As the Organisation for Economic Co-operation and Development (OECD) forges ahead in its efforts to forge a new international tax consensus as part of its BEPS 2.0 project, stakeholders in the asset management industry have raised some significant issues about the business impact of the latest proposals. Going forward, it will be important for stakeholders in the industry to continue engaging in these consultations to ensure such issues are considered as these proposals are finalized.
In this article, we highlight the main concerns raised by the submissions from stakeholders in the asset management industry responding to the OECD’s December 2020 call for comments on its October 2020 draft Blueprints. These concerns relate primarily to the definitions of entities that are excluded from the Pillar Two regime, as well as a number of sector-specific and other issues.
Pillar Two generally consists of two regimes – the subject to tax rule (STTR) and the global anti-base erosion (GloBE) regime.
As currently proposed, the GloBE regime would apply only to entities that consolidate for financial reporting purposes. Because of that general scope, the Pillar Two Blueprint notes that the GloBE rules often would not apply to investment structures. Investors and general partners generally do not consolidate with the investment funds in which they invest, and investment funds generally do not consolidate with the entities in which they invest.
However, the Pillar Two Blueprint points out some situations in which investment funds do consolidate with an investor, general partner, holding company, or portfolio company, so the Pillar Two Blueprint thus proposes an exception from the GloBE rules for investment funds in certain situations.
Specifically, the Pillar Two Blueprint proposes to exclude certain entities (“Excluded Entities”), including investment funds and certain wholly or almost wholly owned subsidiaries of investment funds, provided that the Excluded Entity is otherwise the group’s ultimate parent entity (UPE). However, this exception would not apply to an investment fund that is not the UPE of its group. If the investment fund consolidates with an owner that is an Excluded Entity, the exception may apply (though this is unclear, as we discuss below), but it would not apply if the investment fund consolidates with an entity that is not an Excluded Entity.
Issues with the UPE requirement
An investment fund might consolidate with a non-Excluded Entity in a number of situations. For example, in their submissions to the OECD, several stakeholders highlighted that some insurance groups consolidate with non-wholly owned fund entities, so the insurance company and the investment fund could be subject to the GloBE regime on the fund’s earnings. Further, where there is significant co-investment by a fund manager into an investment fund, consolidation is mandatory, and so the investment fund would not be a UPE.
In submissions to the OECD, stakeholders suggested that the Excluded Entity definition should include insurance companies, as well as an investment fund that is part of a multinational enterprise (MNE) group (but is not a UPE), because one or more other members of the MNE group manages the investment fund in the ordinary course of carrying on a business of providing investment management services and holding rights or interests in relation to the investment fund. Some comments suggested eliminating the UPE requirement for Excluded Entities entirely.
Some submissions argued that subjecting an investment fund to the GloBE regime when it is consolidated with a non-Excluded Entity could lead to unexpected and inappropriate results. For example, if an investment fund in one jurisdiction is consolidated by a non-Excluded Entity (e.g., an insurance company) in another jurisdiction, the fund’s income and the taxes paid could be assigned to different jurisdictions, skewing the determination of the rate of tax that applies to the fund’s income. (A similar separation of taxes from income can occur under the US GILTI regime and high-tax exclusion.)
To avoid this mismatch, some comments suggested that a fund’s income and taxes should be assigned to the jurisdiction of the controlling member of the group that includes the fund (i.e. the controlling “Constituent Entity”). Others noted that if an investment fund is controlled by an MNE group but also has minority third-party ownership, applying the GloBE rules could impose tax on all of the fund’s income, to the detriment of the minority owners. Those stakeholders suggested that either:
If the fund were treated as tax transparent for these purposes, the fund’s income would be assigned proportionately to the jurisdictions of the fund’s owners (including minority owners), unless the owner is a Constituent Entity and the owner’s jurisdiction does not treat the investment fund as tax transparent.
If the owner is a Constituent Entity and its jurisdiction of residence does not treat the fund as tax transparent, that owner’s share of income would be allocated to the “stateless” jurisdiction. A minority investor’s share (i.e., a share of an owner that is not a Constituent Entity of the group that includes the investment fund) would be allocated to the minority investor’s jurisdiction and not taken into account by the MNE group.
