The Irish Alternative Funds industry – an overview

The Irish funds industry is synonymous with alternative investments, having long been renowned as a domicile for setting up and servicing alternative fund structures. This is evidenced by the growth from €151 billion of alternative assets under management in Irish regulated funds in 2009 to in excess of €751 billion at present. Similarly, in an unregulated context, as of Q4 2019, Irish Special Purpose Vehicles (SPVs) had in excess of €850 billion of assets under management.

As these figures demonstrate, Ireland is home to a mature funds industry and its success is linked to a number of key factors. As well as access to the EU market, which provides a number of regulatory and tax benefits, fund managers can rely on a diverse product suite which can be serviced locally by an experienced 'ecosystem' of high-quality service providers. Furthermore, the Irish tax regime has been, and continues to be, one of the key growth drivers of the funds industry in Ireland.

The strategies housed within Irish alternative funds span hedge funds, private equity, private debt, infrastructure, real estate as well as a significant number of aircraft leasing and shipping funds. The Irish Collective Asset-Management Vehicle (ICAV) and Section 110 company remain the most popular Irish regulated and unregulated structure respectively but we have seen many alternative asset managers utilise lesser known Irish structures of late. In this release, we recap on the current Irish product suite and the tax regime as it applies to the most popular class of Irish investment funds. We also consider the impact that the changing global tax landscape and upcoming unilateral tax reform is likely to have on the Irish alternatives landscape and structure of choice for asset managers going forward.

Popular Irish structures for alternative investments

Popular fund structures in the alternative space include:

Irish Collective Asset-Management Vehicle (ICAV)

Since its introduction in 2015, the ICAV has become the vehicle of choice for alternative fund promoters seeking a regulated vehicle. The ICAV has replaced the investment company or PLC structure as the preferred corporate vehicle for investment funds in Ireland. The ICAV is not a company under the Irish Companies Acts, but rather a corporate entity with its own facilitative legislation that has been drafted specifically with the needs of investment funds in mind.

An ICAV is typically established as an umbrella structure with a number of sub-funds and share classes. Each sub-fund has segregated liability and can provide for differing investment strategies and investor pools. It is possible to prepare accounts on an individual sub-fund basis. This ensures that investors in a single sub-fund of an umbrella with multiple sub-funds only receive information that is relevant to them and allows managers to scale the structure which provides flexibility and economies of scale.

Section 110 (S.110) companies

A S.110 company is a special purpose structured finance vehicle. The S.110 company provides a flexible structure that does not require Irish Central Bank approval. Investors typically invest directly into the S.110 company through individual profit participating notes or through a limited partnership which holds the profit participating note. This structure is widely used by asset managers, international banks, and investment funds for securitisations, investment platforms, CLOs, CDOs, capital market bond issuances and asset lessors. Irish S.110 companies are used extensively in aviation financing, for which Ireland is a global hub.

The ability to operate within an onshore regime is attractive to many asset managers in an environment where there is an increased international focus on tax havens and transparency. As an unregulated vehicle, a S.110 company is cost efficient and can be established within a short time frame.

Limited partnerships

Irish law currently provides for two distinct limited partnerships, those established as regulated investment limited partnerships under the Investment Limited Partnership (Amendment) Act 2020 (“ILP”) and those structured as unregulated limited partnerships under the 1907 Act (“1907 LP”). An ILP can only be established as an AIF and is authorised and regulated by the Irish Central Bank. Both the ILP and the 1907 LP are common law partnerships, typically formed by the execution of a limited partnership agreement, between at least one general partner and one limited partner.

Notwithstanding the aforementioned growth in alternative funds in Ireland, and the increasing allocations towards private assets (which are typically housed in tax-transparent structures), the Irish limited partnership offering has not experienced a level of growth that market trends would suggest. However, the ILP has recently undergone significant legislative and regulatory reform bringing it in line with its international counterparts and it is widely anticipated that the ILP will be particularly popular for private asset managers going forward. Further detail on the recent ILP reform can be found here.

Irish trading company

As outlined below, Ireland applies a corporation tax rate of 12.5% on profits earned in the course of an active business (a trade). In certain cases, the activities and operations carried out in Ireland with regard to underlying portfolio investments may be sufficient to constitute a 'trade' from an Irish perspective. This is aligned with the increased levels of substance which are being inserted by asset managers into the product jurisdiction, typically fuelled by regulatory, operational and tax requirements.

While this structure will not be appropriate for all strategies, a lower statutory corporate tax rate coupled with the reduced quantum of leverage typically inserted into a trading company may be preferable in light of some of the reform noted below. As well as being a viable unregulated alternative for structures which may be adversely impacted by the interest limitation rules, the levels of activity and substance required to constitute a trade from an Irish perspective may also be helpful from a double tax treaty (DTT) access perspective.

