Q&A: tax issues for private equity funds in Luxembourg
Q&A: tax issues for private equity funds in Luxembourg
Would a private equity fund vehicle formed in your jurisdiction be subject to taxation there with respect to its income or gains? Would the fund be required to withhold taxes with respect to distributions to investors? Describe what conditions, if any, apply to a private equity fund to qualify for applicable tax exemptions.
The analysis of the tax features of Luxembourg private equity investment vehicles requires a schematic approach. By and large, the available investment vehicles can be divided into vehicles that are in principle (if they are considered opaque) subject to general taxation rules on one hand (non-regulated ordinary commercial company (Soparfi), an investment company in risk capital (SICAR) or reserved alternative investment fund (RAIF) SICAR-like) and vehicles that are generally exempt from tax on the other hand (specialised investment fund (SIF) or the standard RAIF). Within each category, we further need to distinguish between entities that are fiscally opaque (private limited liability company (SARL), public limited liability company (SA) and partnership limited by shares (SCA)) and those that are fiscally transparent (eg, common limited partnership (SCS), special limited partnership (SCSp) or common fund (FCP)).
A Soparfi, whether in the form of an SA, SARL or SCA, is an ordinary fully taxable commercial Luxembourg resident company subject to income taxation (namely, corporate income tax plus an employment fund surcharge and municipal business tax) on its worldwide income (combined rate for the city of Luxembourg in 2022 is 24.94 per cent), subject to specific domestic or treaty exemptions, and indirect taxation (eg, value added tax (VAT)). However, exemptions apply as regards income and capital gains derived from qualifying participations (the participation exemption).
A Soparfi is also subject to a 0.5 per cent net wealth tax on its net asset value as of 1 January of each year (0.05 per cent tax rate for net assets exceeding €500 million). Exemptions apply as regards, inter alia, qualifying participations. Soparfis are subject to a minimum net wealth tax ranging from €535 to €32,100 (depending on the size of their balance sheet). A Soparfi whose assets comprise at least 90 per cent of financial assets and which has a total balance sheet exceeding €350,000 is subject to a minimum net wealth tax of €4,815.
Dividend distributions by a Soparfi are generally subject to Luxembourg dividend withholding tax at a rate of 15 per cent, although this rate may often be reduced to zero by the application of Luxembourg double tax treaties or the exemptions provided under Luxembourg tax law (notably, Luxembourg’s implementation of the Parent-Subsidiary Directive or the withholding tax exemption available for certain shareholders that are resident in a country with which Luxembourg has a tax treaty in force and are subject to a corporate income tax considered as comparable to the Luxembourg one).
Liquidation surpluses distributed by a Soparfi to its shareholders are not subject to withholding tax in Luxembourg. Capital gains realised by non-resident shareholders (who were not Luxembourg residents for more than 15 years in Luxembourg and then non-residents in Luxembourg for less than five years before the sale of the Luxembourg participation) are taxable only if they have held a significant shareholding (at least 10 per cent) in a Luxembourg company for less than six months.
Luxembourg introduced a set of rules implementing Directive (EU) 2016/1164 (Anti-Tax Avoidance Directive 1 (ATAD 1)), which came into force on 1 January 2019. ATAD 1 targets, in principle, taxpayers subject to Luxembourg corporate income tax. Alongside exit taxation, the controlled foreign company rules, the general anti-abuse rule and the intra-EU anti-hybrid rules, these regulations include in particular interest deduction limitation rules, according to which the deduction of a taxpayer’s exceeding borrowing cost in a given fiscal year is in principle capped at the higher of
- 30 per cent of such taxpayer’s taxable earnings before interest, tax, depreciation and amortisation; or
- €3 million.
Non-deductible borrowing costs that cannot be deducted in a given fiscal year can be carried forward without time limitation.
Unregulated transparent investment vehicle
An unregulated transparent investment vehicle, commonly taking the form of an SCS or SCSp, is not subject to corporate income tax or net wealth tax. It is further not subject to municipal business tax (6.75 per cent for 2022 for Luxembourg City) to the extent it does not or is not deemed to conduct a commercial enterprise in the sense of the Luxembourg municipal business tax law. In principle, when an SCS or SCSp qualifies as an alternative investment fund, its activities are deemed not to be commercial. The SCS or SCSp would be deemed to have a commercial activity if its Luxembourg general partner incorporated in the form of a capital company holds 5 per cent or more in the SCS or SCSp.