Accordingly, this approach would assign an investment fund’s income and any taxes on that income to the same jurisdiction. It would also not impose GloBE taxes on income attributable to minority investors as a result of the ETR of the MNE group with which the fund is consolidated, whether by way of tax on payment from the fund to another group member or tax directly imposed on the investment fund. This approach would thus ensure that an MNE group’s share of the investment fund’s income is included in the GloBE tax base while preventing inappropriate taxation of the income under the GloBE rules.
In several submissions, stakeholders noted that requiring an Excluded Entity to be a UPE is inconsistent with the inclusion of wholly owned holding companies as Excluded Entities, because in that situation the holding company almost surely will not be a UPE. Again, it was suggested that this could be addressed by eliminating the UPE condition for investment funds altogether.
Other suggestions were to:
Definition of investment fund
The Pillar Two Blueprint’s definition of an investment fund requires the fund to pool funds from more than one investor (or at least one Excluded Entity). Several stakeholders noted the difficulties that this requirement could create.
For example, during the initial seed period or wind-down period the fund may only have one owner, so the fund might not have more than one investor even if the fund generally would have multiple investors over its life. Some submissions suggested these concerns would be addressed if the Pillar Two rules consistently required only that the fund be designed to pool the assets of more than one investor. This would align with similar UK rules relating to the “genuine diversity of ownership” conditions for an “authorized investment fund.” One stakeholder suggested clarifying that indirect investment by multiple investors through feeder funds should be considered in testing the multiple investor requirement.
The multiple investor requirement could also cause problems for insurance companies, which may be treated as a single investor (and not an Excluded Entity). Accordingly, some comments argued that an investment fund should include a fund that is part of an MNE insurance company that pools investments of multiple policyholders. The proposed rule could apply when the invested amounts are derived from issuing insurance policies and the investment is used wholly or partly to support reserves. Others suggested simply eliminating the multiple investor requirement.
Concerns were also raised over proposals that would require:
The OECD was asked to clarify the standards for determining investor connectedness and how the presence of carried interest would affect the return-related requirement. Some comments suggested that investment funds often are not regulated in the fund vehicle jurisdiction as the Pillar Two Blueprint now proposes, so regulation of an investment fund should not be required.
Some stakeholders identified particular types of structures that the rules should address specifically. For umbrella platforms with sub-funds, for example, one comment suggested that each sub-fund should be considered a separate entity and the investment fund definition should be revised to include sub-funds.
Holding company definition
The Pillar Two Blueprint defines investment funds to include entities that are “wholly-owned or almost exclusively owned, directly or indirectly, by one or more Investment Funds or other Excluded Entity.” Several stakeholders asked the OECD to elaborate on the ownership threshold for being “almost exclusively owned”, suggesting 75 percent as appropriate, and to clarify that ownership by any combination of Excluded Entities would meet the requirement.
Comments further noted that in some co-investment structures, a holding company may be owned by a mix of Excluded and non-Excluded Entities. If so, the comments suggested that the holding company could be treated as an investment fund to the extent of the direct or indirect ownership interests of a parent investment fund. That way, co-investment by a non-Excluded Entity would not disadvantage the fund. Other comments suggested that the ownership limitation is not needed and that an investment fund should include any entity “with a main purpose of holding assets or investing funds” for an Excluded Entity.
The Pillar Two Blueprint also requires that for a holding company to be an Excluded Entity, it must not carry on a trade or business. Many stakeholders asked the OECD to clarify what that means. Some comments noted that the rules for holding companies owned by governmental entities require that they must not carry on a “commercial trade or business” and suggested aligning the restriction on holding companies owned by investment funds so that it also refers to a “commercial trade or business”.
Other stakeholders suggested specific guidance on the treatment as a trade or business of support services. These could include:
In some submissions, it was suggested that an investment fund holding company should be permitted to conduct all of these activities to support the fund and its portfolio companies without jeopardizing the holding company’s status as an investment fund and Excluded Entity. This would be in line with the understanding that an investment fund could undertake these activities itself and that a holding company should be viewed as part of the investment fund’s structure.
