Spotlight: recent developments in asset management in Luxembourg
Overview of recent activity
Luxembourg continues to maintain its position as a premier financial centre for the structuring and the distribution of investment funds, thanks to its stable political and social environment, versatile fund products, robust investor protection, and experienced and responsive regulator and service providers.
Although the covid-19 pandemic has tested the resilience of financial institutions in Luxembourg – prompting a review of continuity plans, working arrangements and office space needs, and accelerating the digital transformation of the industry – the immediate effects of the crisis have largely subsided, and the country now seems ready to take advantage of the recovery ahead.
The assets under management of Luxembourg-regulated investment funds hit an all-time high of €5.9 trillion in December 2021, owing to the continuous growth in alternative investment funds (AIFs) – a category that includes private equity, real estate, infrastructure, debt and hedge funds. Luxembourg has continued to grow its fund finance activity, and has significantly contributed to the emergence of environmental, social and governance (ESG) and impact investing funds, becoming the leader for sustainable funds in Europe.
Luxembourg has confirmed its position as the leader in cross-border distribution, as domestic investment funds are distributed in more than 75 countries around the globe.
Lately, government efforts have been mainly directed at developing sustainable finance, increasing anti-money laundering and tax compliance, transparency, protecting market stability and preventing the build-up of systemic risk in the financial system. These large-scale reforms have been, to a large extent, driven by international and European initiatives, and are expected to continue in the years to come.
General introduction to the regulatory framework
Luxembourg’s comprehensive legal and regulatory system lies at the core of its success as an investment fund centre.
The Commission de Surveillance du Secteur Financier (CSSF), a public institution with legal personality and financial autonomy, is entrusted with the supervision of the financial sector.2 It operates under the authority of the Ministry of Finance.
As regards the fund industry, the CSSF is the prudential regulator of IFMs, and of the regulated investment funds they manage. The main duties of the CSSF in this respect include:
- licensing Luxembourg IFMs and regulated investment funds;
- supervising Luxembourg-regulated IFMs and investment funds based on periodic reporting, on-site inspections, and regular or ad hoc requests for information;
- imposing fines and disciplinary sanctions on regulated IFMs and investment funds, and finance professionals; and
- overseeing the marketing of domestic and foreign investment funds in Luxembourg.
In addition to those supervisory duties, the CSSF issues regulations, circulars and guidance papers in accordance with existing laws.
ii Regulations applicable to investment funds
Fund initiators can choose between the following categories of investment funds:
- funds that are subject to a specific regime (product law) or not; and
- regulated or unregulated funds.
The main product laws are:
- the Law of 17 December 2010 on undertakings for collective investments (UCI Law), which implemented EU Directive 2009/65/EC (UCITS Directive);
- the Law of 13 February 2007 on specialised investment funds (SIF Law);
- the Law of 15 June 2004 on investment companies in risk capital (SICAR Law); and
- the Law of 23 July 2016 on reserved alternative investment funds (RAIF Law).
Regulated investment funds
Regulated funds are subject to CSSF supervision and must (or their IFM must on their behalf) be licensed by the CSSF before they start operating.
The CSSF supervises:
- UCITS subject to Part I of the UCI Law;
- other undertakings for collective investment (UCIs) subject to Part II of the UCI Law;
- specialised investment funds (SIFs) subject to the SIF Law;
- investment companies in risk capital (SICARs) subject to the SICAR Law;
- European venture capital funds (EuVECA) subject to Regulation (EU) 345/2013;
- European long-term investment funds (ELTIF) subject to Regulation (EU) 2015/760;
- European social entrepreneurship funds (EuSIF) subject to Regulation (EU) 346/2013;
- pension savings companies with variable capital (SEPCAVs) and pension savings associations (ASSEPs) subject to the Law of 13 July 2005 on institutions for occupational retirement provision (IORPs) (Pension Law); and
- securitisation undertakings subject to the Law of 22 March 2004 (Securitisation Law) when they offer their securities to the public more than three times in a financial year.
