luxembourg and private equity – an attractive...
TRANSCRIPT
Marcus
Peter
Partner, Bonn & schmitt
LioneL noguera
Partner, Bonn & schmitt
Luxembourg and Private Equity – an attractive symbiosisBesides regulated mutual investment funds, Luxembourg has been experiencing a remarkable development in the sector of private equity investments since the 1990s. This accounts for regulated and non-regulated private equity structures.
Regulated private equity
structures are mainly offering
three product types: the
specialised investment
fund (SIF) subject to the
respective Luxembourg
law dated 7 February 2007;
the so-called part II fund in
relation to the Luxembourg
law on undertakings for
collective investment dated
17 December 2010; and
the risk capital company
(SICAR) governed by the
Luxembourg law on venture
capital companies dated
15 June 2004, as amended.
The most common vehicle
for non-regulated private
equity investments is and
remains the Soparfi. Another
interesting type of vehicle
is the securitisation fund
/ company subject to the
respective Luxembourg law
dated 22 March 2004. It may
be regulated or non-regulated
depending on certain factors.
Thus, Luxembourg legislation
offers a wide array of
possible vehicles to choose
from, ranging from an
unregulated full-fledged stock
company being both a legal
person and a tax subject,
to a regulated investment
fund having neither legal
nor tax personality.
Soparfi, SIF, SICAR and part
II funds are currently in the
process of being adapted
to the new AIFM Directive
(EC/2011/61 of 8 June 2011).
The AIFMD is intending to
require alternative investment
fund managers to apply for
authorisation in order to
manage alternative investment
funds (this includes private
equity funds). Unless a private
equity fund is not in the scope
of certain exemption rules of
the AIFMD it will be subject
to more regulation starting in
2014. Nevertheless, the upside
of this advanced regulation
will be the introduction of
the passport allowing AIFM
to offer their management
services and distribute their
alternative investment funds
throughout the European
Union. Luxembourg is
currently preparing a draft
law to transpose the AIFMD
into national law coping
with its content in the most
favourable manner for the
well functioning of the
relationships among investors,
private equity firms and
alternative investment funds
managers. The existence of
SICAR, SIF and part II funds
gives Luxembourg certain
advantages in implementing
the AIFMD as such vehicles
already comply to a great
extent with its requirements.
Securitisation vehicles
are out of its scope.
In virtually all private equity
structures it will thus be
possible to find the vehicle and
investment instrument types
that guarantee an optimal
allocation of management
oversight and financial
rights both in the eyes of
the promoter and investors,
as well as an efficient tax
treatment at all levels of
the structure (distributions
by the investee, receipt of
income by the Luxembourg
vehicle, distributions to
investors and taxation by
their country of residence in
their hands), depending on
the countries of residence
of the majority of the
investors and of the targets.
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40 MarcH-aPriL 2012
Funds
The investor promoter balance of power
Historically the private equity
industry has built momentum
in Luxembourg in the 1990s
using existing corporate
forms. For a wide array of
reasons, including lighter
capital gains taxation of U.S.
investors, in the Anglo-Saxon
world the most widely used
structures were (and still are)
limited partnerships due to
their transparency for tax
purposes. Many promoters
came to Luxembourg
asking for similar vehicles.
Sometimes a société en
commandite simple (SCS,
a pure partnership, with at
least one unlimited liability
partner and limited liability
partners) was used to
replicate very closed forms
of partnerships used by
the industry in the U.S.
However, as in many cases
a stock corporation was also
needed to benefit from the
exemption of dividends and
capital gains on important
participations under the EU
Parent-Subsidiary Directive,
the société en commandite
par actions (SCA) quickly
became a classic preference:
a corporate partnership
limited by shares, which
allows the promoter to
secure control over the
management by assuming
the role of unlimited liability
partner, while treating the
investors as true corporate
shareholders. In a SCA the
unlimited partner also serves
as manager and may only
be removed in exceptional
circumstances, but limited
shareholders will have their
say on any amendment of
the articles of association,
which can thus be used as
a fundamental pact setting
the base rules all participants
in the SCA agree on.
