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With almost 25 years of tax advisory experience, Teo specialises in fund formation and has structured numerous funds that invest in a diverse range of asset classes, such as hedge, real estate, infrastructure, private equity, venture capital, private debt/credit and digital assets. Besides structuring third-party funds, he is also involved in advising ultra-high net worth (UHNW) individuals in setting up their investment vehicles and management offices in Singapore. Tapping on his expertise in mergers and acquisitions, as well as international tax, Teo has also advised multiple clients in acquiring their investments across the Asia Pacific, Europe and US.

In the last 25 years of your career, what would you say are the key tax considerations relating to fund formation? Any differences depending on the asset classes?

As it is widely believed that a fund is a mere pooling vehicle, any tax should therefore only be levied at the investors’ and at the investments’ level.  As a result, in the past, the main tax consideration has always been focused on ensuring that the fund achieves tax neutrality, a concept that is used to describe the non-imposition of taxes on income and gains and withholding taxes on profit repatriation and return of capital. This objective is quite simply achieved through setting up the fund in a jurisdiction with a favourable tax regime or through a tax transparent structure.

However, the key considerations relating to fund formation have evolved tremendously over time. Increasingly, we see added complexities arising from ensuring that the fund structure considers tax implications at the investment level. For instance, if you are setting up an open-ended Pan-Asian real estate fund, the structure must allow the fund to leverage on both treaty benefits and tax-advantaged domestic structures in the target location.  These objectives must be balanced with the fund’s marketability, which is also important in determining the fund’s legal form and location.

The level of complexity varies across asset classes. Hedge funds possess relatively flat structures and are generally the least complex while setting up a fund that invests in hard assets such as real estate and infrastructure (including renewables) involves greater rigour. This complexity arises from multiple tax considerations on various levels, as such funds tend to have many layers of structures. Funds focusing on private equity, venture capital and debt possess moderate complexity. Lastly, complications in funds focusing on digital assets largely result from the fact that tax treatment of such assets are relatively untested, and many tax incentive schemes globally typically include only conventional capital market products but not digital assets.

Traditionally, funds are set up in tax-neutral locations such as the Cayman Islands but the fund management functions are often located in a different country such as the US, Singapore, Hong Kong, UK, etc. Are you seeing the onshoring of funds in Singapore and Hong Kong as an increasing trend and if yes, what are the possible reasons?

Such a trend has been observed in recent years and can be attributed particularly to changing policies, perceived risks and innovation in fund structures.

Setting up and maintaining funds in traditional tax haven countries such as Cayman Islands have become significantly costlier due to increased regulations. On the contrary, it is becoming more cost-competitive to set up funds in countries such as Singapore, especially because of government-issued grants to enhance attractiveness.

Furthermore, many institutional investors such as sovereign wealth funds and pension funds are moving away from such a structure because of the potential reputational risks. Certain family offices and UHNW investors are also moving away from such structures, fearing that association with such structures would result in them being targets of tax audits.

From a tax perspective, particularly for the purposes of accessing treaty benefits, if the fund and the holding company are set up in the same country, this could arguably reduce the risks of being accused of treaty shopping. For instance, many Asian-focused funds are set up as Singapore limited partnerships (LP) with wholly-owned subsidiaries in Singapore.

Another contributor is arguably the development of new fund structures offering fund managers and investors more flexibility than before and catering to the various needs of each segment. For example, Singapore fund managers may set up their fund vehicle in the form of a Variable Capital Company (VCC), LP or unit trust.

Could you briefly discuss the key benefits of domiciling funds in Singapore?

Singapore is a leading financial services hub and is regarded as being transparent, stable and a gateway to the Asia-Pacific region. It is renowned for having an open and well-regulated economy that is well-served by a vibrant ecosystem of service providers such as banks, tax and legal advisers.

Singapore is a leading financial services hub and is regarded as being transparent, stable and a gateway to the Asia-Pacific region. It is renowned for having an open and well-regulated economy that is well-served by a vibrant ecosystem of service providers such as banks, tax and legal advisers.

Using Singapore entities within a fund structure is ideal for several reasons. Singapore has a wide network of over 90 double taxation agreements and a flat corporate income tax rate of 17%. It has a measured approach to regulation with agencies such as the Monetary Authority of Singapore (MAS) and the Economic Development Board adopting pro-business policies.

Singapore is also a common law jurisdiction and offers a variety of legal entities and arrangements, such as companies (private limited and VCC), trusts or partnerships. To offer a conducive operating environment to the asset management industry, tax incentive schemes are also available for qualifying funds and asset managers.

What about those who want to set up a fund management company in Singapore? What do they need to consider?

First, the fund manager should consider whether the fund management company (FMC) is required to obtain a licence from the MAS to conduct regulated fund management activities in Singapore. There are two self-invoking licence exemptions whereby the FMC either manages a fund that invests solely in immovable assets, such as real estate and infrastructure funds; or provides fund management services to related corporations, such as members of the same group of companies. The second exemption is typically utilised by single-family offices (SFOs). If the requirements for exemption are not met, the FMC would have to apply for a licence with the MAS. They may apply for a Capital Market Services licence, where one key feature is the unlimited assets under management (AUM) (typically for mutual fund/hedge fund managers) or register with the MAS as a Registered Fund Management Company (typically for those who manage smaller funds).

Next, Singapore offers tax incentives such as the Section 13U (Enhanced-Tier Fund Tax Incentive Scheme) and Section 13O (Singapore Resident Fund Scheme) schemes, which provide for tax exemptions on certain income or gains derived by the funds. One key condition of note is that the fund must be managed by a licensed (or exempted) fund manager in Singapore.

Furthermore, FMCs may be eligible for a concessionary tax rate of 10% under the Financial Sector Incentive–Fund Management (FSI-FM) scheme. This is for fund management companies which manage only incentivised funds and commit to, amongst other things, growing their businesses (such as through AUM or headcount) in Singapore over a specified period.