Irish-holding company

Ireland is a popular choice for holding companies due to its capital gains participation exemption, generous foreign tax credit system, membership of the EU, wide DTT network and tax efficient repatriation mechanisms. That said, while extensively used by US multinationals and Irish headquartered PLC groups, the structure is less popular in the financial services space due to certain features of the regime. Albeit that, in the majority of cases, foreign dividend income is effectively exempt from Irish taxation through foreign tax credit relief, the calculation of this relief is complex and burdensome to administer. It is particularly difficult to manage with respect to joint ventures, non-controlled shareholdings and income arising from multiple jurisdictions as the information required to compute the foreign tax credit may not be available to the Irish taxpayer. This added complexity acts as a disincentive for Ireland as a holding company location for asset managers in certain instances.

As a result, changes are expected to the Irish participation exemption regime that, if enacted, will offer increased opportunity to use this structure for alternative investments. Further detail on the proposed reform is included below for your ease of reference.

Common Contractual Fund (CCF)

A CCF is a contractual arrangement established under a deed, which provides that investors participate as co-owners of the assets of the fund. The CCF is authorised and regulated by the Central Bank. The ownership interests of investors are represented by 'units', which are issued and redeemed in a manner similar to a unit trust. The CCF is an unincorporated body, not a separate legal entity and is transparent for Irish legal and tax purposes.

As a result, investors in a CCF are treated as if they directly own a proportionate share of the underlying investments of the CCF rather than shares or units in an entity which itself owns the underlying investments. Similar to an ICAV, a CCF can be established as a UCITS fund or an AIF. Tax transparency is a key feature which differentiates the CCF from an ICAV. Over the past three years, assets under management of CCFs have increased by 150% from $40 billion to over $100 billion with $62 billion of assets under management now sitting in AIF CCFs. While the tax efficiencies from pooling assets in this structure can be significant, the structure is more costly to run and only caters for institutional clients, so the suitability of this structure is typically specific to certain fact patterns.

Key features of Irish tax regime

As noted above, the ICAV and S.110 companies remain the most popular Irish regulated and unregulated structure respectively. A high level overview of the Irish tax regime as it applies to these structures is outlined below. In the context of investment funds, Ireland adopts a tax neutral regime, which has been the case since the establishment of the International Financial Services Centre in 1987 and it remains a key driver of the Irish funds industry. Limited partnerships and CCFs are tax transparent from an Irish tax perspective and consequently provide investors with a pooling vehicle that can facilitate a 'bring your own treaty' type model.

The standard rate of corporation tax in Ireland is 12.5% on trading income. A rate of 25% applies to non-trading income and certain trades. However, a special regime exists for investment funds such that they are effectively tax neutral from an Irish tax perspective.

The Irish framework is legislation-based and does not rely on rulings.

ICAV

Irish regulated funds are exempt from Irish tax on income and gains derived from their investments and are not subject to any Irish tax on their net asset value. There are additionally no net asset, transfer or capital taxes on the issue, transfer or redemption of units owned by non-Irish resident investors. Other than in respect of certain funds which hold interests in Irish real estate (or assets that derive their value from Irish real estate), non-Irish investors are not subject to Irish tax on their investment and do not incur any withholding taxes on distributions from the fund provided the appropriate documentation is in place.

Irish legislation provides for the efficient and effective redomiciliation of funds to Ireland. It allows offshore corporate funds from certain prescribed jurisdictions to migrate to Ireland by re-registering as an Irish UCITS or AIF authorised by the CBI while maintaining its legal identity and track record. Funds from the following jurisdictions can re-domicile to Ireland in an efficient manner: The British Virgin Islands, The Cayman Islands, Jersey, Guernsey, Bermuda and The Isle of Man.

An ICAV can make a check-the-box election to be treated as tax transparent for US federal income tax purposes.

S.110 companies

An Irish S.110 company is a special purpose vehicle. It is a standard Irish company which elects into the Section 110 tax regime provided certain conditions to be treated as a "qualifying S.110 company" are met.

The S.110 company is subject to Irish tax at 25% on profits, but when structured correctly, and subject to meeting certain anti-avoidance provisions, profit participating interest payments are tax deductible. Interest payments can also generally be made free of Irish withholding taxes subject to certain conditions being met.

A S.110 company can make a check-the-box election to be treated as tax transparent for US tax purposes.