UCITS are subject to complex asset eligibility, liquidity and diversification rules. They may only invest in transferable securities and other liquid financial instruments authorised under the UCI Law.
Part II UCIs may in principle invest in all types of assets, subject to diversification requirements and borrowing restrictions. Those rules depend on the assets in which the UCI invests and are further detailed below.
SIFs are not restricted as to their eligible assets either but must in principle comply with a risk-spreading requirement of maximum 30 per cent of their assets or commitments in securities of the same type issued by the same issuer.3 This rule is subject to exceptions and, when appropriately justified, to derogations granted by the CSSF.
SICARs may in principle only contribute their assets to ‘risk capital’, that is, to entities in view of their launch, development or listing on a stock exchange.4 They are not subject to diversification requirements.
Unregulated investment funds
Investment funds that are not subject to CSSF supervision include:
- reserved alternative investment funds (RAIFs) subject to the RAIF Law;
- commercial companies subject to the Law of 10 August 1915 on commercial companies (Companies Law);
- limited partnerships subject to the Companies Law; and
- securitisation undertakings subject to the Securitisation Law, except when they offer their securities to the public on a continuous basis.
RAIFs are in principle subject to the same asset eligibility and risk-spreading requirement as SIFs, except for RAIFs investing in risk capital, which are not subject to diversification rules.
RAIFs must be managed by an external authorised alternative investment fund manager (AIFM) and comply with the requirements of the Law of 12 July 2013 on alternative investment fund managers (AIFM Law).
They benefit from the AIFM Directive5 passport to be marketed to professional investors (and to other investors where permitted) in the EEA.
Standard commercial companies (SOPARFIs)
SOPARFIs are ordinary commercial companies whose purpose is to hold a participation in other companies. While they may take any corporate form available under the Companies Law, in practice they are incorporated as companies with share capital.
SOPARFIs are not subject to any risk-spreading requirements and may invest in any asset class. They may also manage their financial participations and conduct commercial activities that are directly or indirectly connected to the management of their holdings, including the debt servicing of their acquisitions.
Limited partnerships (LPs)
Luxembourg LPs typically take the form of common or special limited partnerships. They are not subject to any risk-spreading requirements or restricted as to the assets in which they may invest.
iii Regulations applicable to IFMsRegulated IFMs
Regulated IFMs include UCITS management companies subject to Chapter 15 of the UCI Law; and authorised AIFMs subject to the AIFM Law.
Commencing business as a regulated IFM in Luxembourg is subject to prior approval by the CSSF. IFMs may apply for authorisation under the UCI Law or the AIFM Law, or both.
Under CSSF Circular 18/698, the application for authorisation must detail, in relation to the IFM, its organisation (shareholding structure, own funds, team and substance); and its operations (internal policies and processes, external control and reporting).
The CSSF reviews in particular the portfolio management and risk management duties, the anti-money laundering procedures, and any delegation arrangements. Once granted, the authorisation as a regulated IFM covers all EEA countries.
Some IFMs established in Luxembourg do not need to seek CSSF authorisation before carrying out the management of a Luxembourg investment fund,6 when they manage either directly or indirectly:
- AIFs that are not leveraged and have no redemption rights for a period of five years, and whose aggregate assets under management do not exceed €500 million; or
- AIFs whose assets under management, including any assets acquired through leverage, do not exceed €100 million.
Those AIFMs must however register with the CSSF, disclose to the CSSF the AIFs they manage and their investment strategies, and report regularly on the investments they hold and their related exposure, and on anti-money laundering matters.
Registered AIFMs do not benefit from the AIFM Directive passport. They may, however, opt to use the European marketing passport regime offered by the EuVECA Regulation or the EuSEF Regulation. The passport under those two regulations only applies if the AIF uses the denomination EuVECA or EuSEF, registers with the competent authority and complies with the applicable regulation.
iv Regulations applicable to depositaries
Under the AIFM Directive and the UCITS Directive, the duties of Luxembourg depositaries in relation to investment funds include:
- safeguarding the assets they have been entrusted with;
- monitoring cash flows, in particular ensuring that all payments made by or on behalf of investors have been received and that all cash of the fund has been booked in cash accounts opened in the name of the fund; and
- overseeing the fund’s operations to ensure that they comply with Luxembourg laws and the constitutional documents of the fund.
