Pension Scheme Asset Pooling and the Rise of Tax Transparent Funds

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Mariano Giralt Chris Mitchell Gildine Cassou

Mariano Giralt, Chris Mitchell and Gildine Cassou, BNY Mellon

Mariano Giralt is Head of Global Tax Services, Chris Mitchell is Head of UK Tax Services and Gildine Cassou is Tax Pooling Manager, BNY Mellon

The investment pooling for the Local Government Pension Scheme in England and Wales is one of the most ambitious reforms seen in the U.K. pensions industry for many years. The U.K. Tax Transparent Fund will be an important vehicle to consider as part of these plans.

The investment pooling for the Local Government Pension Scheme (“LGPS”) in England and Wales, from 89 funds to eight larger pools, is one of the most ambitious reforms we have seen in the U.K. pensions industry for many years. This proposal by the U.K. Government in 2015 was put forward in order to significantly reduce costs whilst maintaining overall investment performance of the LGPS pension funds. Under these plans, the new investment pools are set to be in place and operative by April 2018, and the U.K. Tax Transparent Fund (“TTF”) will be an important vehicle to consider as part of these plans.

As a result of the introduction of the U.K. TTF in 2013, there has been a renewed interest in the development of these U.K. vehicles, together with their existing equivalents in Ireland (Irish “CCF”), Luxembourg (Lux “FCP”) and the Netherlands (Dutch “FvGR”). The U.K. is keen to ensure that its version of the TTF, that is, the Authorised Contractual Scheme (“ACS”) is the best in class amongst its peers.

Background to Pooling and Tax Transparent Funds

“Pooling” is the term used to describe the aggregation of different investors' assets into a single fund vehicle. It offers investors the opportunity to diversify their portfolio and spread portfolio risk, to achieve centralized administration, enhance governance and risk management, and realize cost savings from economies of scale.

Although pooled vehicles are currently used for cross-border investments, one of the challenges of international pooling is the preservation of tax neutrality to the underlying investor. This tax neutrality will not be achieved by pooling within an investment fund, which itself is tax opaque, because the asset owner in this case will be the fund itself, wherever it may be resident. However, pooling through a transparent vehicle can achieve this tax neutrality.

The pooling of assets in a fund which is transparent for tax purposes means that income, and potentially gains from investments made by the fund, accrue to each investor in proportion to their holding in the fund, without changing their character, source and timing. In other words, the fund is “looked through,” and investors are treated for tax purposes as if they held their proportionate share of the underlying investments directly. This allows investors access to the treaty benefits of their home jurisdiction, provided that both the jurisdiction of the investor and of the investment regard the fund as tax transparent. Many tax authorities provide pension funds with the best rates of withholding tax so they pay as little as possible on directly-held investments. Tax transparent pooling allows investors such as pension funds to benefit from these reduced tax rates as if they held the investments directly.

U.K. pension funds, for example, would typically see their withholding tax reduced from 15 percent, or 30 percent if investing in U.S. equities through an opaque fund, to 0 percent if investing through a TTF. Generally, the benefit is greatest for equity holdings as coupons on bonds are often not subject to withholding tax. The TTF may also be beneficial for holding other types of investments such as property and other illiquids, due to economies of scale and cost savings, whilst the position on tax would need to be reviewed on a case by case basis according to the specifics of local jurisdiction taxes.

The Rise in the Number of TTFs in the Market

For a number of years, TTFs could only be found in Luxembourg, the Netherlands and Ireland. Historically, Luxembourg and Ireland were the leaders in tax transparent pooled vehicles, and have widely marketed them. The Netherlands subsequently launched the FvGR to compete with the Luxembourg and Irish vehicles.

Despite being one of the largest fund centers in Europe, the U.K. had previously lacked a tax transparent pooling vehicle. The introduction of the ACS in July 2013 brought the U.K. into line with the other European fund centers by creating a U.K. domiciled tax transparent pooling structure. Over the last four years, investment managers have confirmed their interest in nine such funds, which include 78 sub-funds. The launch of the U.K. ACS regime has also helped to trigger a renewed interest and activity in the establishment and launch of CCFs. There are 38 CCF funds (128 sub- funds) existing in the market today with 23 (86 sub-funds) having been created since 2013.

The ability to achieve a range of operational and cost efficiencies whilst not creating the tax drag, which may have otherwise been present with the use of a non-tax transparent pooling vehicle, has undoubtedly contributed towards the growing market in tax transparency over the past decade (and even more so over recent years).

U.K. Authorised Contractual Scheme

In 2011, the U.K. Government announced its decision to introduce a U.K. transparent fund, which came to fruition in July 2013 with the launch of the product. The U.K. is not only trying to create an ideal master feeder structure, but also is attempting to be the best in class concerning choice of TTF, by continuously trying to improve the U.K. ACS. According to the HM Treasury document “Consultation on contractual schemes for collective investment” published in January 2012, the U.K. Government's main objective for introducing the new scheme was to “ensure that the U.K. is able to compete to win an appropriate share of European pooled funds as U.K. domiciled funds and to consolidate the U.K.’s position as the largest asset management center in Europe.”

