The asset manager’s new normal - PwCPwC | The asset manager’s new normal 3 Our findings at a...

The asset manager’s new normal

www.pwc.co.uk/operationaltaxes

Responding to tax risks and transparency

2 The asset manager’s new normal | PwC

Contents

Executive summary .....................................................................................................2

A changing global landscape .......................................................................................4

What do asset managers mean by operational taxes? ..................................................6

What is the new normal for the asset management industry? ......................................9

Who is currently responsible for operational taxes? ..................................................15

How are asset managers currently managing operational taxes? ..............................16

Conclusion ................................................................................................................23


Executive summary

Continuing regulatory and taxation reform, fiscal deficits, low growth, sovereign risk, and globalisation are unlikely to be viewed merely as short to medium term consequences of the financial crisis but will be the new normal in which the asset management industry will operate for years to come. The industry is facing opportunities and challenges in the form of demographic shifts, the rise in power and interconnectivity of the emerging markets, changing investor behaviours and state directed approaches to economic development.

In the meanwhile, tax authorities continue to combat under reporting of income by some taxpayers and in particular, the use of ‘offshore’ investments. There is an increased emphasis on transparency and cooperation between governments. Extensive tax reforms are emerging from many countries, including the Foreign Account Tax Compliance Act (FATCA) and Financial Transaction Tax (FTT), and given increasing governmental appetite for tax and transparency, collecting taxes and providing information to governments is now the new normal for asset managers.

Collectively, these trends will drive asset managers towards:

• The continuing establishment of diverse product ranges suitable for investors in a larger number of jurisdictions necessitating each fund structure to satisfy specific tax and regulatory requirements.

• A broader investor base which increases the quantum of tailored tax reporting information to both investors and tax authorities.

• Fund investments in an ever larger range of investment territories, and instruments to improve fund performance in a low growth Western environment, will require funds to consider local compliance, capital gains tax and withholding tax obligations.

We conducted a survey of 30 global asset managers to examine the effectiveness of the industry’s management of tax risks associated with the fund business model. We examined the types of controls in place, the way in which risk is managed, the availability of resources and the use of technology.

Our findings are that the majority of managers are adopting a reactive ad hoc approach, rather than a strategic control based approach, to managing the tax risks associated with the fund business model. We believe this could lead to errors, consequential tax liabilities for the fund, and therefore impact investors. Most asset managers have developed their approach to operational tax risk management over time on an ad hoc basis. And largely as a reaction to external factors including a failure by funds to comply with tax rules leading to severe reputational damage and penalties ranging from fines to fund closure and legal proceedings against directors of fund boards.

This fragmented approach will increasingly become a problem for asset managers who will come under more operational and cost pressure as new financial transaction taxes emerge and plans for the automatic exchange of investor related information between the EU and OECD countries begin to take shape.

3PwC | The asset manager’s new normal

Our findings at a glance

StrategyNearly two-thirds of the industry has no strategic policy for the management of operational taxes. In the new normal, asset managers would benefit from a firm-wide strategic plan to enable them to respond quickly to the pressures coming from investors, legislators and regulators for information and tax transparency. The plan would define the compliance approach, set out roles and responsibilities and provide mechanisms for escalation and reporting.

ResourcesCurrently, the majority of respondents outsource a significant portion of operational tax compliance and monitoring to outsource providers (for example, custodians, administrators and professional advisors), whilst approximately 25% of asset managers have no internal operational tax resource.

Whilst there is a clear move towards having dedicated in-house operational tax resource, we expect the trend to outsourcing to continue given increasing complexity associated with expansion of the numbers of products, investment territories and investors. This view is shared by the survey participants, 60% of whom consider that outsourcing will be the most viable approach to meeting the increasing demands of operational tax management.

ControlsAt present, one-third of the industry has no operational tax risk controls. Of those that do have controls, many are not formalised. Part of the challenge in the effective use of constrained resources is to ensure that procedures are followed in such a way that the focus is on exception management, and that in turn requires that the exceptions have been defined. Formal documented controls not only underpin a robust risk management framework but will be crucial to demonstrating ‘best practice’ to both investors and tax authorities in a future age of greater transparency.

