Sovereign wealth funds face growing taxation threats

The removal of tax exemption for sovereign fund investments would have massive implications for foreign fund flows. That hasn't stopped some countries from trying to change the rules.
Sovereign wealth funds face growing taxation threats

The tax status of sovereign wealth funds has become a contentious issue of late, with the US and other countries proposing to remove exemptions that would have major implications for the flow of funds from foreign investors.

Most sovereign wealth funds benefit from the principle of sovereign immunity -- the idea that one state should not bind another to its laws -- which includes not being subject to taxation on profits made from their investments, globally and in their home country.

In the US this July, Senate finance chairman Ron Wyden introduced a bill, the Ending Tax Breaks for Massive Sovereign Wealth Funds Act. The Bill would deny the benefits of Section 892 of the Internal Revenue Code of 1986 to certain foreign governments with large sovereign wealth funds, many of which are active investors in US private markets.

According to law firm DLA Piper, Section 892 serves to encourage significant investment in the US and is frequently relied on by foreign governments.

If passed, the bill would remove the exemption for any foreign government that directly or indirectly holds more than $100 billion of assets for investment or the production of income.

China, North Korea, Russia and Iran are automatically excluded from any exemptions in any case.

“The bill will make it more challenging for private fund sponsors focused on US investments to raise capital from a category of investors that previously made significant fund commitments and, in many cases, anchored such funds. The bill could also encourage accelerated exits of existing investments prior to its full application in 2026,” said DLA Piper.

Given that sovereign wealth funds are some of the largest investors in real estate located in the US, this could have a particularly negative effect on US real estate markets.


Other territories, including the Uk, have flirted with the idea of curtailing tax exemptions available to foreign governments.

According to UK law firm DWF, the current UK sovereign wealth immunity regime is generous in comparison to its international counterparts, in that it exempts all sovereign persons (heads of state, governments and state entities such as SWFs from direct UK taxation.

In 2022, the UK government proposed to withdraw this immunity, but was forced to backtrack after it became clear that such a policy would be detrimental to the flow of investment into the UK economy.

In March this year, chancellor Jeremy Hunt abandoned plans to make sovereign wealth funds pay corporation tax on property and commercial enterprises, after cabinet warnings that the move would hit inward investment and depress growth.

Diego Lopez, managing director of the consultancy GlobalSWF told AsianInvestor he believes most sovereign funds abide by their obligation to pay taxes overseas, by meeting certain thresholds and proving links to government. However, certain SWFs such as Temasek chose to pay taxes overseas.  

Then there is the obligation of a SWF to pay taxes in-country, which is equally contentious. "Not all   SWFs publish financial statements, but we know that some of them are exempt from paying domestic taxes," said Lopez.

For example, Norges Bank Investment Management is exempt from income tax on its operations in Norway, but is subject to taxes in a number of foreign jurisdictions.

Others do pay taxes domestically, including China Investment Corporation and Singapore’s Temasek.

For the year ended 31 March 2023, Temasek Group recorded a net loss of S$7.3 billion, due to unrealised mark to market (MTM) losses of sub-20% investments of S$22.0 billion. Excluding the unrealised MTM losses, Temasek Group’s operating profit was S$14.7 billion, which it said reflects the overall quality of its portfolio.

Reluctant taxpayer

NZ Super is one of the top-rated sovereign wealth funds globally and its long-term investment returns overshadow most other rivals.

Earlier this year, NZ Super’s CIO Stephen Gilmore told AsianInvestor that this is despite the fact that, unlike most of its peers, NZ Super is a taxpayer.

“It could be that we are actually paying more back to the government than we are getting in contributions. If you look back, we’ve had contributions, less tax, of around NZ$14 billion ($8.75 billion), and the fund size is NZ$62 billion,” said Gilmore.

NZ Super's CEO Matt Whineray believes the funds should not have to pay tax at home.

“I don’t think it makes sense," he said in a NZ Herald interview.

"If I take my wallet out of this pocket and put it in this pocket, I haven’t got richer. It makes a difference at the margin from a cashflow perspective, but for us it means we have to incur cost to manage that tax."

NZ Super has long argued that if the fund were tax exempt in New Zealand it would be easier to obtain exemptions overseas, too.

“We end up paying tax in overseas jurisdictions because when we ask for sovereign immunity they ask if we pay tax at home. When we say yes, they say well you can pay tax here.

“We don’t think that’s sensible and we’d like that to change. But it’s hard to get people’s heads around that, because they think we are trying to take something away from them."

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