Directive 2014/91/EU broadly aligned the role and responsibilities of UCITS depositaries with the regime applicable under the AIFM Directive. Those two regimes, however, differ in that the AIFM Directive allows the contractual transfer of liability from a depositary to a sub-depositary (including a broker acting as sub-depositary) and extended possibilities for rehypothecation of assets.
Investment funds subject to a product law and AIFs managed by an authorised AIFM must appoint a single depositary to supervise and monitor their assets. The appointment and replacement of the depositary of a regulated investment vehicle must be approved by the CSSF.
UCITS and retail Part II UCIs are subject to the UCITS V Directive depositary regime.7 Their depositary must be a credit institution with its registered office in Luxembourg or a Luxembourg branch of a credit institution with its registered office in another EEA country.
Non-retail Part II UCIs are covered by the AIFM Directive depositary regime.8 SIFs, SICARs, RAIFs and other AIFs managed by authorised AIFMs, and internally managed AIFs that are subject to the AIFM Law, are also subject to the AIFM Directive regime. They must appoint a Luxembourg credit institution or a Luxembourg branch of an EEA credit institution, a Luxembourg investment firm, a Luxembourg branch of an EEA investment firm, or – under certain conditions detailed below – a Luxembourg professional depositary of assets other than financial instruments.
Professional depositaries of assets other than financial instruments may only be used by AIFs that have no redemption rights for a period of five years from the date of the initial investments, and either do not invest in financial instruments that must be held in custody in accordance with the AIFM Law (typically real estate funds) or invest in issuers or non-listed companies in order to potentially acquire control over such companies under the AIFM Law (typically private equity and venture capital funds).
v MarketingPre-marketing in Luxembourg
New premarketing rules under Directive (EU) 2019/1160 (CBDD) and Regulation (EU) 2019/1156 (CBDR) apply in Luxembourg since August 2021. Under the new rules, EEA AIFMs that engage in pre-marketing in Luxembourg must notify their home Member State national competent authority (NCA) in the two weeks from commencing premarketing through an informal letter. The NCA will then notify the CSSF. Activities beyond the scope of pre-marketing are considered as marketing and require a marketing notification under Articles 31 and 32 of the AIFM Directive. The CSSF has extended the same rules to non-EU AIFMs pre-marketing AIFs in Luxembourg.
Besides defining pre-marketing, the CBDD and CBDR introduce harmonised requirements for marketing materials and rules for ‘de-notification’. These apply to both UCITS and AIFs.
Marketing of foreign UCITS and AIFs in Luxembourg
Foreign UCITS or AIFMs marketing AIFs to retail investors are no longer required to provide local facilities and appoint local agents in Luxembourg. The IFMs of investment funds marketed to retail investors may now provide facilities for subscriptions, redemptions, and payments and information to investors electronically or by other distance communications.
Foreign AIFs may only be marketed to retail investors in Luxembourg if they apply for marketing authorisation to the CSSF and comply with the rules laid down in CSSF Regulation 15-03.
Marketing of other UCIsForeign closed-ended UCIs
Where a closed-end foreign UCI that does not qualify as an AIF is offered to the public in Luxembourg, a prospectus must be published in compliance with Regulation 2017/1129/EU on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market (Prospectus Regulation) and the Law of 16 July 2019 on prospectuses for securities (Prospectus Law).
Foreign UCIs other than the closed-end type
Foreign open-ended UCIs (other than UCITS) must, before engaging in marketing to retail investors in Luxembourg, be authorised by the CSSF under CSSF Regulation 20-10:
- the foreign UCI must apply for a marketing authorisation request and provide the required documents and information;
- subscription and redemption prices must be determined at least once a month; and
- the foreign UCI’s assets must be sufficiently diversified.
Common asset management structures
Investment funds can generally opt for the mutual funds (FCP) or the investment company form. The choice of legal form depends on the applicable product law, corporate governance or tax requirements among other considerations.
