Transcript Collective Investment Institutions

Taxation of Financial Markets
14 - Collective Investment Vehicles
Collective Investment Vehicles

Common characteristics
– publicly marketed
– widely held
– mainly investing in financial assets

Examples
–
–
–
–
–
mutual funds
managed funds
unit trusts
pension funds/insurance companies
known under different names in different countries
Recent Developments in CIIs

Increased in CIIs due to
–
–
–
–
–
–

benefits of diversification (lower risks, higher return)
increasing pressures on public pension schemes
deregulation in financial markets
development in technology
financial innovation
tax reasons (particularly for CIIs located in tax haven)
Institutional investors invest on behalf of households
– in UK: hold over 50% of household financial assets in 1995
– in US, France and Germany: about 40% in 1995
Notable Trends in CIIs Holdings

Increase in cross-border investments
– gross cross border investment flows increased substantially

Increased interests in ‘offshore’ CIIs
– 1986 - 450 offshore CIIs
– 1988 - about 900 funds
– 1996 - more than 5800 funds

Increased in average size of new funds
– 1 fund established in 1996 was seeded with $32 billion
capital
(source: Micropal Ltd)
Tax Issues

Domestic tax issues
–
–
–
–

taxation of the investment
taxation of the investor using a CII
taxation of the CII
how to reduce tax burden of investor to a level similar to
direct portfolio investments
International tax issues
– Triangular case: How to avoid double taxation when CIIs,
investors and income source are in different countries
– Tax evasion through offshore CIIs
Domestic Taxation Issues


Investment in CIIs is a less sophisticated way of
having portfolio investments in a company
What is the tax treatment of domestic sourced
dividend income in your country?
– level of company tax
– personal income tax considerations
•
•
•
•
distinguish between capital and income?
Subject to withholding taxes at source?
company taxes paid creditable at personal income tax level?
Withholding taxes paid at source creditable to other personal
income or final?
Example
$100 dividend paid by corporation to Person A in
Aus
UK
US
Tax system
FI
PI
CL
Imputation rate
42.85%
10%
0
Gross up dividend 142.85
110
100
Tax rate
48.5%
40%
46.6%
Tax liability
69.28
44
46.6
Credits
42.85
10
n.a.
Tax Due
26.43
34
46.6
(Source OECD, 1999 - updated)
Foreign Source Dividend

What is the tax treatment of foreign source dividend
income?
– Important considerations for both inward and outward
investments
– Withholding tax considerations
• What is the level if paid to or from countries with/without
treaties?
• Is double taxation relief available and on what conditions?
– Underlying foreign company taxes paid
• Relief usually not available for portfolio investments
Example
Person A resident in the UK receive $100 dividend paid
by corporation in
Aus
0
100
100
Withholding tax
Gross up dividend
Cash receipt
Tax rate
40%
40%
Tax liability
40
Credits
0
Tax Due
40
Net return
60
(Source OECD, 1999 - updated)
UK
n.a.
110
100
US
15
100
85
40%
44
10
34
66
40
15
25
60
Tax Policy and Administrative Responses
to CIIs

Useful to have direct investments as a benchmark
– CIIs achieve the same thing indirectly
– Often it is more complicated because it involves savings

Policy decisions necessary to deal with
– concessions for certain CIIs involved in retirement savings?
– How to protect investors (a governance issue dealt with
separately by OECD’s Governance section)?
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Administratively
– Try to achieve a tax outcome that is similar to direct
investments
– But, a difficult task because of rules in other countries
Domestic CIIs

Types of CIIs
– Unit Trusts, Investment Companies, Mutual Fund
– Legally can be company or trusts

5 general approaches to taxation of CIIs
– disregard CIIs for tax purposes, tax investors
– recognised CIIs but exempt from tax if fulfils certain criteria
– subject to tax at normal rates, but allow distributions as
deductions so tax is close to nil
– subject to tax at low rates
– subject to tax at normal rates as companies with full
integration (eg. imputation at investor level)
Other Taxation Considerations
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At what level should investments in CIIs be taxed?
– At the underlying investment level, CII level or investor level?
– Influenced by the general approaches described earlier (e.g.
whether CII is treated as taxable unit or transparent)
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Characterisation and timing issues
– are the increases in the underlying investment (e.g. increase
in units) capital/dividend/other income?
– When and at which level to tax these increases?
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Withholding taxes
– Would withholding taxes apply
• to payments from the underlying investment to CIIs?
• to payments made from CIIs to investors?
Key Messages