Being a transparent entity, an SCS or an SCSp is not entitled to claim tax treaty or EU directive benefits. Considering its tax transparency, investors in an SCS or an SCSp are deemed to directly hold the underlying assets and realise the income of the SCS or SCSp in proportion to their respective interests. The SCS and SCSp are not withholding tax agents.
Luxembourg introduced a set of rules implementing Directive (EU) 2017/952 (Anti-Tax Avoidance Directive 2), which aims at combating hybrid situations. Those anti-hybrid rules notably include the reverse-hybrid rule that is applicable since the 2022 tax year. A reverse hybrid is an entity that is seen as transparent in its country of establishment but opaque by (some of) its investors. The reverse hybrid rules apply where non-resident investors who consider the fund as opaque are associated with the fund and own 50 per cent or more of interests, voting rights or rights to profits in the fund.
The reverse hybrid entity will become subject to corporate income tax on its income to the extent that its income is not taxed in any other jurisdiction (ie, at the level of the investors). However, an exemption from the reverse hybrid rule applies if the SCS or SCSp qualifies as a collective investment vehicle (CIV). To qualify as a CIV, the following criteria should be met:
- the SCS or SCSp should be widely held;
- the SCS or SCSp should hold a diversified portfolio of securities; and
- the SCS or SCSp should be subject to investor protection rules.
The SICAR can, generally speaking, be described as a tax-neutral vehicle for private equity investments.
Taxation of the SICAR: fiscally opaque
The SICAR regime for fiscally opaque entities (eg, an SA, SARL or SCA) follows the ordinary income tax regime of the Soparfi with a few risk capital-specific adjustments. The SICAR is thus also subject to corporate income taxes and specific domestic or treaty exemptions, and should qualify as a resident company for domestic and Luxembourg tax-treaty purposes. However, such type of SICAR benefits from a specific, objective, unconditional risk capital exemption: income from securities (namely, bonds, shares, other transferable securities as well as negotiable instruments giving the right to acquire the aforementioned risk capital securities), as well as income derived from the transfer, contribution or liquidation thereof is exempt. Income derived from temporarily invested idle funds also benefits from an exemption, provided that these funds are effectively invested in risk capital investments within a 12-month period. The SICAR is not eligible for the Luxembourg fiscal unity regime.
All other income is fully subject to ordinary Luxembourg direct taxation rules.
Fiscally opaque SICARs are exempt from net wealth tax. However, they are subject to a minimum net wealth tax in the same way as Soparfis.
Taxation of the SICAR: fiscally transparent
A SICAR formed as a fiscally transparent SCS allows for the replication of a common law-type limited partnership vehicle. Although the limited partnership has its own legal personality separate from that of its partners, it is itself not liable for corporate income taxation or net wealth tax in Luxembourg and cannot benefit from double tax treaties concluded by Luxembourg. It should not be liable to municipal business tax, to the extent that its Luxembourg general partner incorporated as a capital company does not hold 5 per cent or more of interest in the SCS, as it is by law deemed not carrying on a business activity. The same applies to the SICAR formed as an SCSp, with the difference that the SCSp has no legal personality of its own.
SICARs that are fiscally transparent (incorporated as an SCSp or SCS) might also be concerned by the above-mentioned reverse hybrid rule. CIV exemption could potentially apply if the aforementioned conditions are met.
Taxation of distributions by the SICAR
The SICAR regime distinguishes itself from the rules applicable to Soparfis in that it always permits fiscally neutral (namely, without source taxation) profit repatriations: neither dividends nor liquidation proceeds distributed by a SICAR to investors are subject to withholding tax.
Generally speaking, a specialised investment fund (SIF) is characterised by its tax neutrality:
- it is exempt from tax on income or capital gains;
- it is also exempt from net wealth tax; and
- distributions (including dividends and liquidation surpluses) made by a SIF to investors are not subject to withholding tax in Luxembourg.
However, the SIF is subject to an annual subscription tax of 0.01 per cent. The taxable basis of the subscription tax is the aggregate net assets of the specialised investment fund as valued on the last day of each quarter. Certain money markets and pension funds or SIFs investing in other funds, which are already subject to subscription tax, are exempt from subscription tax.
SIFs are presumed to be CIVs for the purpose of the above-mentioned reverse hybrid rules, although it is a rebuttable presumption.