Are there any specific rules governing the taxation of carried interest in Singapore?

No. In the absence of any deeming provisions in Singapore, the tax treatment of carried interest would prima facie follow its legal form. For funds managed in Singapore, it is common for carried interest to be structured as investment returns and paid out as dividends or partnership distributions if the carried interest recipients have invested a meaningful amount of capital to show alignment of interest with investors. Whilst less common, carried interest is sometimes structured as a performance fee payable to the FMC.

In what way is Singapore a favourable location for setting up a family office and what are the types of structures available?

Apart from the key benefits mentioned above, Singapore operates in a time zone which allows for greater convenience and ease of communication when servicing clients in Asia. The multi-racial make-up also brings multilingual capabilities. Singapore has a good reputation and infrastructure with an unbiased, fair court and legal system, a strong regulatory framework and a stable political environment.

The structures typically used by Singapore SFOs include private limited companies, VCCs and/or trusts. These allow flexibility and enable effortless assimilation into various categories of wealth planning structures.

What about someone who desires to set up a multi-family office (MFO) in Singapore? How is it different from setting up an SFO in Singapore?

One key difference lies in the licensing requirements. MFOs require an MAS licence to conduct fund management activities, while SFOs typically qualify for licensing exemption. A huge limiting factor for time-sensitive investments by MFOs lies with the approval process of the licence, which may take up to 9 months.

Furthermore, FMCs may qualify for the FSI-FM scheme, subject to conditions met. The intention of this is to incentivise fund managers to grow their AUM/fund management activities in Singapore. This scheme is more targeted towards MFOs since SFOs’ main objective is generally to grow and preserve family wealth. However, the MAS is prepared to approve FSI-FM applications made by SFOs on a case-by-case basis and if conditions are met.

May saw both job vacancies are placements slow, suggesting that employers are beginning to rethink their plans for growth due to skills shortages. According to the Recruitment and Employment Confederation (REC) and KPMG, many recruiters are blaming the situation on candidate shortages. 

According to REC and KPMG’s report, a diminishing pool of candidates and strong vacancy growth has seen rates of starting pay continuing to rise at a near record pace, especially for those taking up permanent positions. 

“These numbers show a hugely positive jobs market if you are looking for work,” commented REC chief executive Neil Carberry. “While the pace of growth has dropped after a stellar first quarter, by any normal measure there are still lots of vacancies out there, offering improved wages [...] Compared to pre-pandemic, labour supply is still the big issue we have to solve.”

Admittedly, 2020 was the year when the early pandemic lockdowns prevented a lot of deal activity, but it is certainly true that deals in the TMT sector have rebounded to beyond the levels they were even before the very first lockdown.

In terms of mergers and acquisitions (trade, PE, IPO, and early-stage investment), the TMT sector represented roughly a quarter of all 2021 deals in the UK, the biggest single sector. KPMG’s TMT Corporate Finance team advised on a record number of transactions throughout the year – 21 in total. We hear more about them from Graham Pearce – Partner and Head of TMT, Corporate Finance at KPMG UK.

How has the pandemic impacted the enterprise technology market?

The range of digital technologies that we came to depend on so much during the pandemic, especially those designed to improve remote working and collaboration, are now completely ingrained within the world of work. We may settle into a hybrid-style way of working going forward, but those collaborative tools are all here to stay as part of that. Indeed, technology requirements have gone beyond these initial use cases to cover other areas including improved cloud integration and enterprise software tools to support the needs of a hybrid workforce; customer engagement; better oversight and control of complex supply chains as well as seamless mobile technology and edge computing.

How active has private equity been in fuelling recent transactions?

In 2021, private equity (PE) firms continued to show significant interest towards tech firms, given the sector’s resilience and the enhanced demand for digital and SaaS solutions from the enterprise through to everyday lives. Tech businesses are typically fast-moving, and often have significant needs for investment early in their lifecycle. As is common in many sectors, entrepreneurs and owners can be open-minded to receiving external investment to either scale, de-risk, or both. As such, PE has been a very active player in the TMT deals arena.

The tech sector in the UK is decentralised – there is a large presence in London (like most sectors) but equally, there are many other established tech hubs in places like Manchester, Leeds, Cambridge and Glasgow, to name a few. These cities act as magnets for institutional investment, and we have seen a significant amount of private equity-sponsored deal activity outside of London.

As institutional appetite to invest right across the enterprise software sector has skyrocketed, this has had the knock-on effect of increasing valuation multiples.

Has there been strong investment from the US?

In terms of transactions involving software and technology companies that came to market in 2021, private equity was an extremely active participant. As part of that, more and more in the UK, US PE acquirers are becoming more active and bidding aggressively for high-quality assets, even those that would previously have been deemed too small to garner interest from across the Atlantic. I saw this happen in many of our processes last year, and about a quarter of our deals last year in the sector drew significant minority or majority investment from American investment houses. 

Are there any particular sub-sectors of enterprise software that have been especially active in terms of deals?

Drilling down into the sub-verticals of enterprise software, we are observing record levels of activity in areas including accounting and financial software, such as the acquisition of asset finance software provider White Clarke Group by Thoma Bravo-backed IDS and the acquisition of process automation player Xceptor by Astorg and Corsair Capital. We are also seeing architecture, engineering, construction (AEC) software prove particularly attractive for investors, with deals including the acquisition of NBS by Byggfakta Group and the acquisition of Causeway Technologies by Five Arrows.

Other sub-sectors where there have been marked increases in deal activity in the software space include supply chain, logistics and workforce management. My view is that all these areas are where inefficiencies – brought to the fore by the pandemic, Brexit or wider economic factors – have led to an increase in digital transformation and innovation to solve complex issues. Our own experience mirrors these trends; we advised on deals in all these sub-verticals last year.