For real estate funds, comments suggested that a subsidiary holding company’s real estate management activities, which would otherwise be considered a trade or business, should not disqualify the company as an Excluded Entity. Another stakeholder took issue with the requirement that a holding company must operate “almost exclusively to hold assets” for the benefit of an investment fund, arguing that the rules should clarify that a regional holding company that both holds assets and provides services to the group meets that requirement.
Several stakeholders asked which types of income and taxes would be taken into account under the GloBE rules. Specifically, one comment requested guidance on whether covered taxes would include those imposed on “fair value” revaluation (e.g., where tax treatment follows accounting revaluations) because it is unclear whether those taxes would be treated as similar to taxes on dividends or capital gains.
In response to a specific request for comments in the Pillar Two Blueprint, a number of stakeholders commented on how the GloBE rules should treat portfolio dividends. Some argued that local income tax rules should determine whether dividends are included in the income tax base. Others called for an across-the-board exclusion without regard to local law, with 10 percent ownership in the dividend-paying company being the most commonly suggested threshold for such exclusion. Alternative suggestions included a five percent threshold, an alternative minimum ownership threshold of 1.2 million Euros. and a minimum 6-month holding period.
Some stakeholders also raised issues specific to certain sectors or types of investment. In particular, stakeholders raised concerns about the possible impact of the Pillar Two Blueprint on investments in infrastructure. For example, stakeholders noted that there may be questions about whether a project company that holds or operates the investment is engaged in a trade or business so the exclusions for investment funds would not apply.
Additional concerns relate to the treatment of intangible assets in infrastructure projects. Although stakeholders noted that the substance-based carve-out generally does not adequately address the financial services industry, they were particularly concerned about the impact on the infrastructure industry, arguing that intangible assets related to infrastructure should be considered for purposes of the carveout.
Stakeholders noted strong policy arguments for exempting infrastructure investments from the rules. Many governments provide tax incentives to stimulate these investments, and activity in the sector is expected to help fuel economic recovery. Applying Pillar Two could negate tax incentives intended to encourage new projects.
Further, income from infrastructure is usually recognized in the jurisdiction of its location, whether by law or for practical reasons, leaving little opportunity for the type of profit shifting that Pillar Two aims to address. However, one stakeholder suggested that it could be appropriate to apply an infrastructure investment exception under the GloBE rules only, and not under the STTR. Because infrastructure development is inherently local, this stakeholder noted that the types of inter-jurisdictional payments that the STTR could apply to are unlikely to arise in an infrastructure project, so if such payments were made, it would be appropriate for the STTR to police them.
Stakeholders also suggested that REITs and non-collective investment vehicle real estate funds should be specifically identified as Excluded Entities, or that REIT regimes be identified as tax neutrality regimes, which would treat a REIT’s income as excluded from the GloBE rules. Stakeholders argued that the second proposal would provide certainty that income that qualifies under local country REIT rules for non-taxation at the entity level (i.e., because it is taxed when distributed to the entity’s owners) would be considered subject to a tax neutrality regime. The GloBE rules under the Pillar Two Blueprint would therefore not apply.
Stakeholders also suggested clarifying that an Excluded Entity that owns an interest in an entity that is subject to a tax neutrality regime is treated as being subject to tax on its share of the entity’s income, so that income would be excluded from the GloBE rules. Stakeholders further asked that the exclusion for tax neutrality regimes be extended to apply to the STTR as well as the GloBE rules.
Most of the comments related to asset management focused on Pillar Two, perhaps because the Pillar One Blueprint suggests that Pillar One would not apply to regulated funds and managers.
However, some stakeholders asked the OECD to clarify how unregulated funds might be treated under Pillar One. In justifying the exclusion for regulated asset managers, the Pillar One Blueprint recognizes that the an asset manager generally provides services to the fund itself, rather than to the investors, so there generally is no consumer-facing business (CFB), even for a retail fund. While it seems relatively clear that unregulated funds also should not be treated as consumers, stakeholders requested clarification that an investment fund could not be considered a consumer. This would confirm that asset management companies could not be considered CFB regardless of their regulatory status.
