EVCA - Private Equity Fund Structures in Europe · 2 Fonds Commun de Placement à Risques (FCPR) 56 3. ... The original EVCA Private Equity Fund Structures Paper was produced in 1994

Private Equity Fund Structures in Europe

An EVCA Tax and Legal Committee Paper

Edited by SJ Berwin LLP

January 2006

Contributors

Dorda Brugger Jordis, Austria

Tiberghien Advocaten Avocats, Belgium

CMS Cameron McKenna v.o.s., Czech Republic

Dansk Kapitalanlæg, Denmark

Borenius & Kemppinen, Finland

SGDM and SJ Berwin LLP, France

Clifford Chance LLP, Germany

Ormai és Társai CMS Cameron McKenna, Hungary

A&L Goodbody, Ireland

Di Tanno e Associati, Italy

Loyens Winandy, Luxembourg

Van Doorne N.V. and Loyens & Loeff N.V., Netherlands

CMS Cameron McKenna, Poland

Abreu, Cardigos & Associados, Portugal

Advokátska kancelária JUDr. Jaroslav Ruzicka in association with CMS Cameron McKenna v.o.s.

and CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH, Slovak Republic

Baker & McKenzie, Spain

Andulf Advokat AB, Sweden

Lenz & Staehelin, Switzerland

SJ Berwin LLP, United Kingdom

Proskauer Rose LLP, United States

^ ^

Exchange Rates, Glossary of Terms, Disclaimer and Date

1 Exchange Rates

The exchange rates for the currencies referred to in this paper are as follows:

These exchange rates are averages for 2005. They have been calculated from data provided by the

European Central Bank on EURO exchange rates, and converted on a one for one basis.

2 Glossary of Terms

The terms used in this paper are explained in section 2 of the Introduction. In particular, the term private

equity fund when used in this paper refers to the corporate and non-corporate structures.

3 Disclaimer

This paper is intended to provide a general overview. The taxation or legal consequences of any structure

will depend on its precise circumstances and proper professional advice must be taken. Neither EVCA nor

any of the contributors to this paper assume any responsibility.

4 Date

The tax and legal provisions described in this paper are as at 1 January 2006.

Country Currency Euro

Czech Republic Czech Crown (CZK) 29.782

Denmark Kroner (DKK) 7.4518

Hungary Forint (HUF) 248.05

Poland Zloty (PLN) 4.0230

Slovak Republic Slovak Crown (SKK) 38.599

Country Currency Euro

Sweden Kroner (SEK) 9.2822

Switzerland Swiss Franc (CHF) 1.5483

United Kingdom Pound (£) 0.68380

US Dollar ($) 1.2441

Table of Contents

Foreword 8

A pan-EU Fund Structure for Private Equity and Venture Capital 8

Introduction 11

1 Scope 11

2 Private Equity Investment Funds and Terminology 11

3 Overview of Countries and Fund Structures Covered 13

4 Objectives 15

5 Structuring Private Equity Funds 15

6 Pan-European and International Funds 16

7 A European Solution 17

Austria 21

1 Available Structures 21

2 Mittelstandsfinanzierungsaktiengesellschaft (MFAG) 21

3 Taxation of the MFAG 23

4 Initiative for the New PE/VC Legislation 23

5 Foreign Fund Structures in Austria 23

6 Outline of Austria’s Tax System applicable to the Taxation of Income and Profits 25

Belgium 29


2 The Limited Liability Company 29

3 Taxation of Belgian Public Privaks 32

4 Taxation of Belgian Private Privaks 34

5 Taxation of Foreign Funds in Belgium 36

6 Outline of the Belgian Tax System applicable to the Taxation of Income and Profits 37

Czech Republic 42


2 Foreign Fund Structures 44

3 Outline of the Czech Republic’s Tax System applicable to the Taxation

of Income and Profits 44

Private Equity Fund Structures in Europe

Denmark 47


2 The Public Limited Company (Aktieselskab) 47

3 Limited Partnership 48

4 Taxation of Foreign Funds in Denmark 49

5 Conclusion 49

Finland 50


2 The Finnish Limited Partnership 50

3 Special Considerations for Foreign Investors 52

4 Outline of the Finnish Tax System applicable to the Taxation of Income and Profits 53

France 56


2 Fonds Commun de Placement à Risques (FCPR) 56

3. Fonds Commun de Placement dans l’Innovation (FCPI) 65

4. Fonds d'Investissement de Proximité (FIP) 67

5. The Société de Capital Risque (SCR) 68

Germany 73


2 The Gesellschaft mit beschränkter Haftung (GmbH) 73

3 The GmbH & Co. Kommanditgesellschaft (GmbH & Co. KG) 79

4 Funds according to the Investment Act 83

5 Marketability to Different Classes of Investors 90

6 Outline of the German Tax System applicable to the Taxation of Income and Profits 92

Hungary 95



3 Outline of Hungary’s Tax System applicable to the Taxation of Income and Profits 97

Ireland 100


2 The Limited Partnership 100

Table of Contents

Italy 103


2 The Fondo Chiuso (Closed-End Fund) 103

3 The Management Company (SGR) 103

4 Supervisory Control 106

5 Assets of the Fund 107

6 Investors 108

7 Custodian Bank 108

8 Marketability and Private Placement 108

9 Listing of the Fund 109

10 Life of the Fund 109

11 Taxation of the Fund 109

12 Taxation of Investors in the Fund 110

13 Capital Losses 111

14 Placing Costs 111

15 Treatment of VAT charged on the Management Fee 111

16 Capital Duty 111

17 Foreign Investment Funds 111

18 Permanent Establishments 112

19 Anti-avoidance Legislation Affecting Foreign Funds 112

20 Outline of the Italian Tax System Applicable to the Taxation of Income and Profits 113

21 Dividends 114

22 Interest 114

Luxembourg 115

1 Available Investment Vehicles 115

2 Established Investment Vehicles 115

3 Investment Company in Risk Capital (SICAR) 115

4 Outline of Luxembourg’s Tax System applicable to the Taxation of Income

and Profits of Income and Profits with respect to Soparfi 119

5 Taxation on Dividends / Capital gains 120

6 Deductions / Recapture / Currency Exchange 121

7 Withholding Tax on Outgoing Dividends, Interest and Royalties 122

8 Capital Gains 123

9 Other Issues 125

Netherlands 126


2 The Dutch Limited Liability Company 126

3 Limited Partnership 139

4 Investment or Mutual Funds 142

5 Outline of the Dutch Tax System applicable to the Taxation of Income and Profits 143

Poland 145



3 Outline of Poland’s Tax System applicable to the Taxation of Income and Profits 146

Portugal 149


2 The Venture Capital Company (VCC) 149

3 The Fundo De Capital De Risco 152

4 Special Considerations For Foreign Funds 155

5 Outline of the Portuguese Tax System applicable to the Taxation of Income

and Profits 155

Slovak Republic 160



3 Outline of the Slovak Republic’s Tax System applicable to the Taxation of Income

and Profits 163

Spain 166


2 Public Limited Companies (SAs) and Private Limited Companies (SLs) 166

3 Private Equity Company (SCR) and Private Equity Fund (FCR) 167

4 Taxation of Foreign Funds in Spain 172

5 Outline of the Spanish Tax System applicable to the Taxation of Income and Profits 173

6 Special Considerations for Foreign Investors 177

Table of Contents

Sweden 180


2 The Swedish Limited Partnership 180

3 A Swedish Consortium 181

4 Foreign Structures 182

5 Outline of the Swedish Tax System applicable to the Taxation of Income and Profits 183

Switzerland 185

1 Available Domestic Structures 185


3 Outline of the Swiss Tax System applicable to the Taxation of Income and Profits 188

4 Taxation of Swiss Investment Companies 191

5 Taxation of Foreign Fund Structures 200

6 Future Developments 203

United Kingdom 206


2 The Limited Partnership 206

3 The UK Company 209

4 The UK Investment Trust 209

5 The Venture Capital Trust 211

6 Unauthorised Unit Trust for Exempt Funds 211

7 Pension Fund Pooling Vehicle 212

8 Parallel Investment 213

9 Taxation of Foreign Funds in the UK 213

10 Outline of the UK Tax System applicable to the Taxation of Income and Profits 217

United States of America 219


2 US Fund Structures 219

3 Marketability 221

4 Non-US Fund Structures 224

5 Outline of the United States’ Tax System applicable to the Taxation of Income

and Profits from Equity Investment Funds 224

Contributing Members 231

The original EVCA Private Equity Fund Structures Paper was produced in 1994. With the further evolution of the

European legislative environment, this was followed by an updated version in 1999, which was itself reviewed

in 2001.

Private equity and venture capital investment funds – independent pools of funds principally made available by

institutional or sophisticated investors on an international basis for investment in European companies – account for

a large proportion of the finance available for investments by the industry in Europe. Furthermore, there is an

increasing trend within the private equity and venture capital industry towards funds that can invest in more than one

country in Europe, and for funds to carry out cross-border deals.

As a result, the central aim of these EVCA papers has been to encourage best practice by providing a useful basis

for understanding not only the necessary requirements in individual European countries, but also the differences

which can hinder pan-European fund structuring.

This new paper highlights the latest developments across the European Union, including first-time contributions from

the Czech Republic, Hungary and the Slovak Republic. Moreover, to enable readers to compare these developments

within the wider international context, contributions from Switzerland and the United States are also included.

As will be seen, there are wide differences between the way in which funds can be structured in different European

countries. This can make the structuring of European funds, and in some countries even domestic funds, extremely

difficult.

The creation of a transparent and mutually recognised fund structure within Europe or at a European level is a

longstanding priority for EVCA: it is actively engaged in ongoing discussions with policymakers across the EU,

stressing the key elements for such a structure as summarised below.

EVCA is convinced that this new paper will prove to be as valuable as its predecessors, and would like to thank all

those who have been involved in its creation for their invaluable contribution.

Javier Echarri

Secretary-General, EVCA

8 Foreword

9

A pan-EU Fund Structure for Private Equity and Venture Capital

Summary

A pan-European single fund structure will permit particularly European institutional investors to invest freely in private

equity and venture capital on a pan-European basis, without either very high costs or even the impossibility to do so.

It would give certainty to legal and tax treatments, and simplify both fund raising and administration, and ensure the

manager of the fund can focus on the commercial requirements of managing and growing the investments it has made.

EVCA recommends the creation of a specific fund structure at European level, by mutual recognition, providing the

same opportunities and benefits to all the fund’s investors and managers. Existing national structures should be

retained alongside but would remain simply as national structures. As fiscally transparent structures are legally

enforced in almost all EU countries, it would be sufficient for member states to recognise this characteristic in a

common fund. Regarding investors, each country would retain fiscal control at the final stage.

Because of the nature of private equity and venture capital investments, such a structure would only be for

sophisticated investors: a minimum investment level could prevent any form of retail marketing. Moreover, to

encourage foreign investment into the EU, investors from around the world should be able to participate in such a

fund structure investing in one or more European countries.

Key Elements for an Effective Fund Structure

1) Regulation of such a fund structure should guarantee the assignment of the funds to private equity and

venture capital activity, and the respect of certain quotas. It will invest within certain restrictions e.g.: equity

and debt in unquoted companies; with limited exception as part of a public to private transaction or when

an investee company goes public; in trading companies or holding companies of trading groups. Definitions

must be appropriate, not overly prescriptive.

2) It is advisable to determine whether the single fund is or is not a legal entity; in any case, the fund’s general

partner shall act as the sole representative, specifically on behalf of the investors.

3) A key principle is to ensure the tax transparency of the fund, which is not a taxable entity in its own right and

does not, by itself create for the investors in the vehicle, or the vehicle itself, a permanent establishment for

tax purposes in countries where investments are made. Investors should be subject to withholding taxes as

if they directly invested in the investee companies. However, it might be convenient to allow the single fund

to profit from international tax conventions in use by the country of its establishment instead of applying tax

treaties on the level of each of its investors.

Private Equity Fund Structures in Europe - An EVCA Tax and Legal Committee Paper - January 2006

10

VAT liability at a zero rating, and suppression of all residual taxes (e.g. wage taxes) would allow the recipient

to claim back VAT as opposed to a full exemption, incurring some irrecoverable VAT. Furthermore, the carried

interest received by the management team must be qualified as distributions of the products or as capital gain

by the fund and taxed as such, and not as a complementary fee or remuneration for the management team.

4) The traditional distinction between investors and the manager of the fund should be safeguarded.

Clarification of legal and tax rules should prevent the accumulation of multiple structures. There should also

be clarification as to whether the fund manager should be approved by a market authority, and if so, either

as a third party manager or the private manager of a private fund.

5) Pan-EU public organisations and their counterparts in each EU Member State should continue to invest in

confidence. The structure could also be used to support policies towards enhancing innovation and small

and medium enterprises.


Foreword

11

1 Scope

The structuring of private equity investment funds is often highly complex. Some European countries have

standard solutions for domestic funds, while others have different structures for different purposes, depending on

the circumstances. Others have no appropriate local structure at all so that it is necessary to choose a foreign

structure. Increasingly, funds have investors from several countries and make investments in more than one country.

In these cases the complexities multiply. This often has the effect of denying international investment

and reducing investors in smaller funds, as the professional costs involved can be prohibitive and in some cases the

problems arising can be insoluble. This paper is designed to give an overview as to the structures available, to

provide information and, hopefully, to show a path through the maze of different options available. A section on

structuring private equity funds in the United States of America and Switzerland have been included as a part of the

comparison. References in this paper to private equity and venture capital are generally used interchangeably as their

fund structures are the same.

This paper has been prepared by the members of the Tax & Legal Committee of the European Private Equity and

Venture Capital Association and their colleagues who are lawyers, accountants and venture capitalists practising in

each of the countries covered. The paper is intended to serve three purposes:

(a) to provide information as to available structures for private equity investment funds in each of Austria,

Belgium, the Czech Republic, Denmark, Finland, France, Germany, Hungary, Ireland, Italy, Luxembourg,

the Netherlands, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland, the United

Kingdom and the United States of America;

(b) to provide a comparison between the structures available in each of those countries; and

(c) to highlight the need for a co-ordinated approach to private equity funds and a pan-European

fund structure.

Each of the chapters in this paper addresses the fund structures available for funds investing in that country.

Each chapter starts by addressing the fund structures available for domestic investment by domestic investors and

then broadens out to consider funds for international investors and the local taxation treatment of foreign funds.

Finally, each chapter gives an outline of the taxation system in that country applicable to the taxation of income and

profit relating to private equity funds. In order that the positions in each country can be properly compared, the

individual chapters each follow a common format.

2 Private Equity Investment Funds and Terminology

A private equity investment fund is a vehicle for enabling pooled investment by a number of investors in equity and

equity-related securities of companies (investee companies) which will generally be private companies whose shares

are not quoted on any stock exchange.


Introduction

12

The vehicle can take the form either of a company or of an unincorporated arrangement such as a limited

partnership. In some countries the use of the word “fund” implies a collective association rather than a company but

in this paper the word is used in its wider context to cover either.

The management of the fund can either be employed by the fund itself or, more usually, by a separate management

company or manager providing services to the fund. The management company is usually remunerated by an

annual management charge which is commonly equal to up to 2.5% of investors’ initial commitments to the fund.

In addition, the management company or individual members of the management team and the sponsor are

commonly entitled to a “carried interest” which is an interest, typically up to 20% of the profits of the fund. Often the

carried interest does not take effect until after investors have been repaid the amount of their investment in the fund

plus, in many cases, a hurdle representing a basic return on their investment.

In the case of a limited partnership,

the founders and investors referred to

above would typically be limited

partners and there would also be a

general partner which would be

responsible for managing or procuring

the services of a separate manager.

The limited partnership (in common

with some other fund structures) is

tax transparent which means that it

is not subject to tax and its partners

are taxed as if any income and profits

allocated to them through the

partnership were received directly

from investee companies.

Summary comparison between a Private Equity Fund and a Hedge Fund

Private equity funds are generally close-ended in that investors commit at the outset and then cannot redeem their

interests. They draw down the commitments from investors as needed to make usually a fairly small number of

investments, and as investments are realised all proceeds are received. The proceeds are distributed, usually without

reinvestment so that the fund is self-liquidating. Investors receive quarterly or half-yearly reports from the fund

manager including reports on each investment made. It is usually only marketed to institutions or sophisticated

investors and the fund documentation is generally subject to negotiation with those investors. All of these features

distinguish a private equity fund from other fund structures such as hedge funds.


Introduction

Outline structure

Generalpartner

or

Managementcompany

FUNDManagement

Charge

Carried interest

Founders(not always present)

Investee companies

Investors

13


3 Overview of Countries and Fund Structures Covered

The countries and fund structures covered in this paper generally fall into three broad categories:

(a) countries which have specific structures to accommodate national and international investors on

a transparent or tax-free basis;

(b) countries which have specific structures for private equity which accord favourable taxation treatment

in that country provided they meet certain requirements. In many cases the requirements are so

restrictive as to render the structures virtually useless; or

(c) countries which have no suitable structure at all. In these cases international structures, such as limited

partnerships or companies resident in low tax areas, are often used.

It can be seen that in many cases the only

satisfactory way of structuring a fund for

investment in a particular country is by the use of

a tax haven. This arises despite the fact that

investment in private companies is a major

benefit to national economies, is growing rapidly

and is being increasingly encouraged by

governments which recognise the considerable

impact of such investment on national and

European employment and economic growth.

The amount of private equity and venture capital

raised in 2004 and the value of the private equity

and venture capital portfolio at cost in each of the

countries covered in this paper and in Europe as

a whole are set out opposite.

Source: 2005 EVCA Yearbook,

in cooperation with Thomson Financial

and PricewaterhouseCoopers

* The European total includes Greece

and Norway, who are not listed

Private equity and venture capital raisedCountry Amount Raised Value of the portfolio

in 2004 at cost (as of EURO (million) 31 December 2004)

EURO (million)

Austria 121.8 547.8

Belgium 563.8 2,485.2

Czech Republic 4.9 301.8

Denmark 536.2 1,802.6

Finland 220.7 1,588.7

France 2,411.3 25,535.9

Germany 1,983.1 20,136.2

Hungary 108.8 337.5

Ireland 47.4 843.8

Italy 1,663.3 12,433.4

Luxembourg N/A N/A

Netherlands 3,207.0 9,011.7

Poland 303.9 1,036.7

Portugal 248.0 503.4

Slovak Republic 5.3 136.2

Spain 1,557.0 6,706.0

Sweden 3,650.7 8,901.5

Switzerland 175.7 2,052.9

UK 10,056.7 59,814.0

European Total* 24,451.2 156,146.6

14


Introduction

The following table shows the principal types of fund available for each country covered although the appropriate

structure often depends on the precise circumstances.

Suitable tax/legal structuresNote: Outline only and subject to change

Country Local Investors Foreign Investors

Austria Mittelstandsfinanzierungsaktiengesellschaft or AG Mittelstandsfinanzierungsaktiengesellschaft or AG /Foreign structures

Belgium NV (Participation Privilege) and foreign structures Foreign structures preferable, possibly NVsubject to tax treaty

Czech Republic s.r.o. (similar to private company) Foreign structures preferable

Denmark Local company possible: no tax on gain Foreign structures preferableif investment held for 3 years

Finland Limited Partnership Limited Partnership for investors from tax treaty countriesForeign structures preferable for investors fromnon-treaty countries

France FCPR, FCPI, FIP or SCR FCPR or FCPI or foreign structures

Germany GmbH, GmbH & Co KG or UBG Foreign structures or passive investment partnerships

Hungary Private Equity Fund Foreign structures preferableInvestment Fund

Ireland Limited Partnership Limited Partnership

Italy Closed-end structure or foreign structures Foreign structures preferable

Luxembourg SICAR, SICAV or FCP SICAR, SICAV or FCP

Netherlands BV or NV (Participation Privilege) & CV (Partnership) BV or NV (Participation Privilege) and CV (Partnership)

Poland Limited liability company Limited liability company

Portugal Local corporate structure, but very restrictive Only foreign structures

Spain Local corporate structure, but very restrictive Foreign structures

Slovak Republic s.r.o. (similar to private company) Foreign structures preferable

Sweden Limited Partnership, Qualified Investment Company Foreign structures preferableand Consortium

Switzerland Foreign limited partnership structures preferable Foreign limited partnership structures preferablefor tax reasons for tax reasons

UK Limited partnership, Investment Trust, Limited partnership & other structuresVenture Capital Trust & other structures

US Foreign structures or US structures may be appropriate Foreign structures or US structures may be appropriatedepending on other factors depending on other factors

15

4 Objectives

The key objectives in structuring a private equity fund are as follows:

(a) to avoid a double charge to tax: the first when the fund receives income or realises an investment and

second when the investor receives income or realises an investment in the fund;

(b) ease of operation: For example, to avoid the need for meetings in tax havens;

(c) management charges and carried interest should be capable of being efficiently structured so that they come

out of the profits of the fund. Any value added tax or management charges should also not be an

irrecoverable cost of the fund as this would make fund structures no more advantageous than others;

(d) it must be capable of being marketed to suitable investors;

(e) any withholding taxes should be minimised; and

(f) it should be suitable for all kinds of investors (whether tax paying or tax exempt (such as pension funds))

in all countries.

5 Structuring Private Equity Funds

The main issue which arises in structuring private equity funds is to avoid the additional layer of taxation (often called

the double charge) which would arise if investors simply invested in a company which in turn made investments in

the desired target companies. Tax would then arise both on the sale by the fund company of its interests in the

investee companies and again on the distribution of those gains to investors or on the sale by investors of their

interests in the fund company. Also, in most jurisdictions, the distribution of proceeds of sale of individual

investments during the life of the fund company will be treated as a dividend rather than a partial realisation of capital,

thus converting a capital gain which arises on the sale of an investment at a profit into income. Although there are

certain investors for whom this can be an advantage, a general principle in structuring private equity funds is that

most investors will be best served by a structure under which they will be no worse off investing through the fund

than they would have been by investing directly into the investee companies. Occasionally some structures can

result in the position of certain investors being better off than they would have been had they invested directly, but

this is usually at the expense of having a structure which is widely acceptable.

Non-transparent structures

Two types of tax-efficient structures therefore exist. The first, where gains made by the fund suffer no tax in

the fund and tax only arises on the distribution of profits to investors, usually involves the use of a company situated

in a tax haven or a country providing an exemption from tax on capital gains and possibly income (e.g. the Dutch

participation privilege).


16

Four possible problems arise:

(a) where the company is situated in a tax haven, there is unlikely to be a double tax treaty between

the country of residence of the fund and that of the investee companies (or, indeed, of the investors).

Thus, depending on whether the country of residence of the investee company charges non-resident

investors to capital gains tax in the absence of an applicable double tax treaty or imposes high

withholding taxes on income or capital gains (which would normally be reduced by the application of a

double tax treaty) there may be a significant tax cost;

(b) where the fund is situated in a country which has the benefit of double tax treaties, there will often be

withholding tax on distributions to investors;

(c) distributions to investors during the life of the fund, or even on its termination, may be taxed

as income rather than as capital gain which may cause a problem for some investors; and

(d) the investors’ country of residence may have legislation along the lines of the US passive foreign

investment company (PFIC) legislation which may have an adverse effect.

Transparent structures

The second involves a transparent structure, such as a limited partnership, where, on the disposal of an investment by

the fund, investors are liable to tax on their share of the profit whether or not it is distributed to them. A structure which

is fully tax-transparent should have the effect of treating each investor as if it had made a proportionate investment

in each underlying investee company and all income and profits from an investee company allocated to it through

the fund derived directly from that investee company. This will therefore avoid a double charge to tax while at the

same time preserve the investor’s ability to apply the benefit of any double tax treaty between its country of residence

and the country of residence of the investee company. There will, however, be a question for each relevant country

as to whether the transparency of the particular structure is recognised in that country and this sometimes creates

a problem. Even where transparency is recognised, care needs to be taken to ensure that the fund itself does not

cause investors to be treated as carrying on business in another country through a permanent establishment and

thus liable to tax in that country at greater rates than they would have been liable to at home.

6 Pan-European and International Funds

Pan-European private equity funds are clearly developing with local management teams in more than one European

country, investors from all over Europe as well as the United States, Japan and other countries and making

investments in more than one European country. Although such funds are clearly consistent with the objective of a

single European market, the structuring, marketing and operation of such funds is a fiscal and regulatory nightmare.

When structuring funds internationally, the first question to consider will often be whether the country in which

the investments are to be made charges non-residents to tax on capital gains. If it does, then the use of foreign

non-transparent fund structures will be extremely restricted and a transparent structure will often be more suitable.

Even where capital gains tax for non-residents is not a problem, for some of the reasons given above, transparent

structures will often be the most appropriate.


17

7 A European Solution

Ideally, in order to address all of the problems raised in this paper, a new European structure should be developed

with a standardised taxation treatment as has been the case with the European Economic Interest Grouping (EEIG).

While this remains an ultimate goal, the EVCA Tax & Legal Committee recognises that this may not be practicable.

The introduction of a mutually acceptable European structure would increase the amount of capital available within

Europe for private companies and increase the incidence of transnational investments. This at a time when it is

increasingly recognised that investment in smaller unquoted companies can be more beneficial to each national and

the European economy than investment in more mature quoted companies for which many appropriate structures

are available.

The EVCA Tax & Legal Committee therefore encourages the adoption and mutual recognition of structures based

on the principle of transparency so that each investor in the structure would be treated as if it had invested directly

in each underlying investee company on the basis discussed below. This, however, would not preclude the existence

of tax-exempt structures as well.

English limited partnerships and the French FCPR appear to form a useful basis having all the characteristics

set out below.

The common features of the suggested fund structure would be that it has no legal personality and investors

in it will be treated for all tax purposes in the country of residence of the investee company (the investee country) as

if they had received the income and gains allocated to them through the fund directly from the investee company

without there being any permanent establishment in the investee country and on the basis that the double tax treaty

between the investee country and the country of residence of the investor would apply.

It is understood that the French FCPR, in the majority of cases, and the Italian Fondo Chiuso provide a deferment

to investors from their own country so that they are only taxed when they receive income and gains from the fund

and not when the fund realises income and gains from an investee company. That deferment would not be

recognised in other countries which would probably view the structure as transparent but there is no reason why it

should not exist in any particular country provided it did not interfere with tax transparency. Likewise there will always

be other suitable structures in particular countries, such as the Dutch BV, the English investment trust and the French

SCR, which provide exemption from tax rather than transparency from tax and which will continue to play a role in

increasing the pool of available private equity alongside the basic transparent model described in this paper.

For transparent structures to work effectively, it is essential that European structures meeting the above requirements

be mutually recognised as fully transparent in each European country. At the same time, countries not having a

structure meeting the above requirements should be encouraged to adopt one.

Jonathan Blake, SJ Berwin LLP


Note: In each case the most appropriate structure available in each country has been taken.1 Tax exemption.2 Depending on structure/clarification with fiscal authorities recommended.3 Depending on structure.4 For tax benefits, restrictions have to be considered; can be avoided by using another - less tax advantageous - structure.5 Under certain conditions, option is granted to avoid VAT on management charges (provided falling within the scope of Director power as stated in the

by-laws). Moreover, it is possible to “reduce” the VAT cost by assuring that certain services can benefit from specific VAT exemptions (e.g. transactions inshares). Finally, a particular exemption provision applicable to management of investment funds could be applied provided certain conditions are met.

18


Country (Structure) Tax transparent for Ability to avoid permanent establishment

domestic investors? for international investors

from treaty or non-treaty countries?

Austria (MFAG) � 1 �

Belgium (limited company or privak) � N/A

Czech Republic � �

Denmark � �

Finland (limited partnership) � �

France (FCPR) � �

Germany 9 (limited partnership) � �

Hungary (Private Equity Fund or Investment Fund) � 11 �

Ireland � �

Italy (fondo chiuso) � 15 �

Luxembourg (SICAR) � 16 � 17

Netherlands (limited partnership) � � 18

Poland � �

Portugal (VCC (SCR) - CRF (FCR)) � N/A

Slovak Republic � �

Spain (SCF-FCR) � N/A 20

Sweden (limited partnership) � �

Switzerland 24 (investment company) � 25 �

United Kingdom (limited partnership) � �

United States 27 (limited partnership) � �

6 It should be noted that a Privak is subject to restrictions on the type of investments which can be made.7 There are some restrictions relating to investments into specific sectors such as the defence sector.8 The management company can choose not to charge VAT, but in that case it cannot itself deduct VAT and has to pay a tax on the wages it pays out,

so that ultimately it needs to raise the amount of management fee it asks from the investors.9 From a tax point of view and in order to avoid a permanent establishment for foreign investors, certain investments such as in trading partnerships should

be avoided. The non-trading status of certain partnerships may change in the future.10 The carried interest treatment may change in the future.

(continued on next page)

19


Ability to incorporate a capital Ability to avoid paying VAT Ability to avoid paying VAT Freedom from undue

investment/ incentive for on management charges? on carried interest? restrictions on investments?

fund managers?

� � 2 � 3 � 4

� � 5 � � 6

� � � � 7

� � � �

� � � �

� � 8 � �

� 10 � � 10 �

� 12 � 13 � 14 �

� � � �

� � � �

� � � �

� � � �

� � � �

� � � �

� � 19 � � 7

� 21 � 22 � 23 �

� � � �

� 26 � 26 � 26 �

� � � �

� � � �

20

11 Hungarian fund vehicles regulated by domestic law (Private Equity Fund and Investment Fund) are tax transparent for domestic investors althoughin practice these are hardly used. Non-Hungarian investors usually prefer to use non-Hungarian fund vehicles. The tax treatment of non-Hungarian vehicleswill vary but if treated as tax transparent in their home jurisdictions, then Hungary should in principle accept this approach.

12 Usually these are non-Hungarian based.13 This results in the non-deductibility of the input VAT.14 Yes, if structured in a way that these retain the same character as the distribution that gave rise to them (e.g. capital gains, dividends etc).15 Despite the fact that the Fondo Chiuso is not tax transparent, non-business investors and all international investors from Treaty Countries benefit from

specific exemptions which in substance give the same results of tax transparency.16 The Luxembourg SICAR may be established under the form for fiscally transparent (SCS) or fiscally opaque (SARL, SA, SCA, and SCSA) undertakings.17 Not an issue in case of a fiscally opaque SICAR. May well be an issue in case of a transparent SICAR. See footnote 16.18 Each foreign investor will be considered to be engaged in the conduct of a business through a Dutch permanent establishment to which the shares in the

portfolio companies must be allocated. In computing the taxable profit of the permanent establishment, however, the benefits (gain and dividend) derivedfrom the portfolio companies should generally be exempt under the participation exemption.

19 It should be noted that it is possible to “reduce” the VAT cost by localising certain services outside the EU (e.g. administrative services) or by assuring thatcertain services can benefit from specific VAT exemptions (e.g. transactions regarding shares.

20 The mere fact of investing through an SCR/FCR would not give rise “per se” to a permanent establishment in Spain. Investing through an SCR/FCR couldgive rise to a permanent establishment in Spain depending on several circumstances, but there are ways for an international investor investingin Spain through an SCR/FCR to avoid a permanent establishment in Spain.

21 The SCR/FCR current regulations do not allow to structure easily a tax efficient carried interest for the promoters. Thus, carried interest structuresare complicated.

22 These management changes are usually VAT exempt in Spain. However, advisory fees charged to the Manager bear VAT, which is usually a costfor the manager.

23 The SCR/FCR current regulations do not allow to structure easily a tax efficient carried interest for the promoters. Thus, carried interest structuresare complicated. Additionally, where carried interest is possible, it would normally be structured as rendering of services and consequently VAT would notbe avoided.

24 In Switzerland, regulatory reasons prevent the use of Swiss investment funds (contractual structure) for typical private equity structures. The only localstructure available for private equity funds is the investment company. Because of the many disadvantages of the investment company (including absenceof tax transparency), offshore structures (e.g. limited partnerships) are the most common vehicles.

25 There might be further developments on this issue with the complete overhaul of the Swiss legal framework applicable to investment funds, which will bereplaced by a new "Collective Investment Schemes Act" the draft of which is currently pending before Swiss parliament.

26 There is no tax efficient option to structure a carried interest payable to the fund managers other than as a "performance fee" which is subjectto Swiss VAT (not recoverable by the fund) and to income tax at the level of the fund manager.

27 To avoid a permanent establishment for non-US investors and to otherwise permit non-US investors to obtain beneficial US federal income tax treatment,certain investments such as investments in real estate or in operating companies formed as tax-transparent entities should be avoided.


21


1 Available Structures

1.1 In Austria the main private equity and venture capital (PE/VC) fund vehicle is the so called Mittelstands-

finanzierungsaktiengesellschaft (MFAG), a stock corporation investing in small and medium-sized companies.

Apart from MFAGs, stock corporations pursuant to the Austrian Stock Corporation Act, favoured for foreign

investments due to favourable taxation of holding companies and the possibility of cross-border group

taxation, and (mostly foreign) limited partnerships or other foreign fund structures are also used, to a more

limited extent, for the purpose of establishing a PE/VC fund.

1.2 As the most popular structure for establishing a PE/VC fund in Austria is the MFAG, the following provisions

concentrate on the Austrian MFAG as well as on certain aspects of taxation in Austria.

2 Mittelstandsfinanzierungsaktiengesellschaft (MFAG)

2.1 The MFAG is a special tax construction regulated by the Corporate Income Tax Act (Körperschaftsteuergesetz

(KStG)). The main impetus behind this vehicle was to enhance the performance of small and medium-sized

enterprises in Austria. This is achieved by granting tax advantages – on corporate income tax as well as

various other taxes and duties – for investments in such companies by means of an MFAG. Therefore, almost

all Austrian PE/VC funds are set up as an MFAG.

2.2 To be accepted by the Austrian tax authorities, an MFAG has to fulfil the requirements summarised below

(see 2.4 to 2.14). These rules have the purpose of preventing the structure of the MFAG from being abused

because of their attractiveness from a tax point of view. The requirements described below are not regulatory

provisions but are "only" relevant for tax purposes (see section 3).

2.3 MFAGs according to current practice, are not subject to ongoing regulation. Only in cases where an MFAG

offers shares to the public, a prospectus in line with the EU Prospectus Regulation would have to be published

as for any issuer of shares. However, in most cases the shareholders of an MFAG are institutional investors.

2.4 The MFAG must adopt the form of a stock corporation (Aktiengesellschaft) with a minimum share capital

of €7.3 million. Therefore, the MFAG is subject to the provisions of the Austrian Stock Corporation Act

(Aktiengesetz (AktG)). This has the disadvantage of stock corporations being obliged to abide by the principle

of capital maintenance, which is difficult to handle for a PE/VC structure that requires flexibility with respect

to draw downs and repayments to investors.

2.5 75% of the founders of an MFAG must be credit institutions or special participation fund corporations

(Beteiligungsfondsgesellschaften). However, after foundation the founders must only hold directly or indirectly

up to 30% of the share capital of the MFAG.

AUSTRIA Dorda Brugger Jordis

22

2.6 The articles of incorporation may permit the issuing of participation certificates under the condition that

these certificates grant a share in any profits and the liquidation proceeds. The maximum nominal value

of the participation certificates is limited to the paid-in share capital.

2.7 The purpose of the business is limited to the investment of equity and additional services connected with such

investments. The MFAG is obliged to invest up to a minimum of two-thirds of its capital in Austrian companies.

The MFAG may acquire only minority participations in companies (up to 49%). The selection of companies

must be spread throughout medium-sized companies whose main business activities are in Austria.

2.8 70% of the equity capital must be invested in the so called financing area (Finanzierungsbereich) as defined

in 2.11 below and the companies invested into have to be industrial enterprises (i.e. enterprises not limited

to the administration of their assets). At least two-thirds of the holdings have to include participations in

goodwill and hidden reserves of the company invested in. The major part of the investment has to consist of

shareholdings in small and medium-sized companies that concentrate their business activities in Austria.

Furthermore, an investment in one single business is limited to 20% of the equity capital of the MFAG.

2.9 The investment-mix as defined by law must be reached within seven years and thereafter, the investment-

portfolio must consist of at least eight investments.

2.10 Investments in foreign enterprises are limited to one-third of the equity invested in enterprises.

2.11 Tax-exempt investments within the Finanzierungsbereich may be made in the form of:

(a) participations as a limited partner in limited partnerships;

(b) participations in silent partnerships;

(c) shares in stock corporations or limited liability companies;

(d) participation certificates, if they include a participation in profit and liquidation proceeds;

(e) loans, bonds and allowances to companies in addition to an existing (a)–(d) investment

(in economically motivated cases).

2.12 Investments other than shareholdings in industrial enterprises (outside of the Finanzierungsbereich)

are limited to bonds and bank deposits (with a maximum of 30%). Income from such investments is tax

exempt only in the first five years.

2.13 Investments in banks or insurance companies as well as investments in companies producing energy,

gas or heat are prohibited.

2.14 In addition to the rules laid down in Section 6b KStG, an ordinance (BGBl 1994/554) and various guidelines

(KStR Rz 239 ff) were issued by the Austrian Ministry of Finance, putting some of the above regulations into

a more detailed and concrete form.


AUSTRIA

23

3 Taxation of the MFAG

3.1 If the requirements mentioned opposite are met, an MFAG is taxed favourably as follows: Pursuant to Section

6b KStG, the profits of an MFAG are completely exempt from corporate income tax up to the end of the fifth

calendar year following the year of registration with the Register of Companies. Thereafter, profits from

investments in small and medium-sized companies are exempted. Furthermore, MFAGs are generally tax

exempt from company tax and any stamp duties which arise while the MFAG is being established (company

tax amounts to 1% of the capital paid in).

3.2 For corporate investors, the taxation of dividends/repayment of capital is the same as for investments

in an "ordinary" stock corporation and, therefore, tax-exempt if the requirements of Section 10 para 1 and

para 2 KStG are fulfilled (see section 6)

4 Initiative for a New PE/VC legislation

4.1 At present, there are ongoing discussions in Austria with regard to the various disadvantages and limitations

of the MFAG structure (and a potential state aid issue). The legal form of a stock corporation limits the flexibility

of the MFAG. Furthermore, the investment restrictions limit the scope of potential targets. Moreover, the

Austrian MFAG structure has to be able to compete with international PE/VC standards.

4.2 The Austrian Private Equity and Venture Capital Organisation (AVCO) started its activities in April 2001 to give

the growing field of PE/VC a representative, and help to raise public awareness and understanding of risk

capital financing as well as to promote the further development of PE/VC in Austria. An AVCO working group,

in which Dorda Brugger Jordis participated, has drafted a proposal for a PE/VC-law, whose main interest is

to create PE/VC structures as flexible and as tax-transparent and competitive as possible. This proposal is

currently being discussed with the Austrian Ministry of Finance.

5 Foreign Fund Structures in Austria

5.1 Pursuant to the Austrian Investment Fund Act 1993 (Investmentfondsgesetz (InvFG)) a foreign investment

fund is defined as any assets that are subject to the laws of a foreign country and invested in accordance

with the principle of risk-spreading under the applicable law, under its articles of association or in practice,

irrespective of the legal form.

5.2 A public offer of units of a foreign investment fund in Austria is subject to the provisions of the InvFG.

The foreign investment fund, therefore, must inter alia name a custodian bank to the Finanzmarktaufsicht (FMA)

and appoint a paying agent through which payments are made by or to the unit-holders as well as a (tax)

representative.


24

The fund rules or the articles of associations of the foreign investment fund must provide for various provisions

with regard to paying methods and forbidden transactions in relation to the foreign investment fund. Further, the

distribution of units of foreign investment funds must be notified to the FMA in advance. A public offering of

fund participations without such registration constitutes an administrative or even criminal offence.

5.3 As a typical PE/VC fund usually will not meet the requirements to be registered as a foreign investment fund,

the question arises, whether PE/VC funds can be classified as foreign investment funds. A PE/VC fund

regularly invests in accordance with the principle of risk spreading. However, in practice often only such

foreign fund structures are regarded as foreign investment funds under the InvFG, which are similar to Austrian

Investment Funds insofar as they invest the majority of their funds in listed securities and only acquire minority

participations. As PE/VC funds regularly exercise an economic influence as they acquire controlling

participations, often to a large extent in non-listed companies, they will usually not have to be regarded as

foreign investment funds under the InvFG. However, this has to be evaluated on a case-by-case basis.

The distinction is important also for tax reasons as investments in non-registered foreign investment funds

may be subject to an unfavourable taxation (see below). Otherwise, the general taxation regime applies (see

6 below).

5.4 The taxation of domestic and non-domestic investment funds is based on the fiction of full profit distribution.

As a consequence, not only profits, which have actually been distributed, are subject to taxation, but

also profits that have been earned but retained. The retained profits are deemed to be distributed

(Ausschüttungsgleiche Erträge) four months after the end of each business year at the latest.

The calculation on the profits deemed distributed depends on whether the fund qualifies as a "white fund"

or a "black fund".

5.5 A "white fund" is a fund with a tax representative in Austria, who provides evidence of the profits earned

by the fund to the tax authorities. With a white fund, the profits deemed distributed are calculated on

the basis of the profits actually earned by the respective fund.

5.6 In contrast, a "black fund" is a fund that does not have a tax representative in Austria. Section 42 para 2

of the Austrian Investment Fund Act provides that profits deemed distributed in the respective calendar year

shall amount to:

(a) 90% of the difference between the first and the last purchase price fixed in the respective

calendar year; but

(b) a minimum of 10% of the last purchase price fixed in the respective calendar year.

5.7 However, the investor in a black fund himself may provide qualified evidence of the profits actually earned by

the fund in a respective calendar year. The legal assumption regarding the amount of the profits deemed

distributed shall only apply if no qualified evidence of the profits actually earned by the fund is provided.


AUSTRIA

25

5.8 In order to avoid double taxation, the profits deemed distributed shall not comprise profits actually distributed.

Therefore, any profits actually distributed shall be deducted from the calculated profits deemed distributed.

However, such a deduction may not lead to a negative profit (loss). If profits deemed distributed are in fact

distributed at a later date, such a distribution shall be tax exempt.

5.9 Further, according to Section 42 para 4 of the InvFG, Austrian credit institutions are obligated to levy

a "safeguard tax" (Sicherungssteuer) of 1.5% of the last repurchase price fixed in a respective calendar year

of non-domestic investment fund participations kept on Austrian accounts unless the investor provides

evidence that he notified his investment to the competent tax authority in his resident state. However, the

safeguard tax shall only apply if the non-domestic investment fund does not provide the same reports

regarding withholding tax on profits distributed and profits deemed distributed as would be the case with a

domestic investment fund. Therefore, the non-domestic investment fund may avoid the safeguard tax by

providing such reports. If the non-domestic investment fund does not provide such reports, the investor

himself can still avoid safeguard tax by providing evidence to the Austrian credit institution that he has notified

his investment fund participation to the competent tax authority in his resident state.

6 Outline of Austria's Tax System applicable to the Taxation of Income and Profits

For the taxation with regard to MFAGs see section 3.

Corporate income tax

6.1 Austrian corporations are subject to corporate income tax at a rate of 25%. Whereas interest payments and

royalties received by Austrian corporations are fully taxable at a rate of 25%, special exemptions exist

regarding dividends received from Austrian (national participation exemption) and non-Austrian subsidiaries

(international participation exemption). Furthermore, capital gains realised upon the sale of a participation in

a non-Austrian subsidiary may also be tax-exempt.

6.2 The following conditions must be fulfilled for the national participation exemption to apply:

• an Austrian entity subject to Corporate Income Tax ("Parent"), e.g. a stock corporation, a limited

liability company or an Austrian private foundation;

• has a participation, whether direct or indirect (i.e., also participations held via a transparent

partnership may qualify); and

• in an Austrian corporation ("Subsidiary").


26

If these conditions are met any dividends received by a Parent through its participation a Subsidiary will be

exempt from Austrian Corporate Income Tax, regardless of the extent of the participation and regardless of

any holding period. However, the national participation exemption does not apply to capital gains realised by

a Parent upon the sale of its participation in a Subsidiary.

6.3 The following conditions must be fulfilled for the international participation exemption to apply:

• an Austrian corporation ("Parent"), e.g. a stock corporation or a limited liability company;

• has a direct or indirect participation of minimum 10% in the share capital;

• of a foreign company ("Subsidiary"), which is either comparable to an Austrian corporation

(as opposed to a partnership) or has a legal form listed in the Annex to the EC Parent/

Subsidiary-Directive; and

• with the participation having been held for an uninterrupted period of at least one year.

If these conditions are met, (i) any dividends received by a Parent from its participation in a Subsidiary and

(ii) any capital gains realised by Parent upon the sale of its participation in a Subsidiary will be exempt from

Austrian Corporate Income Tax.

As a result, dividends and capital gains as well as losses or other changes in the value of a Subsidiary are in

principle tax neutral. However, there is the option to declare a participation as tax effective. This option has

to be exercised in the year of the acquisition and is non-revocable. Upon exercising of such option, dividends

and capital gains resulting from that participation become taxable and losses tax deductible.

Regarding the one-year holding period, it should be noted that any capital gains realised by a Parent before

the expiry of the one-year period are taxable. If, on the other hand, a Parent receives dividends from its

participation in a Subsidiary before the expiry of the one-year holding period, then the dividends are only

temporarily subject to Corporate Income Tax. Specifically, the tax on the capital gains will be refunded

after the expiry of the one-year holding period should a Parent still hold its participation in a Subsidiary.

6.4 Section 10 para 4 of the Austrian Corporate Income Tax Act contains a special anti-abuse provision relating

to the international participation exemption. There is not an exemption for dividends and capital gains if the

tax authorities have reason to suspect tax avoidance or tax abuse. This provision applies if the following

conditions are definitely fulfilled:

• the subsidiary focuses on earning passive income (i.e. interest income, rental income, income from

royalties and income from capital gains) as opposed to engaging in an active trade or business;

and

• the subsidiary's effective tax burden is not comparable to Austrian tax (less than 15%).


AUSTRIA

27

In this case, the international participation exemption is replaced by an indirect foreign tax credit system

("switch-over"). Thus, if a Subsidiary is a company in a low tax jurisdiction earning only (or mainly) passive

income, the anti-abuse provision would apply and dividends received by a Parent from a Subsidiary would

be taxable at a rate of 25%, with the possibility of receiving a tax credit for foreign withholding taxes and taxes

on underlying income of a Subsidiary.

Taxation of income distributed

6.5 As a general rule dividends paid out by Austrian corporations to non-resident shareholders generally trigger

a withholding tax of 25%. If a tax treaty provides for a lower withholding tax rate, the tax authorities will refund

the excess amount (most double taxation treaties to which Austria is a party provide for a maximum rate of

between 5% and 15%). Under special agreements with some countries, treaty relief may be granted at

source if certain conditions are fulfilled (e.g. provision of certificate of residence).

6.6 Under the Austrian provisions implementing the EC Parent/Subsidiary-Directive, however, outbound dividends

are totally exempt from any withholding tax under the following conditions:

• an EC company with a legal form listed in the annex to the EC Parent/Subsidiary-Directive;

• has a direct participation of at least 10% in the share capital;

• of an Austrian corporation, e.g. a stock corporation or a limited liability company; and

• with the participation having been held for an uninterrupted period of minimum one year.

However, tax at source must be withheld temporarily if the dividends are distributed during the first year of

holding; a refund will be granted as soon as the one-year holding period has expired. According to a ruling

issued by the Austrian Ministry of Finance, no temporary withholding is necessary if the taxpayer provides

evidence that the shares will be held for an uninterrupted period exceeding one year and if sufficient security

is provided.

Tax at source must also be withheld in the case of abuse of law and in case of constructive dividends.

Abuse of law does not exist if the EC parent company states in writing that it derives its income from

active business, that it employs its own personnel and that it maintains its own business facilities.

6.7 Austria levies no withholding tax on interest payments to non-residents. However, non-resident corporations

earning interest paid on loans secured by mortgage on immovable property situated in Austria may be

subject to 25% Austrian Corporate Income Tax (limited tax liability). Even in such cases, double taxation

treaties may either provide for a lower tax rate or completely exclude taxation in Austria.

6.8 Royalties paid to non-residents are subject to a 20% withholding tax. Double taxation treaties frequently

reduce this withholding tax rate, in many cases even to zero.


28

Capital gains

6.9 Capital gains realised on the sale of a foreign qualifying participation are tax-exempt in Austria. Capital gains

derived from the sale of shares in a resident company are taxed as business income of a company at

normal rates.

Thin capitalization rules

6.10 There are no statutory thin-capitalization rules in Austria. However, the Austrian Administrative Court

has established broad guidelines that are used to determine whether the equity is inadequate, in which case

a portion of the indebtedness to shareholders may be regarded as the equivalent of shareholders' equity.

Interest paid on such debt may in such cases, not be deducted from the taxable income.

Tax-deductibility of interest

6.11 Financing costs (i.e. interest on loans for the acquisition of a participation) are tax deductible (new since 2005).

Group taxation

6.12 Financially linked companies now may form a group of companies for tax purposes with the legal effect that

the taxable profit/loss of any business year of each group member is assigned to and taxed at the level of

the group leader.

6.13 One of the basic requirements is that the companies are financially linked in a way that one company

owns directly or indirectly more than 50% of the shares and the voting rights in another company. The group

of companies shall exist for a minimum period of three years. In case a group member drops off the group

during this minimum term, any assignment of profits or losses to the group leader is cancelled retroactively.

6.14 One of the main advantages of the group taxation is that losses generated by any group member may be

offset against the profits generated by other group member(s) at the level of the group leader. Also foreign

subsidiaries may become group members. As a consequence, foreign losses become deductible for tax

purposes in Austria (whereby a double use of losses is excluded).

6.15 In case of the acquisition of an interest in an operative company by a group member, a depreciation

of goodwill is allowed also in case of a share deal. The goodwill is calculated as the difference between

the equity of the acquired company plus hidden reserves contained in the non-depreciable fixed assets

on the one side and the acquisition cost on the other side. Any such goodwill is capped at 50% of the

acquisition cost. The calculated goodwill will be depreciable on a straight-line basis over 15 years.


AUSTRIA

29


1.1 The most commonly employed corporate form for private equity funds is the Belgian limited liability company,

which has a share capital limited by shares: naamloze vennootschap (NV) / société anonyme (SA). Since the

Act of 16 April 1997, there is a special tax regime for the so called “Privaks” (Private Equity Investment

Funds). An additional special tax regime has been implemented by the Act of 22 April 2003, for the so called

“Private Privak”.

1.2 This chapter considers the principal features of the NV/SA against the background of the Belgian tax system

in section 2, the Public Privak in section 3 and the Private Privak in section 4. A description of the special

considerations applicable to foreign private equity funds operating in Belgium is given in section 5.

2 The Limited Liability Company

2.1 The Belgian limited liability company limited by shares is known as a société anonyme (SA) in French and as

a naamloze vennootschap (NV) in Flemish. The SA/NV must have at least two shareholders which may

be companies and/or individuals. Their liability is limited to the amount of their subscribed capital.

The minimum share capital amounts to €61,500. A limited liability company can issue registered or bearer

shares, with or without a par or nominal value. However, a proposal is currently pending before parliament

which aims to abolish bearer shares. It is possible to issue non-voting shares. In principle shares are freely

transferable, although company law allows share transfers to be restricted by means of either a shareholders’

agreement or statutory clause.

2.2 An SA/NV is quite simple to operate. There are no specific requirements regarding the nationality of

shareholders or directors. Although the law does not expressly require that statutory meetings take place

in Belgium, it is generally advised that shareholders’ meetings should be held within the country.

Taxation

2.3 Investors in any Belgian limited liability company enjoy advantageous tax treatment for dividends received

if the criteria relating to the so-called participation exemption regime are satisfied. The fiscal benefits and the

circumstances in which they apply are described in detail below. In outline, however, meeting either one or

both (depending upon circumstances) of the regime’s two conditions means that:

(a) capital gains are tax-free; and

(b) a deduction is made from the taxable income of a Belgian company which amounts to 95%

of the dividends it has received.


BELGIUM Tiberghien Advocaten/Avocats

30

VAT

2.4 The VAT status of an entity having its sole activity to acquire stakes in businesses merely depends on

the level of involvement taken in the targets. Indeed, should the entity not intervene directly or indirectly

in the management of its targets, it will generally not be considered as a VAT taxpayer. As a consequence,

such an entity is not entitled to input VAT deduction. However, if the entity, as well as acting as a holding

company, supplies particular goods or services specified in the VAT Code, it would be considered as

a partial VAT taxpayer, enabling, to some extent, an input VAT recovery. The VAT status of Public and Private

Privaks is rather complex as one can try to apply to these vehicles, the recent European Court of Justice

case law in the BBL case. As a reminder, in BBL, the Court considered that open-ended investment

companies are VAT taxpayers (although potentially fully exempt ones).

Without investigating the above mentioned issues further, it could be concluded that a private equity vehicle

will most likely be classified as a partial or mixed VAT taxpayer since it generally performs both VAT exempt

(e.g. transaction in share) or outside the scope of VAT transactions (e.g. pure holding function) and VAT

taxable transactions (e.g. advisory services).

Note finally that a particular regime (option to tax) based on an administrative decision is applicable in Belgium

to management services provided they are exercised within the scope of the power of the Directors as stated

by the by-laws.

Marketability and private placement

2.5 The limited liability company which has a share capital limited by shares is suitable for use as a private equity

investment vehicle, provided that the participation exemption applies, for the following classes of investor:

(a) Belgian corporations;

(b) tax-exempt domestic and foreign investors, as withholding tax is the final liability; and

(c) non-tax-exempt foreign investors, being corporate or private individuals, provided that either an

advantageous tax treaty or the EU Parent-Subsidiary Directive is applicable.

