ELTIF 2.0: What new opportunities does the EU offer investment funds?

The anticipated modification of the existing EU regulation regarding European long-term investment funds (ELTIFs) was approved by the European Parliament and the Council of the European Union on 15 March 2023. Regulation (EU) 2023/606 (”ELTIF 2.0”) was published in the Official Journal of the European Union on 20 March 2023 and amends Regulation (EU) 2015/760. With ELTIF 2.0, the EU legislature hopes to make the ELTIF a more accessible and attractive investment vehicle by improving the flexibility of the regulatory regime. ELTIF 2.0 entered into force on 9 April 2023 (20 days after its publication in the official journal) and will apply as from 10 January 2024.

This alert summarises the key changes introduced by ELTIF 2.0 and provides an overview of the Belgian tax regime for ELTIFs.

Background

Regulation (EU) 2015/760 lays down uniform rules on the authorisation, investment policies, and operating conditions of ELTIFs with the intention of facilitating the raising of capital directed towards European long-term investments in the real economy, in line with the EU’s objective of smart, sustainable, and inclusive growth. However, the regulation has not had the success for which legislators hoped, leading to the EU Commission’s November 2021 proposal to amend the ELTIF regime. Since the adoption of the regulation, only around 85 ELTIFs have been authorised in the EU in total (with none in Belgium).

Key changes in ELTIF 2.0

1)     Master-feeder structures and fund-of-funds structures 

Master-feeder structures

It can be beneficial for ELTIFs to invest in a diversified portfolio of a master ELTIF to diversify their own portfolios and to benefit from the expertise of the managers of other ELTIFs. ELTIF 2.0 therefore allows ELTIFs to make use of master-feeder structures by investing in master ELTIFs.

Fund-of-funds structures

Fund-of-funds structures are considered a common and effective means to invest in illiquid assets (such as real estate) and to reinvest excess cash. ELTIF 2.0 gives ELTIFs the possibility of investing in other funds by adopting the structure of a fund-to-fund vehicle. 

Taking the common fund-of-funds strategies into account, an ELTIF will also be permitted to invest in undertakings for collective investment in transferable securities (UCITS) as well as EU alternative investment funds (AIFs) managed by EU AIF managers.

2)     Broadened scope of eligible assets and reduced threshold for investments

Broadened scope of eligible assets

Regulation (EU) 2015/760 currently requires that eligible investment assets that are individual real assets have a value of at least EUR 10 million. However, in practice, real asset portfolios are often composed of a number of individual real assets which each have a value of significantly less than EUR 10 million. To address these issues and to make ELTIFs more accessible, ELTIF 2.0 abolishes the requirement for a minimum value of individual real assets. It is expected that the removal of this threshold will contribute to the diversification of investment portfolios and will stimulate investments in real assets by ELTIFs.

A “real asset” is defined in ELTIF 2.0 simply as “an asset that has an intrinsic value due to its substance and properties” which is a much broader definition than under the current regulation and no longer makes a specific distinction between infrastructure and other assets. For example, commercial property will be permitted since it can contribute to the objective of smart, sustainable, and inclusive growth. As a result, a larger pool of assets will likely qualify as eligible real assets. 

Furthermore, the scope of eligible investments assets will be broadened by extending it to certain simple, transparent, and standardised securitisations and green bonds.

Reduction in the threshold for investments

The threshold for the proportion of an ELTIF’s capital that must be invested in eligible assets will be reduced from 70% to 55%. The remainder must be invested in “other assets” as described in article 50(1) of Directive 2009/65/EC regarding UCITS. By reducing the limit for eligible investment assets, ELTIF 2.0 aims to enable managers of ELTIFs to better manage the liquidity of ELTIFs.

3)     Increased market capitalisation threshold for qualifying portfolio undertakings

Regulation (EU) 2015/760 requires that qualifying portfolio undertakings which are admitted to trading on a regulated market or on a multilateral trading facility have a maximum market capitalisation of EUR 500 million. However, many listed companies with a low market capitalisation have limited liquidity which prevents managers of ELTIFs from acquiring a sufficient stake in such companies within a reasonable timeframe (and therefore negatively affects the potential investment targets of ELTIFs).

