Marco Guerra, LLM University of Milan; LLM Student, King’s College London
The new tax transparent funds
Mark Hoban, the former financial secretary of the Treasury, said on June 9th June 2011: “The government […] wants the UK to be the home for Master funds and to do this we want to develop the most suitable vehicle working with industry to meet the real demand for a tax transparent vehicle in Britain.”
On 17th July, 2012, the Finance Bill 2012, amending the Corporation Tax Act 2010, introduced the Tax Transparent Fund (hereinafter, the “TTF”), a new authorised collective investment scheme structure. The aim of the TTF is to attract overseas investment into the United Kingdom and reinforce the UK’s reputation as a world-class financial centre to set up vehicles for entity pooling.
Antecedently, several investors have preferred to invest through Common Contractual Funds in Ireland (hereinafter, the “CCF”), Funds Commun de Placement in Luxemburg or Fundsen Voor Gemene Rekening in Netherlands or, outside of Europe, exempted limited companies in Cayman Islands. One benefit of these vehicles is that they facilitate cross-border pooling: pooling by investors from different jurisdictions. These European vehicles were also used by UK pension schemes to pool with the overseas pension schemes of the same corporate sponsor. But these vehicles can also be used to pool the assets of unrelated pension schemes from one or more countries. In fact several asset managers are now offering pooled funds that use these European vehicles to offer pooling to pension schemes in a variety of countries.
According to the new legislation a TTF can adopt one of two forms:
(i) a co-ownership structure, where, while legal title to the assets of the TTF is vested in the depositary, the participants will own the assets beneficially as “tenants in common” and scheme assets will be acquired, managed and disposed of directly on behalf of the participants by the manager;
(ii) a limited partnership structure, under the Limited Partnership Act 1907.
Tax transparent funds in the international tax planning
The attraction of a TTF lies in its tax treatment. Both forms of TTF are transparent as far as they will not be subject to corporation tax, income tax or capital gains tax, thus investors will be treated for UK tax purposes as receiving income directly from the underlying assets of the fund as it arises. This means that foreign investors with beneficial treaty entitlements will receive the same withholding tax rates as if they had directly invested into the market. Additionally, for investors who are non-UK resident this means that taxes will not be withheld from income accumulated in or distributed from the fund except where income arises from real property situated in the UK.
As mentioned above, cross-border investments are often structured using tax transparent contractual funds, such as the Irish CCF. Assume that a treaty-eligible institutional investor or a treaty-eligible pension plan pool their funds to invest in U.S. securities through a CCF. The CCF is fiscally transparent under Irish law yet it is treated as an entity for U.S. federal income tax purposes. Further, assume that the investors are fiscally opaque in their countries. If the investors had invested directly in the U.S. securities, the institutional investor would have been eligible for a 5% rate of U.S withholding tax on dividends under its treaty with the United States, while the pension plan would have been exempt from U.S. withholding tax on dividends under its treaty with the United States.
In particular, institutional investors with tax-exempt status, such as pension funds, may therefore be able to invest in a UK vehicle that does not result in the tax inefficiency caused by overseas withholding tax suffered by a opaque fund, the so called “tax drag”. According to research published in January 2012 by Northern Trust, a leading provider of asset management and fund administration solutions, investors entitled to zero per cent withholding in the U.S. would have saved up to US$ 81 million over 10 years if they had invested US$ 1 billion through transparent vehicles instead of opaque ones (8.1 per cent!).
Further, the introduction of the TTF is intended to facilitate in particular the pooled “master-feeder” structure envisaged by EU Directive 2009/65/EC relating to undertakings for collective investment in transferable securities (“UCITS”). Under such “master feeder” structure, investors invest in separate investment vehicles or “feeder funds”, which in turn pool their assets in one central investment vehicle, the “master fund”, with the purpose of improving efficiencies and economies of scale; to be attractive to investors on a cross-border basis, the master fund needs to be a tax transparent vehicle. A TTF acting as a master fund permits feeder funds in different domiciles to invest in the same master vehicle without affecting the withholding tax treatment of underlying funds.