2.6 Private equity funds may be privately placed. Should any one (or more) of the following criteria apply to

a placing, then it must be undertaken publicly rather than privately:

(a) a professional intermediary is used;

(b) promotional activities are undertaken (publications in newspapers, telephone campaigns, Internet

publicity, etc); and

(c) more than 50 people and/or companies are solicited.


BELGIUM

31

Public placements require the authorisation of the Commission for Banking and Finance.

2.7 The offering of the shares of an SA/NV to the public is regulated by the Commission for Banking and Finance.

The Quotation Committee of the Stock Exchange is responsible for the listing of securities on the stock

market. Before applying to be listed, the company must submit a written prospectus to the Commission

for Banking and Finance.

Conclusions

2.8 From the point of view of private equity investment, the Belgian limited liability company has the following

advantages:

(a) it provides limited liability to the investors; and

(b) provided that its investments comply with the appropriate conditions of the participation

exemption regime, capital gains on shareholdings are tax-free for the fund (without any minimum

participation being needed), 95% of the dividends received are excluded from its taxable income

(provided the minimum participation of 10% or €1,200,000 is met).

As to the investor:

(i) capital gains realised by Belgian individual and corporate investors are tax exempt (no

minimum participation is required); 28

(ii) Belgian resident corporate investors benefit from a deduction from their taxable

income amounting to 95% of the dividends received from the fund (if the minimum

participation described above is met);

(iii) Belgian resident corporate investors should be able to deduct interest charges on the

loans for the acquisition of the shares in the fund from their taxable income; and

(iv) Belgian resident investors (individuals) may under some circumstances take advantage of

a (limited) tax deduction at the time of the subscription of the shares (art. 145-1,4° ITC).

2.9 From the point of view of private equity investment, the Belgian limited liability company has the following

disadvantages:

(a) it is not transparent for tax purposes;

(b) the formalities associated with a public placement are burdensome;

(c) the dividends received deduction only applies where the shareholding is equal to or exceeds

either 10% or €1,200,000; and

(d) capital losses on shares are not tax deductible. 29


28 The transfer of a shareholding in a Belgian company of at least 25% to a foreign company by an individual is subject to taxation at the rate of 16,5%.However, this taxation does not apply if the transfer is made within an E.U. context.

29 Capital losses are deductible to some extent when the company is liquidated (article 198, 7° I.T.C.).

32

3 Taxation of Belgian Public Privaks

Public Privak: Legal aspects

3.1 Public Privaks are, like SICAFs/BEVAKs and SICAVs/BEVEKs, to be considered as investment companies.

Public Privak companies can adopt the form of an NV/SA or a société en commandite par actions /

commanditaire vennootschap op aandelen.

(a) The purpose of the Public Privak Fund, as of every investment company, consists in the collective

investment of capital solicited from the public. Therefore a public offering to possible investors

should be made.

(b) According to the Belgian legislation, the following circumstances can lead to the conclusion that

such a public offering has been made:

• publicity towards possible Belgian investors including publications in newspapers,

telephone campaigns, Internet publicity, etc; or

• the intervention of professional intermediaries; or

• an offering to more than 50 possible investors.

(c) With a literal interpretation of the text, a public offer is made if only one of these conditions is met.

The Belgian Banking Commission however recommends some reasonableness in this matter.

(d) Belgian investment companies can choose to invest in private equity (‘high risk capital’).

This principle is regulated in the Public Privak Fund legislation (Royal Decree of 18 June 1997).

The Public Privak Fund must be registered with the Belgian Banking Commission. This implies that the Public

Privak Fund has to be acknowledged as an investment company by the Commission. The conditions for

acknowledgement are similar to those existing for SICAFs/BEVAKs and SICAVs/BEVEKs companies (e.g.

approval of the by-laws of the investment company).

The Public Privak Fund legislation also regulates what information must be communicated to the investors

(prospectus, annual report, semi-annual report, inventory of the assets, etc).

The Public Privak Fund legislation also comprehensively regulates which investments can and must be made

in order to acquire Public Privak Fund status (i.e. the “investment regulations”). These investment regulations

can be summarised as follows:

• the Public Privak Fund must invest its assets in permitted financial instruments according to

the principle of risk-spreading;

• at least 50% of the assets must be invested in shares;


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• the Public Privak Fund cannot invest more than 20% of its assets in permitted financialinstruments of the same issuer. In any event, the amount that the Public Privak Fund is allowedto invest in one company is capped; and

• the Public Privak Fund must invest at least 70% of its assets in so-called “qualifying” investments.

“Qualifying” investments are:

• investments in permitted financial instruments issued by companies not quoted on a stock exchangemarket;

• investments in permitted financial instruments traded on a stock market (acknowledged by theBelgian Banking Commission) for new, early stage or growing companies. Such investments maynot however constitute more than 50% of the total amount of the “qualifying” investments; and

• investments in shares issued by other investment companies or by holding companies. It shouldbe noted that such investments are only considered as “qualifying” investments for up to 70%of their value.

A strict application of these ‘investment regulations’ is tempered during a transitory period of five years.Furthermore the Royal Decree of 18 June 1997 provides that Public Privaks should distribute at least 80% oftheir net receipts, after deduction of the net amount of reimbursements of debts paid during the accountingyear. However, in this respect there is a transitory regime of five years, during which distributions of less than80% are allowed.

Public Privak Fund: Tax law

3.2 The tax regime applicable to Public Privak Funds is similar to the tax regime applicable to BEVAK companies(i.e. investment funds).

Public Privak Funds are in principle subject to corporate income tax (33.99%). The taxable basis is howevercalculated as the total amount of the abnormal or gratuitous advantages received and the disallowed expenses.This implies that Public Privak companies benefit de facto from a favourable tax regime.

Public Privak Funds are exempt from withholding tax on received interest. Furthermore, no withholding taxwill be due on dividends paid by the Privak Fund to its shareholders, if these shareholders are foreignindividuals or companies which did not affect their participation to a professional activity in Belgium.This latter exemption is not applicable when the dividends paid by the Public Privak Fund originate fromdividends paid to the Public Privak Fund by Belgian companies. If the exemption does not apply, thedividends will be subject to a withholding tax at the rate of 15% or 25%.

Capital gains realised on shares held by the Public Privak Fund are tax-exempt in the hands of the PublicPrivak Fund. According to a so-called ‘transparency-rule’, the capital gains are deemed to be realised by theshareholders of the Public Privak Fund. Please note, however, that this transparency rule only applies if thePublic Privak Fund invested in shares of companies subject to ‘normal’ taxation.


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If the aforementioned condition is not met (the Public Privak Fund realises capital gains on shares of companies

not subject to ‘normal’ taxation), the Public Privak company would lose its special tax regime for the taxable

period in which the capital gains on such shares were realised.

The Public Privak Fund is subject to an annual duty of 0.08% of the investment value.

Transformation of an existing “private equity” company into a Public Privak company

3.3 An existing private equity company can be transformed into a Public Privak company, acknowledgedby the Belgian Banking Commission.

When this happens, an ‘exit tax’ of 16.5% is payable (to be increased by the complementary crisiscontribution of 3%).

This exit tax also applies when a Public Privak participates in mergers or demergers.

VAT aspects

3.4 From a VAT point of view, two issues have to be distinguished, being:

(a) the VAT status of the activities performed by the private equity vehicle; and (b) the VAT treatment applicable to the management of the vehicle itself.

VAT status of the activities performed by the Public Privak will need to be determined on a case by casebasis, taking into account the nature of the activities performed (e.g. transactions in shares).

With respect to the management of the vehicle itself, the Belgian local provision implementing Article 13,B, d), 6° of the sixth Directive is applicable to Public Privak, so that most of the management servicesrendered to the vehicle could benefit from a VAT exemption.

4 Taxation of Belgian Private Privaks

Private Privaks: Legal aspects

4.1 The Private Privak is a non-listed closed-end tax transparent special purpose vehicle for venture capital.

The Private Privak is an entity with legal capacity that can be incorporated as a Company limited by shares(Naamloze vennootschap/Société anonyme), a Limited partnership with share capital (Commanditairevennootschap op aandelen/Société en commandite par actions) or an Ordinary limited partnership (Gewonecommanditaire vennootschap/Société en commandite simple). A Private Privak is a closed-end investmentcompany (as opposed to an investment company with variable capital).


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The by-laws of the Private Privak must be submitted for approval to the Federal Government Service Finance

and the Private Privak has to be registered in a special register maintained by the Belgian tax administration.

The procedure of registration of the Private Privak with the Federal Government Service Finance is a process

of interaction between the applicant and the public authority: the application for registration cannot be denied

without leaving the applicant sufficient time to comply with possible remarks and suggestions from the

Federal Government Service Finance.

The investors may be individuals and/or legal entities established abroad or in Belgium. The investors in

the Private Privak benefit from limited liability. The Private Privak is a non-public company: capital cannot be

raised through a public offer. In order to preserve the non-public character of the investment, each investor

must invest at least €250,000. (As a result, the specific rules for a public offer of securities do not apply).

A contribution in kind is not allowed. In order to distinguish the Private Privak from the traditional holding

company, certain rules have to be complied with: voting stock requirements, the investors in the Private Privak

must be unrelated to one another and to the investee companies, etc.

The statutory intention of the Private Privak must be limited to venture capital investments, i.e. qualifying

financial instruments of non-listed Belgian or foreign companies. Shares and similar securities, bonds and

other debt instruments are amongst others considered as qualifying financial instruments.

Like any other collective investment company, the Private Privak is in principle not allowed to control any of

its investee companies (certain exceptions however apply).

Private Privak: Tax law

4.2 The Private Privak is subject to Belgian corporate tax. The tax base of the Private Privak is limited to the

disallowed expenses and the abnormal or gratuitous advantages that the Private Privak would receive.

The aforementioned tax base is subject to the ordinary Belgian income tax rate of 33.99%. This means that

the effective tax burden of the Private Privak will under normal circumstances be very limited. However, if the

Private Privak does not respect certain rules, its taxable basis is determined according to the common rules

for companies.

The withholding tax on dividends and interest received by the Private Privak can be credited against

the Belgian income tax payable by the Private Privak. Any excess is refundable. No withholding tax is due

with respect to the proceeds of the Private Privak paid on its liquidation or in case of share redemption.

Moreover, dividends paid by the Private Privak to its investors are exempt from withholding tax to the extent

that such distributions originate from capital gains realised on the participations held by the Private Privak.

To the extent the dividends do not originate from capital gains realised by the Private Privak, a 25% or 15%

withholding tax will be due. The latter rate can, however, be reduced under the applicable double tax treaties.


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In the hands of Belgian corporate investors, capital gains realised on the Private Privak participation are

exempt in Belgium provided that the Private Privak meets certain investment requirements. The Belgian

corporate investors will benefit from the so-called dividends received deduction (up to 95%) with respect to

dividends distributed by the Private Privak to the extent, that (i) the dividends result from capital gains realised

by the Private Privak on qualifying shares or capital gains on shares issued by another Private Privak, or

(ii) dividends originating from qualifying shares.

VAT

4.3 Comments made under the Public Privak section are applicable as such to the Private Privak.

5 Taxation of Foreign Funds in Belgium

5.1 Belgian tax law defines a Belgian establishment as the “fixed place through which the professional activities

of a foreign company are entirely or partly conducted in Belgium”. This definition is very similar to the definition

of a permanent establishment under the treaties.

5.2 A foreign fund will be subject to Belgian taxation on realised capital gains and dividends and other income

received in Belgium, to the extent that these are attributable to any Belgian establishment. In such circumstances,

taxation would be levied in the same manner as for Belgian resident companies. The corporate tax rate for

an establishment is 33.99%. No withholding tax is levied on distributions of profits to the head office.

A permanent establishment is eligible for the dividend received deduction provided the necessary criteria are

met (See section 6).

5.3 Foreign funds should benefit from any relevant provisions of the applicable tax treaties, provided that

they are subject to income tax in their home country. This means, inter alia, that the foreign fund will only be

subject to Belgian taxation if it has a permanent establishment in Belgium.

5.4 Belgian law has a number of anti-abuse provisions. Such provisions may under some circumstances apply

to transfers of assets to foreign funds located in tax havens or in countries with a more favourable tax regime.

Furthermore, Belgium has anti-abuse legislation which enable the tax authorities to recharacterise transactions

and attribute to them less favourable tax consequences than those intended by the parties involved.


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6 Outline of the Belgian Tax System applicable to the Taxation of Income and Profits

The participation exemption regime

6.1 The application of the Belgian participation exemption regime requires that a number of conditions are met.

The so-called “taxation requirement” must be satisfied both in order to benefit from the 95% dividend

received deduction on dividends and to benefit from the exemption of capital gains on shares.

(a) The dividend received deduction for dividends requires that the following conditions are met:

(i) the shares must be held in full ownership;

(ii) one of the two following requirements must be met:

• minimum participation of 10%; or

• minimum acquisition price of €1,200,000.

(iii) minimum holding period: the shares should be held in full ownership for an

uninterrupted period of 1 year; and

(iv) financial fixed assets: dividend received deduction only applies to financial fixed

assets as defined under Belgian GAAP. Shares booked in the short-term investment

account (geldbeleggingen/placements de trésorerie) do not qualify for the dividend

received deduction.

(b) Both the dividend received deduction and the exemption of capital gains requires that the

so-called taxation requirement is met. In this respect, it is necessary that one falls out of the

scope of the following categories which trigger the exclusion from the participation exemption:

(i) the company is not subject to any form of corporate taxation, or it is established in a

country whose general taxation regime is substantially more favourable than the one

in Belgium. Since the 2002 corporate tax reform, a list of those countries was drawn

up by Royal Decree. The Royal Decree can only include countries where the nominal

tax rate on company profits is below 15% or where the effective tax burden is below

15%. Corporate tax regimes in EU Member States cannot be deemed to be

substantially lower than in Belgium.

(ii) the company is a financing, treasury or investment company which is, subject to a

tax regime derogating from the common tax regime which applies in Belgium.

A financing company exclusively or primarily engages in the supplying of financial

services for the benefit of companies which do not belong directly or indirectly to the

same group. The activity of a treasury company consists primarily or exclusively of

carrying out cash investments; cash pooling for the group is, however, not included.

An investment company has as its sole purpose the collective investment of capital.


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(iii) Offshore activities: The income of the company should not originate outside the

country of the company’s tax residence, if such income benefits from a tax regime,

derogating from the common tax provisions.

(iv) Foreign Branches: Dividends paid by companies which derive profits from foreign

establishments which are subject to a tax regime which is, viewed on a global basis,

substantially more advantageous than the Belgian income tax regime are excluded

from the participation exemption. Since the 2002 corporate tax reform, the fourth

exclusion does not apply if the company and its foreign establishment are located in

an EU Member State, or if, viewed on a global basis, the tax effectively levied on

profits originating from the foreign establishment amounts to at least 15%.

(v) Intermediary Companies: The company should not redistribute dividends which

would not qualify for the dividend received deduction on basis of one of the

abovementioned exclusion categories.

(c) Please be aware that there are a number of exceptions to all these rules (art. 203 §§ 2 and 3 ITC).

Corporate tax on profits

6.2 An SA/NV is subject to corporate income tax at the standard rate of 33.99%. Provided that a number

of conditions are met, reduced rates apply.

Dividends

6.3 Belgian withholding tax is withheld from dividends paid by a Belgian company. Withholding tax is creditable

against the tax liabilities of the Belgian corporate recipient. The withholding tax is the sole tax liability if the

dividend is distributed to a Belgian individual or to a Belgian non–profit organisation.

6.4 Dividends received from Belgian or foreign companies are included in the profits of the recipient company.

Subject to the conditions referred to above, a deduction amounting to 95% of the received dividends applies.

6.5 For dividends paid by a Belgian company, the dividend received deduction applies to the gross amount

distributed. For dividends paid by foreign companies, the deduction applies to the net amount received

– in other words, after deduction of any foreign withholding tax.

6.6 Where doubt exists as to whether dividends received qualify for the exemption, it is possible to request

an advance ruling from the Belgian tax authorities. This will normally be given within three months.

6.7 Dividends distributed by a Belgian company are subject to withholding tax at a standard rate of 25%.


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This rate is frequently reduced to 15% or to a lesser amount by the provisions of the relevant tax treaties

when paid to foreign shareholders.

If the recipient company is located in a Member State of the EU, dividend distributions are exempt from

withholding provided that the (foreign) parent company and the Belgian subsidiary qualify as parent and

subsidiary companies as defined in the parent subsidiary directive. Furthermore, a minimum shareholding in

the distributing company of at least 20% must be held for an uninterrupted period of at least one year.

Distributions of dividends between Belgian resident companies are also free of withholding tax when

the recipient company has held or holds at least 20% of the shares of the distributing company for an

uninterrupted period of at least one year before and/or after the distribution is made.

The standard withholding tax rate of 25% may be reduced to 15% for:

• dividends attributed to shares that are issued from 1 January 1994 onwards by way of a public

offering;

• dividends attributed to shares that are subscribed in cash from 1 January 1994 onwards on

condition that shares are either registered as from the offering or that they are deposited with

a financial institution; and

• dividends attributed by qualifying investment companies.

6.8 Dividends paid to foreign exempt non-commercial entities are exempt from withholding tax provided these

entities are not distributing these same dividends to another taxpayer as part of a contractual obligation.

Interest

6.9 Interest payments received are treated as ordinary income. As far as interest income from abroad is

concerned, a tax credit is available when foreign source interest has been subject to withholding tax abroad.

Such a tax credit can be used to offset the tax liability of the Belgian company but is not refundable. The tax

credit is computed on basis of a sophisticated formula.

Capital gains

6.10 A 10% withholding tax is payable on the proceeds derived both from a share buy back by a Belgian company

and from the liquidation bonus of a Belgian company.

Capital gains on shares realised subsequent to a redemption of shares or the liquidation of a company

qualifies for the dividend received deduction, provided that a number of conditions are met.


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6.11 Capital gains are exempt for a Belgian corporate shareholder provided that the taxation requirement is met

(see above). If the taxation requirement is not met, the capital gain is taxable at the rate of 33.99%.

Individuals are generally exempt from tax on capital gains realised on shares which are part of their

private estate. However, speculative gains may be taxed at the rate of approximately 33%, to be increased

by communal surcharges.

Capital losses

6.12 A capital loss on shareholdings is not deductible for Belgian tax purposes, except subsequent to the

liquidation of a company. In this case the capital loss may be deducted from taxable income up to the amount

of the investor’s paid-in capital.

Private individual investors are not entitled to deduct capital losses realised on assets within their

private estate.

Costs

6.13 Interest payable on loans taken out by Belgian companies to acquire Belgian or foreign shareholdings should

be fully deductible.

6.14 In general, interest on loans incurred by private individual investors in order to acquire shareholdings

is not tax-deductible.

6.15 Management charges paid by way of salary are generally tax-deductible costs in computing the profits

of the company.

6.16 Other expenses or charges are tax-deductible provided that they are incurred in order to acquire or maintain

taxable income and have been determined on an arm’s length basis.

Capital duty

6.17 As of January 1, 2006, capital contributions into a Belgian company are no longer subject to a registration

tax of 0.5%. As a general rule, capital contributions are exempt.

However, in some cases, contributions of real estate into the capital of a company may still be subject

to registration tax at the rate of 10% or 12.5%.


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Carried interest

6.18 A special fiscal regime of stock options is provided by articles 41 to 47 of the Act of March 26, 1999.

The Act of March 26, 1999 applies both to (qualifying) stock options granted to employees and to

self-employed directors.

According to these rules, the taxable event is the acceptance of the option (regardless of moment of vesting,

regardless of whether the options are transferable or not and regardless of whether the options are subject

to a risk of forfeiture).

The option may be accepted within a 60-day period after the offer was made by the employer.

If the beneficiary accepts, than the option is deemed to be accepted on the 60th day.

Valuation of qualifying stock options

Quoted stock options:

• Taxable value = exchange value at the working day prior to the day of grant.

Non-quoted stock options

• Taxable value = 15% of the market value of the underlying shares if the option is to be

exercised within 5 years of the grant

+ additional 1% per year for each (portion of a) year for which the options

are exercisable beyond the fifth year after the grant.

• Specific rules apply with respect to the valuation of the shares.

• The lump-sum percentages of 15% and 1% are reduced to 7,5% and 0,5% if a number of

conditions are met.

• If the stock options are of value at the time of grant, the taxable income will be increased with

the difference between the exercise price and the market value at the time of grant.

Under the current Belgian legislation, it is not clear what happens if the stock options were not accepted

within the 60-day period.


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1.1 There are very few private equity and venture capital funds operating in the Czech Republic that use fund

vehicles regulated by Czech law. If they are to do so, the following structures would be likely.

Act no.189/2004 Coll. on collective investment differentiates between two types of fund structures; standard

funds and special funds. The difference between these types is that the former complies with the requirements

set out by Community Law, whereas the latter does not. The fund structures, which are likely to be used for

private equity and venture capital investments, belong to the group of special funds and include:

(a) “Special fund of venture capital” – this fund invests mainly into investment instruments or

instruments of the monetary market that have not been accepted for trading on the regulated

capital market;

(b) “Special fund of Real-Estate” – this fund invests mainly into real estate and can invest up to 20%

of its total assets into a single real estate investment;

(c) “Special fund of the funds” – this fund invests mainly into the investment instruments issued by

another fund, subject to a specific approval of a Czech supervisory state office; and

(d) “Special fund of particular property” – this fund invests mainly into objects, property rights and

other property values.

1.2 Another possibility for private equity funds to invest in the Czech Republic is investment through a “common

business company”- in the legal form of an s.r.o. (similar to private company) or alternatively an a.s. (similar

to a PLC). These companies are not as closely regulated as collective investments, however, they do not

benefit from the supervision of the relevant Czech state authority. They are regulated by act no. 513/1991

Coll, of the Czech Commercial Code, as amended.

Limited liability company (společnost s ručením omezeným (s.r.o.))

Under the Commercial Code a limited liability company is a company whose registered capital is made up of

investments, agreed in advance, invested into the company by its members. It comes into existence on the

date of its entry onto the Czech Commercial Register. The company may be established by a sole founder,

a legal entity/entities or one or more individuals. A limited liability company with a sole member cannot also

be the sole member of another limited liability company.

The maximum number of members is 50, and each member holds an “ownership interest” rather than actual

shares. Each member must also be registered on the Czech Commercial Register as such. The minimum

amount of registered capital is CZK 200,000 and the minimum amount of each member's investment in the

company is CZK 20,000. The ratio of a member's investment contribution to the company's registered capital

determines the ownership interest and this determines the rights and duties of this member, unless the

company’s Memorandum of Association stipulates otherwise.


CZECH REPUBLIC CMS Cameron McKenna v.o.s

43

The members are generally not liable for debts and obligations of the company provided its registered capital

is fully paid. Otherwise, they are jointly and severally liable for debts and obligations of the company up to

the amount of their total unpaide contributions recorded on the Czech Commercial Register.

A reserve fund must be created of 10% of the net profit in the first profitable year of operations up to a

maximum of 5% of its registered capital. Furthermore, 5% of the company’s net profit after tax must be

transferred to the company’s reserve fund every following year until it reaches 10% of the company’s

registered capital.

Company accounts do not need to be audited unless at least two of the following three conditions are met

(during the current or prior accounting period): (1) the turnover exceeds CZK 80 million, (2) the value of the

assets exceeds CZK 40 million and (3) the number of employees exceeds 50.

Joint stock company (akciová společnost (a.s.))

A joint stock company must have a minimum registered capital of CZK 2 million (CZK 20 million if a public

offering is held for subscription of the shares). At least 30% of this amount must be subscribed in cash and

fully paid up on incorporation. It may be established by a sole shareholder providing that the sole founder is

a legal entity; otherwise, the minimum number of founders is two. Shareholders are generally not liable for

debts and obligations of the company. The class, number and nominal value of the shares along with the list

of board members must be registered in the Czech Commercial Register. Shares can be publicly traded.

If the company has only one shareholder, the shareholder must be registered on the Czech Commercial

Register.

In the first profitable year of operations a reserve fund must be created of 20% of the company’s net profit to a

maximum of 10% of its registered share capital. Furthermore, 5% of net profit after tax must be transferred

to the reserve fund every following year until it reaches 20% of the company’s registered share capital.

Annual accounts must be audited by a registered auditor and published if one of the following three

conditions was met in the prior or current accounting period: (1) the turnover exceeds CZK 80 million, (2) value

of assets exceeds CZK 40 million, or (3) the number of employees exceeds 50.


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2 Foreign Fund Structures

2.1 A foreign fund structure will not receive special tax treatment in the Czech Republic. If it operates through

a Czech permanent establishment, it will be fully taxable in the Czech Republic, in the same way as a Czech

company. If a foreign fund invests into the Czech Republic without a Czech permanent establishment, it will

be taxed on Czech-source income in accordance with the relevant double taxation treaty.

2.2 If the fund is treated as tax transparent in its home jurisdiction, then in theory the Czech tax authorities should

follow this approach, but the actual approach that will be taken by the Czech tax authorities in respect of the

various non-Czech structures in unclear and should be analysed on a case-by-case basis.

3 Outline of the Czech Republic’s Tax System applicable to the Taxation of Income and Profits


3.1 Corporate income tax is levied on the worldwide income of Czech tax residents and on Czech-source income

of Czech non-residents. This treatment applies irrespective of whether the company is subject to Czech or

foreign ownership and is payable on the basis of profits reported in the company's financial statements (as

adjusted for certain deductible and non-deductible items).

There is no tax consolidation in the Czech Republic. Each company within a group is taxed individually,

i.e. there is no set-off of losses against profits between different companies.

The standard rate of Czech corporate tax for 2006 is 24%. The Czech corporate tax rate for standard funds

and special funds listed in point 1.1 is 5%.

3.2 There are no local taxes in the Czech Republic.

Capital gains

3.3 Capital gains derived from the sale of shares are taxed as other corporate income at the rates noted

in section 3.1.

Capital gains by individuals are exempt from Czech tax after 5 years ownership of interest in an s.r.o.

and after 6 months ownership of securities (shares) in an a.s.


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Dividends

3.4 Dividend withholding tax under Czech law is currently set at a rate of 15%.

According to the EU Parent/Subsidiary Directive, which was implemented in Czech law with effect from

1 May 2004, if a Czech company is a subsidiary of another Czech company, or of a company resident in

another EU member state, there will be no Czech withholding tax on the dividends paid by the Czech

subsidiary, provided that certain conditions are met. For dividends the rule for determining if the parent/

subsidiary relationship exists is the holding of at least 10% of the registered capital of the subsidiary for

at least 12 months. The exemption from tax can be applied before the 12-month period has elapsed.

This rule also applies to dividends “paid” by a Czech permanent establishment of a Czech non-resident

company.

Interest

3.5 Interest income is taxed as other corporate income at the rates noted in section 3.1.

Interest payments are generally tax-deductible when they are due.

Thin capitalisation rules restrict the tax deductibility of interest payments arising from inter-company loans.

Taxation of business income

3.6 When establishing income derived from business activities, the starting point is the profit before tax disclosed in

the accounts, which is subject to adjustments under the Czech Income Tax Act. Generally income and

expenses according to the accounts are taxable/deductible. Where capital gains form part of business

profits, they are taxable as corporate income.

The Czech Income Tax Act attempts to give some guidance (as opposed to an exhaustive list) as to which

expenses should and should not be deductible. The general rule is that expenses incurred for the purpose

of generating or maintaining profits are tax deductible. A large number of specific expenses are also explicitly

listed as tax deductible.


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Tax losses

3.7 Tax losses may be carried forward for five years.

From 2004, losses may not be carried forward on a substantial change in the ownership of the company

unless it is shown that at least 80% of the company's revenues are continued to be derived from the same

activity as those carried on in the period when the loss arose. A change of at least 25% in the ownership of

the registered capital or the voting rights, or a change resulting in a person obtaining a controlling influence

in the company, is always a substantial change.

Permanent establishment

3.8 Czech tax legislation defines permanent establishment in accordance with the OECD Model Convention.

A Czech permanent establishment of a foreign company is generally subject to Czech tax on the same basis

as a Czech tax resident company.

International tax issues

3.9 Czech residents (i.e. companies having their seat (or the place of their effective management) in the Czech

Republic) are subject to Czech tax on their worldwide income.

Other companies (i.e. Czech non-residents) are subject to Czech tax on their Czech-source income only,

subject to the provisions of double taxation treaties.

Double taxation relief

3.10 In the Czech Republic relief for foreign taxes is given by credit only if there is a double taxation treaty with the

source state requiring this. Otherwise, the foreign tax can only be treated as a tax-deductible expense.


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1.1 Denmark has no specific legislation for private equity structures. Previously the most commonly used structure

adopted the structure of a public limited company (Aktieselskab). The shareholders invest in a private equity

company and receive the return as dividend or capital gain. Such companies act normally as evergreen

funds, but can also have a limited life. Some of these private equity companies are publicly listed on

Copenhagen Stock Exchange.

1.2 Recently private equity activities have increased in Denmark and most new funds have adopted the traditional

fund structure with a limited partnership and general partner/management company.

1.3 This paper considers the relative advantages and principal features of each of these structures against

the background of the Danish tax system.

2 The Public Limited Company (Aktieselskab)

2.1 This structure is governed by the Public Limited Company Act, (Aktieselskabsloven). The statutory minimum

share capital is DKK 500,000. Companies are required to have a Board of Directors, consisting of at least

three members. The Board is elected at a general assembly and at least half of the directors must be

residents of EC countries. The Board appoints one or more General Managers. If only one General Manager

is appointed, he or she must be a Danish resident. If more than one General Manager are appointed at least

half of them must be Danish residents.

Taxation

2.2 A Danish resident company is liable to tax in Denmark. The corporate tax rate is 28%. Capital gains are

tax-free provided that the holding period of the shares has been more than 3 years. Dividends are also

tax free if the holding in a subsidiary exceeds 20%.

2.3 Dividends can be distributed to domestic shareholders without withholding tax if their holding exceeds 20%.

For foreign shareholders withholding tax depends on the double taxation treaty between Denmark and

a shareholder’s country of residence.

Management charges and VAT

2.4 In the private limited company structure the management is employed in the company. Therefore the

management charges and VAT are not an issue.


DENMARK Dansk Kapitalanlæg

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Carried interest

2.5 As the management is employed in the company structure there is no normal carried interest. However

incentive schemes, such as options and warrants are common regarding the management team.

Special considerations for foreign investors

2.6 Any foreign investor can invest in a Danish company. The liability is limited to the investment. If the foreign

investor has no permanent establishment in Denmark there will be no tax on capital gains. Withholding tax

on dividends depends on the double taxation treaties.

3 Limited Partnership

3.1 A private equity fund can be structured as a limited partnership with a general partner. The liability for

investments in the partnership is limited to the commitment.

Taxation

3.2 The limited partnership (Fund) structure is tax transparent. The partners will be taxed individually on their

share of income and expenses in the partnership. However the tax aspects must be investigated for foreign

investors, as the investment activities may be considered as a permanent establishment in Denmark.

Management charges and VAT

3.3 Management charges are tax deductible for the partnership. However certain tax cases are pending on

that issue. Hence future deductibility is uncertain.

3.4 VAT must be added to management charges. For the Fund the VAT can be deducted in other VAT liable

income. As it is unusual that a Fund has VAT liable income the VAT may be considered as an additional cost.

Carried interest

3.5 Carried interest is normally structured as a part of capital gains and will therefore be liable to capital gains tax

for the general partner/management company.


DENMARK

49

4 Taxation of Foreign Funds in Denmark

A non-resident investment company will not be liable to Danish tax on capital gains on Danish assets.

However this requires that the investor has no permanent establishment in Denmark. As non-resident

it is required that management and control of the investment company is located outside Denmark.

5 Conclusion

5.1 Denmark has not yet any legislation specially designed to assist the private equity industry.

5.2 Private equity activities can be structured as a private limited company, which has some tax benefits such as

no capital gains tax on shares held more than 3 years.

However for foreign investors double taxation might occur depending on the double taxation treaty.

5.3 Private equity activities can also be structured as a limited partnership. This structure is tax transparent.

Foreign investors will not be liable to Danish tax unless it is considered that they have permanent

establishment in Denmark.


50


The most suitable structure available for private equity funds in Finland is a limited partnership

(Kommandiittiyhtiö). The expression “limited partnership” is used here when referring to this company form,

although it may differ from the limited partnership as recognised by the UK or other jurisdictions. Most Finnish

private equity funds have been structured as limited partnerships.

An alternative to the limited partnership would be the limited liability company (Osakeyhtiö), which can be

either private or public. Distribution of capital returns is, however, much more complicated in a limited liability

company than it is in a limited partnership. It is also difficult to achieve a tax-efficient structure using a limited

liability company. Early losses may also be difficult to deal with in a limited liability company structure.

The limited liability company is seldom used as a fund structure in Finland and consequently this paper

concentrates only on the limited partnership structure.

2 The Finnish Limited Partnership

2.1 A limited partnership consists of a minimum of two partners, one of whom is the general partner and one the

limited partner. The general partner has unlimited liability for the obligations of the limited partnership,

whereas the limited partner’s liability is limited to the sum invested by the limited partner. The number of

partners is not restricted.

2.2 The partners may be individuals or companies. In private equity funds, the management company is typically

the general partner and the investors are limited partners. The management company is normally a limited

liability company and therefore none of the individuals involved in the structure bears any personal liability.

2.3 The general partner’s investment in the limited partnership is often quite small. Transfer of units from one

partner to another will require an amendment to the partnership agreement. The limited partnership may also

be structured so that the partners’ investments in the fund are increased pursuant to capital calls by the

management company.

2.4 The limited partnership is constituted by a partnership agreement. In addition to the agreement, registration

in the Commercial Register is mandatory. To a large extent the partners are free to agree under the freedom

of contract principle. Where no explicit agreement exists, the Finnish Act on Partnerships and Limited

Partnerships governs the relationship between the partners. Certain matters fall outside the freedom of

contract principle, e.g. the agreed term of a limited partnership may not exceed 10 years unless each

of the partners has the right to terminate the partnership after 10 years.


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2.5 The administration of the limited partnership may be stipulated in the partnership agreement.

Failing specific stipulations, the general partner has the power to act in its sole discretion.

In private equity funds, the management powers of the general partner are usually outlined in a separate

management agreement.

2.6 The partners’ ownership units in a limited partnership cannot be quoted on a stock exchange.

Taxation

2.7 The limited partnership is largely transparent to taxation. The structure allows investors with different financial

requirements to invest through the fund almost as if they owned the shares of the target company directly.

This is because the limited partnership itself is not separately taxable.

2.8 Income tax is calculated on the level of the limited partnership, but the resulting tax is payable by each

investor according to its own tax status. The basis for the allocation of taxable income is the distribution of

profits agreed among the partners. The result is that dividends and capital gains from the fund’s investments

are largely taxable at the fund investor level as if it had received them directly itself.

2.9 Losses in a limited partnership are not allocated to the partners in taxation. Losses are carried forward

and deducted from the income or gains calculated for the limited partnership in later years.

Management charge and VAT

2.10 The Finnish tax system does not provide for a priority fixed share of profits, which would be deductible from

income or gains in income taxation. Therefore the management fee is normally charged as a charge for

services and is subject to VAT.

2.11 In some cases the rule on group registration for VAT purposes may apply to a fund structure. The effect

of group registration is that companies registered for VAT purposes as a group are treated as one business

entity. Group registration may only be applied to groups providing mainly VAT exempt financial services or

insurance services. The practical result of group registration is that sales of non-deductible services which

are only sold within the VAT exempt group are exempt of VAT.

Carried interest

2.12 Carried interest can be structured as an allocation of gains and income. If the carried interest is payable

to the general partner which is a company, the same rules that apply to taxation of partners’ profit shares

in the limited partnership also apply to carried interest.


52

2.13 To the extent that carried interest is paid to an individual manager, his/her income will be taxed as earnings

and subject to a progressive tax schedule. If the manager is not resident in Finland, the Source Tax for

employment income is 35% unless otherwise stipulated in a double taxation treaty. For local managers

the carried interest will normally be received by a company where the managers own an interest.

Marketability

2.14 Investments in a limited partnership may be privately offered to a limited number of professional investors

without specific adherence to securities market legislation and without authorisation under any specific rules.

There have for example been a number of feeder funds with a limited number of private individuals as

investors, the minimum investment being €50,000, in which case the Finnish Financial Supervision Authority

has not required a prospectus to be drafted.

2.15 Investments in a limited partnership have not been marketed to the general public in Finland. It is not forbidden

to market such investments but then the rules of the Finnish Securities Market Act (Arvopaperimarkkinalaki)

must be followed. This includes preparing a prospectus, which needs to be approved by the Financial

Supervision Authority prior to issuing.

3 Special Considerations for Foreign Investors

3.1 A foreign investor is in principle liable for tax on Finnish source income. Dividends, interest income, and

royalties are taxed at source. The Source Tax (Withholding Tax) is 28%. In most double taxation treaties

between Finland and other countries the Finnish Source Tax for interest, dividend and royalty income received

from Finland is partly discounted or eliminated. Wittholding Tax is not collected on dividends paid within

European Union in case the company receiving dividends owns more than 20% of the shares in the

distributing company.

3.2 As explained above in section 2.7 the limited partnership is regarded as tax transparent for the purposes of

Finnish income taxation. As a rule the income of the partnership should be taxed at the level of the partners.

There is new legislation on foreign investors investing in Finnish limited partnerships engaged in venture

capital business. According to this new legislation the foreign investor residing in a tax treaty country is only

taxed on the income derived from the Finnish source. In practise this means that the foreign investor is taxed

the same way as if it would have invested directly into the target companies. In cases where the target

companies are Finnish companies the investor is taxed as if it was a shareholder of the company.


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As a conclusion, capital gains and interest are usually tax exempt income for foreign investors in Finland and

the withholding tax on dividends varies between 0% and 28% depending on applicable tax treaties and

the share of ownership in the target company. A Finnish limited partnership is a feasible option for foreign

investors provided that the criteria of the new legislation is met. However, there is no praxis on this new

legislation and the interpretation is still somewhat open.

Capital gains made in respect of Finnish assets

3.3 A corporation which does not have a permanent establishment in Finland and is under a limited liability to

pay taxes in Finland is in general obliged to pay 26% tax on capital gains made in respect of Finnish assets.

However, this concerns only the disposition of real estate property situated in Finland or shares of a company

(or co-operative) whose assets consist of more than 50% of real estate property situated in Finland.

If the object of the disposition is other than the above mentioned property, capital gains are not taxed.

Residence

3.4 See section 4.6.

Anti-avoidance legislation

3.5 There is a general clause against tax avoidance in the income tax legislation. The clause shall be applied

if a circumstance or a transaction has been given a legal form which is not commensurate with its actual

character and meaning. In these situations taxation takes place as if the correct form had been adopted.

Punitive tax increases and even criminal legislation consequences may take place if the avoidance is deemed

to have been intentional.

4 Outline of the Finnish Tax System applicable to the Taxation of Income and Profits

General

4.1 Personal (individual) taxation operates on two bases: the taxable capital income and the taxable earned

income. Interest, capital gains, capital income share of dividends etc. are considered taxable capital income.

Wages, salaries and pensions, earned income.

4.2 A final source tax of 28% is levied on interest on bank deposits and bonds. Share of dividends etc.

are considered taxable earned income.

The capital income is subject to 28% tax. The earned income is subject to various taxes, and some of those

are progressive.


54


4.3 The corporate income tax for limited companies and other corporate taxpayers is 26%. There are no other

taxes based on the income or net wealth of corporations.

Tax on dividends

4.4 The dividends paid by a listed company are partly considered as capital income and the tax rate is 28%.

Taxation of dividends paid by a non-listed company to the individual shareholders is different. Only part of

dividend income from a non-listed company qualifies as capital income, part of the dividend income can be

tax exempt and the rest is treated as earned income. Taxation of dividends received from non-listed

companies is complicated and the proportions of earned income, tax exempt income and capital income

depend on the net asset value of the company distributing dividend and the total amount of dividend received

by a single shareholder.

Tax on interest

Capital gains

4.5 Capital gains are fully taxable as capital income and are subject to the 28% tax rate. In general, the full

amount of the gain is included in the taxable capital income. However, in some situations it is possible to limit

the taxable gain. In these cases, instead of deducting the actual amount of acquisition, it is possible to deduct

20% from the selling price (deemed acquisition cost). If the property has been owned more than 10 years,

this presumed cost is 40%.


4.6 The general rule is that non-residents are taxed on income derived from Finland. Individuals, who have their

main abode in Finland, or stay in Finland for a continuous period of more than six months, are considered to

be resident in Finland. The permanent establishment is defined in the Income Tax Act (Tuloverolaki) Section

13(a) and furthermore in many tax treaties concluded by Finland. There are also several cases concerning

this definition in Finland. The definition of a permanent establishment in Finnish legislation and in Finnish

treaties is usually based on the OECD model.

There are no general provisions concerning the residence of companies. In general, a company is understood

to be resident in Finland if it is incorporated within the territory. There is no precedent for regarding a company

registered in a foreign country as being resident in Finland.


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Local taxes

4.7 Corporate income tax is only paid to the state. However, the earned income taxes consist of the progressive

state income tax and the proportional municipal income tax.

Church tax

4.8 Church tax is also based on the taxable earned income. The tax is paid by the members of the Evangelical-

Lutheran and Orthodox Churches and therefore it is in a way a voluntary tax.

The net wealth tax

4.9 The net wealth tax is payable by individuals with a taxable net wealth in excess of €250,000. The tax rate

is 0.8% of the excess. Non-residents are liable to pay the net wealth tax on their Finnish assets.

The tax is 0.8% of the excess of the net wealth in excess of €250,000. However, most tax treaties concluded

by Finland cover the net wealth tax.

The Net wealth tax system will be abandoned in the beginning of 2006.


56


1.1 The most commonly used structures for private equity funds in France are:

(a) the Fonds Commun de Placement à Risques (FCPR);

(b) the Fonds Commun de Placement dans l’Innovation (FCPI)

and the Fonds d'Investissement de Proximité (FIP); and

(c) the Société de Capital Risque (SCR)

2 Fonds Commun de Placement à Risques (FCPR)

2.1 The Fonds Commun de Placement à Risques (FCPR) legislation was initially enacted in 1983. It was significantly

modified in 1988 (Law n° 88-1201 of 23 December 1988), when France created a unifying legislation

applicable to all UCITS (Undertakings for Collective Investment in Transferable Securities (Organismes de

Placements Collectifs en Valeurs Mobilières (OPCVM)), and has been subject to numerous changes since

that date. The relevant applicable and updated dispositions were codified in December 2000 and are now

found in Articles 214-1 and following of the Financial and Monetary Code (Code Monétaire et Financier).

Formation and Operation of an FCPR

2.2 The FCPR is defined in the law as a a joint ownership of securities (copropriété d’instruments financiers et

de dépôts). It is not a separate legal entity (i.e. it does not have a “personnalité morale” under French law)

and, for this reason, does not have the legal capacity to enter into contracts. Any contracts must be

concluded by the Management Company (see below) on the FCPR’s behalf.

2.3 An FCPR is formed by two founders, the Management Company (Société de Gestion de Portefeuille) and the

Custodian (Dépositaire).

The Management Company must have its registered office in France, and must be approved by the French

securities authority, the Autorités des Marchés financiers (AMF). It has sole responsibility for the management

of the FCPR including all decisions to make or to sell investments of the FCPR.

The Custodian, generally a bank, is chosen by the Management Company from a list established by the

French finance ministry. The Custodian must have its registered office in France. It is responsible for the

safekeeping of the assets of the FCPR, and carries out the instructions of the Management Company. It must

at all times verify that all transactions performed by the Management Company are in accordance with the

applicable laws governing FCPRs and with the By-Laws (Règlement) of the FCPR.


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The Management Company is subject to regulatory and ethical obligations to remain independent and to perform

its duties in the interest of the unit holders of the FCPR. The Management Company must ensure the equal

treatment of the unit holders of the FCPR. In addition, the Management Company must take all possible

measures to avoid conflicts of interest with investors as well as with other related management companies.

2.4 The Management Company and the Custodian enter into a binding legal agreement (Règlement), governing

the operation of the FCPR which sets forth the following terms and conditions, among others:

(a) the investment policy of the FCPR;

(b) the subscription for FCPR units;

(c) the rights conferred by the FCPR units;

(d) the allocation and distribution of FCPR proceeds;

(e) information communicated to the unit holders;

(f) the management fees.

Investors subscribing for units of the FCPR must adhere to the Règlement.

2.5 An FCPR that is open to the public at large (referred to herein as an “Approved FCPR”). must receive the

prior approval of the AMF If the FCPR is open only to qualified investors as that term is defined in the

legislation, the FCPR can be created under the AMF simplified procedure (procédure allégée) and the prior

approval of the AMF is not required 30. In such cases, the Management Company is only required to file the

Règlement of the FCPR (together with other relevant documents) with the AMF within one month of the initial

closing date of the FCPR.


30 An FCPR à procedure allégée is reserved for the following investors:(a) qualified investors, as defined by law (banks, insurance companies, management companies and OPCVMs); (b) the Management Company of the fund, its directors, officers, and employees;(c) States;(d) the European Central Bank, any National Central Bank, the World Bank, the International Monetary FCPR, and the European Investment Bank;(e) investors initially subscribing for or acquiring units in an amount of at least €30,000, who have held a position in the finance industry for at least

1 year;(f) individuals or legal entities initially subscribing for or acquiring units in an amount of at least €30,000 and that contribute technical or financial

assistance to unlisted companies, assist the Management Company of the FCPR, or have knowledge of the private equity industry;(g) investors initially subscribing for or acquiring units in an amount of at least €30,000 which have a portfolio of financial instruments with a total value

of over €1,000,000;(h) companies fulfilling 2 of the 3 following criteria, at the end of the most recent fiscal year:(i) total balance sheet greater than €20 million,(j) total revenue greater than €40 million,(k) equity capital greater than €2 million;(l) investors subscribing for or acquiring units in an amount of at least €500,000.

58

Subscriptions

2.6 The minimum capital required in order to form an FCPR is currently €400,000. When an investor subscribes

to an FCPR it receives units (parts). The FCPR may include several categories of units each with distinct

rights. In practice, the Règlement generally provides for one or more categories of standard units and a

separate category of units that give rights to a carried interest. The liability of the investors is limited to their

commitment to the fund. Investors in an FCPR may be French or foreign.

2.7 It is not necessary for subscriptions to be fully paid up immediately. Payments into the FCPR may consist of

an initial payment equal to a percentage of the total amount committed by the investor followed by

subsequent drawdowns (tranches), called from time to time in accordance with investment requirements of

the FCPR.

2.8 Units of an FCPR may be sold or transferred at any time after subscription. However, the Règlement may

provide that any sale of units requires the prior approval of the Management Company, and it may provide

for pre-emptive rights for the other unit holders. Furthermore the Règlement may provide for a “blocking

period”, during which units of the FCPR may not be redeemed, which may not exceed 10 years as from the

formation of the FCPR.

2.9 Current legislation also authorises other uses for the FCPR, including master feeder funds, funds divided into

different compartments and certain kinds of funds of funds.

Legal and Tax Quota

2.10 Subject to certain exceptions, in order to qualify as an FCPR, the fund is required to invest at least 50% of

its assets (“Legal Quota”) in the following:

(a) securities providing direct or indirect access to the equity of unlisted companies, as well as

shares of limited liability companies (SARLs) or of companies with an equivalent status in their

country of legal establishment;

(b) shareholder loans in unlisted companies that fulfil the conditions to be included in the quota of

50% and in which the FCPR holds at least 5% of the share capital; 31

(c) interests in an investment entity (including partnerships) formed in a member state of the OECD

(“Eligible Entity”), whose primary business activity is to invest in unlisted companies; 32

(d) securities providing access to the equity of companies listed on a EEA Market with a market

capitalization of less than €150 million (“small cap” companies). 33


31 No more than 15% of the assets of the FCPR may be invested in such investments32 The FCPR may attribute towards its quota of 50% an amount in proportion to the percentage of the assets of this entity that are directly invested in

securities that would be eligible for the 50% legal quota33 No more than 20% of the assets of the FCPR may be invested in such securities

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The fund must comply with this requirement as from the end of the second accounting period. When the

unlisted securities of a portfolio company held by the fund subsequently become listed on a regulated stock

market, these securities normally continue to be included in the unlisted securities, for the calculation of the

minimum percentage referred to above, for a period of five years as from the date of the initial listing of the

portfolio company's securities. This five year period is not applicable to investments in “small cap” companies

mentioned above, as long as they are limited to 20% of its total assets.

2.11 In order to obtain important tax benefits for its French investors, an FCPR must, in addition to the

requirements referred above, invest at least 50% of its assets (“Tax Quota”) in companies that meet the

following requirements (hereinafter referred to as “Eligible Companies”):

(a) the companies must have their registered office in a Member State of the European Union or a

Member State of the EEA which has entered into a tax treaty with France with a provision

regarding government assistance in the prevention of fraud or tax evasion (a “Tax Treaty”), that

means all Member States of the EU plus Iceland and Norway;

(b) the companies are engaged in industrial or commercial activities; and

(c) the business activities of the companies are subject to French corporate income tax under

ordinary conditions and at the normal rate or would be subject to such tax under the same

conditions if their activities were carried out in France.

These Eligible Companies can be held either directly (as is the case in many venture investments) or indirectly

through an Eligible Entity and/or through one or more holding companies. 34

Regulatory Requirements

2.12 An Approved FCPR must comply with the following diversification rules at any time as from the second

anniversary of the AMF approval:

(a) no more than 10% of the net assets of the FCPR may be invested in shares issued by one single

company;

(b) no more than 35% of the net assets of the FCPR may be invested, at any one time, in shares or

interests of one single OPCVM;


34 Such Eligible Entities or holding companies must fulfil the following requirements:(a) its registered office (or place of formation, in the case of an Eligible Entity) is located in an EU Member State or another country or territory that has

entered into a Tax Treaty with France;(b) it is subject to corporate income tax under ordinary conditions and at the normal rate or, in the case of companies located outside France, would be

subject to such corporate tax if its business activity was conducted in France (condition to be met only for holding companies) ; and(c) its primary purpose is to hold financial investments (condition to be met only for holding companies)(d) Additional restrictions applicable to Approved FCPRs only.

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(c) no more than 10% of the net asset of the FCPR may be invested in shares or interests of one

single OPCVM subject to the simplified procedure;

(d) no more than 10% of the net assets of the FCPR may be invested in units or interests of one

single partnership or other investment entity (other than another Approved FCPR).

2.13 An FCPR that is open only to qualified investors (a procédure allégée FCPR) may not invest more than 50%

of its net assets in a single OPCVM or in a single Eligible Entity.

2.14 An Approved FCPR is also restricted as to the percentage holding it can have in any one investment

(ratio d’emprise):

(a) it cannot hold more than 35% of the shares or the voting rights of any one company;

(b) it cannot hold more than 10% of the shares or interests of any one investment entity (such as a

partnership).

2.15 A procédure allégée FCPR may not hold more than 10% of the shares or interests of any one OPCVM which

does not qualify as an Eligible Entity.

2.16 Furthermore, there are important restrictions on the contractual commitments that can be made by a Management

Company on behalf of an Approved FCPR. Procédure allégée FCPRs are not subject to these restrictions. 35

Taxation in General

2.17 The FCPR is “transparent” for French income tax purposes. In other words, the FCPR is not itself subject to

any taxation in France and the tax authorities “look through” the FCPR for the purpose of determining the

type of income received by the investor.

2.18 There is no registration tax (droit d’enregistrement) when the units of the FCPR are issued to the investors or

when FCPR units are transferred to a new investor.


35 FCPRs that are open only to qualified investors may therefore enter into most kinds of contracts provided that:(a) the amount of the contractual commitment made is determinable;(b) the Management Company’s estimate of such amount is disclosed to the investors;(c) as would be expected, the total amount of all such commitments cannot at any time exceed the net asset value of the Fund.

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Taxation of French Investors

French Individuals

2.19 Under current French tax law, if the FCPR is an “eligible” FCPR (i.e. it meets the Tax Quota as of the end of

the second accounting year), French individuals who are investors in an FCPR are entitled to certain tax

benefits if the conditions outlined below are met. The four conditions are:

(a) the investor must acquire the FCPR units by way of subscription when they are issued;

(b) the investor, together with his/her spouse, ascendants and descendants, must not own, directly

or indirectly, (or have owned during the five years preceding the subscription to the FCPR units)

more than 25% of the rights to profits of any of the portfolio companies of the FCPR;

(c) the investor must undertake to hold his/her FCPR units at least five; and

(d) the unitholder must immediately reinvest in the FCPR any income or capital gains he/she receives

from the FCPR during this five year period in new FCPR units and must hold these new units until

the end of the five-year “blocking period”.

If these four conditions are met, the unitholder is exempt from French income tax on any distributions from

the FCPR. The unitholder is also exempt from French capital gains realized when the FCPR units are sold or

redeemed after the initial five-year blocking period, provided only that the FCPR is still an “eligible” FCPR at

the time of such sale or redemption (except if the FCPR is in the period of pré-liquidation).

If these conditions are not met, distributions to the investor from the FCPR deriving from dividend and interest

income from portfolio companies are taxable at the level of the investor at the full income tax rate, and

distributions to unit holders from the FCPR deriving from capital gains received from portfolio companies or

upon sale or redemption of the investors’ units, are taxable at the level of the unit holder at the capital gains

tax rate (currently 16%).

