Institutional investors, as entities that pool funds in order to invest, have their tax liabilities and risks directly tied to their investment returns. By contrast, some MNEs are less streamlined when it comes to tax policy.
“MNEs can learn from institutional investors. Large corporates are big sprawling flabby companies that act like a group of individuals doing different things within one company. This is because they’re not incentivised in the same way,” said one head of tax at an M&A tax risk insurance provider.
These insurers typically provide cover for companies on unknown or low tax risk issues. This means that the insurers understand the kinds of tax risks that different companies face.
Institutional investors are not alone in this. Private equity funds, real estate funds and any structure where investors must consider tax for the return and for certainty of returns, are more risk-averse as opposed to large companies that look at growth as the cumulative effect for their business and tax is often a secondary concern.
“MNEs are not usually so concerned on potential liquidity events for shareholders and so may prioritise other aspects of their business over maximising tax efficiency,” said Ben Jones, partner and London head of tax at Eversheds Sutherland.
One way to combat this is to create new incentives to drive tax strategy. Institutional investors have to optimise their tax burden precisely because it will directly impact the company’s investment returns.
Such companies use carried interest as an incentive for the tax team to deliver. So tax professionals gain a share of the profits of investments paid to the investment manager in excess of the amount that the manager contributes to the project.
“Investment managers are tied to the tax risks and liabilities in the long-term, whereas tax people in MNEs are separated from the risk once they leave the company and they are not attached to the risk in the same way,” said the M&A tax risk insurance provider head of tax.
MNEs could establish an incentive system where the tax function is rewarded for managing tax risk below an agreed range. However, the tax insurers said that managing tax liabilities is often tied to the understanding of a company’s products.
“It’s an issue of knowledge and awareness. Tax people in the corporates are less aware of their products than private equity or institutional investment,” said one head of tax of a company providing specialist warranty and indemnity (W&I) insurance.
Many MNEs offer a larger volume of products and services and therefore it becomes more difficult to manage. This is further compounded with operations in several jurisdictions, each bringing their own challenges.
“While I do not think that the general approach to tax by financial investors articulated above is limited to indirect tax liabilities, indirect taxes are often either very complex with much uncertainty or are particularly obvious areas of potential tax leakage,” said Jones.
“As these issues do regularly arise, financial investors who have seen such issues on repeated occasions therefore have a greater focus on managing these issues that many MNEs,” he added.
Furthermore, indirect tax issues can also arise directly to a financial investor rather than being referable to businesses in which they invest such as the VAT on costs incurred in relation to fund management or the acquisition and disposal of investments. Such taxes represent tax leakage will impact net returns.
For example, a key focus of financial investors incurring VAT on costs will therefore be to maximise recovery on these VAT costs, but this can be problematic since much of the activities of a financial investor will be exempt from VAT meaning that recovery is not possible or uncertain.
“Consequently much focus is applied to this issue, which is usually less of a concern for MNEs who either have a better general VAT recovery position or consider irrecoverable VAT as more of a general business-as-usual tax issue, to be managed appropriately but perhaps without the specific focus of a financial investor,” added Jones.
Another common problem among businesses is that they may expand without the due diligence of tax risks. This creates issues for the tax department, which often will have to play catch up with the commercial side of the business.
“The tax risks that can come up are quite well ring-fenced for institutional investors, they’re well-known. Whereas for corporates, it’s very different, they have their own structure and the risk is less defined,” said the specialist W&I insurer head of tax.
Some tax directors at MNEs have identified this issue and push for the tax function to be included in company strategy conversations with upper management. Taxpayers are increasingly pushing for the tax team to be more commercially minded and improve communication with the broader business.
MNEs will need to introduce incentives to match institutional investors on indirect tax. The first step will be to include the tax department at the onset of every business decision. Incentives will be harder to set up.