TechnologyTechnology-based solutions will play a central role in the oversight of operational taxes as reflected by the fact that over three quarters of our respondents regarded technology as crucial to the future successful management of operational taxes. The effectiveness of technology will depend on the ability of the industry to develop cost effective solutions which can be integrated into an asset manager’s business process.

ConclusionIn the new normal, asset managers will need to respond to the challenges of greater tax complexity, continuing uncertainty, and greater requirement for tax transparency both tactically, and strategically. And the most successful of these will be those who recognise that taxes that impact the fund business model, are now a critical business risk.

Teresa Owusu-Adjei Partner, PwC


Figure 1: The project blue framework

A changing global landscape

Asset management is undergoing transformational change as its industry and commercial structures are disrupted by the major trends currently reshaping the global economy. To help

our clients to understand, plan and respond to these challenges, PwC has developed a framework that we refer to as ‘Project Blue’1 (see figure 1).

Source: PwC Project Blue analysis

1 Project Blue - www.pwc.com/projectblue

At its simplest, what Project Blue shows is that the challenge of dealing with destabilising factors such as new regulation, currency and sovereign risk and sustained low growth in traditional markets will continue for the foreseeable future. What’s more, the asset management industry is also facing challenges in the form of demographic shift, the rise in power and interconnectivity of the emerging markets, changing investor behaviours and state directed approaches to economic development.

Individually, each of these factors have the potential to significantly impact

both the performance and direction of your funds in the short-term, but collectively they will undoubtedly shape your funds’ long-term future and define the new normal for the industry.

And what is already clear is that in this ‘post financial crisis’ world that we now find ourselves, the industry is facing increased levels of complexity in the taxes associated with the fund business model. And this is impacting not only the funds themselves, but their investors and their investments. In this report, we collectively refer to those taxes impacting the fund business model, distinct from the asset manager itself, as ‘operational taxes’ (see figure 2).

Global Instability – the ‘New Normal’ realities

Living in a ‘Western’ no growth environment

Managing Sovereign and currency risk

Dealing with external scrutinity and social mediaNavigating the ‘moral’ dimensionDealing with new regulation

Tact

ical

m

anag

emen

t

Planning for transformation – the emerging picture

• Economic strength• Trade• Foreign direct investment

• Capital balances• Resource allocation• Population

Rise and interconnectivity of the emerging markets

• Population growth discrepancies• Ageing populations

• Changing family structures• Belief structures

Demographic change

• Urbanisation• Global affluence• Talent

• Changing customer behaviours – social media• Attitudes to financial institutions

Social and behavioural change

• Disruptive technologies impacting FS• Digital and mobile

• Technological and scientific R&D and innovationTechnological change

• Oil, gas and fossil fuels• Food and Water• Key commodities

• Ecosystems• Climate changes and sustainability

The ‘war’ for natural resources

• State intervention• Country/city economic strategies

• Investment strategies• SWFs/development banks

Rise of state-directed capitalism

Str

ateg

ic a

lign

men

t


In order to fully understand how well placed asset managers are to respond to the operational tax implications of the changes affecting their industry, we conducted a survey including 30 global asset managers ranging from institutions with billions of dollars under management through to smaller boutiques.

Unsurprisingly, given the extensive tax reforms that have emerged from many countries since the financial crisis (see figure 3) asset managers told us that dealing with new regulation is by far the highest concern for them. You only have to look at the recent announcement of five EU Governments intending to pilot

Fund

Investments

EU Savings DirectiveFATCAInvestor tax reporting

Fund indirect taxesWithholding tax management Transactional taxesNon-resident capital gains taxes

Investment Manager Exemption monitoringPermanent Establishment risk managementFund tax complianceMonitoring fund residenceCompliance with special funds regime

Figure 2: Our view of the scope of Operational Taxes

Figure 3: Global tax and regulatory changes in 2012

Inv estment ManagerRegime

Capital gains tax

GAAR

FTT

Capital gains tax

FATCA

G-tax reform

Offshore fund reform

FTT; New WHT/CGT rates

New fund reporting

FTT; Increase inWHT rates

New WHT rules/practices

Increase in WHT rates; Stamp duty

FTT

Increase in WHT rates

New capitalgains tax

Capital gains tax

FTT Tax discrimination

DT agreements

Changes to IOF

New reporting requirement rules

the automatic exchange of financial information, the introduction of Italian Financial Transaction Taxes and announcements on an EU Financial Transaction Tax regime in quarter one of 2013 to see why.