Whether or not the tax exemption mentioned above applies, the investor remains subject to tax with respect

to social charges (prélèvements sociaux (CSG, CRDS and 2% tax)) whose overall tax rate is currently 11%.

Except if an individual investor owns more than 10% of the shares of the FCPR, French individual unitholders

are not taxed in the year in which the FCPR receives the income from its portfolio companies but in the year

in which this income is redistributed to the unitholders. At the time of distribution, each French individual

unitholder is taxed on a pro rata share of each type of income being redistributed.


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French Companies

2.20 Ordinary Income – The distributable income of the FCPR is defined as the net ordinary income of the FCPR

(primarily dividends and interest) less the fees payable to the Management Company and the Custodian.

Because of the fiscal transparency of the FCPR, the different kinds of income received by the FCPR (primarily

interest and dividends) retain their identity when they are redistributed to the FCPR’s unitholders and are

taxed accordingly. In other words, dividends received by the FCPR are taxed as dividends in the hands of

the unitholders and the unitholders are each entitled to their pro rata share of any credits which relate to such

dividends. Similarly, interest received by the FCPR is taxed as interest in the hands of the unitholders and the

unitholders are each entitled to their pro rata share of the credits which relate to such interest.

Despite the tax transparency of the FCPR, French unitholders are not taxed in the year in which the FCPR

receives the income from its portfolio companies but in the year in which this income is redistributed to the

unitholders. At the time of distribution, each French unitholder is taxed on a pro rata share of each type of

income being redistributed.

Income (interest and dividends) is taxed at the normal corporate income tax rate which is currently 33.33%.

2.21 Capital Gains – If the FCPR is an “eligible” FCPR, a corporate investor is not taxed when the FCPR realizes

the capital gain but when the gain is redistributed or when the investor redeems or sells its units in the FCPR,

provided only that the investor holds its FCPR units for more than five years. Capital gains received by the

FCPR and distributed to its unitholders are taxable as follows:

(a) first, the amount received is considered as a return of capital (up to the amount of the paid-up

subscriptions) and is therefore tax exempt;

(b) the amount distributed in excess of the return of the amount paid-up is taxed as long term or

short term capital gains. As such it is taxed according to the proportion of the amount paid-up

during the 2 years prior to the date of the relevant distribution, relative to the aggregate amount

paid up by the unit holder as of the date of distribution.

The capital gains realized by the FCPR from the sale of shares in a portfolio company in which the FCPR, or

several FCPRs acting together has/have held a 5% shareholding for a period of at least 2 years which is

distributed to a unitholder will be taxed at the level of the unitholder at a rate of:

(a) 8%, as from fiscal year 2006; and

(b) 0% as from fiscal year 2007.


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The long-term capital gains which do not fulfil these conditions are taxed at the long-term capital gains

rate of 15%.

With regard to capital gains realized upon the sale or redemption of units, the capital gains realized by the

unitholder upon the sale or redemption of FCPR’s units are taxed at a rate of 8% as from fiscal year 2006,

and at a rate of 0% as from fiscal year 2007, in proportion to (at the date of the transfer or sale):

(a) the value of the investments in portfolio companies in which the FCPR, or several FCPRs acting

together, has/have held a 5% interest for a period of at least 2 years, plus the amount received

by the FCPR from the sale of the shares in portfolio companies mentioned above, and not yet

distributed to investors over the 6 months prior to the date of the sale or redemption of units by

the unit holder; and

(b) the total value of all the assets of the fund. The portion of the long-term capital gains that does

not fulfil the above conditions is taxed at the long-term capital gains rate of 15%.

Short term capital gains are taxed at the normal corporate income tax rate which is currently 33.33%.

When the FCPR is not an “eligible” FCPR, French corporate unitholders are liable for tax at the end of each

fiscal year with respect to the latent gain on the units of the FCPR (based on the valeur liquidative of the FCPR

units), i.e. on a mark to market basis. All distributions made by the FCPR are taxed at the normal corporate

income tax rate (i.e. 33.33%)

Taxation of Foreign Investors

2.22 An investment by a foreign investor in an FCPR will not create a permanent establishment in France.

Furthermore, we will assume throughout the following discussion that the FCPR units are not being held by

the foreign investor through an existing permanent establishment in France.

2.23 Ordinary Income – For foreign unitholders, taxation will depend on the source of the income received. French

source income is subject to withholding tax to the extent that the underlying income received (e.g. - dividends

or interest) would have been subject to withholding. Such withholding may be reduced by applying the

provisions of the income tax convention between France and the country of residence of the relevant investor.

Most international tax conventions concluded by France provide for a withholding tax rate for dividends of 15%.

Foreign source income (i.e. income from sources outside of France) is not subject to any income tax or

withholding tax in France when it is redistributed by the FCPR to a foreign investor. If there has been any

withholding tax in the source country, the investor may request reimbursement under the treaty (if any)

between its country of residence and the source country of the income. The FCPR can be used to centralize

any requests for reimbursement of withholding taxes.


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2.24 Capital Gains – Generally, foreign investors are not subject to capital gains tax in France unless they hold or

have held more than 25% of the rights to profits of the company being sold during the five past years

preceding the sale of the French portfolio company. The percentage of ownership is computed on a “look

through” basis, i.e. each shareholder is deemed to own his/her pro rata share of each portfolio company.

If the shareholder does hold rights to profits greater than 25% in a French portfolio company, capital gains

shall be subject to the tax rate of 16% in France.

Carried Interest

2.25 In order to benefit from important tax benefits, the individual beneficiary of carried interest units must be:

(a) an employee of the Management Company of the FCPR or of a service provider for the

Management Company; or

(b) a director or officer of the Management Company and such person's remuneration is qualified as

salary for tax purposes.

In addition, the following conditions must be met:

(a) the individual subscribed for or purchased carried units in exchange for a capital contribution to

the FCPR;

(b) there is only one distinct class of units which give rights to carried interest;

(c) the individual does not hold ordinary units of the FCPR allowing the individual to benefit from

the tax benefits applicable thereto (mentioned above);

(d) the individual's salary must be consistent with the remuneration received in the industry.

If these conditions are met, then carried interest income is taxed at a preferential rate currently 16%. Social charges,

currently at a rate of 11% will apply to this amount as well. If such conditions are not met, carried interest

income is taxed at the progressive income tax rate, as salary, non commercial profits or securities income,

according to the nature of the relationship of the individual with the Management Company.

Management Fees

2.26 Management fees are not subject to VAT, unless the Management Company has opted to be subject to VAT.

Management fees are taxed at the current corporate taxation rate of 33.33%.


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The FCPR Structure: Conclusions

2.27 An FCPR has the principle characteristics that make a good venture vehicle namely:

(a) limited liability for the investors;

(b) fiscal transparency;

(c) despite its fiscal transparency, French investors are not normally subject to tax until they receive

the relevant income from the fund; thus, if the proceeds of a sale are reinvested by the FCPR,

such investors are not taxed at that time;

(d) flexibility in management.

2.28 There are, however, a few limitations which are also common to other venture vehicles, such as:

(a) the FCPR is a regulated entity; for example, the investments which the FCPR can make are

subject to certain restrictions;

(b) the Management Company of the FCPR, the Société de Gestion, must be situated in France.

3 Fonds Commun de Placement dans l’Innovation (FCPI)

Legal Quota

3.1 A Fonds Commun de Placement dans l’Innovation (FCPI) is an Approved FCPR which has invested at least

60% of its assets in the securities, shares of limited liability companies (SARLs), or shareholder loans, (and

at least 6% in companies with a market capitalization ranging from 100.000 euros two 2 million euros) of non

quoted companies which are eligible for the Tax Quota and are considered to be “innovantes” (i.e. high tech

companies). A company is eligible for status as a “société innovante” if it meets the following requirements:

(a) the company must have its registered office in a member state of the EC or a member state of

the EEA which has signed a Tax Treaty with France;

(b) the company must be subject to corporate tax, or would be if business was conducted in France;

(c) the company must have fewer than 2000 employees;

(d) a majority of its capital must be held, directly or indirectly, by individuals; and

(e) the company must fulfil the following criteria (“high tech requirements”):

(i) its cumulative research expenses over the 3 most recent years must equal to not less

than one third of the highest gross sales of the best year in that 3 year period; or

(ii) it has created a product, process or technique with an innovative nature an economic

development potential which needs financing. A special organization assesses

whether this requirement is fulfilled over a period of 3 years as from the date of the

initial investment.


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3.2 Investments in the following securities may also be taken into account for the 60% quota:

(a) securities providing direct or indirect access to the equity of unlisted companies and shares of

limited liability companies (SARLs) or their foreign equivalents; and

(b) securities of listed “small cap” companies. 36

as long as the issuers of the securities are companies which meet the following requirements:

(a) the company issuing the securities fulfils criteria (a) to (d) in section 3.1;

(b) the company is engaged in commercial, industrial or craft activities, as defined by French law; or

(c) the company exclusively holds investments representing at least 75% of the capital of companies:

(i) whose securities fit with in the categories (a) or (b) of section 3.2;

(ii) that fulfil conditions (a) and (b) in section 3.1;

(iii) whose business activity is inventing or creating products, processes or techniques

fulfilling the high tech requirements set forth above or a commercial, industrial or craft

activity as defined by French law;

(iv) the company holds at least one interest in a company mentioned just above.

Taxation

3.3 French Individuals

Tax Reduction

If the FCPI meets the conditions outlined above, an individual unitholder who subscribes to units of an FCPI

will be entitled to a tax reduction equal to 25% of the amount invested in the FCPI (up to a maximum amount

of €12,000 for individuals and €24,000 for couples), provided the following conditions are met:

(a) the investor, together with his/her spouse, ascendants and descendants, must not own more

than 10% of the units of the FCPI;

(b) the investor, together with his/her spouse, ascendants and descendants, must not own, directly

or indirectly, (or have owned during the past five years) more than 25% of the rights to profits of

any of the portfolio companies of the FCPI;

(c) upon subscription, the investor must undertake to hold his/her FCPI units at least five years; and

(d) the unitholder must immediately reinvest in the FCPI any income or capital gains he/she receives

from the FCPI during this five year period.

Tax Exemption

The tax regime applicable to the FCPR described above are applicable to the FCPI.


36 No more than 20% of the assets of the FCPI may be invested in such securities.

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3.4 Other Investors

Tax Reduction

A specific law temporarily extended the tax reduction mentioned above, to French corporations, for distributions

made in 2005. As of the date of publication of this article, this law has not been extended for 2006.

Tax Exemption

There are no tax incentives for French companies, or for foreign investors (individuals or companies) specific

to the FCPI. The tax regime applicable to the FCPR described above also applies to the FCPI.

4 Fonds d'Investissement de Proximité (FIP)

A Fonds d'Investissement de Proximité (FIP) is an FCPR which invests at least 60% of its assets in unlisted

small and medium sized companies in a specific region.

The FIP must invest at least 60% of its assets in:

(a) transferable securities, shares of limited liability companies and current account advances issued

by companies which:

(i) have their registered office in an EU Member State;

(ii) are subject to corporation tax under common law or would be liable therefore if the

business were conducted in France;

(iii) are considered small and medium enterprises, as defined by law;

(iv) conduct their business mainly through institutions located in the geographic area

chosen by the fund and in one, two or three adjoining regions;

(v) are not holding companies, unless such holding company exclusively holds securities

of companies which are not holding companies and which meet the conditions set

forth in (i) through (iv) above.

(b) Investments in FCPRs and SCRs are also taken into account for the calculation of the investment

quota of 60%, in proportion to the percentage of direct investment of the structure in question's

assets in companies which meet the conditions set forth in (a) above, with the exception of

companies whose objective is holding participating interests. However an FIP cannot invest more

than 10% of its assets in the shares of such companies.

At least 10% of the assets of the FIP must be invested in new companies which have been in business for

fewer than 5 years and which fulfil the conditions set forth in (a) above.


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The following limitations apply to the holders of units in a FIP:

(a) no more than 20% of the FIP may be held by a single investor;

(b) no more than 10% of the FIP may be held by a single investor if such investor is a government-

owned corporation;

(c) no more than 30% of the FIP may be held by government-owned corporations (collectively).

The tax regime applicable to the FCPI also applies to the FIP.

5 The Société de Capital Risque (SCR)

5.1 The société de capital risque (SCR) legislation was initially enacted in 1985. This legislation was completely

rewritten at the end of 2001.

5.2 The SCR must take the form of a société par actions (e.g. a French société anonyme (SA), a French société

en commandite par actions (SCA) or a French société par actions simplifiée (SAS)). The SCR is therefore

subject to all the rules applicable to such companies. However, provided the SCR opts for special tax

treatment and further provided the SCR meets the requirements described below, it is entitled to certain tax

exemptions and its unitholders may be entitled to certain tax benefits.

5.3 In order to qualify for these tax benefits, the SCR must have as their sole purpose investments in a portfolio

of investments. No other activities are allowed (with an exception for smaller SCRs).

5.4 The SCR must invest at least 50% of its net asset value in the following:

(a) securities providing direct or indirect access to the equity of unlisted companies, as well as

shares of limited liability companies (SARLs) or of companies with an equivalent status in their

country of legal establishment;

(b) shareholder loans in unlisted companies that fulfil the conditions to be included in the quota of

50%, in which the SCR holds at least 5% of the share capital; 37

(c) interests of an investment entity formed in a member state of the EU or another country or

territory that has entered into a Tax Treaty with France, whose primary business activity is to

invest in unlisted companies; 38

(d) securities listed on a EEA Market providing direct or indirect access to the equity of companies

with a market capitalization of less than €150 million (“small cap” companies). 39


37 No more than 15% of the net asset value of the SCR may be invested in such investments.38 The SCR may attribute towards its quota of 50% an amount in proportion to the percentage of the assets of this entity that are directly or indirectly invested

in securities that would be eligible for the 50% legal quota39 No more than 20% of the net asset value of the SCR may be invested in such securities.

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When the unlisted securities of a portfolio company held by the fund subsequently become listed on a

regulated stock market, these securities normally continue to be included in the unlisted securities, for the

calculation of the minimum percentage referred to above, for a period of five years as from the date of the

initial listing of the portfolio company's securities. This five year period is not applicable to investments in

“small cap” companies mentioned above, as long as the fund respects the 20% limit.

These eligible companies can be held either directly (as is the case in many venture investments) or indirectly

through one eligible entity (such as an English partnership) and/or one or more eligible holding companies.

The SCR must comply with this 50% test within two years after it has opted for SCR status.

Investments in holding companies may be counted towards the quota of 50% if they meet the following

conditions:

(a) the holding company has its registered office and actual managing office in a member state of

the EC or another country or territory that has entered into a Tax Treaty with France;

(b) the holding company is subject to French corporate income tax under ordinary conditions or

would be if such activity were conducted in France;

(c) the shares or units issued by the holding company are not listed on a regulated French or foreign

Market;

(d) the holding company's main purpose is to hold interests in:

(i) companies that would be eligible for the 50% quota if the SCR held such securities

directly, or

(ii) other holding companies, whose main purpose is to hold interests in companies that

would be eligible for the 50% quota if the SCR held such securities directly.

5.5 The SCR is not permitted to own, directly or indirectly, more than 40% of the vote of any target company and

a unitholder of the SCR is not permitted to own, directly or indirectly, through the SCR (or through a spouse

or through descendants and ascendants), more than 40% of the vote of any target company. If either 40%

threshold is passed, the entire investment is treated as an ineligible investment and is not included in the 50%

quota for the purpose of determining whether the SCR meets the test set out in section 5.4.

5.6 The SCR cannot invest in any one target company an amount which exceeds 25% of its net asset value.

5.7 The SCR is managed internally either by a Board of Directors or by one or more managers (for the SCA).

There is normally no independent Management Company.

5.8 All investors are eligible to subscribe in an SCR, including individuals. However, no individual may hold,

together with that individual’s spouse and his/her ascendants and descendants, directly or indirectly more

30% of the rights to profits in the SCR.


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5.9 Cash investments made in an SCR are subject to a flat capital duty (droit d’enregistrement) in France 40

except at the outset of the fund. When an investor subscribes to a fund it receives actions of the SCR.

The liability of the investors is limited to their investment in the fund.

Taxation of the SCR

5.10 If the SCR meets the different requirements set out above, it will be exempt from tax on income received from

its investments (e.g. dividends and interest) and any gains realized on the sale of such investments.

This exemption applies to all investments made, including investments which are excluded from the 50%

quota (such as companies which are quoted on a stock exchange).

Taxation

Taxation Regulations Specific to French Investors

5.11 The basic rule is to “look through” the SCR for all investors, both for French companies and for French

individuals.

5.12 French Individuals - Under current French tax law, if the SCR is an “eligible” SCR (i.e. it meets the 50% test),

French individuals who are investors in the SCR are entitled to certain tax benefits if the conditions outlined

below are met. The three conditions are:

(a) the investor, together with his/her spouse, ascendants and descendants, must not own, directly

or indirectly, (or have owned during the five years preceding his/her subscription or acquisition of

SCR units) more than 25% of the rights to profits of any of the portfolio companies of the SCR;

(b) the investor must undertake to hold his/her SCR units at least five years before selling them; and

(c) the unitholder must immediately reinvest in the SCR any income or capital gains he/she receives

from the SCR during the same five years.

If these three conditions are met, the unitholder is exempt from French income tax on all distributions made

by the SCR (once the five-year reinvestment period has ended). The French individual who has held his/her

SCR units for at least 5 years will also be exempt from French income tax on any gain realized when that

individual sells his/her units.

If the three conditions above are not met, distributions to the investor from the SCR, deriving from capital gains

on eligible investments are taxable at a rate of 16%. Distributions deriving from sources other than eligible

investments would be subject to the full income tax rate. However, a deduction of €1,525 or €3,050 may

be applicable. Gains realized upon the sale or transfer of the units of the SCR are taxable at a rate of 16%.


40 Currently €375 or €500 depending on whether the capital of the SCR reaches or exceeds €225,000.

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Irrespective of whether an exemption applies, the investor remains subject to tax with respect to the

prélèvements sociaux (CSG, CRDS and 2% tax) whose overall tax rate is currently 11% on the amount

received by the French individual investor, either from distributions by the SCR or capital gains realized upon

sale of units.

5.13 French Companies – If the SCR distributes current income (dividends and interest) to a French company, that

company is taxed at the full corporate income tax rate, currently 33.33%. If the SCR realizes a long term

capital gain (i.e. the asset was held for at least two years) on an eligible asset the distributed gain is taxed as

a long term capital gain in the hands of the unitholder recipient if the unitholder undertakes and holds its SCR

units at least five years). The current rate is 15% although it can be reduced to 8% for fiscal year 2006 and

0% for fiscal year 2007 under certain circumstances. Finally, all other gains distributed to a corporate

unitholder are treated as short term gains and taxed at the full corporate income tax rate, currently 33.33%.

Taxation of Foreign Investors

5.14 For the distribution of items of income which were exempt from tax in the SCR, the “look through” rule is

generally not respected for foreign companies and for foreign individuals

5.15 Foreign individuals – Individuals who reside outside of France in a country that has concluded a treaty with

France that contains an administrative assistance clause, can benefit from a tax exemption in France under

the same conditions as French individuals (see section 5.12).

This tax exemption applies to all distributions of both ordinary income and capital gains made to the individual

unitholder (whether such distributions derive from eligible or non-eligible investments), as well as to gains

realized upon the sale or transfer of its units of the SCR.

If the individual does not meet the conditions set out for such tax exemption, such individual will generally be

subject to the following withholding tax, subject to applicable income tax treaties:

(a) 16% for distributions deriving from gains on eligible investments;

(b) 25% for distributions deriving from income and gains on non-eligible investments.

Capital gains realized on the disposal of units in the SCR are in principle tax exempt in France, however may

be taxable in the country in which the individual is a tax resident. However, if the individual owns, together

with his/her spouse, ascendants and descendants, directly or indirectly, (or have owned during the 5 years

preceding subscription or acquisition of the units of the SCR) more than 25% of the rights to profit of the

SCR, such gains will be subject to a withholding tax of 16%.


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5.16 Some foreign countries (e.g. the U.K.) will treat the SCR as a corporation rather than a tax transparent entity.

As a result, the special tax avoidance rules applicable to controlled foreign corporations or foreign investment

companies may apply to the SCR.

5.17 Foreign Companies – If the SCR realizes a long term gain deriving from eligible investments held for at least

two years, and the investor is a resident of a country that has entered into a Tax Treaty with France, then the

distributed gain is not subject to tax in France.

If the SCR distributes any other kind of income or gain, it is treated as a dividend and subject to withholding

tax at the rate of 25% (unless a the applicable income tax treaty provides for a lower withholding tax rate on

dividends distributed by a French company to a resident of that country). In practice, this will be a problem

only for investors who are not EU residents.

Gains on the sale of units of an SCR are in principle not subject to tax in France. However, if the unitholder holds

(directly or indirectly) more than 25% of the rights to profit of the SCR, a withholding tax of 16% shall apply.

The SCR Structure: Conclusions

5.18 The SCR has the following advantages for venture capital investors:

(a) limited liability for the investors;

(b) fiscal transparency for French investors;

(c) despite its fiscal transparency, French investors are not normally subject to tax until they receive

the relevant income from the fund; thus, if it is reinvested by the SCR, such investors are not

taxed at that time;

(d) flexibility in management.

5.19 The SCR has the following disadvantages for venture capital investors:

(a) it is not a truly “transparent” entity for tax purposes. As a result, it is quite likely that foreign

jurisdictions such as the United Kingdom will treat the SCR as a corporation. This may have

unfavourable fiscal consequences for such investors;

(b) because the SCR is a corporation, it may find it difficult to immediately distribute the proceeds of

the investments it sells. If it wishes to distribute an amount which is greater than its earnings and

profits, it will have to carry out a capital reduction. Such a capital reduction can be a cumbersome

procedure in France.


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GERMANY Clifford Chance LLP


1.1 The most suitable structures which are available for private equity funds in Germany are as follows:

(a) the Limited Liability Company (Gesellschaft mit beschränkter Haftung (GmbH));

(b) the Limited Partnership with a GmbH as the sole general partner (GmbH & Co. Kommandit-

gesellschaft (GmbH & Co. KG)); and

(c) a fund formed under the Investment Act (Investmentgesetz).

The most popular structures for private equity investment are the GmbH and the GmbH & Co. KG.

In addition, the so called Unternehmensbeteiligungsgesellschaft (UBG) (special investment company) has

been designed specifically for the private equity sector. The UBG is a special licensed investment company

for risk capital formed in accordance with the provisions of the UGB Act (Gesetz über Unternehmens-

beteiligungsgesellschaften). The UBG Act was introduced in 1987 and amended in 1998. Under the current

regulations it is not common to use the UBG as an investment vehicle, but attempts are ongoing to introduce

a legislative reform of the UBG Act in order to reflect the special needs of the private equity sector. The German

Federal Ministries (Ministry of Finance and Ministry of Justice) have demonstrated their ambitions to reflect

the special needs of the private equity sector accordingly. However, as the discussions are ongoing, it is

unclear when and to what extent amendments in particular to the UBG Act will be introduced.

1.2 This paper considers the major advantages and principal features of each of these structures against the

background of the German tax system. A description of special considerations applicable to funds pursuant

to the Investment Act and Investment Tax Act is given in section 4. Regulations determining the marketability

of private equity fund structures are outlined in section 5.

2 The Gesellschaft mit beschränkter Haftung (GmbH)

2.1 The GmbH is a legal entity separate from its shareholders, which may be partnerships, corporations or

individuals. Shareholder liability is limited to the amount of their respective subscriptions. Pursuant to the

applicable laws the GmbH is a flexible form and therefore is a popular vehicle for private equity investments.

The stock corporation (Aktiengesellschaft (AG)) is gaining in popularity. The use of an AG in private equity

investments is, however, still very limited because of inflexibility due to strict formalities. The shares of

a GmbH are not listed on a stock exchange. However, a GmbH can easily be transformed into an AG in order

to provide for a stock exchange listing (IPO) at the time of the exit. This aspect should therefore not lead to

choosing an AG over the more flexible GmbH.

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2.2 The GmbH is relatively easy to establish and to operate. Its constitution can be tailored to the private equity

vehicle's requirements. However, the trading of shares in a GmbH necessitates that certain formalities are

undertaken: for example, the foundation, each transfer, as well as the undertaking to transfer, can only be

effected by a document recorded by a notary public. The same applies to the granting of call or put options.

Furthermore, the sale of part of a share in a GmbH generally requires the consent of the GmbH.

2.3 The GmbH must observe accounting and public disclosure requirements.

2.4 The seat of the GmbH must be in Germany. The directors, who must be individuals, do not have to be

German nationals or residents.

Silent partners

2.5 A variation on a simple GmbH structure is the participation of an investor as a silent partner (stiller Gesellschafter)

in the GmbH. The silent partner, whose share is not disclosed to third parties, is not a co-owner of the

GmbH's corporate assets. The silent partner participates in the GmbH's profits and losses (provided the

loss-participation is not excluded in the silent partnership agreement). Upon termination of the silent partnership

arrangement, the silent partner gets back the book value of his original investment. This arrangement is

normally known as a typical silent partnership (typische stille Gesellschaft). In an atypical silent partnership

(atypische stille Gesellschaft), the silent partner may take more responsibilities in the management of the

partnership and may participate in the hidden reserves of the GmbH.

2.6 The silent partnership provides a convenient and flexible way of financing the GmbH. The silent partner's

participation can be contributed and withdrawn without the need to comply with strict capital maintenance

and other requirements prescribed by the laws applicable to GmbHs. Income of a typical silent partner is taxed

as income from capital and not as business income. In case of a typical silent partnership, the active partners

can deduct the profit share of the silent partner as a business expense. For income tax purposes, the atypical

silent partner is in the same tax position as an active investor in a partnership. The profit and loss calculation

therefore will be determined as if the silent partner and the GmbH would have entered into a partnership.

Taxation: general

2.7 The GmbH is not transparent for tax purposes, but see section 2.19.

Corporate income tax and trade tax on the GmbH (Fund)

2.8 Profits of the GmbH, including capital gains, are subject to corporate income tax (Körperschaftsteuer), trade tax

(Gewerbesteuer) and a solidarity surcharge (Solidaritätszuschlag) resulting in an average tax rate of 38 - 40%

depending on the municipality in which the GmbH is resident.


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2.9 Profits of the GmbH are, in general, subject to corporate income tax at a rate of 25% (for dividends and

capital gains received by the GmbH see sections 2.12 and 2.14). In addition, a solidarity surcharge at the

rate of 5.5% of the assessed tax is levied (overall burden of 26.375%).

2.10 The income of the GmbH is also subject to trade tax (Gewerbesteuer), which is levied by the municipality in

which the GmbH is resident. The trade tax rate depends on the applicable local multiplier determined by

the respective municipality. The average trade tax rate in Germany is 16.7%. Trade tax is a deductible item

for corporate income tax purposes.

2.11 No net worth tax (Vermögensteuer) on the capital assets of the GmbH is levied at present.

Taxation of dividends within the GmbH (Fund)

2.12 95% of the dividends received by the GmbH from a corporation are tax exempt (for withholding tax and tax

credit see section 2.21).

Taxation of interest within the GmbH

2.13 Interest received by the GmbH is treated as income and is taxed accordingly, applying the general corporate

income tax rate (including solidarity surcharge) of overall 26.375% plus trade tax.

Taxation of capital gains within the GmbH

2.14 There is no specific tax for capital gains in Germany. Capital gains are in general, subject to corporate income tax.

However, 95% gains from the sale of shares in a (foreign or domestic) corporation are exempt from corporate

and trade income taxation in Germany.

Taxation of returns to investors during the life of the GmbH

2.15 Private individuals, resident in Germany, who hold shares in a GmbH as their private assets (not as business

assets) may dispose of their shares tax-free provided that all of the following conditions are met:

(a) the shares have been held by the investor for more than one year before the disposal;

(b) the individual has not held directly or indirectly 1% or more of the GmbH's share capital at any

time during the five years before the disposal; and

(c) the GmbH has not been established nor its equity been raised by a contribution in kind at

book-value of an active business operation, a part of a business operation or a participation in

a partnership.


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2.16 If an individual, tax resident in Germany or abroad, has held 1% or more of the share capital of a GmbH at

any time during the five years prior to disposal, 50% of the capital gain will be subject to income tax according

to the so called half-income tax system. Furthermore, under certain circumstances, a tax free allowance of

up to €9,060 is available. In addition, solidarity surcharge (at the rate of 5.5% of the assessed tax) is levied.

Further, a church tax is levied on the assessed tax, if the individual is a member of a qualifying church and

resident in Germany.

2.17 A sale of shares held as private (non-business) assets of an individual tax resident in Germany which have

been held by that individual less than one year will be considered as speculative transaction. According to

the half-income tax system, only 50% of the capital gain will be subject to income tax at its individual tax rate

of the shareholder, even if the seller has not held 1% or more of the shares of the company at any time during

the five years preceding the sale.

2.18 A capital gain generated from a sale of shares with a tax qualification according to section 2.15 (c) is subject

to full income taxation, if the shares have not been held for at least seven years and irrespective of the extent

of the participation in the capital of the GmbH. If the shares have been held for at least seven years, only 50%

of the capital gain is subject to the personal income tax rate (half income tax system), if the shareholder holds

less than 1% in the company.

2.19 50% of the capital gains derived from the sale of shares held as business assets of an investor, are, in case

of an individual tax exempt, and 95% tax exempt in case of a corporate investor.

2.20 Please note that the coalition agreement (Koalitionsvertrag) of the newly formed German Federal Government

provides for an increase of the personal income tax rate of up to 48%, applicable on income above €250,000

(in case of married couple of €500,000). However, income from trade or business shall be excluded and shall

be taxed with a tax rate of up to 42%. In addition, it is likely that any asset sales will be subject to income

tax irrespective of a holding period of one year in the future. The coalition agreement provides that the period

of one year shall lapse. Thus, capital gains from private asset sales (including shares in GmbHs) would be

subject to income taxation in the future.

2.21 A withholding tax (Kapitalertragsteuer) of 20% (plus solidarity surcharge: overall burden of 21.1%) must be

deducted by the GmbH before distributions are made to the shareholders/investors. A German resident

receives a corresponding tax credit for this withholding tax, but is, according to the half-income-tax-system,

not entitled to a tax credit for the underlying corporate income tax paid by the GmbH. A foreign investor,

in general, is not entitled to any tax credit in Germany, although there are other possibilities for relief:

sections 2.28 and 2.29 and 2.30 provide further details.


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Taxation of return of capital upon winding up of the GmbH

2.22 The liquidation of a GmbH may produce taxable income to the GmbH as well as to the investors. The GmbH's

winding-up profit is computed by comparing the financial statements as of the beginning of the dissolution

(liquidation) period and the financial statements at the end of the liquidation period. The liquidation period

should not exceed three years. Net operating losses not used to set-off against taxable income in previous

years can be taken into account when computing the GmbH's taxable winding-up profit.

2.23 The liquidation proceeds received by the investor constitute dividends to the extent that they represent

retained or current income in excess of the contributions to capital (including e.g. hidden capital contributions).

If received by an individual, only 50% of the dividends are subject to income tax (half-income-tax-system).

Only distributions of paid-in surplus in excess of the book value of the shares of the respective investor qualify

as a capital gain, which is, depending on the Investor's tax status, taxable. If the book value of the shares is

higher than the distributions, a capital loss will result which, depending on the tax status of the shareholder,

may or may not be used to offset the dividend income or other items of income.

Availability to investors of capital losses

2.24 Capital losses incurred by the GmbH can only be offset for corporate income tax purposes against the

income of the GmbH. They cannot be attributed to the investors. The maximum carry back to the preceding

year by a GmbH amounts to €511,500. Any remaining loss would be carried forward. However, a loss deduction

is limited in subsequent fiscal years to €1 million. The exceeding loss might be offset up to 60% with other

income of the GmbH (so called minimum taxation). That means that after the deduction of €1 million p.a. 40%

of the remaining profit in the respective year is taxable. A typical silent partner in a GmbH can only offset

losses up to the amount of its investment.

2.25 A possibility to enable business investors holding the majority of the voting rights to use the losses of the

GmbH most efficiently would be to create a fiscal unity (Organschaft) by a profit and loss transfer agreement.

In these circumstances, the GmbH's losses could be offset against profits of the parent (investor) including

subsidiaries resident in Germany and having also entered into a fiscal unity with the investor, to the extent

inter alia the business seat and the place of management is in Germany.

Deductibility of costs to investors

2.26 An investor cannot directly offset costs incurred by the GmbH in connection with the investment. An investor

can only benefit from the deductions of these costs indirectly (deduction from income of GmbH), if at all.


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VAT recoverability on management charge

2.27 Recoverability of VAT on the management charge levied by another entity would depend on the nature of

the GmbH's business and whether it performed VAT services subject to VAT. In most cases, input VAT will not

be recoverable because the GmbH has pure holding functions and does not provide services subject to VAT.

Suitability for foreign investors

2.28 In general, on distributions, a non-resident taxpayer is not entitled to tax credits in respect of withholding tax

and/or corporate income tax for German tax purposes. The non-resident taxpayer can reduce the withholding

tax liability, however, if his country of residence has entered into a tax treaty with Germany which provides

specifically for a tax reduction on distributions. The withholding tax rate can in such cases be reduced to as

little as 5%. No dividend withholding tax will apply in circumstances where the EU Parent-Subsidiary Directive is

applicable. This requires a minimum participation of 10% of the parent and a holding period of at least

12 months under the EU Parent-Subsidiary Directive.

2.29 With regard to gains realised on the sale of shares in a GmbH, if a foreign corporation does not have a place

of management or a permanent establishment or a permanent agent in Germany, the foreign corporation

should not be subject to German taxes where:

(a) it sells a substantial shareholding in a GmbH (shareholding of 1% or more at any time in the last

five years prior to disposal) and a tax treaty allocates the right to tax the capital gains to the

country where the foreign corporation is resident; or

(b) it sells shares in a GmbH in which it has not held a substantial shareholding.

2.30 Where there is no treaty protection and the foreign investor sells a substantial participation, (i) only 5% of the

gain, in case of corporation as shareholder, will be subject to corporate income tax or, (ii) in case of individuals

only 50% will be subject to income tax at the applicable rate.

Conclusions

2.31 The GmbH has the following advantages:

(a) it provides limited liability to the investors;

(b) it is relatively easy to set up and operate; and

(c) depending on the investor (corporate or individual), dividends and gains are, in general, tax exempt

or only 50% are subject to income tax (half-income-tax-system).


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2.32 However, the GmbH has the following disadvantages:

(a) it is not transparent with regard to taxes (although see section 2.25); and

(b) tax credits for German tax purposes are, in general, not available to non-resident investors.

3 The GmbH & Co. Kommanditgellschaft (GmbH & Co. KG)

3.1 A limited partnership (Kommanditgesellschaft (KG)) is a commercial partnership established by one or more

limited partners (Kommanditisten) and a general partner (Komplementär).

3.2 The liability of the limited partners is limited to the amount of their respective capital subscriptions. Although, the

general partner has unlimited liability, in case of the GmbH & Co. KG, where the general partner is a GmbH,

it has limited liability, too.

3.3 The GmbH & Co. KG conveniently combines the flexibility of a partnership with the limited liability of a corporation.

Partnership interests may be transferred without notarisation.

3.4 The GmbH & Co. KG must be registered with the Commercial Register. Accounting and public disclosure

requirements are as strict for the GmbH & Co. KG as for the GmbH.

3.5 The place of management must be in Germany.

Taxation: general

3.6 The GmbH & Co. KG is, in general, tax transparent except with regard to VAT. With regard to trade tax it is

only transparent, if it is not a commercial partnership (no commercial trade or business but only asset holding

partnership) for tax purposes. Thus, the partnership itself is not subject to tax, with the exception of VAT and,

if commercial, for trade tax.

3.7 In a decree dated 16 December 2003, the Federal Ministry of Finance listed criteria to differentiate between

commercial and non-commercial private equity investment partnerships. A private equity vehicle holding

shares in a portfolio company will normally be treated as non-commercial, if the following conditions are met:

(a) no debt financing of the investments;

(b) the partnership does not grant guarantees or securities for obligations of the portfolio companies;

(c) the partnerships does not maintain its own organisation;


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(d) the partnership does not use any market experience and abstains from active management

activities in the portfolio companies;

(e) the sales proceeds are not reinvested; and

(f) the partnership does not offer any participation to the public or render services to third parties.

The decree indicates that a partnership might be treated as commercial if the above criteria are not met,

however the "overall picture", taking all facts and circumstances into account, is decisive.

Investors in the partnership are liable for tax when income is received by the partnership as the income is

taxwise directly attributed to the partner. If, therefore, proceeds are reinvested (or otherwise not distributed),

the investors are still liable for tax on the profits and gains without having received them.

3.8 If withholding tax has been deducted from dividend income received by the GmbH & Co. KG from German

corporations, GmbH & Co. KG will receive an appropriate tax credit for its German investors which is

passed on, pro rata, to these investors. The position of non-residents is only the same as for residents, if

the GmbH & Co. KG is qualified as a commercial partnership, because in this case the partners are treated

as having a fractional permanent establishment through the partnership in Germany. On income arising from

a permanent establishment, either individual income tax or corporate income tax, as applicable, is levied from

non-resident investors.

Taxation of returns to investors during the life of the GmbH & Co. KG

3.9 Upon disposal of an interest in a commercial partnership, the capital gain is subject to tax whether the share

constitutes a minority participation or not. Thus, there is no exemption should an individual partner sell a

minority share in the partnership. The capital gains may be taxed at a reduced tax rate which is determined

as if only 1/5 of the capital gains from the sale were realised in that year, provided the selling partner is not

taxed in the highest tax bracket in this year. Furthermore, a tax free allowance is available up to an amount of

€45,000. However, the reduced rate is not applicable, if and insofar the underlying assets of the GmbH & Co.

KG are shares in corporations as only 50% of such capital gains would be taxable (half-income-tax-system).

There is no reduction of the tax rate for corporations receiving capital gains from the sale of the partnership

interest. However, if and insofar the underlying assets (assets of the partnership) are shares in corporations,

the gain is income tax exempt (95%) at the level of a corporate investor.

3.10 Upon the disposal of an interest in a non-commercial partnership (vermögensverwaltende Personengesellschaft),

the partner will be treated as if he had held the assets of the partnership directly (look through perspective).

In case the partnership disposes shares in a German corporation having its business seat (Sitz) or its place

of management (Geschäftsleitung) in Germany sections 2.15 et seq. apply accordingly.


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Taxation of profits on winding up a GmbH & Co. KG

3.11 The winding-up profits on the liquidation of the GmbH & Co. KG are not subject to trade tax as far as profits

are distributed to individuals. Income tax applies to each partner. Each private individual partner may be

entitled to a reduced income tax rate which is determined as if only 1/5 of the capital gains from the sale

were realised in that year if he is not taxed in the highest tax bracket (see section 3.9).

Availability to investors of capital losses

3.12 In contrast to the GmbH, the GmbH & Co. KG structure allows, in general, investors to offset losses against

profits at the investor level. A loss is attributed on a pro-rata basis to each partner and can principally be

offset against his income from other sources for corporate income tax and, if the GmbH & Co. KG is transparent

for trade tax, if any, at the level of the investor.

Each partner, as opposed to the GmbH entity, can then enjoy the benefit of a carry-back of losses to

the preceding year to a maximum of €511,500. The loss allocation to a partner is limited to the partner's

paid-in capital in the partnership or to his exceeding capital account. Losses exceeding this limit are carried

forward and settled against future income from the partnership.

A loss, carried forward, may be deducted without limitation up to €1 million per fiscal year. Exceeding losses

might be offset up to 60% of other items of income (so called minimum taxation).

Deductibility of costs to investors

3.13 A partner, whether an individual or a corporation, in a partnership may deduct from his partnership income

expenses related to his partnership interest and borne personally by him.

VAT recoverability on management charge

3.14 Recoverability of VAT on the management charge by a managing company would depend on the nature of

the GmbH & Co. KG's business and whether it performed services which are subject to VAT. In most cases,

input VAT will not be recoverable, because the GmbH & Co. KG does not provide services which are subject to

VAT (holding of investments). However, if properly structured VAT on the management fee should be avoidable.


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3.15 A foreign individual being partner of a commercial partnership will usually pay the tax at the same rate on

income from the partnership as a German resident partner (with the exception of church tax and tax benefits

granted to married couples filing a joint tax return), even where a tax treaty is applicable. The reason for this

is that most of the tax treaties following the OECD Model Treaty allocate the right to tax the income from a

German partnership to Germany because the partnership maintains its permanent establishment in Germany.

A foreign corporate partner will be subject to corporate income tax and solidarity surcharge at a combined

rate of 26.375% on income from the partnership. Income derived from dividends or gains from the sale of

shares in corporations are tax exempt (95%).

However, a different treatment would be applicable for foreign investors being partner in a non-commercial

partnership. As such they are subject to tax in Germany only under some circumstances. In addition, depending

whether or not the country of residence of the foreign investor and Germany have entered into a double

taxation treaty, the right to tax might be with the country of residence of the foreign investor.

Conclusions

3.16 The GmbH & Co. KG has the following advantages:

(a) it is transparent with regard to all taxes with the exception VAT and trade tax in case of

commercial partnership;

(b) it offers limited liability to its investors;

(c) it offers flexibility in management;

(d) capital gains arising from the sale of an interest in the partnership by a private individual may be

taxed at a reduced rate except for gains attributable to shares in corporations as underlying

assets (to which the half income tax system applies);

(e) losses can, up to certain limits, be offset against profits at the investor level; and

(f) tax exemption for gains of the sale of shares in corporations (95% for corporate investors and

50% for individual investors) also applies, in general, in case of a partnership holding such shares

and attributable to such shares.

3.17 However, the GmbH & Co. KG has the following disadvantages:

(a) it is not transparent with regard to trade tax if it is a commercial partnership; and

(b) as it is, in general, transparent to tax, investors in the partnership are liable to tax when

income is generated by the partnership: if, therefore, proceeds are reinvested (or otherwise

not distributed), the investors are still liable to tax on the profits and gains without having received

the funds (cash flow).


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4 Funds According to the Investment Act

The Investment Modernisation Act

4.1 Both the Investment Act (Investmentgesetz) and the Investment Tax Act (Investmentsteuergesetz) came into force

on 1 January 2004 and replaced the Investment Companies Act (Kapitalanlagegesellschaftsgesetz (KAGG))

and the Foreign Investment Act (Auslandinvestment-Gesetz (AuslInvestmG)). Under the Investment Tax Act

the tax treatment of investors in foreign and domestic funds has been harmonised.

4.2 Two types of investment funds may be established under the regime of the Investment Act: Open-ended

investment funds, structured as Sondervermögen and investment stock corporations, the latter with fixed or

with and variable capital:

Sondervermögen

4.3 Under the German concept of investment funds, the monies deposited with the investment company against

issue of the fund units (Anteilscheine) and any assets purchased therewith constitute the Sondervermögen,

which is under management by the investment company (Kapitalanlagegesellschaft).

4.4 A German investment company must be established in form of either a limited liability company or a stock

corporation. As such, the investment company has limited liability.

4.5 The legal basis of the Sondervermögen (except for investment stock corporations, see section 4.9) is rather

contractual than corporate. Sondervermögen are established by the acceptance of the funds rules in the

form of an agreement between the investment company and the unit-holders. As a result, no separate legal

entity is constituted and the Sondervermögen itself is a separate unincorporated structure.

4.6 The Investment Act distinguishes between public (mutual) Sondervermögen, the fund units of which may be

acquired by an indefinite number of natural persons and/or legal entities, and Spezialfonds, the fund units of

which must be held by not more than 30 unit-holders, all of which are not natural persons.

4.7 The investment company shall ensure in a written agreement with the investors in a Spezialfonds that the

fund units may only be transferred by the investors with the consent of the investment company. Due to the

limitation to "non-individual" investors, Spezialfonds are subject to some exemptions and easements, e.g. the

contractual terms and any amendments thereto does not require the authorisation of the Federal Financial

Services Supervisory Authority (Bundesanstalt für Finanz-dienstleistungs-aufsicht (BaFin)).


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4.8 German funds structured as Sondervermögen, managed by the investment company, are subject to complex

regulatory provisions. As the Investment Act classifies the business of an investment company as banking

business, it is also subject to the Banking Act (Kreditwesengesetz) and the investment company is supervised

by the BaFin. Therefore, a banking licence is required. This will only be granted if, in a nutshell, the investment

company can meet each of the following four conditions:

(a) the provisions on capital requirements under the Investment Act contain a significant modification

that lowers the necessary paid-up initial capital for investment companies from €2.5 million to

€730,000. For investment companies conducting custody business, the minimum initial capital

remains at €2.5 million. The same capital requirements will apply to investment companies managing

real estate investment funds; so far, they had to maintain a minimum capital of €5 million. If the

assets under management exceed €3 billion, a surcharge of at least 0.02% of the asset value

exceeding €3 billion (in total not to exceed €10 million) will be added to the minimum initial

capital. In order to secure sufficient capitalisation, the KAG must at all times maintain sufficient

capital, corresponding to at least one quarter of the expenses shown in the recent profit and loss

account;

(b) the two full-time fund managers (Geschäftsleiter) of the investment company are reliable and have

the necessary professional qualification for the management of the investment company;

(c) the investment company must have established a supervisory board of at least three members; and

(d) the investment company has appointed a custodian bank (Depotbank) in relation to the

Sondervermögen.

Investment stock corporations

4.9 The Investment Act also provides for investment funds, which are established as investment stock corporations

(Investmentaktiengesellschaft).

4.10 The investment stock corporation is established in the corporate form of a German stock corporation

(Aktiengesellschaft). The issue, however, of non-voting shares is not permitted. Any shares of the investment

stock corporation shall represent the same portion in the share capital of the investment stock corporation.

4.11 The corporate object of the investment stock corporation as provided for in the articles of association

shall be the investment and management of its assets according to the principle of risk diversification with

the sole object of giving its unit holders a share in the profits arising from the management of the assets of

the corporation.

4.12 Investment stock corporations shall have a variable share capital (Investmentaktiengesellschaft mit veränderlichem

Kapital), a corporate structure that is, generally speaking, comparable to a Luxembourg SICAV, or a fixed

share capital (Investmentaktiengesellschaft mit fixem Kapital).


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4.13 Investment stock corporations are subject to the general provisions applicable to stock corporations unless

otherwise provided in the Investment Act.

4.14 As the Investment Act classifies the business of an investment stock corporation as banking business, the

investment stock corporation is also subject to the Banking Act and supervised by the BaFin. The operation

of an investment stock corporation requires the written authorisation of the BaFin. The authorisation may, in

a nutshell, only be granted to the investment stock corporation if the following applies:

(a) the initial capital of the investment stock corporation amounts to at least €300,000;

(b) the investment stock corporation has its seat and its management within Germany;

(c) the two full-time fund managers (Geschäftsleiter) of the investment stock corporation are reliable

and have the necessary professional qualification for the management of the investment stock

corporation;

(d) the articles of association provide that only the business of the investment and management of

the investment stock corporation's assets to the principle of risk diversification and the ancillary

business directly related thereto shall be carried on; and

(e) the investment stock corporation has appointed a custodian bank (Depotbank).

Investment assets

4.15 A strict set of rules applies as to permitted investments, minimum number and relative size of investments

(the principle of diversification of risk), borrowings, disclosure and reporting obligations of both, funds structured

as Sondervermögen and investment stock corporations.

4.16 Corresponding to the amended EU-Directive 85/611/EEC, the classification of statutory fund types, which

has been contained in the KAGG, for instance money market investment funds and securities investment funds,

has been abolished. Instead a new catalogue of permissible types of investment assets (Vermögensgegenstände)

is provided for that includes securities, money market instruments, derivatives, bank deposits, real estate,

participations in real estate companies and investment fund units. Since neither GmbH shares (which are not

embodied in the form of securities) nor partnership interests may be acquired by the Investment Funds under

the Investment Act, this structure is the least suitable among the alternatives discussed in this paper.

4.17 Investment Stock Companies may invest in securities, money market instruments, derivatives, bank deposits,

investment fund units and in silent participations of a company which has its seat and business management

within Germany if their current market price can be determined.


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Single Hedge Funds / Funds of Hedge Funds

4.18 The fourth part of the Investment Act (specific provisions for hedge funds) concerns a matter that up to now

has been unregulated in Germany. For the first time, the Investment Act includes explicit provisions for

investment funds with additional risks (Sondervermögen mit besonderen Risiken - Single Hedge Fund) and

for investment funds of funds with additional risks (Dach-Sondervermögen mit besonderen Risiken - Funds

of Hedge Funds), either established as Sondervermögen, managed by an investment company, or as

investment stock corporation. These new provisions are a response to the desire, which has significantly

increased, in recent years among institutional and retail investors, to invest in such "alternative investments".

4.19 The term investment funds with additional risks is not explicitly defined. Rather, the Investment Act describes

this type of investment fund as funds which are not subject to limitations with regard to their investment

strategies and which are allowed to use the techniques of leverage and short selling. The legislator refrained

from laying down a more detailed definition in order to allow for a flexible and attractive regulation. However,

the Investment Act provides for the possibility of restricting the unlimited use of these techniques by virtue of

an ordinance to be issued by the government in its discretion if this is necessary in order to prevent any abuse

or to safeguard the integrity of the market.

4.20 Additionally, the list of investment assets eligible for purchase by a Single Hedge Fund under the Investment

Act has been expanded. Permissible investments include, in addition to the assets permitted for all types of

investment funds, cash-settled commodity futures (although direct investment in commodities is still prohibited).

Participations in companies, if their current market price can be determined, also qualify as eligible assets

(among them also silent participations under German commercial law). However, there is a restriction on private

equity investments as unlisted participations may only be acquired in a value of up to 30% of the Single Hedge

Fund's net asset value. This is to clearly show that the Investment Act shall not cover private equity funds.

4.21 Contrary to Single Hedge Funds, Funds of Hedge Funds may only invest in units of target funds. Leverage and

short sales may not be carried out for Funds of Hedge Funds. In addition, no more than 49% of the value of

such Fund of Hedge Funds may be invested in bank deposits and money market instruments.

Taxation

4.22 The Investment Tax Act is in principle applicable to German investors (and foreign investors investing through

a German permanent establishment or in the course of an over-the-counter-transaction) in both foreign

and German investment funds. In relation to German funds, the Investment Tax Act covers the taxation of

investments in entities established either in the form of Sondervermögen, managed by an investment company,

or investment stock corporations, as well as the taxation of the entities themselves. Sondervermögen and

German investment stock corporations are exempt from German corporate income tax and trade tax.


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As regards investments in foreign funds, the Investment Tax Act in principle maintains a pure economic

approach: any foreign portfolio of qualifying assets, (as listed in the Investment Act) invested according to

the principle of risk-diversification, qualifies as a foreign investment fund for tax purposes on which the

Investment Tax Act is applicable. However, according to a tax circular of the German Federal Ministry of

Finance dated 2 June 2005, partnerships (except for hedge funds) do not qualify as foreign investment funds

within the meaning of the Investment Tax Act. If however such partnership invests in foreign investment

funds, the Investment Tax Act will apply at the lower level. Furthermore, foreign real estate enterprises (other

than partnerships) the shares of which are admitted to the official market of a stock exchange or included in

another organised market and which are not subject to investment supervision in their state of residence are

also exempt from the German Investment Tax Act.

Taxation general

4.23 The taxation of the investor depends on the reporting requirements fulfilled by the fund. It differs whether or

not certain minimum or extended notification and publication requirements are satisfied.

Taxation of income of fund investors

4.24 If certain minimum calculation, notification and publication duties are not satisfied by the fund, German

investors will be subject to a lump-sum taxation.

Investors will be taxed on an annual basis on the higher of: (i) distributions received from the fund, interim

profits plus an amount equal to 70% of the increase in the value of the fund units in that calendar year (calculated

on the basis of the redemption price or, if no such price is available, stock market price); or (ii) 6% of the last

redemption price at the end of that calendar year.

4.25 If only certain minimum reporting duties are satisfied, the investors will, in principle, be subject to tax on the

entire net earnings of the fund irrespective of whether or not such earnings are distributed (semi transparency).

A favorable tax treatment of certain retained earnings resulting in a deferred tax liability is available. Retained

capital gains (other than gains derived from the sale of real property after a holding period of not more than

ten years), retained gains from short sales of securities and retained gains from contracts of differences

(Differenz-geschäfte) are not taxable.

The minimum reporting requirements include e.g. the reporting of the amounts of distributions, distributed

earnings, deemed distributions, creditable or refundable German withholding tax, portion of distributions

or deemed distributions which qualify for a credit or refund of German withholding tax and, in the event of

funds retaining their profits, the aggregate amount of retained profits which has not yet been subject

to withholding tax.


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4.26 To the extent an investment fund satisfies, in addition to the minimum requirements described above, extended

reporting duties by itemising capital gains, dividends or certain other (partly) tax exempt profits, certain types

of income will be (partly) tax exempt at investor level (principle of transparency). Furthermore, foreign taxes

are, within certain limits, creditable at the investor level, if foreign income is subject to tax in the state of

source and the respective foreign income and the amounts of taxes due are specified by the investment fund.

The half-income system (see above) will, in principle, apply to both foreign and domestic investment funds,

if a fund calculates and reports the respective amounts. As a result, 95% of dividends and of distributed

capital gains from the sale of shares in a stock corporation earned by the fund will be tax-exempt in the case

of corporate investors (other than credit institutions holding the fund units in their trading book and life and

health insurance companies) and 50% will be tax-exempt for individual investors.

