Democratising Common Contractual Funds - Ireland's Tax Transparent Fund Structure
How can mid-sized managers, pension funds, insurance companies, charities and other tax-exempt investors use a fund platform to achieve the tax efficiencies in asset pooling and cost savings normally reserved for the largest players?
Ireland’s Common Contractual Fund, or CCF, is recognised by investors as one of Europe’s major tax transparent fund vehicles. It is widely used by pension funds, insurance companies, charities and other tax-exempt investors and continues to see enhanced interest from large investors around the world.
The structure is suitable for a wide range of investment strategies as it can be regulated under both the UCITS and the AIFMD frameworks.
The benefits of investing via a CCF occur where the investors are resident in a jurisdiction that recognises the concept of tax-transparency, and beneficial tax treaties are in place with the countries where the fund’s assets are domiciled. Unlike mainstream corporate, opaque, fund structures where investment withholding tax is applied at the fund level, in a CCF each investor is treated on a look through basis and deemed to be the beneficial owner of the underlying investments (as “tenants in common”).
For insurance companies there is an additional benefit to reduce their regulatory capital requirements under Solvency II.
This article will go on to illustrate the increased returns to tax-exempt investors in CCFs, by reducing the tax drag that is inherent when investing via corporate fund structures.
Due to the complexities of international tax treaties, CCFs are expensive structures to establish and maintain, requiring costly tax analysis and advice, as well as more specialised fund administration to ensure that the tax benefits are correctly accounted for. These costs impact the CCF’s total expense ratio and so ticket size is an important consideration, so that the benefits outweigh the costs. From the investment manager’s viewpoint, the complexity and bandwidth required to structure and maintain a CCF can also be considered barriers to entry to all but the largest, best-resourced firms. In addition, CCFs typically take longer to launch than regular funds due to these factors.
In line with all Irish regulated funds, the CCF requires a fund administrator, depositary and, depending on the regime, either a UCITS Management Company or an Alternative Investment Fund Manager (AIFM). The UCITS Management Company or AIFM role can either be performed by the Investment Manager if they are appropriately regulated in the EU/EEA; alternatively, a Third-Party ManCo can be appointed.
Calculating the benefits of the CCF structure
Savings using CCFs can be considerable for asset managers and investors: according to the Irish Funds Association 1, and as illustrated in their table below, they could save as much as 39 basis points in mitigating ‘tax drag’ on a portfolio paying the dividend yield of the MSCI World, compared to the same portfolio in an opaque fund structure.
Source: Irish Funds
For a mid-sized firm managing an investment of $250m in US equities with an annual dividend yield of 2%, using a CCF would create annual tax savings of either $1.5m (30% withholding tax rate) or $750,000 (15% withholding tax rate) compared to an opaque fund structure. Considering the scale and relative importance of the US equity market (i.e., US equities constitute approximately 54% of MSCI World Index), the benefits of using a CCF are clear.
Referencing Irish Funds’ illustrative table below, with a smaller portfolio of $250m, measured over a 20-year investment period the reduced tax costs associated with a UCITS CCF would create additional investor returns of $28.38m (ignoring capital appreciation).
Source: Irish Funds
Solutions for mid-sized managers and investors
Given the complexities and costs outlined above, how can the benefits of tax-transparent investing be achieved at reduced cost and with a lower administrative burden in terms of management time?
How can smaller pension funds access these structures at an acceptable price point and how can larger pension funds allocate smaller tickets to mid-sized and even emerging managers?
The solution is already embedded in Ireland’s mainstream fund model, where funds are typically structured as umbrella funds with legally ringfenced sub-funds: in other words, through the use of a sub-fund on a CCF platform. The umbrella is the legal entity that contracts with the service providers and seeks the tax advice to achieve the benefits under the tax treaties. These benefits accrue to all the sub-funds under the umbrella. Via a third-party platform provider, a CCF can be established as a fund platform and individual sub-funds can be offered to different investment managers, in the same way as regular UCITS and AIFs.
Compared to a standalone CCF with a proprietary or Third-Party ManCo, the following table sets out some of the main considerations and benefits to establishing a CCF Sub-Fund on an established CCF Fund Platform:
Key considerations when comparing standalone versus platform solutions for Common Contractual Funds
Hayden Reinders, Head of Business Development and Client Management, Prescient Fund Services