Red carpet unrolled for alternative investment funds - 05/09/2012
On 24 August 2012, the Luxembourg Government submitted to the Parliament a draft law in relation to the implementation into national law of the Alternative Investment Fund Managers Directive (the “AIFMD”). This draft law is also the opportunity for the Luxembourg Government to modernise the legal framework and introduce related tax provisions.
A modernisation of the legal regime applicable to the Common Limited Partnership (Société en Commandite Simple - SCS)
The proposed amendments to Law of 10 August 1915 on commercial companies are based on practice developed over the time and on the Anglo-Saxon partnership regime, emphasising the broad contractual freedom principle prevailing for such type of vehicle which notably entails the possibility:
- To keep confidential the identity of the LPs;
- To appoint a manager which, if not a GP, is only liable for the execution of its mandate and any misconduct in the management of the SCS and can delegate powers to a representative which is in turn only liable for the execution of its mandate;
- For the LPs to perform some internal management functions (as opposed to external management) such as advisory functions, supervisory functions, granting loans or guarantees to the SCS or its affiliates (non-exhaustive list);
- To derogate from the “one share, one vote” principle;
- To exclude a partner from the sharing of the profits and/or losses of the SCS;
- To preclude the claw-back of distributions to partners.
There is also an enhancement of the law on partnership limited by shares (Société en Commandite par Actions – SCA).
The creation of a new vehicle: the Special Limited Partnership (Société en Commandite Spéciale - SCSp)
The regime of this new vehicle is for most aspects similar to the one of the SCS but differs from the latter by its absence of legal personality. Besides unregulated funds, SIFs and SICARs would also have the possibility to be set up under this new legal form.
Full tax transparency for Common Limited Partnership and Special Limited Partnership
From a tax standpoint, a main measure of the draft law consists in the achievement of full tax transparency for SCS/SCSp to the extent that any Luxembourg corporate GPs of the SCS/SCSp owns less than 5% of the partnership interests in the SCS/SCSp, which is typically the case for Alternative Investment Funds (“AIFs”).
Indeed, under current tax law, SCS are transparent for Corporate Income Tax and Net Wealth Tax purposes but remain subject to Municipal Business Tax (“MBT”) except for SICAR set up as SCS - and as per the draft law also for those to be set up in the future under the form of SCSp - which are always exempt from MBT. This is due to the application of the “Geprägetheorie ”, which originates from German jurisprudence and was enshrined in Luxembourg tax law in 2001. Under this theory, in case at least one of the GPs of a SCS is a Luxembourg capital company (i.e. a S.à.r.l,, a S.A. or a S.C.A), the SCS is deemed to realise commercial profit irrespective the actual nature of its activities because of the commercial form of the GP which “taints” the nature of the profit of the SCS resulting in the income derived by such an SCS being subject to MBT at the rate of 6.75% (for Luxembourg city).
The draft law would limit the application of the Geprägetheorie to cases where at least one of the GPs is a Luxembourg capital company owning minimum 5% of the partnership interests in the SCS/SCSp therefore achieving full tax transparency for those SCS/SCSp with Luxembourg GP below the 5% threshold to the extent these do not carry out activity with actual commercial nature (such as active trading of securities). The commentaries of the draft law also specify that the recourse to a manager or consultant by the SCS/SCSp should not jeopardize the absence of commercial activity for the latter.
By maintaining the Geprägetheorie for SCS/SCSp with at least one Luxembourg corporate GP owning 5% or more of the partnership interests in the SCS/SCSp, the draft law preserves the possibility for some SCS/SCSp to benefit from the favourable effect that the theory has in some specific cases. This is notably the case for Luxembourg resident shopkeepers exercising their commercial activity through an SCS with real estate allocated to such activity. Indeed upon suspension of activities, the real estate would otherwise be considered as being realised due to suspension of commercial activity meaning that latent gains would become taxable even in the absence of sale of the said real estate. As mentioned in the commentaries of the draft law, it can be considered that the strong ownership link between the GP and the SCS/SCSp reflects the commerciality of the vehicle through the reinforced position of the GP.
Taxation of carried interest
The draft law, aside from clarifying the Luxembourg tax regime applicable to carried interest paid to employees of AIF Managers and of management companies of an AIF (“Employees”), introduces a beneficial temporary regime.