An FCP is similar to a unit trust in the United Kingdom or a mutual fund in the United States. It is organised as an incorporated co-proprietorship whose joint owners are only liable up to the amount they have committed or contributed to the FCP. Because it has no legal personality, an FCP must be managed by a Luxembourg management company.
UCITS, Part II UCIs, SIFs and RAIFs may be formed as FCPs.
ii Investment companies
All investment funds subject to a product law structured in corporate or partnership form may be established as investment companies with variable capital (SICAVs); or investment companies with fixed capital (SICAFs).
In a SICAV, the share capital increases and decreases automatically as a result of the subscriptions and redemptions of the investors. Increases and decreases of share capital in a SICAF, on the other hand, require a formal decision and, where applicable, a notarial deed, which makes SICAFs less attractive, and less common.
The legal forms typically used by investment companies subject to a product law are:
- the public limited company (SA);
- the private limited company (Sàrl);
- the simplified limited company (SAS);
- the partnership limited by shares (SCA);
- the co-operative company in the form of a public limited company (Coop-SA);
- the common limited partnership (SCS); and
- the special limited partnership (SCSp).
While SIFs, SICARs and RAIFs may opt for all these legal forms, UCITS and Part II UCIs established as SICAVs may only be set up as SAs. Part II UCIs set up as SICAFs may also be incorporated as SCAs.
A SOPARFI is usually organised in one of the forms under (a) to (e) above and may only operate with fixed or authorised capital features.
Limited partnerships, such as the SCS and the SCSp, allow more flexibility regarding capital variations. Both partnerships must be formed between one or more general partners, who are liable for all the debts and obligations of the partnership, and one or more limited partners whose liability is limited to the amount of capital that they contribute or commit to the partnership. The SCSp – unlike the SCS – does not have separate legal personality. However, all contributions, acquisitions and dispositions of assets can be made in the name of the SCSp rather than in a general partner’s or the limited partners’ name.
iii Umbrella form
Another feature frequently considered in practice in the choice of the applicable regime is the umbrella form.
All funds subject to a product law may be formed as standalone vehicles, or as umbrella structures composed of one or more sub-funds. Each sub-fund comprises a specific portion of assets and liabilities of the investment fund segregated from the assets of the other sub-funds. The assets of a sub-fund may in principle not be used to satisfy the debts and obligations of other sub-funds.
The sub-funds may have different investment strategies, or be closed-ended or open-ended within the same umbrella fund. Under certain conditions, cross-investments between sub-funds are allowed.
Investment funds not subject to a product law, on the other hand, may not be formed as umbrella funds.
Main sources of investment
Assets under management in Luxembourg funds amounted to €5.169 trillion at the end of June 2022.9 UCITS provide the majority of assets under management in Luxembourg, contributing to 81.7 per cent of total funds. Over the past three years, regulated AIFs have grown 33 per cent to reach €935 billion at the end of 2021.10 Over 96 per cent of funds under management in Luxembourg are from overseas.11
In parallel, the total number of investment fund entities has continued to consolidate, due to a preference to create umbrella structures. There were 3,433 regulated entities at the end of June 2021, representing a decrease of 104 entities over 12 months.12
Luxembourg hosts more than 300 IFMs holding a UCITS or AIFM licence (or both), with 93 per cent of the UCITS management companies and 78 per cent of AIFMs owned by overseas investors. Twenty out of the 50 largest IFMs in Europe are established in Luxembourg and manage 40 per cent of the largest 50 investment funds.13
Luxembourg funds are distributed to investors in more than 77 countries, making the cross-border dimension of Luxembourg’s fund centre unequalled.14 Nearly 60 per cent of the funds authorised for cross-border distribution are domiciled in Luxembourg.15
Luxembourg continues to strengthen its ranking as the world’s second-largest fund domicile after the United States. Interest in regulated funds remains strong, especially those that pursue alternative strategies. Assets under management of regulated AIFs increased by nearly 30 per cent in 2020, while those of sustainable funds almost doubled to €663 billion.16 In addition, since the implementation of the AIFM Directive, non-regulated AIFs – typically real estate, private equity and private debt – and, more recently ESG funds have been the leading force for growth across Luxembourg IFMs.
