28 March 2012
ATOZ NEWS: Tax, ATOZ and Taxand Intelligence | March 2012
by: The Atoz Team
Greetings!
Amidst the continuing talks of global economy turbulence, it is refreshing to hear and see tentative signs of recovery, in the form of market stability and consumer confidence. The liquidity gap and pending political changes still weigh on investors’ minds; however, market economy forces are driving progress. Investors are designing creative solutions for financing and are doing what they do best: taking advantages of the multitude of opportunities presented at home and in the emerging markets. As always, our front row seat as advisor allows us to observe, learn and share such best practices across industries and investor profiles.
With this issue of the ATOZ Newsletter, once again, we bring you current and relevant local and global tax developments and our interpretation of their impact to you. Changes at European level such as the France – Luxembourg DTT renegotiation and the positive developments of the withholding tax refunds on dividends for investment funds call for constant monitoring and careful planning. Furthermore, while aligning regulatory aspects with EU driven directives, recent and upcoming improvements in the Luxembourg based investment vehicles regimes widen the spectrum of opportunities both in terms of investors and investments, making Luxembourg even more attractive. We are confident that trend will continue throughout the year.
We will continue to observe and report on regular basis. We encourage you to contact us should you have questions or comments on any of the Luxembourg and international tax related developments listed below.
Regards,
Keith O’Donnell, Managing Partner
SUMMARY
The French authorities have recently announced that they wish to renegotiate the provisions of the France-Luxembourg Double Tax Treaty (“DTT”), dealing with the taxation of capital gains on French real estate. Even though the outcome of any negotiation is difficult to predict, Luxembourg tax payers, currently investing or willing to invest in French real estate should remain vigilant, as they may soon be impacted by this change.
The French tax authorities wish to amend the DTT in such a way that the capital gains realised by Luxembourg tax payers on the sale of shares in French real estate companies holding French real estate would become taxable in France.
As of today, the situation is such that, when a Luxembourg Company holds French real estate indirectly via a French real estate company, when the Luxembourg Company sells the shares in the French real estate company, no taxation occurs on the capital gains in neither of the countries. This is due to the fact that the taxing right is generally granted to Luxembourg, which exempts the capital gains under certain conditions.
The potential amendment to the DTT would therefore mean an increase of the tax burden on such real estate investment structures (due to the proposed taxation of the income in France). We recommend that tax payers either carefully review the investment structures they have already in place with their tax advisers or reconsider any structuring of French real estate investments for the near future. We will keep you informed about any developments in this regard.
For additional information, please contact Keith O’Donnell keith.odonnell@atoz.lu or Jamal Afakir at jamal.afakir@atoz.lu.
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France has for many years applied a withholding tax to dividends paid to foreign investment funds but not to dividends paid to French investments funds. Claims against this discrimination were recently held in front of the European Court of Justice "ECJ" in Luxembourg. Atoz and Taxand are actively involved in claims of this withholding tax in 12 countries in Europe and were present at the hearing.
On 16 February 2012, following the request of a preliminary ruling (Article 267 of the Treaty of the Functioning of the European Union “TFEU”) of the Administrative Court of Montreuil on 4 July 2011, a hearing on cases C338-11 to C347-11 took place at the ECJ in Luxembourg.
QUESTIONS POSED TO ECJ BY THE ADMINISTRATIVE COURT OF MONTREUIL:
1. Must the situation of the investors be taken into account together with that of investment funds (UCITS)?
2. If yes, what are the conditions under which the withholding tax at hand may be regarded as consistent with the principle of “free movement of capital"?
ANSWERS:
To question 1, the European Commission and the claimants, contrary to the French government’s position, considered that the level at which a comparison should be made is the one decided by France itself in Article 119 Bis §2 of the French Tax Code: the level of the investment funds.
A response to question 2 would only be relevant if the Court should respond affirmatively to question 1, according to the European Court and the claimants. The French government responded that Articles 63 and 65 of the TFEU should not be made enforceable against France.
