Tax changes for Asset Management & Funds

Asset Management in Focus - Edition 5

Welcome to Asset Management in Focus, a series which has been designed to give you an in-depth look into topics within the Asset Management sector. In our fifth edition, we will explore recent legislative and revenue practice changes which may have an impact for funds and the asset management industry, particularly in the alternatives space.

Relevant Finance (No.2) Act 2023 changes in addition to a recent update to Revenue Guidance with respect to interest withholding tax.

Content

Section 1:

Global Minimum Taxation – Pillar 2

Overview of scope
How it operates in practice
Key considerations for funds and fund structures
Joint venture arrangements
Key practical considerations

Section 2:

Outbound payment measures

Overview of scope – who is affected?
Application – how does it impact?
Key practical considerations

Section 3:

Withholding tax treatment on interest payments

Interest paid to Irish partnerships and foreign tax transparent entities

Section 1: Global Minimum Taxation – Pillar 2
Section 2: Outbound payment measures
Section 3: Withholding tax treatment on interest payments

Overview of scope

The Finance (No.2) Act 2023 was signed into law in Ireland in December 2023 and included legislation to implement the 15% minimum tax rate under the OECD’s Pillar Two agreement and as adopted in EU’s Minimum Tax Directive. The 15% minimum tax rate is also known as the Global Anti-Base Erosion (or GloBE) rules. Spanning over 120 pages of legislation, the introduction of these rules into Irish law marks a paradigm shift for in-scope businesses. It also represents a significant challenge as affected businesses seek to grapple with these new rules, which sit in tandem with Ireland’s existing (and increasingly complex) corporation tax system.

It should be noted at the outset that the GloBE rules will not affect the majority of Irish entities – generally only members of multinational groups with annual turnover exceeding €750 million in two of the last four years should fall in scope. However, the concept of a group for the purposes of the rules and subsequent determination of whether an entity is in scope of the rules can be particularly complex in the context of certain fund structures.

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How it operates in practice

The Pillar Two GloBE rules are designed to implement a global minimum effective tax rate (ETR) of 15% on a jurisdictional basis. This means that the financial information of each of the group members in any given jurisdiction must be aggregated, adjusted as required under the rules, and an ETR calculated for that jurisdiction. If this jurisdictional ETR is less than 15%, then top-up tax is payable to bring the ETR up to 15%.

Various mechanisms exist under Ireland’s implementation of the rules to collect top-up tax that arises in respect of a group’s Irish or foreign operations. For Irish operations that have an effective rate of tax of less than 15%, Ireland has elected to adopt a Qualified Domestic Top-Up Tax (‘QDTT’), preserving Ireland’s primary taxing rights over these profits and ensuring that any incremental top-up tax payable with respect to Irish operations should be payable in Ireland.

Ireland’s implementation of the rules also includes mechanisms that would require Irish companies to pay top-up tax in Ireland with respect to foreign group members where the ETR for a particular jurisdiction is less than 15%. The Income Inclusion Rule (‘IIR’) could apply if an Irish entity is the direct or indirect parent of such foreign group members where that tax is not otherwise collected under that particular jurisdiction’s QDTT regime.

The Under-Taxed Profits Rule (‘UTPR’) could also apply if any top-up tax remains payable after the application of the QDTT and IIR rules, meaning the Irish entities could be subject to additional tax in Ireland on behalf of any other low-taxed foreign entity within the same multinational group, be that a subsidiary, parent or sister company.

In line with the EU Minimum Taxation Directive, Ireland will commence collection under the QDTT and IIR mechanisms for accounting periods commencing from 31 December 2023. However, the UTPR will not apply until one year later, for accounting periods commencing on or after 31 December 2024 (subject to certain limited exceptions where it can apply at the same time as the IIR).

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Key considerations for funds and fund structures

Exclusion from scope of rules

A key consideration for funds and fund structures is whether they fall within scope of the rules in the first instance. In this regard, there are a number of categories of entities which are specifically excluded from the rules, such as:

i. Any investment fund (as defined) which is an ultimate parent entity (i.e. broadly speaking, which is not consolidated into any other entity, irrespective of whether consolidated financial statements are required to be prepared); or

ii. Any entity which is at least 95% owned by an entity referred to at (i) above, that operates exclusively (or almost exclusively) to hold assets or invest funds for the benefit of the entity referred to at (i) or exclusively carries out activities ancillary to those performed by it; or

iii. Any entity which is at least 85% owned by an entity referred to at (i) above provided that substantially all of its income is derived from dividends or gains that are excluded from the calculation of income for the purposes of the rules.

