UK pension funds are losing up to GBP 250 million annually by not investing through tax transparent investment funds.

This is the outcome of a recent study by Northern Trust and AMX. Investment funds can be tax transparent or non-transparent. Tax transparent funds are, as the name suggests, “looked through” for tax purposes. This means that all investments and income are the participant's, in proportion to their participation in the fund. Non-transparent funds, on the other hand, are themselves the beneficial owner of the investments and income.

Difference in tax treatment

For pension funds, investing through non-transparent funds can be very unattractive from a withholding tax perspective. This is because they have a better position to reduce or reclaim withholding tax than any other type of investor. However, to benefit from that favorable position there has to be a direct link between the investment income and the investor. Non-transparent funds break that direct link. Cutting pension funds off from the withholding tax relief they would have enjoyed, had they invested through transparent investment funds.

Investment income lost to withholding tax

By ignoring this crucial difference in tax treatment, many pension funds lose up to tens of basis points of investment income to withholding taxes. Withholding taxes they would not have owed in case of investments through transparent funds. Year after year. And as transparent funds can be structured in such a way that they provide the same risk/reward profile as non-transparent funds, there really seems to be no reason why pension funds would not run their pooled portfolio investment through tax transparent funds. Still pension funds continue to invest through non-transparent funds on a large scale. While the referenced study looks at UK pension funds, we see the same phenomenon on a very regular basis with pension funds in other counties.