Will demand for enterprise software continue its current trajectory?

As institutional appetite to invest right across the enterprise software sector has skyrocketed, this has had the knock-on effect of increasing valuation multiples. We can see similar evidence in the public markets, where global listed SaaS businesses have seen their own valuations increase significantly from historic averages of around 10x revenues to mid-to-high teens.

It is impossible to say with any certainty what the future will hold around valuations, but I believe it is a symptom of the structural shift of many advanced economies, such as the UK, towards creative and digital sectors that has driven a lot of this activity and that is unlikely to change. Furthermore, digital transformation going right through established sectors and being used to chase efficiencies across the supply chain is also more anecdotal evidence that the demand, and therefore price, of software businesses will continue to increase.

According to Pitchbook data, the total capital invested in cybersecurity deals grew at a CAGR of 30% per year between 2012 and 2019. In 2020, both the number and value of deals contracted heavily as a result of the global pandemic. However, as of July 2021, the cyberspace deal environment seems to have become red-hot again, with global deals worth €21 billion. 2021 could be a record year for cybersecurity deals.

There are multiple investors in the space, including cyber natives (young companies formed who provide cyber software or services), global consultancies, technology firms, professional services organisations, telcos, engineering businesses and defence companies. The US market is the most mature and advanced globally, but the UK and Europe are not that far behind. Alfonso Marone, UK Head of Deal Advisory for TMT at KPMG UK, delves into the topic/

Consolidation expected to continue

Although there are clear political divides between East and West, and although in some industries such as defence there is a need for obvious reasons to ‘buy local’ in terms of cyber services, we can expect to see consolidation in the global market, for a number of reasons.

Firstly, cyber is inherently a global issue – attackers can strike more or less anywhere, from anywhere. Secondly, software is an inherently suitable product category for scalability and market concentration. Thirdly, on the cyber services side, we also expect consolidation as providers look for economies of scale and scope, build client trust through having a global presence and also, as large international organisations, increase their chances of winning the cut-throat war for talent.

Investor challenges

However, there are a number of key challenges that investors need to overcome in order to realise effective deals:

It is essential that investors recognise this set of very cyber-specific investment challenges. In my view - and experience of working with a wide range of clients across the sector - there are three considerations that are of utmost importance for interested investors throughout the deal cycle.

Three essential areas of focus

Firstly, deal origination. Given the fragmentation of the market and the fact that many potential targets are still relatively small, deal origination can be a challenge. Well-connected local deal sources are needed who can advise and alert a potential investor on targets that may have real substance and potential.

Secondly, pre-signing due diligence must be absolutely robust. This must include both commercial and technical due diligence.

Thirdly, the target operating model (TOM). The difficulties of technical integration that we have discussed, together with the employee retention challenges, mean it’s vital investors think in detail about the post-deal TOM they are aiming for and how that can be achieved in the integration of any target business.

The case for investment in the cybersecurity sector remains compelling. But, like anything that’s hot, it requires careful handling!

KPMG wants working-class people to account for 29% of its partners and directors by 2030, with “working-class” being defined by the company as those who have parents with “routine and manual” jobs, such as electricians, plumbers, or lorry drivers.

Currently, just 23% of KPMG’s 582 partners meet the working-class criteria and only 20% of its 1,297 directors. According to The Times, all of the firm’s 16,000 employees will be expected to undergo training on “invisible barriers” that people from working-class backgrounds have to face. Typically, people from working-class backgrounds are paid 8.6% less than colleagues from middle-class backgrounds — those whose parents had “higher managerial, administrative and professional” jobs. 

KPMG’s chairwoman Bina Mehta says she comes from a working-class background and also says that she is “a passionate believer that greater diversity improves business performance.” 

Mehta was appointed to the role following her predecessor’s forced resignation. Bill Michael was asked to step down after he told staff members to stop complaining about cuts to their bonuses via a Zoom call and dismissed the notion of unconscious bias in the workplace. 

Although people from working-class backgrounds are still less likely to attain professional jobs, social mobility is gradually improving. Last year, 39% of people from a working-class background were in professional jobs, an increase of 6% on 2014.

As KPMG aims to dramatically scale back its costs and restructure its operations, particularly following recent performance backlash, and in preparation for regulatory changes in the financial sector, it is planning a one-off cull of its UK partners.

Back in August KPMG suffered serious reputational damage following the collapse of Carillion, and in the past year or so has had to pay out over £20 million in regulatory fines. In order to manage performance, it appears KPMG is now taking serious action by cutting away around 65 partners form its UK divisions.

According to the FT, it’s pretty normal for KPMG to lose around 45 partners each year in staff turnaround, either by those who leave naturally, or forced into retirement, but this is the single biggest company action in years.

KPMG has confirmed most of the departures will come from its business divisions, though its unlikely many will come from KPMG’s perceivably low-performing auditing divisions.

KPMG said: “It is critical that our firm constantly evolves as we build the mix of capabilities required to service the changing needs of our clients. To achieve this, we are significantly increasing our investment in all of our core businesses — audit, tax, deals and consulting. This year we have appointed 50 new partners and 200 new directors, across all parts of our business.”

You can read more about KPMG and the other Big Four firms’ performance in one of our latest special features: ‘Are the Big Four Still ‘the Best’?


UPDATE:

Recent reports indicate KPMG has now denied allegations that it would be culling a tenth of its UK partners.

Nonetheless, last month high street retailer Sports Direct pleaded with the Big Four to take over their auditing process, which it said a smaller firm would not be able to handle. Sky News reported that the Shirebrook company, the firm heading up Sports Direct’s insolvency, approached Deloitte, EY, PwC and KPMG to ask them to take on one of the toughest jobs in the profession. But is it actually true that any of these Big Four firms would do a better and more thorough job than a smaller firm?