Even if asset managers do not change their investment products or their investor bases, these changes highlight the need for asset managers to have an agile operations function that can react to the broad range of new taxes and regulations affecting their businesses in a way that is both cost effective and protects the firm’s reputation.

In recent years, funds have suffered the embarrassment of having to republish German investor tax reporting figures, experienced a pricing impact on Net Asset Value (NAV) for previously unrecognised foreign tax exposures, have suffered fines for failures to comply with local transaction tax rules and had to manage the consequences of inadvertently becoming tax resident in a foreign territory. Some directors of funds have also faced the difficult prospect of legal proceedings against them in countries like France, Germany, Italy and Spain as a result of the failure of their funds to comply with local tax rules.

Against this background, we examine the current effectiveness of the asset management industry’s operational tax compliance through the types of controls in place, the way in which tax risk is managed, the availability of resources and the measurement of performance. Our report also considers how effective these approaches are likely to be in the new normal.


What do asset managers mean by operational taxes?

At the beginning of this report, we defined ‘operational taxes’ as being those taxes impacting the fund business model, including the funds, their investors and their investments.

We asked the survey participants whether within their firm all taxes associated with the fund business model were regarded as operational taxes, and therefore within the remit of the function or person with ultimate responsibility for managing them.

On investor-related taxes, the majority of survey participants reported that the various types of information reporting to tax authorities and investors are treated as an operational tax matter within their firm (see figure 4). There was still a significant minority, of approximately 20%, that did not agree.

Figure 4: Issues affecting investors – which ones are considered operational taxes by asset managers?

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Investor taxreporting

EU savingsdirective

FATCA

On fund- related taxes, given the potential downside risk and contrary to our expectations, less than half of all respondents shared the view that fund residency tax risks are operational tax matters (see figure 5). As we explore later in this report, we think that if these tax risks are not managed in an

integrated way in an organisation, it potentially leaves some funds open to material tax exposures that have far greater negative consequences than any of the investor or investment level tax risks.

Figure 5: Issues affecting investments – which ones are considered Operational Taxes by asset managers?

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Fund taxcompliance

Compliance withspecial funds

regime

Monitoring fundresidence

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The omission of some taxes from the scope of operational taxes is perhaps the most surprising result of the entire survey. Overall, only a minority of respondents stated that all taxes impacting the fund business model are treated as operational taxes in their organisation. This suggests that the majority of

Figure 6: Issues affecting investments – which ones are considered operational taxes by asset managers?

firms do not take a holistic approach to managing the tax risks associated with the fund business model, which could lead to errors, consequential tax liabilities for the fund, and therefore impact investors.

0%

20%

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60%

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100%

Withholding taxmanagement

Transactional taxes Non-resident capital gainstax

Fund indirect taxes

On investment-related taxes, the respondents broadly reported that withholding taxes, transactional taxes and non-resident capital gains taxes are all operational taxes (see figure 6). This result is consistent with our experience that identifying and quantifying foreign transaction-related tax exposures as a result of a fund’s investments has received greater focus since the introduction of US accounting disclosures under FIN48 (now ASC 740-10). The introduction

of FIN48 led many funds to recognise potential foreign capital gains tax liabilities in countries such as Spain, Australia and China for the first time, which in some instances led to a material pricing adjustment.

Given this experience, we expected a higher proportion of respondents to report that foreign capital gains taxes are treated as an operational tax matter within their organisation.


What is the new normal for the asset management industry?Increased competition, the globalisation of asset managers, and external tax and regulatory pressures will have touch points throughout the fund business model that affect each fund, its investors and and its investments.

The investor base is becoming increasingly global and the information reporting obligations even for business as usual are becoming increasingly complex. The new normal for tax will also be driven by the increase in the

number and type of fund products that will be offered by asset managers to ensure that they have investment products to meet all their investors’ needs.

Overall, we believe that the new normal in tax for asset managers will involve dealing with a much broader range of tax obligations and risks in more jurisdictions and at all levels of the fund business model. In the following section we outline some of the key challenges that managers will need to plan and respond to.

