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Portfolio > Alternative Investments > Hedge Funds

Italy Funds Damaged by Tax Anomalies

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MILAN, Italy (–Italy’s investors began to withdraw en masse from Italian-domiciled investment funds in the first quarter of 2006, according to the latest data from Assogestioni, the Italian fund managers’ association. This was in spite of a robust 1.24% rise in total funds under management.

While total funds under management rose by more 8 billion euro to a shade above 659 billion euro in the first three months of the year, there were net withdrawals of almost 13 billion euro from Italian-domiciled funds. “Roundtrip funds,” or funds domiciled abroad and managed by Italian asset managers, had inflows of almost 8.6 billion euro, while funds placed with overseas managers increased by nearly 12.4 billion euro.

Flows in fixed-income funds, the largest asset category with almost 265 billion euro under management at the end of the quarter, are a fair illustration of the mixed fortunes of funds at home and abroad. Fixed-income funds domiciled in Italy suffered net outflows of almost 15.3 billion euro in the period, while funds in this class that are domiciled overseas but managed from Italy had inflows approaching 3.9 million euro, and funds managed and domiciled abroad saw assets under management leap by nearly 5.6 billion euro.

The main reason for the conflicting fortunes of domestic and non-domestic funds almost certainly lies in the disparity of the tax treatment of these funds. Italian-domiciled funds report net asset value every day, and wherever NAV rises from one day to the next, capital gains tax of 12.5% is levied directly from the fund manager on that day. When NAV falls, the fund receives a tax credit which can be used against future capital gains.

In the meantime, funds domiciled overseas are only subject to tax when the fund is sold and a gain realized. This greatly reduces the administrative burden for foreign funds, which are not obliged to track a series of tax payments and credits in order to ensure the numbers are correct at the end of the year.

The perversity of this setup also extends to the performance figures. As an illustration, take two funds, one domiciled in Italy and one domiciled abroad, which achieve exactly the same performance. In a rising market, the Italian fund will have paid capital gains taxes of 12.5% on its gains, and its NAV will reflect the charge, while the foreign-domiciled fund’s will not. This will give investors looking at the performance figures of each fund the impression that the non-domestic fund has achieved a superior performance.

Nor does the setup work in favor of the Italian fund when performance is negative. The tax credits deriving from capital losses which can be used to offset future capital gains taxes will not be reflected in the NAV of either fund.

Hence the outflow of funds from Italy. Where possible, managers are choosing to domicile their funds abroad.

“Overseas funds now account for about one-third of Italian assets under management,” wrote Guido Cammarano, president of Assogestioni, in an open letter dated May 29. He also noted that Italy’s fund management industry was hampered by the existence of two market watchdogs (Consob and the Bank of Italy), which led to excessively complex and cumbersome legislation.

Mr. Cammarano implied that if the internal situation does not change, Italy’s savings will increasingly be managed from abroad. He invited the government to consult the authorities and industry participants in deciding on the steps that need to be taken to eliminate taxation anomalies and to ease the regulatory burden.

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Contact Bob Keane with questions or comments at [email protected].


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