investors 5

2 The development and advantages of tax transparent pooled funds 7

3 How do Tax Transparent Funds work? 9

4 Finding tax efficiency for institutional investors 10

5 Why asset managers should consider offering Tax Transparent Funds 11

6 AMX – a new route to accessing TTFs 12

7 Staying ahead – what’s new? 13

8 Contact AMX 14

9 Glossary 15

Using Tax Transparent Funds to improve investment efficiency // Page 4 1 Pooled funds – a useful tool for institutional investors

The utility of a pooled fund cannot be overstated. Even the Withholding tax efficiency in the spotlight largest , with the scale and expertise Despite the many advantages of pooled fund structures, ensuring needed to manage multiple segregated accounts, uses they have a withholding tax efficient structure often gets forgotten. collective investment schemes. These funds allow them to Yet paying attention to this aspect of investing can boost the access a particular asset class, even if the allocation is small. performance of a fund by as much as 100 basis points and around 30-40bps on average.2 They are often the perfect investment vehicle for smaller pension schemes as fund managers are unlikely to set up a bespoke A number of key trends will make it more important for pension account for an investment of less than £100m-£200m. schemes to consider greater tax efficiency over the medium-term:

Another benefit is that these funds require less in-house governance. For example, exercising voting rights and Switch from local to global ensuring assets are correctly valued can be outsourced Pension schemes have become more international in their outlook, to the management company. moving away from UK equity dominated portfolios and diversifying into global equities. But the impact of withholding tax on dividend Some institutions, such as the Local Government Pension Scheme income has not always been well understood. (LGPS), may use these vehicles because they would otherwise have to apply European procurement rules (OJEU). These rules may apply when choosing an investment manager versus In 2017 allocations to UK equities a security in a pooled fund. And, using a collective vehicle can relative to overseas had fallen to 30% help corporate defined benefit plans mitigate VAT payments on “compared to 70% in overseas equities“ manager fees versus segregated mandates. which is a significant change from a decade ago where the allocation stood It also suits investment managers to offer these funds as they are at 51% versus 49%. an effective way to distribute their skill and it is an efficient way to The Investment Association: run a particular investment strategy. Asset Management in the UK 2017-2018, September 2018

Chart 1 UK-managed equities by region (2008-2017)

100% Other 90% 80% Emerging Market 70% Latin America 60% Japan 50% 40% Asia-Pacific (ex Japan) 30% North America 20% European (ex UK) 10% 0% UK 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: The Investment Association, Asset Management in the UK 2017-2018

2 Irish funds – Common Contractual Funds: The Tax Efficiency in Asset Pooling, June 2015

Using Tax Transparent Funds to improve investment efficiency // Page 5 Consolidation of defined benefit (DB) pension funds The industry recognises that running a small multi-million DB fund is not efficient and is looking for ways to consolidate these funds to The Regulator (TPR) has improve economies of scale. As funds merge, their management

repeatedly highlighted the regulatory will focus on aspects such as enhancing governance and

“challenge posed by small DB schemes, and minimising the impact of tax drag. consolidation was a key plank of the recent Department for Work and Pensions (DWP) “ DB White Paper and a core recommendation Rising popularity of passive funds from the Pensions and Lifetime Savings The increased popularity of low-cost passive and smart beta funds Association (PLSA) DB Taskforce. makes investors pay greater attention to the performance drag of any charges or fees across all fund holdings. As institutional IPE Magazine, September 2018 investors’ awareness grows, they are reviewing other costs, including the impact of withholding tax on equity performance.