Challenges faced by Big Four

Following the demise of Carillion and BHS, the Competition and Markets Authority (CMA) recently entertained the possibility of the Big Four being split up, forcing them to work with smaller rivals. However, it instead recommended that government officials hold the Big Four accountable when it comes to the close relationship between their auditing divisions and more lucrative consulting services, in order to avoid a conflict of interest. It also stated that it is open to revisiting the prospect of a breakup in five years if the performance of these firms does not improve.

Splitting up the Big Four would certainly change the dynamic completely, and allow smaller firms to show their worth when it comes to larger Sports Direct level ordeals, but it would also create a much more competitive playing field for smaller firms, leaving large organisations without a go-to solution.

Another challenge the Big Four currently face is the rise in new technologies, especially on the back of digitisation and increased regulation. According to a survey from the Chartered Institute of Internal Auditors (IIA), just under 60% of auditing firms believed these factors to be significant problems ahead in 2019.

According to Christian Wolfe, a regular reporter on the Big Four firms, machine learning, artificial intelligence and blockchain accounting solutions are fair game for all smaller firms, and the way it currently works is that “if you want public financial statements that investors trust, you must use a Big Four accounting firm.” However, he points out that once you’ve eliminated the margin for human error, recording and verifying transactions will be equally as trustworthy regardless of which firm you approach for the job.

That sounds a lot like a level playing field when it comes to accounting and auditing performance.

Spread of audit work

This leads me to discuss why in fact it is not an actual level playing field in the auditing profession. Simply put, the spread of work when it comes to the larger Carillion or BHS situations is too much for a smaller company to handle. In this regard, Sports Direct are correct. The Big Four, individually, never mind put together, have the manpower and resources, on a global level, to confront the largest tasks.

The spread of work when it comes to the larger Carillion or BHS situations is too much for a smaller company to handle.

Economia reports that the amount of FTSE 100 clients on retainer between the Big Four has never been closer. In 2005, EY held the least, at 19 FTSE 100 clients, while PwC held the most at 41 FTSE 100 clients. In Q3 2019 the numbers are much closer. EY now holds the least at 22 FTSE clients, while PwC still holds the most at 27 FTSE clients. Clearly, the spread between the Big Four has become more even over the past 15 years, however 100% of FTSE 100 companies are now on the books of a Big Four auditing firm. In September, Steve Smith, research manager at Adviser Rankings Ltd told Bloomberg that “the Big Four have cornered the FTSE 100 market.” And he’s not wrong.

This is not yet the case with FTSE 250, but it’s not far off. According to the figures from Adviser Rankings, the Big Four currently control 95% of the FTSE 250 market in terms of number of clients, and 96% in terms of market capitalisation. The parity between the Big Four and all other auditing firms, based on the number of the UK’s largest companies that contract them, is worrying. The other two firms that control a small share of the auditing of FTSE 250 companies are BDO LLP and Grant Thornton LLP.

These numbers are the real figures on client retention, and should essentially serve as proof that the Big Four are in fact still the best, otherwise, surely the FTSE 100 or 250 would seek auditing services elsewhere?

How much they are paid

As the Big Four are by default considered the best, they of course also cost the most, and partners in these firms are earning figures you can only write on paper. Recent reports indicate Deloitte Partners are due their biggest payday in a decade; the average pay for 699 of Deloitte’s equity partners is $882,000 in 2019, moving up an average of $50,000 from last year.

In addition, Deloitte’s combined member firm revenue has risen a chunky 9.4% to $46.2 billion (£37.4 billion) since last year, and in 2018 this number had already grown 11.3% on the previous year. The growth is volatile, but it is significant growth for the company’s bottom line.

Based on the above, you would figure Deloitte, the largest of the Big Four, is charging its worth in gold, but are the companies that are paying these huge firms getting a fair deal in return?

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Quality Ranking

In terms of quality standards, the Big Four auditing firms are assessed and regulated, often by each other, which in a market of fierce competition between them, is a fair and appropriate method of benchmarking standards. There aren’t rankings available per se, but each of the Big Four has its own strengths and weaknesses; EY, for example, is more Europe centred and therefore by default performs better for European based firms.

On the topic of performance quality, Gennaro Senatore, former Transaction Services AM at KPMG, said on a Quora forum: “…with IFRS and Generally Accepted Audit Standards I can tell you the differences are getting less and less noticeable.” He mentions PwC having an edge, or “at least perceived.” While he says that in terms of advisory, in Europe PwC has the most successful treasury practice, EY is stronger on internal audit and Risk Services, and Deloitte in implementation and IT projects. He concludes that KPMG is very good all-round and has a very strong tax practice. However, the performing results will be different for each client, for each auditing firm, so these opinions are after all highly subjective.

More recently, the UK Financial Reporting Council issued a serious warning about the quality of audits of financial statements in the UK. The watchdog stated that the Big Four have YoY failed to meet the benchmark 90% target of large company audits requiring no more than limited improvements. In 2019, of all auditing firms, 75% of audits reached that level of quality. The consequence was £32 million ($39.5 million) in fines (see above for Deloitte’s bottom line and then think about how this could possibly disincentivize poor performance).

Sir Winfried Bischoff, the outgoing chairman of the FRC, said in the watchdog’s report: “We are not seeing more immediate improvements from the [audit] firms and there is undesirable inconsistency across the market.”

The Big Four have YoY failed to meet the benchmark 90% target of large company audits requiring no more than limited improvements. In 2019, of all auditing firms, 75% of audits reached that level of quality.

Clients Dissatisfied

Despite not improving their performance, the Big Four are set to maintain the top tier stranglehold in the auditing sector, which is strange because a study by Source Global Research found that although over two-thirds (68%) of audit clients still rank a Big Four firm as their go-to external auditor, over half (58%) do not name their current auditor as their first choice.

