UCITS IV from a tax angle
By André Pesch
Business Review
March 2010
UCITS IV, the recast of the UCITS Directive, significantly enhances the harmonized European regime for investment funds. It must be implemented in Member States by July 2011. It will represent significant opportunities, but also challenges, for the European investment fund industry. In this article, I focus on tax issues raised by UCITS IV.
UCITS IV is, inter alia, expected to drive consolidation of a fragmented European investment fund industry, both at fund and service provider level. It is hoped that this consolidation will boost the industry’s competitiveness by lowering costs. Many players want to take advantage of the consolidation opportunities offered by the Directive, the sooner the better. However, whereas moving fast can be good, moving too fast without having analyzed potential pitfalls, including tax leakages or other tax inefficiencies, can lead to very unpleasant surprises.
UCITS IV establishes a procedure for UCITS mergers. This procedure is designed to facilitate the mergers of funds, particularly cross-border, to enable the creation of larger funds, which should be more competitive in terms of costs.
UCITS IV also introduces a new type of structure, the master-feeder UCITS structure. A master fund may be created in one domicile with investors from other Member States investing in this fund via a locally domiciled UCITS feeder fund. This will facilitate the channeling of investments into a single master fund.
With respect to fund mergers and master-feeder structures, recent analysis has shown that, for a given investor base, choosing the wrong home Member State for a fund can decrease the performance of the fund by more than 30 basis points.
From a tax perspective, at the level of the investor, fund mergers are often treated by local tax authorities as a disposal of shares, which may trigger capital gains taxes, withholding taxes, EU Savings Directive and other issues. Also, at the time of the merger, the transfer of assets to absorbing fund may lead to transfer taxes in the country where the assets are located.
Furthermore, heavy post-merger tax burdens can be a deal breaker for a given type of restructuring transaction involving funds distributed and investing in multiple jurisdictions. This being said taxes are not necessarily an insurmountable hurdle in consolidation exercises, but may heavily influence how a tax efficient consolidation is achieved.
The implementation of cross border master-feeder structures raises issues which are in many respects similar to those highlighted above.
Turning to management companies, under UCITS IV, the management company of a UCITS domiciled in one country, such as Luxembourg, may be situated in another country, such as France; it may also provide its services through a branch (the management company passport). Furthermore, apart from the custodian, the management company will not be required to appoint service providers in the domicile of the UCITS.
Tax considerations will be very important when it comes to deciding where to locate the European management company which would serve funds resident in other jurisdictions – i.e. consolidating existing local management companies into a pan-European management company. Indicators of the effectiveness from a tax perspective of the possible home country of the pan-European management company include the corporate tax rate, the method of computation of the taxable basis of the management company, transfer pricing rules, VAT and, last but not least, the taxation of the fund itself. Setting up a pan-European management company in the right country, with well analyzed service and fee flows, can offer very attractive opportunities from a tax perspective.
UCITS IV offers many opportunities, but also pitfalls. A solution which at first glance looks like a saving may entail a cost, or vice versa. Those who do a thorough analysis of the different alternatives from a tax perspective will find their time extremely well spent.
Posted on 22 March 2010
