Navigating Impact Funds – Key Tax Considerations
Navigating Impact Funds – Key Tax Considerations
As the world transitions towards a more sustainable, equitable economy, ‘impact investing’ is moving into the mainstream. Investors are increasingly seeking strategies that generate both financial returns and measurable positive outcomes - whether environmental or social related.
From carbon credit, forestry funds, renewable energy funds to social infrastructure, climate-tech funds, nature-based solutions funds and more, the impact fund landscape is becoming more diverse and sophisticated. Each of these fund types requires tailored structuring, impact measurement frameworks, and specialised regulatory treatment.
Tax considerations are critical in impact investing due to the long-term nature of assets, cross-border operations and evolving regulatory landscapes. A well-structured approach in tax supports compliance, preserves returns and ensures alignments with both investor goals and impact objectives. In this article, we summarise some of these key tax considerations specific to impact funds – note these are not exhaustive and further tax advice should be undertaken to support any positions taken.
Key tax considerations specific to impact funds
Evergreen vs closed-ended structures
Evergreen structures are increasingly favoured in areas like forestry, infrastructure, renewable energy and conservation finance as they align with the long-term nature of the underlying investments. Compared to closed-ended structures, these structures can raise different tax considerations such as potential tax leakage and withholding requirements at fund level, and tax on subscriptions, redemptions and distributions. Whether a structure is evergreen or closed-ended, managing tax is crucial to limit unnecessary tax on exits, ensure efficient distribution of returns, and comply with entity and investor-level tax requirements across relevant jurisdictions.
Fund domiciliation
Fund domiciliation is driven largely by investor base and also legal and regulatory considerations. For instance, in the EU, the Sustainable Finance Disclosure Regulation (SFDR) enables funds to be classified under sustainable investment categories with increased reporting standards and governance expectations, increasingly a requirement for institutional investors. The fund’s domicile should be selected with consideration for tax-efficiency, access to favourable treaty networks and the needs of the investor base including tax-exempt organisations.
Access to tax incentives
Impact funds may be eligible for tax incentives which can provide tax relief for investors, eg income tax deductions, capital gains tax deferrals and tax exemptions depending on the jurisdiction and investor profile. Understanding the access to these tax incentives is important as they can enhance post-tax returns for investors and further support sustainable investment objectives.
Tax-exempt investors
Tax-exempt investors (eg foundations and charitable organisations) are often significant investors in impact funds due to the alignment between investors’ mission-driven goals and the impact fund’s objectives. The tax-exempt status of these investors should be continually reviewed as investments in impact funds can give rise to adverse tax consequences if not carefully managed depending on the nature of investments, jurisdiction and structure of the fund.
Carried interest
A growing number of funds are exploring impact-linked carried interest, where carried interest returns are not just contingent on financial returns, but also on achieving verified impact outcomes, eg CO₂ emissions reduced, hectares reforested or affordable housing units delivered. Such an approach can strengthen investor alignment and impact integrity. It is important to understand how carried interest is taxed on award and on realisation of returns while taking account of any non-financial performance conditions.
Tax compliance
Impact funds are subject to growing demands for transparency, not only around their impact, but also their tax compliance. Investors increasingly expect that tax considerations are dealt with in a manner consistent with broader principles of responsible and sustainable investing. Demonstrating robust tax compliance can enhance investor trust and ensure alignment with ESG principles around transparency, fairness and sustainability. Strong tax governance is increasingly seen as a hallmark of long-term, values-driven fund management.
How we can help
Our team works collaboratively across various specialisms, including partnership tax, corporation tax, transaction tax, personal tax, VAT, and transfer pricing, and across multiple jurisdictions. We can help you and your team with your impact fund structures, including in relation to structuring, incentives, investments, divestments and tax compliance. If you would like to discuss this or your structures more generally, please feel free to get in touch with James Pratt, Jennifer Wall, Shirley Ly or your usual point of contact at BDO.