The RAIF continues to attract investors (especially professional investors) who perhaps see it as a viable alternative to the SIF (and to a lesser extent to the SICAR) in terms of structure and flexibility but without an add-on regulation of the product itself. As of 1 August 2022, 1,943 vehicles have been registered in Luxembourg,17 bringing their total assets under management to €714 billion.18 There still is robust demand for unregulated AIFs structured as partnerships (SCS or SCSp), especially for funds managed by registered AIFMs.
Debt and credit funds are increasingly present in Luxembourg thanks to the flexible legal and regulatory environment that allows them to implement all types of debt and credit strategies, such as mezzanine, distressed and origination strategies. The assets under management of regulated private debt funds increased by 40.6 per cent in 2021 to reach a total of €181.7 billion.19
Heightened awareness of climate change and the European Commission’s Sustainable Finance initiative are important drivers of ESG and sustainable funds in Luxembourg, which are expected to increase in importance compared to other regions. Luxembourg captured 38 per cent of the net flows into sustainable funds in Europe in 2021.20
In addition to circular letters issued by the CAA, insurance companies in Luxembourg are governed by:
- the Law of 7 December 2015 on the insurance sector;
- the Grand Ducal Regulation of 14 December 1994 specifying the conditions for the approval and practices of insurance companies; and
- the Grand Ducal Regulation of 5 December 2007 establishing the terms and conditions of the supplementary supervision of insurance and reinsurance undertakings that are part of an insurance or reinsurance group.
These provisions detail the authorisation procedure and business conduct of insurance and reinsurance companies, the mission and procedural methods of the CAA, and the free provision of services by Luxembourg insurance companies in other EEA countries.
Insurance contracts are governed by the Law of 27 July 1997 on insurance contracts.
Traditionally, life insurance companies offer guaranteed return products where premiums are managed in the insurer’s general fund (or in that of its parent company). In addition, Luxembourg insurance companies propose a wide range of unit-linked products21 established as external investment funds managed by third-party asset managers; internal collective funds that operate like UCITS and that allow discretionary management tailored to the risk profile of the investors; or internal dedicated funds that allow discretionary management that takes the subscriber’s objectives into account. Several dedicated funds can be grouped within the same life assurance contract.
Luxembourg offers three pension vehicles, all of which can be organised as multi-employer schemes and benefit from the umbrella structure to accommodate defined contributions (DC) and defined benefits (DB) plans, to separate investment styles (DC plans), or where different labour law provisions make this necessary.
Pension funds regulated by the CSSF
Pension funds regulated by the CSSF are governed by the Pension Law. They can take the form of pension savings companies with variable capital (SEPCAVs) or pension savings associations (ASSEPs).
SEPCAVs have a corporate structure similar to that of SICAVs, in which the members and beneficiaries are shareholders who will receive a share of a fund’s profits when retiring. They can only be used for DC schemes.
ASSEPs, on the other hand, work like associations that can be used for both DC and DB plans. In an ASSEP, the rights of the members and beneficiaries are debt claims that, when the members and beneficiaries retire, will be paid out either as a lump sum or as an annuity. They may also cover additional benefits on their members’ death or disability.
Pension funds regulated by the CAA
A third pension fund vehicle is regulated by the CAA and subject to the Grand Ducal Regulation of 31 August 2000. The CAA pension fund provides for DC, DB or supplemental benefits in the case of death or disability of members. Four legal forms can be chosen, but in practice, the not-for-profit association form is the most used.
iii Real estate
Real estate funds are typically formed as Part II UCIs, SIFs, SICARs, RAIFs, SOPARFIs or limited partnerships.
Part II UCIs must comply with CSSF Circular 91/75, which requires that the fund invests no more than 20 per cent of its net assets in a single property, subject to a ramp-up period of up to four years. In principle, Part II UCIs may not borrow more than 50 per cent of the value of all the properties. Their net asset value must be calculated at least once a year, and an independent valuer must be appointed to assess the value of the properties.