Fund

Investments

Reporting on investors to increasing numbers of tax authorities

Increased tax transparency and global information reporting obligations

Dealing with many new taxes from a rapidly changing investments landscape

Managing increased fund tax risks from a more diverse product landscape

Figure 7: Our view of the new tax normal for asset management


Reporting on investors to increasing numbers of tax authorities

Trend Issue Our view

Drive towards transparency and information exchange

Tax authorities continue to combat under reporting of income by some taxpayers and in particular, the use of ‘offshore’ investments. Transparency and cooperation between governments to enforce compliance is now common place and this has put pressure on territories with strict confidentiality regimes such as Liechtenstein and Switzerland who have now entered into various forms of disclosure agreements.

FATCA is also currently at the forefront of the industry’s mind, and it is likely that this is the first of many new data requirements in respect of investor identification. The recent announcement by the Governments of France, Germany, Italy, Spain and the UK to develop and pilot multilateral tax information exchange is testament to this. Furthermore, there is the prospect of the OECD’s Treaty Relief and Compliance Enhancement (TRACE) project which aims to simplify withholding tax relief at source on portfolio investments but will also require information to be collected and reported in respect of investors.

Since 2009, the UK, German and Austrian tax reporting regimes have all either significantly changed their investor reporting regimes or introduced proposals to effect such change. In addition, Italy and Sweden have, for the first time, introduced a form of reporting on investors. Outside of Europe, US investors continue to require their own specific reporting in the form of K-1s.

Asset managers need to balance the mandatory information gathering obligations with a desire to provide high quality customer service that is not so onerous as to deter investors.

Managers need to take a more strategic view of the data requirements for potential new information reporting regimes to try to reduce future implementation costs. Project Blue highlights why it is important for firms to look beyond the short term transactional challenges when addressing operational tax risk.


Increased reporting of tax information to investors in multiple jurisdictions


Increasing investor taxation leading to a focus on after-tax investment returns

Since 2008, many countries have attempted to attract business by lowering corporation tax rates while increasing personal income tax rates to balance fiscal budgets. As a consequence, the importance to investors of the distinction between capital and income returns for their personal tax position has increased.

We anticipate the continuation of this trend as investors continue to demand detailed information to enable them to maximise their after-tax investment returns. This includes requiring a fund to enter into a tax reporting regime or provide transparent tax reporting to give the investor access to a lower tax rate or better tax treaty access.

Greater levels of information required by investors

Major investors, particularly those from the emerging economies and well informed institutional investors are increasingly asking more sophisticated questions before they will commit capital.

The impact of technology and social media, coupled with increasing demands for greater transparency will inevitably increase the extent to which all investors (including retail) start to focus on the tax impacts of their investments.

Asset managers are increasingly providing data rich mobile applications that offer real time information to give them a competitive edge and provide a platform from which to showcase their firm’s products. In time, we predict that this will need to include tax information and will be particularly important as the use of fund platforms increasingly provides an opportunity for funds to broaden and maximise the distribution potential of their investments.


Managing increased fund tax risks from a more diverse product landscape


Proliferation of products In the new normal, we anticipate continued product proliferation with a rise in the number and type of local products as asset managers aim to ensure that they have a diverse product range suitable for investors in a larger number of jurisdictions.

We anticipate that AIFMD and FATCA will create further disruption to fund product ranges. And with increasing investor appetite for a more diverse range of funds and changes in the associated regulatory regimes, we expect to see the number of fund products per manager continue to rise.

Investor demand for more sophisticated products

In the new normal, increasing investor sophistication, access to information and a need to supplement pension plan shortfalls has led to a greater demand for products that offer both diversified risk profiles and types of return.

UCITS III brought about a significant change for European funds by allowing structured products to avail themselves of the UCITS brand whilst investing in a more diverse range of instruments that were historically reserved for so called sophisticated clients investing in alternatives.

The trend towards the ‘retailisation’ of alternatives will continue as retail investors turn to alternative products to generate returns in volatile markets. Some governments have reacted to these market trends by developing new investment fund types, including the UK’s Tax Transparent Fund regime and Ireland’s launch of a new listed fund vehicle, which is suitable for US investors.