4.27 Certain formalities regarding the reporting requirements have to be met. The investment funds must e.g.

notify the investors upon each distribution and deemed distributions and must publish such figures in the

Electronic Federal Gazette (elektronischer Bundesanzeiger), together with the annual report and a certification

of a German auditor or tax advisor, confirming that the figures have been calculated in accordance with

German tax law. If requested, the investment fund must also prove the figures to the German Federal Tax Office

(Bundesamt für Finanzen).

4.28 German Spezialfonds are exempt from the reporting requirements stated above and no lump-sum taxation

will apply to investors in a German Spezialfonds.

4.29 In contrast, foreign investment funds for institutional investors are obliged to satisfy the abovementioned

reporting requirements. However, no lump-sum taxation will apply to investors in a foreign fund, if according

to the statues of such fund, the fund units may only be held by up to 30 institutional investors.

4.30 The German or foreign investment fund, in order to provide requested information, will need to set up a special

accounting system on a cash-flow basis (Einnahme-Überschuss-Rechnung).

Deductibility of costs

4.31 To the extent that costs are directly economically attributable to specific (taxable or tax-exempt) income they

share the tax treatment of this income. If that is not the case, the deductibility is based on the average ratio

of the attributable assets in the previous financial year. Accordingly, in the case of a domestic German fund,

a proportion of the profits will be non-deductible if in the previous year part of the assets have been used to

earn tax-free foreign income. From the remaining overhead costs a lump sum of 10% will be non-deductible.

A proportion of the profits will be (partially) non-deductible for tax purposes if, in the previous year, parts of

the assets have been used to earn tax-free dividends or capital gains.


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4.32 Losses suffered by the fund can be offset in calculating net profits "of the same type" and within certain

restrictions remaining amounts can be carried forward.

Sale of fund units

4.33 Capital gains resulting from the sale of fund units by an investor holding the fund units as business assets

are privileged (i) to the extent that such gains result at fund level from (retained) dividend earnings, realised

or unrealised capital gains from the disposal of shares in a corporation or tax exempt foreign income from

real estate (the "share profit" - Aktiengewinn) and (ii) provided the investment fund calculates and publishes

the share profit together with the redemption price of the fund units on each valuation date.

4.34 To the extent the share profit makes up the capital gain from the sale of the fund units, 50% (in the case of

an individual) or 95% (in the case of a corporation other than credit institutions holding the fund units as

business assets and health and life insurance companies) of the dividends/capital gains from shares and 100%

of foreign tax exempt income will be tax-exempt at the level of investors holding the fund units as business assets.

4.35 Capital gains resulting from the sale of fund units by an investor holding the fund units as private assets are

tax exempt, provided the investor has held the unit for more than one year.

4.36 With effect from 1 January 2005 the taxation of interim profits (Zwischengewinn) upon a disposal or redemption

of fund units was introduced. The interim profit comprises retained interest, accrued interest and other

earnings from financial innovations (Finanzinnovationen) or accrued claims for such earnings (both at fund-

of-fund level and at the level of target funds), and realised and accrued interim profits of the fund. The interim

profit is deemed to be part of the consideration for the redemption or disposal of the fund unit and is subject

to German withholding tax on interest (Zinsabschlag) if payment is made via a German disbursing agent.

The interim profit has to be calculated on each valuation date and has to be published by the investment fund

together with the redemption price. If the investment fund does not comply with this obligation, an amount

equal to 6% of the consideration for the redemption/disposal will be deemed to be the interim profit.

German withholding tax on distributed earnings or deemed distributions

4.37 To the extent they contain domestic dividends, the distributed earnings and deemed distributions of a

German fund are subject to German withholding tax (Kapitalertragsteuer) at a rate of 20% (plus solidarity

surcharge). No German withholding tax is imposed on foreign dividends. Other earnings of the fund will in

principle be subject to withholding tax on interest (Zinsabschlag) at a rate of 30% or 35% in case of over-the-

counter-transactions (Tafelgeschäft), in each case plus solidarity surcharge. Certain types of income will be

exempt, such as profits from forward sales, capital gains arising from the sale of shares and other securities,

and tax-exempt foreign income.


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Taxation of German regulated funds

4.38 German open-ended funds which are structured as a Sondervermögen and managed by a KAG and investment

stock companies will be exempt from German withholding tax on interest and will be entitled to a refund of

German withholding tax on other types of income from capital investments, e.g. dividends.

Fund of funds

4.39 In case of an investment in a fund of funds both earnings retained at the level of the fund of funds and retained

earnings of direct or indirect target-funds are tax-wise attributed to the investor at the end of each financial

year of the fund of funds. The legal provisions regarding the statutory reporting minimum requirements and

extended reporting requirements apply analogously to target-funds. If a target-fund does not satisfy the

minimum requirements, a lump-sum taxation will apply with respect to the relevant target-fund, however, this

will not automatically affect the treatment of the residual income of the fund-of-funds (no infection).

4.40 Dividends, capital gains from the disposal of shares and treaty-protected foreign income earned at target-fund

level will only be (partially) tax-exempt if the extended reporting requirements as to the taxable basis are

satisfied (see above).

5 Marketability to Different Classes of Investors

Securities in general

5.1 Sales of securities to the public are regulated by the Securities Selling Prospectus Act (Wertpapier-Verkaufs-

prospektegesetz) and the Securities Selling Prospectus Regulation (Verordnung für Wertpapier-Verkaufsprospekte)

implementing the EC Directive 89/298/EEC.

5.2 According to the Securities Selling Prospectus Act, a prospectus must be published for any securities which

are offered to the public in Germany for the first time and which have not yet been admitted to trading on a

German stock exchange. Certain exemptions, however, apply with respect to the type of the offer, to specific

issuers and with respect to specific securities.

5.3 The prospectus shall be published at least one working day before the public offer is made. As a general rule,

the prospectus may only be published if the BaFin has permitted its publication, or if after receipt of the

prospectus ten working days have elapsed without the BaFin having prohibited the publication.

5.4 The required content of the prospectus depends on whether an application for a stock market listing has

been filed or not.


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Units in Investment Funds / Shares of an Investment Stock Corporation

5.5 The public offering of units in (German) Investment Funds, including Single Hedge Funds and Funds of Hedge

Funds, and of shares of a German Investment Stock Corporation in Germany is subject to complex regulatory

provisions under the regime of the Investment Act and the Investment Tax Act, which contain, inter alia, strict

provisions in respect of information that is to be made available to investors.

5.6 The investment company and the investment stock corporation respectively shall provide to the public a

simplified (vereinfachten) and a detailed (ausführlichen) sales prospectus for the fund managed, which contain

the contractual terms and conditions. A simplified sales prospectus, however, must not be prepared for real

estate funds and Funds of Hedge Funds. Both the simplified and the detailed prospectuses must include the

information necessary to enable investors to form a reasonable judgment on the investment offered to them

and, in particular, on the risks attached thereto.

5.7 At least nine tenths (9/10) of the shares of an investment stock corporation must be offered to the public or,

in case that a public offer is not permissible (see section 5.8), sold to investors on a private placement basis

within six months after the authorisation to carry on business operations was granted to the investment stock

corporation. Shares of the investment stock corporation with fixed capital may only be offered to the public

if they are admitted to trading on the official or regulated market at a domestic exchange and the investment

stock corporation with fixed capital has published a listing prospectus or a company report.

5.8 In relation to the distribution of units in Single Hedge Funds and in Funds of Hedge Funds in Germany, the

Investment Act stipulates that only Funds of Hedge Funds may be publicly distributed in Germany, whereas

Single Hedge Funds remain barred from public distribution, although, it is possible to distribute them by

private-placement.

Participations in private equity funds

5.9 The Anlegerschutzverbesserungsgesetz as of 28 October 2004 stipulates a prospectus requirement also for

the offer of participations in private equity funds, effective since 1 July 2005.

Professional investors and sophisticated investors

5.10 The GmbH or the GmbH & Co. KG is more likely to be an appropriate investment vehicle for a small group of

professional investors. An expansion which requires public money would require a conversion of the GmbH

or the GmbH & Co. KG to an AG. This is because only AGs can be listed on a Germany stock exchange.

5.11 The Securities Selling Prospectus Act exempts offers which are made only to persons who purchase and sell

securities for professional or trade reasons.


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5.12 As regards private placement, the Securities Selling Prospectus Act exempts an offer to a restricted circle of

persons from the requirements to issue a prospectus.

6 Outline of the German Tax System Applicable to the Taxation of Incomeand Profits

This section contains brief details on the different types of taxes that exist in Germany. The effect of tax

treaties is not taken into account in this section.


6.1 The corporate income tax (Körperschaftsteuer) is a tax on corporate entities (such as AGs and GmbHs).

The tax rate for profits is 25%.

Tax on dividends

6.2 Tax on dividends is levied in accordance with the Income Tax Act (Einkommensteuergesetz). Dividends are

paid net of 20% withholding tax (plus solidarity surcharge at a rate of 5.5% on the tax payable) by the

company, for which a domestic investor obtains a tax credit for the withholding tax and the solidarity

surcharge paid. If received by a corporate shareholder 95% of the dividends are tax exempt. If received by

an individual shareholder only 50% are taxable (half income tax system).

Tax on interest

6.3 Tax on interest received under loans without profit depending elements and without being secured by real

estate or ships (collateralised debt rule) is levied in accordance with the Income Tax Act. In general, a withholding

tax at the rate of 30% has to be withheld (plus solidarity surcharge) if the debtor is a German bank of if bonds

are deposited at a German resident bank. No tax is withheld on interest paid to a foreign creditor.

Capital gains

6.4 Capital gains are taxed according to the rules described in sections 2.14 to 2.19, 3.9 and 3.10.


GERMANY

93

Net worth tax

6.5 No net worth tax (Vermögensteuer) is levied in Germany at present.

Trade tax

6.6 Trade tax (Gewerbesteuer) is levied by the local authorities on business income as determined for (corporate

or individual) income tax purposes and adopted by special additions and deductions for trade tax purposes.

Different rates apply depending on the local authority. Trade tax is tax deductible for corporate and individual

income tax purposes and reduces the trade tax base itself.

Local taxes

6.7 The only local income tax that can be levied by local authorities in Germany is trade tax as discussed in

section 6.6. Other local taxes are not relevant for the purposes of this paper.

Church tax

6.8 Church tax (Kirchensteuer) is levied on assessed income tax if an individual is a member of a qualifying church

and tax resident (residence or habitual abode) in Germany.

Solidarity surcharge

6.9 The Solidarity Surcharge (Solidaritätszuschlag) is a supplementary tax which is presently levied at a rate of

5.5% on the individual and corporate income tax due (including withholding taxes).

Carried interest / Other incentives for the management

6.10 Different benefits are available or can be granted for entrepreneurial management teams taking the risks in a

new venture. (The phrase "entrepreneurial management team" refers to the management of the private equity

management or advisory company, as well as to the management of the portfolio company).

6.11 On 18 June 2004 and 9 July 2004 the German Federal Parliament and the German Federal Council of the

States decided on a beneficial treatment of carried interest for German income tax purposes. Only 50% of

such payments are subject to German income tax. The term carried interest means compensations/

payments which will be made to management persons who are acting on behalf and in favour of a holding

entity (holding shares in corporations).


94

In order to benefit from such exemption, carried interest shall only be paid if all investors of the entity have

previously received their invested capital. In addition, payments do only qualify as carried interest, if the recipient

is participating in a mere asset holding company (as defined in the decree, see section 3.7), the purpose of

which is to acquire, hold and sell shares and corporate entities and the payment is made for services

rendered to further the objects of the GmbH & Co. KG.

6.12 Stock options can be granted with regard to the share capital of an AG or a GmbH. In general, although

hardly discussed, the mere granting of the option should not represent income for the employee, but on the

date the option is exercised, however, tax will be due on any capital gain computed as the difference between

the fair market value and the option price. Certain tax benefits may be available with regard to stock options

under tax treaties for employees of foreign corporations or German employees who are working overseas for

substantial periods of time.

6.13 A right to share in the profits (Genussrecht) of a corporation which may also include a right to a surplus on

the liquidation of the enterprise can be granted to an employee. However, this gives no entitlement to vote

or to have a later equity interest in the issuer of the Genussrecht.


GERMANY

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In Hungary, from 1 January 2006, a new act replaces the previously effective legislation in relation to private

equity investments. The former legislation, Act XXXIV of 1998, regulated the formation and operation of private

equity funds (kockázati tőkealap) and private equity enterprises (kockázati tőketársaság). Although the legal

background of private equity funds and enterprises was already provided in detail in Hungary under the

former legislation, the actual application of these in everyday practice was very limited: until this date, only state

owned Hungarian venture capital funds were established. Foreign investors are keener on using different

Hungarian or non-Hungarian structures and currently Hungarian investors have little interest in private equity

investments. Instead of using Hungarian private equity funds and private equity enterprises, foreign investors

generally use the combination of non-Hungarian funds and Hungarian companies (as acquisition SPVs).

The legislator realised that due to the several weaknesses of the former legislation the forms of private equity

funds and private equity enterprises are not used in practice and has therefore introduced new legislation,

which will, in the hope of the legislator, promote the activity of this sector. Instead of introducing a separate

act, as was done previously, the regulations relating to private equity investments have been incorporated in

Act CXX of 2001 on Capital Markets, which as a result includes all capital market related regulations in a

consolidated form. As the new legislation has only been recently introduced and therefore has not yet been

tested, it is not easy to envisage how the amended rules will be appreciated in the market but the new

legislation clearly offers more flexible rules for private equity investors than the former one.

As mentioned, the lack of Hungarian private equity funds and enterprises can be attributed to the

disadvantageous features of the former Hungarian legislation, which outweighed any advantages. One of the

main disadvantages of this legislation was that it required Hungarian private equity funds and enterprises to

deal exclusively with private equity investments. Another factor that also hindered the widespread use of

Hungarian fund vehicles is that the law required these to receive at least HUF 500 million (approx €2 million)

as registered capital. Neither provided the preferential taxing regime granted by the Hungarian legislator for

the funds, a real appeal for the investors, as they can mostly take the advantages of foreign tax havens.

The new legislation cancels the form of private equity enterprises and brings in new rules for private equity funds.

Presumably, the decrease in the minimum registered capital to HUF 250 million (approx €1 million) and the

simplified establishment procedure will enhance the use of private equity funds even by Hungarian investors.

At present however the most common structure is to use a non-Hungarian fund vehicle and to establish a

Kft (limited liability company) or an Rt (company limited by shares) as an acquisition vehicle.

A Kft is a company limited by quotas or business shares (i.e. set sums of capital are invested by the members)

and approximates most closely to a German GmbH. The nearest English equivalent is a private limited liability

company. An Rt is a company limited by shares and is more like an English PLC or a German AG.

HUNGARY Ormai és Társai CMS Cameron McKenna

96

A Kft may have one or more quotaholders (members), who may also include foreign individuals and foreign

legal entities. Membership in a Kft is evidenced by entering the names of members into a list of members,

which the directors of the Kft are obliged to maintain under the Hungarian companies act. Unless the specific

provisions of the Kft's deed of association provide otherwise, the quotaholder's liability for the obligations of

the Kft is limited to the value of their quota, subject to few statutory exceptions.

It is important to note that quotas in a Kft are not the same as shares in an Rt. Each quota is indivisible

(except with the consent of the Kft itself), must be denominated in Hungarian Forints, in an amount divisible

by 10,000 (approx. €40) and its “face” value may not be less than HUF 100,000 (approx. €400). Voting and

dividend rights can be set out in the Kft’s deed of association, subject to the proviso that at least one vote

must be allocated per stake of HUF 100,000 (approx. €400). Unlike shares, it is difficult to take security over

the quota as they do not qualify as securities. This is often relevant when financing a Kft.

Although both a Kft and an Rt offer limited liability to its members/shareholders, for many investors a Kft is

more attractive than an Rt. Some of the reasons include:

(a) a Kft requires a lower minimum paid up initial capital. Only HUF 3 million (approx. €12,000) needs

to be paid to form a Kft, as opposed to a minimum capital of HUF 20 million (approx. €80,000)

for an Rt;

(b) the procedures for calling a general meeting and taking corporate decisions are generally

considered to be more flexible as regards a Kft; and

(c) a Kft has managing directors but no formal decision-making Board of Directors, which an Rt does.

However, it may be more appropriate to form an Rt for the following reasons:

(a) it is more suitable to take security over the shares of an Rt (as shares may be evidenced by the

issue of a share certificate or dematerialised shares). A quota (or business share) in a Kft on the

other hand is regarded as being a series of rights reflecting the proportion of the capital

contributed by that member and is only evidenced in the books of the Kft and not in any physical

or other form. As such, it is more difficult (although not impossible) to pledge a quota interest as

it is not represented by securities;

(b) the larger paid up capital of an Rt can sometimes give it an advantage in raising finance on the

local or international financial markets; and

(c) unless otherwise provided in the deed of association, the directors of an Rt can be removed by

a simple majority, whereas the directors (managing directors) of a Kft may only be removed by a

resolution supported by at least 75% of the quotaholders.


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A foreign fund structure will not receive special tax treatment in Hungary. If it operates through a Hungarian

permanent establishment, it will be fully taxable in Hungary, in the same way as a Hungarian company. If a

foreign fund invests into Hungary without a Hungarian permanent establishment, it will be taxed on its

Hungarian-source income in accordance with the relevant double tax treaty.

If the fund is treated as tax transparent in its home jurisdiction, then in theory the Hungarian tax authorities

should follow this approach (although no specific Hungarian domestic rules are in force to this effect).

Nevertheless, as Hungary does not levy dividend, interest, royalty or service fee withholding taxes on non-

Hungarian entities by way of its domestic legislation, whether the non-Hungarian fund is treated as

tax-transparent or not is generally irrelevant from a practical perspective.

3 Outline of Hungary’s Tax System applicable to the Taxation of Income and Profits


3.1 Corporate income tax in Hungary is levied currently at a rate of 16% on the worldwide income of Hungarian tax

resident companies and the income attributable to Hungarian permanent establishments of non-Hungarian

companies.

There is no group tax consolidation available in Hungary, therefore each company within a group is taxed

individually.

Hungarian private equity funds and investment funds are treated as tax transparent in Hungary, irrespective

of the tax residence of the investors.

3.2 There are various local taxes in Hungary, the most relevant of which is a local turnover tax levied at a rate up

to 2% on net sales revenues (excluding interest and royalty income) of a Hungarian tax resident company or

a Hungarian permanent establishment. This form of tax is expected to be abolished as of the tax year 2008.

Capital gains

3.3 Capital gains derived by companies on the disposal of their shares/holdings are subject to Hungarian taxation

and these are taxed currently as part of the corporate profits of the seller at the rate of 16%.


98

In general, capital gains derived by individuals will be taxed at a rate of 25%. However, capital gains derived

from the sale of shares at a Hungarian stock exchange or the stock exchange of an EU Member state

are exempt from Hungarian taxes (with certain exceptions). As of 1 January 2007, however, such capital

gains derived by individuals will be subject to Hungarian taxes at a rate of 10% (and at a rate of 18% as of

1 January 2010).

Dividends

3.4 As of 1 January 2006, Hungary has abolished its domestic dividend withholding taxes. This applies to any

dividends paid on or after 1 January 2006 to non-Hungarian tax resident entities.

Interest

3.5 Interest income of a company is subject to Hungarian taxation and will be taxed as part of its corporate profits

currently at a rate of 16%. Nevertheless, 50% of related party interest revenue (in excess of related party

interest expenses) reduces the tax base of a Hungarian company (or a Hungarian permanent establishment).

Interest payments are generally tax deductible, subject to thin capitalisation and transfer pricing limitations.

Interest income of individuals (as defined by the relevant Hungarian legislation) is currently exempt from

Hungarian taxes.

Hungary does not levy interest withholding taxes at present on interest derived by non-individuals.


3.6 The taxable profits of a company subject to Hungarian taxation will be established on the basis of its profits

(or losses) calculated in its profit and loss statement, subject to adjustments required by the relevant

Hungarian legislation. In general, costs and expenses related to the income generating business of a

company will be tax-deductible. The relevant Hungarian legislation gives a general guidance (as opposed to

an exhaustive list) as to whether various classes of costs and expenses should be treated as tax deductible

or non-tax deductible.

Tax losses

3.7 Tax losses incurred up to 30 December 2004 may be carried forward for up to five years. Tax losses incurred

after this date can be carried forward for an unlimited period of time, but subject to a licence of the Hungarian

tax authorities in certain cases. Losses cannot be carried back to previous periods.


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3.8 Hungarian tax legislation defines permanent establishment in accordance with the OECD Model Convention

and if a double tax treaty exists between Hungary and the other relevant country then the treaty definition of

a permanent establishment will prevail. The Hungarian permanent establishment of a non-Hungarian

company will generally be subject to Hungarian taxes similar to a Hungarian tax resident company.

International tax issues

3.9 Companies having their registered seat in Hungary and/or having their place of effective management in

Hungary will qualify as Hungarian tax resident and will be subject to Hungarian taxes on their worldwide income.

Non-Hungarian tax resident companies will be subject to Hungarian taxes on their Hungarian source income,

according to the applicable double tax treaty (or, in the absence of an applicable double tax treaty, the

relevant Hungarian legislation).


3.10 Hungary grants unilateral double tax relief by way of exemption (with progression) in general and in the case

of interest, dividends and royalties by way of a foreign tax credit.

Capital duty and share transfer taxes

3.11 Hungary does not levy share transfer taxes if the shares/quotas of a Hungarian company are transferred and

only a minor flat fee is payable for the corresponding registration of the new shareholders/quotaholders with

the Hungarian commercial register. The Hungarian duty levied on a capital increase of a Hungarian company

is also a small flat amount.


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1.1 The principal structure which has been used for private equity funds in Ireland is the limited partnership

formed and registered under the Limited Partnership Act, 1907.

1.2 This paper identifies the principal advantages and features of the limited partnership structure.

2 The Limited Partnership

2.1 A limited partnership must have at least one partner who has unlimited liability for the debts and obligations

of the partnership – a general partner which can be a body corporate. Very often the general partner is a

newly incorporated special purpose corporate vehicle controlled by the fund management team.

2.2 Investors become limited partners in the fund and their liability for the debts and obligations of the limited

partnership is limited to the amount of capital they have subscribed to the partnership. A limited partner may

lose the benefit of his unlimited liability if he takes any part in the management of the affairs of the limited

partnership but as there is usually a clear distinction between management and investors that is rarely a

concern in practice.

2.3 Typically limited partners fund their commitment by subscribing a mixture of capital and loan finance to the

partnership. Very often the capital to loan ratio is in the region of 1% to 99%. There are two primary reasons

for this capital/debt financing structure:

(a) the Limited Partnership Act provides that if during the continuance of the partnership a limited

partner directly or indirectly draws out or receives back any part of his capital contribution,

he should be liable for the debts and obligations of the firm up to the amount so drawn out or

received back – this provision would not apply to repayment of a loan; and

(b) secondly, under the 1907 Act a limited partner’s liability for the debts and obligations of the

partnership is limited to the amount of capital which he has contributed to the partnership and

would not extend to include a loan finance which he had agreed to commit to the fund.

2.4 A limited partnership does not have separate legal personality in Irish law.


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2.5 The number of partners who can be properly registered as members of a limited partnership is normally 20.

However, in the case of a limited partnership engaged in the business of venture capital this limit is increased

to 50.

Taxation of limited partnerships

2.6 A limited partner in an Irish limited partnership will be taxable in Irish law in respect of the income and gains

arising from an investee company which are allocated to it through the partnership as if the limited partner

had received such income and gains directly itself. Losses are allocated in the same way and their

deductibility will depend upon the tax circumstances of the limited partner.

Management charge and value added tax

2.7 The management charge taken by a general partner is generally the first fixed share of profit arising to the

partnership so that the limited partners are not liable to tax on that part of the profit of the partnership

allocated to the general partner. Such profit share is generally outside the scope of Irish valued added tax.

Carried interest

2.8 The carried interest of a general partner is generally structured as an allocation of the capital gain arising on

disposal of an investment by the partnership so that to the extent that it takes the form of an allocation of a

capital gain then in the hands of the recipient it is liable to capital gains tax as opposed to being taxed as

income which is typically taxed at a higher rate.

Marketing of limited partnerships

2.9 A limited partnership could constitute an unauthorised unit trust for the purpose of the Unit Trusts Act 1990

and there are prohibitions on the sale of unauthorised unit trust schemes to the public. Typically the minimum

commitment required of an investor in a limited partnership and the very focussed nature of fundraising is

such that promoters can be satisfied that the offering of participations does not amount to an offer to the

public requiring regulation. In all circumstances however detailed advice needs to be obtained from legal

advisors who are given all relevant facts.

Special consideration for foreign investors in an Irish limited partnership

2.10 In the absence of anything further a foreign investor who agrees to become a limited partner in an Irish limited

partnership would generally not be regarded as establishing a permanent establishment in Ireland.


102

As the limited partnership is regarded as tax transparent by the Irish Revenue authorities there is no usually

no exposure to Irish tax for foreign limited partners except in respect of Irish source interest which is generally

subject to withholding tax of 20%.

Conclusions

2.11 The Irish limited partnership has the following advantages:

(a) it is transparent for Irish tax purposes;

(b) it provides limited liability to the limited partners subject to the points mentioned above;

(c) the management fees payable to the general partner are typically outside of the scope to value

added tax; and

(d) it provides a tax efficient means of paying carried interest to Irish based executives.


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1.1 The typical structure available for carrying on private equity activity in Italy is the “fondo chiuso” (closed-end

fund), although in principle other vehicles may be used.

1.2 This paper outlines the principal features of the fondo chiuso on both the regulatory and the tax side as well

as some relevant aspects of the treatment of non-Italian private equity funds operating in Italy.

2 The Fondo Chiuso (Closed-End Fund)

2.1 The legislation introducing the Italian closed-end fund (the fondo chiuso) was enacted with the Law n. 344,

of August 14, 1993. All the provisions comprised in such Law and regarding the civil law aspects of the investment

funds were repealed and replaced by the Legislative Decree No. 58, of February 24, 1998, (Testo Unico delle

disposizioni in materia di intermediazione finanziaria - the Consolidated Act on Financial Brokerage Activities),

as executed by the Decree of the Ministry of Treasury No. 228, of May 24, 1999, the Regulation of Bank of

Italy of April 14, 2005 (altogether, the “Regulations”), and the Regulations of the National Commission for

Companies and the Stock Exchange Market (CONSOB).

The entities involved in the set-up of the funds are:

(a) the management company (Società di Gestione del Risparmio (SGR));

(b) the assets of the fund;

(c) the investors; and

(d) the custodian bank (banca depositaria).

3 The Management Company (Società di gestione del risparmio (SGR))

3.1 The SGR must be authorised by the Bank of Italy and registered in a special register (kept at the Bank of

Italy). Under the law, the authorisation is given within 90 days from the date of the filing with the Bank of Italy.

Such term may be suspended or interrupted by the Bank of Italy. Before giving authorisation the Bank of Italy

consults with CONSOB.


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3.2 The Bank of Italy shall authorise the provision of the service of collective portfolio management by SGR if the

following conditions are satisfied:

(a) the legal form adopted is that of a joint stock company (società per azioni (S.p.A.));

(b) both the registered office and the head office of the company are located in Italy;

(c) the paid-up capital is not less than €1,000,000. SGRs with a lower share capital may be allowed

under certain circumstances;

(d) the persons performing administrative, management and supervisory functions fulfil the experience,

independence and integrity requirements referred to in article 13 of the Consolidated Act on

Financial Brokerage Activities. 41 In particular, the directors and the members of the board of

auditors of Italian asset management companies must be selected on the basis of the criteria of

professionalism and competence. 42 Moreover, neither the directors nor the members of the

auditors must have convictions for certain crimes. 43 Failure to fulfil those requirements shall result

in disqualification from the office. The disqualification shall be declared by either the board of

directors, the supervisory board or the management committee within thirty days from the

appointment or from the date of knowledge in case of subsequent failure. In the event of inaction

by the board of directors, the supervisory board or the management board, the disqualification

shall be declared by the Bank of Italy or by CONSOB;

(e) the owners of shareholdings fulfil the integrity requirements referred to in article 14 of the

Consolidated Act on Financial Brokerage Activities. In particular, individuals holding more than a

certain percentage of the voting rights of an Italian asset management company may not exercise

the voting rights exceeding the threshold if they have been convicted of certain crimes; 44

(f) the structure of the group to which the company belongs does not hinder the effective

supervision of the company;

(g) a program of initial operations and a description of the organisational structure are submitted

together with the deed of incorporation and the bylaws; and

(h) the name of the company contains the words “società di gestione del risparmio”.

Authorisation shall be denied if the examination over the conditions indicated in this paragraph 3.2 shows

that sound and prudent management is not ensured.


41 According to art. 13 of the Consolidated Act on Financial Brokerage Activities, persons performing administrative, management and supervisory functions(inter alia) in Italian management companies shall fulfill the experience, integrity and independence requirements established by the Minister of Economyand Finance in specific regulations adopted after consulting the Bank of Italy and Consob. The Minister of Economy and Finance implemented suchprovision by enacting the Decree No. 468 of November 11, 1998.

42 Decree of the Minister of Economy and Finance No. 468 of November 11, 1998.43 Decree of the Minister of Economy and Finance No. 468 of November 11, 1998.44 Decree of the Minister of Economy and Finance No. 469 of November 11, 1998, that implements the above mentioned art. 14 of the Consolidated Act

on Financial Brokerage Activities.

ITALY

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3.3 The SGR must act on behalf of the investors and in their best interest. Under Italian law, the SGR assumes

the obligation and responsibilities of an agent (mandatario) with respect to the investors. The SGR assumes

full responsibility for the management of the Fund, including all decisions to invest and divest. Nevertheless,

it may assign specific investment choices to intermediaries authorised to provide asset management services

(e.g. other SGRs, SICAVs, etc.) within the framework of asset allocation criteria laid down from time to time

by the managers. Furthermore, the SGR may delegate specific functions (such as investment advice

concerning financial instruments) to third parties in ways that avoid turning the company into an empty shell,

without prejudice to its responsibility vis-à-vis participants in the fund for the actions of agents. The SGR may

manage both funds set up by itself and funds set up by other SGRs.

3.4 The SGR managing closed-end funds, not reserved to “qualified” investors is obliged to contribute an

additional 2% to the capital under management for every single fund. In case the net asset value of the fund

is higher than €150 million the additional amount of 2% is reduced to 1% with reference to the amount exceeding

€150 million. If two different management companies are respectively in charge of the management activity

and the promotion, each of them contributes half of the amount determined after the above mentioned rules.

3.5 The SGR must draw up the by-laws of the fund (hereinafter, the “Regolamento” or “Fund Rules”) concerning

the management of the fund, which has to be approved by the Bank of Italy within three months from the

filing, unless the request of authorisation is denied. Such term can be extended if the Bank of Italy requires

amendments to the Regolamento. However, a draft of the Regolamento can be presented to and discussed

with the Bank of Italy during the period necessary to obtain the authorisation of the SGR. Simplified procedures

are provided by the Regulations under certain circumstances.

The Regolamento regulates, inter alia, the following aspects:

• the name of the fund;

• the duration of the fund;

• the purposes of the fund;

• the features of the fund (e.g. the business purposes, the investment policy);

• the bodies responsible for the selection of investments and the criteria for the apportionment of

investments;


106

• the manner of participating in the fund, the time limits and procedures for the issuance and

cancellation of certificates and for the subscription and redemption of units, as well as the

procedures for the liquidation of the fund. As the fund must derive from one or more issuances

of units of equal value, (that must be subscribed within 18 months from the date of the

publication of the prospectus or if the units are not offered to the public, from the date of the

Regolamento by the Bank of Italy), 45 the Regolamento also provides rules governing the

modalities for the issuance of units at different moments. The new units can be issued only once

the commitments undertaken in relation to the previous issuances have been fully drawn down;

• the minimum subscription size;

• indications concerning the certificates. Units will be represented either by registered or bearer

certificates depending on the investors’ preference. The certificates will comply with Italian law

and will have the signature of a director of the SGR and of an officer of the Custodian Bank. The SGR

may issue cumulative certificates that represent multiple units. An investor may, at any time,

request the issuance of single certificates;

• a description of the different classes of units (if any) and of the relating rights;

• details of the expenses to be borne by the fund or by the SGR;

• the amount of, or the method for determining, the fees due to the SGR and the charges to be

borne by the investors; and

• the method for determining the fund’s operating income and profits and, where appropriate, the

manner in which the latter are allocated and distributed.

3.6 According to article 37, paragraph 2-bis, of the Consolidated Act on Financial Brokerage Activities, the

investors shall in any case be called to vote, inter alia, on the replacement of the SGR as well as on changes to

the investment policy. Meetings shall be called by the board of directors of the SGR, inter alia, at the request

of the investors representing at least 10% of the value of the units in circulation, and resolutions shall be

adopted with the favourable vote of at least 50% plus one of the units represented in the meeting. In no case

may the quorum be less than 30% of the value of all the units in circulation. The resolutions adopted by at

the investors’ meetings shall be submitted to the Bank of Italy for its approval. They shall be deemed to be

approved if four months elapse from their submission without the adoption of a measure rejecting them.

4 Supervisory Control

The SGR is subject to the supervisory control of the Bank of Italy (in association with CONSOB).


45 Article 14, paragraph 2, Decree of the Ministry of Treasury No. 228/1999.

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5 Assets of the Fund

5.1 The assets of each fund are distinct (patrimonio separato) from those of the SGR itself, of the participants in

the management company and of the investors in the fund or in each other fund managed by the same SGR.

Consequently, creditors of the SGR cannot make claims against the fund; and creditors of the investors of

the fund can only make claims in respect of the shares of the specific investors.

5.2 According to article 4, of the Decree of the Ministry of Treasury No. 228/1999 the fund shall invest in the

following assets:

(a) financial instruments listed on a regulated market;

(b) financial instruments not listed on a regulated market;

(c) bank deposits of cash;

(d) property, property rights and equity interests in property companies;

(e) credits and securities representing credits; and

(f) other assets for which a market exists and that have a value that can be determined with certainty

at least once every half year.

The minimum amount of each subscription of units of closed-end funds investing primarily in the assets

referred to in letter (b) and (f) and in credits referred to in letter (e) may not be less than €50,000.

5.3 Investment funds shall be set up in conformity with the limits and criteria provided by the Bank of Italy in the

Regulations. Under the principal rules applicable to closed-end funds:

• the fund may not invest more than 20% of its net asset value in unlisted financial instruments

issued by the same entity;

• the management company may not hold, through funds it manages, more than 10% of the voting

rights of a listed company. Such a limit may be increased in the context of deals aimed at

increasing the value of the participations in the target companies in order to subsequently sell

such participations, in the investors’ interest, in a timeframe consistent with the investment policy

of the fund;

• the fund may borrow money within the limit of 10% of its net asset value;

• the fund may give its assets as guarantees to cover financings only where the guarantees are

instrumental to or connected with the performance of the fund; and

• the fund may give financings that are instrumental to or connected with the acquisition of

participations in target companies. The amount of money lent is compounded in the calculation

of the above mentioned limit of 20%.


108

5.4 Nevertheless, with reference to funds reserved to “qualified” investors, the Regolamento may provide investment

limits different from those established on a general basis in the prudential rules for limiting and spreading risk

issued by the Bank of Italy. For example, with reference to this kind of fund, the Regolamento may provide

that (i) the fund may acquire the majority of the share capital of the target company or (ii) the base of

calculation of the aforesaid limits may be the total amount of the fund and not the value of its activities, etc.

6 Investors

6.1 Usually private equity funds are established in the form of closed-end funds reserved to “qualified” investors

only. According to article 1, paragraph 1, letter h) of the Decree of the Ministry of Treasury No. 228/1999,

the “qualified” investors are the following: investment firms, banks, stockbrokers, SGR, SICAVs, pension funds,

insurance companies, financial companies heading banking groups and companies registered in the lists

referred to in Articles 106, 107 and 113 of the Legislative Decree No. 385 of September 1, 1993; foreign

intermediaries authorised under the law in force in their home country to perform the same activities as those

performed by the intermediaries specified immediately above; banking foundations; natural and legal persons

and other entities possessing specific expertise and experience in transactions involving financial instruments

expressly declared in writing by the natural person or the legal representative of the legal person or entity.

7 Custodian Bank

The custodian bank keeps custody of the investments of the fund. In particular, in performing its functions it shall:

(a) verify the legitimacy of the operations of issuance and redemption of the units and the allocation

of fund income;

(b) either verify the correctness of the calculation of the value of the units or make the calculation if

appointed to do so by the SGR;

(c) verify that in transactions involving fund's assets any consideration is remitted to it within the

customary time limits; and

(d) follow the instructions of the SGR unless they conflict with the law, the Regolamento or the

prescriptions of the supervisory authorities.

8 Marketability and Private Placement

If the units of the fund are the object of a public offering, the Consolidated Act on Financial Brokerage Activities

and the enactment provisions adopted by CONSOB on 14 May 1999 (as amended from time to time) apply.


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9 Listing of the Fund

The Regolamento shall specify whether it is intended that the certificates representing the units of a fund will

be listed on a regulated market.

Application for listing shall be mandatory for closed-end funds that provide for the minimum subscription to

be less than €25,000.

In case of listing, the application must be submitted by the management company within 24 months from

the closure of the offering period.

10 Life of the Fund

The life of the fund must be consistent with the nature of the investments. In no case may it exceed the life

of the SGR that promoted and set the fund up. Nevertheless, the life of closed-end funds may not exceed

30 years, plus an extension of three years (so called grace period - periodo di grazia) for the completion of the

sale of its investments, if so provided by the Regolamento and upon request to the Bank of Italy by the SGR.

11 Taxation of the Fund

11.1 Closed-end funds are not subject to ordinary income taxes. However, an annual substitute tax applies on the

yearly yield at a rate of 12.5%. 46 The taxable base would roughly include the difference between:

(a) the net asset value (gross of the substitutive tax) of the fund as of the end of the year, increased

by the reimbursements of the invested capital made and the profits distributed by the fund in the

course of the year and decreased by the draw downs made during the year; and

(b) the net asset value of the fund as of the beginning of the same fiscal year, increased by (i) the

profits received by the Fund which are exempt or subject to final withholding tax, (ii) the profits

received by the Fund from other investment funds subject to substitutive tax and (iii) by the 60%

of the profits received by the Fund from non-Italian investment funds that are subject to the 5%

substitutive tax (see footnote No. 6), which are resident in EU countries and comply with EU

directives.

For completeness sake, it should be mentioned that a similar tax regime applies to open-end UCITS (funds

and SICAVs).


46 Either a 5% rate or a 27% rate may apply under certain circumstances. An infringement procedure is currently pending at the EU Commission to verifywhether the 5% rate constitutes a state aid.

110

Italian open-end and closed-end funds and SICAVs are exempt from the 12.5% annual substitute tax if all

the investors are “qualified”. For these purposes an investor is “qualified” if he resides in a country that allows

an adequate exchange of information with Italy. A list of the “qualifying” countries is set forth in the Decree of

the Minister of Economy and Finance of September 4, 1996 (the “White List”), as amended from time to time.

Moreover, the following subjects are in any case deemed to be “qualified” investors: (i) entities and

international bodies established according to international treaties implemented in Italy; (ii) institutional

investors, even if not subject to tax, established in one of the above mentioned “qualifying” countries; and (iii)

central banks and bodies that manage the official reserves of a country.

11.2 Withholding taxes applied at source on financial proceeds received by the Fund are not recoverable.

However, it should be noted that most of the profits received by the Fund are not subject to the Italian

withholding tax. For example, the withholding tax does not apply to (i) dividends, (ii) interest from bonds

issued by banks or listed companies, (iii) interest from bank accounts under certain conditions, (ii) interest

from non-Italian entities, and (iii) interest from certain stock exchange dealings.

11.3 Should the operating profits be negative, the loss can be either carried forward for the same fund or used to

offset the operating profits of other funds managed by the same management company.

12 Taxation of Investors in the Fund

12.1 Profits from the fund received by Italian resident individuals not holding the investment in the capacity of

entrepreneur are fully exempt from tax.

12.2 Profits from the fund received by Italian resident individuals holding the investment in their capacity of

entrepreneur are treated as ordinary income and subject to tax at the applicable marginal rate. A tax credit

equal to 15% of the profits received is granted without any condition or restriction.

12.3 Profits from the fund received by Italian resident corporate entities and non-resident corporate entities with a

permanent establishment in Italy are treated as ordinary income and subject to tax at the ordinary rate of

33%. A tax credit equal to 15% of the profits received is granted without any condition or restriction.

12.4 All non-Italian resident investors (individuals, corporations, partnerships, etc) are fully exempt from Italian taxation

provided that a permanent establishment is not maintained in Italy. In particular, it should be remarked that no

withholding tax applies on profits distributed by the fund to non-Italian investors. In addition, “qualified”

investors (as defined under paragraph 11.1) are entitled to a refund of the substitutive tax for an amount equal

to the 15% of the profits received. Such refund is paid by the management company (and not by the Italian

tax authorities), granting simplicity and quickness to the refund procedure.


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Eventually, as a matter of fact, the “qualified” investors receive the profits from the fund gross of the

substitutive tax. It should finally be reminded that if all the investors are “qualified”, the 12.5% annual

substitute tax mentioned under 11.1 does not apply at all.

12.5 Withholding taxes (if any) applied at the fund level (i.e. to profits received by the fund) are not recoverable by

the investors.

13 Capital Losses

Losses realised by the fund may, in principle, be used by investors to write down the value of their investment

in the fund. The decrease in value of the units is deductible for tax purposes by Italian resident investors to

the extent it exceeds the previous increase in value that had not been taxed.

14 Placing Costs

Any placing cost in connection with the assumption of an interest in a fund must be added to the cost of the

interest itself, rather than being payable by the fund.

15 Treatment of VAT charged on the Management Fee

The management fees charged to the fund by the management company are VAT exempt.

16 Capital Duty

No capital duty applies to fund raising.

17 Foreign Investment Funds

17.1 The two legal entities most commonly used for structuring a foreign investment fund operating in Italy are

the following:

• the UK limited partnership - this is popular because of its tax transparency;

• the Dutch BV - this is popular because of its participation exemption.


112

In order to outline the regulatory and tax treatment in Italy of the offer of shares of the above mentioned

entities, one must first identify the nature of such entities.

17.2 For regulatory purposes, if the above mentioned entities qualify as non-harmonised investment funds (such

qualification would be reasonable for the LP, while it would be less certain as regards the Dutch BV) the

following provision applies. The marketing in Italy of the units of investment funds not falling within the scope

of the directives on collective investment undertakings shall need to be authorised by the Bank of Italy, after

consulting CONSOB, provided the operating arrangements are compatible with those prescribed for Italian

undertakings. The authorisation must be required even if the units of the fund are offered to institutional

investors only.

17.3 The foreign investment fund itself is not liable to any Italian taxation on capital gains provided that the

following conditions are met:

(a) it has no permanent establishment in Italy; and

(b) it only acquires “non-qualified” participation (as defined under paragraph 20.2) in Italian companies

whose shares are quoted in regulated markets. In such case the relevant shares might even be

physically kept in Italy.

It is not certain whether the above mentioned entities may benefit from the tax treaty provisions.

17.4 Consultancy fees received by Italian advisors for services rendered to foreign management companies are

taxed as ordinary income. No VAT applies if the manager is a taxpayer within the EU.

18 Permanent Establishment

Art. 162 of the Italian Income Tax Consolidated Act defines what is meant to be a “permanent establishment”

under Italian law. Such definition is roughly the same as the definition that can be found in Art. 5 of the OECD

Model Convention on Income and Capital.

19 Anti-avoidance Legislation Affecting Foreign Funds

Italy does not have any general anti-avoidance legislation. However, there are specific measures designed to

recharacterise tax abusive transactions, such as mergers, demergers, transfers of assets and exchanges of

shares that are with no valid economic reason and were undertaken solely to avoid obligations or prohibitions

provided by tax law and to obtain undue tax benefits.


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20 Outline of the Italian Tax System applicable to the Taxation of Income and Profits

Italian resident companies and non-resident companies with a permanent establishment in Italy

20.1 Both income and capital gains are subject to:

• corporate income tax (IRES) at a 33% rate; and

• regional tax on productive activities (IRAP) at a 4.25% rate. 47

As a general rule, capital gains on assets held longer than three years may be taxed pro rata in five fiscal periods.

However, capital gains from the sale of shares are exempt from taxation for 91% of their amount (reduced to

84% from January 1, 2007) if the following conditions are met:

(a) the shares have been uninterruptedly held for 18 months;

(b) the shares have been reported as a long term investment in the first financial statements further

to the acquisition;

(c) the participated company is not resident in a country with a privileged tax system. A list of those

countries is contained in the Decree of the Minister of Economy and Finance of November 21,

2001 (the “Black List”); and

(d) the participated company carries on a business activity.

Non-resident companies without a permanent establishment in Italy

20.2 Non-resident companies without a permanent establishment in Italy are subject to tax on capital gains from

the sale of shares in Italian companies as follows:

• capital gains from the sale of “qualified” participations are in principle subject to Italian corporate

income tax at a rate of 33% on 40% of the capital gain. According to the relevant legislation, the

interest is to be considered “qualified” when it exceeds 2% of the voting rights or 5% of the equity

for companies whose shares are quoted on regulated markets. For non-quoted companies, such

thresholds are respectively 20% and 25%;

• capital gains from the sale of non-qualified participations in unlisted companies are subject to a

substitutive tax at a rate of 12.5%. However, if the seller satisfies the requirements for “qualified”

investors described under paragraph 11.1, the capital gain is not subject to tax in Italy;

• under domestic law, capital gains from the sale of non-qualified participations in listed companies

are not subject to tax in Italy; and

• if a treaty with Italy is applicable, no capital gain is taxable in Italy.


47 The rate may vary depending on the type of activity and on the region where the activity is carried on.

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21 Dividends

21.1 The tax regime of dividends paid by Italian companies varies depending on the nature of the recipient.

Dividends are generally not taxable for IRAP purposes.

21.2 As far as Italian resident individuals are concerned, dividends from “qualified” participations (as defined under

paragraph 20.2) are subject to tax as ordinary income on the 40% of the relevant amount, while dividends

from “non-qualified” participations and not related to an entrepreneurial activity are subject to withholding tax

at a rate of 12.5%.

21.3 Dividends received by Italian resident companies and commercial entities are subject to tax only on 5% of

the relevant amount and the remaining 95% is not subject to tax.

21.4 Dividends received by non-resident shareholders without a permanent establishment in Italy are subject to a

27% final withholding tax. The withholding tax can be refunded up to four ninths of the relevant amount if the

non-resident shareholder proves that a final tax has been paid on the same dividends in the country of residence.

21.5 Reduced withholding rates may apply to shareholders who are resident in treaty countries. No withholding

tax is applicable on payments made in the context of the EU Parent-Subsidiary Directive.

22 Interest

22.1 In principle, interest paid by an Italian company is deductible in computing its taxable income as far as IRES is

concerned. However, thin capitalisation rules and other limitations on interest deductibility may apply. In general,

under thin capitalisation rules, interest on loans granted or guaranteed from “qualified” shareholders 48

(including those from related parties) is limited if the ratio between the amount of loans granted or guaranteed

by that shareholder and the quota of the company’s net worth attributable to that shareholder exceeds 4:1.

Moreover, it should be noted that interest is not deductible for IRAP purposes.

22.2 Interest paid to non-resident lenders is subject to withholding tax at a rate of 12.5%, which is increased to 27%

in the case of non-Italian taxpayers residing in countries with a privileged tax system (a list of those countries is

contained in the Decree of the Minister of Economy and Finance of January 23, 2002). No withholding tax

applies if the EU Interest & Royalties Directive, as implemented by the D.Lgs. No. 143/2005, applies.

22.3 A few double taxation treaties grant a withholding tax rate on interest lower than 12.5%.


48 A shareholder is “qualified” if he either (i) controls directly or indirectly the company according to art. 2359 of the Italian Civil Code or (ii) has a participationnot lower than 25% of the share capital (including participations of the related parties).

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LUXEMBOURG Loyens Winandy

1 Available Investment Vehicles

The société d’investissement en capital à risque (SICAR) has been enacted by a law of June 15, 2004

(the SICAR Law), which regroups the two concepts of private equity and venture capital under the generic

term of “risk capital”. The SICAR aims to become a truly international risk capital investment company inter

alia following the 1998 recommendation of the European Commission calling upon Member States to

facilitate private equity and venture capital investments within the EU.

2 Established Investment Vehicles

2.1 Prior to June 15, 2004, private equity and venture capital investors choosing Luxembourg as their investment

hub already had the choice between two investment platforms: investors could either lodge their project in a

close-ended or open-ended capital company i.e., so-called sociétés de participations financières (Soparfi),

or they could pool their resources into a specialised Undertaking for Collective Investment (UCI) either in the

form of an investment company, with variable (SICAV) or fixed (SICAF) capital, or as a common investment

fund (FCP). Whereas the first option may lack the legal and fiscal flexibility typically associated with risk capital

transactions, the second option remains often unattractive due to regulatory restrictions. Neither regime thus

offers an entirely satisfactory tax or legal regime for risk capital projects.

2.2 As for UCIs, SICARs are subject to prior authorisation and remain subject to the prudential supervision of

the Commission de Surveillance du Secteur Financier (CSSF), the Luxembourg supervisory authority of the

financial sector. However, the application process as well as the monitoring obligations have been substantially

reduced when compared to UCIs, and (lighter) regulation was still perceived as a marketable advantage over

the broad range of non-regulated regimes in Luxembourg and abroad. The fact that investors may be lured

into or attracted by above average returns, without the necessary risk awareness, further prompted the

legislator to impose certain investor restrictions aimed at the protection of small or inexperienced investors.

3 Investment Company in Risk Capital (SICAR)

3.1 Quoting the SICAR Law, a SICAR may solely invest in risk bearing values. This potentially qualifies any type

of investment in an unquoted enterprise whether in the form of equity or debt securities (see tax aspects below).

The parliamentary documents give further indication of the legislator’s intent to provide maximum flexibility as

to the interpretation of the same. Listed companies may therefore under certain circumstances qualify as risk

bearing investments to the extent the investment aims at the financing of e.g., a new business development or

where the target company is to be taken private. The risk level may also depend on the location or type of

the stock exchange. Most importantly, a risk capital investment company is not subject to any risk diversification

rules and may thus invest into a single target. The SICAR Law does further not impose any geographical or

sectorial restrictions.

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Legal form and modus operandi

3.2 The SICAR is formed as a body corporate having its own separate legal personality. It is as such not a new

company form or type. Any of the following well known company forms may therefore elect to become a SICAR:

(a) a public limited company (Société Anonyme);

(b) a private limited company (Société à Responsabilité Limitée);

(c) a partnership limited by shares (Société en commandite par actions);

(d) a limited partnership (Société en commandite simple); or

(e) a cooperative company (Société coopérative sous forme de société anonyme).

3.3 A SICAR requires a minimum subscribed capitalisation of €1 million within 12 months following the authorisation.

Capital calls may be freely organised with a minimum of 5% (in kind or in cash) due at subscription. A SICAR

may furthermore opt for a variable or fixed capital structure (with the exception of the limited partnership company

form which does not have a traditional share capital structure). The SICAR also deviates from ordinary company

law rules by suppressing the mandatory legal reserve allocation. In addition, the dividend policy (e.g., periodicity)

is freely determined in its constitutive documents (i.e., articles of association or partnership agreement).

Otherwise, share transfer regulations as well as corporate governance rules will in principle follow ordinary

company law rules and do not give rise to specific comments. A SICAR may furthermore freely organise the

offering of additional securities to (other) investors, unless otherwise provided for in its constitutive documents.

3.4 Luxembourg limited partnerships formed as investment companies in risk capital deserve special attention.

A limited partnership is formed by agreement between one or several general partners with unlimited liability

together with one or several limited partners who participate in any profits and share in any losses pro rata

with their participation in the company and up to the amount of their commitments. A limited partnership has

unlimited legal capacity separate from that of its partners. The mutual rights and duties of the partners may

thus be organised with maximum flexibility. The partnership agreement may furthermore be adopted under

private seal or in a public deed. The importance of the limited partnership as investment vehicle is gaining its

full meaning when looking at its fiscal treatment (see below).

Investors’ restrictions

3.5 It is important to stress that the SICAR regime is reserved to three investor categories only, being institutional,

professional 49 and expert investors. The latter category is a new creation under the SICAR Law. In order to qualify

as an expert, the investor must (i) adhere to the expert investor status and (ii) either (a) invest a minimum amount

of €125,000, or (b) benefit from an express recommendation issued by a professional of the financial sector

confirming the expertise, experience and expert knowledge of the given investor to engage in risk capital projects.


49 For a definition of professional investor please refer to Annex II of Directive 2004/39/EC on markets in financial instruments amending Directives85/611/EC and 93/6/EEC and Directive 2002/12/EC.

LUXEMBOURG

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Depositary / Custodian

3.6 The SICAR further distinguishes itself from other venture capital and private equity regimes (e.g., PRICAF in

Belgium) as its assets must be entrusted to a Luxembourg established custodian bank. The legislator thereby

clearly aims at higher investor protection standards. The custodian is a routine institution for Luxembourg

based UCIs. Under the SICAR Law, the role of the custodian is however substantially reduced. The custodian

must inter alia ensure that the subscription monies are received within the timeframe set forth in the constitutive

documents of the SICAR, verify that the counterpart is delivered or paid upon disposal of assets and further

ensure that the asset allocation is made in accordance with the SICAR’s constitutive documents. It may thus

be important to note that the custodian operates independently in the exclusive interest of investors.