Real estate SIFs are subject to CSSF Circular 07/309, which restricts investment in a single property to 30 per cent of their assets, but they may in practice take advantage of the four-year ramp-up period. Although borrowing restrictions are more flexible than for Part II UCIs, the AIFM Law requires that their AIFM determines the maximum leverage levels for the fund.
SICARs may also invest in real estate to the extent that they:
- demonstrate an element of risk capital, such as the objective of developing the target asset, or specific risks associated with the property that are beyond the common level of real estate risk; or
- are acquiring the property to sell at a capital gain in a relatively short time frame.
Depending on their strategy, real estate RAIFs follow the same rules as those detailed for SIFs and SICARs above.
Finally, SOPARFIs and limited partnerships can also be used to set up unregulated real estate funds and are not subject to investment restrictions.
v Hedge funds
Although a limited number of UCITS employ hedge fund strategies, hedge funds are usually set up as Part II UCIs, SIFs or RAIFs.
CSSF Circular 02/80 details specific investment rules applicable to regulated investment funds pursuing hedge fund strategies.
SIFs and RAIFs are not in principle subject to any asset restrictions, and are, therefore, best suited to accommodate all sorts of hedge fund strategies. They are both, however, required to diversify their investments to 30 per cent of their assets (subject to exceptions) as further detailed in CSSF Circular 07/309.
CSSF Circular 02/80 details specific investment rules applicable to regulated investment funds pursuing hedge fund strategies.
CSSF Circular 08/372 specifies the rules on the appointment of prime brokers, the relationship between the depositary and the appointed prime brokers, and the liability of the depositary in that respect.
vi Private equity
Private equity funds may be established as Part II UCIs, SICARs, SIFs, RAIFs, and other types of unregulated companies or partnerships. In practice, the SCSp, the SCS or the SOPARFI are typically used.
In addition, regulated and unregulated vehicles can be set up as EuVECA funds. These are restricted to equity instruments issued by or loans granted to qualifying portfolio undertakings, meaning undertakings that are at the time of the first investment by the fund in that undertaking not admitted to trading on a regulated market or multilateral trading facility, and that employ up to 499 persons. Small and medium-sized enterprises (SMEs) that are listed on SME growth markets will also be allowed under the revised EuVECA Regulation.
EuVECA funds are also subject to specific rules in respect of fund portfolio composition, investment techniques and own funds.These funds must intend to invest at least 70 per cent of their aggregate capital contributions and uncalled committed capital in assets that are qualifying investments and, as a consequence, not use more than 30 per cent for the acquisition of assets other than qualifying investments. One of the defining features of the EuVECA regime is that it does not require the appointment of a depositary.
The EuVECA Regulation applies to EEA managers that are subject to registration with the competent authorities of their home country under the AIFM Directive and manage qualifying venture capital funds with total assets under management of less than €500 million.
The use of the revised EuVECA label is now also open to above-threshold AIFMs that continue to be subject to the requirements of the AIFM Directive while complying with certain provisions of the EuVECA Regulation (those on eligible investments, targeted investors and information requirements).
EuVECA managers can also manage and market AIFs that are not EuVECA funds. However, the EuVECA passport does not apply to these funds.
vii Other sections
Luxembourg also provides an appropriate legal, regulatory and tax environment for microfinance, ESG and other sustainable funds. It is also home to several investment funds compliant with shariah principles.
The tax regime applicable to Luxembourg investment funds depends on the legal form of the fund and whether it is subject to a specific product law or not.
i Corporate income tax, municipal business tax and net wealth taxInvestment funds subject to a product law
UCITS, Part II UCIs and SIFs are exempt from corporate income tax (CIT), municipal business tax (MBT) and net wealth tax (NWT), but are subject to subscription tax on their net asset value. The annual subscription tax rate is 0.05 per cent (0.01 per cent in certain circumstances) for a UCITS and Part II UCIs, and 0.01 per cent for a SIF of their NAV, subject to certain exemptions. There is also a decreasing rate if certain proportions of investments in environmentally sustainable economic activities are reached.