For additional details read the hearing transcript summary below.
IMPLICATIONS:
The hearing was, in our view, positive for EU and non EU funds that were making the claims.
This is another step in favour of foreign investors in their efforts to recover withholding taxes levied on dividends. The ECJ is expected to render its decision shortly. Investors are advised to follow this case closely, examine the opportunities for refunds and consider filing protective claims.
HEARING TRANSCRIPT SUMMARY:
Article 119 Bis §2 of the French Tax Code and the principle of fiscal transparency/neutrality
To answer the first question, the European Commission and the claimants demonstrated that the position of the French government to consider investors along with investment funds is contrary to Article 119 Bis §2. This article organizes the taxation of outbound dividends solely at the level of investment funds. Hence, the fiscal “transparency” and fiscal “neutrality” arguments put forward by the French government are not sustainable since investment funds are treated as separate legal entities by Article 119 Bis §2.
The European Commission recalled that a Member State has the right to exercise its own fiscal competence and that, Article 119 Bis §2 is exactly the result of how France decided to organize the taxation of outbound dividends. Once this competence is exercised, it must remain constant.
Related ECJ jurisprudence and the OECD Tax Model Convention of 23 April 2010
The French government invoked the case of Orange European Smallcap Fund (20.05.2008 / C194-06) and the OECD Tax Model Convention in support of its reasoning. The taxpayers and the European Commission retorted that these were not applicable to the case at hand. In particular, the ECJ had always settled cases by analyzing the level applied by the Member State itself, in line with its right to exercise its fiscal competence. Cases quoted for this argument: the Orange European Smallcap case (considering the position of investors), the Denkavit case to the Commission vs. Germany case (considering the level of investment funds). More specifically, the ECJ concluded in the Orange European Smallcap Fund case that the investor level was relevant because this was the level applied by the Dutch fiscal legislation for taxing dividends.
The taxpayers and the European Commission argued that the OECD Model Tax Convention recommendation to include the investor level in order to guarantee fiscal neutrality between direct and indirect investments was not applicable as the fiscal competence actually applied by Member States supersedes the OECD Model Tax Convention.
The actual situation of investors in distributing funds
The European Commission, the taxpayers and the President of the Court noted that the actual situation of the investors is not relevant as the levy of the 25% withholding tax (30% as from 01.2012) only occurs when the dividends are paid to foreign investment funds. Also, since French investments funds are not subject to withholding tax on French dividends, it results in no charge of withholding tax on French and foreign investors (except the “prélèvement libératoire” levied on all distribution made by the fund, regardless of the investors’ residency) and demonstrates, according to the President of the Court, that the level of comparison is de facto at the investment fund.
Capitalization investment funds
The claimants and the President of the Court recalled that capitalization investment funds compare themselves at the level of the investment funds since there is no systemic distribution to the investors, and the growth of the net asset value of the investors’ portfolios held by French investment funds is clearly favoured compared to foreign funds.
Financial assessment of the French withholding tax reclaims
According to the French government, the claims filed before the French Courts at present amount to EUR 4.2 Billion. Given this amount, France requested that ECJ’s judgment, if unfavorable to France, should be time-limited in order to avoid any potential economic troubles and to recognize its good faith when implementing European law into national legislation.
According to the claimants however, by time-limiting the decision, the ECJ would favour France over other Member States which already revised their legislation and in some cases, granted refunds of unduly levied withholding tax i.e. Norway, The Netherlands, Belgium, Italy and Sweden.
Finally, the European Commission reminded the Court that the French government should be aware of the European Law since the French Council of State already declared Article 119 Bis §2 in breach of the principal of “free movement of capital”, Article 63 of the TFEU. (Council of State, Case Stichting Unilever Pensioenfonds Progress v. France, 13.02.2009).