RAIFs are also characterised by their tax neutrality. The default tax regime applicable to RAIFs mirrors the SIF regime. This means that the RAIF will only be subject, at the fund level, to an annual subscription tax levied at a rate of 0.01 per cent of its net assets calculated on the last day of each quarter. Depending on the investment assets, some exemptions from subscription tax apply to avoid a duplication of this tax. Irrespective of the legal form chosen for the RAIF, it is wholly exempted from corporate income tax, municipal business tax and net wealth tax, and distributions of profits by the RAIF do not give rise to a withholding tax.
However, RAIFs whose constitutive documents provide that their sole object is the investment in risk capital assets (the RAIF SICAR) and that they are subject to article 48 of the RAIF law, are taxed according to the same tax rules as those applicable to SICARs. In the case of an umbrella fund, this option will apply to the entire umbrella and cannot be applicable to only some of the compartments involved. An auditor will have to certify annually that the investment requirement has been met during the accounting period.
Under these SICAR-mirroring tax rules, a RAIF SICAR that takes a corporate legal form (eg, the SA, SARL or SCA) is fiscally opaque and is a normally taxable entity for corporate income tax purposes, but with an exemption for any profits and gains derived from securities and funds held pending investment in risk capital. Fiscally opaque RAIF SICARs are subject to a minimum net wealth tax (as SICARs).
Likewise, a RAIF SICAR that takes the form of a partnership (the SCS or SCSp) is tax transparent.
RAIFs are presumed to be CIVs for the purpose of the aforementioned reverse hybrid rules, although it is a rebuttable presumption.
Local taxation of non-resident investors
Would non-resident investors in a private equity fund be subject to taxation or return-filing requirements in your jurisdiction?
The answers that follow are given for non-resident investors who do not have a permanent establishment or representative in Luxembourg to which their holding in the respective fund is attributed.
Unless a reduced rate under a double tax treaty or an exemption (either domestic or under a tax treaty) applies, dividends distributed by a Soparfi are subject to 15 per cent withholding tax. A non-resident investor is not subject to any tax reporting formality in this respect – it is the company that has to file a withholding tax return – unless the investor wants to effect any entitlement to a (partial or total) reimbursement of the withholding tax on dividends.
Non-resident investors are taxed in Luxembourg for the capital gains realised upon the alienation of their shares in a Soparfi only if the investor has not held the shares in the Soparfi for more than six months and disposes of a participation representing more than 10 per cent of the share capital of the Soparfi. In all other cases, the capital gain is not taxable unless the non-resident investor has not been Luxembourg-resident for more than 15 years in Luxembourg and then non-resident in Luxembourg for less than five years before the sale of the Luxembourg participation. Liquidation surpluses distributed by Soparfis are not subject to withholding tax in Luxembourg.
It is important to note that in most cases, if a double tax treaty concluded by Luxembourg is applicable, the non-resident investor could benefit from treaty protection (most of the double tax treaties concluded by Luxembourg stipulate that such capital gains are not taxable in Luxembourg, but the country of residence of the foreign investor).
Unregulated transparent investment vehicle
When incorporated under the form of an SCS or an SCSp, unregulated transparent investment vehicles are not withholding tax agents. Provided that the SCS or SCSp does not (or is not deemed to) conduct a commercial enterprise, non-resident investors should not be liable to any taxation in relation to their interest in the SCS or SCSp, as well as filing obligations in Luxembourg. However, as a result of the transparency, they may be subject to Luxembourg non-resident taxation in respect of Luxembourg assets held by the SCS or SCSp, and notably non-resident capital gains taxation as described earlier.
Further, dividends paid to the SCS or SCSp will be deemed paid directly to its investors. Hence when paid by a Luxembourg company, these dividends might attract 15 per cent withholding tax, unless the investors themselves would be entitled to an exemption or a reduction under a tax treaty.
SIF and RAIF (not opting for SICAR regime)
As a general rule, non-resident investors in a SIF or RAIF are not subject to Luxembourg income tax unless they invest in an FCP, SIF or RAIF and derive capital gains taxable in Luxembourg from an indirect participation in a Soparfi incorporated as a Luxembourg capital company (a rare scenario).