Issues in the application of tax treaties
From an international tax perspective, the introduction of TTF will create several practical issues because of a lack of coordination present in the treaties against double taxation. As known, double tax treaties are agreements between two taxing states aimed to state how their tax systems will interact. In particular, with reference to transnational incomes received by investment funds (i.e. passive incomes as interests or dividends) the treaties provide for a reduced or nil withholding tax by the State of the source, where the income rises. Actually, the application of those treaties in the presence of transparent entities, when the treatment by each contracting State does not match, gives rise to few anomalies. As known, in some States, an investment vehicle is treated as fiscally transparent; that is, the holders of interests are liable to tax on the income received by the vehicle, rather than the transparent entity itself being liable to tax on such income. Other States regard it as an entity interposed between investor and investments (“opaque”). In this case the member of the vehicle generally is taxed only on the distributions made by the entity.
There are several treaties (inter alia, the United Kingdom – Italy Treaty) where those provisions are recognised only to who is liable for tax purposes. Due to the fact that the transparent entities (as TTF) are not tax exempt (taxable persons are members whose income is imputed for transparency), such entities cannot be considered as persons who can benefit from the treaties.
Accordingly, the Italian tax authority denied the treaty benefits in a case where dividends were paid by a company resident in Italy to a common contractual fund (CCF) established in Ireland. The CCF is not liable to tax in Ireland and therefore the Treaty did not apply; furthermore, the treaties with the residence states of the participators did not apply either, because the CCF is not a true flow-through entity.
A more flexible approach seems to have been adopted by the Italian Supreme Court. It held on a case concerning the investment that a Japanese pension fund, managed by a Japanese resident bank, had made in an Italian company through a special purpose vehicle; a limited partnership set up in the United States, but treated as transparent there for tax purpose. The Court denied a partial refund of withholding tax on dividends paid to the limited partnership on the grounds that it was not the beneficial owner of the dividends and that the dividends had not been paid to the Japanese pension fund. It would seem in this case that the inclusion of an implicit beneficial ownership clause in the Italy – Japan tax Treaty would have enabled the pension fund to access treaty benefits as member of a fiscally transparent entity.
That said, it should be added that according to the Decree-Law 24 January 2012 No. 1, Italian undertakings for collective investment are to be considered liable to the corporate tax (IRES), even if generally exempt from tax. This means that funds established in Italy, who receive income from foreign States with which a convention against double taxation is in force, are recognized by the Italian Tax Administration (Agenzia delle Entrate) as persons who may benefit from the treatment (as nil or reduced withholdings) provided by such conventions.
The matter involves, at first, a deeper reflection on the compatibility of these issues in the context of the European treaties that differ from one another.
Here I would stress, once again, that the United Kingdom’s efforts to become more competitive often find their obstacles in other European countries which, theoretically, should consist of its allies in the design of the single capital market.
During his institutional visit to England on 1st April 2014, the Italian Prime Minister, Matteo Renzi, said that the Italian economic recovery also depends on the ability to attract foreign investment. Prime Minister, David Cameron, has already engaged in doing his part. However, it is my view going forward, that without pretending to set up new fiscally attractive corporate structures, why not first start with fiscal harmonization?
 Northern Trust, Enhancing investment efficiencies via tax-transparent funds, December 2012.
 A. Miller, L. Oats, Principles of International Taxation, 2014, p. 125.
 J. Schwarz, Schwarz on Tax Treaties, 3rd Ed., 2013, paragraph 14-050.
 OECD, The granting of treaty benefits with respect to the income of collective investment vehicles.
 HMRC, International Tax Manual, INTM180020 – Foreign entity classification for UK tax purposes.
 Agenzia delle Entrate, Ruling No. 17 of 27 January 2006.
 “Irish tax law did not attribute the income to the participators, nor was the CCF required by its own statutes to distribute all its income each year”. J. Wheeler, The missing keystone of income tax treaties, 2012, p. 109.
 Corte di Cassazione, 26 February 2009, No. 4600.
 M. Lang, P. Pistone, J. Schuch, C. Staringer, Beneficial ownership: recent trends, 2013, p. 209.
 This clause, for example, is present in the Article 10 (2) of the UK – Italy Treaty: “but if the recipient is the beneficial owner of the dividends the tax so charged shall not exceed […]”.
 M. Lang, P. Pistone, J. Schuch, C. Staringer, ibidem, p. 16. See also M. Gusmeroli, The Supreme Court Decision in the Government Pension Investment Fund Case: A Tale of Transparency and Beneficial Ownership (in Plato’s Cave), in Bulletin for international fiscal documentation, 2010 (Volume 64), No 4.
 Agenzia delle Entrate, Circular 28 March 2012, No. 11.
 See my previous article here: http://kslr.org.uk/blogs/europeanlaw/2014/03/07/robin-hood-tax-really-an-eu-outlaw/.