For additional information, please contact Keith O’Donnell keith.odonnell@atoz.lu or Mariem Sahraoui mariem.sahraoui@atoz.lu.
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The law of 8 February 2012 amends retroactively as of 1 January 2012 the regime applicable to SPFs (Private Wealth Management Companies), as defined by the law of 11 May 2007 (“SPF Law”). SPFs are investment vehicles, dedicated to private investors which benefit, to the extent that they meet certain requirements, from an exemption from Corporate Income Tax (“CIT”) and Municipal Business Tax (“MBT”) on profits and capital gains as well as from Net Wealth Tax (“NWT). Peter Kleingarn and Samantha Nonnenkamp explain why the SPF regime had to be amended and why this amendment makes SPFs even more attractive to investors.
Why the regime had to be amended
The EU Commission informed Luxembourg in 2010 that one of the provisionsof the SPF regime was not in line with EU law: it provided for different tax treatments to situations which, according to the EU Commission, were comparable.
The EU Commission threatened that SPFs could lose their privileged tax status if more than 5% of the dividends received in a given year came from foreign non-listed companies, not subject to a tax, which was considered as comparable to Luxembourg CIT.
As this dividend limitation only applied to shareholdings in foreign entities, and not to shareholdings in Luxembourg entities, SPFs were limited in their investments in foreign entities. They could however invest without any restrictions in any type of Luxembourg entity, regardless whether these entities were subject to tax in Luxembourg or not, such as Luxembourg regulated undertakings for collective investment.
The Luxembourg Government decided therefore to remove the limitation as regards investments in tax exempt companies.
The SPF regime in brief
The SPF was launched by the Law of 11 May 2007 and was aimed to serve the private wealth management sector. The objective of this vehicle is to hold passive investments (acquisition, holding, management and disposal of financial assets, excluding any type of commercial activity). The circle of investors is restricted to private individuals i.e. individuals managing their private wealth or private wealth entities, acting on behalf of one or several individuals, or intermediaries acting on behalf of either of the above.
The SPF is exempt from CIT, MBT and NWT. It is also exempt from Luxembourg withholding tax on distributions. Due to its tax exempt status, the SPF is not able to benefit from the Double Tax Treaties concluded by Luxembourg.
The SPF is subject to subscription tax at a rate of 0,25%, applicable on its share capital, including any share premium. The minimum tax is EUR 100 and the maximum tax is EUR 125.000 a year. Subscription tax also applies to the part of the debt (if any), that exceeds an equity-to-debt ratio of 1 to 8.
Income from financial assets is therefore exempt at the level of the SPF. It may be taxed subsequently at investor level, once the income is distributed.
- Interest paid by the SPF on issued liabilities may be subject either to 10% withholding tax for individuals, residents in Luxembourg, or subject to withholding tax (at 35% since July 2011) under the provisions of the so-called “Savings Directive” (Council Directive 2003/48/EC of 3 June 2003 on taxation of savings income in the form of interest payments). The latter applies mainly for EU resident individuals, but only to the extent they do not opt for an exchange of information, i.e. they do not opt for the taxation of the income in their country of residence.
- Dividends paid to Luxembourg resident shareholders (individuals) will be fully taxed in their hands. Dividends paid to non-residents are subject to tax in accordance with the laws of the country of residence.
- Gains realized by non-residents upon the sale of a participation in an SPF, either upon sale or upon liquidation of the company, are not subject to tax in Luxembourg.
Implications
The new law has retroactive effect as of 1st January 2012 and eliminates a potential source of discrimination.
SPFs are now able to hold participations in any type of entity, regardless of the jurisdiction in which the subsidiary is located and the tax regime, applicable to the subsidiary in this jurisdiction. This simplifies the management of an SPF and increases the range of situations where using an SPF is appropriate. Nevertheless, the SPF remains a holding vehicle only for investments undertaken by private individual investors.