Further, an asset manager’s services generally would not meet the definition of automated digital services (ADS). However, the precise scope of ADS is not clear, and ALFI requested that the provision of technology services that are tailored to the specific needs of the financial and asset management sector be specifically excluded from the application of Pillar One. Several stakeholders also requested that Pillar Two’s investment fund definition be used to identify which investment funds and their managers would qualify for Pillar One’s financial services exception.
While the Blueprints address some business issues raised for the asset management industry, our discussion above shows that many others still need to be addressed.
Further, as we noted in our previous article, there’s no guarantee that the more than 130 member countries of the Inclusive Framework will succeed in reaching consensus on the proposals. If they do not, asset managers may need to contend with even more uncertainty and tax risk in the coming years. More broadly, a lack of a consensus deal would increase the likelihood that more jurisdictions move forward with digital services taxes, their own versions of Pillar Two, and other unilateral measures.
As the OECD’s work continues, asset managers should consider:
Michael Plowgian, Principal, International Tax, Washington National Tax KPMG in the US
Rose Jenkins, Managing Director, International Tax, Washington National Tax KPMG in the US
Jamal Aquil, Tax Associate, KPMG in the US
1 See comments by Generali, at pg. 2; Insurance Europe, at pg. 5; and the Securities Industry and Financial Markets Association Asset Management Group (SIFMA AMG) and the Investment Association (IA) concerning the Pillar Two Blueprint, at pg. 7.
2 See comments by Brookfield Asset Management Inc. (BAM), at pgs. 2-3.
3 See comments by Irish Funds concerning the Pillar Two Blueprint, at pg. 3.
4 See comments by BAM, at pg. 4.
5 See comments by ICI Global, at pg. 4, and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 8.
6 See comments by the Gesamtverband der Deutschen Versucheringswirtschaft e.V. (GDV), at pg. 2, and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pgs. 6-7.
7 See comments by Association of British Insurers (ABI), at pg. 6; GDV, at pg. 2; and Global Federation of Insurance Associations (GFIA), at pg. 14.
8 See comments by SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 7.
9 See comments by Ernst & Young, LLP (EY), at pg. 24, and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 8; see also comments by the Alternative Investment Management Association (AIMA), at pg. 3; the European Fund and Asset Management Association, at pg. 4; Generali, at pg. 4; and Tremonti Romagnoli Piccardi e Associati, at pg. 25.
11 See comments by SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 8.
13 See comments by AIMA, at pg. 3; Chiomenti, Cuatrecasas and Macfarlanes, at pg. 8; representatives of APG Groep N.V., GIC Private Limited, New Zealand Superannuation Fund, Ontario Teacher’s Pension Plan, PGGM Investment Management, and PKA A/S (Coalition), at pg. 2; Irish Funds concerning the Pillar Two Blueprint, at pg. 3; and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pgs. 4-5.
14 See supra footnote 5.
15 See comments by Irish Funds concerning the Pillar Two Blueprint, at pg. 3, and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pgs. 5-6.
16 See comments by Cayman Finance, at pg. 7.
17 See comments by ABI, at pg. 6; AIMA, at pg. 3; Chiomenti, Cuatrecasas and Macfarlanes, at pg. 8; ICI Global, at pg. 4; Irish Funds concerning the Pillar Two Blueprint, at pg. 4; SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 4; and Travers Smith LLP, at pg. 2.
18 See comments by EY, at pg. 24; Irish Funds concerning the Pillar Two Blueprint, at pg. 4; and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 5.
19 See HMRC Investment Funds Manual IFM17000 for a discussion of the “genuine diversity of ownership” conditions and their satisfaction despite a seeding period or ceasing to accept additional investments and in cases in which there is a single feeder fund that pools investments.