In order to resolve this, ELTIF 2.0 increases the market capitalisation threshold for qualifying portfolio undertakings from EUR 500 million to EUR 1.5 billion. To avoid potential changes to the eligibility of such investments due to currency fluctuations or other factors, the determination of the market capitalisation threshold will be made only at the time of the initial investment.

4)     More flexible rules on diversification and concentration

Diversification requirement

The diversification requirement for investments in each underlying asset or qualifying portfolio undertaking will be increased from 10% to 20%. In addition, ELTIF 2.0 will increase the investment limit from 5% to 10% for investments in other assets (see 2), above) if they have been issued by a single body.

Concentration limits

The concentration limits for ELTIFs will be increased from 25% to 30%. An ELTIF will be able to acquire no more than 30% of the units or shares of a single ELTIF, European venture capital fund (EuVECA), European social entrepreneurship fund (EuSEF), UCITS, or EU AIF managed by an EU AIF manager.

5)     Flexibility for professional investors

Waivers from diversification and concentration requirements

ELTIF 2.0 introduces various waivers from investment limits for ELTIFs marketed solely to professional investors. In particular, the waivers relate to the diversification and concentration requirements (see 2), above).

Flexibility regarding borrowing in cash limit

ELTIF 2.0 also provides for more flexible rules regarding the borrowing in cash limit. The current limit of 30% of the value of the capital of the ELTIF is modified by ELTIF 2.0 and makes a distinction between the types of investor to whom the ELTIF is marketed. For ELTIFs that can be marketed to retail investors, the limit will be set at 50% of the net asset value of the ELTIF. However, for ELTIFs solely marketed to professional investors, ELTIF 2.0 permits a higher leverage limit of 100% of the ELTIF’s net asset value because professional investors have a higher risk tolerance than retail investors.

6)     Abolition of winding down due to unsatisfied redemption requests

It is currently foreseen that investors in an ELTIF may request its winding down if their redemption requests, made in accordance with the ELTIF’s redemption policy, have not been satisfied within one year from the date on which they were made. Due to the long-term character of an ELTIF and the fact that an ELTIF’s assets are often illiquid, the winding down possibility is sometimes perceived as disproportionate and is abolished by ELTIF 2.0.

7)     More flexibility for the distribution of retail ELTIFs

Abolition of cap on portfolio’s exposure and initial minimum amount

ELTIF 2.0 abolishes the 10% cap on a portfolio’s exposure for retail investors whose financial instrument portfolio does not exceed EUR 500,000 as well as the requirement that the initial minimum amount invested in one or more ELTIFs must amount to at least EUR 10,000.

No more investment advice

ELTIF 2.0 also abolishes the requirement for distributors and managers of ELTIFs to provide appropriate investment advice to retail investors, since this was not clearly defined and led to legal uncertainty and confusion.

Alignment of suitability test with MiFiD II

The suitability test that needs to be performed when distributing ELTIFs to retail investors will now be aligned with the markets in financial instruments directive (referred to as MiFiD II).

Possibility of a “green” ELTIF

Another important element of ELTIF 2.0 is that the European Commission will perform an assessment by 11 January 2026 to assess, amongst other things, whether an environmentally sustainable or “green” ELTIF is feasible and whether there should be a general obligation for ELTIFs to comply in their investment decisions with the “do no significant harm” principle (within the meaning of Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector).

Date of application

ELTIF 2.0 entered into force on 9 April 2023 and will apply as from 10 January 2024.

Transitional regime

ELTIF 2.0 provides for a transitional regime for five years for ELTIFs already authorised as at 10 January 2024 under the provisions of Regulation (EU) 2015/760 and compliant with that regulation, which will be deemed to comply with ELTIF 2.0 until 11 January 2029.

ELTIFs authorised as at 10 January 2024 under the provisions of Regulation (EU) 2015/760 and compliant with that regulation and that do not raise additional capital, will be deemed to comply with ELTIF 2.0 indefinitely.

