Managing tax implications for investment advice today
With investment suitability becoming a regulatory requirement in many countries in recent years, most financial institutions have introduced respective processes. However, what remains often untapped is the impact of tax regulations on clients portfolios’ investments, be it in an investment advisory or discretionary asset management context. This fact contradicts an increasing expectation from experienced investors and wealth management clients that require tax efficiency as a basic feature of every financial instrument in their portfolio.
While some investment advisers and portfolio managers do not have any information on tax regulations at hand, others struggle with the incredible complexity of applying country-specific tax laws at the investment product level. Typically, this process requires reading tax manuals applicable for the client’s tax domicile country or consulting in-house tax experts. Both manual processes are inefficient and come with the constant risk of the tax rules being outdated.
On the other hand, from a client or investor perspective, understanding tax implications sound rather simple. All they expect are answers to their simple questions:
- What are the general tax implications for a financial instrument on its own and how does it compare to other potential instruments?
- What is the after-tax performance of an investment product?
- Which instruments should not be considered due to their negative tax impact?
The challenge of tax implications for investment advice
Today, the main challenge is the amount of data one must gather to answer one question. There are three main factors to consider to provide the best advice: the number of jurisdictions, the type of product, and the risk aversion level of the client. The first two alone can consume hours of work to find the best suitable option.
Financial institutions have different ways how they can handle the complexity around tax efficiency on a portfolio level, all coming with respective pros and cons:
| Meeting client expectations | Risk Minimisation | Ease of scalability | Country comparison | |
|---|---|---|---|---|
| Option 1: Not taking into account tax suitability on client portfolio level | + | ++ | +++ | + |
| Option 2: Clarify tax impact of investment products manually (e.g. with tax manuals) | +++ | ++ | + | ++ |
| Option 3: Digital tax implication checks embedded in the advisory or portfolio management process | ++++ | ++++ | ++++ | ++++ |
Introducing embedded tax optimisation for investment advice
Using a dynamic and adaptable tax efficiency check tool enables financial institutions to optimise the after-tax performance of the client portfolios they manage. All while considering one’s tax residency, investment appetite and strategy. At the same time, the firm can ensure that the client understands:
- the general tax implications of the investor’s portfolio;
- the costs of the tax impact (relative and absolute) and the after-tax performance and the reasons not to consider certain investments, for example, due to their product features.
In sum, the three pillars of a scalable tax optimisation framework on a portfolio level are the following must-have items:
- Machine-readable tax rules: a set of country-specific rules provided by premium tax experts and customizable by in-house legal teams;
- Dynamic access to tax implications: access to tax rules in a portfolio context, either in an existing advisory or portfolio management application;
- Easy integration options: technology empowering developers to integrate tax rules into existing advisory and portfolio management solutions.
Benefits of using embedded tax implications for investment advice
In the race for private banking and asset management clients, the combination of investment, tax and technology expertise are the deciding factors and long-term business enablers.
With the help of embedded tax optimisation on a portfolio level, tax suitability checks are performed automatically and therefore allows organisations to:
- Support investment units with tools and tax data that will increase the quality of client portfolios both in an advisory and discretionary context;
- Reduce risks of investing in a product for a client that is non-tax suitable
- Scale efficiency across client-facing units in multiple jurisdictions by easy addition of tax rules for new countries
- Remove IT bottlenecks thanks to a one-time integration into in-house systems