A range of inter-related issues involving
– underlying investments by CIIs
– CIIs themselves
– investors
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No international norm
– often a number of systems exist within one country for
different types of CIIs
– for examples of the possible range see OECD, 1999
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Most important criteria
– needs to be internally consistent to ensure taxes collected
where intended and to avoid double taxation
Cross-Border Intermediated Investments

Three cases considered as illustrations
– a domestic CII with domestic investor, earning foreign source
income
– domestic investor, earning foreign source income through a
foreign CII (a two country case)
– domestic investor, earning income source from country A
through a CII in country B (a three country case)

Benchmark is foreign direct investment: consider
– income tax implications
– withholding tax implications
– tax relief implications
Domestic CII, Domestic Investor, Foreign
Source Income
Example:
investment
Domestic
CII
dividend
investment
returns
Investor
Foreign Co
Tax Issues

Income tax
– should any tax be levied at the CII level: depends on
whether CII transparent or not?
– will income returned to investor have the same
characteristics for tax purposes (e.g. dividend income)?

Withholding tax considerations
– at what withholding rate should payments made to CII be
subject to at source country?
– CII may not qualify for reduced rate under treaty if not a
treaty subject

Tax credit and imputation relief availability is unclear?
– foreign tax credit on taxes paid by CII available to investor?
– Underlying company taxes paid by foreign company?
Two Country Case
Example:
investment
CII
dividend
investment
returns
Investor
Company
Three-Country Case
Example:
investment
CII
returns
dividend
investment
Investor
Foreign Co
Income Tax Considerations
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CII may pay tax in country of resident that does not
give rise to foreign tax credits for foreign investor
Low tax on CII and deferral of tax until repatriation
– CII resident in offshore tax haven or when taxes on CII are
waived in some jurisdictions (e.g. US waive tax or regulated
investment company if 90% of earnings are distributed)
– earnings accumulated in CII without tax if country of investor
does not have FIF rules

Conversion of the characterisation of income
– dividend income of CII may become capital gains of investor,
or vice versa
Withholding Tax Considerations

Two country case
– implications are complicated under tax treaties
– main issue: access reduced withholding rates by converting
portfolio dividend income into capital gains (also preferential
income tax consequences)
– can have disadvantageous characterisation consequences

Three country case
– different withholding rates could apply cf direct investment
– more restrictive conditions for foreign tax credit relief wrt
withholding tax imposed by source country
– CII country may also impose withholding tax on dividend
distributed by CII (that also may not give rise to FTC)
Offshore Tax Havens

CII could be resident in an offshore tax haven or a
jurisdiction that provides favourable tax treatment to
CII
– CII invests to get income with little or no withholding taxes
(often there are ways to avoid these withholding taxes)
– no tax at CII level
– convert income into capital gains or defer tax on distributions
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OECD work with Tax Haven
– Harmful tax competition
– Defence mechanisms: effective exchange of information, FIF
rules, etc.
Tax Revenue Sharing - Two Country Case
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Taxes for source country
– underlying corporate tax
– withholding tax at source for distribution? (e.g. zero if fully
franked: Australia)
– availability of imputation relief to CII/investor?

CII and investor resident country
– tax at CII level? Withholding for distribution to investor?
– foreign tax credits available for taxes paid at source
• corporate taxes paid
• withholding taxes paid
– credits allowed to investors for taxes paid at CII?
Tax Revenue Sharing - Three Country
Case

Taxes for source country
– underlying corporate tax
– withholding tax at source for distribution? (e.g. zero if fully
franked: Australia)
– availability of imputation relief to CII/investor?

CII country
– tax at CII level? Withholding for distribution to investor?
– foreign tax credits available for taxes paid at source
• corporate taxes paid
• withholding taxes paid
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Investor country
– credits passed on to investors for taxes paid at source/CII?
Summary

CIIs are integral to the development of financial
markets
– allow intermediated investments and have certain economic
benefits

Taxation of CIIs can be complex
– possibilities of avoiding taxes using CIIs (e.g. offshore CIIs,
conversion of dividend into capital);
– can overtax CIIs and hinder their development (e.g. not
provide tax relief where it usually would occur in direct
investment case)
– tax revenue sharing issues!!