The tax is computed and payable quarterly, and there are certain reductions and exemptions, notably for sustainable funds. Exempt funds do not usually qualify for the benefit of EU directives or double tax treaties.
SICARs organised as a corporate entity are formally fully subject to CIT and MBT, but benefit from specific exemptions on income and gains from risk capital securities. In addition, SICARs are exempt from NWT, except for the minimum NWT. SICARs are deemed to qualify for the benefit of EU Directives and double tax treaties. Foreign tax authorities may, however, take a different stance. SICARs that are transparent for tax purposes follow the partnership provisions detailed below.
RAIFs follow the tax regime of the SIF by default, but can opt for the tax regime applicable to the SICAR if they invest in risk capital.
Investment funds not subject to product lawsPartnerships
As transparent entities for Luxembourg tax purposes, the SCS and the SCSp are not subject to CIT or NWT. An SCS or SCSp may, however, be subject to MBT at a rate of 6.75 per cent (in Luxembourg City in 2021) on its profits if it carries out a business or is deemed to carry out a business. An SCS or SCSp that is an AIF in the meaning of the AIFM Law is deemed not to conduct a business unless its general partner qualifies as a Luxembourg capital company holding at least 5 per cent of interests in the partnership or a foreign capital company with a permanent establishment in Luxembourg through which it holds at least 5 per cent of interests in the partnership.
SOPARFIs are companies subject to CIT and MBT on their income at an aggregate rate of 24.94 per cent (in Luxembourg City in 2021), and NWT on the fair market value of their worldwide net assets (again, subject to certain exemptions) at a rate of 0.5 per cent for the first €500 million of net assets and 0.05 per cent for the tranche of net assets exceeding €500 million. However, income received by a SOPARFI from its shareholdings (dividends, liquidation proceeds) and capital gains realised upon the sale of these shareholdings are exempt to the extent that the conditions of the Luxembourg participation exemption regime are met.
SOPARFIs benefit from the double taxation treaties concluded by Luxembourg, as well as from the EU Directives.
ii Real estate tax
From 1 January 2021, an annual 20 per cent real estate tax is levied on income and gains arising from real estate assets situated in Luxembourg and realised directly or indirectly by Part II UCIs, SIFs and RAIFs that are not tax-transparent.
iii Withholding tax
In relation to WHT on distributions to investors, the following rules apply:
- there is no withholding tax on distributions made by funds that are (1) tax-transparent for Luxembourg tax purposes or (2) subject to a product law; and
- distributions made by funds subject to a product law are not subject to withholding tax;.
iv Taxation of IFMs
Luxembourg IFMs are generally subject to CIT, MBT and NWT under the same conditions as those that apply to SOPARFIs.
Managing funds subject to a product law is exempt from VAT in Luxembourg. The exemption covers investment management (portfolio and risk management), administration (e.g., investment advice, fund accounting, registrar and transfer agent), and marketing and distribution. Essential management services outsourced to third parties also benefit from the exemption under conditions.
Depositary services are partly exempt from VAT; services related to the control and supervision functions of the depositary are subject to a reduced rate of 14 per cent.
Other services, such as legal and audit services, are not exempt from VAT and are subject to the standard rate of 17 per cent.
As the trend in sustainable finance accelerates in 2022, the Luxembourg fund industry is determined to continue developing sustainable investment products and not only overcoming regulatory challenges but also uncertainties related to the evolution of the covid-19 pandemic and geopolitical and economic instability.
i Sustainable finance
Despite the decision made by the European Commission to defer the application of the Regulatory Technical Standards under SFDR22 by six months to 1 July 2022, the journey to a more sustainable funds industry continues at a rapid pace.
As Luxembourg reinforces its position as the European leader in sustainable finance, IFMs will face three main implementation deadlines.
Since 1 January 2022, they must disclose information that enables the investor to understand the degree of environmental sustainability of a fund’s investments. This deadline marks a first step on two environmental objectives: climate change mitigation and climate change adaptation. IFMs must disclose ESG information in their offering documents as well as in the annual reports of the funds they managed for the reporting period.