Approval and supervision

3.7 A company may be treated as a SICAR upon formal election and is subject to the prior approval by the CSSF.

The CSSF verifies that the SICAR and its representatives comply with the applicable legal provisions and

contractual arrangements. When submitting an application to the CSSF, the legal representatives of the

SICAR (i.e., its managers or directors) as well as the custodian must show professional honorability and the

required expertise for the performance of their duties. Any replacement of the same is subject to the prior

approval by the CSSF. The CSSF license is further conditioned by a show of evidence that the central

administration of the SICAR is located in Luxembourg. The applicant thus needs to ensure that the various

activities (e.g., management, accounting, keeping of shareholders’ register, redemptions and subscriptions,

etc.) are carried out in and from Luxembourg. Typically certain of these services may be organised by the

SICAR itself or delegated to local specialised service providers. The substance question may thus be

addressed on a case by case basis. Investment management may however be delegated to wherever the

expert manager or advisor is established. Such third party investment manager or adviser will not be subject

to approval by the CSSF.

3.8 Once authorised, the SICAR will be entered into the official SICAR list maintained by the CSSF. Such entry

will dispense the SICAR from complying with the formalities required for obtaining the visa of prospectuses

relating to public offerings of transferable securities.

Disclosure requirements and audit

3.9 The SICAR must comply with various disclosure requirements. It must inter alia produce an offering

prospectus and an annual report. The annual report must be finalised within six months after the end of the

financial period to which it pertains. Although the annual reporting obligations are in line with the common

reporting obligations of commercial enterprises, the SICAR is not subject to consolidated reporting.


118

Even though the SICAR is not obliged to publish or disclose its net asset value (per share class/category)

to the public, it must communicate such information to investors upon request at least every 6 months.

The applicable valuation method must be detailed in the constitutive documents and should be based on

the probable realisation value.

3.10 The annual accounts must furthermore be audited by a certified Luxembourg auditor. The auditor is

appointed and remunerated by the SICAR. The auditor must inform the CSSF about serious (grave) violations

of the applicable legal provisions or about any facts or decisions which could potentially threaten the

continuity of the SICAR.

Tax aspects

3.11 Entry level taxation is insignificant since capital contributions to a SICAR will only be subject to a one-time

flat capital duty of €1,250 (due upon formation).

3.12 A SICAR is subject to profit taxes on its worldwide income (combined rate for Luxembourg City in 2006:

29.63%) 50 and does thus from Luxembourg’s tax authorities point of view qualify as a tax resident for

Luxembourg’s tax treaties. Return (whether in the form of interest income, capital gains or dividends) derived

from risk capital investments benefits from a profit taxes exemption. Taking into account the hybrid nature of

risk capital investments a SICAR thus benefits from an extended exemption regime. Temporary idle funds

pending investment will equally benefit from such exemption, provided such funds are invested in risk capital

within a 12 month period. All other income is fully subject to Luxembourg profit taxes.

3.13 Most importantly, a SICAR allows maximum flexibility ensuring fiscally neutral profit repatriations, be it by way

of redemption, distribution or liquidation.

3.14 Distributions received and capital gains realised on the disposal of an investment in a SICAR by non-resident

shareholders will not attract Luxembourg tax, either by withholding or assessment.

3.15 A SICAR is furthermore exempt from the annual 0.5% net wealth tax.

3.16 The tax features of the limited partnership may be easily summarised. Although the limited partnership is

a legal entity separate from its partners, it is itself not liable for income or net wealth taxes in Luxembourg.

The limited partnership is to be treated as transparent for Luxembourg tax purposes and profits received from

a partnership as well as capital gains realised on the disposal of units by non-resident partners will not attract

Luxembourg tax, either by withholding or assessment.


50 See point 4.3. for more details.

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3.17 It may furthermore be worthwhile noting that management services rendered to a SICAR will not be subject

to VAT. Whether a SICAR itself has to be regarded as VAT entrepreneur has to be determined on a case-by-

case basis.

Conclusion

3.18 The SICAR, with its flexible legal options and attractive tax regime completes the product range of existing

investment vehicles available in Luxembourg. The SICAR does however not replace any of the existing

vehicles but merely closes the gap by delivering a made to measure risk capital investment vehicle aimed at

both the domestic and international investor base.

3.19 Special attention should further be devoted to the limited partnership which is set to become an attractive

alternative to UK limited liability partnerships.

4 Outline of Luxembourg’s Tax System applicable to the Taxation of Income andProfits with respect to Soparfi

Corporate and tax status

4.1 A Soparfi, as mentioned under section 2.1, is a normal commercial company, which may carry out any

activities which fall within the scope of its corporate object clause. As such, a Soparfi is fully subject to

Luxembourg income tax and net wealth tax. Profit distributions by a Soparfi are generally subject to Luxembourg

dividend withholding tax. A Soparfi is entitled to benefit from the tax treaties concluded between Luxembourg

and other countries (currently 44 in full force and effect), the EU Parent-Subsidiary Directive, the EU Merger

Directive and the EU Interest & Royalty Directive.

Capital duty

4.2 A Soparfi is subject to capital duty of 1% (or in case of a so-called family company 0.5%) on the higher of

the market value of the contribution and the par value of the shares issued. Exemptions may apply for certain

so-called share mergers and business mergers.


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Profit taxes

4.3 The Luxembourg profit tax system consists of a national corporate income tax (impôt sur le revenu des

collectivités or IRC) at a rate of 22% and the municipal business tax (impôt commercial communal or ICC)

which rate vary from municipalities to municipalities. The ICC rate for Luxembourg City in 2006 is 6.75%.

In addition, there is a 4% surtax for the unemployment fund calculated on the IRC. The total combined tax

rate (inclusive of surtax) applicable to Soparfis’ profits is therefore 29.63% for Luxembourg City in 2006.

Net wealth tax

4.4 A Soparfi is subject to a net wealth tax, which is levied at a rate of 0.5% on the company's worldwide net

wealth on January 1 of each year. inter alia, qualifying participations (see point 5 below) net of allocable debt,

are excluded from the taxable base. The annual burden of the net wealth tax of a Soparfi can, therefore, generally

be limited to the legal minimum of €63 (for a Société Anonyme) or €25 (for a Société à Responsabilité

Limitée). The IRC is creditable to the net wealth tax, provided certain conditions are met.

5 Taxation on Dividends / Capital Gains

Participation exemption (general)

5.1 A Soparfi is entitled to the participation exemption. The Luxembourg participation exemption slightly differs

for dividends and capital gains. It should be noted that capital losses on alienation or otherwise (e.g. liquidation

or depreciation) are tax deductible.

Dividends and capital gains

5.2 According to article 166 of the IRC Act and the Grand-Ducal Decree of December 21, 2001, dividends

(including liquidation dividends) and capital gains (including currency exchange gains) are exempt from

income tax provided the following requirements are met:

(a) the subsidiary is a resident of Luxembourg and fully subject to Luxembourg income tax or a

resident of an EU Member state and covered by the EU Parent-Subsidiary Directive or, in the case

of another non-resident subsidiary, it is subject in its country of residence to an income tax which

is comparable with the Luxembourg corporate income tax; 51 and


51 Generally, a foreign income tax system is considered to be comparable if the taxable basis is similar to the one in Luxembourg and the tax rate is at least 11%.

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(b) at the time of a dividend/liquidation distribution or a capital gain realised upon the alienation of

shares, the Soparfi must have held for a period of at least 12 months (or must commit itself to

continue to hold until a period of at least 12 months has elapsed) a direct participation of 10% or

more of the nominal paid up capital of the subsidiary or, in the event of a lower percentage

participation, a direct participation having an acquisition price of at least €1,200,000 (for dividends

and liquidation proceeds) or €6,000,000 (for capital gains).

5.3 The exemption also applies to participations held through a Luxembourg tax transparent entity (e.g., a

partnership), which may or may not have legal personality. 52 The Soparfi is considered to have a direct

investment equal to its pro rata part of the net assets of the tax transparent entity.

5.4 If the above mentioned conditions are not all met, an exemption of 50% is available where it concerns

dividend income (excluding liquidation proceeds and capital gains), provided that the dividends are distributed by

a resident fully taxable company, a company covered by the EU Parent-Subsidairy Directive, or a company

resident in a state with which Luxembourg concluded a tax treaty. The exemption applies to the net dividend

income, i.e. the dividend income minus directly related costs and write-offs on the participation in connection

with a dividend distribution of the same year.

6 Deductions / Recapture / Currency Exchange

Deductions

6.1 Expenses directly connected to a participation and write-offs thereon are not tax-deductible in a given year

to the extent that exempt income (gains and dividends) from the participation is derived in the same year.

Furthermore, capital losses on alienation or otherwise (eg. liquidation or depreciation of the participation or of a

loan granted to such participation) are tax deductible. Expenses are allocated to the extent possible on a

historical basis and otherwise on a pro-rata basis (e.g. divided over the number or the value of the participations).

Recapture rule

6.2 A future capital gain, if any, on a qualifying participation is not exempt to the extent of the related expenses

and value adjustments that have decreased the tax result of preceding years (“recapture rule”). However, prior

year losses can be carried forward indefinitely and can thus be offset against the recapture.


52 The law only refers to Luxembourg entities. However, in practice also non-Luxembourg entities may qualify.

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Currency exchange results

6.3 Currency gains and losses on, inter alia, debt instruments the proceeds of which are used to finance the

acquisition of subsidiaries are taxable and deductible respectively. Currency exposure could be avoided by

denominating such debt instruments in Euro. Agreements which are concluded to cover the exchange

exposure of a non- Euro denominated loan are acceptable.

6.4 Currency gains on the investment itself are exempt by virtue of the participation exemption (see above).

Currency losses on the investment itself are tax deductible, but may fall under the recapture rules.

7 Withholding Tax on Outgoing Dividends, Interests and Royalties

Domestic dividend withholding tax and tax treaties

7.1 Dividends (including hidden dividends) paid by a Soparfi are subject to Luxembourg dividend tax at the rate

of 20% (25% of hidden dividends if the withholding tax is effectively borne by the Soparfi), unless a domestic

law exemption or a lower tax treaty rate applies.

7.2 Reduced dividend withholding tax rates or exemptions also apply to participations held through a Luxembourg

tax transparent entity (e.g., a partnership), which may or may not have legal personality. 53 The Soparfi is

considered to have a direct investment equal to its pro rata part of the net assets of the tax transparent entity.

EU Parent-Subsidiary directive

7.3 Dividends paid by a Soparfi to its EU resident parent company falling within the scope of the EU Parent-

Subsidiary Directive are exempt from Luxembourg dividend withholding tax, provided at the time of the

dividend distribution, the parent company has held (or commits itself to continue to hold) 10% or more of the

nominal paid up capital of the Soparfi or, in the event of a lower percentage participation, a participation

having an acquisition price of €1,200,000 or more for a period of at least 12 months.

7.4 In case a dividend distribution takes place before the 12 month holding period is completed, the Soparfi has

to withhold the dividend tax unless it has received a certificate from the EU parent company that the latter

commits itself to continue to hold the minimum participation until the 12 months period has lapsed.


53 The law only refers to Luxembourg entities. However, in practice also non-Luxembourg entities may qualify.

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Withholding tax on outgoing interest

7.5 Arm’s length fixed or floating rate interest payments are not subject to Luxembourg withholding tax. However,

profit sharing interest paid on loans as well interest paid on certain profit sharing bonds is subject to 20%

withholding tax, unless a lower tax treaty rate applies.

7.6 In connection with the EU Savings Directive, Luxembourg introduced as of July 1, 2005 a withholding tax of,

initially 15%, on interest paid through a Luxembourg paying agent (usually a bank) to a non disclosed EU

resident individual. The withholding tax rate will be increased to 20% as from July 1, 2008 and to 35% as

from July 1, 2011.

7.7 As per January 1, 2006 Luxembourg introduced a withholding tax of 10% on interest paid by a Luxembourg

paying agent (usually a bank) to Luxembourg resident individuals. The withholding tax would apply to interest

on e.g. bank deposits and bonds and does not have such a wide scope as the EU Savings Directive.

The withholding tax is libratory in the sense that the interest does no longer have to be reported in the income

tax return.

Withholding tax on outgoing royalties

7.8 Apart from a withholding tax on certain artistic and literary royalties, there is no withholding tax on outgoing

royalty payments.

8 Capital Gains

Capital gains in the hands of shareholders

8.1 Under Luxembourg law, resident individual shareholders (not being entrepreneurs whose business assets

include shares) are taxable on the alienation of shares (including by way of liquidation) in a Soparfi if (1) the

alienation takes place within 6 months after acquisition (speculation gain) and if (2) the alienator holds, either

directly or indirectly, a substantial interest in the Soparfi. In very broad terms, a substantial interest exists if a

shareholder either alone or together with certain close relatives has held a shareholding of more than 10% in

a Luxembourg company at any time during the 5 year period preceding the alienation. A gain realised on

the alienation of convertible debt is subject to Luxembourg income tax if the creditor of the convertible debt

has a substantial interest in the debtor.


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8.2 For participations of more than 10% acquired prior to January 1, 2002, a threshold of more than 25% applies

up to and including the tax year 2007. The latter rule does not apply if and to the extent such more than 10%

interest in aforementioned participation is increased after January 1, 2002.

8.3 Non-resident shareholders (not having a Luxembourg permanent establishment to which the shares and/or

the income/gains from the shares in a Soparfi belong) are, however, only subject to Luxembourg tax in case

they hold, either directly or indirectly, a substantial interest and (1) the alienation (including liquidation) takes

place within 6 months after acquisition (speculation gain) or (2) in the case of an alienation after 6 months or

more, they have been a Luxembourg resident taxpayer for more than 15 years and have become a non-

Luxembourg taxpayer less than 5 years before the alienation takes place. Note however, that Luxembourg

will in general not be entitled to tax this gain (or the gain realised on the alienation of aforementioned

convertible debt) under applicable tax treaties.

Liquidation

8.4 Under Luxembourg law, a liquidation distribution by a Soparfi is not considered to be a dividend and is,

therefore, not subject to Luxembourg withholding tax. For non-residents the same comments as those given

under the preceding heading would apply.

Capital reduction

8.5 A repurchase of shares by a Soparfi followed by a cancellation of shares is subject to Luxembourg dividend

tax if and to the extent the Soparfi has distributable reserves available. However, a repurchase by a Soparfi

of all shares from one or more shareholders, who thereby cease to be a shareholder, followed by a

cancellation of such shares is not considered a dividend and is, therefore, not subject to Luxembourg withholding

tax. For non-residents the taxation would be the same as for capital gains and liquidation proceeds.

8.6 A repayment of capital (share capital and/or share premium) by a Soparfi is treated as a dividend, unless the

taxpayer proves that it is based on sound business reasons. Sound business reasons are deemed not to

exist if the reduction is financed by a loan taken up for that purpose or if the Soparfi has reserves available

for distribution.


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9 Other Issues

Debt-to-equity ratio

9.1 Luxembourg law does not contain debt-to-equity ratio provisions for a Soparfi.

9.2 Nevertheless, if loans are taken up from related parties or such related parties have guaranteed (re)payment

of obligations under loans taken up from third parties and these loans are used to finance the acquisition of

a participation, the Luxembourg tax authorities apply in practice a debt-to-equity ratio of 85:15 as a safe-harbour.

The interest rate on the loans within the safe harbour should be arm’s length.

9.3 Financing the acquisition of a equity participation to a higher extent with debt is in principle accepted, as long

as the interest on the total debt cannot be considered excessive. Interest will in that case not be considered

excessive if the total interest on the debt does not exceed the interest that would have been due if

the participation had been financed with 85% debt to which an at arm’s length interest remuneration had

been applied.

9.4 Generally, interest is considered to be at arm’s length by the Luxembourg tax authorities if it does not exceed

12-months EURIBOR plus 200 basis points. If the taxpayer can demonstrate to the satisfaction of the

Luxembourg tax authorities that a higher interest rate should apply, such higher rate should be allowable.

9.5 If interest payable on the loans taken up to finance the participations is considered excessive, the excess

interest will be treated as a deemed dividend, so that in principle dividend withholding tax may become due

and the interest deduction may be denied.

Advance confirmation

9.6 In the case of doubt regarding the applicability of any of the above rules (e.g. whether the comparable tax

test is met), such applicability can generally be discussed in advance with the Luxembourg tax authorities.


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1.1 The principal structures available for private equity funds in the Netherlands are as follows:

(a) the Dutch limited liability company;

(b) the limited partnership; and

(c) the investment or mutual fund.

1.2 This paper considers the relative advantages and principal features of each of these structures against the

background of the securities regulations and the tax system of the Netherlands. A description of the special

considerations applicable to foreign private equity funds operating in the Netherlands is given in sections 2.31

to 2.33 inclusive.

2 The Dutch Limited Liability Company

2.1 There are basically two types of company structures available in the Netherlands:

• the naamloze vennootschap (NV); and

• the besloten vennootschap met beperkte aansprakelijkheid (BV).

2.2 In many respects these two types of company are identical. Both, for example, have limited liability and are

subject to the same tax treatment. However, some of the differences between them have important consequences

from the point of view of their suitability for use as private equity investment vehicles:

(a) the NV can issue registered shares or bearer shares or a combination of both. The BV, however,

can only issue registered shares. Registered shares are not represented by share certificates, but

are recorded instead in a shareholders’ register;

(b) only the NV may be listed on the Amsterdam Stock Exchange; and

(c) only the NV can qualify as an investment company with variable capital.

2.3 Both types of company are formed by way of the execution of a notarial deed of incorporation. This comprises

its articles of association. These should conform with the Netherlands civil code and certain specific regulations

as issued by the Ministry of Justice. As a result, it is sometimes difficult to set up the BV or NV so as to match

a corporate structure known in another jurisdiction.


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Van Doorne N.V. (legal) and Loyens & Loeff N.V. (tax)

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For example:

• non-voting shares do not exist;

• differences in voting rights require different classes of shares often combined with different par

values; and

• redeemable shares can only be created in a way which requires further action at the moment of

actual redemption. (Further action means a shareholder’s resolution approving the redemption of the

shares, publication of the proposal for redemption in a national newspaper and a compulsory waiting

period of two months after publication during which time creditors of the company may oppose).

2.4 The Dutch government has proposed a new bill to simplify the rules for BVs as set out in Book 2 of the Dutch

Civil Code and create more flexibility for shareholders to structure the BV in a way they prefer. Although the

full text of the proposed bill is not yet available, it is expected that more flexibility will be created in the

following areas:

• abolition of the minimum share capital requirement (now €18,000) for newly incorporated BV’s;

• a departure from the mandatory rules of Book 2 of the Dutch Civil Code;

• abolition of the link of voting power to nominal value of shares, i.e. freedom of the shareholders

to assign voting rights as they see fit;

• the option of giving shareholders of a particular class the right to appoint and dismiss directors;

• less strict rules for financial assistance;

• less strict rules for adopting shareholders’ resolutions without being obliged to convene a

shareholders’ meeting; and

• removal of mandatory character of restrictions on the transfer of shares.

2.5 It is noted in section 2.2 that only NVs can qualify as investment companies with variable capital. In the

Netherlands civil code, an investment company with variable capital is defined as a company:

• “the sole object of which is the investment of its capital in such manner as to spread the risks to

enable its shareholders to share in the proceeds”;

• “whose management is authorised by its articles to issue, acquire and dispose of shares in its

own capital”;

• “whose shares are officially listed on an exchange, safe for shares, in respect of which the articles

provide a special right in respect of the control of the company”. (The phrase “a special right in

respect of the control of the company” refers to the following: under Dutch corporate law, it is

possible to declare that certain key decisions, which are usually taken by a general meeting of

shareholders, must instead be taken by a meeting of a special class of shareholders, the class in

question normally identified as the holders of priority shares); and

• “whose articles state that the company is an investment company with variable capital”.


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2.6 Apart from the possibility of obtaining a listing on the stock exchange, the requirements regarding the offering

of shares in these types of companies to investors are identical under the Dutch Securities Regulations.

Taxation

2.7 Prior to describing the current Dutch corporate income tax rules it is noted that on 29 April 2005 the Underminister

of Finance issued a discussion paper ”Working on Profit” (the Paper). In the Paper the Dutch Underminister

of Finance describes the outlines of a reform of the Dutch corporate income tax system. The intended

effective date of the new rules is 1 January 2007. The amendments proposed in the Paper will, to the extent

(still) relevant be addressed below.

Dutch resident corporate shareholders - income from shares

2.8 A Dutch limited liability company (either the NV or the BV) is taxed on its worldwide profits. The 2006 tax rate

is 29.6% (25.5% for the first €22,689 of profits). The Paper proposes to further reduce the tax rate to 27.4%

in 2007, and to 26.9% in the years following. In addition, the Paper proposes to reduce the tax rate for the

first €41,000 of profits (currently: €22,689).

2.9 Dividends and capital gains received by a Dutch limited liability company are taxed as ordinary income, unless

the participation exemption applies. The participation exemption is applicable if all of the following conditions

are met with respect to the respective equity investments in portfolio companies:

(a) the company owns at least 5% of the nominal paid-up share capital of the portfolio company;

(b) the shares are not held as ’inventory’;

(c) if it concerns a non-Dutch portfolio company, the profits of the foreign portfolio company are

subject to a local profits tax; and

(d) if it concerns a non-Dutch portfolio company, the equity investment in the foreign portfolio

company does not qualify as a passive investment. Passive investment is not defined in law; it

basically means that the investment is solely held to derive a return from the investment that does

not exceed the return of a ‘normal’ portfolio investment. This non-passive investment test in

general does not apply for a shareholding of at least 20% (2006; 15% in 2007 and 10% in 2009)

in an EU portfolio company provided that this EU portfolio company is listed as a qualifying entity

in the EU Parent-Subsidiary Directive.

The Dutch Supreme Court has decided that the participation exemption is applicable even if the aforementioned

5% test is not satisfied, provided that it can be shown that the shares in a portfolio company are owned

“in the line of business”, i.e. the respective shareholding is not owned purely as a passive investment.


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The Paper proposes to abolish the non-passive investment test and the subject to tax test for non-Dutch

portfolio companies. This means that in principle, the participation exemption will apply to all Dutch and foreign

resident shareholdings, in which the fund owns at least 5% of the nominal paid-up share capital. If the

proposal will be adopted, as of January 1, 2007, the participation exemption will no longer apply to interests

of less than 5%, even if they are owned “in the line of business”.

As to 5% or more interest in a passive subsidiary, the participation exemption will apply only if the profits of

the subsidiary are adequately taxed. If this 'subject to tax' requirement is not fulfilled, the participation

exemption will not apply but instead a credit system will become applicable.

The treatment of interests in investment institutions (operation under a privileged tax regime) remains

unchanged; neither exemption nor tax relief will be available.

2.10 Losses realised upon the sale of a shareholding that a Dutch limited liability company has in a portfolio

company (including currency losses) which qualifies for the participation exemption are not tax-deductible.

There is one exception to this general rule of non-deductibility. This exception relates to a loss realised upon

the liquidation of a qualifying participation. Such a loss is in principle computed as the difference between the

liquidation proceeds (if any) and the historic cost price of the investment (in other words, the amount actually

paid at the time the investment was originally made, with no indexation, adjusted for any (in)formal capital

contributions and repayments of capital). There are, however, a number of stringent anti-abuse provisions

which limit the availability of liquidation losses substantially.

Dutch resident individual shareholders - income from shares

2.11 The income of Dutch resident individuals is taxed in three different boxes. In Box 1 income from employment

and enterprise is taxed. In Box 2 income from a substantial interest is taxed and in Box 3 income from savings

and investments is taxed. As a general rule, a Dutch resident individual (i) who's shareholding is not

attributable to his enterprise (Box 1) and (ii) who does not have a substantial interest in the company (Box 2),

is subject to income tax on the basis of a deemed income (Box 3). This deemed income is currently 4% of

the average fair market value of the qualifying assets minus the qualifying liabilities of the individual.

This average is generally determined according to the individual’s situation on 1 January and 31 December

in the relevant tax year. The fair market value of the shares on 1 January and 31 December in the relevant

tax year is generally taken into account for the calculation of this average. The deemed income is taxable at

a current rate of 30%. In such case the actual dividends received and capital gains realised on the disposal

or repayment of the shares, by a Netherlands resident individual are as such not taxed as income.

2.12 When a Dutch resident individual holds shares in a company that are attributable to the individual's enterprise

(Box 1) (or qualify as income from miscellaneous activities (overige werkzaamheden)), the individual will be

taxed at progressive rates up to 52% on dividends received and capital gains realised on the shares.


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2.13 When a Dutch resident individual has a shareholding in a company which shareholding forms a substantial

interest (Box 2) (and the shares are not attributable to the individual's enterprise) the individual will be taxed

at 25% on dividends received and capital gains realised on the shareholding. Generally, an individual will have

a substantial interest in a company if he, his spouse, certain other relatives (including foster children) or

certain persons sharing his household, hold, alone or together, whether directly or indirectly, the ownership

of, or certain other rights over, shares representing 5%. or more of the total issued and outstanding capital

(or the issued and outstanding capital of any class of shares) of a company, or rights to acquire shares,

whether or not already issued, that represent at any time (and from time to time) 5%. or more of the total

issued and outstanding capital (or the issued and outstanding capital of any class of shares) of the company

or the ownership of certain profit participating certificates that relate to 5%. or more of the annual profit of

the company and/or to 5%. or more of the liquidation proceeds of the company. A deemed substantial

interest is present if (part of) a substantial interest has been disposed of, or is deemed to have been disposed

of, on a non-recognition basis.

Limited double tax relief is granted for any foreign withholding tax suffered. Credit is available either under an

applicable double tax treaty or under the unilateral provision for the avoidance of double taxation (in the

absence of a double tax treaty).

Foreign corporate shareholders - income from shares

2.14 Foreign corporate shareholders of a Dutch company are in general subject to 25% Dutch dividend withholding

tax on dividends received. The dividend withholding tax rate can be reduced under tax treaties (normally to

5% for substantial shareholdings and 15% for all other shareholdings) and to 0% under the application of the

EU Parent-Subsidiary Directive.

Capital gains are not taxable. This is only different when the foreign corporate shareholder holds a substantial

interest in the Dutch company and that shareholding does not form part of the assets of an enterprise.

In the latter case, the foreign corporate taxpayer will be subject to Dutch corporate income tax at 29.6%

on dividends received and capital gains realised. Under tax treaties the right to tax capital gains is often

attributed to the state of residence of the substantial shareholder. The right to tax dividends is normally

reduced to the rates mentioned in the treaty (see above).

2.15 Repayment of capital by a Dutch limited liability company to its investors is usually treated as a dividend to

the extent that there are profits in the company. A repayment of capital contributed can however be made

free of tax if prior to such repayment the company’s articles of association have been amended whereby the

nominal paid-up capital on the shares is reduced with the amount of the capital repayment.


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A repurchase of shares is for Dutch tax purposes treated as a dividend to the extent the repurchase price

exceeds the average paid up share capital. However, for tax treaty purposes a repurchase of shares from

a substantial shareholder can, under circumstances, be treated as a capital gain (article 13 OECD Model

Tax Convention).

Foreign individual shareholders - income from shares

2.16 Dividends paid by a Dutch company to any foreign individual shareholders, that do not hold a substantial

interest in the Dutch company and that do not (have to) attribute the shares to the assets of a Dutch enterprise,

are in principle subject to the statutory withholding tax of 25%. This withholding tax can be reduced under

applicable tax treaties (often to 15%). Capital gains on the shares will, in principle, not be subject to tax.

Foreign individuals holding a substantial interest in a Dutch company will be subject to 25% income tax on

dividend payments received and capital gains realised on these shares (Box 2). The tax on dividends is often

reduced under an applicable tax treaty (often 15%). Under tax treaties the right to tax capital gains is often

attributed to the state of residence of the substantial shareholder.

Interest income received by Dutch resident companies

2.17 Income on loans (including interest and capital gains) received by corporate creditors is subject to Dutch

corporate tax, except for income on certain hybrid loans (see 2.24.2).

The Paper proposes to introduce an inter-company interest box, pursuant to which the balance of interest

aid and funds received on inter-company receivables would be taxed at a 10% rate. The lower rate will be

applicable only if the balance of inter-company interest received exceeds the balance of interest paid. The box

will be optional. If the option is exercised, all group companies must adopt the interest box.

Interest income received by Dutch resident individuals

2.18 As a general rule, a Dutch resident individual creditor (i) who does not hold a substantial interest in the debtor

(Box 2) and (ii) who does not carry on a business to which the receivable is attributable (Box 1), will be taxed

at 30% on a deemed income of 4% of the average fair market value of the qualifying assets minus the

qualifying liabilities of the individual on the taxable base (Box 3). The actual interest received and capital gains

realised will not be taxed as such.

When the individual creditor holds a substantial interest in the debtor the creditor will be taxed on the income

on his receivable (including interest and capital gains) as if he were an entrepreneur. This means that he will

be taxed at progressive rate up to 52% on the income received on his receivable. The same applies when

the receivable is attributable to an enterprise carried on by the individual creditor.


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Interest income loans received by foreign resident companies

2.19 The Netherlands do not levy interest withholding tax on interest payments made from the Netherlands,

except for dividend withholding tax over the interest on certain hybrid loans.

A foreign resident creditor will not be subject to Dutch corporate income tax on interest received and capital

gains realised on receivables on Dutch resident debtors, unless the foreign resident creditor holds a substantial

interest in the debtor and the receivable does not belong to the creditor's business assets. The Dutch

corporate income tax rate for 2006 is 29.6%.

However, based on an applicable tax treaty the Dutch tax on the interest will in general be reduced. Under tax

treaties the right to tax the capital gains is often attributed to the state of residence of the substantial shareholder.

Income on loans received by foreign individuals

2.20 The Netherlands do not levy interest withholding tax on interest payments made from the Netherlands,

except for payments on certain hybrid loans.

A foreign individual creditor will not be subject to Dutch income tax on interest received and capital gains

realised on receivables on a Dutch corporation, unless the foreign resident creditor holds a substantial

interest in the debtor. In the latter case the individual creditor will be subject to income tax at progressive rates

up to 52% in Box 1.

The Dutch individual income tax rate on the interest received and capital gains realised on receivables on

Dutch resident substantial interest shareholdings can be reduced under the application of tax treaties.

Losses incurred by Dutch corporate investors

2.21 Dutch corporate investors may in general deduct a loss resulting from their investment unless - and to the

extent - the participation exemption applies. If the participation exemption applies a loss can, subject to

stringent anti-abuse provisions only be deducted if the portfolio company is liquidated.

Losses incurred by Dutch resident individuals

2.22 Dutch individuals cannot deduct any capital loss in connection with the ownership of shares in a Dutch or foreign

company unless they have a substantial interest or when the shares are attributable to the individual's business

assets (please refer to section 2.11). Where Dutch individuals have a substantial interest, they can claim a

loss that can be offset – via carry back or carry forward – against income from (other) substantial

shareholdings. Under certain conditions the individual can claim a tax credit equal to 25% of the capital loss.


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Costs incurred by Dutch companies

2.23 Interest costs of corporate tax payers are in principle tax deductible, unless certain rules that limit the

deductibility of interest apply (such as thin-capitalization rules, specific anti-abuse provisions, rules for the

classification of debt into equity, or the arm's length principal). The limitation to deduct interest costs in relation

to foreign participations has been abolished per 1 January 2004. In connection therewith thin-capitalization

rules have been introduced per 1 January 2004.

2.24.1 Thin capitalization

In short, the thin capitalization rules provide that if a taxpayer has excess debt, the inter-est on the excessive

part is not deductible in any fiscal year. Whether a taxpayer is considered to have excess debt is determined

on the basis of the individual fixed ratio test or, upon election by the taxpayer, the group ratio test.

Individual Fixed Ratio Test (3 to 1). According to the legislative proposal, a taxpayer has excess debt if (i) the

amount of average debt of the taxpayer exceeds three times the average equity and (ii) the excess part of

the debt exceeds €500,000. The interest on the excessive part of the debts is not deductible in any fiscal

year. Debt is defined as the net amount of interest bearing cash loans receivable and interest bearing cash

loans payable. Equity is to be determined independently and is not intended to be the net amount of the

balance sheet total minus liabilities.

The thin capitalisation rules do not apply if the taxpayer does not form part of a “group” (and the interest

remains tax deductible if no other limitations apply). Furthermore, the amount of interest that is disallowed is

limited to the net interest due, directly or indirectly, to “related entities”. Related entities are defined as entities

in which the taxpayer has an interest of at least one-third (a subsidiary company), an entity that has an interest in

the taxpayer of at least one-third (a parent company), or an entity in which a third party has an interest of at

least one-third and that third party also has an interest of at least one-third in the taxpayer (a sister company).

Group Ratio Test. Upon election in the tax return, the taxpayer may alternatively choose the commercial debt-

to-equity ratio instead of applying the fixed ratio test based on the tax accounts. When the debt-to-equity

ratio of the taxpayer based on its commercial accounts is lower than the debt-to-equity ratio of the group as

a whole based on the commercial accounts of the group, the thin capitalisation rules do not apply.

For purposes of the group ratio test, the relevant amounts of debt and equity are to be determined based on

the financial annual accounts as drafted according to Dutch accounting rules or similar foreign rules, such as

U.S. GAAP. Unlike the fixed ratio test, debt is not defined as the net amount of cash loans payable and cash

loans receivable, but rather debt is to be derived from the commercial accounts. If the taxpayer forms part

of more than one group, the group with the largest balance sheet total will be taken as standard.


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2.24.2 Hybrid loans

Per 1 January 2002 new rules were introduced for the deduction of costs on 'hybrid loans'. Hybrid loans are loans

that have elements of debt as well as of equity. A loan instrument will be re-characterised as equity for tax

purposes if:

(a) the instrument has the appearance of a loan yet the parties intended the instrument to constitute

equity;

(b) the creditor grants a loan under such circumstances that the receivable, at the time of granting

the funds, is wholly or partly without value because the loan cannot or cannot entirely be repaid; or

(c) the loan is issued under such conditions that the creditor (to a certain extent) “participates” in

the (equity of) the debtor.

When a loan is re-characterised as equity the interest on the loan is not tax deductible.

A creditor is deemed to participate in the equity or the debtor ((c) above) if:

(a) the amount of the remuneration is fully dependent on the profits or distribution of profits by the

taxpayer (debtor) or an affiliated entity of the taxpayer and the loan has no fixed term or a term

exceeding 10 years; or

(b) the amount of the remuneration is partly dependent on the profits or distribution of profits by the

taxpayer (debtor) or an affiliated entity of the taxpayer, the loan has no fixed term or a term

exceeding 10 years and the part of the remuneration that is not dependent on profits is less than

50% of the market-remuneration for similar loans (same risk, same term, etc.) without a profit

dependent remuneration; or

(c) the amount of the remuneration is not (fully or partly) dependent on the profits or distribution of

profits by the taxpayer (debtor) or an affiliated entity, but the obligation to pay such remuneration

is dependent thereon. Furthermore, such loan is subordinated and either has no fixed term, or

has no fixed term or a term of more than 50 years.

When a loan qualifies as a hybrid loan, then the loan will be regarded as capital for corporate income tax and

dividend withholding tax purposes. Consequently, interest paid on the hybrid loan will be non-deductible for

corporate income tax purposes and will be subject to (in principle) 25% dividend withholding tax.

On the other hand, the remuneration on a hybrid loan will be exempt from taxation in the hands of the

recipient (subject to Dutch corporate income tax) if the recipient owns a shareholding in the debtor that

qualifies for the participation exemption.


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In case a foreign resident debtor pays interest on a hybrid loan to an entity subject to Dutch corporate income

tax, the remuneration will only be exempt under the participation exemption rules if it can be demonstrated

that the debtor has not been able to deduct the remuneration from its profits.

Costs incurred by Dutch resident individuals

2.25 Interest costs incurred by Dutch individuals relating to his shares in a BV/NV are not tax deductible unless

the individual:

(a) has a substantial shareholding in the BV/NV; or

(b) the shareholding belongs to the individuals business assets.

For shareholders with a substantial interest, the deduction can in principle only be offset against income from

a substantial shareholding (taxed at a rate of 25%.) For shareholders whose shares form part of his business

assets the interest is deductible from his taxable income in Box 1 (taxed at a maximum rate of 52%).

VAT

2.26 As a general rule, the management fee charged by the management company of a private equity fund (if owned

by two or more investors) is exempt from VAT.

2.27 The VAT position of the Dutch fund depends on the question of whether such a fund is treated as an entrepreneur

for Dutch VAT purposes. If so, VAT charged to the fund by a Dutch entrepreneur relating to VAT taxable

supplies of goods or services by the fund is recoverable and the same applies to the VAT under the reverse

charge mechanism if invoices are sent by EU entrepreneurs.

Invoices sent by entrepreneurs from outside the EU to the Dutch venture fund follow the reverse charge

system. Therefore, Dutch VAT is recoverable if the fund is treated as an entrepreneur for VAT purposes. If the

fund is not treated as an entrepreneur, no reverse charge arises; this means that there is probably no foreign

input VAT on the invoice and as the VAT is not reversed, no VAT is lost in the Netherlands.


2.28 Both the NV and BV are suitable for foreign investors given the comparatively low overall corporate tax in the

Netherlands and the availability of the participation exemption. Non-Dutch investors would normally only be

subject to a low dividend withholding tax whilst capital gains would in principle not be taxable in the

Netherlands. The dividend withholding tax could be avoided by interposing a feeder entity in a “tax friendly”

jurisdiction, for instance Luxembourg. Alternatively, a tax transparent limited partnership could be set up as

a parallel fund entity (see below).


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2.29 Private individual foreign investors in a Dutch limited liability company would normally have a limited liability

to Dutch taxation: please refer to section 2.11.

Taxation of foreign funds in the Netherlands

2.30 If a foreign company maintains a permanent establishment in the Netherlands, those gains and dividends

which can be attributed to that establishment will be subject to Dutch taxation in the same manner as for

Dutch resident companies and at the same rate(s).

2.31 Dutch permanent establishments might benefit from the participation exemption. Assuming that the participation

exemption applies, taxation on dividends and capital gains will be limited to minority interests (that is to say,

those with less than 5%).

2.32 An offshore company could become subject to Dutch taxation if its central management and control are

exercised in the Netherlands: this would depend upon the applicable tax treaty and/or Dutch domestic rules.

If liable to Dutch taxation, the offshore company would be treated the same as a Dutch incorporated entity:

it would thus be liable to Dutch taxation (including capital duty) on its worldwide activities and may enjoy the

participation exemption in respect of its qualifying investments.

2.33 A foreign fund could also be taxable in the Netherlands for the income derived from a shareholding in a Dutch

portfolio entity, if the fund holds a substantial shareholding in such portfolio entity and such shareholding

would not be considered to form part of the assets of an enterprise.

Carried interest

2.34 Management charges when paid by way of salary are in principle deductible in computing the profits of

a company.

2.35 In the absence of tax treaty provisions to the contrary, the manager’s salary will be taxable in the Netherlands

to the extent that the salary was earned for work performed in the Netherlands.

2.36 Remuneration received by way of a director’s fee is always taxed in the Netherlands, even where a tax treaty exists.

2.37 Dutch companies can issue shares, share options, phantom shares and other employee benefits to its

management.

2.38 When shares are issued to the manager in his/her own name, the manager would in general be considered

to earn taxable income to the extent the fair market value of the shares issued exceeds the purchase price

payable by the manager.


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The shares held by the manager would form so-called “box 3-assets” subject to tax at a flat rate of 30% on

a deemed yield of 4%. If the shares (or stock options) constitute a substantial interest, different rules apply:

please refer to section 2.11.

Please note however that a Dutch tax inspector has taken the position that the – in his view – “disproportionate”

part of the return payable on carried shares should be subject to tax in Box 1 as employment income (rate

up to 52%) if and when such disproportionate return has been realised, either as dividend or as capital gain.

This position is disputed and might therefore result in one or more court case(s).

The company will have to deduct a 25% withholding tax on dividends paid on the carried shares, unless

reduced under the applicable tax treaties. This dividend withholding tax can be credited against the Dutch

personal income tax due.

2.39 Management shares are sometimes held by an intermediary holding company, owned and controlled by

the management. This reduces the number of shareholders in the fund: this can simplify voting procedures.

Such an arrangement may also facilitate tax planning. Provided the management company is a Dutch

company owning at least 5% of the shares in the fund, the management company will have the benefit

of the participation exemption. Dividend income will be received tax-free by the management company.

The management decides internally whether to add these profits, for the time being, to the reserves, or to

distribute dividends from the management company, in which case the dividend withholding tax will apply in

the same way. Managers who own the shares in such intermediary holding companies can become subject

to tax on gains if they own a substantial interest.

Please note that in the recent view of the tax inspector described above, also the disproportionate part of

the return earned by such intermediate company on the management shares should be taxed in the hands

of the managers and therefore not at the level of this intermediate entity.

Employee Share Option Plans (ESOP)

2.40 As of 1 January 2005 all benefits derived from ESOPs will be taxable at the moment such benefits (i.e. capital

gains) are enjoyed by the employee. Taxation takes place against the normal (progressive) tax rates for Dutch

wage/income tax purposes (box 1). In other words, benefits derived through an ESOP are in fact taxed as

any other wage component (such as a cash bonus etc), be it that the benefit ultimately enjoyed by the

employee from an ESOP is linked to the share price/the success of the company.

2.41 Phantom Stock / Stock Appreciation Rights (PS/SAR). In brief: through PS/SAR the employee may enjoy a

benefit equal to the increase in value during a certain period of an x-number of shares in the company,

without actually receiving shares in the capital of the company. Generally, SAR's are taxed similar to an ESOP

for Dutch wage tax purposes.


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2.42 A tax benefit offered by Dutch (wage) tax law specifically for foreign workers employed by a Dutch based

employer, is the so called “30% facility”. Briefly, this facility offers the Dutch employer to pay qualifying foreign

employees a tax free compensation/remuneration to the amount of 30% of the employee's wages. A foreign

employee qualifies for this facility in cases where he/she possesses of specific expertise which can be rarely

found on the Dutch labour market. An additional benefit is that an individual benefiting from the 30%-rule can

opt to be taxed as a non-resident individual.

Marketability to different classes of investors

2.43 The offering of shares in a venture capital company to investors is subject to the Securities Markets

Supervision Act of 1995. If the shares in the investment fund are to be marketed to the general public, either

by way of a listing on a stock exchange or otherwise, a prospectus will have to be made generally available

which must satisfy various legal requirements. If shares are only offered to professional investors, there is no

requirement to publish a prospectus, provided there is sufficient protection so that the initial offering of the

shares and the subsequent trade therein will be restricted to professional investors only. When the private

equity fund is structured as an NV, which issues share certificates, a suitable selling restriction will have to be

printed on the certificates. In the case of a BV, which cannot issue share certificates, the articles of

association must contain clauses which restrict the free transferability of the shares.

2.44 Where the Dutch security regulations explicitly exempt an offer to professional investors from the prospectus

requirement, the Dutch regulations do not in the same way explicitly exempt offers to sophisticated

individuals. However, there is also a general exemption from the prospectus requirement in the case of

an offering of shares with a denomination of at least €45,000 each. This rule clearly aims to exempt

the sophisticated individual.

2.45 In principle, a private equity fund qualifies as an investment institution under the Netherlands Act on the

Supervision of Investment Institutions. This Act defines an investment institution (when a company) as “a legal

person which seeks or has obtained monies or other assets for collective investment in order to enable the

participants to share in the proceeds of investment”. To act as an investment institution the fund will have to

obtain a licence and will have to meet certain criteria and qualifications in order to obtain such a licence.

Recognising the fact that this Act does not primarily aim to protect investors in private equity funds, such

funds are exempt on the basis of a general exemption. The second general exemption applies to investment

funds in which only professional investors are allowed to invest. There is no exemption under this Act for

funds in which sophisticated individuals may invest.


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Conclusions

2.46 From the point of view of private equity investment, the Dutch limited liability company (both the BV and the

NV) has the following advantages:

(a) it provides limited liability to the investors;

(b) the participation exemption is an advantage for the fund, to the extent it applies, since neither

dividends nor capital gains from equity investments in portfolio entities are taxed;

(c) neither dividends nor capital gains that a Dutch corporate investor in a fund realises on its

investment shall be taxed, provided that the investor’s investment in the fund meets the

necessary requirements for the participation exemption (in other words, where the investor owns

at least 5% of the nominal paid-up share capital of the fund and so on); foreign investors could

avoid Dutch taxation by using a feeder entity in a “tax friendly” jurisdiction; and

(d) its choice of investment opportunities is lightly regulated.

Furthermore, as regards the NV (but not the BV), the company’s shares may be listed on the Amsterdam

Stock Exchange.

3 Limited Partnership

3.1 A limited partnership is known in the Netherlands as a commanditaire vennootschap or CV. It needs to have

at least one managing partner who is fully and personally liable for all obligations of the partnership and it

needs to have at least one limited partner who has no further liability than up to the level of what he or she

has contributed or should contribute to the partnership. Personal liability for the limited partner can only arise

when either the name of the limited partner appears in the name of the partnership or when the limited

partner is involved in the management of the partnership. There is no maximum to the number of partners.

The managing partner can be (and very often is) a limited liability company and this company can be owned

by the limited partners.

3.2 A limited partnership is formed through the execution of a partnership deed, which may be a deed under

hand. A deed under hand is an agreement, only signed by the parties thereto and which does not require

any notarial form. The Deed of Incorporation of a Dutch company must be in notarial form. Whether or not

the partnership is formed by way of notarial deed, the partnership has considerable flexibility in relation to

issues such as the type of contributions to the partnership (whether in cash or in kind), differences in profit-

sharing and voting rights.

3.3 The interest in a limited partnership cannot be quoted on a stock exchange.


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Taxation

3.4 A limited partnership is transparent for Dutch tax purposes if admission and/or substitution of limited partners

is only possible with the unanimous consent of all the partners, including both the general and limited

partners. Hence, the investors in the partnership are taxed as if they had received the income and capital

gains themselves. If the admission or substitution of limited partners is possible without the unanimous

consent of all the partners, the partnership is taxed as a corporation.

Dutch corporate limited partners in a Dutch closed limited partnership

3.5 Dutch corporate investors in a transparent limited partnership are taxed on their pro rata share of the profits

in the partnership irrespective of whether or not the profits or gains are distributed. Losses from the Dutch

limited partnership are deductible against other income of the corporation. Any losses on the sale of a share

in the partnership are also deductible. Any gains on the sale of a share in the partnership are taxed but current

taxation can be avoided if roll-over relief (mergers, etc) is available. However, such gains are not taxable if and to

the extent the participation exemption applies to such limited partner’s share in the income of the partnership.

3.6 If the partnership carries on its business through one or more foreign permanent establishments, the limited

partner may - based on an applicable tax treaty or the Unilateral Decree - claim double taxation relief to the

extent the income of the partnership is attributable to such permanent establishment.

Dutch individual limited partners in a Dutch closed limited partnership

3.7 For Dutch individual investors, the limited partnership share is either taxed as passive income or as business

income depending upon whether the partnership carries on an enterprise.

Dutch general partners in a Dutch open or closed limited partnership

3.8 The management share, received by the general partner, is tax deductible in computing the profit of the

limited partnership. It constitutes taxable income for the general partner as part of his/her overall profit share

from the partnership.

Dutch limited partners in a Dutch open limited partnership

3.9 Dutch investors in an open limited partnership are treated as shareholders, which means that limited partners

who are private individuals are taxed on the income distributed as if they had received a dividend. Corporate

limited partners in an open limited partnership are taxed on the income from their investment, unless the

participation exemption applies.


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Foreign limited partners in a Dutch closed limited partnership - general

3.10 If the limited partnership is regarded as tax transparent, foreign investors in a Dutch limited partnership are

also taxable in the Netherlands if their share in the partnership can be treated as a permanent establishment under

either Dutch domestic law or applicable tax treaties. If not, they might still be taxable in the Netherlands on

the income derived from a Dutch portfolio company of the partnership, in which they hold a substantial interest.

Foreign individual limited partners in a Dutch closed limited partnership

3.11 Generally speaking, a foreign private individual investor in a tax transparent limited partnership that carries on

a business (i.e. not holding mere portfolio investments) would be deemed to earn income in the Netherlands

taxable in Box 1.

Foreign corporate limited partners in a Dutch closed limited partnership

3.12 Also foreign corporate investors would in principle earn taxable profits in the Netherlands to the extent the

tax transparent partnership carries on an enterprise through a Dutch permanent establishment.

Foreign individual and corporate limited partners in a Dutch open limited partnership

3.13 Foreign limited partners in an open limited partnership, whether corporate or private individuals, are taxed as

shareholders. Dutch taxation would normally be limited to dividend withholding tax unless they hold a substantial

interest in the Dutch open partnership or if the partnership interest would be attributed to a permanent

establishment in the Netherlands.

Foreign general partners in a Dutch open or closed limited partnership

3.14 Foreign general partners, whether corporate or individual, would be taxed in the Netherlands if their interest

in a partnership constituted a permanent establishment in the Netherlands (place of management, office, etc).

In such circumstances, the management fees paid to the general partner would also be taxed in the Netherlands.

Marketability to different classes of investors

3.15 It is questionable whether the offering of interests in a limited partnership is subject to the Securities Markets

Supervision Act of 1995. If the Act would not apply, an offer to invest in a partnership would not be subject

to any legal restriction. As long as, in practice, investments in a private equity fund are made by professional

investors, the issue is of a somewhat academic nature.


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3.16 There is no doubt that a limited partnership will in principle be subject to the Act on the Supervision of

Investment Institutions. For the limited partnership the same exemptions apply as mentioned above in relation

to the limited liability company.

Conclusions

3.17 From the point of view of private equity investment, the limited partnership has the following advantages:

(a) it provides the investors with limited liability;

(b) it is tax-transparent except when structured as an open limited partnership, in which case it is

taxed as a Dutch limited liability company and the participation exemption may apply;

(c) its choice of investment opportunities is lightly regulated; and

(d) it is not subject to restriction on the number of limited partners.

3.18 From the point of view of private equity investment, the limited partnership has the following disadvantages:

(a) the interests in a limited partnership cannot be quoted on a stock exchange;

(b) a tax transparent limited partnership cannot enjoy treaty protection as it would not be treated as

a “resident” of a treaty country; and

(c) a tax transparent limited partnership would not normally enjoy the participation exemption.

4 Investment or Mutual Funds

4.1 Investment funds, also called mutual funds, do not provide limited liability for their investors. Furthermore,

they do not constitute a vehicle which can act and enter contracts in its own name. It merely provides its

investors with joint ownership of the underlying investments. Investments in portfolio companies will therefore

have to be made in the name of a fund’s investors. Investors may not like this and practical difficulties arise

when existing investors leave the fund and new investors step in. The fund is represented by the fund

manager. The securities or other assets in which the fund has invested must be deposited with a custodian.

Such funds can be closed-end or open-ended.

4.2 In closed-end funds the transfer of a shareholding denoting an investor’s participation in the fund itself (not a

shareholding which the fund has bought in a portfolio business) requires the consent of all of the fund’s

shareholders. Closed-end funds are tax-transparent.

4.3 The open mutual fund is treated as a Dutch limited liability company for tax purposes. It is eligible for the

benefits of the participation exemption regime.


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Conclusions

4.4 From the point of view of private equity investment, the investment or mutual fund has the following

advantage in that in its closed-end form it provides its investors with tax transparency. In its open-ended form,

it benefits from the participation exemption which, subject to the provisions being met, results in transparency

to tax on dividends and capital gains.

4.5 Despite the advantage of the investment or mutual fund given above, it is not a popular vehicle for private

equity investment because of the following disadvantages:

(a) the liability of investors is unlimited; and

(b) it may not act, such as when entering into a contract, in its own name.

5 Outline of the Dutch Tax System applicable to the Taxation of Income and Profits

Corporation tax on profits

5.1 Both income and capital gains are subject to corporation tax in the Netherlands at a flat rate of 29.6% (25.5%

for the first €22,689 of profits). The Paper proposes to reduce the tax rate to 27.4% in 2007, and to 26.9%

in the years following. The Paper proposes to reduce the tax rate for the first €41,000 of profits (currently:

€22,689) to 20%. Corporation tax is levied on Dutch resident companies, open limited partnerships, cooperative

societies, mutual funds and similar entities. Foreign incorporated companies may be subject to Dutch

corporation tax if their central management and control is exercised in the Netherlands. Provided certain

conditions are met, an investment in either a Dutch or a foreign company may qualify for the participation

exemption in which case dividends and capital gains in respect of this qualifying investment are exempt from

corporation tax.

Capital gains on the disposal of certain assets may be deferred into a replacement reserve provided

reinvestment is made within the 3 years following the year in which the disposal was made.

Dividends

5.2 A dividend paid by a Dutch company will be subject to 25% withholding tax unless reduced under an applicable

double tax treaty or the EU Parent-Subsidiary Directive. If the dividend is paid by a Dutch resident company

which qualifies for the participation exemption, no dividend withholding tax needs to be withheld. Dividends

paid by a subsidiary which is part of a fiscal unity with its Dutch parent can also be paid without withholding

tax. Upon request, a fiscal unity is granted if the parent company owns at least 95% of the shares in the

subsidiary. As a result, the profits/losses of the members of the fiscal unity are taxed on a consolidated basis.


144

5.3 Dutch resident companies which have a qualifying stake in another company, being either domestic or foreign,

may be exempt from corporation tax on any dividend (including stock dividend and hidden profit distributions)

by virtue of the participation exemption.

