There are two methods of investing in venture capital and private equity in Luxembourg - through a private equity vehicle or through a public equity fund. The former, though not open to public solicitation, is far less cumbersome than the latter, which is subject to regulatory authority approval.
Private equity vehicles
Luxembourg corporate law provides ample flexibility to tailor structures that meet the needs and requirements of promoters and investors in private equity. These structures are implemented in a favourable tax environment with numerous attractive characteristics, such as having no withholding tax on interest and exemptions for dividends and capital gains on large equity stakes.
Corporate forms
The two main alternatives for private equity vehicles are the Société Anonyme (SA) and the Société en Commandite par Actions (SCA). Both are commercial companies and benefit from the same favourable tax treatment. The choice of one of these corporate vehicles must therefore rest primarily on considerations of corporate law and governance.
Société Anonyme
The SA is a public limited liability company. Management is entrusted to a board of at least three directors who are not liable for the indebtedness of the company if corporate assets do not satisfy the claims of creditors.
The board of directors is appointed and removed by decision of the general meeting of the shareholders. The board of directors has no assurance against removal, which is possible without cause or indemnity. Maintaining control over management thereby requires the holding of the majority of the share capital.
The board of directors is the body responsible for the management of investments in target companies. It is, however, entitled to appoint an external investment manager (generally related to the promoter) to which it can then delegate day-to-day investment management.
Société en Commandite par Actions
The SCA is a corporate partnership limited by shares set up between one or more shareholders who are indefinitely, jointly and severally liable for the obligations of the company (the unlimited shareholders) and shareholders who contribute a specific amount of share capital, whose responsibility is limited to their contribution (the limited shareholders). Investors will naturally enjoy the position of limited shareholders, while the manager will be the unlimited shareholder.
In an SCA, the manager owns shares in the vehicle and manages the investments of the vehicle.
Shareholders' powers are more restricted in this type of company, because the unlimited shareholder carries out the management of the company. To have any effect, most shareholder decisions also need the manager's approval, and removal of the manager is possible only for legitimate cause.
The law imposes personal liability on the manager if the company becomes insolvent. In order to limit this potential liability, it is common to set up an SA or a private limited company (a société à responsabilité limitée) to be the manager and unlimited shareholder of the SCA.
Regulatory issues
The formation of a private equity vehicle is not subject to any regulatory requirement, approval or authorization as long as it does not extend its activities to banking, lending money on the basis of customer deposits, or ancillary activities.
This applies, however, only to entirely private structures. All public solicitations must be prohibited to avoid any risk that the offer to subscribe for shares be considered as a public offering, triggering the application of the rules relating to public offerings. Any assimilation to a public investment fund (SICAV, FCP) must be avoided, because these are subject to authorization and control by the Commission de Surveillance du Secteur Financier (the CSSF).
Taxation of private equity structures
The private equity vehicle
On incorporation, a civil or commercial company is subject to 1% capital contribution duty assessed on the net worth of the contributed assets.
Net worth tax is levied annually at a rate of 0.5 % on the net assets. Equity stakes held by the vehicle and qualifying under the important participation exemption are exempt from net worth tax.
The vehicle is subject to the normal corporate tax regime. All items of income not covered by an exemption will be subject to the Luxembourg corporate income tax at a total effective rate of 30.38%.
Any stock company resident in Luxembourg can benefit from a participation exemption (SOPARFI regime) in respect of dividends and capital gains received from qualifying equity stakes. Broadly, a shareholding will qualify if:
it amounts to at least 10% of the capital of the subsidiary (or €1.2 million ($1.41 million) for dividends / €6 million for capital gains), and
it is held for a minimum of 12 months, and
the subsidiary is a Luxembourg resident stock company, or an EU resident company covered under Article two of the EU Parent-Subsidiary directive of July 23 1990, or a non-resident company that is subject in its country of residence to an income tax comparable to the Luxembourg corporate income tax (this condition being fulfilled if the foreign income tax results in an effective tax rate of at least 15%). All dividends received from any of these three types of companies further enjoy an automatic 50% exemption if they are not covered by the SOPARFI regime.
As a matter of principle, there is no withholding tax (WHT) in Luxembourg on payments of all items of income from capital other than dividends. In particular, Luxembourg does not apply any WHT on interest paid by one of its residents to either a resident or a non-resident. Shares and bonds issued by the vehicle are exempt from any stamp duty. No stamp duty is levied on the trading of shares and bonds on the Luxembourg Stock Exchange.
Distributions to the investors
A WHT of 20% is normally assessed on dividends paid by the vehicle to its shareholders.
But distributions are free from Luxembourg withholding tax if:
the beneficiary investor is a fully taxable Luxembourg limited company (SA, Sàrl, SCA), a company resident in a EU member state and listed under Article two of the EU directive of July 23 1990, a Luxembourg permanent establishment of such a company, or a Luxembourg permanent establishment of a limited company resident in a state with which Luxembourg has concluded a double tax treaty, and
at the moment of the distribution the beneficiary investor has held or undertakes to hold a participation of at least 10% of the share capital of the Luxembourg paying vehicle, or bought for at least €1.2 million, during a minimum period of 12 months.
Redemption of shares
The proceeds of the repurchase of one isolated investor's stake in the vehicle do not bear WHT. In most cases, a proportionate redemption of all investors' stakes upon divestment should only trigger WHT in respect of the part of the proceeds that consists of capitalized reserves and retained earnings.
Public equity funds
Part II of the law of March 30 1988 relating to undertakings for collective investment and more recently the law of December 20 2002 provides a legal framework to promoters of specialized funds, the principal object of which is the investment in private equity and venture capital. The principal difference between this form of venture capital fund and the private equity vehicle is that units of the venture capital fund may be made available to the public. Their structure is quite cumbersome since they have to be authorized by the CSSF and their promoters and managers must first be approved by the CSSF.
Investment Restrictions
Investment in venture capital must be diversified to such an extent that an adequate spread of the investment risk is assured. A venture capital fund may not invest more than a fifth of its net assets in any one company.
Taxation
At the time of incorporation a fixed capital duty of €1,200 is payable. An annual subscription tax of 0.05% of the fund's net asset value (or 0.01% in certain circumstances) is payable by the fund. The fund is exempt from any income, withholding or capital gains tax and it is not subject to VAT.
Developments
The CSSF's Investment Fund Committee recently approved a pre-draft law on venture capital funds the aim of which is to promote investment in venture capital or private equity through a new vehicle called a SICAR (société d'investissement en capital à risque). The access to such funds will be restricted to investors with a high level of expertise in this particular field of investment and who can afford to lose their total investment in the fund.
The SICAR will be more flexible than the current regime under Part II of the Law but will be more stringent than unregulated private equity vehicles. This proposed law remains in draft format and has not yet been put before the Luxembourg parliament.