Don’t panic… but BEPS is coming

Written by: Richard Willsher Posted: 09/11/2017

BL53_BEPSA tightening of international corporate tax rules means that managers of Channel Island funds will have to review their business models

The Organisation for Economic Co-operation and Development’s (OECD’s) Base Erosion and Profit Shifting Project (BEPS) has been in the making for years. Most developed countries have signed up to BEPS, and while it will take a few more years for the project to be fully implemented, its aims are clear. 

Its 15 ‘actions’ have been framed to ‘equip governments with domestic and international instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created’. 

Their main target is multinational businesses that shift their profits to low-tax or no-tax jurisdictions to reduce their tax liabilities, even though they may have no significant operations there. 

BEPS also relates to tax strategies used by multinational organisations that operate in different jurisdictions, which seek to exploit the mismatch and gaps in tax rules of those jurisdictions, so that profits aren’t taxed anywhere. As a consequence of the changes proposed, investment funds will also be affected by a number of the measures.

Investment funds weren’t the main focus of BEPS. Nor are the Channel Islands under more scrutiny than other jurisdictions. However, funds will need to be mindful of the structures they adopt if they’re to avoid falling foul of this tightening international anti-tax-avoidance initiative.

“The whole BEPS regime was conceived as a coordinated approach for all the OECD countries to come up with some principles that sought to ensure that if you earned profit in one jurisdiction, you were taxed in that jurisdiction,” explains John Riva, KPMG’s Head of Tax for the Channel Islands. “Because our international fund business is global in its reach, BEPS affects the fund operating models of jurisdictions with which we trade.”

Country by country

BEPS has slowly started to take effect, but those operating models will only be affected as countries implement it and possibly amend their local tax regimes at the same time.

In June this year, 68 countries, including Jersey and Guernsey, signed up to the Multilateral Instrument (MLI) – its effect will be to make it easier to amend a significant number of the thousands of bilateral tax treaties currently in force. This, in turn, will make it easier to achieve the objectives of the BEPS project as they apply to tax treaties. 

This isn’t expected to come into full force before 2019. “There’s no need to panic,” advises Anthony Chandlen, Senior Tax Manager at PwC, “but it’s time to look at your fund structures, particularly where they utilise tax treaties, to ensure that the structure established will work in future and, where necessary, take remedial action.”

There’s reason for optimism, however. First, the jurisdictions that funds deal with may be unaffected by BEPS if treaty platforms aren’t used and the investment holding structure is straightforward. Second, the tests that BEPS proposes may prove that the particular fund structures remain fit for purpose and will continue to serve their investors well. 

In addition, the Channel Islands have a proven track record in responding and adapting to various anti-tax avoidance measures. These include the US Foreign Account Tax Compliance Act (FATCA), the UK version of it that followed and the OECD Common Reporting Standard (CRS), as well as ever-tightening Know Your Customer rules and the Alternative Investment Fund Managers Directive (AIFMD).

The islands’ jurisdictions have come through these tests with flying colours for their transparency and the quality of compliance.

“In many ways, the potential impact on funds could be described as the unintended consequences of the bigger initiative to ensure global commercial companies pay the right amount of tax,” explains Tim Morgan, Partner at Mourant Ozannes. 

“But our jurisdictions have been early adopters of new regulation and the work that funds have already been doing in compliance will assist them in demonstrating they’re fully transparent. 

“At the same time, there’ll be an increased focus on the type of fund investors involved – whether, for example, they’re international institutions or high-net-worth individuals who invest in the islands, typically in alternative investment funds such as property or private equity.”

A matter of substance

As with much that’s emerging from the BEPS initiative, it’s early days in trying to establish what the various tests and criteria actually mean. For example, what constitutes ‘substance’?

The integrity of the Channel Islands as financial centres is key. Others may be better known for brass plates rather than fully functioning businesses, but as PwC’s Anthony Chandlen points out: “We’re not a volume centre, we focus on quality and substance. Jersey is larger than many of our competitors and has the substance to effectively manage the business booked here. We have nearly 1,300 funds and around 32,000 companies on our registry. 

“There are about 13,000 people here working in the financial services industry to serve those entities, and they’re a highly skilled workforce working in a well-regulated industry that’s been recognised as such by external monitoring bodies. In fact, this is one of the positives to come out of BEPS as far as we’re concerned. 

“You also have to look at what functions are being performed in a particular jurisdiction. What skills do those people bring? What value is attributable to the work that they do? And as far as fund management companies are concerned, a lot of the profit can be booked in Jersey because there are real people working here in real offices, doing highly skilled jobs.”

Elliot Refson, a Director at management services provider Crestbridge, agrees. “I have the impression that BEPS is mind-blowingly complicated,” he says. “However, particularly in real estate and private equity funds, Jersey absolutely has the expertise needed to manage and administer funds. And we’re always open for business. If we need to add to our talent pool, we can bring in more highly skilled people from elsewhere. Substance is not a problem.”

So, could the islands lose business as a result of BEPS, or could it actually open up new opportunities? Those funds with inappropriate business models could potentially suffer. However, by the time some of the other jurisdictions bring in BEPS measures – and that could be years hence – funds that have, say, a five-year life could already have come to an end. 

Meanwhile, the Channel Islands have been thinking about BEPS for some time and have started taking on board what the ‘new normal’ will look like. 

Adapting to BEPS

Craig Cordle, Group Partner at law firm Ogier in Guernsey, has been doing exactly that. “As a fund structuring lawyer, the issues raised by BEPS aren’t necessarily new,” he says. “The product isn’t necessarily changing, it’s just that the regulatory sphere in which we’re working is becoming a bit more complex. 

“BEPS has, in part, caused us in Guernsey to think about the products that we offer here. For example, the private investment fund (PIF) and the manager-led product (MLP), are both new products we’ve developed over the past couple of years. 

“These have moved the focus away from funds themselves and on to the manager and this is consistent with European regulation and with BEPS’ substance criterion. What’s the manager doing? Where is it operating and where’s the controlling mind of the fund? What’s more, BEPS compliance is facilitated by leveraging the talent we have here and the new talent that’s coming to the islands.”

BEPS means careful assessment of existing funds and the deployment of the islands’ deep pool of skills in offering new funds that will be BEPS-compliant.

John Riva at KPMG points out that the fund environment is a kaleidoscope of regulatory change. “Every single structure that has a tax dimension needs to have a health check annually. The tax rules tend to change and an arrangement which is fit for purpose one year, may not be the next. We operate in a global environment and there’s an unbelievable amount of change going on.” 

The BEPS initiative may have been developing over several years but it’s not yet the finished article. Perhaps it never will be. So, constant vigilance and adaptability will be essential. 

However, the Channel Islands have demonstrated time and again their integrity and nimbleness as fund business centres. That looks like remaining as solid ever, despite the tempestuous tax and regulatory changes that swirl around the global financial services industry.

Three key BEPS tests

Transparency/principle purpose – What is the fund designed for? Who are its investors and its ultimate beneficiaries? Why has it been established in the Channel Islands? Are its investors paying the right amount of tax on profits or capital gains in the right jurisdictions?
Substance – Does the fund and its manager have substance in its business – that is, does it have staff? 
If so, what functions do they perform – for example, risk management, fund management, accounting, compliance and so on?
Operating model – Does the operating model of a fund enable it to meet these tests?

 


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