15 July 2013

Taxand: AIFMD - The positive and negative tax implications

The AIFMD does not primarily address tax, but will have significant tax implications. While implying changes to the way alternative funds are managed, where they are managed and multiplying the cases where management is not located where the fund is, the AIFMD triggers inconsistencies with tax provisions that remain national.

The key elements of AIFMD provisions that should be noted are:

Place of effective management, tax residency and substance

In international tax law, the “place of effective management” test is used to allocate the tax residency of a company to one country or the other. A (de facto) delegation of core decision-making - e.g. regarding investments of the fund to managers located abroad - can elicit another country claiming tax residency of the fund and/or the Alternative Investment Fund Manager (“AIFM”), potentially creating unpredictable tax claims because of dual tax residency of the fund and/or the AIFM. Alternatively, the country from which a fund is effectively managed could also consider the fund or its AIFM as a permanent establishment in its state, which would trigger partial income taxation.

Transfer pricing: decision-making and allocation of risks

For existing fund management companies, the increased number of functions will lead to revised remuneration models. According to the OECD Transfer Pricing Guidelines [§1.49], the allocation of risks is largely based on the capacity of a company to make decisions. Consequently, most risk related to the management of the funds will be allocated to the AIFM’s, which have to be adequately remunerated for bearing the risk. Existing remuneration models for fund management companies will have to be adjusted to include higher profit margins for AIFM’s to reflect the increase of risk.

VAT issues

From a VAT perspective, the AIFMD brings an extension of the scope of the VAT exemption that is applicable to the management of investment funds. The Luxembourg VAT legislation will be amended to include management services rendered to AIFs as a part of the VAT exemption. The scope of the exemption should include management functions of AIFs such as portfolio management and administrative functions. VAT shall, however, apply on most deal costs and may not be recoverable. The design of service flows should take into account the nature and VAT treatment of services as well as the right to recover input VAT of the entities concerned.

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