Chart 2 Active and passive as proportion of total UK assets under management (2008-2017)

74% of assets are actively managed, down from 83% a decade ago

100% 90% 80% 70% 60% 50% 40% 30% 20% Active 10% 0% Passive

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: The Investment Association Annual Survey, September 2018

The introduction of auto-enrolment Schemes and investment funds therefore need to work with a Defined contribution schemes are now the most important form partner who has the necessary knowledge and robust accounting of occupational pension provision and assets under management systems to make this work smoothly. For example, income needs are growing rapidly. Ensuring scheme members can access distributing on an arising basis to the beneficial investors whilst high-quality yet low-cost pensions is an important policy making sure the source and nature of the income is not changed – principal that has resulted in a management charge cap. this requires accurate tracking and allocation of income to Ensuring employees are not sacrificing performance to individual investor accounts. unnecessary withholding tax will drive companies and master trusts to consider more tax efficient structures. was more prevalent among equities than fixed income.“ Making a fund tax transparent is a complex process which requires More“ than half of equities were being managed tracking dividend income for managers as well as applying on a passive basis (53%) compared to just over the relevant tax treaties to the right investor. Technological one third of fixed income (34%). developments have made it easier but expertise is still required to make sure this can be done without following foul of tax laws. The Investment Association Annual Survey, September 2018

Using Tax Transparent Funds to improve investment efficiency // Page 6 2 The development and advantages of tax transparent pooled funds

The Undertakings for Collective Investment in Transferable Understanding international tax treaties Securities (UCITS) has enabled the liberalisation of the fund The FCP can take advantage of international tax treaties. management industry so products can be sold throughout For example, the double-taxation agreement negotiated with Europe to both institutional, and retail, investors. the US in 1997 allows tax exempt investors, such as UK pension schemes, to pay no withholding tax on US dividends. The UK As UCITS is a directive rather than a regulation, it has led to the has a large treaty network with other investment markets. creation of a plethora of different fund structures developed by Some examples: multiple jurisdictions, which can be sold throughout the European UK pension Union. The acronyms of those structures are familiar to investors: Source country ICAV OEIC fund OEICs were developed by the UK while developed 15% 10% 0% the SICAV range. Canada 25% 15% 0% 15% 10% 0% While many countries have developed their 35% 35% 0% own collective investment range, Ireland and Luxembourg have Sweden 30% 5% 5% become the largest centres for fund registration. Source: AMX

Only a few fund structures are tax efficient Reduce the tax drag on The advantages of using a fund that looks at the tax status There is, however, a less well-known range of funds, called a of the underlying investor (rather than the fund’s tax status) Fonds Commun de Placement (FCP), offered in Luxembourg. when applying withholding tax on dividends can be significant. At the start of the millennium these fund structures became of For example, a UK OEIC which owns US securities would have interest to multinational corporations looking to consolidate their to pay a 15% withholding tax on dividends. And a Luxembourg global pension assets in one place. The FCP is useful because it SICAV would have to pay 30%. These can materially impact the can be structured to be tax transparent. The administrator of the returns generated from funds. A SICAV holding US securities fund can ‘look through’ the contract to the tax status of the owner. yielding 2% would lose 60 basis points of return. That’s helpful for UK pension schemes because they are usually tax exempt.

Tax drag in top 5 MSCI tax treaty countries MSCI World Tax paid via an Irish Tax paid via an Tax paid via a Country Dividend yield Tax paid via a CCF allocation UCITS vehicle Cayman vehicle segregated account United States 59.2% 1.8% 32 32 0 0 United Kingdom 6.6% 4.1% 0 0 0 0 3.9% 3.1% 0 4 2 0 3.7% 1.2% 1 0 0 1 Canada 3.6% 2.0% 2 2 0 0 Total tax draga 35bps 38bps 2bps 1bps CCF tax saving 34bps 37bps 1bpsb –

In a typical active global equity product a CCF can provide tax savings of around 20-40bpsc All tax rates assumed are for a tax exempt UK pension scheme. Tax savings calculations are also subject to changes in yields and tax treaties. Other markets, in addition to the a On those countries shown in the table and could be higher depending on portfolio allocation above, also recognise the CCF b Assumes all tax exemptions are reclaimed as tax transparent and therefore c Individual manager tax savings will vary depending on country allocation – provide withholding tax savings. the example above is based on the MSCI World Index allocation Source: AMX, 2018

Using Tax Transparent Funds to improve investment efficiency // Page 7 Improving the returns from a fund by making it tax transparent Tax Transparent Funds become a trend has obvious benefits for institutional investors. These These fund structures have become slowly more popular, with the additional savings can provide a useful buffer during periods UK launching its own version – the Authorised Contractual Scheme of underperformance and will bolster overall performance of (ACS) – in 2013. This was part of a move to develop the fund market the fund making it easier to meet funding goals. to compete with Luxembourg and Ireland.

