Tax avoidance scandals over the past decade have put international organisations' tax affairs in the spotlight. Paying a fair amount of tax in the countries where companies operate is increasingly seen by stakeholders and the wider public as the right thing to do.
Authorities have responded to this climate by stepping up scrutiny of multinational entities and tightening enforcement on a global level. New data sharing and collaboration agreements have also allowed countries to share intelligence about corporations' tax affairs that was previously beyond their reach.
This certainly holds true in the UK, where His Majesty's Revenue and Customs (HMRC) has been paying greater attention to the tax reporting of non-UK investment funds and their managers. Private equity funds - a complex area that has been historically overlooked - have been intentionally targeted given perceived contentious issues such as the tax treatment of carried interest and executives' non-domiciled status.
In this article, we discuss the challenges associated with the changing global tax landscape and how offshore funds in the UK can advance their tax reporting practices to stand up to increased scrutiny.
Understanding different tax regimes
Multinational funds may be subject to UK reporting requirements either by having UK tax resident investors, UK-based vehicles or an onshore advisor/subadvisor. Ultimately, HMRC will expect the filings from all these stakeholders to hang together in a consistent manner.
Favouring distribution statements or local jurisdiction reporting rather than UK tax analysis carries significant risks because of inherent differences between countries' tax regimes. Understanding both sides of the equation is critical to stay compliant and ensure optimal after-tax returns.
For example, while US Schedule K-1 reporting covers calendar years, the UK tax year runs from April 6 to April 5 of the next year, meaning taxable income and gains may be reported incorrectly due to the timing mismatch. Countries' tax principles may also be fundamentally distinct, leading to reporting mistakes. One case in point is the depreciation of real assets, which is allowable as a deduction under the US tax regime but not under UK rules.
These discrepancies can create undue tax burdens and inefficiencies as well as an heightened risk of HMRC enquiries that may damage the fund's reputation and trigger penalties, often of hundreds of thousands of pounds. Moreover, once a fund has entered the authority's radar, future compliance checks could become more likely. These processes are not only burdensome, stressful, and time-consuming for the organisation but present a significant distraction from its core business activities.
Tax inconsistencies also emerge from the fact that reporting is still a manual process in many organisations, with poor quality of information provided by different administrators, in-house finance teams and advisors. This information is ultimately supplied to individuals (e.g. fund managers) to report on their tax return, increasing the risk of conflicting or incorrect reporting.
Better reporting can make an impact on business
The benefits of a robust and harmonious tax reporting approach go beyond compliance. It also supports the needs of fund executives and institutional investors, with direct impact on the business' ability to attract talent and investments.
Appropriate reporting gives partners and executives confidence to plan for potential tax due and ensure optimum compliance that will reduce the risk of scrutiny. This is especially relevant in light of special tax rules for non-domiciled individuals, who represent a significant part of the fund manager population within PE.
For instance, UK investors can be subject to income or corporation tax even if they do not receive cash distributions from the fund. Profits from the sale of assets, even if used to reinvest into new companies, could be taxable. Providing executives with robust and transparent tax information will allow them to accurately report taxable allocations on their UK tax returns.
Seamless and compliant reporting is also a powerful marketing tool for the fund as tax transparency moves up the agenda of institutional investors. It is increasingly common for limited partnerships (LPs) to require PE houses to make tax disclosures as a condition of investment. Similarly, tax is emerging as an important element when it comes to ESG concerns, with many investors expecting funds and their managers to conduct their tax affairs in a sustainable, transparent and fair manner.
In this context, it is also important for funds to find the right balance between supplying investors with information and not providing tax advice for which they can potentially be liable.
Finally, in addition to demanding stronger tax reporting, tax authorities are also tightening the pressure on firms' transfer pricing strategies and related tax issues. In 2020, HMRC demanded multinational businesses review transfer pricing arrangements and ensure they were "appropriate". Documenting and integrating transfer pricing into the funds' wider tax strategy will therefore become a key element of tax risk management.
How can A&M help?
A&M's Tax Reporting team offers a technology-driven approach to bolster the efficiency of funds' tax reporting processes, improving readiness and compliance as well as adding value. For example, we undertake a real-time analysis of all returns made through the fund structure, ensuring that compliance milestones are delivered throughout the year, instead of relying on compressed timeframes that often puts in-house teams under pressure. We also work directly with fund controllers or administrators with standardised workbooks, ensuring that all the required information to correctly report fund returns is captured.
This approach not only reduces the risk of errors from highly manual processes but is less time-consuming for funds, freeing up their internal resources to focus on more valuable tasks. Being technology-led also allows us to quickly scale the service as our clients' businesses grow and as regulation continues to evolve rapidly.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.