Tax opportunities can be unlocked by real estate fund managers when improving their investor tax onboarding process. This publication highlights the need for investor tax data in a European real estate fund context, the business processes that are affected and how to unlock certain opportunities.
Background
Investors can impact the tax position of a fund and its subsidiaries by triggering (additional) taxation or tax reporting obligations. This generally depends on the tax profile of the investor and, for example, its stake in the fund. This new reality for real estate funds is mainly a result of the EU's anti-hybrid (ATAD2) and mandatory disclosure (DAC6) rules, the rise of 'look-through' beneficial ownership approaches applied by holding and property jurisdictions (Danish-cases) and the introduction of EU-blacklist measures (e.g., the Luxembourg EU-blacklist interest deduction limitation and Dutch conditional withholding tax on interest and dividends). As a result of these rules, real estate fund managers require quality tax data from investors to assess and manage possible tax implications.
Impact on business processes
- Fund documentation - The fact that local tax rules can lead to (additional) taxation depending on the profile of ultimate investors have led to the introduction and need for sophisticated investor tax allocation provisions. Tax liabilities of the fund and its subsidiaries that are triggered by an investor should be allocated to that investor. Examples are withholding taxes triggered at holding or property company level, and additional corporate income tax as a result of non-deductible costs. The allocation is typically executed by deducting the tax liability from distributions to that investor. This mechanism aims to protect the returns of other investors and is usually accompanied by an indemnification and hold harmless clause, as well as a provision giving the fund manager a certain level of discretion.
- Investor onboarding and relations - The need for investor tax data usually translates into detailed tax onboarding questionnaires. The investor tax data needs to be re-assessed on an annual basis, which leads to an ongoing dialogue with investors. Investors may also request copies of DAC6-disclosures. Relations with investors especially require careful attention when tax liabilities are triggered. The introduction of Pillar 2 can also lead to the need for funds to understand how investors account for and report their participation in the fund or feeder funds and/or questions from investors in respect of reporting and regulatory aspects at the level of the fund and its subsidiaries.
- Commercial provisioning - The possible tax liabilities triggered by investors need to be assessed timely for commercial accounting purposes, as it can impact the current year tax liabilities and deferred tax positions of the fund and its subsidiaries.
- Compliance - The quality of a fund's tax compliance position can be partly dependent on the quality of investor tax data (e.g., when applying for withholding tax exemptions or reductions, or determining the impact of anti-hybrid rules on the deductibility of costs for corporate income tax purposes). This applies to both tax filings and tax documentation requirements. Compliance is typically the capstone when determining the final amount of (additional) taxation triggered by an investor.
- Structuring - The availability of investor tax data gives more insight into tax structuring possibilities (e.g., assessing withholding tax risks, deductibility of costs, the need for feeders, the availability of tax exemptions for qualifying investors and access to REIT-regimes).
- Transactions - Low quality investor tax data can also impact disposals of holding and property companies. Prospective buyers will be unable to adequately assess historic tax risks (e.g., the deductibility of costs for corporate income tax purposes), which can adversely impact the commercial pricing and lead to burdensome tax due diligence procedures.
Unlocking opportunities
Different departments and different external service providers are typically responsible for different business processes when onboarding investors. This leads to a possible lack of oversight and delay in awareness of the investor-related tax implications for the fund and its subsidiaries. To counter the risk of needing to go back-and-forth with investors, the tax onboarding of investors becomes an important process. If this process is effective and conclusive on the tax implications, investors relations and other business processes will benefit.
There is an evident push to assess investor tax data as soon as it becomes available. This all starts with high-quality investor tax data, which requires a high-quality investor tax onboarding process. The persons responsible for the tax onboarding should subsequently ensure that relevant findings are made available within the fund manager's organisation in a timely manner. The related opportunities include a better investor onboarding experience (i.e., efficiency for the investor and fund manager), better investor relations (e.g., no surprises in connection with the investor tax allocation mechanism), and better quality tax provisioning and tax compliance which in turn also benefits future transactions. A clear view on a fund's investor base will also provide insights that will benefit tax structuring.
Originally published 15 October 2024
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.
