Multinational fund houses are bracing for a potential hit to net profitability as the world’s leading industrial nations look to implement a global framework to clamp down on tax avoidance.

Ministers at the G20 meeting in Moscow last month agreed to a 15-point action plan set out by the Organisation for Economic Co-operation and Development (OECD) to close tax loopholes.

The proposals are put forward in a document entitled Action Plan on Base Erosion and Profit Shifting (Beps), which is available online.

It includes developing a new set of standards to prevent double non-taxation and comes in the wake of revelations about multinationals abusing the transfer-pricing mechanism and avoiding paying tax in certain jurisdictions.

Transfer pricing potentially allows companies to minimise tax liability by setting as low a price as possible when selling goods or services from one part of a company to a subsidiary.

The action plan lists a series of recommendations to tackle such problems over the next two years to 2015, although it is for members themselves to adopt the recommendations under domestic law.

One target of the plan is the widespread practice of using offshore jurisdictions to shift profits away from where investments are made, as well as using transfer pricing to separate income from corresponding economic activity.

This is clearly applicable to multinational fund houses that generate profits out of one jurisdiction and shift it to another in Asia with a more favourable tax regime.

In other words, the OECD’s action plan will impact what has become a traditional model for fund houses with operations in Asia, many of which have structures using offshore managers based in the Cayman Islands. The understanding is that such entities will come under closer scrutiny.

Florence Yip, a tax partner at professional services firm PwC in Hong Kong, says fund managers will have to demonstrate sufficient commercial value and justifiable transfer-pricing practices so as not to fall foul of incoming Beps standards.

“If you have a fund management company in Hong Kong and are running an investment management business there, you need to hire relevant, competent people, get a licence from the SFC, have proper audits done and, last but not least, the company should have reasonable remuneration," she notes. "This means it has commercial substance.”

The understanding is that managers at multi-national fund firms need to ensure each jurisdiction has a fair share of overall profits generated from the business.

Darren Bowdern, tax partner at KPMG, adds: “Essentially it’s [Beps] looking to ensure that each location where functions are performed receives a fair share of the profits generated from such activities. It means looking at the ways in which management fees should be allocated, among other things.”

But while the OECD action plan is likely to be implemented over a two-year time-frame if members agree to adopt it, some jurisdictions such as Hong Kong are already taking steps to ensure appropriate taxes are being paid on profits.

Bowdern notes that the Hong Kong government’s inland revenue department has been targeting the asset management industry over the last 18 months, challenging the pricing arrangement that fund managers have adopted.

He notes, for example, that 30 to 35 funds have been subject to auditing since 2012, ranging in size from large regional funds to small boutiques.

“Asset management houses have been using cost-plus arrangements to pay fees to their operations in Hong Kong,” says Bowdern. He is referring to the practice of remunerating an employee or business based on the cost of their services plus a mark-up.

“The inland revenue has challenged such pricing arrangements and is adopting revenue-sharing methodology to allocate a fairer share of the management fees to Hong Kong,” says Bowdern, referring to taxing a fund house based on its revenue generated in Hong Kong.

But the question of what must be declared for tax purposes for a business operating in multiple jurisdictions remains a key question.

“From the industry’s perspective, the biggest concern is an apparent attempt by the IRD [Hong Kong's Inland Revenue Department] to tax a share of carried interest.” says Bowdern. He refers to the compensation method at private equity and hedge fund managers, which is typically around 20% share of an alternative fund’s overall profit.

But this could adversely impact the government’s drive to attract more fund management companies to set up in Hong Kong.

Overall, Yip is concerned about the practicality of how this will all come into play. “In the business and investment world, clarity and certainty of law is very important,” says Yip. “If you have one set of domestic tax laws and different sets of international tax law subject to interpretations, how can people make a decision [on how to pay taxes]?"