Summary:
– Luxembourg’s tax environment is conducive to the development of investment funds thanks to a high level of investor protection, the swift implementation of European directives on UCITS, and the absence of taxation on investment funds.
– The numerous investment structures offer portfolio managers considerable flexibility thanks to a variety of vehicles.
– The country is currently pursuing a strategy of creating funds dedicated to financing European start-ups.
A few decades ago, the Grand Duchy’s wealth came mainly from its steel industry. From the 1960s onwards, Luxembourg opted for industrial diversification based on three pillars: the construction of the European Union, the development of other sectors of activity, and the development of an international financial center. This political and industrial strategy led to the creation of numerous industrial companies of all sizes operating in a wide range of sectors. Luxembourg then focused on financial services, which began with the arrival of American, German, and Swiss banks.
Luxembourg is now the leading investment fund center in Europe and the second largest in the world after New York. Three out of four investment funds marketed on a large scale internationally are domiciled in Luxembourg. The activity generates a quarter of the national GDP and employs 13,000 people (43,000 for the entire financial sector). In addition to fund activities, this financial center also offers other services such as private banking and reinsurance, areas in which Luxembourg is also one of the European leaders. Above all, Luxembourg has succeeded in creating a tax and regulatory environment that best meets the expectations of investors.
In this article, we will look at two of Luxembourg’s comparative advantages: attractive taxation (1) and a wide choice of legal structures for investment funds (2).
A tax environment conducive to the development of investment funds: three explanations
Unlike some financial centers with favorable tax regimes, Luxembourg ensures a high level of investor protection through two bodies: the Financial Sector Supervisory Commission, known as the CSSF (a body that ensures that all players in the financial sector in Luxembourg fully comply with applicable laws and regulations) and the Insurance Supervisory Authority, known as the CAA (Luxembourg’s official insurance sector supervisory body, which, for example, examines applications for approval from insurance companies).
Luxembourg was also the first country to transpose the European directives on UCITS into law on March 30, 1988, thereby promoting the marketing of its investment products in a large number of countries (e.g., the « European passport »). This swift action enabled Luxembourg to stay ahead of its European competitors, effectively attracting numerous funds wishing to take advantage of this regulatory innovation.
The tax framework is also characterized by neutrality (no taxation) on investment funds, with the exception of capital duty (tax on investor contributions) and taxation of investors and managers.
Investment structures tailored to asset management methods
Investors are given a high degree of flexibility in structuring their funds. For example, under a single legal entity, a single fund can create sub-funds that are independent in terms of their investment strategies and investors. This offers greater flexibility to managers.
Luxembourg has also created two other investment structures that respond to new issues in terms of diversification, debt, and investment strategy, particularly for products considered to be riskier: SICAR vehicles and specialized investment funds (as defined by the law of February 1, 2007).
The SICAR vehicle (venture capital investment company) is dedicated to venture capital and private equity transactions. Unlike « mainstream » funds, this fund is not required to comply with the principle of risk diversification. This vehicle benefits from double taxation agreements. All payments in the form of dividends, liquidation bonuses (profit after judicial liquidation) or other income are not subject to withholding tax or wealth tax. Consequently, foreign companies are not penalized for creating this type of vehicle in Luxembourg.
In 2007, Luxembourg created a structure for « specialized » investment funds that benefit from more flexible regulations but are only accessible to professional and private investors who are considered to be knowledgeable. Unlike SICARs, this investment structure can invest in all forms of assets (movable, monetary, alternative, real estate). However, the principle of diversification must be maintained. Disclosure requirements are less strict than for so-called public funds. Like SICARs, these structures are not subject to capital gains tax or wealth tax, but are subject to an annual subscription tax representing 0.01% of the net value of the assets held. However, capital gains realized by non-residents holding significant stakes are taxable in Luxembourg. In addition to the tax aspect, this vehicle allows for more opaque management, similar to hedge funds, which have virtually no communication requirements with the general public.
Conclusion
The success of Luxembourg’s financial center is not only due to low taxation on its investment funds, but rather to the establishment of structures that meet the needs of investors and their subscribers.
In order to continue its influence on a European and even global scale, Luxembourg is currently developing microfinance organizations and striving to create public funds such as the Life Science Fund (exclusively dedicated to biomedical technologies) and the Luxembourg Future Fund dedicated to innovative entrepreneurial activities. Having become a renowned financial center, could Luxembourg become a hub for European start-up financing?