These developments are also driven by the U.K. Government's strong desire to see the LGPS create large pools of assets with a minimal negative tax impact. In 2014, the government launched a consultation process to reform the LGPS: this was followed by the 2015 Autumn Statement which included government proposals to reform the asset investment by these LGPSs. The four main criteria which the government was looking for the LGPS to achieve were:

  •  asset pools to achieve benefits of scale;
  •  strong governance and decision making;
  •  reduced costs; and
  •  improved capacity and capability to invest in infrastructure.

A number of legal entity structures in the U.K. were considered to meet these criteria, but the government put forward the ACS. The view was, and remains, that the ACS would combine the criteria set forth by the government's consultation whilst keeping the tax advantages of holding assets directly which are intrinsically linked to pension funds.

Following the government's proposal and guidance, a timeline was set up with final submissions to be sent in July 2016, with the recommendation for liquid assets to be transferred into the pools over a relatively short timeframe, starting in April 2018. The LGPSs have all decided with whom they will partner to create eight large pools, and although the entity type which will be used is still under discussion for some of the pools, the majority of the pools have decided to launch a U.K. ACS, with London councils and the Local Pensions Partnership having led the way and launched their own ACSs over the past year. The strong push from the U.K. Government to use the U.K. TTF for the LGPS, has placed the ACSs in the spotlight, and some subsequent improvements in the rules have ensued.

U.K. Legislative Changes

One such improvement was the Stamp Duty Land Tax (“SDLT”). The Finance Act 2016 introduced a new seeding relief for the initial transfer of property into ACSs. The measure supports the U.K. Government's objective of making the tax system more competitive and making the U.K. a more attractive location for the management of Co-ownership ACSs (“CoACS”).

Specifically, the measure changed the rules so that the CoACS is no longer transparent for SDLT, so that SDLT would apply when the CoACS acquired the property, but at the same time introduced a seeding relief for the initial transfer of properties into the scheme. This seeding relief applies where there is genuine diversity of ownership in the CoACS. The seeding period commences with the first property seeding date and ends on the date of the first external investment into the scheme, subject to a maximum of 18 months (from first seeding date), where the sole consideration for the transfer is units in the fund. There is also a portfolio test limiting the application of the relief to transactions where a minimum number of properties and a minimum value of properties are transferred.

This was a welcome change for the LGPS as well as other investment funds as SDLT would have made the move to pooling, in respect of initial transfers of property, costly.

Mindful of the type of underlying investor investing in a CoACS and more particularly of LGPS, HM Revenue & Customs issued a consultation in August 2016 on reducing tax complexity for investors in ACSs. The U.K. Government was consulting on potential changes to the tax rules on how capital allowances (where relevant) are allocated to investors in CoACSs, and on the reporting obligations of fund managers. Concerning capital allowances, these changes allow for flexibility in the application of the rules to meet different investor needs, and it is possible to elect for the operation of a partnership model in this respect.

This legislation was included in the Finance (No 2) Bill 2017 published on March 20, 2017. The changes will therefore be good news to the funds industry and investors.

Product Comparison

Although the U.K. ACS is now a key player in the tax transparency world of funds, the historical precedent of the other European TTFs, as well as the uncertainty in the U.K. fund market following Brexit, means that asset managers are looking at the U.K. ACS as well as alternative TTF structures in Europe. Many asset managers are considering the option of launching or moving existing assets to a CCF in Ireland, where, like the U.K., there is an objective to utilize local management and operational expertise and to retain or enhance share of the European fund business. Asset managers are also contemplating launching TTFs in several locations, mainly in the U.K. and Ireland, to ensure that they are prepared for the consequences of Brexit.

The main difference between the U.K. ACS and the Irish CCF is the fact that a U.K. ACS can be set up under two legal frameworks—the co-ownership ACS or the limited partnership ACS— whereas the Irish CCF can only be only set up under a deed of constitution, which requires investors to participate as co-owners in the assets of the fund. Although this was a key difference when the U.K. ACS was initially launched, it appears that only the U.K. co-ownership scheme has been of real interest up to now. It will be interesting to see whether this will change.

Going Forward

We expect the popularity of tax transparent funds to keep growing as the benefits they offer continue to be recognized by pension funds, life companies, asset managers and others in the financial services industry. We continue to watch and monitor changes in this evolving and dynamic market with interest.

Mariano Giralt is Head of Global Tax Services, Chris Mitchell is Head of U.K. Tax Services and Gildine Cassou is Tax Pooling Manager, BNY Mellon. The authors may be contacted at:;;

The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon. This does not constitute tax advice, or any other business or legal advice, and it should not be relied upon as such.

Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.

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