Collective Investment Vehicles

1
Collective Investment Vehicles

• 10/22/09 Draft Presentation for Beijing
  Conference
• By Victor Thuronyi

2
Concept and Significance of CIVs

• CIV is a fund which allows investors to pool
  their assets
• direct diversified investment infeasible
• pooling provides liquidity
• -- minimize advisory and transaction fees.
• Investors are typically individuals but may also
  be pension funds, other exempt entities, or
  companies, and may be nonresidents.
• CIVs take different legal forms corporations,
  trusts, joint ownership, etc.
• Over 20 trillion assets worldwide.

3
Concept of CIV cont.

• Broadly, CIV is an investment arrangement that
  does not involve direct ownership by the
  investor.
• But this too broad since it includes life
  insurance, banks, derivatives, etc.
• Once you carve these out, you are left with CIVs
  but they can take quite diverse forms not a tidy
  concept.

4
Examples of legal forms

• Open-ended vs. close-ended fund (each type can
  take a variety of legal forms)
• Investment trust that is treated for tax purposes
  as a trust (grantor or ordinary)
• Collateralized debt obligations issued by a
  special purpose vehicle
• Trust which issues interests that are treated as
  debt for tax purposes
• Corporation (or trust treated as a corporation)
• Joint ownership.

5
Policy considerations

• Look-through should be achieved or approximated
  so as not to discourage CIVs.
• Neutrality and administrability.
• Practical difficulty because investment shares
  may change daily (makes accurate flow-through
  impossible).
• Taxation at entity level easier, but often
  violates neutrality.

6
Varied tax models

• Full transparency (tax at investor level)
• Application of trust rules (either grantor trust
  or partial flow through)
• Corporate level tax with a distributions
  deduction
• Entity tax but shareholder exemption or
  imputation credit

7
Tax models cont. full transparency

• Complete pass through to individual owners
• REMIC model interest income to one investor
  class, and residual interest to another

8
Tax models trust rules

• Grantor trust trust contains a pool of loans.
  Each investor treated as owning their share
  directly.
• Ordinary trust (Australia) trust is taxed,
  except on income distributed to beneficiaries.

9
Corporate level tax with a distributions deduction

• RIC, REIT
• For these vehicles, the U.S. imposes
  diversification and distribution requirements,
  and limits the types of assets that may be held
  and income that may be earned.
• Concern is to protect corporate tax base.

10
Entity tax with shareholder exemption or credit

• Works well in countries where investment income
  of individuals is taxed at a flat rate.
• Imputation credit alternative (may be used by
  countries that use imputation credits for
  corporate integration generally)

11
Challenge for neutrality capital gains

• Some investors might cash out, causing the fund
  to realize capital gains. The tax liability on
  these gains is passed through to the remaining
  investors even thought they have not received any
  cash.
• Fund might buy and sell assets, generating
  capital gains. These are allocated to investors
  as of the end of the year, even though they might
  hold shares for a short period.
• Closed-end ETFs can avoid problem, allowing
  investors to defer gains until they sell shares.

12
Challenge for neutrality cross-border

• Fund located in Country A.
• Investors resident in Country A and Country B
• Fund invests in Country C.
• How to apply the A-C treaty to relieve Cs
  withholding tax?
• Will Country A impose a withholding tax on
  Country B investors?
• How does Country B tax its resident?
• Is a foreign tax credit available?

13
Cross-Border Legal Framework and Possible
Solutions

• See the two OECD reports (available on OECD
  website)
• THE GRANTING OF TREATY BENEFITS WITH RESPECT TO
  THE INCOME OF COLLECTIVE INVESTMENT VEHICLES
  (Jan. 12, 2009)
• POSSIBLE IMPROVEMENTS TO PROCEDURES FOR TAX
  RELIEF FOR CROSS-BORDER INVESTORS (Jan 12, 2009)

14
Cross-Border One solution to applying treaties

• In applying the A-C treaty, country C allows the
  CIV to claim treaty benefits if at least 90 of
  the shares are held by investors from Country A.
• Alternative also count investors from Country B,
  if the B-C treaty is comparable to the A-C
  treaty.
• How to determine ownership share given that
  ownership varies?

15
Cross-border investment abuse?

• Country A imposes no tax on the fund.
• Country A has a favorable treaty with Country C.
• Alternatively, Country C has a favorable tax
  regime for the fund.
• The investor resident in Country B may be
  noncompliant.