US fund managers, Luxembourg proposes to codify withholding tax – New York office Snippet

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05-07-2024

2 minutes read

US fund managers with an EU investment strategy generally use one or more special limited partnerships (“SCSp”) to raise capital from European investors. Especially EU assets are, for a variety of commercial reasons, often held through Luxembourg holding companies (“LuxCos”). Upon exit of an investment, the LuxCos would repatriate proceeds to the SCSp and ultimately to the investors.

Distributions made by a LuxCo to an SCSp with a diverse pool of investors likely suffer Luxembourg withholding tax (“WHT”) at a maximum rate of 15%. Distributions in the context of LuxCo’s liquidation are not subject to WHT. LuxCos normally hold multiple assets and function as master holding companies (“MHC”). An MHC can therefore not be liquidated at the first exit as it needs to continue functioning as the MHC for the other investments.

The repatriation of exit proceeds out of an MHC can be done free of WHT tax by the so-called partial liquidation strategy (“PLS”). In a PLS strategy, the equity capital of an MHC is divided into several classes of shares. Typically, each class tracks the performance of a specific asset or there is a specific profit allocation among the classes (a small preferred dividend on most classes and allocation of the remaining profit to the last class outstanding). Upon an exit, the relevant share class is bought back and cancelled, with the consideration paid to the SCSp not being subject to WHT. Although the Luxembourg tax code did not explicitly confirm the PLS mechanism, Luxembourg tax courts have generally established a framework to accommodate the PLS, save for abusive situations. The Luxembourg government has now proposed to codify the PLS. To benefit from the PLS:

the share classes must be set up either at incorporation or upon a share capital increase;
these classes must have distinct economic rights;
the redemption price must reflect the fair market value that can be determined based on articles of association; and
a share class must be cancelled entirely and within 6 months of its repurchase.

The proposal does not impose any conditions regarding the holder of the share class(es).
We expect that the codification will further strengthen the reliance on the PLS as it will no longer be based on an interpretation of (case) law but on the law itself. The PLS’ benefits remain subject to the abuse doctrine, but the same goes for any other Luxembourg tax provision. Meeting the above PLS conditions substantially limits the possibility for the tax authorities to successfully invoke the abuse argument. As such, abuse should become a more remote concern.
The proposal will likely be enacted later this year. It strengthens Luxembourg’s leading position for the launch of MHCs.

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