For treaty benefits, investors turn to tax-transparent funds

Because of their low tax burdens and higher financial security, tax-transparent funds are becoming more and more popular in the UK, Ireland, and Luxembourg.

According to experts in finance and tax, ever-popular tax-transparent funds give investors lower tax bills, more certainty, and growth opportunities by making it easier to access treaty benefits.


Investors are using TTFs in part because of their increased attention to tax efficiency, according to the tax director of a London-based investment firm.


"Tax transparency as a concept is important, but, equally, if you are an entity investing directly into the market you get a more beneficial tax rate rather than investing through an opaque structure," he says.

Investors can more easily take advantage of a variety of tax treaty benefits thanks to tax transparency. To avoid double taxation, the investment jurisdictions can determine who the beneficial owners of the assets are by applying the two countries' tax treaty.


TTFs and other inexpensive options like exchange traded funds (ETFs) have grown in popularity as investments over the past few years. Cost effectiveness is a major driving force behind this trend.


A tax director at a US financial institution with operations in London claims that UK pension funds investing directly in the US market will pay no withholding tax on dividends.


However, he continues, "iif you’re investing through an opaque structure, you will pay 15% or 30% easily. YYou have to think about the millions you would pay in taxes."


TTF investments are considered direct investments and as a result, no withholding tax is applied. Investors are becoming more and more interested in the TTF schemes that have been set up in financial centers across Europe.


In an effort to compete with other European fund hubs on equal footing, particularly Ireland, Luxembourg, the Netherlands, and Switzerland, the UK established the authorised actual schemes (ACS) in July 2013.


More than $150 billion in assets have been managed by 40 funds and 150 sub-funds since Ireland's common contractual fund (CCF) scheme was established in 2003. A 200 percent growth rate is anticipated between 2015 and 2020, according to Irish asset management company Carne.


Since it began operations in 2014, the UK's ACS has grown, with the emergence of 22 funds and 172 sub-funds in the first five years. Investment has increased despite Brexit and the subsequent loss of financial passporting rights to the EU because US companies are the top target for UK TTFs.


TTFs are attracting the interest of insurance companies, pension funds, and multinational corporations due to the favorable rates provided by tax treaties. However, because asset management companies are out of more lucrative options, they may be more inclined to promote these funds.


According to the managing director of a London-based asset management company, "asset managers have been struggling with alpha products, namely products that drive the growth in profits."


"We’ve seen a trend of growth in products that are lower in costs. If you think about the costs of your investments, the most relevant costs are the taxes."


Because the structure can be ignored for tax purposes, TTFs have attracted the attention of the insurance industry and pension funds. When compared to other types of funds, the withholding tax burden of the investment is lower because investors are treated as though they directly own the assets.


Withholding taxes on other kinds of fund structures can range from 15% to 30% in some circumstances. TTFs enable investors to pool their assets, so it is not just about the tax benefits.


The managing director of the asset management company in London claims that "A lot of investors are thinking about bringing these assets together into a single management company, a single pool of assets. That’s another important trend."


TTFs are another tool that investors can use to spread their money out globally while lowering their costs and risks. TTFs are VAT exempt, which means businesses in the UK could save money on asset management costs.


There are conditions attached to these advantages. Investors are required to submit upfront documentation and keep their records up to date. There is a compliance burden associated with accessing treaty benefits because every investor is required to separate their capital and income in UK tax reporting, for instance.


According to the head of tax at a London-based asset management company, tax authorities are becoming more accepting of this type of structure. He said that "the industry is becoming more familiar with the tax authorities and tax authorities are becoming more familiar with this type of structure."


The head of tax continues, "the more clients are using TTFs, the more tax authorities are familiar with the structures and more countries are interested in this."


Tax transparency is not the only option because there are still other opaque structures that exist, even though more nations may be interested in launching TTF schemes.


According to the tax director of a financial services company in Luxembourg, certain markets have a logic and purpose for opaque structures. The director continues, "what we’ve also seen is that TTFs serve a purpose for select client types who benefit from these structures."


According to what you are trying to accomplish, there is a "better recognition that these tax-transparent structures have a purpose and can be useful," he continues.


Although opaque structures are very different from the financial products of the past, tax authorities are more likely to scrutinize them.


Therefore, it should come as no surprise that the TTF market is expected to expand in the future as a result of the advantages that treaties bring.

By fLEXI tEAM