As a result of targeting a broader group of investors, managers need to consider the tax and regulatory consequences of a particular type of product in the context of this more diverse range of investors.

Expansion into the emerging markets

Outside Europe, the resilience of Asian economies through the financial crisis and their rising middle classes has led to substantial increases in Assets Under Management (AUM) in the region. In response the finance ministries of the Asia Pacific Economic Cooperation countries issued a joint announcement in 2012 supporting the establishment of a pilot Asia region fund passport scheme. The aim is to launch a pilot scheme later in 2013. Once introduced, asset managers are expected to introduce an Asian product that is recognised and suited to the Asian market.

The question remains whether the governments in other emerging economies such as Brazil, Russia, India and China will use tax or regulatory policy to promote local funds at the expense of foreign funds.

The expansion of asset managers into new investment territories and new markets is anticipated to lead to a significant increase in the number of fund products and investment structuring entities. Every new fund or investment structure has associated tax compliance obligations and filings and this must be understood and monitored.

In addition, each foreign fund or entity must be monitored to ensure that it remains taxable on its profits only in its home jurisdiction. This ensures that the fund maximises its tax efficiency for investors.

Two thirds of our survey respondents already have more than six fund domiciles and out of those asset managers, over 90% have some form of specialist in-house operational tax resource (see figure 8). The requirement for dedicated operational tax resource is expected to increase as asset managers launch funds in new jurisdictions to attract new investors.



An increasingly connected and mobile workforce

The tax risks to which a fund is exposed will become more acute as the industry becomes increasingly globalised and technologically connected.

There are very real risks that traders could potentially create a taxable permanent establishment in a foreign jurisdiction if they trade using devices such as smart phones and iPads whilst travelling abroad.

Similarly, in the drive to attract new investment, investor relation teams are increasingly travelling to territories for extended periods to enter into contracts with investors.

Asset managers need to implement effective controls to manage and mitigate these types of tax risks without them becoming commercially prohibitive.

Figure 8: Operational tax resources compared to number of fund domiciles

< 5 6 to 10 > 110%

Number of fund domiciles

Num

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of r

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10%

20%

30%

40%

50%In-house team with at least one person dedicated to operational taxes

In-house tax function with shared responsibility for operational taxes

Single in-house tax specialist covering all areas

No in-house operational tax resources

There are very real risks that traders could potentially create a taxable permanent establishment in a foreign jurisdiction if they trade using devices such as smart phones and iPads whilst travelling abroad.


Dealing with many new taxes from a rapidly changing investments landscape


Increased competition forcing fund managers to invest in a wider range of territories

Increased competition and pressure to deliver strong fund performance is requiring funds to invest in a broader range of instrument types and in new emerging market territories.

Each new instrument may impact on the reporting required to investors. Each new investment jurisdiction brings its own level of compliance to understand and comply with; each of which carries a reputational risk if an error is made.

Tax is becoming an increasingly important key factor to be considered when making an investment and we anticipate that asset managers will seek to ensure that tax is better integrated into the portfolio management process to ensure that the investments generate the best post-tax returns.

For example, under the current proposals for a EU Financial Transaction Tax, the cumulative impact of the tax on portfolio transactions could eliminate returns for money market funds and mean that they are no longer viable products when compared to bank savings accounts and insurance contracts.

Our survey results show that most of the respondents already invest in more than 60 territories. We anticipate that most asset managers will significantly increase the number of territories that they invest in which in turn, will also trigger the need for more dedicated tax resources.


Who is currently responsible for operational taxes?

As we expected, our survey shows that, at present, asset managers take different views as to which function should have ownership for operational taxes (see figure 9). For 20% of the industry, it is either Fund Accounting or Finance that has overall responsibility for operational tax. Over time, and given the increasing level of complexity surrounding operational taxes, most firms will need to consider whether finance, fund accounting or even tax are in fact the most appropriate functions to manage operational taxes in the new normal.

As indicated in the previous section we anticipate that in the new normal, increasing numbers of governments will legislate tax rules that have broad operational impacts and as a result we expect the trend will move towards operations taking management responsibility for operational taxes with support from an internal operational tax function.

