Does Investment Limited Partnership reform represent a renewed opportunity?
By Colin Farrell, PwC Ireland
Published: 22 March 2021
The passing of the Investment Limited Partnership (Amendment) Act 2020 (the Act), coupled with proposed amendments to the rules governing closed-ended funds introduced by the Central Bank of Ireland (CBI) has significantly enhanced Ireland’s offering for asset managers seeking to set up an onshore private fund. In this article we recap on the current landscape for Irish private funds and consider the impact that changing investor preferences and OECD/EU mandated tax reform are likely to have on interest in the enhanced limited partnership structure.
What are the key enhancements to the Investment Limited Partnership?
The Act makes a number of positive changes which broadly seek to improve the operation of the ILP and align it with other EU legislation such as AIFMD. Some notable amendments;
- The inclusion of additional "safe harbour" activities which limited partners can complete (such as taking part in advisory committees) without losing their limited liability status;
- clarifying that limited partners should not be liable for partnership debts beyond their committed capital;
- modernising capital withdrawal requirements;
- updating registration and record keeping requirements in line with international standards; and
- permitting the ILP to register an alternative foreign name which is helpful for ILPs operating in a non-English speaking jurisdiction.
In addition, confirmation from the CBI that the general partner of a partnership will not require a separate regulatory authorisation will be welcome news to industry. Instead, it is expected that the CBI’s fitness and probity regime will be applied to each director of the general partner. Further, a CBI consultation paper issued in late 2020 which indicates an intent to clarify and/or update the AIF rulebook to cater for closed ended funds. The proposed updates include issue of shares/interests at a price other than net asset value, provision for 'excuse and exclude' mechanisms, allowance for stage investing and clarifications around the ability to implement a carried interest waterfall.
It is with noting in the context of the referenced enhancements to the ILP regime that there has been no change to the Irish tax treatment of the vehicle. ILPs continue to be treated as “look-through entities” for Irish tax purposes, with partners effectively taxed on their share of the partnership profits. This means partnerships are effectively disregarded for Irish income tax and corporation tax purposes such that no income tax or corporation tax should arise at the level of the vehicle itself. Notwithstanding this look-through approach, there are a number of other tax issues that require consideration in structuring an Irish limited partnership, typically linked to the profile of the investors and/or underlying assets held. In certain cases, investment into the underlying asset may require the use of an underlying holding structure together with the ILP, which may be driven by operational and/or tax needs. Similar to other Irish regulated products, the provision of management services to an ILP should be exempt from Irish VAT.
Private assets - an Irish perspective
Ireland has long been renowned as a domicile for setting up and servicing alternative fund structures, evidenced by the growth from €151bn of alternative assets under management in Irish regulated funds in 2009 to in excess of €770bn at present. The growth in the Irish alternatives industry reflects broader global market trends, where there has been a noted increase in allocations to private markets. 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. It is worth noting in this context that while this article focuses on the regulated fund platform and positive developments in that respect, it is acknowledged that many of these strategies are currently housed in other unregulated holding structures (special purpose vehicles, holding companies etc). In certain cases, these holding structures may also be combined with an Irish regulated product, or equally a non Irish feeder vehicle, depending on the specifics of a structure. Indeed, such holding structures may still be desirable in combination with an ILP, depending on the profile of the investors and/or underlying strategy of the fund.
What is clear is that investor demand for exposure to these asset classes continues to grow, particularly in the institutional space, where the illiquidity premium and long-term nature of the investment strategy are in many instances aligned to the investment objectives of institutional investors such as pension funds, sovereign wealth funds and insurance companies. Notwithstanding the aforementioned growth in alternative funds in Ireland, and the increasing allocations towards private assets (which are typically housed in tax-transparent structures), to date the Irish limited partnership offering has not experienced a level of growth that market trends would suggest. However, we expect that trend to change on foot of this reform.
In an Irish regulated context, alternative investments have largely been structured into Irish fund vehicles that take a corporate form and are opaque from a tax perspective. From a tax perspective, Irish regulated funds are exempt from Irish tax on income and capital gains derived from their investments and are not subject to Irish withholding tax on payments to non-resident investors (if the fund does not house Irish real estate assets). Consequently, tax neutrality at fund level is also achieved in a corporate fund context but in a different manner from the tax-transparent treatment afforded to limited partnerships. In this way, although the two regimes follow the same policy principle (i.e. ensuring that investors are not penalised for pooling assets to achieve scale and diversification), they achieve it in different ways.
A tailored approach?
