Report on a session at the 14th Annual IBA Finance & Capital Markets Tax Conference held in London on 21 January 2025

Session Chair

Sylvia Dikmans, Houthoff, Amsterdam

Panelists

Caroline Clemetson, Schellenberg Wittmer, Geneva
Andrew Howard, Ropes & Gray, London
Ron G Nardini, Vinson & Elkins, New York
Jan Neugebauer, Arendt & Medernach, Luxembourg City
Raul-Angelo Papotti, Chiomenti Studio Legale, Milan
Karin Spindler-Simader, Wolf Theiss, Vienna

Reporter

Andrew Haikal, Fasken Martineau DuMoulin, Montréal

Introduction

Sylvia Dikmans started the session by introducing the panel and presenting the agenda. The panel discussed the latest trends in European and United States fund structures, and whether any changes to such structures are warranted in the future.

Panel discussion

General EU and US fund structures

Jan Neugebauer provided an overview of common EU fund structures and the main actors involved in upstream, downstream and side-stream activities.

Neugebauer began by noting that typical EU structures involve closed-end funds, taking the form of limited partnerships, with carry and co-investment components (upstream).

Included in such structures are regulated entities, such as alternative investment fund managers (AIFMs), which can be Luxembourg vehicles (side-stream). Neugebauer highlighted the two main functions of AIFMs, being risk management and portfolio management. While both functions can be performed internally, it is not unusual for them to be delegated to investment advisors and investment managers.

As for the downstream component, various aggregators or special purpose vehicles can be involved in order to accommodate different investment structures.

Trends in onshoring

Dikmans asked Andrew Howard whether he has noticed any recent trends in regard to the onshoring of funds. Howard answered in the affirmative and stated that he is currently seeing one clear winner among the more conventional taxpaying jurisdictions used for onshoring: Luxembourg. He noted that EU investors are attracted to onshore jurisdictions, not necessarily for tax reasons, but because of the regulatory regime applicable to onshore fund vehicles. Howard highlighted a notable advantage working in Luxembourg’s favour, namely its attractive value-added tax (VAT) regime.

Dikmans then asked Ron G Nardini the same question. Nardini also answered in the affirmative, noting a clear trend involving marketers pushing for funds to be moved from the Cayman Islands to Luxembourg. He expanded on the VAT issue raised by Howard, stating that American fund managers are not necessarily aware of the VAT implications of such a move. While Luxembourg generally has a very extensive VAT exemption, managers usually push many different expenses that are not subject to such exemption directly to the fund. It was said that this may come as an unpleasant surprise for American fund managers.

The Swiss regulatory regime

Caroline Clemetson expressed some thoughts on the Swiss regulatory regime. While Switzerland seems to have lost the market for fund domiciliation to jurisdictions such as Luxembourg and Ireland, Clemetson noted that Switzerland remains a relevant jurisdiction for the distribution of foreign funds due to the significant presence of institutional investors. She also stated that the Swiss regulatory regime is very favourable to Swiss funds as long as they do not need to distribute within the EU.

In order to attract investments, Switzerland has introduced a new regime that does not have to be approved by the Swiss regulator, so-called limited qualified investor funds (L-QIF). This new regime has been particularly effective, notably due to the absence of stamp duty applicable to such funds and of VAT on management fees.

Clemetson confirmed that Switzerland should be viewed as a favourable onshore jurisdiction, highlighting the fact that Swiss funds regulation is very strict and that investment management is also heavily regulated.

Fund structuring in the US

Nardini explained that the focus of US fund structuring is to come up with arrangements that are tax efficient for all types of investors, which is often complex.

This may create the need to insert corporate blockers into the fund structure, catering to tax-exempt investors (sensitive to unrelated business taxable income issues) or non-US taxable investors (sensitive to US tax filing and payment obligations). Another concern is the mitigation of withholding tax through the fund structure, by relying on the available tax treaty exemptions. Finally, Nardini highlighted the need to minimise the recognition of phantom income by US taxable investors.

Nardini proceeded to describe a typical US fund structure and provided an overview of US ‘check-the-box’ elections that partnerships may file in order to be treated as corporations and, therefore, as tax or filing blockers.

One change that Nardini often sees now as a response to the hybridity issues created by the base erosion and profit shifting (BEPS) rules is the insertion of a Cayman corporation below the partnership in which tax-exempt investors are invested (as opposed to such a partnership ‘checking the box’).

Another variation is the insertion of a sponsored treaty entity, typically established in Luxembourg or Ireland, in order to maximise the availability of tax treaty benefits for investors in US fund structures.

Nardini concluded by confirming that US fund structuring is becoming increasingly complex, as investors’ tax needs are evolving. Nardini used the example of alternative investment vehicles (AIVs) that are often created for specific investors, which require their own audits and add costs. Another example is the typical fund structure Nardini summarised earlier, which needs to deal with different layers of EU rules, anti-hybrid measures and treaty eligibility concerns.

Retailisation

Neugebauer touched on the retailisation of fund products and, more specifically, of alternative assets. He described a new structure, the EU long-term investment fund, which has been replicated approximately 150 times to date. Nardini interjected that part of the reason for retailisation is the increasing difficulty that managers are encountering in raising capital from institutional investors. He also noted that high-net-worth individuals are becoming a more significant investment area and that managers are now interested in accessing this form of wealth.