Other important tax features

Value Added Tax (VAT)

There are a number of other areas within the Irish alternatives industry that facilitate the establishment of an effective fund structure. For example, the provision of management, administration and custody services to an Irish fund is typically exempt from Irish VAT. Management is broadly defined in this context and can create significant efficiencies in terms of how fee flows are directed. Furthermore, to the extent that VAT is charged to a fund, it is possible to recover an element of that VAT by reference to the number of non-EU investments or investors within that fund structure. This regime is applicable to both an ICAV and S.110 company.

Tax treaty network

Ireland has an extensive tax treaty network with over 70 treaty partners. While the availability of treaty benefits in a particular case will ultimately depend on the relevant tax treaty and the approach of the tax authorities in the treaty country, this can often significantly reduce portfolio tax drag.

A changing tax and product landscape

The changing global tax landscape and upcoming unilateral tax reform across multiple jurisdictions is undoubtedly going to have an impact on the product of choice going forward. Given the many challenges facing asset managers in an evolving global economy, the importance of a structure that is both efficient and operationally effective has never been greater. The industry continues to experience new challenges in the form of tax, regulation, technological disruption and volatility in international markets. Some key areas of reform which are expected to impact on the Irish alternatives landscape are set out below.

Domestic legislative reform

The Irish Finance Bill 2019 contained the legislation required to align Ireland's current transfer pricing rules with the 2017 OECD Transfer Pricing (TP) Guidelines and broaden the scope of TP in Ireland. Helpfully, the expansion of the TP rules has not been extended to regulated funds or profit participating loans or notes (PPL or Ns) issued by Section 110 companies thus ensuring that these collective investment vehicles can continue to meet their policy objectives. However, in addition to TP changes, the Bill introduced additional anti-avoidance provisions with respect to Section 110 companies in order to strengthen the existing protections included within the regime. Irish policymakers have been clear in their appreciation of the policy rationale for the need for a tax neutral structure but have sought to implement measures to target aggressive structures so as to ensure the regime is robust and future proof.

The Bill also contained a number of property related measures which are relevant to investment funds which hold interests in Irish property, commonly referred to as Irish Real Estate Funds or IREFs.

EU Anti-Tax Avoidance Directive (ATAD) II – Anti-hybrid Rules

Finance Bill 2019 also introduced anti-hybrid rules into Irish tax law with effect from 1 January 2020. The anti-hybrid rules are very complex and introduce some important new definitions and concepts into Irish tax legislation. In terms of the potential impact of the new legislation on the Irish alternatives sector, the measures which apply to payments under hybrid financial instruments are likely to require consideration for any payments under PPL or Ns typically made by S.110 companies. Further, the most significant impact is likely to be on groups or investment structures where US shareholders or investors are involved, due to the US "check-the-box" elections which can give certain entities (such as an ICAV or S.110 company) a specific US tax designation.

Overall, Ireland has sought to introduce the anti-hybrid rules in a form which closely aligns with the wording of the ATAD II Directive. The rules do not go beyond the requirements of the Directive which is welcome. Furthermore, the fact that the measures have been transposed in a manner which ensures the provisions can interact and coexist with existing Irish tax concepts will likely provide much needed certainty to taxpayers. Notwithstanding this practical approach the complexity of the rules should not be underestimated.

The first tranche of guidance from Irish Revenue has been recently released which provides helpful clarification with respect to the Irish anti-hybrid legislation. Our next release will cover this guidance in detail and the key considerations for the Irish Alternative Funds industry from an anti-hybrid perspective.

ATAD I – Interest limitation rules

The interest limitation rules will be of most relevance to leveraged companies operating in Ireland with a significant annual interest expense (such as an Irish S.110 company). In contrast, the ICAV, being a tax exempt entity (and typically equity funded), does not make tax deductible payments therefore regulated structures are unlikely to be adversely impacted by these rules.

The ATAD provides for a derogation to January 1, 2024 where the existing rules of a Member State are "equally effective" in preventing tax avoidance. Almost immediately, Ireland notified the EU Commission of its intention to avail of this derogation. The EU initially challenged Ireland's basis for seeking the derogation and, when Ireland failed to introduce the rules with effect from the start date of 1 January 2019, the EU Commission issued a letter of formal notice to Ireland requiring the implementation of the measures and has also commented infringement proceedings against Ireland in relation to the delay. 

Interest limitation rules will be introduced in Ireland with effect from January 1, 2022. A formal public consultation process into the implementation of the rules is ongoing and a Feedback Statement has issued which provides some insight into the form and shape of the rules. Draft legislation is expected to be published in the Finance Bill in October later this year. 