5.4 In the absence of the participation exemption, Dutch dividend withholding tax can be credited against

the corporation tax due. In respect of foreign dividends, the credit is usually limited to the applicable, lower

treaty rate.

Interest

5.5 Interest is not subject to withholding tax unless it is paid on certain hybrid loans, in which case the interest

is treated as a dividend for Dutch domestic tax purposes. This withholding tax may be reduced under the

applicable double tax treaty or the EU Interest and Royalty Directive.

5.6 As the Netherlands does not levy withholding tax on interest payments, the provisions of the double tax treaty

would normally not have any impact on the right to impose any withholding tax except in the case of certain

hybrid loans. This may be different in case the recipient of the interest holds a substantial interest in the debtor.

Capital gains

5.7 The Netherlands does not subject non-residents to tax on taxable gains unless the non-resident carries on

a business in the Netherlands through a permanent establishment to which the asset is attributed. Capital

gains on the disposal of Dutch real property are in principle always taxable in the Netherlands

Foreign companies may be subject to Dutch taxation on the capital gains in respect of a so-called substantial

shareholding in a Dutch company if the foreign company’s shareholding does not form part of its business

assets. This could be different when the foreign company is a resident of a tax treaty country.

Capital duty

5.8 The Dutch capital tax has been abolished per 1 January 2006.


5.9 In order to determine the existence of a permanent establishment, the Dutch Revenue would follow the guidelines

of the OECD-Model Treaty. Thus a permanent establishment would exist in the Netherlands if a non-resident

carries on (part of) his/her business through a branch, an office etc. situated in the Netherlands. The Netherlands

would tax that part of the profits, including the capital gains, which are attributable to the Dutch operation.

An investment activity may also be taxable if this activity is attributable to a permanent establishment.


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1.1 The majority of the private equity funds operating in Poland invest through Polish limited liability companies

(spółka z ograniczoną odpowiedzialnością) and not typical funds. The shares in the Polish limited liability

companies usually are owned by a holding company located in other jurisdictions, such as the Netherlands

or Luxembourg.

Limited Liability Company (LLC)

1.2 The minimum share capital of a Polish LLC is PLN 50,000 (approx. €13,000). The minimum nominal value

per share is PLN 50. The shares in the LLC can be paid for by both cash and in-kind contributions of tangible

or intangible assets (eg. real estate, movable property, machinery, trademarks, patents or copyrights, etc.).

The LLC must choose a city in Poland as its seat (e.g. Warsaw) and the registered office address of the LLC

must be located within the geographical limits of its chosen seat. Furthermore, the LLC must have a

registered address before its incorporation.

The LLC is represented and its business managed by a management board composed of one or more

members. As a rule, the members of the management board of an LLC are appointed by the shareholders

in a general meeting. The Articles of Association, however, may specify other rules regarding the appointment

of the management board (eg. appointment by the supervisory board, if such is appointed for the LLC).

A supervisory board must be appointed for the LLC only if there are more than 25 shareholders and the share

capital is PLN 500,000 (approx. €130,000) or more. It would be unusual for a wholly owned LLC to have a

supervisory board.

In order for an investor to establish an LLC, the Articles of Association of the new LLC must be executed by

the founders in front of a Polish notary public. An LLC is legally formed when it is registered on the Polish

National Court Register maintained by a local Polish Registration Court. After such registration, the LLC must

also be registered with the appropriate tax office.


A foreign fund structure will not receive special tax treatment in Poland. If it operates through a permanent

establishment, it will be fully taxable in Poland, in the same way as a Polish LLC. Most foreign funds invest

without a permanent establishment, and they will be, as a rule, subject to Polish tax only on Polish sources

of income, such as dividends, interest and capital gains. However, based on the tax treaties and/or EU

Directives, foreign funds if properly structured will benefit from exemptions from tax in Poland.


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3 Outline of Poland’s Tax System applicable to the Taxation of Income and Profits


3.1 The rate of Polish corporate income tax applicable to resident corporations (including LLCs) and to permanent

establishments of foreign companies is 19%. The corporate taxpayers pay during the tax year monthly

advances and make the final computation within 3 months after the end of the year. Companies resident in

Poland are liable to Polish corporate income tax on their worldwide income. The taxable basis includes all

sources of income such as income from operating activity, capital gains and interest. Special tax treatment

applies to income from dividends.

Dividends

3.2 Dividends are not tax-deductible by the distributing company.

Distribution of dividends is, as a rule, subject to 19% withholding tax. If the dividend is received by a Polish

company, the Polish company may credit 19% withholding tax against the tax paid on other sources of income.

The rate of Polish withholding tax on dividends paid to foreign shareholders may be reduced under the

relevant tax treaties.

The EU Parent-Subsidiary Directive has been implemented into Polish tax law. Dividends paid by a Polish

company to a company resident in another EU Member State will be exempt from tax in Poland if the EU

company has more than 20% holding in the shares of the Polish company for more than 2 years. This limit

will be reduced to 15% in 2007 and 2008 and 10% from 2009 onwards. The exemption from tax can be

applied before the 2 year period has elapsed.

Interest

3.3 Interest income derived by a company subject to Polish tax is taxed as other corporate income and at a rate

of 19%.

Interest payments are tax-deductible when they are due.

When interest is paid to a related party, arm’s length rates must be applied. The term “related party” refers

to a situation in which one company owns the majority of shares in another such that it has control over it.


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Interest is subject to Polish withholding tax at the rate of 20% when paid to foreign companies. This rate may

however be reduced under the relevant double tax treaty.

Poland has implemented the EC Directive No. 2003/49/EC on the taxation of interest and royalty income.

However, under Directive 2004/76/EC amending the Directive 2003/49/EC, Poland is allowed to apply

transitional periods for the application of a common system of taxation applicable to interest and royalty

payments. During a transitional period of eight years, started on 1 July 2005, Poland may levy withholding

tax on payments of interest or royalties at a rate of 10% during the first four years, and at a rate of 5% during

the final four years. After the transitional period, interest payments arising in Poland will be exempt from

withholding tax, provided that the beneficial owner of the interest is a company of another EU Member State,

or a permanent establishment situated in another EU Member State. In addition to that, the reduction in the

rate of the tax will only be applicable if the recipient holds at least 25% of the shares of the payor for at least

2 years. This condition is also met if the 2-year holding period is completed after the interest or royalty is paid.


3.4 The tax treatment of income derived from business activities is almost the same for individuals and

companies. Individuals operating a business activity are also subject to 19% Polish tax. As a rule, the tax

basis is the difference between taxable income and deductible expenses. The Polish tax regulations provide

for a list of the expenses which are not tax deductible.

Capital gains and losses on the sale of shares constitute a part of taxable income of a Polish corporate

taxpayer. This means that this either increases or reduces the taxable profit subject to 19% corporate income

tax. There is no participation exemption in Poland.

Tax losses may be carried forward for up to five years. However, in one year, the taxpayer cannot deduct

more than 50% of the losses which have been suffered in the previous five years.

VAT recoverability on the management charge

3.5 Management services provided to a fund by a management company are VAT exempt. Such services

provided to a limited liability company would be subject to VAT, and this company would in general not be

able to deduct such VAT. This issue is however hypothetical, since normally the limited liability companies are

not managed by external entities.


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Stamp duty

3.6 The transfer of the shares in a Polish company is subject to 1% stamp duty on the market value of the shares.


3.7 There is no separate domestic definition of a permanent establishment in the Polish tax legislation. Normally, the

relevant double tax treaty’s definition is followed. In general, the treaties limit the taxation of industrial and

commercial activities in Poland to the profits attributable to a Polish permanent establishment. The computation

of taxes on the profit of the permanent establishment generally corresponds to the computation for a Polish

resident company.


3.8 Poland has a comprehensive network of tax treaties with other countries for the avoidance of double taxation.

Each item of foreign income is treated as a separate source of income. Credit relief is given on a separate

source basis. Where foreign taxes are paid that are not covered by such a treaty, credit is given; this is limited

to what the Polish tax would have been on such income.


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1.1 The principal structures which are available for private equity funds in Portugal are as follows:

(a) the Venture Capital Company (VCC); and

(b) the Fundo de Capital de Risco (FCR).

1.2 This paper considers the relative advantages and principal features of these two structures against the

background of the Portuguese tax system, a summary of which is contained in section 5. Section 4 describes

special considerations for foreign private equity funds operating in Portugal.

2 The Venture Capital Company (VCC)

2.1 The framework applied to Venture Capital Company was amended in 2002 by the Decree-Law number 319/2002,

December 22 that tried to simplify the framework.

2.2 The VCC is structured as a Sociedade Anónima (SA). A Sociedade Anónima has limited liability.

2.3 The VCC must comply with the following requirements:

(a) Main objective:

(i) execution of temporary investments by periods no longer than 10 years in companies

with high development potential and the management of an FCR incorporated only

for qualifying investments;

(ii) the development of its activity includes:

(A) the acquisition of participations in companies with high development

potential;

(B) the acquisition of credits over companies in which it has or shall have a

participation;

(iii) the grant of credit or guarantees in favour of companies in which it has a participation;

(iv) the application of its excess cash flow in financial instruments;

(v) the execution of exchange transactions related to its activity; and

(vi) the acquisition of participation units in an FCR managed by it.


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(b) Secondary objective:

The VCC may develop activities needed to comply with its main objective, including:

(i) rendering services related to technical, administrative, commercial and financial

consulting in related companies;

(ii) execution of technical and economics studies connected with the viability of

companies and investment projects; and

(iii) rendering services related to the detection of investors.

(c) Forbidden activities:

(i) investment in activities not integrated in its main object, including the direct exercise

of agricultural, commercial or industrial activities;

(ii) investment in property, except that required for its own premises. If by means of

acquisition of assets or other legal instruments the VCC becomes the owner of a

property it has to sell it within the two years after the acquisition;

(iii) grant loans or guarantee loans taken by unrelated parties;

(iv) investment in companies that directly or indirectly control it;

(v) investment of more than 25% of its assets in one single company or more than 35%

of its assets in one single group of companies, over the two year period following the

start up of its activity; and

(vi) ownership of participations in companies for more than 10 consecutive or non-

consecutive years.

(d) Incorporation procedures:

(i) it must have a minimum share capital of €750,000 which must comprise cash or

participations in companies with high develop potential;

(ii) the shares are nominal shares; and

(iii) the VCC can not begin its activity without a prior registration with the Comissão do

Mercado de Valores Mobiliários (CMVM). The cost of this registration is €2,500.

2.4 There are no regulations affecting the split of unquoted versus quoted investments which may be made.


2.5 The Tax Benefit Code (TBC) provides that the calculation of the VCC’s taxable profit benefit from some

deductions, notably:

(a) deduction of the income corresponding to profits distributed by resident companies;

(b) deduction of the income corresponding to profits distributed by non-resident companies with

head-office in the EU;


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(c) deduction of capital gains resulting from participations held for more than one year; 54

(d) deduction of financial costs resulting from the acquisition of participations, provided that such

participations are held for a period of less than one year; and

(e) deduction of an amount equal to the sum of the income tax of the previous five years, provided that

such amount is used for investments in companies with a high potential of growth and valuation.


2.6 The VAT rate applicable to management charges is, since 1st July 2005, 21%. The VCCs may render limited

services – mainly technical and financial studies – for which they charge a fee, part of their revenue will be

liable to VAT. This enables them to recover VAT charged to them on a pro rata basis.


2.7 VCCs tend to be closely held by institutional or family investors. They have not proven to be a vehicle for the

public to invest in private equity. To float such a company, an initial public offer at the time of incorporation

or placement of existing shares by a public offer for sale – Oferta Pública de Venda – is possible. The Capital

Markets Commission oversees the related process. The same route is followed where the VCC wishes to exit

an investee company by a flotation of shares. A private placement, not involving an offer to the public, is a

much more flexible route, and the involvement of Capital Markets Commission is not required.

Carried interest

2.8 It is relatively easy to establish tax efficient carried interest for management. Capital gains realised on the sale

of shares in SAs held longer than twelve months are exempt from individual tax.

The Venture Capital Company: Conclusions

2.9 A VCC is not an especially attractive vehicle for venture capital investors, apart from offering limited liability.


54 The ownership period of one year is extended to three years if ths participation was acquired for:i) related companies;ii) companies with head office in countries with a more favourable tax regime;iii) resident companies with a special taxation system.Moreover the ownership period is also extended if the VCC results from the transformation of a company that did not benefit from this taxation system.

152

2.10 The principal disadvantages of a VCC are as follows:

(a) it does not offer any significant material fiscal or other legislative advantages over other forms of

investments;

(b) foreign investors derive no tax advantage from investment via a VCC; this is a result of a lack of

any general treaty provision requiring the investor’s home country to grant a credit for underlying

tax; and

(c) generally, direct investment gives those investors which prefer capital gains to a running yield, a less

regulated and an at least as equal tax efficient regime (Domestic individual investors must hold shares

for at least twelve months to receive tax free capital gains on their disposal. Resident companies

cannot avoid taxation on such gains, whereas non-resident companies are expressly exempted).

3 The Fundo De Capital De Risco

3.1 It has been possible to structure Fundos de Capital de Risco since 1991. The framework applicable to this

vehicles was recently updated by the referred Decree Law number 319/2002 dated December 28 and its

amendments (Decree Law number 252/2003 dated October 17 and Decree Law 151/2004 dated June 29).

3.2 The law provides two types of FCR:

(a) the FCR whose participation units must be subscribed by qualified investors (FIQ); and

(b) the FCR whose participation units may be subscribed by any investor (FCP).

Incorporation

3.3 The share capital of the FCR is potentially stable and should not be less than €1,000,000. The share capital

may be increased by new subscribers or reduced by means of a refund of capital, cover of losses or cancellation

of participations units.

3.4 Activities:

(a) the acquisition of participations in companies with high development potential;

(b) the acquisition of credits over companies in which it has or shall have a participation;

(c) the grant of credit or guarantees in favour of companies in which it has a participation;

(d) the application of its excess cash flow in financial instruments; and

(e) the execution of exchange transactions related to its activity.


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Forbidden activities:

(f) investment in activities not integrated in its main object, including the direct exercise of agricultural,

commercial or industrial activities;

(g) investment in property, except that required for its own premises. If by means of acquisition of

assets or other legal instruments the VCC becomes owner of a property it has to sell it within the

two years after the acquisition;

(h) grant loans or guarantee loans taken by unrelated parties;

(i) investment in companies that directly or indirectly control it;

(j) investment of more than 25% of its assets in one single company or more than 35% of its assets

in one single group of companies, over the two year period following the start up of its activity; and

(k) ownership of participations in companies for more than 10 consecutive or non-consecutive years.

3.5 The FCR are incorporated when the subscribers subscribe their first participation’s units. The subscription of

participations’ units in a FIQ depends on a prior registration before the CMVM.

The incorporation of a FCP depends of an authorisation from CMVM and the subscription of participations’

units depends on a prior registration before the CMVM.

The fee of the registration is €2,500.

3.6 Each FCR shall have management guidelines.

Management of FCR

3.7 Each FCR is managed by a management entity registered with the CMVM. This entity is the legal representative

of the FCR.

The assets of these management entities cannot be less than the following percentages of the FCR’s net profit:

(a) up to €75 million – 0.5%; and

(b) €75 million and above – 0.1%.

Corporation tax and capital gains

3.8 The FCRs that are incorporated under the Portuguese law are exempt of Portuguese corporate income tax.

3.9 The income resulting from the participations’ units are taxed as part of either Personal or Corporate Income

Tax, as appropriate.


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VAT recoverability on the management charges

3.10 The VAT rate applicable to management charges is, since 1st July 2005, 21%. The fund is exempt for VAT

purposes and so is enable to recover the VAT paid.


3.11 The rules governing the marketing and administration of FCRs are identical to those laid down in relation to

securities investment funds in general. The units of an FCR may be marketed directly to the public through

the depository banks where the related certificates are kept. The rules under which the fund is to operate

require the prior approval of the Bank of Portugal. The usual channels for marketing securities investment

funds are branches of the main banking groups. If and when FCRs begin to be placed or marketed, a similar

distribution method is likely to be employed. However this does not preclude private placements if investors

can be found in advance.

Carried interest

3.12 It is relatively easy to establish tax-efficient carried interest for management.

Capital gains realised on the disposal of shares in SAs held longer than twelve months are exempt from

individual tax.

Gains on the disposal of shares (quotas) in a private limited company are taxable at a 10% rate in the hands

of individuals. The acquisition cost is indexed in computing the taxable gain.

The FCR: Conclusions

3.13 Apart from offering limited liability a FCR may be an especially attractive vehicle for venture capital investors.

3.14 The principal disadvantages of a FCR are as follows:

(a) generally, direct investment gives those investors which prefer capital gains to a running yield a

less regulated and an at least as equally tax efficient regime (Domestic individual investors must

hold shares for at least twelve months to receive tax free capital gains on their disposal. Resident

companies cannot avoid taxation on such gains, whereas non-resident companies are expressly

exempted); and

(b) FCRs compete with traditional investment funds for the attention of private individuals.


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4 Special Considerations for Foreign Funds

The following aspects should be considered when dealing with a foreign fund:

Payment to low-tax jurisdictions

4.1 Payments made to entities located in low-tax jurisdictions of the standard corporation income tax rate, which

currently amounts to 25% are not deductible unless the taxpayer can prove that they relate to transactions

effectively realised and that they are not abnormal or exaggerated.

Imputation of profits to Portuguese shareholders

4.2 The profits of companies’ resident outside Portugal and subject to a taxation regime that is clearly more

favourable, as mentioned above, are imputed to their resident shareholders in proportion to their

shareholdings and independently of distribution where they hold, directly or indirectly, at least 25% of such

companies or, where more than 50% of the non-resident company is held, directly or indirectly, by

Portuguese residents, each holding at least 10%.

4.3 The Portuguese tax system is designed without regard to foreign structures such as the English limited

partnership or the Dutch BV or NV. Where a tax treaty is in force, Portugal will be obliged to treat income or gains

from participation in such entities as having the character given to them by the country of residence of the entity.

5 Outline of the Portuguese Tax System applicable to the Taxationof Income and Profits


5.1 Portuguese corporate tax applies to:

(a) commercial or civil companies in commercial form, cooperatives, nationalised corporations and

other collective persons under public or private law with their head office or place of effective

management in Portugal;

(b) entities without legal personality but with their head office or place of effective management in

Portugal, receiving income not otherwise liable to Individual or Corporate Tax; and

(c) entities which receive Portuguese income whether or not they have legal personality, or a head

office or place of effective management in Portugal.


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5.2 The following are taxable:

(a) the profit, including capital gains, of taxable entities which carry on an activity of a commercial,

industrial or agricultural nature;

(b) the total revenues of resident entities not carrying on an activity of a commercial, industrial or

agricultural nature;

(c) the profit, including capital gains, attributable to the Portuguese permanent establishments of

non-resident entities;

(d) revenues of various kinds, as defined for the purposes of Personal Income (IRS), received by non-

resident entities not liable to IRS. (The reference to IRS arises in this context as the IRS

regulations are the relevant rules for computation of the taxable income for non-resident entities

without permanent establishment in Portugal); and

(e) taxable profits are determined by making specified adjustments to the profits of the period, and

adding or subtracting any amounts not reflected in the profit and loss account but required to be

included for tax purposes. Accounts are normally drawn up to 31 December, but a different year

end for tax purposes may be requested.

5.3 The normal rate of corporate tax is 25% of profits with an additional municipal tax in certain areas of up to

10% of the corporate tax due.

Dividends

5.4 As of 1 January 2006, the standard rate of withholding tax on dividends is 20%.

Foreign source dividends are liable to a 20% withholding tax if paid through a local agent.

The above withholding taxes are final, but the resident may choose to include the income and benefit from

a 50% tax credit.

In the case of corporate recipients not qualifying for the dividend exclusion (see section 5.5), the gross

dividend is included in taxable income and a credit is granted for 50% of the underlying corporate tax.

5.5 Where the recipient of the dividend is a resident company and the shareholding is 10% or more and has been

held for at least one year or from the date of incorporation of the paying company (in this case, provided that the

shareholding is held for a minimum period of one year), none of the dividend is taxable. Portugal has implemented

the EU Parent-Subsidiary Directive with effect from 1 January 1992, giving the same favourable treatment to

dividends received in the same circumstances from companies resident in another EU Member States.


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Interest

5.6 Interest is subject to withholding tax when paid by an entity required to keep organised accounts.

5.7 The normal rate of 20% applies to bank deposit interest. For companies, this withholding constitutes a payment

on account, with any balance of tax due being paid on filing the annual corporate tax return. For individuals,

this withholding constitutes full settlement of their Portuguese tax liability, unless they opt to include it in

reported income, in which case they have the right to a tax credit.

Capital gains and losses

5.8 There is no separate capital gains tax in Portugal. Taxable capital gains of individuals and companies are

included in ordinary income and taxed at the usual rates.

5.9 Taxable capital gains or losses of companies generally differ from the accounting profit or loss, and an

adjustment to accounting gains or losses is usually required for tax purposes. Where the disposal takes place

two years or more after the acquisition, the cost of the asset is adjusted to reflect the effects of inflation.

Partial reinvestment relief is available for the excess of any capital gains over capital losses where the

proceeds are reinvested, before the end of the second year subsequent to that of the disposal, in fixed assets.

Where the disposal proceeds are only partially reinvested, relief is only available for the reinvested portion.

The untaxed gain reduces the cost for tax purposes of the new assets.

5.10 For individuals, gains arising on the disposal of the following items are excluded from the computation of

taxable capital gains:

(a) Portuguese corporate bonds or debentures;

(b) shares in SAs held for more than 12 months (this tax exemption doesn’t includes the capital gains

derived from the sale of shares of companies in which 50% or more of the assets of whole are

immovable property located in Portugal); and

(c) gains arising from the sale of a taxpayer’s Portuguese home provided that, within 24 months of

the date of sale, the proceeds are invested in a new home or in building or extending one, or in

land for this purpose.

5.11 For individuals, a 50% deduction is available in computing taxable gains on the disposal of:

(a) real property (real property means immovable property i.e. land and buildings);

(b) industrial property;

(c) a business lease or sub-lease; and

(d) intellectual property.


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5.12 In the Portuguese tax system, there is no capital gains tax, although a special rate of income tax of 10% is

applied to gains realised by individuals in the following circumstances:

(a) upon the sale of quotas: a quota is an ownership share in a Sociedade por Quotas, Portugal’s

most common limited liability company, sometimes referred to as a “Limitada” or “Lda”; or

(b) upon the sale of shares in SAs held for less than 12 months.

Capital duty and stamp tax

5.13 Portugal does not have capital duty and stamp tax on the transfer of shares.

The Limitada (Lda) versus the Sociedade Anonima (SA)

5.14 There are certain differences in the legal and tax treatment of the Limitada or Lda, Portugal’s most common

limited liability company, if compared to the Sociedade Anonima or SA, the other common corporate form.

These are as follows:

(a) transfer of ownership of an Lda always require a public deed, whereas, in some cases, this can

be avoided for an SA; in most cases where ownership changes will be frequent, an Lda will be

inappropriate;

(b) from a day-to-day point of view the two can be managed in broadly similar ways, although the

Lda can in some cases be less formally and bureaucratically managed;

(c) an SA must usually have a minimum of five shareholders, while an Lda only requires two (however,

it is now possible to incorporate a Lda with a single quota-holder); and

(d) property transfer tax (IMT) can arise on a transfer of ownership of 75% or more of the Lda but

will not on transfer of an SA.

Taxation of non-residents WITH a permanent establishment in Portugal

5.15 In most respects, the rules for calculating the taxable profits of a permanent establishment are the same as

those for a Portuguese company.

5.16 A permanent establishment is defined as “... any fixed installation or permanent representation through which

an activity of commercial, industrial or agricultural character is carried on.” The definition of the Portuguese

domestic law is somehow identical to the definition of the OECD Model Convention for the Avoidance of

Double Taxation. For companies located in countries where there is a tax treaty with Portugal, the rules

determining permanent establishment status may differ.


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5.17 In addition to the income and capital gains directly earned by a Portuguese permanent establishment, non-

resident companies are also liable to tax on income or gains of whatever character obtained through the

permanent establishment, or through the conduct in Portugal of identical or similar activities to those of a

permanent establishment already there.

Taxation of non-residents WITHOUT a permanent establishment in Portugal

5.18 Non-residents with no permanent establishment in Portugal are liable to Portuguese corporate tax (IRC) on:

(a) income from immovable property situated in Portugal, including capital gains arising on their

disposal; and

(b) certain types of income (dividends, interest and royalties, technical assistance fees and service fees).

The IRC liability in respect of these is usually collected at source at the rates shown in the following

table. Tax treaties may modify some of these rates or prevent Portugal from taxing the income.

In most cases, withholding fully discharges the tax liability of the non-resident.


The applicable withholding taxes are as follows:

Type of income Rate

Income from intellectual property and from the provision of information derived

from experience acquired in the industrial, commercial or scientific sectors 15%

Dividends 20%

Technical assistance fees 15%

Fees from services provided to resident entities (except transportation, communication and financial services) 15%

Income from the use or granting of the right to the use of agricultural, industrial, commercial or scientific equipment 15%

Interest on bonds 55 20%

Rental income 15%

Income arising from the holding of an office as a member of a statutory board 25%

Winnings from gambling or lotteries 35%

55 For interest on most treasury bills issued by the Portuguese Government, an exemption for non-residents was introduced in 1994.

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1.1 Slovakia has no specific legislation covering the private equity industry. As a general rule, a private equity

investment in a Slovak company does not require the establishment of a subsidiary or branch in the Slovak

Republic.

1.2 Offshore companies or special purpose vehicles incorporated in tax beneficial jurisdictions are commonly used.

1.3 Most Slovak private equity companies have adopted the structure of a limited liability company (spolocnost

s rucenim obmedzenym) or joint-stock company (akciova spolocnost). These structures provide limited liability

for the investors.

1.4 Moreover, general Slovak commercial partnerships (verejna obchodna spolocnost) or limited partnerships

(komanditna spolocnost) are also available.

Limited liability company

1.5 This is the form most commonly used by Slovak private equity companies.

1.6 The existence of the company is independent of its members.

1.7 The company is liable for any breach of its obligations with its entire property. The shareholder (participant)

is liable for the company’s obligations only up to the amount of his/her outstanding obligation undertaken to

be contributed, as registered on the Slovak Commercial Register.

1.8 The registered capital of a limited liability company must amount to at least SKK 200,000 and if founded

by a sole founder, it is to be paid up in full prior to the incorporation of the company onto the Slovak

Commercial Register.

1.9 The company must create a reserve fund in the amount stated by its Memorandum of Association. Unless the

reserve fund is established upon incorporation of the company, the company must create such fund from the

first financial year’s reported net profits by transferring a minimum of 5% of the net profits to the reserve,

subject to a maximum of 10% of the registered capital. The reserve fund shall be increased annually by

transfer of at least 5% of the net profits for the respective financial year until it reaches the amount set in the

Memorandum of Association of the company, which must be at least 10% of the registered capital.

1.10 The general meeting is the supreme body of the company authorised to take all major decisions. Based on

the decision of the general meeting, one or more executives are appointed (acting as the management body

of the company). The establishment of a supervisory board is not obligatory.


SLOVAK REPUBLICAdvokátska kancelária JUDr. Jaroslav Ružička in association with CMS CameronMcKenna v.o.s. and CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH

161

Joint-stock company

1.11 The company is independent of its shareholders and that means that they are not liable for the debts of the

company. The company is liable for the breach of any of its obligations with its whole property.

1.12 The Slovak Commercial Code recognises public and private joint-stock companies. The public joint-stock company

is designed by the law as a joint-stock company issuing all or part of its shares based on call for subscription

of shares, or the stock exchange received the shares for trading on the securities market respectively.

1.13 The list of shareholders of joint-stock companies in the Slovak Republic is kept by the Central Securities

Depository.

1.14 The registered capital of the company may not be less than SKK 1,000,000 (approx. €25,000). Prior to

the incorporation of a joint-stock company, the entire registered capital must be subscribed and at least 30%

of the monetary contributions fully paid up.

1.15 Shares may be issued in either registered or bearer form. Registered shares may be issued in documentary

form with a share certificate or book-entered (dematerialised) form, whereas bearer shares can only be issued

in book-entered (dematerialised) form.

1.16 The supreme body of the company is the general meeting. The board of directors is the management body

of the company that manages company's operations and acts on its behalf. The board of directors decides

on all corporate matters, except for those reserved to the authority of the general meeting or the supervisory

board by Slovak law or the Articles of Association of the company, and it is responsible for ensuring proper

accounting and reporting procedures.

1.17 Joint-stock companies must create a reserve fund upon their incorporation amounting to at least 10% of their

registered capital. This reserve fund has to be increased annually with an amount defined in the company’s

Articles of Association, but subject to a minimum of 10% of net reported profits, until it reaches a limit shown

in the Articles of Association (which must account to at least 20% of the company's registered capital).

Tax-transparent companies

1.18 Slovak transparent partnerships are treated as legal entities (companies) and have a legal personality separate

from their partners.

1.19 The legal and tax treatment of Slovak partnerships is different in the Slovak Republic in comparison to the UK.


162

1.20 The taxation of Slovak tax-transparent partnerships depends on the type of the partnership. Slovak General

Commercial Partnerships are transparent for Slovak tax purposes and Slovak Limited Partnerships are

partially transparent.

1.21 A Slovak Limited Partnership can be established by at least one general partner (“komplementar” that is fully

liable for the partnership’s debts) and at least one limited partner (“komanditista” that bears generally no

liability beyond his capital contribution). The income (profits) portion pertaining to the general partner(s) is taxed

as part of the income of such general partner(s), and the part pertaining to the limited partner(s) is subject to

Slovak corporate income tax at the Slovak partnership’s level.

In theory, non-Slovak tax transparent entities should be treated as tax transparent by the Slovak tax

authorities. Consequently, if a foreign tax transparent entity invests in the Slovak Republic, the tax residence

of the partners should be taken into account, when applying the Slovak tax legislation and the respective

double tax treaties. This interpretation is supported by the OECD Commentaries and by the fact that the

Slovak Republic, as a member of the OECD, should apply its double tax treaties in compliance with the

guidelines set out in the OECD Commentaries. However, in practice it is still unclear if this approach would

be adopted by the Slovak tax authorities and what approach they would take in the case of the various

non-Slovak investor entities. The transactions including non-Slovak tax-transparent vehicles investing into

Slovakia would therefore require analysis on a case-by case basis.


2.1 A foreign fund structure will not receive special tax treatment in the Slovak Republic. If it operates

through a permanent establishment in the Slovak Republic, it will be taxable in the same way as a Slovak

resident company. If a foreign fund invests without a permanent establishment, it will be taxed only on Slovak

sourced income.

2.2 In principle, non-Slovak investors are subject to Slovak taxation on gains derived from the sale of shares in

a Slovak company, even if they do not have a branch or permanent establishment in the Slovak Republic,

provided such capital gain is sourced in the Slovak Republic (i.e. the share purchase price is paid by a Slovak

tax resident).

2.3 However, under most double tax treaties concluded by the Slovak Republic, foreign investors are exempted

from Slovak taxation on gains derived from the sale of shares of a Slovak company, provided they do not have

a permanent establishment in the Slovak Republic.

2.4 We would expect that most double tax treaties concluded by the Slovak Republic follow this principle,

but each particular treaty needs to be checked on a case-by-case basis in this respect.


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3 Outline of the Slovak Republic’s Tax System Applicable to the Taxationof Income and Profits

3.1 The Slovak Republic has a relatively standard tax system similar to the tax systems in the member states of

the European Union.

3.2 Major taxes in Slovakia are:

(a) income tax (19% flat rate);

(b) value added tax (19% flat rate);

(c) municipality taxes (primarily real estate tax); and

(d) excise duties.

3.3 Slovakia operates a system of self-assessment, with tight filing deadlines. The tax authorities may perform detailed

audits. Significant interest and penalty costs may arise in respect of under-declaration and late payment of tax.

Income tax

3.4 Slovak resident companies are subject to Slovak corporate income tax on their world-wide income.

3.5 Non-Slovak resident companies will only be taxable on their Slovak sourced income.

3.6 The base for corporate income tax is the pre-tax accounting profit adjusted by increasing and decreasing

items. Only expenses incurred to generate, assure and maintain the taxable income of a company should be

treated as tax deductible. This rule is further detailed by listing examples of expenses, which should be treated

as tax deductible and those which should not.

3.7 The Slovak corporate income tax rate is 19% at present.

3.8 A business year normally corresponds to the calendar year but the companies may harmonise their business

year with the business year applied by the parent company.

Dividends

3.9 Dividends are not tax-deductible by the distributing company.

3.10 Distribution of dividends already taxed at the distributor’s level is not subject to any further Slovak taxation

(i.e. withholding tax or tax securing).

3.11 Inbound dividends and liquidation proceeds are not subject to any Slovak income taxation.


164

Interest

3.12 Slovak tax legislation does not restrict or limit financing Slovak or foreign entities.

3.13 Interest income is taxed as other corporate income and currently at a rate of 19%. Interest payments are

tax-deductible when they are due.

3.14 Effective from 1 January 2004, the thin capitalisation rules were abolished in the Slovak Republic.

Therefore, there are no such rules limiting tax deductibility of interest on loans received from a parent

company or other related entities.

3.15 As a general rule of Slovak tax law, an arm’s length price should be set for related party transactions (such

as interest on loans). Should the parties fail to apply arm’s length prices, the Slovak tax authorities may adjust

the taxable base accordingly, which in practice will result in the tax non-deductibility of the interest (or the

relevant part thereof).

Capital gains

3.16 Capital gains derived from the disposal of shares/holdings are included in the taxable income of a Slovak

seller company and are taxed at the corporate income tax rate of 19%.

3.17 If a non-Slovak resident sells the shares of a Slovak company to another non-Slovak resident, no Slovak

taxation applies.

3.18 The income is treated as Slovak sourced income if the shares are sold to a Slovak tax-resident (whether

individual or corporate). However, if the seller is a resident of a state that has a double tax treaty with Slovakia,

under most of Slovakia’s double tax treaties, such income would not be subject to any Slovak taxation.

3.19 If the selling company is a tax resident in a jurisdiction, which has no double tax treaty with Slovakia (or the

respective double tax treaty allows for Slovak taxation of the capital gains), currently such income will be

subject to Slovak taxation by withholding tax of 19%.


3.20 Slovak tax legislation defines a permanent establishment in accordance with the OECD Model Convention.

3.21 The computation of the corporate income tax levied on a Slovak permanent establishment corresponds to

the computation of the corporate income tax levied on a Slovak resident company.


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Stamp duties

3.22 There is no stamp duty on the transfer of shares in the Slovak Republic.

3.23 The transfer of shares in a Slovak company is only subject to small registration fees for the registration of the

changes in the shareholders with the Slovak Commercial Register or the Central Depository.

Value added tax

3.24 The value added tax is based upon the framework of the relevant European Union Directives.

3.25 The unified rate of VAT is 19%.

3.26 A taxable entity is obliged to register for VAT purposes if it achieves a turnover of at least SKK 1.5 million

(approx. €35,000) during a maximum period of 12 months. For entities not exceeding this threshold,

voluntary VAT registration is possible.


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1.1 The structures available in Spain for private equity purposes are the following:

(a) Public Limited Companies, or Sociedades Anónimas (SAs), and Private Limited Companies, or

Sociedades de Responsabilidad Limitada (SLs);

(b) Private Equity Companies, or Sociedades de Capital Riesgo (SCRs); and

(c) Private Equity Funds, or Fondos de Capital Riesgo (FCRs).

1.2. Below is contained the analysis of the main characteristics of these structures, both from a regulatory and

tax standpoint.

2 Public Limited Companies (SAs) and Private Limited Companies (SLs)

2.1 SAs and SLs are limited liability corporations, whose incorporation requires the grant of a public deed before

a Spanish Notary Public, to be registered with the Commercial Registry. SAs and SLs can be incorporated

with a limited life, although this option is not very usual, SAs and SLs being commonly set up for an indeterminate

period of time.

2.2 SAs are governed by Royal Legislative Decree 1564/1989, of December 22. It is required that SAs have a

minimum share capital amounting to €60,101.21, fully subscribed and paid-up up to 25%.

2.3 It is possible that SAs have their shares listed on the stock exchange, upon compliance with certain

requirements, including reaching a minimum capitalisation of €1,200,000.

2.4 The Board of Directors of SAs must be formed with a minimum of three Directors. As an alternative to

the Board of Directors, it is also possible that SAs be managed by a sole manager.

2.5 It is required that an SA’s general shareholders meeting is held at least once a year.

2.6 No specific rules apply to investments made by SAs or interests held in SAs, unless they are listed SAs.

2.7 SLs are governed by Law 2/1995, of March 23 and SLs must have a minimum share capital of €3,005.06.

2.8 The functioning of SLs is very similar to that of SAs. However, it must be noted that, in general, less stringent

regulatory formalities apply to SLs (calling of general meetings, contribution of funds, etc.). Due to this reason,

the majority of companies filed with the Commercial Registry are SLs.


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Taxation

2.9 SAs and SLs are subject to the standard Corporate Income Tax regime and have no specific concessions.


2.10 VAT borne by the SAs and SLs as a result of management services charges will be normally non-recoverable,

due to the activity of the SA or SL.

Marketability

2.11 No specific rules apply.

Conclusions

2.12 The use of SAs and SLs as structures for private equity purposes has the following advantages:

(a) they have a limited liability standard;

(b) no limitation on the investments made by them or on the investments held by them apply; and

(c) SAs can be listed on the stock exchange.

SAs and SLs have the following disadvantages:

(a) there are no specific tax concessions; and

(b) there is no tax transparency.

3 Private Equity Company (SCR) and Private Equity Fund (FCR)

3.1 SCRs and FCRs are structures governed by current Law 25/2005, of November 24 (“the Law”), which

entered into force on December the 26th 2005. SCRs must have the form of an SA. It is required that SCRs

have a minimum share capital of €1,200,000, 50% of which must be paid-up at the incorporation and the

rest within a three year term. Contributions to the share capital of SCR must be made in cash, in eligible

assets or in fixed assets (with the limit, in the latter case, of 20% of the share capital). Once the minimum

share capital has been reached additional contributions may be paid up in fixed assets or certain financial

instruments (principally debt instruments).


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3.2 In contrast, FCRs lack legal personality. It is required that FCRs have a minimum capitalization of €1,650,00,

contributed in cash at their creation. FCRs must be managed by a Management Company (Sociedad

Gestora de Entidades de Capital Riesgo).

3.3 The incorporation of SCRs and FCRs must be authorised by the securities regulatory authority, the Comisión

Nacional del Mercado de Valores (CNMV). Once the authorisation is obtained, a public deed must be

granted, and SCRs and FCRs must be registered with the Commercial Registry, and with the public registry

of the CNMV.

3.4 The Law introduces an important distinction between undertakings directed to qualified investors (which would

be subject to a “light touch” supervision, hereinafter referred to as “simplified undertakings”) and undertakings

directed to retail investors, which would be subject to more stringent supervision.

3.5 Simplified undertakings will be deemed to be directed to qualified investors provided that:

(a) they have twenty investors or less; for this purpose employees, managers or directors of the

undertaking or of its management company shall not be counted; and neither will institutional

investors;

(b) these investors qualify as “institutional investors”;

(c) each of the investors undertakes to invest at least €500,000; and

(d) the simplified undertaking is offered to investors without a public offering.

Simplified undertakings will benefit from a reduced supervision at the time of incorporation, since they do not

need to deposit with CNMV an informative prospectus and there is a legal presumption that they have been

authorised to operate if there has been no express administrative response to their petition in the period of

one month after the petition was filed by the promoters. Simplified undertakings (unlike those in the more

general regime) are not required to obtain a prior authorisation to modify their bylaws or regulations, provided

that the conditions that originated their treatment as “simplified” are not modified.

Venture capital undertakings in the general regime are required to release periodic information, by making

filings with CNMV, and to make such information available on demand to their investors. Simplified undertakings

are subject only to this second requirement.

3.6 The Law renders investments by venture capital undertakings more flexible than under previous legislation,

although no distinctions are made between simplified and non-simplified undertakings. The Law permits the

acquisition of listed companies, provided they are delisted within one year of investment, and also investment

in foreign venture capital undertakings; for the first time, the Law addresses specifically the creation of venture

capital “funds of funds” (both under the form of corporate and contractual funds), which are those that must

invest at least 50% of their assets in other venture capital undertakings.


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3.7 Generally, according to the Law, venture capital undertakings must invest at least 60% of their assets in the

capital of non-financial companies (although part of this ratio can be invested through loans to these

companies), although a certain degree of flexibility is given to allow for the periods following the creation of

the undertaking or disinvestment of an asset, and to take account of distributions made to investors and of

increases in capital of the undertakings. The Law also allows venture capital undertakings to develop other

activities, including that of advising companies in which they do not hold participations.

3.8 Additionally, the Law allows for the use of separate classes of shares (or parts, in the case of FCRs), that

could be used for the distribution of carried interest.

Taxation

3.9 SCRs and FCRs are subject to the standard Corporate Income Tax regime, and are therefore subject to the

standard 35% tax rate. However, in order to promote private equity activities, several tax concessions have

been granted to these entities. SCRs and FCRs are entitled to a profit distribution tax credit of 100% of the

tax payable on dividends and profit participations received from the qualified Spanish resident companies in

which they participate, regardless of their participation percentage in said companies and the holding period

of the stake. Likewise, SCRs and FCRs are entitled to a 100% participation exemption on dividends and

profit participations received from the qualified non-Spanish resident companies in which they participate,

regardless of their participation percentage in said companies and the holding period of the stake.

3.10 SCRs and FCRs are also granted a partial exemption from taxation of capital gains. Thus, capital gains arising

from the transfer of their participation in qualified companies are entitled to a 99% tax exemption if the

transfer takes place between the second and fifteenth year (both inclusive) following the acquisition of the

stake. Under exceptional circumstances, and subject to specific conditions, this period may be extended up

to the twentieth year. Except in this case, shares held for less than a year or for more than fifteen years, shall

not be entitled to the aforementioned partial exemption.


In summary, the tax credit is applied as follows, for fiscal years commencing on January 1st, 2004:

Years of holding to transfer date Applicable coefficient

1st year No exemption

From the 2nd to the 15th year (both inclusive) 0.99

From the 16th year onwards No exemption

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3.11 The Law, however, contains provisions that restrict the application of the above mentioned 99% tax

exemption for transactions between related parties.

3.12.1 The exemption shall not be applied when the purchaser of the shares or participations in the qualified

company is related to the SCR/FCR, or to its shareholders or participants, or is a resident in a listed tax haven

jurisdiction, unless the purchaser is one of the following persons:

(a) the participating company; or

(b) a shareholder or director of the participating company, who is not or has not been related

(according to the broad definition provided by the corporate income tax law) to the private equity

entity in a way other than the relation derived from being a participating company; or

(c) another SCR/FCR.

3.12.2 The 99% exemption shall also not be applied to capital gains arising from the transfer of shares if those

shares had directly or indirectly been acquired by the SCR/FCR from a person related to the mentioned entity

or to its shareholders or participants. In this particular case, the parties must have been related before the

acquisition of the shares took place.

3.12.3 Should the participation in a qualified company be transferred to a related SCR/FCR, the latter will inherit the

tax basis and acquisition date of the seller for the purposes of the 99% tax exemption.

For the purposes of 3.12.2 and 3.12.3 a party will be deemed related to another if it holds (either directly or

indirectly) 25% of the share capital or equity of the other party.

3.13 If a qualified company invested in by a SCR or FCR were to become listed on the stock exchange, the

application of the partial exemption on capital gains requires that the SCR/FCR transfers said participation

within a three year period to be counted from the admission of the company to the listing on the stock exchange.

3.14 The shareholders and other participants in the profits of the SCRs and FCRs are also granted a profit

distribution tax credit of 100% of the tax payable corresponding to dividends and profit participations received

from the SCRs or FCRs, regardless of their participation percentage and holding period.

3.15 In the transfer or reimbursement of the shares of the SCRs or FCRs, the shareholders shall also be entitled

to a tax credit equal to the tax payable which corresponds to the undistributed reserves assignable to the

transferred participation.

3.16 If the aforementioned dividends, profit distributions and capital gains derived from SCRs and FCRs are

received by non–resident shareholders without a permanent establishment in Spain (excluding tax haven

residents), neither the dividends nor the capital gains shall be considered as having been obtained in Spain.

Therefore, no withholding tax would apply in Spain.


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Costs

3.17 Management and custody costs are generally deductible against the dividends distributed by the SCRs

and FCRs.

3.18 According to the Law, both the incorporation and the capital increase of venture capital entities are exempt

from capital duty.

3.19 For the purposes of capital duty, merger operations between venture capital entities shall enjoy a 99% tax

credit on the tax basis of the merger. The exemption shall be of 100% if the operation qualifies for the special

neutral tax regime for mergers, spin-offs, asset contributions and share for share deals, set forth in the

Spanish Corporate Income Tax Law.


3.20 The management services charges made by a regulated and registered venture capital management

company to a SCR/FCR, are VAT exempt in Spain. In other cases, the management fees would be subject

to and not exempt from VAT in Spain and the VAT would be most probably non-recoverable due to the

activity of the SCR/FCR.

Marketability

3.21 No specific rules apply (except those noted above, as regards “simplified undertakings”).

Conclusions

3.22 SCRs/FCRs have the following advantages when used for private equity investments:

(a) they have limited liability;

(b) listing on the Stock Exchange is possible; and

(c) they are an attractive vehicle from a tax perspective. Both the SCR/FCR and their shareholders

benefit from preferential tax treatment.

3.23 SCRs/FCRs have the following disadvantages:

(a) they have regulatory limitations as to the investments they can make;

(b) the Law includes a number of anti-avoidance rules in order to benefit from the preferential tax

treatment; and

(c) SCRs / FCRs are not tax transparent.


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4 Taxation of Foreign Funds in Spain


4.1 The mere fact of investing in a Spanish entity (including SCRs/FCRs) does not lead to a permanent establishment

in Spain. Further, the existence of a permanent establishment in Spain to which the participation in the

Spanish entity is allocated depends upon several circumstances which can normally be controlled and avoided.

4.2 Foreign Funds must take appropriate measures in order not to establish a presence in Spain.

Tax treaty applicability for foreign funds

4.3 When a Double Taxation Treaty is in force between Spain and the country of residence of the foreign fund,

the said fund may be entitled to the benefits set forth in the relevant tax treaty. However, in order for these

favourable provisions to apply, the fund must obtain a tax residency certificate, in the sense of the Treaty,

issued by the foreign tax authority.

4.4 If the fund is unable to obtain a tax residency certificate (this is typically the case when the fund is tax transparent),

it would be taxed according to the Spanish Non Resident Income Tax regulations. However, if the fund is

characterised as a look-through entity (entidad en atribución de rentas) the Spanish Tax Authorities would

allow for the benefits of the treaty of the fund’s members to apply, subject to the provision of tax residence

certificates by the latter.

Anti-avoidance legislation for foreign funds

4.5 The Spanish tax legislation has an extensive number of anti-avoidance rules regarding tax havens.

Therefore, direct investment in Spain from a tax haven resident fund is not advisable.


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5 Outline of the Spanish Tax System applicable to the Taxation of Income and Profits

Corporation tax on profits applicable to funds and companies

5.1 Corporate Income Tax (Impuesto de Sociedades) is levied at a general rate of 35% on the net taxable

worldwide income of resident corporations and other associations that are deemed legal entities for tax

purposes. The relevant legislation is Royal Decree Law 4/2004, approved on March 5, 2004.

5.2 Both companies and branches are taxed on their net income (i.e., after the deduction of expenses incurred

in the development of its activities). However, in the case of branches, there are certain expenses which are

not tax deductible for CIT purposes (e.g. commissions, royalties, interest and payments for technical

assistance services made by the branch to its head office or to another permanent establishment of the same

head office).

Taxation of dividends

Spanish resident companies

5.3 The distribution of dividends and participations in profits of Spanish resident corporations, is subject to a 15%

withholding tax.

5.4 To prevent double income taxation Spanish resident companies are granted a tax credit of either 50% or 100%

of the tax payable corresponding to the dividend or profit distribution received from a Spanish resident subsidiary.

In order to benefit from the 100% tax credit, the recipient company must own, either directly or indirectly, at

least 5% of the paying company for at least one year prior to or following to the date of the profit distribution.

If these requirements are not met, the dividend/profit distribution shall be entitled to a 50% tax credit instead.

The 15% withholding tax on dividends and profit distributions shall not be applied when the entities meet the

requirements for the 100% tax credit.

This tax credit shall also be applied to corporate liquidations, shareholder’s and partner’s dismissals, acquisitions

by companies of their own shares or quotas to redeem them, mergers, spin-offs and similar transactions shall

be entitled to the mentioned tax credit for the undistributed profits of the qualifying subsidiary.

Excess of these credits can be carried forward for the following seven years.


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5.5 In order to avoid international double taxation, participation exemption is granted for dividends and capital gains

received from foreign subsidiaries provided the following requirements, among others, are met:

• a minimum participation of 5% is held for a period of at least 1 year (in the case of dividends,

before or after the date on which the payment is due);

• the subsidiary is subject to a CIT of identical or analogous nature as the Spanish CIT. This requirement

is deemed to be met if the subsidiary is resident in a country that has executed with Spain a double

taxation treaty including an information exchange clause. For capital gains, the aforementioned

conditions will have to be met during each year of the holding. A number of exceptions apply;

• 85% of the income of the subsidiary in the tax year of reference derives from revenues obtained

in the performance of an active enterprise outside Spain; and

• a tax credit is granted with respect to dividends and other participations in profits derived from

non-resident subsidiaries provided that the Spanish parent has held, directly or indirectly, at least

5% of the subsidiary for at least one year before or after the date on which the dividend payment

is due. The credit is granted for the foreign corporate income tax effectively paid by the direct

foreign subsidiary with respect to the distributed profits and by the second and third tier

subsidiaries, 56 provided that said foreign corporate income tax is included in the Spanish

company CIT base and the aforementioned requirements are met.

The amount of the tax credit corresponding to the dividend cannot exceed the Spanish corporate income

tax that would be payable if the income were obtained in Spain. Excess foreign tax credit can be carried

forward for the following ten years.

5.6 In addition, Spanish resident corporations (and, as from January 1, 2003, Spanish permanent establishments

of non-resident companies) deriving income from a foreign source that has been taxed abroad can credit the

lower of the following amounts:

(a) that effectively paid abroad for reason of a foreign income tax of a nature identical to or analogous

to the Spanish corporate income tax (CIT); or

(b) the tax payable that would have been paid in Spain if that income had been obtained in Spain.

This deduction applies on a per country basis except for foreign permanent establishment income which

is deemed to be separate, so that the limitation in this case is computed individually for each permanent

establishment. To determine the basis of the tax credit, foreign withholding taxes must be added to the income

earned abroad and included in the taxable base.


SPAIN

56 Provided that the first tier subsidiary has a minimum direct participation of 5% in the second tier subsidiary held for at least one year, and the second tiersubsidiary has a minimum direct participation of 5% in the third tier subsidiary held for at least one year.

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Excess foreign tax credit can be carried forward for the following 10 years. Taxes paid in listed tax haven

jurisdictions are not creditable.

5.7 Under domestic law, it may be possible to depreciate the shares of subsidiaries when a dividend is paid.

When the indirect foreign tax credit is available, the depreciation of the participation resulting from the

dividend paid, will not be deductible unless the profits out of which the dividend was paid have already been

taxed in Spain on a previous transfer of the participation.

Spanish resident individuals

5.8 Dividends received by a private individual from an entity who is subject to the standard corporate income tax

regime, shall be included in the individual’s taxable base. To mitigate double taxation on the distribution of

dividends and other profit participations, the above mentioned dividends shall be multiplied by 140% in order

to obtain a 40% tax credit (maximum effective tax rate: 23%).

Interest

5.9 Spanish interest payments are subject to a 15% withholding tax. The recipients of interest payments are

entitled to a tax credit for the amount of the withholding tax borne on those payments. Interest received by

a corporation will be taxed at the standard 35% rate, whereas interest received by individuals will be subject

to a progressive tax rate that ranges from 15% to 45% depending on the taxable base of the individual.

Spanish resident companies

Capital gains

5.10 Capital gains are taxed at the standard CIT rate (35%). Nevertheless, taxation on capital gains arisen in the

transfer of fixed assets linked to the business activity of the company (among them participations of, at least,

5% in other active companies) can be reduced to a 15% effective tax rate by means of a 20% tax credit

which requires the reinvestment of the funds obtained in the transaction in qualified rights and assets.

Partial re-investments are also allowed.

5.11 Capital gains arisen from the transfer of shares in other Spanish resident companies who are subject to CIT

either at the standard rate or at the rate of 40% shall also be entitled to a tax credit equal to the tax payable

which corresponds to the undistributed reserves assignable to the transferred participation provided that the

Spanish holding company has directly or indirectly owned at least 5% of the subsidiary for at least one year

prior to the date of the transfer.

5.12 Capital gains arising from the transfer of shares in non-resident companies will be taxed as explained in

section 5.5.


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5.13 During the life of a fund/company, a deductible provision is admissible for losses in the value of securities.

The Law does not contain any special provisions regarding the depreciation of shares quoted on the stock

exchange. Therefore, the accounting rules shall apply. Under these rules, the securities must be registered

at year end at the lower of book value or market value. The market value of listed securities will either be the

average quotation during the last quarter of the accounting year or the quotation on the date of closing.