As the likes of FATCA and Financial Transaction Taxes begin to have an impact, asset managers are beginning to make this transition. While both are derived from tax legislation, asset managers have recognised that they each have an operational impact on almost every part of their business. And as such, for most asset managers, it is the operations functions that are taking the lead in implementing a firm’s compliance with the tax rules, supported by the tax function to provide technical insight and analysis.

It is interesting to note that where survey participants responded that their tax function was responsible for the operational taxes, they were more likely to include all of the operational taxes within their remit of responsibility. This suggests that where operations or other non-tax functions are ultimately responsible for operational taxes, asset managers might benefit from creating a strategic partnership between the tax function and other functions over the management of operational taxes.

Figure 9: Who is ultimately responsible for operational taxes?

Fund accounting17%

Operations37%

Other10%

Tax33%

Finance3%


How are asset managers currently managing operational taxes?Most asset managers have developed their approach to operational tax management over time and on an ad hoc basis as a reaction to a series of external factors that have necessitated short term change.

It is clear from our survey that there is not a single approach to the management of operational taxes and, that each firm’s overall approach depends on its size, investors, products, investment strategies and global reach, as well as its history. In order to be able to gain meaningful insight, our survey focused on the operational taxes strategy, the use of internal and external resources, the risk control framework and the use of technology at each asset management firm.

The strategic approachGiven the dynamic and global nature of the industry and governments increasing appetite for tax and transparency, it is important for asset managers to have a strategic policy in respect of operational taxes. In the absence of a strategy that defines success, it is difficult to implement, monitor and report on the processes required to manage operational taxes. This may in turn make it difficult to react to emerging taxes and information reporting obligations in a co-ordinated and cost effective fashion.

The reality however is that 63% of respondents have no strategic policy on operational taxes (see figure 10) which suggests that managers are exposed to risks that are not clearly defined and deal with change as a reaction to short-term pressures.

Figure 10: How do asset managers strategically approach the management of operational taxes?

General operational management linked to a strategic policy, 23%

No strategic policy, 63%Objectives for each

transaction/process linked to a strategic policy, 14%

Managers are exposed to risks that are not clearly defined and deal with change as a reaction to short-term pressures.


Our experience shows that the successful management of operational tax risk can be optimised through the use of an appropriate risk control framework. We believe that firms should implement controls to monitor operational tax risk on an ongoing basis and that these controls should be formalised with documented responsibilities and procedures to enable resources to focus on exception management. Control objectives should be defined, for example, lowest cost of compliance or lowest risk of error, and resources identified to manage that process.

The figure below illustrates that, at present, a third of respondents indicated that they have no operational tax

controls in place whilst another third rely on periodic reviews. These results suggest a recognition of the importance of controls but whilst they may be in place, the way in which they are implemented limits any form of effective monitoring. As the operational tax debate heightens we expect to see CEOs and fund boards place an increasing level of focus on reputational risk in the new normal. And that this focus will be a key influence on those asset managers without any formalised operational taxes controls to implement some form of periodic review as a risk control. At a minimum, this may start with an extension of the FIN48 reviews previously discussed that are already adopted by hedge funds and others that prepare accounts under US GAAP.

Figure 11: What are the characteristics that define asset managers’ controls over operational taxes?

Robust design of an internal control framework that is aligned to operational risks, 20%

A risk based approach toperforming regular independent assurance, 27%

None of the above, 33%

Risk monitoring framework with key metrics and indicators to identify measure, monitor and escalate risks, 20%


Whilst the alternatives industry has proved that periodic reviews are helpful retrospective studies to quantify exposures and learn from mistakes, there is only limited benefit in a retrospective view. A firm’s operational tax strategy can only deliver value for funds, and therefore investors, if it embodies controls that are forward looking and allows the asset manager to identify issues and address them before they materialise and result in damaging consequences for funds and their investors. However, transactional controls

Our survey respondents also showed that at present, for most, the effective management of operational taxes is not measured or linked to performance metrics or remuneration (see figure 12). Our conclusion therefore is that for now, there is little incentive for the responsible function in most asset managers to implement an operational tax risk management strategy.