The reduction in tax drag is also an incentive for investment And the Dutch also developed their own version of this fund, managers to use these structures as it is a simple way for them the Fonds voor Gemene Rekening (FGR). This has been used to boost the performance of the funds. Managers in Luxembourg primarily for domestic clientele rather than as a way to compete recognised the advantage of these structures for tax exempt for international assets. institutional clients, such as UK pension schemes, and started to develop funds.

Irish competitors became aware of this development and set about replicating the structure. The (CCF) was developed in 2005 as a competing product range. This replicates the tax transparent nature of the FCP.

Tax Transparent Funds: A timeline

2003- 2005- Late 2004 2005 Present 2000’s 2013 2018

Multinational Ireland sets up Others set up CCFs Holland Financial Authorised AMX launches pension schemes the Common with nearly 100 Centre promotes Contractual CCFs for long- first set up asset Contractual Fund now authorised use of Fonds voor Scheme (ACS) global equity pooling fund (CCF) as a Gememe Rekening set up in UK with managers structures in Ireland fund type (FGR) for subsequent use and Luxembourg asset pooling by insurance companies, investment managers and Local Government Pension Schemes

Not all tax transparent structures are equal These fund structures can be used by investors in multiple Even though institutional investors now have a range of different jurisdictions, introducing economies of scale and reducing costs fund structures to choose from, the CCF has become more compared to smaller, more domestic structures such as ACS popular. The volume of CCFs therefore provides more precedent and the FGR. CCFs also allow local pension schemes to invest in terms of tax rulings, understanding by investors and agreements in a withholding tax efficient manner, as well as making it easier by tax authorities. for multinational companies to consolidate all their pension scheme assets.

Using Tax Transparent Funds to improve investment efficiency // Page 8 3 How do Tax Transparent Funds work?

Fund structure of a CCF CCFs are regulated by the Central Bank of Ireland, in the same way as many other collective investment schemes. These can be compliant with UCITS or QIAIFS; UCITS fund are generally for retail investors and the structure will govern eligible investment types. CCFs are currently being promoted as part of the fund range to maintain Ireland’s position as a strong domicile for fund operators.

Chart 3 A pooled fund that is not tax transparent

Investor A Investor A UK US dividend 30% withholding tax Dividends Investor B Opaque fund all taxed at Investor B South African life fund (e.g. Irish ICVC) the tax rate US dividend 30% withholding tax of the fund Investor C Investor C Irish pension fund US dividend 30% withholding tax

Chart 4 A Tax Transparent Fund

Investor A Investor A UK pension fund US dividend 0% withholding tax Dividends Tax Transparent Investor B all taxed at Investor B South African life fund Fund individual US dividend 15% withholding tax (e.g. Irish CCF) investor level Investor C Investor C Irish pension fund US dividend 30% withholding tax

These funds have been constructed as contracts. This enables Apart from its tax benefits a CCFs is just them to be tax transparent because they are not tax resident in like any collective investment scheme Ireland. If the fund were resident in Ireland, it would be treated • Net asset values can be quoted daily, weekly or monthly differently by the tax treaties. This structure allows tax authorities to ‘look through’ the fund to the tax status of the beneficiaries. • The fund is run by a management company

• There is depositary for the assets owned by the fund

• It has a fund accountant

• Investors subscribe to unit classes which determine the currency-denominated, tax outcome and fee (Ongoing Charges Figure)

Using Tax Transparent Funds to improve investment efficiency // Page 9 4 Finding tax efficiency for institutional investors

The popularity of pooled funds among institutional investors shows no sign of diminishing. They are an easy way for a How an investor used AMX to source a large scheme to access a particular asset class quickly and cost-efficient CCF they reduce the governance burden on smaller schemes. An investor had run a selection exercise for their equity portfolio and was interested in the approach offered by a particular global equity fund manager. The manager But it will become increasingly important for institutions to didn’t have an existing Tax Transparent Fund so, having ensure they use a structure which is efficient from a withholding been introduced to AMX, the investor was faced with tax perspective since tax drag can significantly reduce the three options: performance of fund.

