How Tax Reclamation Can Help CITs Beat Their Benchmarks

Although Collective Investment Trusts (CITs) have existed for over 100 years, they have risen in prominence over the past decade, becoming the go-to investment vehicle for qualified investors seeking to increase return on investment. As the vehicles need not adhere to reporting requirements from the Securities and Exchange Commission or the Investment Act of 1940, they boast lower administrative costs (often 10 basis points or less) than separately managed accounts, a benefit that asset managers and CIT sponsors have touted widely.

While these reduced management and administrative fees are attractive, investors should be mindful that the benefits come with a cost: reduced ability to recover entitlements through foreign withholding tax reclamation. As a refresher, Double Taxation Treaties allow investors who receive dividend and interest income from cross-border investments to reduce their tax burden by qualifying for a lower “treaty” rate and recovering over-withheld tax, adding up to 45 basis points to annual portfolio performance when benchmarked to indices such as EAFE or ACWI-ex US. Unfortunately, several factors inhibit CITs from receiving tax entitlements: the fund structure, the complicated nature of foreign tax recovery, and current custodial tax processes, which are not designed to accommodate the processing nuances that these funds require.

Tax reclamation is an administratively burdensome process with varied requirements depending on the country of issuance. As a general principle, tax authorities seek to confirm that the beneficiaries in a fund are eligible for favorable tax treatment before granting access to entitlements. While tax authorities may grant benefits to ’40 Act Funds, ETFs, or entities like pension and retirement systems at the “fund” level, CITs are considered “transparent” entities. Tax authorities thus seek to identify the underlying investors. As CITs do not segregate investors into separate accounts, it can be difficult to ascertain the portion of assets owned by each investor, depriving them of the opportunity for crucial entitlements.

While it is possible to document these underlying investors, it is not easy, even for the most sophisticated asset managers and CIT providers. Despite their investment prowess, these managers often lack the dedicated operational teams necessary to oversee and manage the changing tax rates, administrative procedures, and documentation requirements needed to file claims and reconcile payments. Custodians face the same issues. Their custody models cannot support the fulfillment and maintenance of beneficial owner documentation that is necessary for these transparent entities to receive entitlements.

Failure to secure withholding tax entitlements is ultimately harmful to CITs for several reasons. Withholding tax drag can create a ‘tracking error’ of 25 basis points or more when the fund is compared to a benchmark, decreasing its attractiveness to investors. CITs depend on increasing Assets Under Management, as more assets translate to better performance, more favorable economies of scale, and thus potentially lower administrative costs. Moreover, CIT trustees have fiduciary obligations to maximize fund performance, and failure to maximize performance by reclaiming tax entitlements represents a potential breach of those responsibilities.

Fortunately, GlobeTax understands the complexities surrounding the tax reclamation requirements for CITs. As an expert in transparent entities for over 28 years, GlobeTax manages the entire recovery process, including document generation and management, entitlement identification, claim filing, payment, and reporting. By pursuing a third-party vendor, asset managers and CIT providers can beat their benchmarks, differentiating their own offering by increasing client revenue. Best of all, the fees associated with a tax reclamation service are entirely contingent-based. Fees are taken from the revenue generated by the reclaims, eliminating upfront costs (and risk). Contact to find out more.