5.14 In the case of marketable unlisted securities, the provision created in any one year may not exceed the

difference between the net book value of the company at the beginning of the taxable year and its value at

the end of the fiscal year, adjusted in accordance with distributions and contributions made during said period.

These amounts will reduce the acquisition cost of the relevant shares, and will therefore increase hypothetical

future capital gains.

5.15 The same criteria will apply to participations in the capital of group or associated companies (even if quoted).

5.16 The provision for losses in the value of securities shall not be deductible if participated entities were resident

in a tax haven.

Spanish resident individuals

5.17 Capital gains are determined by the difference between the transfer value of the asset and its acquisition value.

5.18 All long-term capital gains realised by individuals are subject to a 15% flat rate. A minimum holding period of

one year is required for a gain to qualify as long term capital gain.

5.19 A transitory regime applies to transfers of assets not connected to economic activities and acquired before

December 31, 1994. Such transfers attract additional tax benefits because the capital gain or loss derived thereon

is computed in accordance to the provisions set forth under a previous law that granted the tax payer with

the following reductions (for each year of holding of the asset rounded up): 14.28% in general; 25% for

quoted securities; and 11.11% for real property.

5.20 If the winding-up of a fund involves the realisation of its investments, then capital gains will be taxable at the

level of the fund. When the fund itself is then wound up, investors are also subject to tax on the capital gains

realised from their investment in the fund.


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6 Special Considerations for Foreign Investors

Dividends

6.1 Dividends and profit distributions are considered to be Spanish source of income if they are derived from

participation in the equity of any kind of Spanish resident entity. The concept is broad enough as to include

any kind of revenue, whether in cash or in kind, derived from equity participations.

6.2 As a consequence of the thin capitalization rules, interest in excess of the allowed ratio (3:1) for non-EU

related party debt can be recharacterised as a dividend.

6.3 Dividends paid by a Spanish resident company to a foreign investor are subject to a 15% withholding tax

at source, unless the reduced tax rates established in the relevant tax treaty are applicable or tax exempted

if the parent company is resident in the EU and all the requirements set forth in the Non Residents Income

Tax provision which implement the EU Parent-Subsidiary Directive are complied with.

6.4 Spain has implemented the EU Parent-Subsidiary Directive according to which, distribution of dividends by

Spanish companies to the EU parent company are exempted in Spain if the EU parent company has held

directly at least 20% of the capital of the Spanish subsidiary for a continuous period of one year prior to the

date on which the dividend is payable. Dividends distributed before the end of the one-year period are

subject to tax but the tax will be refunded when the one year period is met. Such exemption is not applicable

if more than 50% of the voting rights of the EU parent company are held directly or indirectly by individuals

or entities who are non-resident of the EU except:

(a) when such parent company is effectively engaged in a business activity directly related to

the business activity carried out by the Spanish subsidiary; or

(b) when its main purpose is the management and control of the subsidiary provided that it has

enough personal and material resources to do so; or

(c) when evidence is shown that the EU parent company has been incorporated for valid economic

reasons and not simply to benefit from a preferential tax treatment.

6.5 The exemption from withholding tax on dividends shall not be applied when the parent company is located

in a tax haven. In this regard, it must be noted that Luxembourg 1929 Holding Companies are considered

to be tax haven residents. Therefore, said holding companies shall be treated as companies resident in a

non-EU and non Treaty country.


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Interest

6.6 Interest is generally subject to tax at a 15% tax rate unless the interest is paid to an EU resident, in which

case is exempted from Spanish taxation.

6.7 On July 1st, 2005, EU Directive 2003/48/CE on savings income in the form of interest payments entered into

force. By the means of this Directive, all the EU members – except for Austria, Belgium and Luxembourg –,

and several other jurisdictions (Cayman Islands, Aruba, Anguila and Montserrat), have to automatically

exchange information regarding the saving income paid in the form of interest as well as certain capital gains

derived from collective investment institutions.

Luxembourg, Belgium and Austria together with 11 non-EU countries and territories (Switzerland, San Marino,

Monaco, Andorra, Liechtenstein, Turks and Caicos Islands, British Virgin Islands, the Isle of Man, Jersey,

Guernsey and The Netherlands Antilles), will levy a withholding tax on those payments instead of exchanging

information with the tax authorities of the recipient’s country of residence.

6.8 The EU Directive and the treaties signed with those countries and territories provide for a transitory period

during which these countries will practice the mentioned withholding tax (15% withholding until 2008, 20%

withholding until 2011, and up to 35% from there on) instead of providing the rest of the jurisdictions with

information regarding the identity of the recipient. 75% of earnings from the mentioned withholding tax shall

be transferred to the country of residence of the recipient.

Until the end of the transitory period, investors will choose whether they bear the cost of the withholding tax,

or they choose to provide the tax authorities of their country of residence with information regarding the

saving income that they receive in the form of interests as well as certain capital gains. After this period,

the exchange of information between all the mentioned jurisdictions shall be complete.

Capital gains

6.9 Regarding capital gains, Spain imposes a 35% rate on capital gains obtained by non-residents. Therefore, the

35% tax shall be applied to the transfer or exchange of the stock of Spanish companies even if the transferor

and transferee are non-residents in Spain and the transfer takes place outside of Spain.


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6.10 Gains deriving from the transfer of the stock of Spanish companies shall not be taxed in Spain if:

(a) the seller is resident in the European Union (excluding tax haven territories) and has not had a

participation in the Spanish company equal or higher than 25% during the last 12 months prior

to the transfer or the company’s assets do not mainly consist in real estate located in Spain; and

(b) the Spanish company is quoted on the Spanish stock exchange and the seller is resident in a

country that has signed a tax treaty with Spain that includes a clause of exchange of information.

6.11 Taxable capital gains are determined following the general rules applicable to resident individuals. Coefficients

regarding monetary depreciation for the calculation on capital gains derived from real property also apply, but

reduction coefficients for assets acquired before December 31, 1994 apply to non-resident individuals.

Capital losses

6.12 Under the current regulation, capital losses can be offset against future profits and can be carried forward for

the following 15 years.

Capital duty

6.13 Capital duty is levied on transactions such as the constitution, increase or reduction of capital, mergers,

etc of companies. The applicable rate is 1% on the nominal value involved (plus the premium issued if any)

or the market value of distributed assets. This tax is compatible with VAT but incompatible with property

transfer tax.

6.14 Capital duty is deductible from taxable income.

Transfer tax

6.15 No transfer tax is levied on the transfer of shares or fund participations (except in the case of real estate

companies).

Carried interest

6.16 The Law will make the implementation of these structures much easier.


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1.1 The principal structures which may be used for private equity funds in Sweden are as follows:

(a) a Swedish limited partnership;

(b) a Swedish consortium;

(c) a foreign structure;

(d) a foreign company; or

(e) a foreign limited partnership.

In addition to the abovementioned structures, there are presently some private equity vehicles being

structured as limited liability companies. However, the limited liability company is normally only used for family

and friends funds since the limited liability company structure has limitations which are not acceptable to

professional investors.

1.2 This paper considers the relative advantages and principal features of each of these structures against the

background of the Swedish tax system.

2 The Swedish Limited Partnership

2.1 A limited partnership and all partners must be registered in Sweden at the Swedish Companies Registration

Office. Limited partnerships consist of one or more limited partners and at least one general partner. A limited

partner will not under the provisions of the Swedish act governing limited partnerships have any obligation

for the debts and liabilities of the limited partnership in excess of the amount which it has committed to the

limited partnership. The general partner will be solely responsible for the limited partnership’s debts and liabilities

which exceed the responsibility of the limited partners.

Taxation

2.2 The limited partnership is tax-transparent and thus the partners will be taxed directly at the time the income

arises in the limited partnership. The income (profits or losses) from the limited partnership will be taxed in

the resident state of each limited partner, unless the business income is deemed to derive from a permanent

establishment in Sweden. In an advance ruling, income from a Swedish limited partnership was deemed to

be derived from a permanent establishment in Sweden. In another case, a county court has found that a

foreign investor (the limited partner) in a Swedish based buy-out fund has received income from a permanent

establishment in Sweden and therefore been subject to Swedish taxation. It should be noted however that

the matter has not been subject to judgment by the Supreme Administrative Court.


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2.3 Due to the fact that any income from the limited partnership which is taxed in Sweden will probably be

deemed to be business income, this causes a less favourable tax situation for Swedish tax resident

individuals and certain entities liable for Swedish income tax, which have favourable tax treatment for capital

gains in Sweden. Discussions have been initiated with the government to achieve equal treatment for the

investors regardless if they invest via a limited partnership or directly in the investee company.


2.4 The management charge is normally received by the general partner as an annual fixed fee based on the

commitment of the limited partnership. The management charge should not be subject to value added tax.

If an advisory company which is not a partner in the limited partnership receives the management charge,

value added tax should normally be added and this would be irrecoverable.

Carried interest

2.5 The general partner will receive a share of the limited partnership’s profit as compensation for its responsibility

as general partner. The carried interest should not be subject to value added tax.

Conclusions

2.6 The limited partnership has the following advantages:

(a) it is transparent for tax purposes;

(b) it provides limited liability by law for the investors; and

(c) management fee and carried interest should not be subject to value added tax.

2.7 The limited partnership has the following disadvantages:

(a) as it is transparent to tax, investors in the limited partnership are liable to tax when income is received

by the limited partnership and then most likely as business income which is unfavourable for

some Swedish investors (this might be changed, see above); and

(b) any value added tax payable by the limited partnership is irrecoverable and will only be deductible

as a cost.

3 A Swedish Consortium

3.1 A Swedish consortium is a private equity investment vehicle where the investors invest directly and in parallel in the

investee company. The consortium does not constitute a separate legal entity which may hold rights and be

subject to obligations by itself. A managing company will act as nominee for the investors for investment activities.


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The managing company will charge each investor a fee, which should not be subject to value added tax, for

the duties of the managing company. The managing company may receive a share of the consortium’s profit

based on risk taken by the managing company by assumption of an unlimited liability similar to the one the

general partner has in a limited partnership. The activities of the consortium will be governed by the same

act that governs limited partnerships. However, the rules for the consortium and the limited partnership differ

in certain aspects. Each investor must be registered with the Swedish Companies Registration Office.

Conclusions

3.2 The Swedish consortium has an advantage as a private equity investment vehicle since the investments are

held directly by the investors and thus favourable tax treatment for capital gains and dividends may be achieved

for investors who enjoy favourable tax treatment in Sweden for capital gains and not for business income.

3.3 The Swedish consortium has a disadvantage as a private equity investment vehicle in that the managing

company may often need powers of attorney from the investors in order to fulfil its duties.

4 Foreign Structures

Foreign company

4.1 A non-resident private equity investment company will not be liable to Swedish tax on capital gains made in

respect of Swedish assets, unless it is deemed to have a permanent establishment in Sweden. Certain

companies domiciled in the European Economic Area (EEA) may not be subject to Swedish capital gains

taxation on capital gains emanating from unquoted shares and quoted shares, if certain requirements are

fulfilled, even if the capital gain pertains to a permanent establishment in Sweden. Consequently, the company

may normally not act, directly or indirectly, via a dependent agent or other delegate in Sweden. However, an

independent delegate does not normally constitute a permanent establishment in Sweden. A management

charge paid by a Swedish company to a foreign company will not be subject to Swedish value added tax.

Conclusions

4.2 The foreign company has the following advantages as a private equity investment vehicle:

(a) no taxes are payable on capital gains in Sweden, unless the foreign company is deemed to have

a permanent establishment in Sweden in which case the capital gains are not tax exempt (other

than companies domiciled in the EEA which may be tax exempt, see section 4.1 above); and

(b) the management charge will not be subject to value added tax in Sweden.


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4.3 The foreign company has the following disadvantage as a private equity investment vehicle. There are onerous

requirements in certain cases that must be fulfilled if the company is not to be taxed in Sweden, for income

derived from Sweden. To achieve this, the company cannot act directly or indirectly through a dependent

agent in Sweden, which might present a problem if the investee company is resident in Sweden. The management

can therefore only act in a strict advisory role in order to avoid the risk of the investors being taxed in Sweden

due to a deemed permanent establishment in Sweden.

Foreign limited partnership

4.4 The Swedish tax authorities will regard the limited partnership as transparent for Swedish tax purposes and

thus look directly to the limited partners. Consequently the tax aspects must be investigated for the limited

partners in each case, especially the risk of the investors being deemed to have a permanent establishment

in Sweden due to the advisor acting as dependent agent or if the fund is deemed to have a fixed place of

business in Sweden.

5 Outline of the Swedish Tax System applicable to the Taxation of Income and Profits


5.1 Swedish limited liability companies are subject to national income taxation on their worldwide income.

For tax purposes, all corporate income is treated as business income. Capital gains and dividends received

on shares deemed to be held for business purposes should however normally be tax exempt when

calculating the taxable business income. Foreign companies are normally subject to national income taxation

in Sweden in respect of income derived from Swedish sources e.g. income from real property situated in

Sweden or income derived through a permanent establishment in Sweden. The corporate income tax rate

is 28%.

Dividends

5.2 Corporate income other than tax exempt income (see above) is subject to double taxation. Dividends paid

from a Swedish limited liability company to an individual resident in Sweden may first be taxed at a corporate

level and then taxed in the hands of the recipient. The tax rate at the individual shareholders’ level is in general

30% (in some cases 25%) unless the dividend derives from shares held in a closely held company in which

case the tax rate could be up to approximately 58% and in some cases could be reduced to 20%.

Dividends other than dividends received on shares deemed to be held for business purposes received by

a Swedish limited liability company or similar foreign companies domiciled within the EU are normally taxed

as business income at a tax rate of 28%.


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A foreign company which receives a dividend from a Swedish company may be subject to withholding taxation

in Sweden. The tax rate is 30%. However, the tax rate may be reduced through a tax treaty. No withholding

tax will be levied if the recipient is (i) a company within the EU and holds shares in the distributing company

representing 20% or more of the votes in the company or (ii) a company which in its home country is subject

to taxation similar to the taxation it would have been subject to had it been a Swedish limited liability company

and the dividend is received on shares deemed to be held for business purposes.

Group contribution

5.3 It is possible to transfer profit from one Swedish company (the paying company) to another Swedish company

(the receiving company) within the same group by way of group contribution. The contribution is tax deductible

for the paying company and is treated as taxable income for the receiving company. This is a benefit in leveraged

transactions, where interest payments may be set off against taxable income within the purchased group.

Interest

5.4 Swedish limited liability companies are subject to income taxation on interest income and foreign recipients

of interest payable from Sweden will not be subject to any withholding tax as long as the interest is not

deemed to constitute dividends, which could be the case if the interest paid is not on arm’s length terms. In

such case, the withholding tax on dividends could be applicable.

Capital gains

5.5 Other than the aforementioned taxation on shares deemed to be held for business purposes, capital gains are

taxed as ordinary business income. However, special rules apply for the calculation of capital gains arising from

i.a. the sale of shares in closely held companies and other property normally not owned by private equity vehicles.

A company, resident in Sweden, which sells shares in another company in exchange for shares in the

acquiring company may be granted a tax deferral if the following conditions are met:

(a) the compensation consists of shares in the acquiring company;

(b) the acquiring company holds more than 50% of the shares in the acquired company at the end

of the fiscal year; and

(c) with respect to the shareholder who exchanged shares, the sale (exchange) must have resulted

in a capital gain.

Subsequently, the capital gain will be taxed when the shares in the acquiring company are divested.

Where a foreign company sells Swedish shares at a gain, such gain is not subject to Swedish income tax

other than in certain circumstances where the holding is effectively connected with a permanent establishment

in Sweden.


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1 Available Domestic Structures

1.1 There is no local Swiss structure which is perfectly suitable for private equity funds in the current state of legislation.

1.2 The limited partnerships so often used in other countries do not have any Swiss equivalent. Further, regulatory

reasons prevent the use of a Swiss investment fund 57 for private equity and venture capital investments.

Thus, the only Swiss structure available to private equity funds in Switzerland is an “investment company”.

This structure entails, however, some corporate and tax disadvantages.

Swiss limited partnership

1.3 The Swiss limited partnership governed by Articles 594 et seq. of the Swiss Code of Obligations is a standard

general partner/limited partner structure with a general partner fully liable for all the partnership's liabilities and

limited partners liable only for up to the amount of their interest. However, there is a major obstacle to using

the Swiss limited partnership as a private equity fund. By law, the general partner must be an individual.

Given the nature of private equity investments, individuals do not readily assume such risks.

1.4 This situation will change with the upcoming revision of the Swiss legal and regulatory framework applicable

to investment funds by the adoption of the new Collective Investment Schemes Act (CISA) which is currently

pending before parliament (see section 6).

Investment company

1.5 The investment company is a Swiss corporation limited by shares (société anonyme - Aktiengesellschaft)

governed by Articles 620 et seq. of the Swiss Code of Obligations (SCO). Ordinarily, a standard Swiss holding

company (HoldCo) is set up as a two-layer structure with a wholly owned offshore subsidiary. HoldCo collects

funds by issuing shares to the public and the targeted private equity investments are then made through the

offshore subsidiary. The HoldCo does generally not make dividend distribution. Sometimes, the two layer

structures are combined with direct investment in corporations or real estate interests. Several companies

structured in this way have been listed on the SWX Swiss Exchange (SWX) over the past few years.

1.6 In the current state of legislation, the Swiss Investment Funds Act of 18 March 1994 (IFA) regulates only:

(a) Swiss contractual open-ended mutual funds; and

(b) “foreign mutual funds” whether in contractual or corporate form, whose shares or units are offered

to the public in or from Switzerland (please refer to the definition in paragraph 2.2 et seq. below).


SWITZERLAND Lenz & Staehelin

57 A Swiss investment fund takes the form of a contractual collective investment scheme, i.e. a tri-partite relationship involving the fund managementcompany, the investors and the custodian bank.

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1.7 The Swiss investment company does not fall within the ambit of the IFA and is thus neither classified, nor

subject to supervision as a Swiss investment fund. The public offering of shares in a Swiss investment

company is governed solely by the provisions of the SCO applicable to Swiss stock companies generally.

Please note however that the current legal framework is under revision (please refer to section 6).

1.8 This being said, in view of all the disadvantages of the Swiss investment company – inter alia, cumbersome

capital increase procedures, absence of any redemption rights, extensive shareholders' rights as compared

to the usual limited partnerships structure – the structure that is mainly used for private equity investment

vehicles in Switzerland is, however, a foreign limited partnership.


2.1 Non-Swiss private equity funds set up as a foreign corporate structure or as a foreign limited partnership,

regardless of their home jurisdiction, are generally viewed by the Swiss Federal Banking Commission (SFBC)

as “foreign mutual funds”, which can be marketed in or from Switzerland only within the constraints of the

private placement rules.

Definition of “foreign mutual funds”

2.2 Swiss law defines “foreign mutual funds” (Article 44 IFA) as comprising:

(a) contractual and corporate collective investment schemes where investors have redemption rights

(open-ended structures);

(b) contractual and corporate collective investment vehicles which do not offer any redemption

rights to their investors (closed-ended structures), but which are subject in their jurisdiction of

incorporation to fund supervision; and

(c) other types of closed-ended collective investment structures which, although not regulated as

mutual funds in their jurisdiction of incorporation as per (ii) above, do not offer a minimum level of

investors' protection.

The SFBC has expansively construed this last category so as to include collective investment schemes which

do not offer corporate governance rights similar to those available to shareholders in a Swiss stock company

(e.g. voting rights, representation on the board or managing body thereof, etc.).


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Classification of foreign private equity funds

2.3 Under the current Swiss regulatory practice, foreign limited partnership structures fall within the category

described in paragraph 2.2 (c) above and are consequently classified as “foreign mutual funds” under

Swiss law. A foreign collective investment scheme with a foreign corporate structure is also classified under

Swiss law as a “foreign mutual fund” falling in this category.

2.4 This qualification results from the practice of the SFBC to consider that foreign corporate and limited

partnership structures generally do not offer a level of corporate governance rights similar to those available

to shareholders in a Swiss stock corporation, except when the following cumulative conditions are met:

(a) the investors (limited partners) are either (i) entitled to replace the general partner or the manager

or (ii) have a veto right on every new investment and the right to terminate the LP. These rights

are exercised and the decisions taken at general meetings of limited partners;

(b) the investors have extensive information rights as regards the assets under management;

(c) the investors have the majority of voting rights at the general meetings of limited partners;

(d) the general partner does not have any veto right against any resolution of the general meeting of

limited partners; and

(e) the LP agreement provides that a limited number of investors (the maximum allowed being a number

of investors representing 20% of the voting rights) may call a general meeting of limited partners.

Marketing restrictions

2.5 The public offering in or from Switzerland of units of or shares in a non-Swiss mutual fund is subject to the

prior authorisation of the fund by the SFBC (Article 45 § 1 IFA and Article 1a of the Implementing Ordinance

to the IFA, “OIFA”).

In accordance with Swiss law, foreign mutual funds may only be authorised by the FBC if:

(a) they are subject in their jurisdiction of incorporation to state supervision comparable to Swiss

standards; and

(b) the fund's organization as well as investment policy are comparable, as regards investor protection,

to those of Swiss funds (Article 45 § 2 IFA).

2.6 In practice, the SFBC considers that state supervision of collective investment schemes offered by the

Member States of the EEA, the United States of America, Guernsey and Jersey is deemed comparable to

that offered by Swiss law.


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2.7 That being said, “private equity funds” emanating from these jurisdictions generally do not meet the

comparability test referred to under 2.5(b) above to the extent they do not, as a rule, offer their investors the

minimal level of protection of their rights as required by Swiss law and, in particular, a redemption right. As a

result, interests in foreign private equity funds having a foreign limited partnership or corporate structure are

only suitable for private placement in Switzerland (i.e. maximum of 20 offerees in a given financial year or an

unlimited number of “institutional investors” 58).

Conclusion

2.8 In view of the above, the choice of a foreign structure for a private equity fund aimed at Swiss investors would

largely depend on the tax treatment of such structures (please refer to section 5), insofar as from a Swiss

regulatory perspective foreign private equity funds are characterised as “foreign mutual funds” and their

offering and distribution in or from Switzerland is therefore limited to the private placement exemption.

3 Outline of the Swiss Tax System Applicable to the Taxation of Income and Profits

Introduction

3.1 As indicated above, the only suitable domestic structure for private equity investments is an “investment

company”. The main issue which arises in structuring a private equity fund in Switzerland as an investment

company is the lack of tax transparency. This has two main consequences:

(a) the distribution of proceeds by the investment company, either during the life of the structure, or

upon its liquidation, will be treated as a dividend or liquidation proceeds, rather than a capital gain

(free from any tax for Swiss private non-professional investors) arising on the sale of an

investment at a profit; and

(b) the Swiss investment company would be subject to an additional layer of tax (double economic

taxation) which would not have arisen if investors invested directly in the desired target companies.

Section 4 provides a more detailed overview of the taxation of Swiss investment companies.

3.2 For tax reasons, Swiss individual venture capitalists' preference goes to foreign fund structures, which can

be treated as tax transparent for Swiss tax purposes and the investors can thus achieve direct capital gains.

Section 5 outlines in more detail the tax treatment of foreign fund structures marketed to Swiss tax resident

investors.


58 In substance, the concept of "institutional" investors comprises banks, broker-dealers, fund management companies, insurance undertakings, pensionfunds, as well as the treasury departments of large industrial and commercial undertakings. That being said, an investor qualifies as "institutional" only tothe extent it has entrusted at least one person with the management of its assets on a permanent basis. Further, independent financial advisers and highnet worth individuals are specifically excluded from that definition in the current state of legislation.

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3.3 Below is a comparative table showing the difference in tax treatment of a Swiss investment company and

a foreign limited partnership, from the perspective of a Swiss individual investor:

1 Listed Swiss investment companies allow investors to realise direct capital gains by selling their participation.2 Import of services is always subject to Swiss VAT under the reverse charge mechanism if the amount of fees paid for imported services per

calendar year exceeds CHF 10,000.3 Assuming that a tax transparent foreign limited partnership has been selected, which does not maintain a permanent establishment in

Switzerland.4 Export of services outside of Switzerland is not subject to Swiss VAT, unless the foreign limited partnership is controlled by Swiss resident

investors, in which case, the tax administration applies a “look-through” approach.5 This presupposes that the foreign limited partnership structure is not subject to any kind of reverse charge mechanism and that the services

provider does not levy domestic VAT.

Taxation of dividend and interest

3.4 The taxation of dividends and interest, whether at the level of Swiss investors or the Swiss investment

company, is subject to taxation as income at the ordinary applicable rates which are:

(a) For individual investors – progressive rates (federal, cantonal and communal levels) up to 43% for

Swiss resident, depending on the location of their tax residence in Switzerland; and

(b) For companies – proportional (flat) rates, depending on the canton where the Swiss company is

tax liable, and ranging from approx. 20% to 34% (effective rate). Investment companies are

typically able to achieve a holding company status, 59 thus being only liable to federal income tax

at the rate of 8.5% (7.83% effective). Further, income derived from qualifying participations may

be subject to further reductions on account of corporate income tax (see paragraphs 4.15 et seq.

below for conditions and details).


Structure Tax transparency VAT is a final cost

Double layer Direct capital gains Swiss investment Foreign investmentof taxation for investors manager manager

Swiss investment company � � 1 � � 2

Foreign limited partnership 3 � � � 4 � 5

59 Please refer to the specific requirements to obtain the status of "holding" company and the reduction for participation for income tax purposes which areset out in paragraphs 4.6 and 4.15 et seq. below.

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Capital gains

3.5 Individual investors – Capital gains realised by Swiss resident investors who are not deemed professionals

are tax free. This is the main reason for Swiss private investors to choose a tax transparent foreign investment

vehicle rather than a Swiss investment company for private equity investments.

On the other hand, capital gains realised by Swiss individuals holding their investment as business assets

(professionals) are subject to ordinary income taxation on the difference between the sale proceeds and the

acquisition costs (which generally amounts to the book value of the relevant assets).

The taxation of capital gains of foreign investors will depend on their tax regime in their jurisdiction of

residence, but such capital gains will normally not be subject to any tax in Switzerland, unless such capital

gains are attributable to a permanent establishment in Switzerland.

3.6 Companies – The capital gains realised by a Swiss company are taxable as ordinary income, subject to a

reduction for qualifying participations (see paragraphs 4.15 et seq. below).

Swiss VAT on the management charge and carried interest

3.7 The VAT treatment of management fees and carried interest will depend on the way these are structured.

Typically, the investment management is delegated to an external service provider, who will receive a

management fee and, as the case may be, some form of carried interest or performance fee.

3.8 Management fee – Investment management services are not VAT exempt in Switzerland. Thus, if the

investment manager is a Swiss entity providing services to a Swiss investment company, Swiss VAT will be

due at 7.6% on such fees and will be a cost to the Swiss investment company that generally does not qualify

as a VAT tax payer entitled to input VAT deduction. The same would apply where the investment manager is

a foreign entity, to the extent the amount of management fees is likely to exceed CHF 10,000 per calendar

year (application of the reverse charge mechanism).

If, on the other hand, the investment manager is a Swiss entity providing services to a non-Swiss investment

vehicle, the management fees will be exempt from Swiss VAT (zero-rated export of services), unless the

majority of the investors are Swiss residents.

3.9 Carried interest – There are no tax efficient ways to structure the carried interest with a Swiss private equity

investment company. Any carried interest payable to the investment manager would indeed be subject to

Swiss VAT either directly (i.e. levied by such manager) or indirectly (i.e. due to the application of the reverse

charge mechanism).


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The granting of share options or other form of incentive to the investment managers (individuals) which could

benefit from a favourable tax regime in Switzerland is only feasible where the latter are actually employees of

the investment company itself, something which is infrequent for private equity investment structures, mainly

because these are set up for a limited duration.

If such retention and/or bonus schemes are nevertheless put in place in the form of a stock and/or option

grant, the Swiss individual beneficiary will benefit from the following tax treatments:

(a) shares granted under an ESPP are taxable at grant on the difference between their fair-market

value and the acquisition price; however, if these shares are subject to a blocking period, their

fair-market value is discounted by approx. 6% per blocking year; and

(b) options granted under an ESOP are generally subject to taxation at grant on the difference

between their fair-market value and the acquisition price (if any). In this case, options are generally

valued according to the Black-Scholes model. If options are subject to a blocking period, the

value of the underlying shares is discounted accordingly, by approx. 6% per blocking year.

In certain cases, options may nevertheless be taxed upon vesting or upon exercise. This is notably

the case if the options are subject to a blocking period that exceeds 5 years or if they have a

duration that exceeds 10 years.

The tax regime applicable to shares and options acquired under employees’ retention plans is currently under

review in Switzerland. The entry into force of the new legislation is expected for 2007. For the time being, the

draft legislation that has been published provides in particular for a new tax treatment of options, which would

be OCDE compatible, options being subject to taxation upon exercise on the difference between the market

price of the underlying shares and the exercise price (strike).

4 Taxation of Swiss Investment Companies

Tax transparency

4.1 The Swiss investment company is not a tax transparent vehicle in the current state of legislation. This means

that the capital gains realised at the level of the investment company are not passed on to investors, but

transformed into ordinary income whether in the form of dividends or liquidation proceeds.

Another consequence of the lack of tax transparency is that the Swiss investment company is taxable on its

income and capital, something which adds an additional layer of taxation which is a final cost to investors,

who typically do not benefit from any tax credit (economic double taxation).


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Capital stamp tax

4.2 Capital stamp duty is due at the federal level at a 1% rate on the issuance of share capital (including

participating shares) and on any contribution made by the shareholders to the company's equity (so-called

“agio” or paid-in surplus).

4.3 As from January 1st, 2006, no stamp duty will be due as long as the equity subject to taxation does not

exceed CHF 1 million (previously CHF 0.25 million).

Corporate income and capital taxes

4.4 Corporate income tax – Corporate income tax is due at both the federal and cantonal levels. In all cantons,

municipal tax is due as well and in some cantons the companies have also to pay parish taxes. Generally,

corporate tax is subject to proportional (flat) rates. Net income, as determined in the statutory accounts of

the company, and more precisely in its “profits & losses” account, is subject to taxation, it being understood

that taxes payable are actually deductible for tax computation purposes. Net losses may be carried forward

for the following seven years. There is no loss carry-back.

Federal corporate income tax rate amounts to 8.5% (effective 7.83%) and cantonal/municipal (effective) tax

rate varies from 13 to 25%, depending on the canton where the company is tax liable. If the company is

characterised as a “holding” (see below), only federal corporate income tax is due (effective rate of 7.83%),

subject to any further reduction (e.g. participation reduction, see below).

4.5 Capital tax – Capital tax is due at the cantonal/municipal level exclusively on the company's net equity.

In some cantons, parish tax is due as well. Capital tax rate varies from 0.02 to 0.75%, depending on the

canton where the company is tax liable. If the company qualifies as a “holding” (see below), the tax rate may

be as low as 0.005%.

Holding status and other tax regimes

4.6 Holding status - If certain requirements are met, notably if more than two thirds of the assets of the company

consist in participations or if more than two thirds of its revenues are dividends, an investment company may

qualify as a “holding” company, in which case no corporate income tax is due at the cantonal/municipal level.

In the case of private equity investment companies, the above conditions will likely be met, insofar as the

main corporate purpose of the investment company will indeed be to hold participations in selected investee

companies.


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4.7 Taxation as domicile / auxiliary company – An investment company that does not qualify as holding company

may, under certain circumstances (particularly absent any significant substance in Switzerland), and in a

limited number of cantons as this particular treatment does not amount to a standard practice, qualify as

domicile/auxiliary company that is entitled at the cantonal and municipal levels to a more favorable tax

regime, according to which the cantonal/municipal tax rate may be lowered by 90% or even 100%, in which

case the company is simply exonerated at the cantonal/municipal level.

Taxation of dividends, interests and capital gains at the level of the investment company

4.8 Dividends and interests are generally subject to ordinary corporate income tax, unless the company qualifies as

a holding company (see section 4.6), in which cases they are exonerated at the cantonal/municipal level.

4.9 Dividends – If the conditions for a reduction for participations are met (notably if the dividends received derive

from qualifying participations; see below), corporate income tax due on dividends may be subject to a

reduction of at least 95%. In some cases, the reduction may even amount to a total exemption.

4.10 Interests – As per practice of some cantonal tax authorities, interests derived from loans granted to qualifying

subsidiaries are treated like dividends and are either exonerated (holding regime) or entitled to the reduction

for participations (see above).

4.11 Capital gains – The general rule for capital gains is that these are subject to ordinary corporate income tax

on the difference between the sale proceeds and the acquisition value (which in general amounts to their

back value) of the assets realised.

4.12 Because of lack of tax transparency, dividends received and capital gains realised at the level of the Swiss

investment company are not passed on to investors, but transformed into income either in the form of

dividends (during the life of the company) or liquidation proceeds (upon liquidation) which are subject to

ordinary taxation for Swiss individual investors.

In order to limit these disadvantages, Swiss investment companies typically do not make dividend distribution

and are listed on the SWX Stock Exchange or a foreign exchange. This presents the double advantage of

(A) allowing investors to realise capital gains (free from taxation for Swiss individuals who are not deemed

professionals) by selling their shares in the investment company into the market and (B) allowing for an exit

possibility to investors during the life of the company which is otherwise rendered difficult by the fact that

Swiss law does not allow for redemptions of shares.


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4.13 That being said, capital gains realised upon the sale of qualifying participations representing at least 20% of

the share capital of the underlying investee company (see paragraph 4.16 below) benefit from the reduction

for participation at all levels of taxation. Because of the nature of private equity investments, the conditions

for a reduction for participation will usually be met.

Taxation of returns to investors during the life of the investment company

4.14 To date, Switzerland has not taken any measure against double economic taxation other than the reduction

for participations described below in paragraph 4.15, which apply only to Swiss resident corporate investors.

Accordingly, in case of dividends distribution by an investment company to Swiss resident individual

shareholders, personal income tax is due at both federal and cantonal levels and no particular tax credit is

available. The tax rate is progressive and the overall tax burden may amount up to 43%.

Reduction for participations with respect to dividends received and capital gains realised by the investment

company

4.15 If certain legal requirements are met (see below), the Swiss investment company may benefit at all levels of

taxation from the reduction for participations, which applies with respect to dividends arising out of qualifying

participations, and according to which the corporate income tax due on dividend income at the level of the

company may benefit from a reduction of at least 95%. In some cases, the reduction may even amount to a

total exemption.

A qualifying participation is given for this purpose if the participation held by the investment company

amounts to at least 20% of the share capital of the investee company or if such participation has a fair market

value of at least CHF 2 million.

4.16 Capital gains realised upon the sale of qualifying participations may also benefit from the reduction for

participation at all levels of taxation.

A qualifying participation is given for this purpose if the participation sold represents at least 20% of the share

capital of the underlying investee company and if such participation has been held during at least 2 years.

4.17 From a practical perspective, the aforementioned conditions are usually met for Swiss investment companies

which serve as a private equity vehicle. A particular issue may however arise with respect to the qualification

of the underlying investee entity as a corporation, as the reduction for participations exclusively applies with

respect to shares held in a corporation.

Indeed, as per standard practice of the Federal Tax Administration, fund units and shares held in similarly organised

collective instruments do generally not qualify as shares for the purpose of the reduction for participation.


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Accordingly, depending on the organisational nature of the underlying foreign vehicles (e.g. Investment Trusts,

Mutual Investment Funds, SICAV, and other hybrid entities), it may be difficult to precisely determine whether

this particular regime applies, this all the more since there is very few published precedents on this, cantonal

and federal tax authorities do not always share the same view, and finally since this issue is debated among

the scholars.

As a consequence, if a private equity structure is put in place via a Swiss investment company holding an

interest in an offshore subsidiary (common two-layer Swiss investment structure), it may be advisable to

clarify this particular issue in advance by way of a tax ruling request filed with the competent tax authorities.

4.18 In case of disposal of the shares held in the investment company, Swiss resident individual shareholders

holding their shares as private assets are realising a tax-free capital gain. However, if the individual investors

hold the shares as a business asset, the difference between the sale proceeds and the acquisition (generally

equal to their book value) value of the assets that are disposed is subject to personal income tax.

Taxation of return of capital to investors upon winding-up of the investment company

4.19 The winding-up of an investment company may trigger taxation at both company and shareholders' levels.

Indeed, the potential liquidation proceeds are subject to ordinary corporate income tax, unless the company

is entitled to a specific regime (see above). Furthermore, upon distribution to Swiss resident individual

investors holding their investments as private assets, any amount that does not correspond to the

reimbursement of the nominal value of the share capital is subject to ordinary personal income tax. If the

shares are held as business assets either by a Swiss resident individual or by a Swiss resident corporation,

only the difference between the liquidation proceeds received by the investor and the basis of such

investment in its books of account is subject to taxation.

Swiss withholding tax

4.20 Under Swiss law, withholding tax is levied at the federal level, among other cases, on dividends, including

dividends upon winding-up of the company or hidden profit distributions such as constructive dividends,

distributed by Swiss resident companies, provided these distributions do not amount to a mere reimbursement

of share capital. The company making the dividend distribution levies Swiss withholding tax at source at the

rate of 35%, the tax being calculated on the gross amount of dividend paid to the shareholders.

4.21 Swiss individual investors may apply for the full refund of such withholding tax, provided they are the ultimate

economic beneficiaries of the returns and provided they declare the corresponding gross amount in their tax

return for personal income tax purposes. If a Swiss corporate investor holds a qualifying participation (> 20%) in

the investment company, the latter may replace the levy of withholding tax by a mere declaration.


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4.22 With respect to foreign investors, the withholding tax is final. It can however be reduced or eliminated in

application of double tax treaties concluded between Switzerland and the country of residence of the beneficiary

of the dividend. The withholding tax is usually reduced to 10 or 15% for foreign individual investors, and to

15, 10, 5 or even 0% for foreign corporate investors depending of the importance of the participation held.

In this respect it is important to note that, due to the entry into force on July 1st, 2005 of the bilateral

agreement entered into between Switzerland and the EU Member States on savings taxation, which also

implements measures equivalent to the EU Parent-Subsidiary Directive in Switzerland, the withholding tax

rate is reduced to 0% provided that specific requirements are met (e.g. participation of at least 25% of the

share capital, held during at least two years).

4.23 As a matter of principle, the reduction or elimination of the Swiss withholding tax described above is granted

by mean of a subsequent refund. Under certain circumstances, Swiss domestic rules which have recently

been enacted provide that such a subsequent refund may be replaced for qualifying corporate shareholders

by a reduction at source of the Swiss withholding tax rate. In most cases, the non-refundable portion of Swiss

withholding tax is subject to a tax credit in the residence country of the foreign shareholders.

Thin-capitalization rules

4.24 There are no specific rules in Swiss civil law that would impose a certain debt-to-equity ratio for investment

companies. However, the capital structure of Swiss companies is strongly influenced by tax rules that provide

for restrictions both at federal and cantonal levels.

Federal income tax law provides for instance for finance companies that the debt-to-equity ratio should not

exceed 6 to 1 for federal corporate income tax. In most cantons, the same rule applies for investment

companies with respect to both cantonal corporate income and capital tax, whereas some other cantons

allow for a ratio of 10 to 1.

4.25 These rules are of relevance to private equity investment structures only insofar as leverage is concerned. In

practice, however, the standard ratio of 6 to 1 allows for leverage of up to 85% debt and 15% equity, which

should be sufficient for even the highly leveraged acquisitions.

Swiss VAT and recoverability on management charges

4.26 According to Swiss VAT rules, management services supplied by third-party providers that are Swiss VAT

taxpayers are generally subject to VAT at the ordinary rate of 7.6%. Additionally, management services

supplied by foreign suppliers are also subject to Swiss VAT via the reverse charge mechanism (self-

declaration procedure), and this irrespective of whether the acquirer of such services is a VAT payer or not.


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4.27 Accordingly, the recoverability of input VAT may become a crucial issue. Under Swiss law, the recoverability

would heavily depend on the nature of the business activities carried out by the investment company, a full

recovery being only available in cases where such a company would exclusively perform taxable activities. In

most cases, however, due to the rather passive nature of the activities generally performed by investment

companies, which are mainly mere holding vehicles, input VAT would not be recoverable and would be a final

cost for the Swiss investment company.

Turnover stamp duty

4.28 Swiss investment companies dealing with securities (shares, bonds, funds units, etc) or acting as

intermediaries with respect to securities transactions are subject at the federal level to turnover stamp duty

on a self-declaration basis. The tax rate amounts to 0.15% (for Swiss securities) and to 0.30% (for foreign

securities) of the consideration paid in exchange for the securities subject to the transaction. If the securities

dealer acts as an intermediary, it must pay half of that duty for each party that does not evidence its status

of securities dealer or of exempted investor. If the securities dealer acts as a party in the transaction, he pays

half of that duty for himself and half of that duty for the other party that does not evidence its securities dealer

or exempted investor status.

4.29 Typically, individuals, corporations and other entities, the main activity of which consists in the purchase/sales

of securities or the intermediation of securities transactions, as well as Swiss corporations having securities

on the assets side of their balance sheet in excess of CHF 10 million qualify as securities dealers for stamp

tax purposes.

A Swiss investment company used as a private equity investment vehicle would as a matter of principle

qualify as a securities dealer for stamp tax purposes and would thus be subject to turnover stamp duty.

Personal net wealth tax

4.30 Swiss resident individual investors have to pay net wealth tax at the cantonal/municipal levels. In some

cantons, parish tax is due as well. The tax rates are progressive and may vary from 0 to 3%.

4.31 In general, for net wealth tax purposes, investments held in non-listed companies are valued at a lower

(discounted) value than fair-market value according to particular valuation rules provided for by the tax

authorities, which take into account favorable capitalisation rates. That being said, Swiss investment companies

are typically listed on a Swiss or foreign stock exchange (see above) and, therefore, the value of the market

value of the shares would serve as a basis for personal wealth tax.


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Venture capital companies

4.32 The Federal Law on Venture Capital Companies of 8 October 1999 allowing the creation of private equity and

venture capital companies (sociétés de capital risque - Risikokapitalgesellschaft) that would benefit from

special tax advantages, entered into effect on 1st May 2000.

That statute defines a venture capital company as being a Swiss joint stock company pursuant to Articles

620 et seq. of the Swiss Code of Obligations having as its purpose to put venture capital at the disposal of

Swiss companies and investing at least fifty percent of its funds in new companies with innovative,

international oriented projects and services.

4.33 This being said, the Federal Law on Venture Capital Companies of 8 October 1999 had a very limited impact

on the Swiss private equity industry. An extensive evaluation of the law commissioned by the State

Secretariat for Economic Affairs (SECO) was completed in January 2003. The recommendations made by

the authors of this report include the extension of tax advantages and the creation of a tax transparent

investment structure suitable for private equity.


4.34 The use of a Swiss investment company for non-resident investors may entail interesting features, in particular

for EU resident corporate investors willing to make exclusive investment in corporations by way of shareholding.

Indeed, Switzerland has a large double tax treaty network, enhanced by an attractive cantonal holding regime

and a federal reduction for participations regime. Additionally, in case of residual taxation at the federal level,

the corporate tax rate amounting to 8.5% (or 7.83% effective) is relatively low and no particular anti-abuse

provision applies if the investment company is organised as a pure holding company. Finally, upon distributions of

the current profits or winding-up of the investment company, withholding tax is no longer retained at source

if the investors are EU resident corporations holding qualifying participations in the Swiss investment

company, due to the application of rules similar to the rules applicable under the Parent-Subsidiary Directive.

However, even under such circumstances, the use of a Swiss investment company may present certain

disadvantages. The 1% capital stamp duty is due on all equity contributions. Swiss VAT may represent a final

cost in most cases. Finally, if the investment policy is oriented toward relatively large and short-term

investments, the investment company rapidly qualifies as Swiss securities dealer subject to turnover stamp

tax on each transaction.


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4.35 For the majority of other investors, Swiss withholding tax may only be partially refunded, leading to potentially

to significant temporary cash-outs due to the refund procedure. Furthermore, in the residence country, tax

credits may not be fully available against Swiss withholding tax. The same applies with respect to Swiss corporate

income tax that may not be creditable in the home country of the investors. Finally, Swiss withholding tax at

a rate of 35% may represent a final cost for foreign investors that are not entitled to treaty protection.

4.36 For gains realised on the sale of the shares in an investment company, absent any limited tax liability in

Switzerland due to the presence of a permanent establishment to which the gains are to be allocated, a

foreign investor would not be subject to Swiss taxes, irrespective of the nature of such investor.

Conclusions

4.37 From the point of view of private equity investment, the Swiss investment company has the following

advantages:

(a) it provides limited liability to the investors; and

(b) it may represent an interesting alternative for Swiss and EU resident corporate qualifying investors if

they are themselves entitled to participation exemption regimes and provided the Swiss investment

company qualifies as a holding company.

4.38 The Swiss investment company has the following disadvantages:

(a) it is subject to cumbersome capital increase/reduction procedures and gives to the investors

extensive shareholders’ rights that are compulsory and that may not be contractually

circumvented;

(b) it is not transparent with regard to taxes;

(c) it leads Swiss and most foreign resident individual investors to be subject to double economic

taxation, as no tax credits are available at the shareholder's level with respect to corporate

income tax paid at the company level; and

(d) it is subject to capital stamp duty, turnover stamp tax, and final VAT costs (e.g. in respect to

management charges and/or carried interest).


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5 Taxation of Foreign Fund Structures

5.1 Foreign private equity funds may take the form of a foreign corporate structure or that of a foreign limited

partnership. In practice, for Swiss tax purposes, the characterisation of a foreign entity, either as a legal entity

or a partnership, follows the rules of the law under which the foreign entity is organised. This approach

conforms to the applicable rule in Swiss international conflict law (Article 154 of the Federal Act on Swiss

private international law).

Unlimited income tax liability issues for foreign entities (corporate income tax)

5.2 According to Swiss rules, foreign legal entities may be subject to Swiss corporate income tax (unlimited tax

liability) if they are found to be effectively managed from Switzerland.

5.3 This rule also applies with respect to a foreign partnership, provided such partnership may be viewed as a

standing-alone legal entity. However, if the foreign partnership does not qualify as a legal entity under its own

domestic law, it cannot be subject to unlimited tax liability in Switzerland; it may nonetheless still be subject

to limited tax liability in Switzerland in case it has some other connection with Switzerland (so-called

economic affiliations).

5.4 In general, a legal entity will be considered as effectively managed in the place where the main business

decisions are taken and where the daily management and the core business activities of the company are

undertaken to achieve its statutory goal. As the case may be, the effective management can also be given

at the place where the business books and records are kept.

5.5 The practice distinguishes these criteria related to daily business activities from the performance of mere

administrative activities or of decision taking activities by the higher organs of the legal entity, as e.g. the

board of directors, if the decisions so taken are limited to mere fundamental decisions associated with the

general business strategy or to the mere control and ratification of the daily management. Please note in this

regard that the distinction between management and advisory services is of course crucial in these types of

structures.

5.6 In the case a foreign legal entity is deemed to be effectively managed in Switzerland, its liability for corporate

income tax is subject to the common rules presented above (see section 4).

Swiss withholding tax liability issues for foreign entities effectively managed in Switzerland

5.7 Swiss withholding tax is levied at the federal level, among other cases, on distributions made by Swiss

resident companies, funds or similarly organised collective investment vehicles, provided these distributions

do not amount to a mere reimbursement of share capital.


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5.8 An entity qualifies as a Swiss resident for withholding tax purposes if it either has its registered corporate

seat in Switzerland or if it is (i) effectively managed and (ii) carries on a business activity in Switzerland

(cf. Article 9 § 2 of the Federal Withholding Tax Act).

5.9 According to the scholars, the conditions of the above mentioned two-prong test applicable in case of

effective management in Switzerland are very similar to the conditions applicable for income tax purposes,

as they are defined above in section 4. Indeed, as per standard practice of the Federal Tax Administration,

the mere holding of shares is sufficient to admit a business activity for this purpose. Accordingly, the second

portion of the test appears to have very little practical significance.

5.10 It should nonetheless be emphasised that the tax authorities have not issued any guidelines or safe harbours

with respect to issues addressed in the preceding paragraphs 5.2 to 5.9. Accordingly, the place of effective

management is not determined on the basis of formal criteria, but in light of the specific circumstances of

each case. As a consequence, some level of certainty can thus be achieved in this respect only by obtaining

an advanced tax ruling.

Limited tax liability issues for foreign funds (corporate income tax)

5.11 A foreign entity, either organised as a stand-alone entity or as a limited partnership, that creates a permanent

establishment in Switzerland will be subject to Swiss limited tax liability on its net profits and net equity

attributable to the permanent establishment.

5.12 As a rule, a permanent establishment may be created due to the use of a fixed place of business in Switzerland,

in which a significant part of the activity of the foreign entity is exercised. The mere fact that books and

records are kept in Switzerland generally does not mean that income is realised through that location.

5.13 Specific rules apply to foreign partnerships having a permanent establishment in Switzerland. Indeed, under

such circumstances, even though domestic (and foreign, absent any economic affiliation in Switzerland)

partnerships are generally considered for Swiss tax purposes as transparent entities, such a partnership is

treated as a legal entity for corporate income tax (see Article 11 of the Federal Direct Tax Act) and is therefore

taxed in the same manner as the domestic legal entity which it legally or factually most closely resembles,

i.e. either as a (i) corporation, or (ii) an investment fund.


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Particular issue related to the characterisation of a foreign entity for Swiss resident investors

5.14 If a foreign entity is owned by Swiss residents, and absent any tax liability of such entity in Switzerland, the

additional issue arises as to whether the income derived by the Swiss resident owners should be classified

as dividend distributed by a legal entity, which is taxable in Switzerland as any other dividend, or income of

a foreign permanent establishment, which is not taxable in Switzerland for both Swiss resident corporations

and individuals, as such income is generally attributable to the place of incorporation.

5.15 If a foreign entity is considered to be a partnership for Swiss tax purposes and if such partnership has

a permanent establishment in Switzerland, the practical solution is that the foreign partnership is taxed in

Switzerland on profits and capital which does not include the portion of the Swiss resident partners in such

profits and capital, the Swiss resident partners being directly taxed on that portion as if the foreign partnership

were a transparent Swiss partnership.

Resident partners’ ability to deduct losses from foreign partnerships

5.16 When losses are incurred in a foreign partnership that does not maintain a permanent establishment in

Switzerland, the issue is whether the Swiss resident partner may deduct the losses from its own Swiss profits,

or whether the losses should be entirely abandoned to the state of residency of the foreign partnership.

5.17 Swiss tax law does not provide for specific rules in this respect. Accordingly, ability to deduct losses is subject

to the common rules. If the investor is a Swiss resident individual holding its investments in the foreign entity

as a private asset, he cannot offset these losses against its net income as capital gains are not taxable and

losses not deductible under such circumstances. If the investor is a Swiss corporation or a business

individual, it is very likely that such investor may be entitled to the rules made available by Swiss tax law to

Swiss corporations maintaining permanent establishment abroad. As a consequence, such an investor may

deduct from its Swiss taxable profit for a given tax period the losses incurred in the same tax period by a

foreign permanent establishment. However, the tax assessment of the Swiss resident investor for that given

tax period could be reopened afterward if the foreign permanent establishment makes a subsequent profit

during the next seven years and if the losses previously incurred are offset against such profit.

Dividends, interests and royalties from Swiss sources paid to foreign partnerships with foreign partners

5.18 In principle, Switzerland will apply Articles 10 to 12 of the OECD Model Convention to foreign partnerships

without taking in to consideration the residence of the partners, provided that the partnership has its place

of management in the contracting state.


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Therefore, in practice, partnerships managed in a treaty country may generally apply for direct reduction or

for partial (or, as the case may be, even total) refund of Swiss withholding tax under the applicable treaty. In

some cases, this particular regime is explicitly provided by the double tax treaties concluded by Switzerland

(see the treaties with Belgium, Canada, Denmark, Finland, France, Ireland, Italy, Japan, the UK, the USA, and

the treaties with Austria and Germany, which provide for specific conditions).

Swiss VAT on management services provided by Swiss suppliers

5.19 Management services provided by Swiss VAT taxpayers are generally subject to VAT at the ordinary rate of

7.6%, unless they are zero-rated because they are acquired by a foreign recipient. Indeed, under Swiss VAT,

these services qualify as immaterial services located at the place where the acquirer has its seat.

5.20 However, as per standard practice of the Federal Tax Administration, no exoneration applies if these financial

services are provided to an offshore passive investment entity that is controlled by Swiss resident investors.

In this respect, control is given if more than 50% of the investments are directly or indirectly held by Swiss

residents.

Suitability for foreign investors and conclusions

5.21 The use by foreign investors of foreign fund structures to hold investments in Switzerland present interesting

features, notably with respect to the ability to obtain, under certain circumstances, the refund of Swiss

withholding tax and the VAT exoneration on management services provided by Swiss service suppliers.

5.22 The interest of using such a structure significantly decreases if the foreign investment structures are effectively

managed in Switzerland or if they maintain a permanent establishment in Switzerland, in which case they are

subject to corporate income taxation in Switzerland. The same restriction applies with respect to foreign

structures holding direct real estate interests in Switzerland, which leads to immediate taxation in Switzerland.

6 Future Developments

Collective Investment Schemes Act

6.1 On 23 September 2005, the Swiss Federal Council approved the message to the Parliament relating to

the draft of a new “Collective Investment Schemes Act” (CISA). The draft CISA will be subject to modifications

taking into account the debates of the Swiss Parliament. The entry into force of the new legislation is not

expected before mid-2007.