Some of the key trends driving this requirement are the Use the manager’s existing opaque switch from domestic, e.g. UK equities, to global investments, 1 pooled fund the rising popularity of passive funds and the introduction of

auto-enrolment.

2 Set up a segregated mandate “ The UK has added an additional nine million individuals to workplace Invest via the AMX platform through 3 “ saving in the past five years. its tax transparent structures

IPE, February 2018: ‘UK auto-enrolment: Good start, must do better’

Given the size of the proposed allocation it was doubtful Setting up a Tax Transparent Fund is complex. A high volume of whether a segregated mandate was feasible. This approach data and the requirement for timely, fast and accurate calculations also involves substantial work, particularly in terms of requires process automation; for example US withholding tax rules reclaiming taxes and setting up the required trading markets, require that income needs to be distributed on a rising basis and so AMX was asked to provide a comparison of the pros and different jurisdictions will have their own specific requirements. cons, from a cost perspective, of using the existing pooled fund or joining the platform. The review looked at elements Schemes and investment funds need to work with a partner who including manager fees, operational costs, tax savings and has the necessary knowledge and robust accounting systems to the impact of VAT. make this work smoothly. This gives pension trustees peace of mind as they can minimise their risk and governance burdens. The exercise identified clearly that even with the AMX fee, the platform offered a better solution, particularly in terms of cost and tax savings. AMX launched a tax transparent CCF version of the preferred fund on the platform, mitigating the effort for the manager.

Therefore the first investment with AMX was driven by cost but the benefits of the streamlined, efficient and transparent approach would be increasingly apparent with subsequent investments through AMX.

Using Tax Transparent Funds to improve investment efficiency // Page 10 5 Why asset managers should consider offering Tax Transparent Funds

As the demand for Tax Transparent Funds from institutional CCFs – the manager view investors is expected to increase, it makes sense for asset managers to offer these structures. Scenario 1 Global equity managers from outside Europe who want to expand A small boutique manager into the European institutional market, should consider a UCITS fund which is also tax transparent as this could give them an A small boutique UK manager worked with AMX to launch a CCF. advantage over incumbent players. However, this comes with a Their existing UK was not as useful as a global vehicle, level of complexity and knowledge of regulatory environments. particularly for accessing markets such as South Africa, Canada or Europe (as well as the UK). Accordingly, those managers which already offer CCFs may need to recognise they are too small to be cost efficient and should Partnering with AMX allowed the manager to offer the fund in consider offering their investment strategy in the AMX CCF that an Irish domicile without having to launch a complex structure benefits from the scale of the platform and can therefore allow themselves. This offered tax efficiency to end investors as well operation at a lower cost. as providing ease of onboarding, distribution and reporting for the manager. And managers which do not yet offer tax efficient funds, will need to address this issue if they do not want to lose out on particular mandates, such as global equities, to managers offering these collective investment vehicles. Scenario 2 A global equity manager

Another advantage of offering tax efficient funds is they are ideally structured to respond to the needs of a multinational company A global equity manager with an opaque Irish fund (ICVC structure) with a large cross-border pension scheme. Investors are becoming was able to offer an average 30 BPS tax saving to a UK institution more aware of the improved yield offered by tax efficient funds and by offering their strategy in an AMX CCF fund. are challenging managers accordingly.

Having become aware of the potential to remove tax inefficiencies in its current structure, the manager revisited options. However, even for this larger fund house, the cost and effort involved in setting up a CCF would have been substantial. Using AMX allowed for an enhanced client relationship with minimal additional work.