From 1 August 2022, sustainability risks must be integrated into their decision-making and operational processes. Two European Commission Delegated Regulations (published in 2021) incorporate sustainability issues and considerations into the UCITS and AIFM Directives framework strengthening the SFDR and the Taxonomy Regulation obligations.
By 1 January 2023, IFMs will need to apply the delegated acts concerning the disclosure requirements under the SFDR and the Taxonomy Regulation. These cover a classification system and additional mandatory disclosures under the SFDR and the Non-Financial Reporting Directive (NFRD).
ii Anti-money laundering/counter terrorist financing (AML/CTF)
Already postponed several times owing to the covid-19 pandemic, Luxembourg’s FATF onsite visit is now expected to take place in November 2022, with plenary discussions to follow in 2023. The adjustment of the reference period for the FATF assessment has prompted a thorough review of existing arrangements and relationships, and an acceleration of the legislative agenda.
At EU level, a package published by the European Commission expected to be adopted in 2022 involves:
- a proposal for a regulation establishing an EU anti-money laundering/counter terrorist financing (AML/CTF) authority; and
- the establishment of an EU single rulebook on AML/CTF, which includes: (1) a new proposal for a regulation on AML/CTF containing rules applying immediately; (2) a new proposal for a Sixth Directive on AML/CTF; and (3) a recast of Regulation (EU) 2015/847 on information accompanying transfers of funds.
iii Self-assessment questionnaire
Circulars CSSF 21/789 and 21/790 require a new self-assessment questionnaire (SAQ) to be completed annually by all regulated investment funds and Luxembourg AIFMs regarding their compliance with the applicable legal and regulatory requirements for financial years ending on or after 31 December 2021 (for authorised AIFMs and self-managed regulated funds) or 30 June 2022 (for externally managed regulated funds). The auditors of the funds or AIFM must review annually certain questions of the SAQ and complete a separate SAQ report. This report will be required for the financial years ending on or after 31 December 2021 for Luxembourg authorised AIFMs, 30 June 2022 for UCITS and Part II UCIs, and 30 June 2023 for SIFs and SICARs.
iv AIFM Directives
Following its 2020 review of the application and scope of the AIFM Directive23 and possible convergence towards the UCITS Directive, the European Commission concluded that the AIFM Directive is mostly effective.
On 25 November 2021, the Commission proposed to amend the AIFM Directive. The main amendments regard delegation arrangements, liquidity risk management, supervisory reporting, the provision of depositary and custody services, and loan origination by AIFs. While the Commission recognises the value of the delegation regime, which allows for the efficient management of investment portfolios, its proposals aim to ensure that AIFMs keep core functions in-house. A new Annex V introduces a list of liquidity management tools (LMTs) for AIFMs managing open-ended AIFs. When a fund they manage faces substantial redemptions under stressed market conditions, those AIFMs will be required to choose at least one LMT from this list, in addition to the possibility of suspending redemptions. The Commission also determined that there is a need to harmonise requirements for AIFMs of loan-originating AIFs. The amended AIFM Directive is expected to be adopted in early 2023. Member States will then have two years to update their national legislation.
Besides ATAD and ATAD 2, tax-transparent alternative investment funds will need to carefully monitor how the reverse hybrid rules applicable as from 2022 affect them. Under the reverse hybrid rules, a Luxembourg tax-transparent entity may become subject to CIT on its income not otherwise taxed in Luxembourg or abroad where at least 50 per cent of the interests, voting rights and rights to profits are held by associated investors resident in a jurisdiction that sees the entity as non-transparent. An ‘acting together’ test applies in the context of the association test.
Further developments are expected through Council Directive (EU) 2021/514 of 22 March 2021, which introduces rules on income earned by sellers on their digital platforms (DAC7), and on a legislative proposal in relation to reporting and exchange of information on cryptoassets and e-money for tax purposes (DAC8), as well as the possible introduction of an EU digital levy.