Tax reporting or transparency

There are also increased demands for transparency and reporting fuelled by the compliance obligations imposed by FATCA and CRS reporting, and these are likely to grow with the adoption of mandatory reporting of certain cross-border transactions under the EU regime (commonly referred to as DAC 6) this year. Irish Finance Bill 2019 introduced the primary legislation necessary to transpose the provisions of DAC 6 into the Irish tax code. While the Irish legislation has aligned the domestic rules very closely to the DAC 6 Directive, it has introduced some additional clarity by leveraging the definitions contained in existing domestic legislation, relating to the meaning of "tax advantage" and "arrangements". Albeit the legislative clarifications are welcome, considerable uncertainty remains with respect to the correct application and interpretation of the rules, given the ambiguity included within the DAC 6 Directive itself.

Irish Revenue have published detailed guidance notes which provide much-needed clarity with respect to the Irish DAC 6 reporting obligations. The guidance in its current form does not deal with Hallmark C, which relates to cross-border deductible payments between associated enterprises. We understand that Irish Revenue did not want to finalise guidance on Hallmark C until the aforementioned first tranche of Irish anti-hybrid guidance was finalised. Given the prevalence of alternative fund structures that rely on tax deductions to achieve tax neutrality, Hallmark C is a key DAC 6 consideration and the related guidance will be welcome.

Multilateral Instrument (MLI) and the Principal Purpose Test (PPT)

Arguably, one of the most significant changes introduced by the MLI under the BEPS Action Plan is the introduction of a PPT into Ireland's DTTs. Despite the OECD commentary and draft guidance released to address the relevant issues for non-collective investment schemes, significant uncertainty remains, and there is uncertainty in the market about how treaty partners intend to interpret and police the PPT.

In an effort to future proof investment platforms, asset managers have moved to put boots on the ground and establish their substance in the same jurisdiction as their asset owning entities. Ireland's reputation as a hub for alternative investment platforms has proved helpful in this context. Access to EU distribution channels and a well developed ecosystem of servicing capabilities has helped to substantiate the use of an Irish platform in this context.

Participation exemption for dividends

With the introduction of the MLI into legislation, and aforementioned resulting substance and product alignment, a fit for purpose holding company regime is crucial to the continued success of the Irish market. It is necessary that Ireland has a product suite that caters for all asset classes to service the needs of asset managers who are seeking to consolidate their product offering into one jurisdiction. For these reasons, there has been a concerted effort by industry to lobby policy makers to modernise certain aspects of the existing regime. Previously, discussions involving the introduction of a Participation Exemption regime in Ireland were rejected in the absence of any corresponding anti-avoidance rules such as a Controlled Foreign Company (“CFC”) regime or thin capitalisation rules. Given that we have now introduced a CFC regime in Ireland in accordance with the provisions of ATAD, this lack of anti-avoidance position is no longer relevant.  This position is supported by the recommendations set out in the independent review of the Irish corporate tax code carried out in 2017.

On 14 January 2021, the Irish Minister for Finance published an update to Ireland's Corporation Tax Roadmap, initially issued in 2018, following an independent review of the Irish Corporation Tax system. The update to the Roadmap provides an indication of the further actions that will be taken over the coming years and confirms that a consultation on moving to a territorial based system of tax will be held in 2021. This, coupled with the recent ILP reform, will further enhance Ireland’s product offering and ability to service the private equity market. 

BEPS 2.0

Finally, as the OECD continues the development of the 'BEPS 2.0' project, it will be important to monitor how these proposals will impact the Irish funds industry. Based on a two pillar approach, BEPS 2.0. seeks to redefine how taxing rights are currently being allocated, while simultaneously applying a minimum effective global tax rate on groups that exceed certain de minimis thresholds.

As BEPS 2.0. is largely focused on large multinational companies, its applicability in a funds context is yet to be ascertained. Ireland is acutely aware of the potential impact of Pillar 1 given the importance of multinationals and FDI to the Irish economy. As both a multinational and financial services hub, Ireland is uniquely placed to understand how the proposals are likely to impact both sectors. As a result, Irish policymakers are actively engaged in the process and continue to liaise with both industry and their global peers to ensure any proposals are given adequate consideration.

Conclusion

The unprecedented rate of change in the international tax environment is undoubtedly causing headaches for asset managers. While much of the referenced tax reform was not designed specifically to target the alternative investment fund sector, the industry is being significantly affected because of the multi-tiered, widely held nature of investment structures.

Countries such as Ireland need to remain agile and innovative to meet the needs of alternative asset managers while also meeting minimum standards mandated by EU or OECD tax reform. There is no one-size-fits-all approach and now, more than ever, a full suite of products is needed to allow asset managers run different strategies and deals out of alternate and bespoke designed investment structures. We look forward to keeping you up to date as to how Ireland is managing to walk this tightrope in future releases.