Domestic and international legal framework
Collective investment funds take different legal forms and their tax treatment varies from country to country. It is therefore often unclear whether the benefits of tax treaties are available to the funds themselves. Further, the question arises if, where these benefits are not available at the level of the fund, would they be available to the investors themselves to the extent that they are residents of countries which have concluded a tax treaty with the country from which the fund derives income.
In general, domestic lawmakers have dealt with the domestic tax issues arising from Collective Investment Vehicles (CIVs) where the investors, the CIV, and the investment are all located in the same country. In many cases, it is reflected in domestic legislation that sets out conditions for a special tax treatment. Most countries have a tax system that provides for neutrality between direct investments and investments through a CIV. Some countries had started addressing some issues related to CIVs in their bilateral tax treaties. However, cases where the investors, the investment and the CIV are located in three or more different countries remain problematic.
Application of double tax traties to CIVs
On 31th May 2010 the OECD Committee on Fiscal Affairs released the Report “The Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles” which set forth some changes to the Commentary on the OECD Model Tax Convention dealing with the question of the extent to which either CIVs or their investors are entitled to treaty benefits on income received by CIVs. These changes were included in the 2010 Update to the Model. For the purpose of the discussion, a "CIV" was defined as a widely-held fund, which holds a diversified portfolio of securities and is subject to investor-protection regulation in the country in which it is established.
Following the general conclusions, in order for a CIV to qualify for the benefits under double tax treaties in its own right:
- it has to qualify as a person; and
- it has to be a resident in a Contracting State; and
- it has to be the beneficial owner of the income that it receives.
Taking into account the description of a CIV for the purpose of the Report, such a CIV that meets the first two requirements should also be treated as the beneficial owner of the income that it receives. This is the result of significant functions performed by managers of such a CIV and a general position of investors in such vehicles.
A CIV as a "person"
The treatment of CIVs differs substantially from country to country and between various types of vehicles. CIVs take various legal forms: companies, limited partnerships, trusts and contractual arrangements. In many European countries, both joint ownership vehicles and companies are commonly used. In many cases, a CIV is treated as a person for purposes of the tax law of the state in which it is established.
The Commentary of the OECD Model Tax Convention states that the definition of the term “person” is not exhaustive and should be given a very wide sense. To determine whether a CIV is a person, one needs to analyse its legal structure.
Applying the OECD's guidance to the case of CIVs, a CIV structured as a company clearly would constitute a person. The issue may be less clear in the case of a CIV that is structured as a trust. The Commentary provides also the example of a foundation as an arrangement that may fall within the meaning of the term “person” because it is treated as a body corporate for tax purposes. Generally speaking, in the absence of specific provisions, the fact that a CIV is treated as a taxpayer under the tax law of the State in which it is established would indicate that it is a person for purposes of tax treaties.
A CIV as a "resident"
The residency of a CIV for tax purposes is determined by its tax treatment in the country in which it is established, namely its "liability to tax", and not by its legal form. The Commentary points out thet the tax treatment of CIVs that are exempt from taxation depends on how states of their establishment approach the concept of "liability to tax" in case of an exemption. As a result, in some states CIVs may be “liable to tax”, and therefore be residents of a Contracting State, even if that State does not in fact impose any tax on such CIVs. The Commentary notes that some countries would take the opposite view - that an entity that is exempt from tax would not be "liable to tax". Accordingly, if one of the countries involved adheres to such position, it would be prudent to address the issue of CIVs directly in bilateral negotiations.
It should be noted that a CIV that is transparent for tax purposes in the country in which it is established will not be treated as a resident because it is not liable to tax in that country.
A CIV as a "beneficial owner"
CIVs have at times been denied treaty benefits because the relevant source country had taken the position that a CIV can never be the beneficial owner of the income that it receives. The term “beneficial owner” is given the meaning by the law of the country which applies the treaty. Accordingly, a Contracting State might consider itself entitled to decide the question with respect to CIVs investing in that State, even if the country of residence would apply different tax treatment. The Commentary states that broad consensus on this issue was required, and that a widely-held CIV should be treated as the beneficial owner of the income it receives. This is subject to the conditions that the managers of the CIV have discretionary powers to manage the assets on behalf of the holders of interests in the CIV and as long as it meets the requirements of “person” and “resident” in the country in which it is established.
If a CIV cannot claim treaty benefits, then the treaty would have failed in its purpose of eliminating double taxation as investors who invest through a CIV would be put in a possible worse position than if they had invested directly. The OECD has proposed a mutual agreement system which has already been implemented in some countries. The mutual agreement would allow CIVs to make claims for tax relief in respect of investors or obtain a confirmation of the treaty entitlement for the CIV.
With respect to future treaties, the favoured approach is for the inclusion of provisions that treats a CIV as a resident of a Contracting State and the beneficial owner of its income, at least to the extent that its investors would themselves be eligible for treaty benefits regarding the income from the source country, rather than adopting a full look-through approach. However, the question still remains as to whether treaty-eligible residents of third countries should be taken into account in determining the extent to which the income of a CIV should be entitled to treaty benefits. Therefore the new Commentary includes the possibility to adopt a full look-through approach, under which the CIV would make claims on behalf of its investors rather than in its own name.
CIVs in Malta
The Investment Services Act (ISA) establishes the regulatory framework for investment services and for Collective Investment Schemes (CIS) in Malta. A CIS may be set up as: Open Ended Investment Companies (SICAVs), Close Ended Investment Companies (INVCOs), Limited Partnerships, Incorporated Cell Companies, Unit Trusts or Contractual Funds.
A Contractual Fund may also set up a Special Investment Vehicle for the purpose of investing and holding assets on behalf of the fund in accordance with the fund’s deed of constitution and prospectus. This fund would take the form of a limited liability company and is regulated under the same CIS license as the fund itself.
Licensed CISs may choose between two fiscal regimes. A licensed CIS may choose to be exempt from income tax in Malta but, in that case, they cannot avail themselves of Malta's vast network of double tax treaties. However, the exemption does not apply in the case of investment income of a Prescribed Fund. Prescribed Funds are those which have at least 85% of their assets situated in Malta. A withholding tax is imposed on all income derived by these Funds. Capital gains realised by the fund remain exempt from tax in Malta.
The alternative regime is for the CIS to opt to be liable to income and benefit from Malta's double tax treaties. This fiscal regime is more suitable for CISs that invest internationally since it would be entitled to treaty relief as well as other methods of avoiding double taxation.