For additional information, please contact Peter Kleingarn at peter.kleingarn@atoz.lu or Samantha Nonnenkamp at samantha.nonnenkamp@atoz.lu.
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The regime applicable to SIFs (Specialized Investment Funds) is amended as of 2012. In the following developments, Dominique Léonard explains the purpose of the changes, introduced by the new law as well as the implications for the investors.
Overview of the current SIF regime
SIFs, as defined by the law of 13 February 2007 (“SIF Law”), were created to replace the Institutional Investor Funds, introduced by the law of 19 July 1991 with a view to introduce additional flexibility, as well as to extend the circle of eligible investors to professional and well-informed investors. SIFs are funds, benefitting from an attractive regime, combining structural flexibility and investor protection. SIFs may invest in all asset classes and may implement all types of investment strategies, subject to certain basis risk diversification requirements.
SIFs are not subject to Corporate Income Tax and Municipal Business Tax, nor are they subject to Net Worth Tax. They are also not subject to withholding tax on dividend distributions. A SIF is only subject to an annual subscription tax amounting to 0,01% of its Net Asset Value.
The SIF regime has proven to be a success since its entry into force, as it has met the industry’s pressing needs of rapid launch of a tailored but regulated vehicle, available to a clearly defined range of investors. As of 31 October 2011, 1352 SIFs had been authorized by the Luxembourg Regulator (“CSSF)”, representing 35,40% of all Undertakings for Collective Investments (“UCIs”) regulated in Luxembourg.
Main objectives of the changes
The changes introduced seek to align the SIF regime with the new law on UCIs (i.e. the law of 17 December 2010, which has implemented into Luxembourg law the so-called “UCITS IV” Directive), as well as with the upcoming implementation of EU Directive 2011/61/EU on Alternative Investment Fund Managers (so-called “AIFM Directive”). (In addition, the Luxembourg legislator expressly wanted to take into account the 4 years of practical experience of the CSSF in the authorization process of SIFs.?) Finally, the aim of the law is to give the CSSF the necessary tools to perform its supervisory role in the best manner, while ensuring that the SIF remains an investment vehicle of quality and good reputation.
The amendments in brief
Regulatory process and supervision requirements:
- Active management: SIFs have to provide the service of active portfolio managers, so as to exclude passive management activities (that should be undertaken rather by private wealth management companies, i.e. SPFs) from the scope of the SIF Law. The commentaries to the draft law however indicate that the aim of the change is not to exclude the possibility of creation of real estate or private equity SIFs.
- Prior CSFF approval: The launch of a SIF is not possible before an approval is obtained from the CSSF on the SIF’s constitutive documents, choice of custodian and identity of the directors and persons in charge of the portfolio management.
New operational requirements:
- Risk management: Risk management policy and appropriate systems have to be put in place to identify, measure and manage the risks, associated with the portfolio positions and the impact of these positions with respect to the general risk profile of the portfolio.
- Conflict of interests: SIFs have to be structured and organized so as to limit the risk of conflicts of interest between the SIF and anyone involved or linked to it. In the event of potential conflict, the SIF must seek to safeguard the interests of investors.
- Delegation of functions: SIFs, which delegate the tasks of carrying out functions on their behalf to third parties must notify the CSSF before the delegation arrangement can become effective. The delegation of functions is subject to conditions: (i) the delegation must not prevent the effectiveness of the supervision of the SIF by the CSSF and must not prevent the SIF from acting, or from being managed, in the best interests of its investors, (ii) the directors of the SIF must be in a position to demonstrate that the delegate is qualified and capable of undertaking the functions in question and was selected with all due care, to monitor the delegated activity effectively at any time, to give the delegate further instructions at any time and to withdraw the delegation, with immediate effect, when it is the in the best interest of the investors. The delegation of portfolio management is subject to additional restrictions, one of them prohibiting the custodian bank from undertaking such function.