In the US, there are reports of the Big Four bungling 31% of their most recent audits, as analysed by the Public Company Accounting Oversight Board (PCAOB). The data shows that in 2019, Deloitte bungled 20% of audits examined, PwC bungled 23.6%, EY bungled 27.3%, and KPMG bungled 50%. For what is expected of the Big Four, falling short of near-perfect is a bad image, so missing the mark on 31% of audits could be considered poor performance for the top firms; firms which are paid and are growing as if they were truly the best of the best.

(Source: www.pogo.org/investigation/2019/09/botched-audits-big-four-accounting-firms-fail-many-inspections/)

 

According to The Independent, Stephen Haddrill, the FRC’s chief executive, said: “At a time when the future of the audit sector is under the microscope, the latest audit quality results are not acceptable.

“Audit firms must identify the causes of their audit shortcomings and take rapid and appropriate action to improve quality. Our latest results suggest that they have failed to achieve this in recent years.”

So are the audits that were surveyed by both the UK and US watchdogs actually botched or bungled, or are the firms simply not as good as everyone thinks they are? Are the Big Four really still the best?

Based on what we’ve looked at, it is apparent that action should be taken, and further regulation implemented, while large companies should start considering the auditing and accounting services of smaller consultancy firms and perhaps then the status quo on the Big Four will change. What are your thoughts?

To hear about FinTech and cryptocurrencies in Japan, this month Finance Monthly reached out to Kenji Hoki, Deputy Head of FinTech Promotion Support Office at KPMG Japan, who provides advisory services on financial regulations to financial institutions, as well as FinTech start-ups in Japan.

  

What have been the hottest topics in relation to FinTech in Japan in the past 12 months?

Not only in Japan, but globally, cryptocurrencies or virtual currencies have been what everyone’s been talking about recently. In Japan, they have been in the spotlight for a broad range of parties, including retail investors, FinTech start-ups, major financial institutions and authorities like financial regulators and central banks, while attitudes towards cryptocurrencies are varied across the sectors.

Retail Investors in Japan who trade cryptocurrencies are rapidly increasing and expanding their investments.

FinTech start-ups like a provider of personal financial management and marketplace to trade goods between users are seeking opportunities to incorporate cryptocurrencies as a mean of payment in enhancing their competitiveness.

Critical characteristic of the cryptocurrencies, when compared to traditional banks, is bypassing bank accounts to transfer money and the potential to disrupt their position in the financial industry. Large banks in Japan have plans to issue their own digital money, which can keep money flow via the account. In this context, Bank of Japan is conducting joint research with ECB on cryptocurrencies.

Japan has taken a very unique approach to emerging cryptocurrencies and has become the first country to give them legal status. The amendment of Payment Services Act (PSA) came into effect in April 2017, introducing new regulations that require virtual currency exchangers to register with the Financial Services Agency prior to setting up their exchange business.

 

What are the key recent developments in relation to cryptocurrencies?

Based on the amended PSA, 16 virtual currency exchangers were registered and are now subject to the regulations, while a lot of potential virtual currency exchangers are in the process of obtaining the status and are on the cue to register.

These companies include not only business operators that provide exchange services, but also various institutions, such as traditional financial institutions (banks, brokers, etc.), non-bank payment service providers, foreign virtual currency exchangers, etc. This increased interest to register highlights the potential of cryptocurrencies to become a business tool that can enhance the offerings of ordinary companies, which are not financial institutions.

New regulations have forced certain virtual currency exchangers that re not able to meet the registration criteria to close their business before the revised PSA came into effect.

As the cryptocurrency sector evolves rapidly, a study group from the Financial Council has started discussing a fundamental transformation of the regulatory frameworks in Japan - from focusing on entities like banks, securities companies, asset managers and insurance companies to functions like payments, finance and risk transfers, as well as redefining basic financial terms such as ‘money’, that will need adding ‘cryptocurrency’ to them.

Last but not least, global discussions on cryptocurrencies might affect the regulatory approach in Japan. In fact, coordinated regulations on cryptocurrencies are likely to be a priority on the global agenda for 2018. Discussing and considering how to face and use the cryptocurrencies, as well as fiat currencies, plays a new role in the future eco-system in the financial sector.

 

What would you say have been the best inventions of 2017 around the cryptocurrencies on an international level?

I would like to stress that these opinions are my own, and not the views of KPMG Japan.

Initial Coin Offering (ICO) could be a game changer at an international level, when it comes to shifting means of fund raising and hence, change the financial market/products (such as stocks) dramatically. A fundamental feature of ICO is to provide a broad range of parties an easier access (not easier money) to means of fund raising, in particular those who could not have had such access before ICO, including NPOs, start-ups, projects and even a divisions of a company.

These organizations and units who have had limited access to raise funds in the current financial markets can now benefit from fund raising via ICO and may facilitate innovation not only in the financial sector but in other sectors and markets too.

 

What have been the impediments on cryptocurrencies in Japan?

In facilitating business treating and/or using cryptocurrencies, many rules, other than regulations need to address cryptocurrencies. For example, accounting and auditing standards need to be reviewed to fit into this new environment and tax needs to be looked at too.

Furthermore, the regulations are still trying to keep up with the change. The above amendment of the PSA does not address ICO. As the sector expands continuously, differentiating digital currencies, including cryptocurrencies and fiat currencies, may be the next focus of the Financial Council and other similar organisations.

 

What does 2018 hold for cryptocurrencies in Japan?

Digitization in the financial sector will enter a new phase that will challenge the established systems. Banks will accelerate consideration or development of digital currencies which would be issued by themselves in order to keep the money flow in their hands.

Cryptocurrencies will be used more as a mean of payment from the current status, as opposed to an asset to invest in, while many FinTech start-ups that sell non-financial products/services are considering to add cryptocurrencies to their business model and expand the business in order to meet with users’ needs.

