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Collective Investment Vehicles. 10/22/09 Draft Presentation for Beijing Conference By Victor Thuronyi. Concept and Significance of CIVs. CIV is a fund which allows investors to pool their assets: – direct diversified investment infeasible; – pooling provides liquidity;

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Collective investment vehicles l.jpg

Collective Investment Vehicles

10/22/09 Draft Presentation for Beijing Conference

By Victor Thuronyi


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Concept and Significance of CIVs

  • CIV is a fund which allows investors to pool their assets:

    – direct diversified investment infeasible;

    – pooling provides liquidity;

    -- minimize advisory and transaction fees.

  • Investors are typically individuals but may also be pension funds, other exempt entities, or companies, and may be nonresidents.

  • CIVs take different legal forms: corporations, trusts, joint ownership, etc.

  • Over $20 trillion assets worldwide.


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Concept of CIV cont.

  • Broadly, CIV is an investment arrangement that does not involve direct ownership by the investor.

  • But this too broad since it includes life insurance, banks, derivatives, etc.

  • Once you carve these out, you are left with CIVs but they can take quite diverse forms: not a tidy concept.


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Examples of legal forms

  • Open-ended vs. close-ended fund (each type can take a variety of legal forms)

  • Investment trust that is treated for tax purposes as a trust (grantor or ordinary)

  • Collateralized debt obligations issued by a special purpose vehicle

  • Trust which issues interests that are treated as debt for tax purposes

  • Corporation (or trust treated as a corporation)

  • Joint ownership.


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Policy considerations

  • Look-through should be achieved or approximated so as not to discourage CIVs.

  • Neutrality and administrability.

  • Practical difficulty because investment shares may change daily (makes accurate flow-through impossible).

  • Taxation at entity level easier, but often violates neutrality.


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Varied tax models

  • Full transparency (tax at investor level)

  • Application of trust rules (either grantor trust or partial flow through)

  • Corporate level tax with a distributions deduction

  • Entity tax but shareholder exemption or imputation credit


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Tax models cont.: full transparency

  • Complete pass through to individual owners

  • REMIC model: interest income to one investor class, and residual interest to another


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Tax models: trust rules

  • Grantor trust: trust contains a pool of loans. Each investor treated as owning their share directly.

  • Ordinary trust (Australia): trust is taxed, except on income distributed to beneficiaries.


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Corporate level tax with a distributions deduction

  • RIC, REIT

  • For these vehicles, the U.S. imposes diversification and distribution requirements, and limits the types of assets that may be held and income that may be earned.

  • Concern is to protect corporate tax base.


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Entity tax with shareholder exemption or credit

  • Works well in countries where investment income of individuals is taxed at a flat rate.

  • Imputation credit alternative (may be used by countries that use imputation credits for corporate integration generally)


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Challenge for neutrality: capital gains

  • Some investors might cash out, causing the fund to realize capital gains. The tax liability on these gains is passed through to the remaining investors even thought they have not received any cash.

  • Fund might buy and sell assets, generating capital gains. These are allocated to investors as of the end of the year, even though they might hold shares for a short period.

  • Closed-end ETFs can avoid problem, allowing investors to defer gains until they sell shares.


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Challenge for neutrality: cross-border

  • Fund located in Country A.

  • Investors resident in Country A and Country B

  • Fund invests in Country C.

  • How to apply the A-C treaty to relieve C’s withholding tax?

  • Will Country A impose a withholding tax on Country B investors?

  • How does Country B tax its resident?

  • Is a foreign tax credit available?


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Cross-Border: Legal Framework and Possible Solutions

  • See the two OECD reports (available on OECD website):

    THE GRANTING OF TREATY BENEFITS WITH RESPECT TO THE INCOME OF COLLECTIVE INVESTMENT VEHICLES (Jan. 12, 2009);

    POSSIBLE IMPROVEMENTS TO PROCEDURES FOR TAX RELIEF FOR CROSS-BORDER INVESTORS (Jan 12, 2009)


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Cross-Border: One solution to applying treaties

  • In applying the A-C treaty, country C allows the CIV to claim treaty benefits if at least 90% of the shares are held by investors from Country A.

  • Alternative: also count investors from Country B, if the B-C treaty is comparable to the A-C treaty.

  • How to determine ownership share given that ownership varies?


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Cross-border investment: abuse?

  • Country A imposes no tax on the fund.

  • Country A has a favorable treaty with Country C.

  • Alternatively, Country C has a favorable tax regime for the fund.

  • The investor resident in Country B may be noncompliant.


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