As the institutional asset management industry grows, asset managers must assess and upgrade their tax reporting functions, or risk exposing their clients to unnecessary tax liabilities, according to Michael Shehab, a Northville, Mich.-based partner at PricewaterhouseCoopers LLP.
A recent survey conducted by PricewaterhouseCoopers LLP revealed most of the money manager respondents — about 80% — make investment decisions on a pre-tax basis and don't factor in all of the tax-related consequences. Mr. Shehab says that making decisions on an after-tax basis can enhance returns and impact reporting. According to Mr. Shehab, there can still be some inefficiencies within the structures of these private equity funds and hedge funds, which can create what he calls “leakage” and exposure to unwanted unrelated business taxable income.
“We view tax more as an operational risk,” he added. “We see there's much more to the role of tax than a reporting situation.”
The tax transformation process is a project in which a firm's tax function is assessed and upgraded, with the goal of creating a tax department that's more integrated within the business. In a transformation project, companies evaluate their people, process, technology and data to look for opportunities where changes can lead to benefits both within the tax function and the entire business as a whole.
Technology is also a serious issue within money managers' tax transformation processes. Although the asset management industry has grown significantly, many money managers are using outdated tax-reporting systems, which can increase institutional investors' risk of exposure to added unrelated business income tax. “A lot of stuff is still being done manually,” Mr. Shehab said.
To make sure institutional clients aren't more vulnerable to unrelated business income taxes — and they can be particularly vulnerable in private equity funds or hedge funds — he suggested money managers need to upgrade from a manual spreadsheet-based system to a more updated and scalable online system for client access.
Money managers also need to identify who within the organization is performing tax functions. “There's a lot of disparity as to who is doing the tax function calculations. Some perform it internally, some outsource, some do a hybrid,” Mr. Shehab explained. “So, rationalizing roles and responsibilities is crucial.”
He pointed out that no one system is better than the other, but asset managers just need to figure out which system works best for them.
“Managers are becoming more adventurous. That takes them into different tax issues,” said Tony Warren, a London-based executive vice president of product management at SunGard Financial Systems, which provides technology services, such as tax reporting systems, to money managers.
Mr. Warren also noted that increased global investing is adding additional layers of tax monitoring to the money management industry.
PwC is projecting significant growth in the asset management industry in the next few years, which could cause a strain on the manual tax reporting processes still being used. Institutional investors, according to Mr. Shehab, should make sure their asset managers are focused enough on their tax functions and aren't making them susceptible to unnecessary UBTI.
“Asset managers need to offer more frequent and more transparent reporting, and have the automated technology to provide this,” Mr. Shehab added.