An investment fund for the purposes of the above is defined as an entity (which includes a partnership) which:

is designed to pool financial or non-financial assets from a number of investors, some of which are not connected;
invests in accordance with a defined investment policy;
allows investors to reduce transaction, research and analytical costs or to spread risk collectively;
has as its main purpose the generation of investment income or gains, or protection against a particular or general event or outcome;
its investors have a right to return from the assets of the fund or income earned on those assets, based on the contribution they made;
is, or its management is, subject to the regulatory regime, including appropriate anti-money laundering and investor protection regulation for investment funds in the jurisdiction in which it is established or managed; and
is managed by investment fund management professionals on behalf of the investors.

In practice, it is expected that many investment funds and entities within investment fund complexes should fall outside the scope of the rules. That said, it is not clear that all collective investment vehicles will automatically satisfy the above conditions. Furthermore, there are some circumstances where a fund could require consolidation such that it will not automatically fall outside the scope of the rules. Alternatively, there may be aggregator or other similar entities in a fund structure which complicate the application of the 95% and 85% tests previously mentioned. On a separate note, there is no exclusion applicable to investment management entities, which need to be assessed based on the relevant facts and circumstances in the context of the corporate groups which they are part of.

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Joint venture arrangements

There are specific provisions in the rules in relation to “joint venture” entities which are defined as any entity in respect of which at least 50% is held directly / indirectly by a parent entity where its results are reported under the equity method in the consolidated financial statements.

Whilst the entities described at (i) – (iii) above are excluded from this definition, it is worth noting that any vehicle within a fund complex which does not fall within (i) – (iii) and which is considered a joint venture entity could be within scope of the rules.

In assessing whether the €750m threshold is met, there is a requirement to include turnover from entities which are otherwise excluded from the rules.

As a result, the joint venture rules could result in a non-consolidated 50%+ entity in a fund complex coming within the scope of the rules, unless it is considered exempt (e.g. further to (i) – (iii) above), once the turnover of the broader fund complex is taken into account. This could be the case even where such an entity does not itself exceed the €750m threshold.

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Key practical considerations

Although there is a broad exemption from the scope of the rules which can apply to both fund and below the fund vehicles, it should not automatically be assumed that fund complexes are fully outside the scope of the rules. In this context, the following considerations are important:

Is the fund vehicle itself consolidated into another entity or would it require consolidation should any investor(s) prepare consolidated financial statements?
Do below the fund vehicles meet the relevant criteria in every case, particularly where the consolidated turnover of the fund structure exceeds €750m?
Are there non-consolidated entities in the structure which are 50%+ held, particularly where the consolidated turnover of the fund structure exceeds €750m?

If the answer to any of the above is yes, it is important to consider the extent to which the rules might apply in more detail in the context of the fund structure (in addition to considering application in respect of any management entities).

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Overview of scope – who is affected?

The Finance (No.2) Act 2023 implemented a new provision which could result in the application of withholding tax to certain outbound payments of interest, dividends and royalties made by Irish tax resident entities. This legislation operates by disapplying existing domestic withholding tax exemptions to certain payments made to non-resident entities, so is potentially relevant to any Irish entity which has been relying on domestic withholding tax exemptions to date in respect of such payments (including the Quoted Eurobond exemption in respect of interest).

That said, it will not apply to the long-standing tax exemption which applies to distributions and redemption payments made by regulated funds to non-resident investors, which remains in place.

To be in scope of this legislation, which effectively switches off exemptions which would otherwise apply, the payment made by the Irish company must be made to an “associated entity” that is resident in a “specified territory”. Both of these concepts are therefore important in assessing whether an arrangement falls within scope of the rules.

Specified territory – a specified territory is defined as (i) a territory that is on Annex I of the EU list of non-cooperative jurisdictions (such as Anguilla and the Bahamas) or (ii) a zero-tax / no-tax territory. A specified territory cannot be another EU/EEA country, so these new provisions will not apply to any payments made to any recipient in an EU country.

Associated entity – two entities are considered associated for the purposes of the rules if there is more than a 50% relationship in terms of share capital or ownership interests in the case of an entity which does not have share capital, voting power or entitlement to profits.

Two entities will also be associated in cases where one entity has “definite influence” in the management of the other entity, or where the two entities are both associated entities of another entity. Broadly speaking, a company will be considered as having definite influence in the management of another entity where it has the ability to participate, via the board of directors or equivalent governing body of the entity, in its financial and operating decisions.

As the rules generally only apply where there is a greater than 50% relationship (in addition to where the recipient has definite influence), this could result in investments in joint ventures falling outside the scope of these new measures. Transactions with unrelated third parties should not be affected by the provisions.