Under the beneficial regime, the income that the Employees derive from their rights to profit participation in the AIF (“Carried Interest”) will be subject to a reduced rate, i.e. a maximum rate of 10.335% (extraordinary income regime). This beneficial regime will apply to Employees who:
(i) transfer their residence to Luxembourg during the year the law enters into force or during one of the 5 following years;
(ii) have neither been Luxembourg tax resident nor subject to taxation on their professional income in Luxembourg during the 5-year period preceding the year the law enters into force;
(iii) did not receive any advance payment relating to their Carried Interest; and
(iv) can demonstrate that prior to payment of the Carried Interest, committed capital has been fully repaid to investors.
Eligible Employees will be able to enjoy the advantages of this regime for 11 years from the year they take on the position in Luxembourg that entitles them to the Carried Interest.
The draft law also confirms that capital gains the Employees may derive from the sale or redemption of their shares/units of the AIF are taxable according to the usual tax regime applicable to capital gains (i.e.: exemption if the shareholding did not exceed 10% at any point in time during the 5-year period prior to the sale or redemption and the holding period exceeds 6 months).
Combined to the advantages granted by the tax regime for highly skilled workers (the two regimes have conditions in common), Luxembourg - which is a long-standing location for investment funds - becomes a location of choice for funds managers as well. Whereas the tax regime for highly skilled worker may already lead, on average, to yearly savings of personal income tax ranging from EUR 40,000 to EUR 50,000 for an executive whose compensation package is properly structured, this executive would also save 30% tax on his Carried Interest through the beneficial temporary regime.
VAT impacts of the implementation of the AIMFD in Luxembourg
If the previous investment vehicles remain eligible to the VAT exemption on “management services” (including: UCITS, SIF, SICAR, ASSEP, SEPCAV, Pension Funds as defined by the Law dated 6 December 1991 as well as Securitisation vehicles as defined by the Law dated 22 March 2004), this draft law extends the scope of the eligible vehicles to the assimilated investment vehicles located in another EU Member State as well as to any AIF as defined by the draft law itself.
By extending the scope of the VAT exemption to the assimilated investment vehicles located in another EU Member State, the anticipated goal is to avoid any VAT distortion of competition between the management of investment vehicles either registered in Luxembourg or registered in another EU Member State. A Luxembourg based management company that would be involved in both local and cross-border management of (eligible) investment vehicles would then be able to monitor its services from Luxembourg in the same VAT way wherever be located the investment vehicles. A Luxembourg management company should then accordingly be able to delegate part of its management tasks (still viewed as a “whole” according the EUCJ Case Law) to a third party provider (established in Luxembourg or abroad) and continuing benefiting from the VAT exemption on “management services” if all the VAT conditions are met irrespective of whether the relevant investment vehicle is registered in Luxembourg or in another EU Member State.
Due to the usual place of taxation rules (“B2B” / “B2C” rules) and to the extent that the investment vehicles established in another EU Member state qualify as VAT taxable person in their own country, it would remain nevertheless important to verify whether or not the management services rendered from Luxembourg could benefit from a VAT exemption in the country where the investments vehicles are registered. Effectively, sometimes it appears in practice that the scope of “management services for Funds” is not defined in the same way in each EU Member state - in spite of the theoretical EU VAT harmonisation - leading potentially to a local VAT liability for the investment vehicle.
In addition, this draft law allows the management services invoiced by the AIFM to the AIFs to be VAT exempt (for instance for the management services rendered to the new Special Limited Partnership acting as an AIF).
Finally, there is no doubt that the granting of “VAT exemption” to the management of AIFs together with the increase of the “cross-border” management to (eligible) EU investment vehicles could impact the corresponding input VAT right of deduction of the managers. The VAT deduction right of the management companies would have thus to be monitored carefully together with their new VAT obligations in terms of reporting towards the VAT Authorities.
Moreover, and similarly to that which exists for UCITS and as per the provisions of the AIFMD, the draft law provides that an authorised AIFM established in Luxembourg is allowed to manage AIFs established in other EU Member States. From a tax point of view, these cross-border management services should not create any management and control issue since the draft law specifically excludes the subjection to Luxembourg tax of these AIFs established outside Luxembourg and having their effective centre of management or central administration in Luxembourg.
To conclude, the new measures are a clear willingness towards more flexibility and competitiveness to the alternative investment fund industry.
For further information on the other opportunities provided by the draft law, please refer to Deloitte Luxembourg Regulatory News Alert of 28 August 2012.
The Luxembourg parliament would approve the draft law before year end. Further developments will be communicated in due course.
Should you have any question regarding this matter, please feel free to contact us.
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