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Over the past four years, an informal task force, which includes the International Fund Managers Association (IFMA) and a number of other City institutions and professionals, has been working on a mechanism to make London a more attractive centre for international pension fund management. The mechanism is a form of unit trust called a pension fund pooling scheme (PFPS), which enables the assets of pension funds from different jurisdictions (host countries) to be pooled so that they can then be invested in markets worldwide (market countries). The critical factor is tax. The PFPS must not be subject to tax itself, otherwise it will be less efficient than a direct investment from the host country to the market country. And it must be transparent so that market countries will allow taxes withheld by them to be repaid under double-tax treaties with host countries (and not with the UK, where the PFPS is located). In short, the PFPS must be tax-neutral, so that a host country’s pension fund would be in an identical position if it had itself directly invested in its portion of the underlying securities in the market countries. The benefit to UK investment managers is efficiency. They can run pooled funds without having to segregate and administer each client fund’s assets separately. But multinational companies are also behind the initiative. Although pension fund assets do not, legally speaking, belong to the companies but to their pension funds, chief financial officers (CFOs) know that any shortfall in the pension fund has to be made good by the company. Other concerns include the increased duties imposed on trustees (of whom the CFO is usually one) in the wake of the Maxwell affair, and the inefficiency of having separate subsidiaries’ pension funds managed by different managers trading in and out of the same underlying investment. The PFPS mechanism gives the CFO a strong argument for centralizing group pension assets spread amongst subsidiaries, each with its own trustees and investment managers. Although the UK has had exempt unauthorized unit trusts (EUUTs) for some time (exempt from tax and unauthorized in that they cannot be sold to the public), these have been used only by UK pension funds and other UK investors exempt from tax on chargeable gains. This is because these EUUTs are treated as taxable entities for capital gains tax purposes the exemption, which applies to non-taxable UK investors, does not apply to investors which are exempt only by virtue of being non-UK resident and because, since 1988, the trustees of EUUTs have been subject to UK income tax. Although income tax is reclaimable by investors, the fact that it is itself taxable is likely to impede transparency for double-tax purposes. The problem for the IFMA task force was that these tax provisions were embedded in UK legislation. Trying to change any country’s tax laws can be a Sisyphean task. The IFMA has been fortunate in two respects. The first is that professional advisers have been prepared to do the initial work on a pro bono basis. City law firm Ashurst Morris Crisp has been leading the discussions with the Inland Revenue. It has recently been joined by Ernst & Young, which is spearheading the effort to agree the tax position with tax authorities in host countries. Consultant actuary Watson Wyatt is seeking approval of the new vehicle from regulatory authorities in host countries. ERISA issues in the US (so called after the legislation governing US pension funds) are being handled by US law firm Debevoise & Plimpton to enable US pension funds to invest in the PFPS structure. The second is that the UK’s Inland Revenue has been particularly accommodating: the initiative to change the legislation which was done by regulations laid before parliament on June 19 came not from ministers in the Treasury but from senior Inland Revenue officials who could see the benefit to the City and, at the same time, realized that no tax would be lost as a result. “The point of the PFPS is that it does not produce some new statutory entity,” says John Watson, a tax partner at Ashurst Morris Crisp, “but simply leaves the unit trust structure in its natural form as it is in, say, Jersey.” The fact that the professional advisers have not been acting for specific clients has made it easier for the Inland Revenue to cooperate. They in turn have been able to pool information and, following the regulations’ enactment on June 19, will be able to publicize progress. At the same time they are keen to coordinate efforts to have the PFPS structure sanctioned by tax authorities in market countries and pension fund regulators in host countries, so that the respective authorities are not confused by being presented with a number of different PFPS structures which might discourage them from giving their approval. Custodians in particular are likely to be interested: by providing the PFPS structure to managers, they will gain custody of the underlying securities while taking on much of the administration currently handled in-house by pension funds. There are strict rules on the types of pension fund which are eligible. There is always a risk that an overseas pension fund will misunderstand the pooling regulations, thereby causing a PFPS to include a non-qualifying participant. If that happens, the tax status of the PFPS will not be lost, provided the trustee and manager of the PFPS take action to jettison the participant within a set time limit. The Inland Revenue has indicated that it will not regard a PFPS as carrying on business in the UK for treaty purposes; it, too, will regard the PFPS as transparent. However, at the same time, discussion is continuing as to the mechanism under which managers should be able to claim tax credits on behalf of unit holders. The PFPS documentation can be structured so that the manager is treated as providing services to the unit holders directly and not to the PFPS itself. This means that investors outside the EU will not suffer value-added tax on management expenses, while those within the EU will be in precisely the same position as if they had themselves employed managers for direct investment. Attempts have been made to use limited partnerships in the Netherlands to pool international pension funds, but these have never really taken off. It may be that it would be more difficult to persuade market countries to regard these as transparent on a worldwide basis since most have partnership structures of their own frequently on the basis that their partnerships are legal entities. Similarly, the US has a structure called the common trust fund which may prove a useful precedent in obtaining agreement from market countries. The common trust fund is, however, generally run by US banks and not available as a general pooling vehicle. “If London hadn’t come up with the PFPS, someone else would have done,” says Watson, “and we would in effect have been placing an obstruction in the way of the UK’s international investment management business, which would not have been a clever thing to do.” |