In-house resourcesIn contrast to banks and insurers, asset managers have historically had relatively small numbers of dedicated tax resources and these resources have been focused on the tax affairs of the asset manager itself, rather than on taxes related to the fund business model. Tax and specifically operational

that identify errors as they occur can limit risk and protect an organisation’s reputation. Our survey results confirm that organisations with more specialist operational tax resource already have some form of operational tax risk controls in place. We expect increasing numbers of asset managers with complex businesses multiple product types and investments in a large number of territories to introduce transactional controls that are subject to ongoing monitoring linked to an operational taxes strategy.

tax resource across the asset management industry varies with the size and complexity of a business. Our survey showed that almost 20% of asset managers have no in-house tax resource at all whilst 50% have fewer than 10 people in their global tax function. In the past, asset managers had little reason to focus their limited tax resources on operational taxes, therefore understandably, only 60% of the industry has dedicated operational tax resources. The remaining 40% either have no tax resource at all, or have a single tax specialist that is charged with managing both the asset manager’s tax affairs and those of their products (see figure 13).

Figure 12: How do asset managers measure operational tax management performance?

It is part of the responsible function's performance metrics18%

The personal reward of the person with ultimate responsibility for operational taxes includes an element for their successful management15%

The e�ective management of operational taxes is not measured or linked to performance metrics or remuneration programs67%


Figure 13: Operational tax resources compared to total size of tax resources

Given the potential reputational damage, it can be argued that product tax risk already outweighs the tax risk faced by management group entities and therefore having the right resources is a necessary cost of doing business. For example, an enquiry and fines levied by a tax authority on a fund manager’s corporate tax return may not be apparent to the investors while a fine on an investment fund will impact the NAV of the fund. As a result, firms are now starting to question how scarce tax resource should be split between managing the tax affairs of the asset manager and managing the more complex tax affairs associated with their products and, to what extent tasks should be outsourced.

Over the last five years, we have seen some of the larger asset managers strengthen their in-house tax resources; with the largest tax teams reallocating part of their resources to operational taxes. Smaller asset managers are also beginning to recruit employees with a focus on operational taxes.

Given, we do not expect that the pace of change in product-related tax developments to slow over the next few years, it therefore seems reasonable to conclude that all asset managers will need to strengthen their operational tax resources as the industry moves towards the new normal, either by recruiting dedicated in-house operational taxes resources, finding other resources in-house or through more effective outsourcing arrangements. For those that recruit new in-house resource, the challenge will be to locate the best people from a small resource pool.

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In-house team with at least one person dedicated to operational taxes

In-house tax function with shared responsibility for operational taxes

Single in-house tax specialist covering all areas

No in-house operational tax resources


Most asset managers already outsource a number of everyday product tax functions. This is particularly the case where reporting obligations require the collation and analysis of large volumes of data. Understandably, data intensive tasks,

Similarly, investment level operational taxes are highly data intensive and require local specialist expertise. As a result the industry has moved towards outsourcing the associated tasks to access that expertise (see figure 15).

This trend will continue as fund managers look to more diverse countries for investment opportunities. This presents asset managers with the challenge that they cannot have specialists in every country where they invest or distribute their products, but must understand and comply with the tax obligations in order to ensure that the post-tax investment return is maximised for investors.

such as investor tax reporting and the EU Savings Directive, are currently outsourced by the majority of asset managers (see figure 14).

Figure 14: Operational tax issues affecting investors – which ones are outsourced?

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Investor tax reporting EU Savings Directive FATCA

Figure 15: Operational tax issues affecting investments – which ones are outsourced?

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Transactional taxes Fund indirect taxesNon-resident capitalgains tax

Withholding taxmanagement

External resources: Outsource providers


Most asset managers try to manage this by relying on custodians that use their network to ensure compliance with withholding and transactional taxes, and professional services firms that have local specialists and the ability to provide resources to suit demand. Most asset managers are trending towards the use of in-house resources for less data intensive but more complex tasks such as fund tax residency risks.

In all outsourcing models best practice suggests that oversight and ultimate responsibility should be retained in-house to ensure the approach taken is consistent with the manager’s desired approach (for example, ensuring the custodians have applied the correct rate of withholding tax).

