Periods of regulatory change, while challenging, can also present an opportunity to refresh strategic direction and to re-examine the effectiveness of all aspects of an organisation’s operating model. The purpose of this article is to draw out some tax considerations that should be borne in mind by the boards of Irish fund management companies in light of recent regulatory developments.
In October 2020, the Central Bank of Ireland (CBI) published a letter to the Chairs of all 358 Irish fund management companies (FMCs) setting out the findings from its recent sectoral review of compliance with the CBI’s fund management company framework. The CBI framework addresses the standards to be met by FMCs in respect of their governance, management, control and resourcing. The CBI letter sets out that while some FMCs were found to have largely demonstrated compliance, a significant number have not yet fully implemented the framework.
Specific areas have been highlighted in the CBI letter as requiring prompt review and action by FMC boards, including the following:
• Adequate resourcing to ensure that they are in a position to fully implement the FMC framework (a minimum of 3 full-time employees or equivalent (FTE) is expected for even small and simple FMCs, with higher FTE expected in entities with greater scale and complexity);
• Designated Persons must ensure that they have the necessary time and support to carry out their responsibilities to a sufficiently high standard;
• Formalised processes are required to facilitate ongoing oversight of delegate arrangements, supported by documented Service Level Agreements (SLAs);
• Timely and robust discussion is essential at board level in relation to proposed new fund strategies/structures and their attendant risks.
The CBI’s expectation is that the board of directors of each FMC should “take immediate action to critically assess their operations to identify the steps necessary to ensure that they meet the required standards.” The CBI letter is very clear in requiring that an action plan must be discussed and approved by all FMC boards by the end of Q1 2021.
As well as potentially adapting a FMC’s operating model and future strategy to meet the CBI requirements, boards will also need to consider the many implications of doing so, not the least of which are the tax consequences.
Clearly the payroll cost and employment tax implications of deploying any additional FTEs (or any changes to roles and responsibilities of existing employees) will need to be considered as part of the decision to increase headcount in a FMC. Equally as important is the tax efficiency of the remuneration and reward arrangements put in place to attract suitably experienced people in a competitive market.
In cross-border working arrangements, as well as navigating the employment tax rules of multiple jurisdictions, FMCs will need to understand whether such arrangements could create a taxable presence in another jurisdiction from a corporation tax perspective. While measures may exist in tax law to mitigate double taxation, there remains an administrative burden in having to file tax returns and meet the ever-expanding tax reporting obligations in multiple jurisdictions.
Changes to a FMC’s operating model will likely have implications for its transfer pricing arrangements. Ireland’s transfer pricing regime was effectively rewritten in Finance Act 2019 (with further amendments proposed in Finance Bill 2020) to align it with the 2017 OECD guidelines and to broaden its scope.
The regime requires that the pricing of intra-group arrangements is at arm’s length and fully reflects the allocation of (and the financial capacity to bear) risk, having regard to the actual conduct of the parties rather than the terms of legal agreements. As such, any changes that impact on a FMC’s management or mitigation of risk are likely to have consequences for how it should be remunerated under its transfer pricing policy. FMCs should take care to ensure that they do not rely on legacy group transfer pricing methodologies that do not reflect the revised operating model or take into account the recent changes to the Irish transfer pricing rules.
Finally, with FMC’s typically suffering a degree of restriction on the deduction of VAT incurred on operating costs, any change to the value of a FMC’s intra-group arrangements could generate additional VAT costs which would need to be addressed and taken into account in the budgeting process.
The content of the recent CBI letter strikes something of a common theme with a recent letter to the EU Commission from the European Securities and Markets Authority (ESMA), which highlighted the topics of delegation and substance in the sector. It is clear that this is and will continue to be an area of intense focus for both domestic regulators and European supervisory authorities for the foreseeable future.
Irish FMCs will need to navigate that evolving landscape with caution as they consider their own arrangements. While regulatory requirements, in this instance, may initially drive FMC boards’ actions, it is important that tax and other implications of operating model changes are given due attention and form part of a wider sustainable plan for the future.
Seamus Kennedy is a tax director in Deloitte LLP.