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Application – how does it impact?

As noted above, the rules operate by disapplying existing domestic exemptions however there are some nuances depending on the type of payment in scope:

Interest

Where a company makes a tax-deductible interest payment to an associated entity that is tax resident in a specified territory (or a permanent establishment of an associated entity which is situated in a specified territory), the legislation will disapply the application of the existing Irish domestic interest withholding tax exemptions, which could result in the application of 20% withholding tax to payments which were previously exempt.

The legislation will also bring ‘short’ interest payments – interest payments on loans with a term of less than 12 months – made to an entity in a specified territory within the scope of Irish withholding tax.

Notwithstanding the above, there is an exclusion from the legislation which will result in an interest payment continuing to qualify for exemption (assuming the relevant conditions are satisfied) where:

the recipient makes an onward payment of a corresponding amount (the meaning of which is undefined) to another entity within 12 months;
the corresponding amount would have been an excluded payment if it had been made directly to that entity (e.g., the payment would have been subject to tax); and
the payments were made for bona fide commercial purposes.

Whilst this is helpful, it only addresses a situation where there is an onward payment of a corresponding amount direct to another entity within 12 months and therefore where there are multiple tiers of intermediate recipients, there could be withholding tax.

Distributions / dividends

Where a company makes a distribution to an associated entity that is tax resident in a specified territory (or a permanent establishment of an associated entity which is situated in a specified territory), existing domestic reliefs from Irish dividend withholding tax will be disapplied. However, the new withholding tax provisions will not apply where the distribution is being made out of income, profits or gains that have been subject to (i) Irish domestic tax, (ii) foreign tax at a nominal rate greater than 0%, or (iii) a CFC charge or a top-up tax under Pillar Two. In addition, the provisions should not apply to distributions made out of foreign branch profits that are subject to foreign taxation.

The range of exclusions included in the legislation for distributions should therefore allow a company to effectively look up and down its ownership chain when considering whether the profits being distributed have been subject to tax within the group’s corporate structure, and whether the distribution should therefore fall outside the scope of the new withholding tax requirements.

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Key practical considerations

The measures will apply to in-scope payments made on or after 1 April 2024. However, there is a deferral of this date for existing structures, as the application date is 1 January 2025 in respect of any arrangements in place on or before 19 October 2023.

From a practical perspective, the following questions should be considered in the context of existing structures (particularly complex / alternative structures):

Is there any existing reliance by an Irish tax resident company on a domestic withholding tax exemption?
If yes, is the recipient of the payment non-EU and located in either an EU non-cooperative jurisdiction or zero / low tax jurisdiction (including the Cayman Islands)?
If yes, is the recipient of the payment associated with the Irish paying company.

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Irish partnerships and foreign tax transparent entities

Irish Revenue recently published eBrief No.252/23 to highlight that they have updated their Tax and Duty Manual (TDM) Part 08-03-06 “Payment and receipt of interest and royalties without deduction of income tax”. In this updated guidance Revenue have included a new section which provides a basis for existing domestic withholding tax exceptions to be applied on a “look through” basis where interest is paid to Irish partnerships and foreign tax transparent entities, provided certain conditions are satisfied.

This updated guidance is welcome in the context of a practical issue which used to arise where interest was paid to a partnership (or foreign tax transparent entity) which had partners who would be entitled to a domestic withholding tax exemption. Prior to the guidance, a 20% interest withholding tax would potentially need to be applied at source and subsequently reclaimed by partners in the partnership (or foreign tax transparent entity) entitled to a domestic exemption from withholding tax.

Specifically, the guidance clarifies that Revenue are accepting of a ‘look through’ approach being applied to interest which is paid to an Irish partnership (or a tax transparent foreign entity) subject to the following conditions:

All members of the partnership or tax transparent foreign entity would qualify for exemption from withholding tax which would apply if the interest was paid directly to the members;
The Irish partnership or tax transparent foreign entity is considered to be tax transparent in its jurisdiction of residence (or place of creation) and by all of the jurisdictions where the members of the tax transparent entity are resident i.e., the interest income is treated as arising to those members directly, and
Where business is conducted through the Irish partnership or tax transparent foreign entity for non-tax commercial reasons and not for tax avoidance purposes.

The updated TDM notes that if any member of the transparent entity cannot satisfy these conditions, withholding tax should be deducted from the gross interest payment.

Whilst we welcome these changes in the context of structures which utilise partnerships or tax transparent foreign entities, it will be necessary to be comfortable that all members are residents of a relevant territory (another EU member state or country with which Ireland has a double tax treaty) in line with the relevant withholding tax exemption requirements.

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