However, the results of our survey showed that a significant minority of asset managers attempt to outsource the management of these tax risks (see figure 16). For most businesses, the responsibility for ensuring that the activities of the traders and marketing teams do not create tax residency risks is better placed in-house close to the business teams to monitor and react quickly to potential issues.

As tax law and business complexity increases, asset managers will need to increase the amount of resource allocated to the oversight of their custodians. This may be through a combination of technology to review their work, internal reviews or independent reviews.

Figure 16: Operational tax issues affecting funds themselves – which ones are outsourced?

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Compliance with special

funds regime

Fund tax compliance

Monitoring fundresidence

Investment manager

exemption monitoring

Permanentestablishment risk

management

Best practice suggests that oversight and ultimate responsibility should be retained in-house.


TechnologyGiven the need to identify and manage tax risks on a timely basis, and the amount of data associated with this task, it is almost inevitable that technology-based solutions will play a central role in the oversight of operational taxes in the new normal.

Technology solutions are of course more effective when they are integrated into the business processes as they can provide cost-efficient oversight through monitoring tools to flag issues or reporting tools to produce tax reporting figures in a timely and efficient way. Unsurprisingly, given the prospect of new taxes and more reporting obligations in the new normal, 60% of asset managers consider the role of technology to be important and this figure rises to 76% when respondents were asked to consider the future importance of technology in the new normal (see figure 17).

For example, it is unlikely that asset managers will be able to meet their funds’ obligations under the European Financial Transaction Tax, without some investment in technology.

This will represent a marked shift in how transaction taxes are currently managed by asset managers.

Figure 17: The importance of technology on the management of operational taxes now and in the future

Now In the future

Very important

33%

Not important

20%

Notimportant at all

20%Quite important

27%

Very important

45%

Not important

10%

Not important at all

14%

Quite important

31%

It is unlikely that asset managers will be able to meet their funds’ obligations under the European Financial Transaction Tax, without some investment in technology.


Conclusion

There is no question that the new normal creates both operational tax opportunities and challenges for asset managers. In the new normal, successful asset managers will rise to the challenges of greater tax complexity, continuing uncertainty, and greater requirement for tax transparency both tactically, and strategically and will recognise that taxes that impact the fund business model are now a critical business risk.

Many asset managers are grappling with the issue of how they can evolve to meet changing business requirements and develop a sustainable operational tax risk management framework.

In our view, an agile asset manager should be able to identify all potential operational tax risks, proactively assess their impact on the organisation, provide insight to facilitate management decision-making and implement practical solutions that embed risk management practices whilst optimising the use of their resources.

We suggest that a starting point may be for asset managers to ask ‘What does good look like in the context of an operational tax risk management framework?’ and to benchmark their key capabilities and strategy against best practice as illustrated in figure 18.

Poor Fit for purpose

Needs improvement

Leadingclass

Strong

Tec

hnic

al

com

pet

ency

Ris

k m

anag

emen

t

The majority

Key capabilities

The minority Desired state

Issue management and resolution

Education and advisory

Design and specification

Proactive oversight

Figure 18: How are you managing your operational tax risks?


Authors

Teresa Owusu-Adjei

Partner

+44 (0)20 7213 3302

[email protected]

Rob Bridson

Partner

+44 (0)20 7804 7590

[email protected]

Elizabeth Stone

Partner

+44 (0)20 7804 9678

[email protected]

James Stewart

Senior Manager

+44 (0)20 780 41401

[email protected]

Asset managers can then use the results of such benchmarking to define their own risk tolerance and risk strategy; specifying and designing a risk management framework which embeds the requisite degree of proactive oversight, issue management and resolution.

Critical to the success of the implementation and running of a sustainable risk management framework will be agreement on the key principles that underpin the risk management framework (for example, the degree of transparency, level of analysis and insight, use of resource etc.), the extent of the integration of the tax function with the wider business, the cooperation and buy-in from the business, and crucially, the active participation and sponsorship of senior management and other key stakeholders.

www.pwc.co.uk/operationaltaxesPwC UK helps organisations and individuals create the value they’re looking for. We’re a member of the PwC network of firms in 158 countries with more than 180,000 people committed to delivering quality in assurance, tax and advisory services. Tell us what matters to you and find out more by visiting us at www.pwc.com/uk.

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2013 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.

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