Opt-in possible

It will be possible for ELTIFs authorised before 10 January 2024 to choose to be subject to ELTIF 2.0, provided that the competent authority of the ELTIF is notified.

Belgian tax regime for ELTIFs

The ELTIF regulation allows each individual EU member state to establish a competitive tax regime for ELTIFs. In Belgium, the tax framework for ELTIFs has been constructed on the same basis as that for Belgian fund managers, including real estate fund managers, ensuring that ELTIFs can benefit from:

• Corporate income tax neutrality as provided in article 185bis of the Belgian Income Tax Code 1992 (BITC): In accordance with article 185bis, Belgian resident ELTIFs are subject to a favourable income tax regime, as their taxable base, subject to the standard 25% corporate tax rate, is limited to abnormal or benevolent advantages received, plus certain disallowed expenses. For example, where the ELTIF invests directly in real estate assets, income streams (both periodic income and capital gains) deriving from investments in real assets are, in principle, not subject to corporate income tax at fund level. This is the same tax regime as that currently applicable to Belgian real estate investment trusts (B-REITs) and Belgian real estate investment funds (B-REIFs).
• The possibility for Belgium-based corporate investors to benefit from the dividends received deduction (DRD) provided in article 202 juncto 203 of the BITC: Dividends paid by a Belgian investment company are in principle taxable in the hands of corporate resident investors at the standard 25% corporate income tax rate. However, to prevent income taxed in the hands of the ELTIF’s portfolio of qualifying small and medium-sized enterprises being subject to economic double taxation at the level of the ELTIF’s corporate investors, ELTIFs may offer their Belgian corporate investors the benefit of the DRD on dividends arising in full or in part from real estate income received by Belgian ELTIFs, provided that certain taxation requirements are met.
• An exemption from Belgian withholding tax (WHT) for nonresident investors on dividends distributed by Belgian ELTIFs, introduced in a new article 264/2 of the BITC: In respect of nonresident corporate investors, the ELTIF’s tax regime provides for an exemption from Belgian WHT (either at source or via a WHT repayment claim) on distributions made by ELTIFs from dividends and capital gains on shares meeting specific taxation requirements and provided that certain other conditions, such as the completion of an affidavit, are met. ELTIFs also are eligible for WHT reductions or exemptions provided through Belgium’s extensive network of tax treaties.

• A reduction in the annual subscription tax: Investment vehicles regulated by the Belgian Financial Services and Markets Authority, such as ELTIFs, are subject to an annual subscription tax in Belgium imposed at a rate of 0.0925% on net assets placed in Belgium. As a result of the changes following from ELTIF 2.0, the tax rate may be reduced to 0.01% where an ELTIF’s compartments or share classes are dedicated to qualified (non-retail) investors. Eighty percent of the annual subscription tax is a non-deductible expense at the level of the ELTIF, with subsequent corporate taxes resulting from the disallowance being fully non-deductible.

Comments

Following the approval of ELTIF 2.0 providing for the removal of various restrictions and impractical requirements (such as the EUR 10 million per asset investment rule) and the introduction of a specific tax framework in 2022, the ELTIF has now finally become a viable alternative to investment structures such as “SICAV/BEVEKs,” B-REITs, and B-REIFs; unlike such structures, the ELTIF has no annual distribution requirement.

Whereas “DRD SICAV/BEVEK,” B-REIT, and B-REIF entities are required to distribute 80% or 90% of their annual net profits (or allocate such funds to debt repayment), no such strict distribution rules apply to ELTIFs, as this would conflict with the long-term investment perspective of the ELTIF. As a result, a Belgium-based ELTIF may opt to accumulate its revenue (dividends and capital gains on shares) for several consecutive years and, subsequently, still offer its Belgian corporate investors the benefits of the DRD exemption on distributed dividends, provided that the underlying income meets certain taxation requirements.

For completeness, it should, however, be noted that the Belgian government intends to introduce some amendments to the DRD rules applicable to investments into investment funds.