SIF and RAIF: fiscally transparent
Generally, non-resident investors are not taxed in Luxembourg on the income (dividends, liquidation surplus and capital gains) derived from a SIF or a RAIF incorporated under the form of an FCP, SCS or SCSp. However, if such SIF or RAIF holds a shareholding in a Soparfi, the non-resident investor would be deemed to hold directly the shares in the Soparfi owing to the tax transparency of the SIF or RAIF. In this case, the non-resident investor could be taxed on the capital gain realised on the alienation of its units only if the investor has not held the shares in the Soparfi for more than six months and has a participation representing more than 10 per cent of the share capital of the Soparfi via the fiscally transparent SIF or RAIF taxable in Luxembourg. It should be noted that such taxation could be mitigated if a double tax treaty concluded by Luxembourg (with the country of residence of the investor) was applicable and stipulated that such capital gain is not taxable in Luxembourg.
SIF and RAIF: fiscally opaque
Distributions made by a fiscally opaque SIF or RAIF (including dividends and liquidation surpluses) are not subject to taxation in Luxembourg in the hands of a non-resident investor.
Non-resident investors are not taxed in Luxembourg for the capital gains realised upon the alienation of their shares in a fiscally opaque SIF or RAIF.
SICAR and RAIF SICAR
Dividends and liquidation surpluses distributed by any type of SICAR or by a RAIF SICAR are not subject to Luxembourg taxation in the hands of non-resident investors (either fiscally opaque or transparent). The same rule applies to capital gains deriving from the sale of shares in the SICAR.
Local tax authority ruling
Is it necessary or desirable to obtain a ruling from local tax authorities with respect to the tax treatment of a private equity fund vehicle formed in your jurisdiction? Are there any special tax rules relating to investors that are residents of your jurisdiction?
The tax exemption applicable to SIFs and RAIFs does not need to be confirmed by way of a tax ruling. The same is generally true for SICARs. In certain instances, it may be desirable to obtain tax clearance from the tax authorities for the tax treatment of a Soparfi – whether the fund is a Soparfi itself or Soparfis are used by SIFs, RAIFs or SICARs as an investment vehicle – to get five years of certainty regarding certain tax matters. The tax authorities will charge an administrative fee ranging from €3,000 to €10,000 for the treatment of each tax ruling request. For ruling requests that meet the requirements (simply, a detailed description of the applicable facts and circumstances and a sufficiently detailed tax analysis), the responsible tax office will have to provide an answer. As of 1 January 2017, certain pieces of information on cross-border tax rulings and advanced pricing agreements have been subject to automatic and spontaneous exchange of information obligations with jurisdictions affected by the cross-border tax ruling or advanced pricing agreement. A ruling is generally valid for a period of at most five years.
Finally, rulings issued before 1 January 2015 were automatically terminated as per the end of the tax year 2019 and are no longer valid as from the tax year 2020.
Must any significant organisational taxes be paid with respect to private equity funds organised in your jurisdiction?
RAIFs, SICARs, SIFs and Soparfis are subject to an annual fee due to the Chamber of Commerce. SICARs and SIFs, given that they are regulated vehicles and supervised by the Luxembourg Financial Supervisory Authority (CSSF), have to pay certain fees to the CSSF. In certain instances, fixed registration duties of €75 become due upon the incorporation of a corporate vehicle or any changes made to its constitutional documentation.
Special tax considerations
Describe briefly what special tax considerations, if any, apply with respect to a private equity fund’s sponsor.
The initiators, to the extent that they are not residing in Luxembourg, of a RAIF, SICAR, SIF or Soparfi will generally be able to structure their carried interest and incentive payments in a fiscally neutral manner in Luxembourg.
In addition, a VAT exemption for management fees applies to management services when supplied to a range of fund vehicles.
List any relevant tax treaties to which your jurisdiction is a party and how such treaties apply to the fund vehicle.
