European Union: UCITS IV And AIFM: Two Directives That Pose A Tax Brain Teaser In France

Last Updated: 9 January 2012

Article by Bruno Leroy, Pierre Bouron and Olivier Dumas*

The European Union has adopted two directives that facilitate the cross-border marketing of shares or units of investment vehicles within the EU: UCITS IV, applicable in France since August 2011; and AIFM, which should be applicable in France in July 2013 (collectively, the "Directives").

Pursuant to the Directives, it is now possible for UCITS or alternative investment funds (AIF) to set up an investment vehicle in an EU Member State, managed by a company located in another EU Member State. The goal of the Directives is to promote the development of a Pan-European market for these types of investment vehicles. However, the EU has not provided any specific tax regime for such structures, which may lead to new tax issues.

The Question of Tax Residency

Foreign Management Company Managing a French Investment Vehicle

A foreign entity that conducts commercial activities in France may, under certain circumstances, be deemed to have a "permanent establishment" within France and therefore be subject to French taxation. However, the question of permanent establishment should not be an issue for a management company that is tax resident in another Member State and manages a French investment vehicle. Indeed, since the management companies that passport into another Member State pursuant to one of the Directives should be subject to tax in their country of registration/incorporation, the French Tax Administration ("FTA") should not challenge this tax residency, so long as the management company does not carry out activities in France through a local office or French employees.

The goal of the Directives is to promote the development of a Pan-European market for these types of investment vehicles. However, the EU has not provided any specific tax regime for such structures, which may lead to new tax issues.

French Management Company Managing a Foreign Investment Vehicle

With regard to the investment vehicle, the issue is more complex. Investment vehicles registered/organized in France are tax-exempt, and their profits are subject to tax at the level of the investors. Therefore, such investment vehicles should not be considered as tax resident in France, and, in fact, should not be considered as having a tax residency at all.

If a foreign investment vehicle is managed by a management company located in France, and the management company makes binding decisions on behalf of the investment vehicle, the FTA might determine that the investment vehicle itself is located in France, pursuant to the "effective place of management" concept, and thus consider the investment vehicle to have a permanent establishment in France. To reduce the likelihood that the FTA may question the tax residency of a foreign investment vehicle: (i) the implementation scheme of the investment vehicle should provide for a precise allocation of the powers and functions between the management company and the investment vehicle; and (ii) the investment vehicle should have enough substance (e.g., office, assets, employees) to be able to carry out its activities in the jurisdiction where it is registered. If the foreign investment vehicle does not meet these two conditions, the FTA might subject the investment vehicle to the imposition of French corporate income tax.

Furthermore, in order to respect the EU principle of free movement of capital, the FTA distinguishes between foreign investment vehicles that are transparent (or pass-through) entities, and those that are structured as companies. In the case of a transparent foreign investment vehicle that is similar to a French tax-exempt investment vehicle (e.g., an FCP), the FTA should not be entitled to subject the foreign investment vehicle to corporate income tax in France.

However, if the foreign investment vehicle is organized in the form of a company (e.g., an investment company such as a Luxembourg SICAV, SICAR, SIF or QIF), it may be difficult to compare the foreign investment vehicle to a similar French entity.

If the FTA recharacterizes the tax residency of a foreign investment vehicle, this could lead to withholding tax issues.

Withholding Tax Issues

If a foreign investment vehicle were to be considered as having a permanent establishment in France, it would be subject to the 25% withholding tax on dividends paid to the investors. This withholding tax would correspond to the taxation, in France, of the foreign investors in the French investment vehicle.

The country in which the investment vehicle is organized could have the same position, and therefore also apply a withholding tax on payments made to the end-investors. As investment vehicles are generally not eligible for the benefits of double tax treaties, this could create a double taxation and generate important issues for investors who wish to claim tax credits for the withholding taxes paid. On the other hand, if the foreign investment vehicle has no permanent establishment in France, there should be no tax issues in France.

If the foreign investment vehicle does not meet these two conditions, the FTA might subject the investment vehicle to the imposition of French corporate income tax.

The EU Court of Justice is currently investigating the French withholding tax rules and their compatibility with the EU principle of the free movement of capital, particularly in the context of investment vehicles. The EUCJ decision should provide more clarity and guidance regarding these issues.

In addition to the issues discussed above, the Directives may present other tax issues, such as those involving VAT and cross-border mergers of management companies or investment vehicles.

Conclusion

We believe that the Directives should be amended or supplemented by other directives, to clarify the tax issues that could seriously challenge the effectiveness of the Directives and the implementation of a Pan-European investment regime.

* Damien Fenard also contributed to this article.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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