Token will be used more broadly to digitize existing non-financial products, while certain disciplines to sell Token without regulated intermediaries need to be introduced to the market. Distributed ledger technology might support the movement to replace certain goods like paper-based certificates with digital Token.

 

Any final thoughts?

In a digitized society, personal data and user interface is a critical source of competitiveness since every company, including financial institutions, has to customize its product and/or services to meet their users’ needs.

Meanwhile, digitization tends to remove the process of intermediation to deliver the products/services and payment, and bring old-fashioned processes to exchange directly between end-users.However, there’s the possibility of it falling apart both physically and electronically.

Until recently, it was impossible to transfer monetary value without trusted intermediaries and repositories who use expensive IT system and comply with strict regulations. However, distributed ledger technology enables the end user to do so directly by using cryptocurrencies as a mean of payment as well as Token as a digitized product/asset.

Financial authorities need to face that regulating intermediaries to be bypassed is not appropriate any longer in protecting users and markets.

Financial institutions need to know the above irreversible transformation and change their business model fundamentally and rapidly in order to keep up with an environment where personal data and user interface move to platformers to provide marketplace to users to exchange goods/services and monetary value instead of intermediaries.

 

E-mail: kenji.hoki@jp.kpmg.com

 

The swell of rumours, conjecture, and concerns surrounding Britain’s exit from the EU has, in the eight months since Article 50 was triggered, ebbed somewhat. Though many questions still remain on the pending negotiations, financial companies in London have known since last year that Brexit will change their ability to do business in the EU. As a result, hubs within the EU like Ireland, Germany, and Luxembourg have been vying for the attention of these firms—and now, one year after the Brexit vote, companies have begun making decisions.

From the beginning, Ireland has been a contender, sharing a language with the UK and many of its legal aspects, as well as having an attractive fund framework. However, Luxembourg has been mentioned in the same breath—notably by Standard Life CEO Keith Skeoch, who, CNBC reported, specified these two countries as top options for asset managers. By the latest count, there are 11 companies moving house to Ireland, 10 to Germany, and 4 to the Netherlands.

 

And 24 to Luxembourg.

There are perhaps many reasons for this. Ireland does speak Britain’s language, but that language happens to be the international tongue of business—and is thus, the core language spoken in Luxembourg’s finance industry, whose widespread proficiency in German and French adds extra accessibility to those markets. And while Dublin’s fund toolbox is attractive, Luxembourg’s is at least as alluring—and its Government has made it clear that this will not change. Just last year they introduced a new vehicle, the Reserved Alternative Investment Fund (RAIF), to meet customer demand for less supervision and a faster time-to-market. Again, to support these comments with numbers: Luxembourg is the second largest fund hub in the world, second only to the United States, a country whose population is 500 times bigger.

Luxembourg has also taken its own approach to attracting firms from London. Due to its size, the Grand Duchy must consider quality over quantity. In fact, having large insurance companies, fund houses, and banks putting their entire headquarters in Luxembourg’s capital city—population 100,000—wouldn’t be sustainable. So, instead, led by Finance Minister Pierre Gramegna, the country has asserted itself as a partner to London, rather than a replacement. Why not move a core part of your workforce to Luxembourg, argues Mr Gramegna, rather than the entire cohort? This may have played well with Britain-domiciled companies, whose employees probably don’t relish leaving their UK homes.

A key issue to moving part of a company is, of course, substance. Companies should know that there is a wealth of guidance out there on this topic, substance being central to this post-crisis zeitgeist.

And since we are discussing the merits of Luxembourg as a finance hub, some of the main talking points—industry veterans will be well-acquainted with them already—must be mentioned: Luxembourg has a AAA stability rating; its sovereign debt is 22.1% of its GDP and saw growth in 2016 by 3.7%; it has a highly-skilled and multilingual workforce; it is a leading European financial centre (both for cross-border fund distribution and cross-border insurance and reinsurance activities); and finally it has a predictable and competitive legal, tax, and regulatory framework.

To top it all off, you can get Bus 16 from the airport to the business district of Kirchberg in about 7 minutes. Dublin Airport to the city centre is, so I hear, up to an hour in traffic.

 

Website: https://home.kpmg.com/lu/en/home.html

Paul Taylor, Partner and UK Head of Cyber Security at KPMG discusses why a shift in thinking is needed in the way we think about the role of cyber in business risk planning.

In the race to improve efficiency, increase productivity and outstrip rivals, the adoption of new technologies is now a permanent characteristic of the business landscape. The prospect of rapid productivity gains and breakthrough opportunities is driving organisations to automate processes, connect systems and leverage new kinds of infrastructure before the competition can. However, the reliance on competiveness through technological adoption has blurred the boundaries between devices, systems and employees, creating new vulnerabilities that are increasingly exploited by cyber criminals and nation-state backed groups.

In today’s digital landscape, connected medical devices provide physicians with faster and more accurate patient diagnoses, whilst retrofitted smart sensors allow production equipment to automatically signal to other devices once a process is complete and when the next processes need to begin, speeding up manufacturing time and efficiency. At the other end of Industry 4.0, rail providers adopt real-time cab signalling and traffic management systems, which have the potential to add time to train pathways and avoid the need for extra lines of track by increasing capacity on existing lines. In the public sphere, vehicle manufacturers race to deploy driverless cars with the latest automated control systems and sensory equipment, designed to help identify safe navigation paths, obstacles and traffic light systems.

The unrelenting pursuit of better, faster and more efficient ways of deploying and creating technology has driven innovation in our businesses and across our economy, ensuring the UK is a world leader in a multitude of industries. Yet this position at the top of the leader board has to an extent come at the cost of security. The current nature of cyberspace means it is far easier and simpler for malicious actors to carry out vulnerability-based attacks over targeted hacking campaigns. Taking full advantage of the constantly evolving technological landscape, hostile individuals and criminal groups invest their time researching digital infrastructures and devices in order to design attack software that exploits vulnerabilities and weak points.