A société anonyme (SA)
may also be used to group
a number of more active
investors, who would
typically have a greater
say on a key acquisition or
disposal, be it as a matter of
reserved competence within
the articles of association or
because the management
wishes to avoid any
possible liability exposure.
Finally, the Luxembourg
société à responsabilité
limitée (SARL), with its
simple structure and closed
character, is ideally suited
as an interim acquisition
vehicle for assets that may
need to be singled out, such
as real estate properties.
A versatile, reliable legal and regulatory framework
What really matters in the
Luxembourg corporate law
is its versatility. Contrary
to certain neighbouring
countries, the founders
of a company still enjoy
a wide discretion in
drafting clauses of the
articles of incorporation to
accommodate any particular
terms of the promoter-
investor relationship. Each
corporate form is bound by a
set of fundamental principles
(for example, in a SCA, the
equality amongst limited
shareholders) which must be
adhered to, but within those
principles wide freedom is
granted to the drafter. The
notary – a skilled professional,
who in most cases took on
a notarial office only after
many years of practice as
an attorney – will validate
the lawfulness of the articles
and grant legal personality to
the newly formed company
instantly upon executing
the deed of incorporation.
This is a significantly more
flexible approach than
that prevailing for example
in France or Germany
where the attributes of the
different corporate forms are
regulated in much heavier
detail, and where legal
personality is granted upon
registration of the company
with the trade register
after a somewhat lengthier
administrative process.
The contractual approach of
the Luxembourg corporate
law translates in the wide
variety of investment
instruments that may be
issued by a Luxembourg
vehicle, particularly when
such instruments are issued
to limited circles of investors
(i.e. without being impacted
by securities laws and
regulations that attach to
listed securities), as is the case
in a private equity context. It
also facilitates the definition
of attractive remuneration
policies for managers
through direct participation
in the investment vehicle,
sometimes through a
dedicated management
participation vehicle; for
example through special
incentive dividends
based on capital gains or
other performance from
underlying investments.
As mentioned in the
introduction, starting in
2004 with the securitisation
company, followed by
the SICAR and the SIF, the
lawmaker has in effect
MarcH-aPriL 2012 41
Funds
broadened the choice
of vehicles to grant the
promoters and investors
more freedom, not less.
These regulated structures
can either replicate the
traditional corporate
forms, or be organised
around funds without legal
personality, and/or enjoy
extra structuring possibilities
such as the creation of
different investment or
investor compartments
within one and the same
vehicle. The main purpose
of regulation in Luxembourg
is not to arbitrate between
vested interests; rather it
is to offer the extra safety
of regulation (including
depositary bank rules, criteria
for and supervisory oversight
over selection of resident
management, etc.) to those
promoters and investors to
whom such added security
appeals. Hence the need
to implement carefully any
proposed new regulatory
framework, such as the one
arising out of the AIFMD.
Luxembourg should consider
the AIFM Directive less as a
threat and over-regulation
but rather an opportunity
to enhance its status
pertaining to private equity
investments and alternative
investment managers
by relying on the same
advantageous factors as the
ones upon which the UCITS
industry built its success.
Tax adequacy
In many cases, taxation
is also part of the reasons
why promoters choose
Luxembourg. But tax need
not necessarily be wizardry.
For instance, a very simple
reason why so many
investors in the EU choose to
establish an interim holding
company in Luxembourg is
the important participation
exemption. This is basically
the implementation in
Luxembourg tax law of a
European directive of 1990,
which aimed at ensuring
that intercompany dividend
flows would not incur
multiple levels of taxation
where a sizeable participation
is held for some time. As
in all directives, Member
States are free to exceed
the minimum requirements
set by the directive as long
as they further the purpose
of the directive. In 1990,
Luxembourg decided to
grant the dividend exemption
from a 10 percent equity
stake onwards (in lieu of
the minimum 25 percent
that were foreseen by the
directive), as long as such
minimum stake is kept for 12
months at least, and to extend
it to capital gains (which is
optional under the directive).