Luxembourg is currently party to 89 tax treaties covering most industrialised nations, according to data provided by the Luxembourg tax authorities, with some 15 additional treaties (including new treaties with countries having an existing treaty with Luxembourg) under negotiation or pending entry into force. Soparfis and fiscally opaque SICARs should be entitled to benefit from all the treaties currently in force. Insofar as SIFs are concerned, they might be able to do so for those countries for which the Luxembourg tax authorities state that investment companies with variable capital and investment companies with fixed capital can benefit from the respective tax treaty, which are the treaties with Andorra, Armenia, Austria, Azerbaijan, Bahrain, Barbados, Brunei, China, Croatia, the Czech Republic, Cyprus, Denmark, Estonia, Finland, France, Georgia, Germany, Guernsey, Hong Kong, Isle of Man, Indonesia, Ireland, Israel, Jersey, Kazakhstan, Kosovo, Laos, Liechtenstein, Macedonia, Malaysia, Malta, Moldova, Monaco, Morocco, Panama, Poland, Portugal, Qatar, Romania, San Marino, Saudi Arabia, Serbia, Seychelles, Singapore, Slovakia, Slovenia, Spain, Sri Lanka, Tajikistan, Taiwan, Thailand, Trinidad and Tobago, Tunisia, Turkey, the United Arab Emirates, Uruguay, Uzbekistan and Vietnam. For Bulgaria, Greece, Italy and South Korea, the applicability of the tax treaty is not clearly derived from its wording.
In June 2017, Luxembourg formally signed the Organisation for Economic Co-operation and Development’s Multilateral Instrument (MLI) developed as part of BEPS Action 15. The MLI will implement in the tax treaties (between its signatories) certain recommendations arising from the BEPS project, for example, the prevention of treaty abuse and anti-hybrid rules. Luxembourg has not excluded any of its bilateral tax treaties from the scope of the MLI, but made a series of reservations regarding specific provisions. The Luxembourg parliament approved the ratification of the MLI on 7 March 2019. With respect to many double tax treaties, the MLI has been in force as of January 2020.
Other significant tax issues
Are there any other significant tax issues relating to private equity funds organised in your jurisdiction?
On 14 October 2020, the Luxembourg government published the 2021 budget bill, which provides for the introduction of a new real estate tax for investment vehicles such as SIF and RAIF. Certain non-transparent investment vehicles will be subject to a new real estate tax, at a flat rate of 20 per cent, on income derived directly or indirectly via a transparent entity held in real estate assets (rental income and capital gains) located in Luxembourg.
Also, to the extent that SICARs, SIFs or any kind of alternative investment funds (AIFs) (including RAIFs) typically rely on the services of specialist investment managers or advisers, a specific VAT exemption applies to fund management services in accordance with article 44.1.d) of the Luxembourg VAT Law implementing article 135.1.g) of Directive 2006/112/EC (the Value Added Tax Directive). This exemption also covers some of the administrative services generally provided to funds. The case-law of the Court of Justice of the European Union confirmed that fund investment advisory services can be covered by the exemption, even when delegated to a third party, and irrespective of whether the fund investment adviser has a power of decision for the investment fund.
According to the Luxembourg VAT Authorities, funds benefiting from the VAT exemption for fund management services qualify as VAT taxable persons. Although this does not, per se, trigger an obligation for the SICARs, SIFs, RAIFs or other AIFs to register for VAT, the latter may have to do so, should they receive VAT-taxable services from suppliers located outside Luxembourg.
SICARs, SIFs, RAIFs and other AIFs are generally not able to recover VAT incurred on their costs. However, thanks to the broad application of the VAT exemption of article 44.1.d) of the Luxembourg VAT Law, the VAT leakage is in practice limited to the VAT due on services such as custodian notary, auditor or lawyer services. Moreover, the Luxembourg VAT rate is the lowest in the European Union (17 per cent as of 1 January 2015, compared with an average of 21 per cent in the European Union (20 per cent in the United Kingdom and 23 per cent in Ireland)).
In 2018, Luxembourg implemented the VAT grouping mechanism, to replace the no-longer-available cost-sharing agreements. The VAT grouping mechanism allows for savings of VAT costs and may therefore be beneficial for Luxembourg private equity structures.
On 22 December 2021, the European Commission released several legislative proposals that will impact corporate taxpayers. One of these is the proposed directive laying down rules to prevent the misuse of shell entities for tax purposes (the Shell Directive). The Shell Directive aims to avoid the use of legal entities and arrangements without minimal substance for tax avoidance or tax evasion purposes in a cross-border context. The proposal will be tabled for discussion and, finally, adoption in the forthcoming 2022 meetings of the European Council on Economic Affairs. The aim of the European Commission is to have it adopted in 2022. Once adopted, the Shell Directive should be transposed into member states’ national law by 30 June 2023 and come into effect as of 1 January 2024. It is currently still too early to conclude on the exact impact the Shell Directive will have on the private equity industry in Luxembourg.
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