Using Tax Transparent Funds to improve investment efficiency // Page 11 6 AMX – a new route to accessing TTFs

In the past, when global multinational companies wanted For example, a South African insurance investor invested in US to consolidate their assets in a tax efficient manner, securities would pay a different withholding tax rate on dividends they would have no choice but to launch their own fund than a UK pension scheme. It would pay 15% rather than 0%. structure and had to get to grips with the technicalities Over time, the NAV for the UK pension scheme will be higher. of these structures and international tax regimes, even And for a multinational company, the CCF will have to apply the though this was not their area of expertise. The AMX CCF right withholding tax rate for those pension assets held in each removes this challenge, as it provides the fund structure, individual country. the management company and takes care of the operational set up, manager negotiations, in-specie transfers etc. Part of AMX’s role is to ensure these tax reclaims are being correctly administered at the right rate for a particular investor, providing operational oversight of the tax services provided by the Risk and governance administrator through the use of robust technology and expertise. But while Tax Transparent Funds offer many advantages to institutional investors, they are complex structures which involve considerable operational expertise to run efficiently. Protecting the trustee From a trustee’s perspective, it’s important to get this right. Risk management and governance are key considerations. The regulator requires the trustee to understand the implications Returns need to be tailored for the jurisdictions of the different of an investment, even if they are not a financial specialist. investors; the returns earned by UK pension scheme will be different to those by a German one because of the differing tax treaty networks.

The Asset Management Exchange

€ $ ¥ Transparency € Consistency £ ¥ ¥ $ £ £ € € ¥ £

€ $ ¥ £ Scale $ € Governance

Using Tax Transparent Funds to improve investment efficiency // Page 12 7 Staying ahead – what’s new?

Just like other regulations, tax rules change and adapt over time. There are a number of new developments, and others on the horizon, which have the potential to benefit both institutional investors and providers of tax efficient funds. Here are some of these recent developments:

Danish SKAT ruling on withholding tax transparency of CCFs gives comfort for Danish Investors and outcome tax ruling for investments in Danish equities.

HMRC Continuing discussions around VATable services for UK pension funds and the application of VAT to the views on life company management fee. The CCF as an EU specialised continues not to have VAT VAT on the fee.

ECJ Continued push to get to a “level playing field” in Europe means that Collective Investment Schemes (CIS) statements can obtain good withholding tax outcome at the fund level, i.e. on the basis of being an UCITS or a non UCITS fund.

CCFs in Work being done to prove out efficacy of double tax agreements between Japan and investment markets. Japan

European Tax treaties are in place but other rules and directives apply, i.e. how the EU says tax is treated between law and OECD member states and the treatment of collective investment schemes under the OECD ‘model convention’.

Using Tax Transparent Funds to improve investment efficiency // Page 13 8 Contact AMX

We look forward to talking to you about the benefits of Tax Transparent Funds if you are an investor, or how we can launch your Tax Transparent Fund if you are an asset manager.

Managers: [email protected]

Investors: [email protected]

Website: www.theAMX.com

Using Tax Transparent Funds to improve investment efficiency // Page 14 9 Glossary

ACS: OEIC: Authorised Contractual Scheme Open Ended Investment Company

CCF: OJEU: Common Contractual Fund Official Journal of the European Union

FCP: QIAIFS: Fonds Commun de Placement Qualifying Investor fund

FGR: SICAV: Fonds voor Gemene Rekening Société d’investissement à capital variable. An open-ended (Fund for Joint Account) collective investment fund, much like a unit trust or OEIC

ICVC: UCITS: Investment Company with Variable Capital Undertakings for Collective Investments in Transferable Securities (used interchangeably with OIEC)

LGPS: Local Government Pension Scheme

Using Tax Transparent Funds to improve investment efficiency // Page 15 For Professional Clients only. The Asset Management Exchange and AMX are trading names of (1) The Asset Management Exchange (Ireland) Limited (“AMX Ireland”) registered in Ireland, No. 632258, authorised and regulated by the Central Bank of Ireland, (2) The Asset Management Exchange (UK) Limited (“AMX UK”), registered in England, No. 11555138, authorised and regulated by the Financial Conduct Authority No. 823316) and (3) The Asset Management Exchange (IP Co.) Limited (registered in England, No. 11686713).

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March 2019: 2019-90