Similarly, the directive
allows Member States to
consider that 5 percent
of the dividend or gain so
derived can be allocated to
expenses that were previously
deducted in connection
with such income, so that
the exemption is in practice
95 percent in virtually all
neighbouring countries.
Luxembourg on the contrary
has chosen to exempt 100
percent and to reintegrate
only the actual expenses
effectively deducted for
tax purposes, which –
specifically on multi-million
investments – will rarely
make up 5 percent.
Of course, the range
of investment vehicles
susceptible of being used
for a private equity fund
means that it is possible
to accommodate the
requirements of many
investor/investee countries
(tax personality, availability
of benefits under double tax
treaties, or on the contrary
tax transparency). The
instruments and securities
issued to investors may
also be tailored differently
depending on how such
investors would for instance
be taxed on dividend income
vs. interest income, as long
as the instrument chosen
matches the economics
of the structure.
As so many vehicles and
instruments can be custom-
tailored to a significant
extent, when a taxable entity
is chosen as private equity
investment vehicle it often
becomes very useful to
seek an advance clearance
with the tax authorities to
ensure the tax treatment
of such a “one-of-its-kind”
private equity investment
company remains secured
and predictable. In turn, this
allows the authorities to
understand the economics of
the contemplated structure
ex ante, and to verify that
the legal agreements of
the parties are on arm’s
length terms in line with
such economics.
Such clearances remain
confined to direct taxes,
though. The VAT treatment
of the vehicle and its
management structure will
in each case need to be
thoroughly analysed. VAT
taxability and the eventual
availability of exemptions
will depend on the exact
nature of any management
services provided and on
the remuneration profile for
such services. Depending on
whether the Luxembourg
vehicle and/or its management
company is considered a VAT
taxable person or not, the VAT
treatment of any inputs in the
management process, such as
advisory services rendered by
third parties, will be different.
The dynamic potential of
Luxembourg as a European
hub for private equity and
alternative investment funds
is thus considerable. But
Luxembourg’s weakness is
that it remains difficult to
attract and retain a sufficient
number of talented people
to fuel the growth in the
number of these structures.
On the tax front for instance,
compared to the number of
options available to build the
ideal investment structure,
relatively little has been
done to facilitate the entry
of new talent, such as e.g.
asset managers. Many private
equity firms are typically lean
organisations with greater
investor accountability, where
small but gifted players can
end up managing billions in
investments with a team of
less than ten managers and
staff in total. As such, they will
place higher emphasis than
large organisations on the
value of each individual, just
as we lawyers do, and given
their role in the economy
it seems efficient that they
be allowed to remain so.
By Lionel Noguera and Marcus Peter
42 MarcH-aPriL 2012
FunDs
About
Bonn & Schmitt has a strong track
record pertaining to setting-up
and assisting private equity and
alternative investment structures
on an ongoing basis since the early
1990s. The fi rm has been involved in
the very fi rst private equity deals ever
done in Luxembourg. In 1995 Bonn &
Schmitt created the now well-known
SCA structure for Deutsche Morgan
Grenfell then one of the fi rst market
entrants in this area. Subsequently
to this deal, the SCA has become
industry standard before the SICAR
law entered into force. As one of the
few legal fi rms with actual experience
in the private equity sector for so
many years, Bonn & Schmitt took a
leading role in shaping the 2004 law
on SICARs. Finally, Bonn & Schmitt
was the fi rst Luxembourg law fi rm to
create a joint venture private equity
vehicle between Europe and the Far
East, called Mandarin, still being the
fl agship model for Chinese/European
joint ventures. International Financial
Law Review has just granted the
fi rm its “High Yield Deal of the Year”
European Award for its assistance to
sellers EQT in the sale of KabelBW to
Liberty Global, Inc.
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