Tax Governance and Transformation in the Alternative Investment Industry
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 […]
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:
- Prior to the investment, the deal team(s) must inform the fund management platform of the intention to invest.
- During the transaction, the fund management platform must have sufficient information to assess the profitability/viability of the investment, so it can raise a red flag when needed.
- Finally, at the investment’s “end-of-life” phase, i.e. when the investment is to be disposed of, the fund management platform should be in a position to determine which of the proposed exit options is the most appropriate so it can ensure that all the efforts made throughout the process have not been made in vain.
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.