Umbrella funds:
- Autonomy of CSSF approval between sub-funds: The withdrawal of the CSSF approval for a particular compartment has no impact on the other sub-funds of the same SIF, which remain registered on the official list of SIFs.
- Compartment cross investments: subject to certain conditions, sub-funds of a multiple compartment SIF are allowed to make investments within other sub-funds of the same SIF.
Other amendments:
- No translation of articles of incorporation: The SIF is exempted from the requirement to translate the articles of incorporation or any modification thereto or any notarial deeds into French or German, in the case these documents have been originally drafted in English.
- Communication of annual reports to investors: For SIFs incorporated as SICAVs and SICAFs, there is no obligation to send the annual report, the independent’s auditor’s report, the management report nor the observations of the supervisory board (if applicable) to the shareholders at the same time as the convening notice to the annual general meeting. The convening notice only needs to indicate the place of the meeting and practical arrangements for providing the documents to shareholders, and to specify that each shareholder may request that these documents be sent to him.
Implications
The law will enter into force on the 1st day of the month, following the publication of the law in the Memorial. Given that this publication should in principle take place during the course of March or at the latest in April, it can be expected that the changes will enter into force as of the 1st April or the 1st May 2012.
SIFs existing at the date of the entry into force of the new law will benefit from grandfathering provisions as follows:
- Until 30 June 2012 to conform with the new Risk management, Conflict of interests and Active management requirements;
- Until 30 June 2013 to conform with the new Delegation of functions requirements.
All these changes should be welcomed as positive for SIF investors. They aim at anticipating the implementation of the AIFM Directive, by imposing additional rules with regard to the delegation of functions, risk management and conflict of interest. Because of the European Passport, the new SIFs will be able to provide management services and distribute funds in all EU member States. The additional changes are also designed to enhance the attractiveness of the SIF regime by creating new structuring opportunities, in particular compartment cross investments and removing certain administrative requirements.
For additional information, please contact Dominique Léonard at dominique.leonard@atoz.lu.
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On 1 March 2012, the hearing in the case C-44/11 Deutsche Bank (“DB”) vs. Finanzamt Frankfurt am Main V-Höchst took place.
The case relates to the VAT treatment of the management of securities-based assets (portfolio management), where a manager takes, at his own discretion and for remuneration, decisions in regards the purchase and sale of securities and implements these decisions by buying and selling the securities. The case also addresses the criterion of defining ancillary services and in particular, if certain services provided by the manager shall be bundled or split for defining the VAT treatment applicable.
According to Deutsche Bank, the management of securities-based assets (portfolio management), where a portfolio manager receives a remuneration for the decisions he takes at his own discretion to buy or sell securities and for the buying and selling of these securities, is tax exempt based on the specific VAT exemption, applicable to transactions in shares and the negotiation of such transactions.
The German government had taken the view that such management of securities is only tax exempt in the case of management of investment funds assets. In their view, in case of portfolio management services rendered to private individuals, the buying and selling of securities-based assets within a portfolio management activity is part of the global remuneration related to the portfolio management activity and thus does not as such fall under a VAT exemption. The Dutch government is also in favour of such taxable treatment The view of the European Commission however, appears to be less restrictive and in favour of a VAT exemption.
We strongly suggest that portfolio managers follow this case as depending on the current VAT treatment applied, opportunities or risks could arise. The ATOZ indirect tax team will continue to monitor and report on the developments of this case.
For additional information please contact Christophe Plainchamp at christophe.plainchamp@atoz.lu or Nicolas Devillers at nicolas.devillers@atoz.lu
Since March 22, 2004, the Grand-Duchy of Luxembourg has had a specific securitization regime, provided by the law of the same date. Said law provides for several different types of securitization vehicles: corporate types and two different kinds of funds. While the then legislator likely had considered it, one of them turned out to be the perfect vehicle for Sharía compliant investments.
