As the dust settles on the recent G7 announcement the analysis turns to the winners and losers from the deal. The FT highlights that the UK Treasury is fighting for a financial services exemption which, to date, had meant investment managers and other financial institutions could turn a blind eye. Has anything from the weekend’s announcement changed this?
Well, the G7 agreement is high-level and at just 150 words the missing detail can only be inferred from the earlier OECD Blueprints published in October 2020 and the recent correspondence between the US Treasury and the OECD/Inclusive Framework. We provide more detail on the agreement in a separate article on the subject, as this piece is focussed on what the OECD Blueprints tell us about how the rules may or may not apply to investment managers. The conclusion of which looks set to become more political than anticipated given the recent coverage by the FT.
By way of recap, although the weekend's headlines focused on a global minimum tax, the agreement was twofold and in line with the approach the OECD has set out in its Blueprints (Pillar 1 and Pillar 2). This analysis covers both:
- Pillar 1: a new taxing right for market jurisdictions; and
- Pillar 2: a global minimum effective tax, the G7 suggest at least 15%.
The original Pillar 1 proposal set out by the OECD targeted certain “digital” and “consumer-facing” businesses. Under the rules, these industries would have been required to re-allocate a certain amount of profit to the jurisdiction where their consumers or users are based. The Blueprint acknowledged that there were certain sectors where the policy challenges of the digitalised economy were not present and paragraphs 135–140 of the Blueprint set out the detailed rationale for an exemption for asset management businesses. However, recent developments have created some uncertainty about whether the exemption will hold.
In April 2021, the US pushed back on the design of Pillar 1 citing two reasons. First, it could not accept a measure that was discriminatory towards US firms and second, the complexity of the proposal was a potential barrier to its successful implementation. Instead it proposed a non-sector approach by designing new quantitative scoping criteria to bring in only the largest and most profitable MNE groups, and in particular, sought to limit the measure to just 100 businesses. It appears that the G7 have shifted towards these revisions, but crucially, the G7 deal is silent on how many businesses are in scope and whether the exemptions still apply. In the absence of an exemption for investment management businesses, the industry would need to monitor where this threshold is set and how the profit margin test is ultimately calculated.
Of course, a clear industry exemption would be preferable. If sector based exemptions do exist it is likely that they will be established on clear principles or as the US suggests “irresolvable administrability constraints”. The investment management industry has a good case to be made here. Including the industry within the scope of the rules feels detached from the original impetus of the rules which came as a result of concerns about tech and branded goods. Furthermore, it is not clear who the consumer is in an investment management context. Presumably this is the investor but, does this fit neatly with the original policy rationale? There are also a number of practical reasons as to why investment managers should be excluded. Sufficient access to information about investors to determine their location to allocate profit accurately would be difficult for privacy and regulatory reasons, and furthermore investors move in and out of funds meaning the investor base is in constant flux. Most, but not all jurisdictions represented at the OECD/Inclusive Framework accepted this position and as a result Pillar 1 had largely been discounted in its relevance to the industry (with the exception of its application to portfolio companies). The industry will need to await the next round of negotiations to see if the exemptions withstand the scrutiny.
The Pillar 2 proposal, to introduce a global minimum tax rate through a number of mechanisms, received more attention from the industry in the initial phase of consultation due to the risk that it undermined the established principle of tax neutrality for collective investment funds and lead to a duplicative layer of taxes borne by investors (as compared to if they had invested directly). However, when the Blueprint was published it was clear the OECD understood the implications and proposed investment funds and asset holding vehicles owned directly or indirectly by the investment fund should be excluded from the scope of the minimum tax (portfolio entities would be potentially caught if they meet the threshold requirements). Based on recent press reports it appears that this exemption may also come under increased scrutiny and its survival will be subject to the outcome of the forthcoming negotiations.
If the excluded entities exemption does not survive then the implications for the industry would depend on whether the group breaches the proposed consolidated revenue test (€750m). If the threshold is passed, the other important aspect will be to understand how the effective tax rate is calculated in particular the treatment of distributions in the income inclusion rule and the payments of interest in the subject to tax rule to fully appreciate the implications for the industry.