Managers and investors alike have sharpened their focus on the manner in which tax neutrality at fund level is achieved as a result of OECD and EU-mandated reform. While the complexity of the tax and broader operating environment should naturally drive asset managers towards leaner investment structures, that approach does not always align with key investors who want a tailored solution and may require designated holding structures. The ILP and other tax transparent structures can act as an effective solution in many cases allowing for collective investment together with the option for tailored structuring below the collective investment vehicle for certain investors. This can often be an attractive proposition for investors and managers alike.
A further notable development in this context is the increasing focus on tax sustainability from investors and particularly European institutional investors. It is now common for institutional investors to have tax sustainability/transparency/reputational questions within their standard investment due diligence questionnaires. Similarly, the ESG agenda more broadly is requiring a departure from the status quo in terms of structuring new products in many cases. Increasingly, investors expect asset managers to incorporate ESG principles into their investment strategies and this is having an impact on the product which is chosen to house these strategies. Transparent structures can lend themselves well to these initiatives in that they facilitate direct exposure to the underlying asset class for an investor.
That is not to say that tax transparent structures such as the ILP will be the structure of choice in all cases going forward, and clearly assessing the impact of any OECD and EU mandated reform requires a more holistic review of the entire structure (including that of the investor and where an underlying holding structure is used as referenced above) to determine any impact.
What is clear however is that there is no “one size fits all” approach and, consequently, it is welcome news that Ireland will now have a full product suite available to managers in both corporate and transparent form to service the needs of the market.
Flow-through treatment and double tax treaty access
Using a transparent structure to house private assets has proven to be an attractive proposition from an investor perspective, particularly in light of the ability for the underlying return to retain its natural form. Where a capital gain is realised on the disposal of the underlying asset held within the limited partnership structure, that gain is deemed to be directly attributed to the limited partners and therefore the return typically retains its natural form. The very nature of these real-asset-type investments (such as infrastructure for example) means that the return on investment tends to be by way of capital uplift as opposed to income; the ability for this to be taxed as a capital gain in the hands of the investors has been an attractive feature and has fuelled the growth in transparent structures. This point can be particularly relevant for sovereign wealth fund investors, which, along with typically being exempt from taxation in their own right, are generally in a position to avail of double tax treaty (DTT) or domestic exemptions at the level of the portfolio investment (e.g. exemption from source-country withholding taxes/capital gains taxes). Direct sight of this investor class by portfolio-jurisdiction tax authorities is therefore of utmost importance.
Arguably, one of the most significant changes introduced by the Multilateral Instrument (MLI) under the BEPS Action Plan was the introduction of a principal-purpose test (PPT) into Ireland’s DTTs. This general anti-avoidance clause, providing tax authorities with the ability to deny benefits available under a DTT if obtaining the treaty benefit was “one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit”, will clearly be influential in the choice of investment vehicle going forward. Undoubtedly, the PPT has raised the bar in terms of the ability to access benefits in most of Ireland’s DTTs, with corporate funds and opaque structures no less affected. Aside from the increased threshold that has been introduced by the MLI, DTT access for investment funds was already challenging under existing rules, notwithstanding the policy objectives with which they were established. Despite the OECD commentary and draft guidance released to address the relevant issues for collective investment schemes and non collective investment schemes, significant uncertainty remains, and uncertainty remains in the market about how treaty partners intend to interpret and police the PPT in the future. Contrast this with the impact that the same rules are likely to have on a limited partnership structure. The tax-transparent nature of a limited partnership is helpful in this regard, given the look-through approach that typically applies for income tax, corporation tax and capital gains tax purposes. Jurisdictional consolidation throughout a structure is another important trend in this context, particularly where fund vehicles are used in conjunction with underlying holding structures. Increasingly, we are seeing an appetite to consolidate the fund and holding structure into the same location for commercial reasons and this also helps to bolster presence in a particular jurisdiction. In this way, having a full product suite is crucial for the competitiveness of any domicile.
The updates to the ILP regime significantly enhance Ireland’s product suite for private fund managers at a time when tailored investment structuring is of paramount importance. As asserted throughout this article, due to a variety of both operational and tax driven investor requirements, a “one size fits all” approach to structuring investment in private assets will be unsustainable into the future. Consequently, the availability of a full product suite (in both corporate and transparent form) to adopt a tailored approach will be crucial.
Going forward, asset managers and their advisers will need to take a more holistic approach to structuring investment platforms and, in doing so, critically assess and weigh up the pros and cons of each layer in the structure. The broader asset management infrastructure will need to have the flexibility to service these tailored solutions in an efficient and effective manner.
The enhancement of the ILP means that Ireland has taken a very positive step in its continual evolution to meet the needs of an ever-changing market.