The EU has launched several pieces of legislation as part of a wide-ranging initiative to tackle tax abuse and tax avoidance schemes. The Luxembourg financial community is concerned that schemes such as ATAD-3, which targets shell companies or the Pillar II implementation on international corporate taxation could intentionally or unintentionally affect what were until now perfectly legal tax or investment fund structures.
Many Luxembourg firms use shell companies for non-tax-related reasons. They worry about the impact of the European Commission’s upcoming ATAD-3 anti-tax avoidance “Unshell directive”, which will introduce “very extensive” reporting requirements for such entities and will deny treaty and directive benefits to those it considers lack sufficient substance.
Maxime Budzin, a counsel with Clifford Chance - he specialises in the “design and implementation of tax-efficient corporate restructurings” - described this as a “hot topic for the market”, adding that “we have plenty of these special purpose vehicles (SPVs), sitting below the regulated funds.” Budzin specialises in international tax transactions, direct tax, VAT and duties.
“The fund industry is concerned because in your typical fund structure, you often use entities such as “propcos”, “holdcos”, acquisition companies, and for various non-tax reasons,” explained Andrius Bielinis, another Clifford Chance counsel, who specialises in German tax law. “The concern is, these companies have little or no employees and they don’t own exclusive premises. And they’re often managed from the outside.”
Budzin conceded that SPVs are ”are not equipped with their own substance”, but he explained are “usually interposed, for legitimate reasons – commercial or operational reasons, for example to provide legal or geographical segregation between the different types of assets, or for example, to put a pledge in place.”
Fund manager substance
The fund industry takes the view that while there isn’t substance in the shell company, “there is some substance in the structure: it lies with the fund manager,” said Bielinis, who along with Budzin spoke at a tax law event held by the Clifford Chance law firm in early March. The fund industry, he said, is asking the Commission to consider the “fund as a whole, including the fund manager.”
The SPVs currently in use in various structures, he explained. are fully-taxable companies benefitting from double tax treaties. “If this is not the case any more, then it may create an additional tax burden for these investment structures,” he said. “Obviously, a carve-out for these SPVs would be, I think, a big relief for the Luxembourg fund industry.”
However, the draft directive in its current version doesn’t follow that approach and it is due to come into effect at the beginning of 2024. “I think Luxembourg could be one of those jurisdictions that may be affected the most.”
Pillar 2 carve-out limits
Often discussed in the same context as ATAD-3 is the Pillar II proposal introduced by the OECD. Pillar II targets “base erosion and profit-shifting.” It targets large multinational groups with an annual turnover of at least 750 million euros and introduces a global minimum corporate tax of 15% for these groups on a country by country basis.
The fact there are exemptions in the directive for investment funds has led the Luxembourg market to be “quite relaxed on that one,” said Budzin. However, explained Bielinis, these exemptions give funds with a diverse investor base a carve-out.
However, there are other cases where the carve-out won’t apply. This could be that the fund “does not meet the specific definition of the investment fund set out in the directive,” said Bielinis. This would also be the case if the fund is not the ultimate parent entity.
Single-investors funds beware
But he said that the most relevant case that they should be concerned about are “single investor funds”, but also those with a group of related investors. “In these cases, the carve-out may not apply,” he said. “And it may trigger minimum tax at the level of the fund or the investors.”
The directive has put into place certain mechanisms that may mitigate these taxes, Bielinis pointed out. “But they’re complex and we’re going to have to look at it case by case.”
“I think specifically in these structures, sponsors and investors should be more careful and take a look at that.”