20 See comments by Irish Funds concerning the Pillar Two Blueprint, at pg. 3.
21 See comments by ABI, at pg. 6; EY, at pg. 24; Generali, at pg. 2; and PricewaterhouseCoopers International Limited, at pg. 28.
22 See comments by the Association of the Luxembourg Fund Industry (ALFI), at pg. 9; GDV, at pg. 3; and International Financial Centres Forum (IFCF), at pg. 2.
23 See comments by Travers Smith, at pgs. 1-2.
24 See comments by Global Infrastructure Investor Association (GIIA), at pg. 13, and Travers Smith, at pg. 2.
25 See comments by AIMA, at pg. 3; INREV, at pg. 2; and Irish Funds concerning the Pillar Two Blueprint, at pg. 4.
26 See comments by Travers Smith, at pgs. 1-2.
27 See comments by GIIA, at pg. 13, and Travers Smith, at pg. 2.
28 See comments by AIMA, at pg. 3; INREV, at pg. 2; and Irish Funds concerning the Pillar Two Blueprint, at pg. 4.
29 See comments by Irish Funds concerning the Pillar Two Blueprint, at pg. 2.
30 See comments by ALFI, at pg. 5; GIIA, at pg. 12; Travers Smith LLP, at pg. 3.
31 See comments by ALFI, at pg. 5.
33 See comments by Capital Markets Tax Committee of Asia (CMTCA), at pg. 3; GIIA, at pg. 12-13; and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 5.
34 See comments by CMTCA, at pg. 3.
35 See comments by EY, at pg. 24, and SIFMA AMG and IA concerning the Pillar Two Blueprint, at pg. 6.
36 See comments signed by Coalition, at pg. 2.
37 See comments by GIIA, at pgs. 13-14, and the Qatar Investment Authority (QIA), at pgs. 2-3.
39 See comments by GIIA, at pgs. 13-14.
40 See comments by QIA, at pgs. 2-3.
41 See comments by Maisto e Associati concerning the Pillar Two Blueprint, at pg. 2.
42 See comments by Generali, at pg. 3.
43 See comments by CMTCA, at pg. 5; GFIA, at pg. 14; Insurance Working Group on BEPS, at pg. 15; Loyens & Loeff N.V., at pg. 19; and SIFMA, at pg. 8.
44 See comments by ALFI, at pg. 6; CMTCA, at pg. 5; GDV, at pg. 3; GFIA, at pg. 14; Insurance Europe, at pg. 6; and Texas A&M University School of Law International Tax Risk Management Curriculum, at pg. 14.
45 See comments by Loyens & Loeff N.V., at pg. 19.
46 See comments by ALFI, at pg. 6.
47 See comments by CMTCA, at pg. 5.
48 See comments by GIIA, at pg. 5.
49 See comments by Cayman Finance, at pg. 9; GFIA, at pg. 16; Hong Kong Federation of Insurers, at pg. 4; and IFCF, at pg. 6.
50 See comments by GIIA, at pgs. 7 and 21.
51 See comments by GIIA, at pg. 2, and IFCF, at pgs. 2-3.
52 See comments by GIIA, at pg. 11.
54 See comments by Asia Pacific Real Estate Association and Association for Real Estate Securitization, at pg. 2; British Property Federation, at pg. 1; European Real Estate Association, at pg. 4; Fédération des Sociétés Immobilières et Foncières, at pg. 2; INREV, at pg. 2; and Travers Smith LLP, at pg. 5.
55 See comments by European Real Estate Association, at pg. 4, and NAREIT, at pg. 2-3.
56 See comments by NAREIT, at pgs. 2-3.
57 See comments by EY, at pg. 25, and NAREIT, at pg. 4.
58 See comments by EY, at pg. 25, and NAREIT, at pg. 5.
59 See comments by ALFI, at pg. 2.
60 See comments at pg. 3, pg. 2, and pgs. 4-5, respectively.
61 See comments by ALFI, at pg. 2.
62 See comments by ALFI, at pg. 4; the British Private Equity and Venture Capital Association concerning the Pillar One Blueprint, at pg. 2; and Invest Europe concerning the Pillar One Blueprint, at pg. 2.