More clarity needed on alternative fund status under BEPS

There needs to be greater clarity as to whether alternative funds will be eligible for treaty benefits following the Base Erosion and Profit Shifting (BEPS) initiative spearheaded by the Organization of Economic Co-operation and Development (OECD).

BEPS distinguishes between Collective Investment Vehicles (CIVs) like UCITS and non-CIVs, which are typically offshore hedge funds or private equity funds. It is not entirely clear whether funds managed by regulated AIFMs (Alternative Investment Fund Managers) would be capable of being classified as CIVs for these purposes. Under the current proposals, CIVs can more easily benefit from treaties post-BEPS than non-CIVs.

Mark Stapleton, tax partner at Dechert, said that the definition of what constitutes a CIV versus a non-CIV remained unclear. “It may be that it could cover a fund where the manager is an AIFM, for example, especially if it is subject to regulation in the same jurisdiction as the fund. However, this is unclear and I think the general view is that hedge funds and private equity funds should generally be classified as non-CIVs if the fund itself is not subject to regulation even if they are managed by a regulated AIFM,” said Stapleton.

BEPS’ final recommendations are likely to be implemented over the next 18 months. The rules are aimed primarily at large multinational corporations which have developed imaginative tax practices, and it seeks to clamp down on aggressive tax planning. While the asset management industry was not a core focus of the OECD’s remit, it has been ensnared nonetheless.

BEPS comprises of a 15 point action plan. Action 6 is the most concerning for alternative asset managers as it seeks to restrict treaty shopping through its Limitation on Benefits (LOB) provision. This could apply to funds which have established treaty eligible structures to minimise downstream tax leakage in tax efficient or offshore jurisdictions.

“Hedge fund and private equity fund managers structure their funds in tax efficient jurisdictions because they have global pool of investors and want to achieve tax neutrality as compared to a direct investment by investors in the underlying assets. However, if the hedge fund or private equity fund has no substantive links, investments or investors in the jurisdiction in which it is structured, it could be ineligible for treaty benefits under the post BEPS rules on the basis of treaty shopping. For example, a London-based AIFM managing a Cayman Islands domiciled fund could be caught by BEPS’ treaty shopping rules if it has reduced its withholding tax on income or dividends on underlying assets through the use of intermediary vehicles in treaty eligible jurisdictions like Luxembourg,” said Stapleton.

As such, managers will need to think about enhancing substance in the jurisdictions in which their funds are structured and considering the treaty eligibility of their investors.

However, the OECD is not a regulatory body and it is up to individual countries to implement BEPS accordingly. This is already happening to an extent. The UK’s Diverted Profits Tax (DPT) is already in force as a result of the Finance Act 2015 and obliges UK taxpayers to pay an increased 25% tax rate on any profits artificially diverted to lower tax jurisdictions or to entities with no economic substance. The rules will also apply to foreign companies with UK subsidiaries or branches.

As with other global tax initiatives such as the OECD’s Common Reporting Standard (CRS) – dubbed the Global Foreign Account Tax Compliance Act [GATCA], there appears to be little in the way of harmonization of the rules among countries.