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In view of the recent developments and needs of the markets, the primary aims of the revision are to adapt

the existing law to the new EU directive on UCITS and to strengthen the competitiveness of Switzerland as

a location for collective investment vehicles.

Regulatory developments

6.2 In particular, it is anticipated that the CISA would introduce the following changes:

(a) a new form of Limited Partnership for Collective Investment would be introduced which will be

mainly governed by the provisions of the Swiss Code of Obligations applicable to limited

partnerships generally, but a corporate entity would also be authorised to act as general partner.

This would provide the Swiss market with a viable local structure for Swiss private equity funds

(please see section 1.2);

(b) the concept of the Investment Company with Variable Capital, which has been inspired by

Luxembourg legislation, is one of the most innovative proposals. The capital of such structure is

not fixed in advance, but corresponds to the net asset value of the fund. This structure would

thus allow the continuous issuing and redemption of shares. Like contractual investment funds,

the Investment Company with Variable Capital would obviously be open-ended;

(c) Swiss investment companies would be classified under the CISA as a form of closed-ended

collective investment structure and would thus become subject to investment fund supervision.

That being said, they will remain mainly regulated by the relevant provisions of the SCO and stock

market regulations;

(d) Swiss independent asset managers, who are not subject to any state supervision on the current

state of legislation, except for anti-money laundering purposes, would be subject under the CISA

to a specific licence requirement, but only to the extent they act as asset managers for Swiss

collective investment schemes. Swiss asset managers acting for foreign investment schemes

would be allowed to opt for the same supervisory regime (“opting in”); and

(e) the CISA introduces few modifications to the current legal framework applicable to foreign mutual

funds. Under the draft, the scope of application of the Act would be clarified so as to explicitly

cover all open-ended and closed-ended non-Swiss collective investment schemes whether they

are subject to a State supervision in their jurisdiction of incorporation or not. For the rest, it is

contemplated that “high net worth individuals” would be included in the definition of “qualified

investors”, similarly to the EU Prospectus Directive, which is to replace the concept of

“institutional investors” applicable in the current state of legislation. From a practical perspective,

this would significantly widen the scope of the private placement exemption.


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Tax developments

6.3 The currently available draft CISA, which will certainly be subject to further amendments at the parliament

level, also clarifies some tax issues.

6.4 Both the limited partnership for collective investment and the investment company with variable capital

(SICAV) would be treated as transparent entities, similarly to what is currently the case for Swiss investment

funds (other than real estate funds which directly holds real estate interests and which are subject to direct

taxation like associations, foundations and other similar entities). This would effectively create a suitable

Swiss structure for private equity investments, insofar as this would enable capital gains to be realised directly

at the level of the investors, without any re-characterisation thereof at the level of the investment vehicle.

In addition, these investment vehicles would not be themselves subject to corporate income tax in

Switzerland. Nonetheless, Swiss withholding tax would be levied on the distributed earnings, if any, but not

on the capital gains realised by the investment vehicles.

6.5 Impact for Swiss investors – Investors that are tax resident in Switzerland would effectively be taxed on

the remitted earnings (income tax) and on their respective share in the structure's net capital (wealth tax).

6.6 Impact for foreign investors – Foreign investors would not be deemed to have a permanent establishment

solely by virtue of becoming investors in such an investment vehicle. Insofar as capital gains are concerned,

these will not be subject to any taxation in Switzerland (in particular no withholding tax would be levied).

Any distribution of earnings by the investment vehicle would, however, be subject to Swiss withholding tax

at the applicable rate, which may vary depending on whether the investor may benefit from a double-taxation

treaty or not.


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1.1 The principal structures which have been used for private equity funds in the United Kingdom are as follows:

(a) an English limited partnership;

(b) an English (or Scottish) company;

(c) a UK investment trust company;

(d) a venture capital trust;

(e) a UK unauthorised unit trust for exempt funds;

(f) parallel investment schemes or clubs;

(g) a foreign structure:

(h) foreign company;

(i) foreign unit trust; and

(j) foreign limited partnership.

1.2 This paper considers the relative advantages and principal features of each of these structures against

the background of the UK tax system, a summary of which is contained in section 10. The taxation of foreign

structures in the UK is considered in section 9.

2 The Limited Partnership

2.1 Currently the most common structure in the UK for private equity and management buy-out funds is the

English limited partnership. The use of limited partnerships as private equity investment funds was specifically

approved by H M Revenue & Customs (HMRC) and the Department of Trade and Industry in 1987.

2.2 The limited partnership must be registered in England under the Limited Partnerships Act 1907. For this

purpose it must have a general partner with a principal place of business in England, but it is not necessary

for this to be maintained throughout the life of the partnership.

2.3 Investors who are limited partners have their liability limited to the amount of their capital in the partnership

provided they do not take part in its management.

2.4 The interests in a limited partnership cannot generally be quoted on a stock exchange.


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Taxation

2.5 This structure allows investors with different financial requirements and from different countries to invest side

by side in investee companies as if they owned the shares directly. This is because a limited partnership is

not taxed in the UK itself nor is it regarded as a permanent establishment in the UK of overseas investors

other than those carrying on a financial trade, e.g. banks.

2.6 The result, from a UK point of view, is that each investor will receive the income and gains arising from the

investee company which are allocated to it through the partnership as its own income and gains, taxable as

if it had received it directly itself. Losses are allocated in the same way and their deductibility will depend upon

the domestic laws of each investor.

2.7 Investors are liable to tax when income and gains arise in the partnership. There is no liability to tax when the

partnership distributes assets in specie to partners.


2.8 The management charge is taken by the general partner as a priority fixed share of profit, so that investors

are not liable to tax on that part of the income and gains of the partnership allocated to the general partner

as its profit share. The profit share payable to the general partner is outside the scope of value added tax.

Carried interest

2.9 The carried interest is structured as an allocation of gains and income so that, to the extent that the carried

interest takes the form of an allocation of capital gains, a UK manager in receipt of the carried interest would

be liable to capital gains tax on that allocation as opposed to its being taxed as employment income.

Marketability

2.10 The limited partnership is an unauthorised collective investment scheme. It can, therefore, only be marketed to

certain limited categories of investors. A UK manager or adviser of a limited partnership will need to be authorised

under the Financial Services and Markets Act 2000 but this is likely to be the case with all structures.


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Special considerations for foreign investors

2.11 As the limited partnership is regarded as tax transparent by HMRC, there is no exposure to UK tax for foreign

investors holding their investments as limited partners except:

(a) UK source interest, which is generally subject to a withholding tax of 20%; and

(b) for overseas financial traders (see 2.13 below).

2.12 HMRC has confirmed that partners resident in countries with double taxation treaties similar to the UK/USA

treaty are not treated as carrying on a business in the UK through a permanent establishment for the

purposes of obtaining relief from UK tax under the dividend and interest articles of UK tax treaties in respect

of UK source dividends and interest. (The vast majority of relevant UK double tax treaties are similar to that

between the UK and the USA).

2.13 There is a limited exception to this rule in the case of investors who hold their investments as part of a

financial trade, for example a bank. A foreign bank would be treated as carrying on part of its trade in the UK

through a permanent establishment, namely the general partner, and would be liable to UK tax on its share

of profits.

2.14 Although it is the view of many countries within the EU and elsewhere that limited partnerships are

transparent for tax purposes, some countries have so far been unable to confirm that they share this view.

This causes some uncertainty in relation to the applicability of double taxation treaties, not only for local

source dividends and interest but also, where relevant, local source capital gains. As a matter of equity and

commerce, it would seem unfair for relief to be denied as investors would usually be liable to tax in their own

country on their share of the profits of the partnership and this should therefore receive the benefit of double

taxation treaties between their countries of residence and the countries of residence of investee companies.

Conclusions

2.15 The limited partnership has the following advantages:

(a) it is transparent to tax;

(b) it provides limited liability to the investors;

(c) it is subject to fewer investment restrictions and other regulations than most other private equity

vehicles in Europe;

(d) the general partner’s “management charge” taken as a profit share is outside the scope of VAT; and

(e) it provides a tax-efficient means of paying the carried interest to UK based executives.


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2.16 The limited partnership has the following disadvantages:

(a) as it is transparent to tax, investors in the partnership are liable to tax when gains or income are

received by the partnership: if, therefore, the proceeds are reinvested (or otherwise not

distributed), the investors will still be liable to tax on the gains, without having received them;

(b) limited partnerships cannot directly be marketed under the Financial Services and Markets Act

2000 to individual investors as they are unauthorised Collective Investment Schemes;

(c) the limited partnership enables the management charge to be paid to the general partner as a

share of profits and therefore without VAT (which would be irrecoverable by the partnership).

However, as compared to a VATable fee, this can lead to irrecoverable VAT arising with the

general partner’s group; and

(d) the interests in a limited partnership cannot generally be quoted on a stock exchange.

3 The UK Company

3.1 A UK resident company is liable to tax in the UK on capital gains at the corporation tax rate of 30%. If a

company’s annual profits, taking income and capital gains together, do not exceed £300,000 then it pays the

lower rate of 19% with a sliding scale operating up to the point where annual profits reach £1,500,000, at

which point the higher 30% rate is levied on the whole of such profits.

Dividends are payable free of withholding tax.

3.2 There is, therefore, a significant tax leakage, so the structure is not considered further in this paper.

4 The UK Investment Trust

4.1 This is a company which invests in securities and whose shares are quoted on the London Stock Exchange

PLC. It also has to comply with Section 842 of the Income and Corporation Taxes Act 1988 which provides, inter

alia, that it is not permissible to distribute capital gain by way of dividend.

4.2 An investment trust is exempt from corporation tax on chargeable gains.

4.3 As regards income, it is taxed like any other UK resident company.

4.4 An investment trust would clearly be a resident of the UK for purposes of the UK double taxation treaties and

therefore could benefit under them.


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Management charges

4.5 Management charges paid by an investment trust are deductible. They are also subject to VAT at the standard

rate of 17.5% which would not be recoverable by the investment trust. This liability can be avoided if the

manager is a company within the same VAT group as the investment trust or if the management services are

provided by employees of the investment trust who are remunerated by salary.

Carried interest

4.6 A carried interest is incorporated through the issue of options or warrants (quoted options) but investors in

investment trusts usually expect the number of shares under option or warrant to be very restricted.

Marketability

4.7 The shares in an investment trust may be marketed by a prospectus and have to be quoted on the London

Stock Exchange.

Conclusions

4.8 The UK investment trust has the advantages listed below as a private equity investment vehicle:

(a) it provides limited liability to its investors;

(b) it is exempt from tax on chargeable gains;

(c) management charges are deductible;

(d) management charges are not subject to VAT if they are paid to a company in the same group or

if its executives are employed by the investment trust itself;

(e) it can benefit from double taxation treaties where being subject to tax on the capital gain is not a

requirement for obtaining relief under the treaty; and

(f) its shares will be quoted.

4.9 The UK investment trust has the following disadvantages as a private equity investment vehicle:

(a) it cannot distribute capital gain by way of dividend. Capital gains have to be obtained during

the life of the investment trust by the investors selling shares at a quoted price: this is often at a

significant discount to net asset value. This discount can make the investment trust unattractive

for an institution to hold as the quoted price may be significantly less than the amount subscribed.

Alternatively capital gains can be distributed on a liquidation, but this fails to take advantage of

the stock exchange quotation;

(b) it is taxed on income like any other company; and

(c) management charges are subject to VAT if they are not paid to a company in the same group or

if the executives are not employed by the investment trust itself.


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5 The Venture Capital Trust

5.1 The Venture Capital Trust is a variation on the investment trust structure providing tax-free income and capital

gains to individual investors but with restrictions on the types and company in which it can invest.

5.2 The key features of the Venture Capital Trust are as follows:

(a) their shares will be listed, to allow an easy exit route for investors;

(b) they are generally subject to the same tax rules as investment trusts. In particular, they are

exempt from corporation tax on capital gains on shares in UK resident companies but unlike

investment trusts they are allowed to distribute capital profits. On the other hand, they do not

need to be resident in the UK;

(c) 70% of their assets have to be invested in unlisted trading companies meeting certain requirements;

(d) the companies in which they invest must have gross assets of less than £15 million immediately

prior to the investment and not more than £16 million immediately after the investment, and not

more than £1 million may be invested in any one company in any year;

(e) not more than 15% of their assets at the time of making an investment may be in any one

company or group of companies;

(f) investments in unlisted trading companies may include both equity and debt but at least 30% of

the 70% of assets referred to in (c) above must be in ordinary shares and the holding in any one

company must include at least 10% by value in the form of eligible shares, which are ordinary

shares carrying no preferential rights to dividends or to the company’s assets in a winding-up and

no present or future rights to redemption;

(g) individual investors will have exemption from UK tax on dividends when they are received and on

capital gains from shares in the trusts when they are made (but no tax relief for any capital losses);

and

(h) although only individual investors resident in the UK will qualify for tax relief, other investors are

able to invest.

6 Unauthorised Unit Trust for Exempt Funds

6.1 For UK tax purposes, a unit trust, which is any arrangement whereby assets are pooled and held on trust for

the benefit of participants, is treated as a company for UK tax purposes and is therefore liable to UK

corporation tax on chargeable gains. The only exception to this is where every investor in the unit trust is a

person who is exempt from tax on chargeable gains otherwise than by reason of residence: in those

circumstances, chargeable gains made by the unit trust are not taxable. It is therefore a suitable structure for

UK pension funds, charities and investment trusts.


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6.2 Management charges payable by the trustees are not deductible for tax purposes. Traditionally, the trustees

will distribute the gross income to unitholders with a contractual right to claw-back the expenses from the

unitholders, thereby maximising any tax credits in the hands of the unitholders.

6.3 A management charge rendered to the trustees of a unit trust will be liable to VAT at the standard rate of 17.5%.

There is no scope to avoid the VAT by establishing a VAT group and although the trustees of the unit trust

could employ the managers, and save VAT, the salary costs would not be deductible.

Carried interest

6.4 Since the holders of the carried interest are not tax-exempt, they cannot be unitholders and the carried

interest therefore needs to be structured as an addition to the management fee or through options. In either

case the benefit is likely to be subject to income tax rather than to capital gains tax.

7 Pension Fund Pooling Vehicle

7.1 A Pension Fund Pooling Vehicle (PFPV) is a unit trust which is approved by the Pensions Schemes Office of

HMRC as specialising in managing the assets of both UK approved pension plans and overseas plans.

7.2 The regulations governing PFPVs, which came into force on 11 July 1996, disapply the tax rules for

“unauthorised unit trusts” which would otherwise apply to such funds. The effect is to treat unit trust schemes

which register as PFPVs as being “transparent” for tax purposes. The participants in such a scheme are

therefore treated, as far as income tax, capital allowances, and capital gains are concerned, as though they

themselves directly own a share of each of the assets held by the trustees.

7.3 In addition, the regulations provide for PFPVs not to be treated as unit trusts for stamp duty purposes. So

participants are able to transfer assets they own (other than land or buildings) into the PFPV without incurring

a charge to stamp duty or stamp duty reserve tax.

7.4 PFPVs enable multinational groups of companies to arrange for the assets of their individual pension funds

to be managed collectively in the UK.


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7.5 In order to qualify as a PFPV a unit trust has to have a number of characteristics. The main points are:

(a) each unit-holder must be approved by HMRC and must be:

(i) either an exempt approved pension scheme (or a superannuation fund falling within

s615(6) TA 1988) or a scheme which is before HMRC for a decision as to whether it

qualifies under either head; or

(ii) an overseas scheme. Such a scheme must be established outside the UK and

be accepted by HMRC as equivalent to a retirement benefits scheme approved by

HMRC for the purposes of Chapter 1 of Part XIV of TA 1988.

(b) the unitholders must be jointly and absolutely entitled to the assets of the PFPV against the trustee

within the meaning of s60 TCGA 1992. Essentially therefore the PFPV has to be a bare trust.

7.6 Whilst a PFPV is more flexible than an unauthorised unit trust by virtue of the fact that it may involve foreign

pension funds, the same inefficiencies arise with respect to the management charge and VAT on that charge,

and the inability for executives to have a direct carried interest in the fund. These matters will not be discussed

further here.

8 Parallel Investment

One structure which has been used for a few funds is simply a series of parallel management agreements,

each between the private equity manager and a single investor, and with a custodian or nominee company

acting as nominee for all investments held. There is therefore no fund at all and the arrangement is

transparent for tax purposes. The main disadvantages are that the structure is difficult to operate and it is

difficult to incorporate a suitable carried interest scheme. This can only be done through options and these

will be subject to income tax and not taxed as capital gains. It is less flexible than, and offers no real advantage,

over the limited partnership.

9 Taxation of Foreign Funds in the UK

Foreign company

9.1 A non-resident investment company will not be liable to UK tax on capital gains made in respect of UK

assets. It has a relatively straightforward structure and its shares can be easily traded and quoted on a stock

exchange.


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Residence

9.2 However, in order to ensure that it is regarded by HMRC as non-resident it is necessary for the central

management and control of the company to be located outside the UK. This imposes onerous requirements

to ensure that the company’s strategic decisions are taken by a competent and convincing board of non-

resident directors. There is a wide choice of jurisdictions which do not themselves charge tax on capital gains

in the hands of such companies.

Taxation of income

9.3 The foreign jurisdiction selected is unlikely to have the benefit of a comprehensive double tax treaty with the

UK but there is no withholding tax on dividends paid by UK resident companies.

9.4 Where the foreign company distributes tax-free capital gains by way of dividend, the UK resident investor is

then taxed on what it receives as income and not as underlying capital gain in respect of which it might

otherwise have had the benefit of indexation (or tapering relief for an individual or trust).

9.5 Income and capital gains accruing to the non-resident company will not be taxed in the hands of UK resident

shareholders unless distributed except in certain cases where the company is controlled by a small number

of UK shareholders.

Disposal of shares

9.6 A disposal of shares in a non-resident company by a shareholder resident or ordinarily resident in the UK will

normally be subject to capital gains tax. Tax is levied for companies on the difference between the net sale

proceeds and the acquisition cost of the shares as increased by the rise in the UK retail price index over the

period of ownership. For individuals and trusts, taper relief operates to reduce the amount of the gain

charged to tax if the shares have been held for at least one year.

Redemption of shares

9.7 Where shares are redeemed at a premium, the characterisation of the premium as income or capital will

generally depend upon the corporate law regulating the affairs of the company effecting the redemption. If,

under that jurisdiction’s corporate law, a redemption of shares at a premium is not treated as a distribution,

the UK will generally treat that premium as a capital gain rather than as a dividend.


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Anti-avoidance legislation

9.8 There is complex UK anti-avoidance legislation (“the Off-Shore Fund Legislation”) aimed at passive foreign

investment companies (like the US PFIC legislation). This, broadly, may result in gains made on the disposal

or redemption of shares in the foreign company being treated as income and not capital gain unless the

investors cannot at the outset reasonably expect to realise their investment within seven years of acquisition.

VAT

9.9 A management charge rendered by a UK adviser to the foreign company or its foreign manager is outside

the scope of VAT but the adviser is entitled to full input tax recovery.

Carried interest

9.10 A carried interest can be incorporated either through special shares or options (although the gain realised

through the latter may be subject to income tax).

Conclusions

9.11 From the point of view of private equity investment by UK resident investors into UK companies, the foreign

company has the advantages listed below:

(a) it provides the investors with limited liability;

(b) no tax is payable on gains;

(c) with an appropriately chosen country as its base, no tax would be payable on income;

(d) its shares can be easily traded and quoted on a stock exchange; and

(e) a management charge made by a UK adviser is outside the scope of VAT though carrying full

input tax recovery.

9.12 From the point of view of private equity investment by UK resident investors into UK companies, the foreign

company has the following disadvantages:

(a) onerous requirements must be fulfilled if the company is to be regarded as non-resident; and

(b) the Off-Shore Fund Legislation may prevent capital gains tax treatment when shares are realised.

9.13 Clearly, where a foreign company is used as a private equity investment vehicle by UK resident investors into

non-UK resident companies, or by non-UK resident investors into either UK or non-UK resident companies,

the tax laws in, and any treaties with, the countries concerned would apply.


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Foreign unit trust

9.14 Prior to 1987, when the Inland Revenue approved the use of limited partnerships, the foreign unit trust was

the most popular structure used in the UK. It is still used by a number of funds.

It is treated as a company for the purposes of UK tax on capital gains but not for tax on income. It combines

all the advantages of a foreign company with the possibility of transparent treatment for income. Thus, tax

credits attaching to UK dividends are available to UK participants as if they owned the shares in the

underlying company directly.

9.15 It also enables gains to be distributed during the life of the fund by the fund repurchasing or redeeming units.

9.16 The foreign unit trust is treated as a company for the purposes of UK tax on chargeable gains and the

comments above concerning foreign companies therefore apply.

9.17 Redemptions of units will always be treated as capital rather than income for UK tax purposes but the Off-

Shore Fund Legislation referred to in paragraph 9.8 above will apply so that the gain may be taxed as income

unless investors cannot realise their investment within seven years of acquisition.

9.18 Internationally it has the same positive aspects as a foreign company but similar negative aspects too.

Many countries take different attitudes towards a foreign unit trust: some treat it as a company, whilst others

do not. This inconsistency of approach may weigh against its adoption.

Foreign partnership

9.19 HMRC will generally regard a foreign partnership as transparent for UK tax purposes so that income and

capital gain accruing to the partnership will be taxed in the hands of UK resident partners automatically,

according to the nature and source of the underlying income or capital gain.


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10 Outline of the UK Tax System applicable to the Taxation of Income and Profits


10.1 Both income and capital gains are subject to corporation tax in the UK at the same rate. The normal rate is

30% though there is a lower rate of 19% where profits do not exceed £300,000 in a company’s financial year.

A sliding scale operates between profits of £300,000 and £1,500,000 so that, by the time the latter figure is

reached, the whole of that profit pays tax at 30%. Chargeable gains are subject to indexation relief: only the

excess of the sale price over the acquisition price adjusted upwards according to the increase in the retail

price index is brought within the charge to tax.

Dividends

10.2 Dividends are paid free of withholding tax.

10.3 UK companies do not pay corporation tax on dividends received from other UK companies.

10.4 When the UK company makes a qualifying distribution to a shareholder, the shareholder receives a tax credit

equal to 10% of the aggregate of the dividend and the associated tax credit. Individual UK shareholders

use the tax credit to frank their liability to tax at the lower and basic rates and only pay additional tax on

the dividend if they are liable to tax at the higher rate.

10.5 As a matter of UK domestic law, non-resident shareholders are not entitled to a tax credit on the receipt of

a qualifying distribution from a UK company. A company resident in a country which has a comprehensive

double tax treaty with the UK owning 10% or more of the UK company will receive a minuscule repayment

of tax credit after withholding tax.

Interest

10.6 Annual interest paid by UK companies is generally payable under deduction of tax at the lower rate (currently

20%) unless the interest is paid to a bank carrying on a bona fide banking business in the UK.

10.7 Many of the UK’s double taxation treaties with other countries provide that non-resident owners of UK source

interest do not suffer UK tax on that interest or, in a minority of cases, suffer tax at a reduced rate. It is possible

for a non-resident investor to file a claim with HMRC leading to a direction from HMRC to the investee

company to make payment of interest at a zero rate of withholding tax or at a reduced rate of withholding

tax, according to the treaty concerned. Until such a direction is given, the investee company should pay

under deduction of tax, and the non-resident lender will have to make a reclaim to HMRC.


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Capital gains

10.8 The UK does not subject non-residents to tax on chargeable gains, unless the non-resident is carrying on a

trade in the UK and disposes of an asset held in connection with that trade.

Capital duty

10.9 Capital duty has been abolished in the United Kingdom.


10.10 H M Revenue & Customs would generally take the view that where persons carry on a trade through the

medium of a UK partnership they would be liable to UK tax on that portion of the profits of the trade

attributable to the permanent establishment in the UK through which the trade is carried on. However,

carrying on an investment activity in the UK is not relevant to the UK permanent establishment rules and can

be carried on in the UK by a non-resident without a permanent establishment being taxed on its share of

profits from its investment activities. H M Revenue & Customs regards private equity limited partnerships as

carrying on the business of making and monitoring investments, which is considered to be an investment

business and not a trading activity, which would otherwise make them liable to UK tax. The exception is for

foreign “financial traders” who will be taxed as set out in section 2.13.

10.11 In respect of private equity limited partnerships, H M Revenue & Customs, subject to one exception, have

taken the view that partners resident in countries with which treaties have been concluded along the lines of

the UK/USA treaty (that is, along the OECD model treaty lines) will not be treated as carrying on a business

in the UK through a permanent establishment. This ruling applies so long as that partnership interest is not

connected with any other taxable activity they are carrying on in the UK. This means that such partners will

be able to take advantage of the usual interest articles in UK double taxation treaties, despite the fact that

these generally deny relief where the recipient of the interest is undertaking business in the UK through a

permanent establishment. The foreign financial traders’ exemption described above applies.


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The structure most commonly used for domestic private equity investment funds is a limited partnership

organised under the laws of the State of Delaware. Though a limited partnership may be formed under the

laws of any of the 50 states, Delaware is generally favoured because its laws governing limited partnerships and

other business entities are very well developed, are relatively flexible and are most favourable to business founders.

In addition, off-shore entities domiciled in tax-haven jurisdictions (commonly the Cayman Islands or Bermuda)

are used to address special concerns of certain investors or related to certain investment strategies.

2 US Fund Structures

2.1 A Delaware limited partnership is formed upon the filing of a Certificate of Limited Partnership with the Secretary

of State of the State of Delaware. A Delaware limited partnership is a separate legal entity which continues

as such until it dissolves and winds up its affairs pursuant to its partnership agreement, which term is

generally 10 years (though there is generally flexibility to extend that term to enable the fund to wind-up its affairs)

or unless otherwise dissolved pursuant to Delaware law. Limited partnerships organised in Delaware are not

required to register with any regulatory authority; however, if the fund or a promoter of the fund maintains an

office in a state other than Delaware, the fund or its promoter may be required to register in that state.

2.2 The limited partnership structure for a fund usually comprises a single general partner (an entity owned by

the founders of the fund, as described more fully below) and multiple limited partners that are investors in

the fund. This structure allows the investors, as limited partners, to limit their individual liability to their

commitments to the fund and any distributions received in violation of law.

2.3 For regulatory and business reasons, a limited partnership interest is generally not freely transferable and may

be treated as a voting or non-voting interest. While Delaware law allows flexibility with respect to the terms

of a limited partnership agreement, because limited partnership interests are securities, the offer and sale of

such interests as well as certain investor profiles are regulated extensively; such regulations and the common

exemptions to such regulations are described below.

2.4 Typically, the general partner of a US fund is a separate legal entity – either a Delaware limited partnership or

limited liability company – owned by the founders of the fund and possibly other carry-recipients. If the

general partner of the fund is organised as a limited partnership, typically the founders of the fund will be

admitted to the general partner entity as limited partners, and a limited liability company wholly-owned by

some or all of the founders will be admitted as the general partner and will have only a small economic

interest in the general partner of the fund. This two-tier structure provides the founders with limited liability

and, at the same time, allows them to receive their share of the general partner’s carried interest through a

limited partnership (which may be more tax-efficient than a limited liability company if the fund makes

investments in certain non-US jurisdictions such as Canada).


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2.5 The management company of a US fund is usually organised as a separate entity that is owned by the

founders of the fund. Typically, the management company serves as the management company for each

fund organised by the founders, which allows the founders to centralise the management functions of the

fund-family and concentrate the value of the enterprise in a single entity. The management company is

responsible for the day-to-day operations and overhead expenses of the funds, and generally receives

management fees paid by the funds pursuant to a contract with each of the funds or with the general partner

of each of the funds. Generally, the management company is structured as a Delaware corporation or limited

liability company in order to shield the fund managers from individual liability. The type of entity chosen

generally depends upon various tax considerations, some which are discussed in section 5 below.

2.6 The following chart depicts the typical US fund structure, though the structure of any particular fund will be

tailored to the fund’s investor base, geographic focus, industry focus, and other factors that raise special

federal, state, and international tax issues and other regulatory concerns.


General Partner(subject to unlimited liability,but has no assets other thana negligible intereset in the G.P., L.P.)

General Partner(subject to unlimited liability)

INVESTORSLimited Partners(entitled to limited liability)

Members(entitled to limited liability)

Limited Partners(entitled to limited liability)

Management Contract

G.P., LLC FOUNDERS

Fund, L.P.

ManagementCompanyLLC/Corp.

G.P., L.P.

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3 Marketability

Federal Regulation

3.1 The offering of limited partnership interests to US persons is subject to the US Securities Act of 1933,

as amended (the “Securities Act”) which requires that sales of securities, such as limited partnership interests,

must be registered with the appropriate regulatory body, unless the offering otherwise qualifies for an exemption

to such registration requirement.

3.2 Regulation D under the Securities Act allows issuers to avoid the costly and time-consuming securities

registration process by offering securities on a controlled basis to “accredited investors”. Such investors must

meet certain financial or sophistication thresholds, must acquire their interests for investment purposes (as

opposed to investing with the intention of selling the interests) and must have had an opportunity to make

inquiry of the general partner about the details of the offering.

3.3 The US Securities Exchange Act of 1934, as amended (the “Exchange Act”) requires periodic public disclosure

from each “reporting company”. In order to avoid such reporting requirements, a fund must have less than

500 “holders of record” of each class of equity security. A security is deemed to be “held of record” by each

person who is identified as an owner of the security on the issuer’s books and records. Therefore, each

partner listed on a fund’s schedule of partners would count as a holder of record.

3.4 Regulation S under the Securities Act allows certain non-US securities offerings to be deemed to occur

outside of the US and therefore not be subject to the registration requirements under the Securities Act.

Generally, in order to take advantage of this exemption, the offer or sale of the limited partnership interest

must be made in an “offshore transaction” and neither the issuer, an affiliate of the issuer, nor any person

acting on their behalf may direct selling efforts to US persons in the US, Generally, to be considered and

“offshore transaction” the offer must be made to non-US persons or, if an offer is made to a US person, the

seller must reasonably believe that the buyer is offshore at the time of the offer or sale.

3.5 Managers of private equity funds may avoid registration with the Securities and Exchange Commission (SEC)

under the US Investment Advisers Act of 1940, as amended, by having fewer than 15 “clients.” In general

each private equity fund managed by such manager, rather than each of the underlying investors, counts as

a single client, provided each such fund follows certain structural guidelines, including centralised management

and prohibition of investor redemptions within the first two years.


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3.6 Private equity funds seek to avoid the comprehensive regulations of the US Investment Company Act of

1940, as amended (the “1940 Act”) by relying on the exemptions under Sections 3(c)(1) or 3(c)(7) of the 1940

Act. Without the availability of such exemptions, private equity funds would be required to register with the

SEC as “investment companies” and be subject to onerous regulation. The exemption provided by Section

3(c)(1) limits the number of beneficial owners of a private equity fund to not more than 100, and the 3(c)(7)

exemption limits ownership if interests in a private equity fund to “qualified purchasers” only, without limitation

on the number of beneficial owners (note, however, the limits imposed by the Exchange Act, discussed above).

3.7 The financial sophistication requirements to be considered a “qualified purchaser” are more stringent than the

financial requirements to be considered an “accredited investor” (as discussed above). Generally, a “qualified

purchaser” includes: (1) a natural person with at least $5 million in investments; (2) a company owned by family

members that own at least $5 million in investments; (3) a trust not formed for the specific purpose of acquiring

the securities offered and the trustee and each person that contributed to the trust was a qualified purchaser

at the time of such contribution or (4) any entity that owns and invests at least $25 million in investments.

State Securities and Investment Adviser Regulation

3.8 In addition to the federal securities regulation regime, each state has securities regulation and state investment

adviser regulation, many of which have exemptions that correspond to the federal exemptions discussed above.

Promoter restrictions

3.9 The US National Association of Securities Dealers regulates independent broker dealers or “finders” who offer

or promote private equity funds in the US. In addition, many states require registration of broker dealers or

placement agents before permitting such persons to make offers to potential investors in their jurisdiction.

The US Employee Retirement Income Security Act of 1974, as amended (ERISA)

3.10 Generally, if benefit plans subject to ERISA (ERISA Plans) invest in private equity funds, the various provisions

of ERISA would apply to the fund and its managers because the assets of the fund would be deemed to be

assets of an investing benefit plan. Among other things, the managers would be ERISA fiduciaries and the

fund would be subject to the prohibited transaction rules and other onerous fiduciary requirements with which

the fund would have difficulty complying. In order to allow the ERISA Plans to invest while complying with

ERISA regulations, fund managers generally use best efforts to cause their funds to qualify for one of the

exemptions from the plan asset regulation under ERISA including (1) the exemption for venture capital

operating companies (VCOC) or (2) the exemption for funds in which commitments made by benefit plans

(including ERISA Plans) is less than 25% of the total commitments to the fund.


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FDIC Bank Holding Company Act (BHCA)

3.11 By and large, financial holding companies may invest in private equity funds. However, the BHCA prohibits a

private equity fund that is “controlled” by a financial holding company from routinely managing or operating

a portfolio companies, except under very limited circumstances. Thus, in order to prevent a financial holding

company from controlling a private equity fund and therefore prohibiting it from providing indispensable

management expertise to portfolio companies, the financial holding company must not: (1) serve as a general

partner, managing member or other similar role with respect to a fund; (2) own or control 25% or more of any

class of shares or similar interests in the fund; (3) directly or indirectly select, control or constitute a majority

of the management of the fund or (4) act as the investment adviser to the fund and own or control more than

5% of any class of voting shares or similar interest in the fund. Therefore, fund managers often include these

limitations as provisions in the limited partnership agreement and such provisions apply to investors that are

subject to the BHCA.

Federal Communications Commission (FCC)

3.12 The FCC imposes limitations on cross-ownership of media companies (e.g., newspaper, television, radio and

cable companies). Thus fund managers typically include insulating language in the limited partnership agreement

to preclude a limited partner in the fund from having the fund’s ownership of media companies attributable

to the limited partner. Such insulating language generally prohibits a limited partner from having an active role

with the limited partnership or any media company in which it invests.

USA Patriot Act

3.13 The USA Patriot Act was adopted in 2001 and far-reaching regulations were promulgated with the goal of improving

the ability of the US to counter terrorism. Specifically, private equity funds and their managers must be vigilant

with respect to implementing anti-money laundering compliance provisions and anti-terrorism financing detection.

Open records laws

3.14 Open records laws generally required that a wide range of information held by public agencies be made

available to the public upon request. With respect to private equity funds, investors who are public entities

(e.g., public pension plans, endowment funds of public universities and publicly traded funds-of-funds) are

subject to such laws and the scope of information required to be disclosed – which varies from state to state –

often includes a limited partnership’s organizational documents and the data set forth in a limited

partnership’s periodic reports that are provided to these public entities, as limited partners. Most fund

managers are concerned about allowing performance data and other sensitive information into the public

domain, therefore private equity fund managers make significant efforts to avoid such disclosure through an

extensive confidentiality provision in the partnership agreement.


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4 Non-US Fund Structures

In general, non-US funds may invest in the US without encountering regulatory or tax restrictions beyond

those applicable to US funds. The US tax treatment of a non-US-based fund will depend upon whether the

fund is classified as a partnership (rather than a corporation) for US tax purposes. The comparative tax

treatment of US funds and non-US funds is discussed below.

5 Outline of the United States’ Tax System Applicable to the Taxation of Incomeand Profits from Private Equity Investment Funds

5.1 In general, the US government taxes its citizens and residents (including corporations organised within the US)

on their worldwide income. Foreigners are generally not taxed in the US on capital gains (unless effectively

connected with a US trade or business or attributable to US real estate, as discussed below), though

foreigners are taxed on most other types of US-source income.

5.2 US and non-US entities classified as partnerships for US federal income tax purposes are fiscally transparent.

Therefore, income, gains, losses and expenses realised by a partnership are treated as if they were realised

directly by the partners of such partnership, regardless of whether the partnership distributes such amounts.

5.3 The following discussion describes the tax treatment of US- and non-US private equity investment funds,

US investors in such funds, non-US investors in such funds, and fund managers.

United States taxation of private equity investment funds

5.4 Private equity investment funds that are treated as partnerships for US federal income tax purposes are

fiscally transparent, and therefore are not subject to US federal income tax. A private equity investment fund

organised as a limited partnership under Delaware law (or the laws of any state within the US) will be fiscally

transparent for US federal income tax purposes provided that the fund does not make a special election to

be taxed as a corporation. A non-US private equity fund can ensure partnership classification by filing an

affirmative election with the US Internal Revenue Service (IRS) to be classified as a partnership, though certain

foreign entities will default to partnership classification even in the absence of such an election and certain other

foreign entities, considered “per se” corporations, are not entitled to elect partnership classification.

5.5 Notwithstanding these general classification rules, if the fund is treated as a “publicly traded partnership,”

it will be subject to entity-level tax as a corporation. In general, fund managers may regulate transfers of fund

interests in a manner that allows their funds to qualify for one or more safe harbours and thereby avoid

classification as a publicly traded partnership.



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5.6 Though non-US partnerships are not subject to US tax at the entity level, amounts that they receive from

sources within the US may be subject to withholding taxes. Certain withholding taxes may be reduced if the

owners of the non-US partnership demonstrate (by providing the appropriate withholding certificates) that

they are US persons or are entitled to treaty benefits or certain other exemptions. These withholding rules

are discussed further in section 5.11.

5.7 A non-US fund that is classified as a corporation for US federal income tax purposes will be subject to the

US tax rules applicable to non-US persons, as described below, but its non-US owners will not be required

to pay tax on, or report to the United States Internal Revenue Service, the income of such corporation. For

this reason, non-US persons sometimes use corporations organised in tax haven jurisdictions to hold their

US investments – though this may increase the overall tax liability attributable to such investments, it should

shield such non-US persons from tax filing obligations in the US.

United States taxation of US investors in private equity investment funds

Taxable US persons

(a) except for tax-exempt organizations (such as universities and charities), US persons are subject

to US federal income tax on their shares of gains and other income of a fund (US or non-US)

regardless of whether such amounts are distributed. US corporations are currently subject to tax

at a maximum rate of 35% on all income. US individuals are currently generally subject to tax at

a maximum rate of 15% on their qualified dividend income and long-term capital gains (i.e., gains

from the sale of capital assets, such as securities, held for longer than one year). Interest and

short-term capital gain is generally taxable to US individuals at a maximum rate of 35%;

(b) US non-corporate investors, including individuals, are subject to certain limitations on their ability

to offset taxable income with investment-related expenses. Because of these limitations, it is

generally fair to assume that such US investors in private equity investment funds will not be

entitled to deduct their full share of the fund’s expenses, including management fees and

organizational expenses.

Tax-Exempt US persons

US tax-exempt organizations, despite their general exemption from US federal income tax, are subject to tax

on income attributable to business activities unrelated to the purposes for which they are exempt (e.g., their

educational or charitable purposes). This income is often referred to as “unrelated business taxable income”

or “UBTI”. Because interest, dividends and gains from the sale of securities are generally not treated as UBTI

unless attributable to debt-financed property, most of the income of a typical private equity investment fund

should not be taxable to US tax-exempt investors.


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However, if a fund borrows money to make investments or pay expenses, the fund may generate “unrelated

debt-financed income”, which is treated as UBTI. In addition, if a private equity fund receives fee income –

such as director’s fees, consulting fee, monitoring fees, or any other fees for services provided – tax-exempt

investors will be taxed on their shares of such fee income. It is common for such fee income, if paid by

investee companies of a private equity investment fund, to be received by the managers of the fund and not

by the fund directly; the management fee paid by the fund is then sometimes reduced by some or all of such

fee income. Finally, if a private equity fund invests in a portfolio company that is fiscally transparent, such as

a limited liability company, any income or gain from that investment will be treated as a UBTI.

Non-US Investments: “CFCs” and “PFICs”

(a) special rules apply to US persons that invest (directly or indirectly through a partnership) in non-

US companies that are classified as “Passive Foreign Investment Companies” (PFICs) or

“Controlled Foreign Corporations” (CFCs). These rules are generally intended to prevent US

persons from accumulating income offshore and thereby avoiding, or deferring, US taxation;

(b) a non-US corporation will be a PFIC if 75% or more of its gross income is “passive income” (such

as interest, dividends, royalties, and gain from the disposition of property that generates such

income), or 50% or more of its assets produce (or are held for the production of) passive income.

A non-US corporation generally will be a CFC if US persons collectively (but excluding those

persons who own less than 10% of the voting power of the corporations stock) own more than

50% of the total combined voting power or total value of the corporation’s stock. The US

government has determined that non-US corporations meeting these qualifications present

unique opportunities for US taxpayers to control the repatriation of foreign-source income and

thereby defer US taxes. As a deterrent, investments in PFIC’s and CFCs generally result in higher

effective tax rates for US persons and/or current taxation of income held offshore. In addition,

such investments may result in special filing obligations.

United States taxation of non-US investors in private equity investment funds

U.S. trade or business issues

In general

(a) if a non-US person is engaged in a US trade or business, US-source income (including capital

gains and dividend and interest income) that is effectively connected with such trade or business

will be subject to US federal income tax at the regular rates applicable to US domestic taxpayers.

Such income is often referred to as “effectively connected income” (ECI). Non-US persons engaged

in a US trade or business will also be required to file US tax returns;



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(b) a non-US person will be considered to be engaged in a US trade or business if it holds an interest

in a partnership (such as a private investment fund) that is engaged in a US trade or business,

regardless of the jurisdiction in which the partnership is organised. The non-US partner’s share

of any income connected with that trade or business will be subject to regular US income taxes,

collected initially by withholding. Furthermore, if the non-US person is a corporation, an additional

30% tax (a “branch profits” tax) generally will be imposed on certain earnings and profits that are

attributable to such income. This branch profits tax is intended to equalise the tax treatment of

US business activities conducted through a branch or a partnership, and those conducted

through a US corporate subsidiary (i.e., if such activities were conducted through a US corporate

subsidiary, dividends distributed to the non-US parent would be subject to a 30% withholding tax).

Securities transactions

Under the US Internal Revenue Code and US case law, certain types of investment activities will not be

treated as a US trade or business. In general, under these rules, the investment activities of a typical US

private equity investment fund should not be treated as a trade or business. However, the analysis is factual,

and will depend upon the activities of the particular fund.

Investments in tax transparent entities

Even if a private equity investment fund is not directly engaged in a trade or business in the US, it (and its

non-US partners) will be deemed to be so engaged if the partnership acquires an equity interest in a flow-

through entity (such as a partnership or a limited liability company) that is so engaged. Therefore, if a private

equity investment fund invests directly in an operating company that is organised as a US limited liability

company, its non-US investors will generally be required to file US tax returns and pay tax on their shares of

the income that is connected with the limited liability company’s trade or business. It is generally possible to

avoid this result by structuring such investments through “blocker corporations”, though such structures may

be complicated and tax-inefficient.

Fees for services

If a private equity fund receives fee income – such as director’s fees, consulting fees, monitoring fees, or any

other fees for services provided – such income likely would constitute ECI. It is common for such fee income,

if paid by investee companies of a private equity investment fund, to be received by the managers of the fund,

and not by the fund directly. The management fee paid by the fund is then sometimes reduced by some or

all of such fee income.


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Capital gains: United States real property holding corporations

5.8 A non-US person generally will not be subject to tax in the US on gains unless that person is an individual

who is present in the U.S. for 183 days or more during the taxable year in which such gains are realised and

certain other conditions are satisfied, or unless such gains are ECI (as discussed in section 5.3.1).

5.9 This rule does not apply to gains attributable the sale of the securities of a “U.S. real property holding

corporation” (USRPHC). Rather, such gains are treated as ECI. Therefore, even if the non-US person is

not actually engaged in a US trade or business, such gains would be subject to US income tax, collected

initially by withholding, and the non-US person would be required to file a US income tax return.

Similar consequences would result from the sale of a partnership interest at a time that the partnership

held an interest in a USRPHC.

5.10 In general, a corporation will be a USRPHC if 50% or more of the fair market value of the corporation’s

business assets (generally excluding cash) consist of real property (including buildings, other permanent

attachments to land and other interests such as certain leases) located in the US.

Interest and dividends: withholding on Fixed or Determinable Annual or Periodic Income (FDAPI)

5.11 Non-US persons are subject to US withholding tax on US-source interest and dividend income, and most

other types of income other than capital gains. Such income is generally referred to as “fixed or determinable

annual or periodic income” (FDAPI). US persons that pay such amounts to non-US persons (including US

private equity investment funds that receive such income from investee companies) are “withholding agents”

and must withhold at a 30% rate.

Treaty reduction

Non-US persons residing in jurisdictions with which the US has a tax treaty may claim an exemption from or

a reduction in withholding, if the treaty so provides. To claim these treaty benefits, a non-US person must

provide the withholding agent with a proper withholding certificate certifying its non-US status and certain

other information. A non-US partnership, intermediary, or other flow-through entity claiming treaty benefits on

behalf of its owners must provide the withholding agent with withholding certificates prepared by such

owners. Non-US persons are required to obtain a US taxpayer identification number from the IRS before they

may claim reduced withholding rates on interest and dividends paid on securities that are not actively traded.



229

Exemption for portfolio interest

(a) interest that qualifies as “portfolio interest” is not subject to the 30% withholding tax. In general,

US-source interest on a registered debt obligation will be “portfolio interest” if the recipient owns

less than a 10% interest in the company and certain other requirements are satisfied. If non-US

persons receive US-source interest payments indirectly through a partnership, the IRS may

assert that the 10% test is applied at the partnership level (regardless of the size of the non-US

person’s indirect interest in the company);

(b) to claim this exemption, non-US persons must provide the withholding certificates described

above under “Treaty Reduction”.

Bank deposit interest

Interest earned on deposits with US banks generally is not subject to the 30% withholding tax. To claim this

exemption, non-US persons generally must provide the withholding certificates described above under

“Treaty Reduction”.

US federal income taxation of US fund managers

5.12 Carried interest

The carried interest paid by US private equity investment funds is normally structured as an allocation of fund

profits to the general partner of the fund. The general partner (which, is normally a partnership or a limited

liability company) then allocates the carried interest among its partners, the fund managers. To the extent that

such profits represent long-term capital gains realised by the fund, those profits will be taxed at preferential

capital gain rates when allocated to the managers (provided that the managers are treated as “partners” of

the general partner entity for US federal income tax purposes). In general, it is not difficult to achieve this

result if certain US partnership tax rules are followed and certain other precautions are taken.

Management fee

5.13 US private equity investment funds often pay the management fee to a management company that is

separate from the general partner entity. Alternatively, the management fee is paid by the fund to the general

partner entity, which typically pays the fee (net of expenses) to the management company. The management

fee is normally taxed as ordinary income. However, to achieve a more favourable tax result, some fund

managers have taken measures to receive a lower management fee and, instead, receive a priority allocation

of fund profits.


230

5.14 If the management company is organised as a flow-through entity (such as a limited liability company or a

corporation that makes a special election to be a “subchapter S corporation”), the management fee, along

with any expenses of the management company (including salaries), will be allocated to the owners of the

management company and included in the calculation of their taxable income.

5.15 If the management company is organised as a corporation (other than a “subchapter S corporation”) the

management company will be taxed on the receipt of the management fees. Generally, this fee income, net

of any expenses of the management company, will be paid to the managers as compensation which the

managers must include in their taxable income at ordinary income rates. Because the corporation should

receive a tax deduction for these compensation payments, the net result should be a single level of tax

(comparable to the flow-through treatment applicable to a partnership). However, if the compensation

payments are unreasonably high, this tax deduction may be disallowed, in which case the use of a corporate

entity would be inefficient.



231

Austria

Andreas Zahradnik

Dorda Brugger Jordis Rechtsanwälte GmbH

A-1010 Vienna

Dr Karl Lueger-Ring 10

Tel: + 43-1-533 47 95-42

Fax: + 43-1-533 47 95-63

Belgium

Bernard Peeters

Tiberghien Advocaten/Advocats

Avenue du Port 86 C /419

B-1000 Brussels

Tel: + 32 2 773 40 00

Fax: + 32 2 773 40 55

Czech Republic

Duncan Weston

Šárka Robinson

CMS Cameron McKenna v.o.s

Karolíny Svûtlé 25

110 00 P Praha 1

Tel: + 420 221 098 888

Fax: + 420 221 098 000

Denmark

Frede Mørck

Dansk Kapitalanlæg

Gothersgade 103

DK-1080 Copenhagen K

Tel: + 45 3315 3070

Fax: + 45 3336 9444

Finland

Jyrki Tähtinen

Borenius & Kemppinen

Yrjönkatu 13A

00120 Helsinki

Tel: + 358 9 615 333

Fax: + 358 9 6153 3499

France

Daniel Schmidt

SGDM

15, Avenue Victor Hugo

75116 Paris, France

Tel: + 33 1 44 17 34 45

Fax: + 33 1 40 67 13 04

France

George S. Pinkham

SJ Berwin LLP

64, Avenue Kléber

75116 Paris, France

Tel: + 33 1 44 346 346

Fax: + 33 1 44 346 347

Germany

Daniela Weber-Rey

Klaus Weinand-Härer

Clifford Chance LLP

Mainzer Landstrasse 46

60325 Frankfurt am Main

Tel: + 49 69 71 99 01

Fax: + 49 69 71 99 4000


CONTRIBUTING MEMBERS

232

Hungary

Duncan Weston

Gabriella Ormai

Ormai és Társai CMS Cameron McKenna

Ybl Palace, 3rd Floor

Károlyi Mihály utca 12

H-1053 Budapest

Tel: + 36 1 483 4800

Fax: + 36 1 483 4801

Ireland

John Olden

A&L Goodbody

International Financial Services Centre

North Wall Quay

Dublin 1

Tel: + 353 1 649 2000

Fax: + 353 1 649 2649

Italy

Fabio Brunelli

Di Tanno e Associati

Via G. Paisiello, 33

00198 Roma

Tel: + 39 06 845661

Fax: + 39 06 8419500

Luxembourg

Marco de Lignie

Gilles Dusemon

Loyens Winandy

1, Allée Scheffer

L-2520 Luxembourg

Tel: + 352 466 230 230 / 244

Fax: + 352 466 230 230

Netherlands

Hans van Ramshorst

Rob de Win

Van Doorne N.V.

Jachthavenweg 121

1070 AG Amsterdam

Tel: + 31 20 6789 123

Fax: + 31 20 6789 589

Netherlands

Marco de Lignie

Loyens & Loeff N.V.

Fred Roeskestraat 100

1076 ED Amsterdam

Tel: + 31 20 578 5785

Fax: + 31 20 578 5800

Poland

Duncan Weston

CMS Cameron McKenna

Warsaw Financial Centre, 18th Floor

Ul Emilii Platen 53

00-113 Warsaw

Tel: + 48 22 520 5555

Fax: + 48 22 520 5556


CONTRIBUTING MEMBERS

233

Portugal

Miguel Teixeira de Abreu

Miguel de Avillez Pereira

Paulo Cordeiro de Sousa

Pedro Sousa Machado

Alexandra Courela

Abreu, Cardigos & Associados

Av das Forças Armadas 125-12°

1600-079 Lisboa

Tel: + 351 21 723 1800

Fax: + 351 21 723 1899

Slovak Republic

Duncan Weston

Ian Parker

Advokátska kancelária JUDr. Jaroslav Ružička in

association with CMS Cameron McKenna v.o.s. and

CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH

Kapitulská 15

811 01 Bratislava

Tel: + 421 2544 22 490

Fax: + 421 2544 35 906

Spain

Luis Briones

Maria Gracia Rubio

Baker & McKenzie

Pasco de la Castellana 92

028046 Madrid

Tel: + 34 91 230 4500

Fax: + 34 91 391 5149

Sweden

Ulf Soderholm

Andulf Advokat AB

Kungsgatan 8

SE-111 43 Stockholm

Tel: + 46 8 505 31 000

Fax: + 46 8 505 31 001

Switzerland

Olivier Stahler

Fedor Poskriakov

Daniel Schafer

Lenz & Staehelin

30, route de Chêne

CH–1211 Geneva 17

Tel: + 41 22 318 7000

Fax: + 41 22 318 7001

United Kingdom

Jonathan Blake

SJ Berwin LLP

10 Queen Street Place

London EC4R 1BE

Tel: + 44 20 7111 2222

Fax: + 44 20 7111 2000

United States of America

David Tegeler

Mary B. Kuusisto

Jamiel E. Poindexter

Sascha A. Rosebush

Proskauer Rose LLP

One International Place

Boston MA 02110

Tel: + 1 617 526 9600

Fax: + 1 617 526 9899


234


NOTES

About EVCA

The European Private Equity and Venture Capital Association (EVCA) was established in 1983 and is based in

Brussels. EVCA represents the European private equity sector and promotes the asset class both within Europe

and throughout the world.

With over 925 members in Europe, EVCA’s role includes representing the interests of the industry to regulators

and standard setters; developing professional standards; providing industry research; professional development

and forums, facilitating interaction between its members and key industry participants including institutional

investors, entrepreneurs, policymakers and academics.

Minervastraat 4, B-1930 Zaventem, BelgiumTel: + 32 2 715 00 20 Fax: + 32 2 725 07 04e-mail: [email protected] web: www.evca.com

The Private Equity Fund Structures in Europe paper is published by the European Private Equity andVenture Capital Association (EVCA). © Copyright EVCA January 2006 €100

[ visit: www.evca.com ]

Documents

EVCA - Private Equity Fund Structures in Europe · 2 Fonds Commun de Placement à Risques (FCPR) 56 3. ... The original EVCA Private Equity Fund Structures Paper was produced in 1994