The securitization operation
The securitization operation under Luxembourg law implies two basic elements: (i) the transfer of a risk to the securitization vehicle and (ii) the issuance of securities.
Luxembourg law has given an extremely wide interpretation to the notion of “risk”; so while it can be applied to the straightforward situation of the transfer of questionable receivables, the risk assumed by the securitization vehicle can also be represented by an asset, a pool of assets, including securities, whether newly issued or acquired on a secondary market.
The securitization fund
While a securitization vehicle can present itself under the form of a company, such as a joint stock company, with its own legal personality, bylaws, shareholders and a board of directors, it can also exist under the form of what is term a “securitization fund”.
While the term fund can also refer to some type company, such is not the case in matters of securitization. The securitization fund (the specific type of fiduciary fund is not considered here) is in fact a pooling of assets held by the investors in co-ownership. This pool of assets is managed by a management company, which does not have any ownership right on said assets.
The securitization fund hence has no legal personality or existence of its own: it is and remains a pool of assets, the interests of which are represented by the managements company. While such a fund has no bylaws, its functioning is governed by management regulations, approved by the investors.
It should be noted that this co-ownership regime specifically derogates to general legal provisions applicable to assets held by several owners: the law of 2004 creates an ad hoc treatment of the assets held by a securitization fund.
Among other exceptions, the ownership over the assets pooled together is represented by securities.
As indicated above, while the securitization fund is not a company, the ownership over the pool of assets pool in such a fund is represented by securities.
An added advantage of the securitization fund is the ability to create compartments: each one being independent from the other, towards investors and creditors. The limitation of liability the investor incurs is thus twofold: it is limited to the amount of his investment, and it is also limited to a specific compartment, resulting in increased investor’s protection.
Furthermore, the fund is not liable for the debts incurred by the management company itself, which should not be confused with debts incurred by the fund represented by the management company, which are specific to each compartment.
Sharía compliance
Sharía compliance for these types of fund is readily attainable.
In a classic setup, the securitization fund serves a special purpose Mudarabah (profit & loss partnership): it pools the assets, but the investors retain their direct ownership rights to it. The management company serves as Mudarib (manager) and the management regulations provide for the profit sharing rules, expressed in terms of percentage of total profits.
The investors bring in capital through the subscription of Sukuks (Sharía compliant securities); the latter providing an ownership right over the assets, and the entitlement to a proportion of return, as provided by the management rules.They do not however entitle their holders to be involved in the management of the fund. Neither return, nor the principal is guaranteed, but the risk is limited to the amount invested by each investor.
The setup above is merely one of the possibilities amongst many others. A securitization fund could also be used to house an Ijarah lease structure. The securitization fund would acquire and lease the assets, with their acquisition being financed through the securities’ issuance. It should be noted that even through a Luxembourg setup, the IjahrawaIqtina (separate contract to purchase the asset at the end of the lease) is also conceivable.
Some sukuk issuers have found themselves in default as a result of the crisis, with their investors finding out at such time that their securities were only assets based (as opposed to asset backed) and that, as such, they did not have the expected ownership rights over the underlying assets. So in addition of seeing their investments fail, investors are also surprised that these investments were in fact not sharía compliant, as advertised.
The securities issued by a Luxembourg securitization fund present the advantage of being purely and unequivocally asset backed: the holders of these securities have a direct right of ownership on the underlying assets. Under the proper supervision of a sharía board, Luxembourg securitization funds offer great flexibility to create a reliable sharía compliant investment platform.
Dominique Leonard is a Director with ATOZ Corporate implementation team and one of the firm experts in Sharia compliant structuring. Dominique can be reached for comments and questions at dominique.leonard@atoz.lu
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- 25-27 April 2012 - Taxand Annual Conference
- 29 March 2012 - Olivier Remacle, ATOZ Partner will lead a session titled "PE Structures: The Impact of Taxation" at the upcoming ALFI Leading Edge Conference & LPEA: AIFMD and PE Industry.
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