Neugebauer mentioned that, in addition to AIFMs, the fund structure needs a product that is regulated by the authorities. In Luxembourg, two main vehicles are being used, namely the so-called ‘Part II’ vehicle and the reserved alternative investment fund (ie, non-partnerships, as partnerships are more difficult to administer when many investors are involved and liquidity is required).

Nardini then discussed the new trend in the evergreen fund industry, namely hybrid funds that allow investors to redeem their interest, but that are limited in duration (like traditional private equity funds). Such funds come with challenges around cash flow, investment management and tax planning, which are caused by regular changes in the investor base and complex structuring.

Switzerland: investment fund structures

Clemetson explained that the targeting of Swiss investors by non-Swiss funds is subject to extensive regulation and registration requirements. Accordingly, it is often simpler to enter the Swiss market, in regard to various industries (and especially for retailisation) via a Swiss fund. The same goes for the distribution of foreign funds into the Swiss market, as well as for real estate funds.

Downstream structuring and substance holding companies

Neugebauer discussed the creation of holding structures in the downstream context, and the need for them to be sufficiently robust from a substance and tax treaty benefit standpoint. Neugebauer touched on examples provided in commentary from the Organisation for Economic Co-operation and Development (OECD) and highlighted the fact that the need for a holding company is notably dependant on the type of investment in each particular case.

In the private equity context, Raul-Angelo Papotti confirmed a recent Italian trend caused by a change in legislation and pursuant to which a holding company may not be required. This is due to the fact that certain EU funds can benefit from an exemption for dividends received from Italian targets and for Italian-source capital gains. While this may be seen as an alternative to meeting substance requirements in regard to some transactions, Papotti said that he would not be surprised to see the Italian tax authorities attack certain structures (particularly if they involve non-regulated funds).

Nardini shared that in the US the presence of a holding company is dependent on the portfolio vehicle. For example, a holding company will typically be interposed above a partnership.

Howard then provided an overview of the United Kingdom’s qualifying asset holding company (QAHC) regime. He reminded the audience that the UK has historically had an advantageous holding company regime. Its exemptions on distributions, dividends and capital gains provide comfort that the holding company will not suffer from significant tax leakage. Howard noted, however, that this regime is not relevant for debt investments (particularly profit participating debt), as the UK imposes withholding tax on interest. There are also some stamp duty issues to navigate, as well as some challenges involving buybacks.

In this context, and considering the substance issues that managers have been encountering in other jurisdictions, the UK looked to improve its funds regime by creating the QAHC regime. While a QAHC is taxable in the UK, it can benefit from elective exemptions, leading to only a narrow financing margin being paid at the holding company level. The regime has certain limits in regard to who can set up a QAHC and the types of investments/strategies it can be used for. The regime is, therefore, mostly being used for debt investments and capital gains on shares.

Downstream structuring and substance management companies

Papotti explained why Italy is now an important jurisdiction for foreign managers. New legislation, which includes investment management exemption rules, is now in force and serves as an incentive for foreign managers to move to Italy. Papotti also highlighted that the recent legislative changes announced in the UK with respect to carried interest structures have resulted in many UK managers moving to Italy.

Papotti highlighted the importance of structuring, as foreign managers may have a taxable presence in Italy through the creation of a permanent establishment. He explained the main differences between setting up an Italian advisory company and operating through an Italian branch.

Papotti noted that structuring for Italian tax purposes is particularly relevant as the threshold for criminal liability is quite low. A trend that he is currently seeing develop is the request for advance pricing agreements (APAs) on the absence of an Italian permanent establishment for the fund manager. Such rulings are useful as individuals who move to Italy typically have significant involvement in fund operations, creating a significant risk. The development of an APA helps to manage such risk.

Karin Spindler-Simader provided a summary of the situation from an Austrian perspective and focused on the importance of planning around VAT in regard to fund structures. She explained that Austrian VAT applies at a rate of 20 per cent and that it is not deductible by the fund, causing it to be a significant cost factor. The management of certain investment funds is exempt from VAT, but not as it relates to outsourced services. That being said, some favourable case law has stated that the nature of the services being provided, as opposed to the identity of the provider, must be looked at in determining whether the VAT exemption applies. At a high level, outsourced services that are solely used for the management of fund assets and related administrative tasks are targeted by the VAT exemption. This typically excludes certain types of services related to software and due diligence.

Clemetson then touched on the regulation of Swiss asset managers. She highlighted the importance of only dealing with Swiss managers who are regulated, as enforcement proceedings can be instigated against unregulated fund managers.

Carried interest

Howard discussed typical carried interest structures, and the UK’s attempt to target certain perceived loopholes. A newly proposed regime will cause carried interest to be taxed as income rather than capital, at a rate expected to be around 34 per cent (ie, favourable in comparison to the tax rate of 47 per cent ordinarily applicable to income). The regime will likely be subject to a minimum holding period and capital commitment, without any possible grandfathering.

Spindler-Simader highlighted that Austria is an interesting jurisdiction for carried interest recipients, as it is typically considered to be a share of the fund’s profits and, therefore, is taxed as capital at a flat rate of 27.5 per cent. The setting up of non-transparent carry vehicles should however be avoided, as it may lead to the recognition of employment income for the management team members.

Papotti explained that Italy is benefitting from the changes announced in the UK. It has a carried interest scheme which includes a safe harbour whereby, when certain conditions are met, carry is qualified as financial carry (taxed at a rate of 26 per cent) as opposed to employment carry (taxed at a rate of 47 per cent). On top of this, according to Italy’s non-domiciled tax regime, a full exemption can be obtained for carry recipients of foreign funds.