This kind of exploit-based hacking was seen when criminals took advantage of an overlooked vulnerability in Sony’s computer systems, which gave them full access to the company’s wider network. The alleged group behind the attack crippled the company network before they released sensitive corporate data, including four unreleased films, business plans, contracts and the personal emails of senior staff – having a huge impact on the business. Such attacks are not only restricted to large company networks. Advances in the UK’s rail signalling system to upgrade to a ‘connected network’ have also been shown to be vulnerable to hackers who could use software to tell a train that it’s speeding up when it is slowing down or even give a false location. These fears were almost realised last year when it was revealed the UK rail network had been compromised in four major ‘exploratory’ cyber-attacks. In Finland, hackers hit a building management system with a distributed denial of service (DDoS) attack that left residents with no central heating and in 2015, Chrysler was forced to recall 1.4 million cars after security researchers revealed that the vehicle’s internet-connected entertainment system could be hacked. To add the icing on top, at last year’s cyber security contest DEF CON, contestants found 47 vulnerabilities in 23 IoT devices, including smart door locks, refrigerators, and solar panel arrays.

Whether it’s increased connectivity, automating systems or upgrading networks, organisations – both public and private – are finding themselves dependent on new technological capabilities long before they have even begun to consider how they are leaving them open to cyber-attacks.

Many businesses are taking steps to begin to deploy things like RegTech (Regulatory Technology) as part of preparation for regulations such as GDPR and MiFiD II, possibly taking this more seriously due to the fact that the cost of non-compliance is clear and outlined, however the impact and cost of a cyber hack could be just as bad, so there needs to be a shift in thinking – a cyber hack is not just a cyber hack, it’s a risk to the whole business.

The impact that these kinds of attacks can include lost revenue, losses to intellectual property and customer loyalty and reputational damage. The practice of innovation at the expense of security cannot therefore be maintained, and leaders need to start to think of a lack of security for what it really is – a risk to the whole business.

As outlined in a recent white paper on cyber security business risk by information security professionals body (ISC)2 titled, ‘What Every Business Leader Should Know About Cyber Risk’ organisations must ultimately incorporate cyber into the wider risk plan of the business. Within this, key operational dependencies that are being overhauled, upgraded or introduced must be identified and any critical technology that needs protection must be prioritised. This could be your organisation’s server network, the website upon which your customer’s financial trades take place or even individual devices. Bringing the CISO into risk evaluation discussions should also be made compulsory going forward.

Technological transformation is an inherent part of the world in which businesses operate, but in order to mitigate the threat, accepting cyber security as a business risk is paramount. Cyber attacks are only going to increase and businesses are offering hackers an open door by failing to incorporate cyber security within the risk register. If the uptake in new capabilities by businesses is to be maintained securely, then cyber security must come become a deciding factor in the implementation of any technology.

 

 

To hear about taxation in Cyprus, this month Finance Monthly reached out to Panicos G. Loizou, a Board Member at KPMG in Cyprus. After obtaining an Honors degree in Economics from the University of Salford, he trained with a big eight practice in Manchester and became a member of the English Institute of Chartered Accountants and subsequently a Fellow member. Panicos has also attended a crash management Course at Wharton School, University of Pennsylvania, Philadelphia. He is a member of the Institute of Taxation by examinations, and a member of STEP and was recently elected as a member of the Council of STEP, taking full responsibility in January.

 

What are currently the hottest topics being discussed in relation to tax in Cyprus?

The implementation of standards and regulations about exchange of information like CRS and Country by Country reporting, increased the taxpayers’ desire for a last time tax amnesty, aligned with many other jurisdictions. Instead, the Cyprus House of Representatives introduced new legislation which incorporates special arrangements for the settlement of overdue taxes. The legislation has induced a number of tax payers to come forward and declare income and assets not previously reported in their tax returns.

 

What amendments have been made to the tax regulation recently?

Apart from the aforementioned legislation referring to the settlement of overdue taxes, recent amendments include mainly provisions relating to transfer pricing, as well as amending the tax residency definitions for individuals and non-domiciled individuals. These amendments have already arose increased interest by wealthy individuals and families, who are taking necessary steps in order to comply with the provisions of the new legislation. In this way, they will become Cyprus tax residents and at the same time they would be registered with the Tax Authorities for the Non-Dom status.

It is important to pay attention for the revised definition, meaning that the foreign national who is physically present in Cyprus for more than 183 days within a calendar year, will be considered as a Cyprus tax resident and he/she will be subject to taxation in Cyprus on his/her worldwide income. The definition has been amended to also provide that, an individual who does not stay in any other country, for one or more periods exceeding in aggregate 183 days in the same tax year and is not tax resident in any other country for the same year, is deemed as a resident in the Republic in that tax year, if all of the following conditions are met: (i) the individual stays in the Republic for at least 60 days in the tax year, (ii) exercises any business in the Republic and/or is employed in the Republic and/or holds an office with a Cyprus tax resident person at any time during the tax year, and (iii) maintains (by owning or leasing) a permanent residence in the Republic.

 

Do you believe there is potential for further significant legislative development in the tax field in Cyprus?

Yes, indeed, as the Cyprus Government is already fostering the efforts to prepare the new legislation concerning the audiovisual industry. Just to be on the same line, the forms of audiovisual communication include television advertising, sponsorship, teleshopping, product placement, on-demand audiovisual media services and radio broadcasting, which aim the provision of programs in order to inform, entertain or educate the general public. Bound by certain criteria, there would be a number of tax incentives such as “Cash Rebate”, “Tax Credit”, tax reduction for infrastructure and equipment investments and VAT return over eligible expenditure. Moreover, special attention is given by the Authorities to the benefits in kind provisions.

 

In terms of tax structures, what are the advantages for foreign companies wanting to establish a business operation in Cyprus?

