Funds industry experts gathered in São Paulo and Rio de Janeiro to discuss the pain points that local asset managers in Brazil are suffering. Jon Roney, Director of Fiduciary Services at Intertrust, rounds up his observations.
The elephant in the room? The UBO issue.
It was clear from the start that the UBO issue – in essence, the Brazilian IRS’s requirement to look through structures for Brazilian UBOs – was top of mind. This initiative is driven by the concern that taxable gains are not being properly reported.
I can imagine critical eyebrows arching at this point. At least initially, this doesn’t appear to be a governance drive similar to Cayman’s regulatory environment experience, but it would be impossible to write this article without devoting a few column inches accordingly; this topic is as hot as a Brazilian summer. At this point I’d like to remind readers that the Cayman funds industry is founded upon two basic tax principles: tax neutrality and tax transparency.
Tax neutrality is the concept whereby a collective investment vehicle is established in a tax neutral jurisdiction, such as the Cayman Islands, allowing global investors to aggregate capital without the need for complex and costly tax advice and structuring considerations. In terms of transparency, Cayman is a model 1 jurisdiction for the Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS). Accordingly, the directors of Cayman funds are responsible for reporting taxation information on each investor to the Cayman Islands Tax Information Authority (CIMA) who in turn report the investors’ taxation information to the relevant countries’ tax authorities. The important consideration here is that the taxable gains are reported to the jurisdiction where the investor is tax resident.
The disappointing point from a Cayman perspective? The introduction of CRS reporting was specifically established to address this issue. And as Cayman is on the Brazilian blacklist, the Brazilian IRS is imposing a different standard in Cayman funds than those based in Canada or Delaware.
Somewhat unsurprisingly, for an industry renowned for innovation, managers are looking at addressing the issue in a number of novel ways:
- Investor look through: Identifying the tax residency of all the investors in your fund, which can be tricky. Especially where fund of funds or pension funds are the investors and the IRS requires you to look up and through to the ultimate beneficial individuals.
- Jurisdictional switch: Other managers are looking to structure their new products and re-domicile their existing funds in jurisdictions that don’t suffer the Brazilian black-listing, but do enjoy the same tax neutral status as those in Cayman. Issues however remain, like the lack of jurisdictional familiarity, quality of service providers, speed to market and, most worrying of all, the concern of doing business in a less regulated market resulting in less protection for investors.
Investors seeking independent directors
A number of asset managers, noticeably the larger ones, are reporting that their institutional investors expect to see independent directors on their boards. This is a much more common expectation in North America where it would be uncommon to find a hedge fund without independent representation. As investors become increasingly global and governance standards homogenize, Brazilian asset managers are increasingly seeking independent directors for their offshore boards.
Increasing Cayman Regulations
In response to international organisations such as the Organisation for Economic Co-operation and Development (OECD) and the Financial Action Task Force (FATF), Cayman introduced a raft of legislative changes to remain at the vanguard of cooperative jurisdictions. In fact, as recently as July, the OECD announced that Cayman’s tax neutral regime was not harmful to other jurisdictions, evidencing the country’s willingness to work with the international community. Some of the key legislative and regulatory changes are:
- beneficial ownership reporting
- FATCA/CRS reporting
- Anti-Money Laundering (AML) officers and associate reporting
- Economic substance
- Data Privacy legislation
- CIMA penalties and fines regime
Asset managers rightly observe that the risk of inadvertently breaching a rule has never been higher. Couple this with CIMA’s fines regime, the cost of non-compliance has increased appetite for Cayman based (independent) directors to ensure the board had the necessary skillset to comply with all the changes.
As for future regulatory changes on the horizon, many managers sought confirmation whether CIMA would commence regulating close-ended funds. It’s important to note CIMA has not yet officially stated that this fund class will become regulated, but the industry does believe this to be the case and I suspect we’ll learn more in the coming months.
Outsourcing of non-core operations
Another trend discussed was the increased appetite for outsourcing non-core functions. These included requests for fund administration, mirror accounting, AML only services, director services, board support services, cyber and compliance services. Managers are less and less willing to tie up valuable internal resources on non-investment management (fee earning) business.
On the one hand, Cayman finds itself in a difficult position with the Brazilian IRS and it’ll likely take nothing less than government to government discussions to understand and address the Brazilian IRS concerns. On the other hand, if these issues can be resolved, Brazilian managers will continue to use Cayman as the gold standard in the funds space with quality service providers to assist asset managers with their governance and outsourcing needs.
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