Corporate tax of Cyprus tax resident companies is currently imposed at the rate of 12,5% for each year of assessment on the taxable income, derived from sources both within and outside Cyprus. In arriving at the taxable income, deductions on such income and exemptions must be taken into account. All relevant expenses incurred wholly and exclusively for the production of that income are deductible expenses whereas dividends, capital gains or profit from the sale of shares and other securities constitute tax exempt income. Expenses that directly or indirectly relate to tax exempt income are not tax deductible.

 

What actions has Cyprus taken towards remaining competitive as a financial centre?

In the current fluent, economic and political environment, Cyprus takes all appropriate measures to remain competitive as a financial centre. That includes, considering the measures adopted by other competitive countries and undertaking measures in order to attract business and investments through the implementation of tax incentives.

 

Website: https://home.kpmg.com/cy/en/home.html

 

 

Written by Christophe Diricks & Axel Butaije, KPMG Luxembourg 

Running a cross-border business isn’t exactly like sailing down a peaceful river… perhaps it’s more like crossing an ocean full of dangers. However, on the other side may be a land of opportunity. New regulations, political trends, and business restrictions populate this ocean of challenges, but the wind of new technologies is picking up too, offering new paths across. And every good sailor knows that wind can be a fearless enemy but also a powerful ally, if you know how to harness it.

Disruptions to the business environment have been many, recently, like new reporting obligations (FATCA, CRS, and country-by-country reporting) or the new level of transparency that the Base Erosion and Profit Shifting (BEPS) action plans require. These changes may lead to a paradigm shift on how businesses deal with tax authorities.

In such a context, new technologies have (and will keep having) major impacts on how business is done—on one hand, negatively, by for example turning sensitive information into publicly available data, but, on the other hand, positively, by helping you meet the new requirements which ultimately keeps you competitive.

In this article, we will examine recent tax developments in private equity, real estate, and debt/hedge funds (so-called alternative investment funds) and discuss how new technology can be your best ally in navigating these changes.

Following several crises in the financial sector over the last decade, governments have put more pressure on companies (and to some extent individuals) by verifying their compliance with new international requirements, as well as by ensuring that they pay their fair share of taxes. Tax authorities have furthermore been performing tax audits based on information available via search engines (like Google), public online trade registers, and social networks (like LinkedIn, Facebook, or Twitter). This atmosphere of high-tax pressure has engendered new tax audit methodologies which look not only at a company’s tax returns/accounts but which also verify all the publically accessible information that tax authorities might be able to access.

Companies are thus asking themselves how they can comply with the new substance, oversight, and documentation norms in a cost-efficient manner. It could be hard to determine whether your fund platform in Luxembourg or Ireland has enough substance to benefit from tax treaties and directives under the new standards, but the BEPS Action 6 recommendations and information on non-CIVs offer guidance on this. Basically, they mention two pillars: infrastructure and human capital.

Infrastructure in terms of substance might sound obvious, but it could be worth revisiting. Broadly speaking, infrastructure comprises all the tangible fixed assets necessary to running your business like having a dedicated furnished office space, but also less tangible elements like your IT system or personalised email address or domain.

The substance definition of human capital is maybe a little less straightforward. Generally, by “human capital requirements,” it should be understood that you must have a task force appropriately qualified to run the business and to ensure that there is proper oversight over activities both performed and delegated. In addition, simply having the human capital is not enough anymore: the qualified workforce must be involved throughout the whole process of the (alternative) investment.

As industry members know, it is currently common for deal teams to be located in the country (or countries) of investment, and for investment funds and holding platforms to be in financial centres such as Luxembourg or Dublin for Europe, Singapore for Asia, or New York for the US.

However, deal teams are only a link in the long chain of the investment transaction, and fund management platforms (including special purposes vehicles) in Luxembourg or Dublin must have a more and more important role to play in those transactions:

Having an experienced management team to review, approve, and monitor investments is also one of the key functions of the alternative investment fund manager (AIFM). Having an AIFM means that strategic decision-making abilities and management have to be performed in-house, with sufficient substance, people, and systems to effectively manage the overall operations.

We can therefore see a convergence between the AIFM Directive and the OECD’s BEPS Action 6 in the level of substance, responsibility, and activity required. This is probably why, following Brexit, the biggest alternative investment funds managers have decided to transform their Luxembourg or Dublin investment fund and holding platforms into AIFM-compliant platforms.

So management teams in Luxembourg or Dublin must play their roles seriously during the whole lifecycle of the investment—however, in instances of tax audit, this is not enough. The teams should also be able to demonstrate (through documentation) that all the appropriate functions are being effectively performed.

Management teams, in order to adequately and promptly document the oversight of the business, need efficient IT dashboard tools that allow them, in one click, to access the compliance status of their entities. They must furthermore be able to perform risk management and compliance duties (according to FATCA/CRS, MIFID, AIFMD, and any other local requirements) smoothly and efficiently. Tailor-made software solutions already exist in this area.

Looking ahead, artificial intelligence (AI), robotic process automation (RPA), blockchain and digital ledger technology (DLT) will shape how alternative investment managers operate and even how investments are structured. RPA, for example, will enhance productivity, reduce costs, streamline processes, and limit operational errors. It will affect many routine tasks with limited added-value such as invoice processing or investor reporting, taking them over from human workers, who in turn will focus on more interesting and dynamic functions such as review, approve, and monitor investments

The oversight is becoming an increasingly important activity within the alternative investment fund industry notably because of the regulatory requirements for the AIFM conducting officers and the tax international developments (BEPS) obliging directors to understand the business into which they invest.

AIFMs understand the importance of creating strategies around tax technology. They are pursuing investments in these areas in order to transform the tax function into a strategic business aspect of the organisation. Now is the time to assess where you are in terms of substance and technology, where you want to go, and how to get there.

 

 

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