Spotlight on subscription tax: recent challenges and benefits
By Daniel Rech in Financial Services, Tax, 28.07.2021
Let’s be honest, subscription tax in Luxembourg has never been center stage. Frankly, why would it? For most asset managers, it’s an administrative tax, handled back-office, with easy, straightforward rules. Subscription tax ) is calculated according to the type of fund vehicle and its rate varies between 0.01% and 0.05% with quarterly filings. No big deal.
Following several recent developments, however, the tables have started to turn. The Luxembourg state and its supervising authorities will increase the number of reviews and audits regarding subscription tax going forward.
The Luxembourg government introduced new measures (in effect as of 2021) stipulating that the subscription tax rate for UCITS and UCI could be reduced from 0.05% to a maximum of 0.01% by investing in sustainable assets. This may put UCITS and UCI on an equal level with other fund vehicles that already benefit from a reduced subscription tax rate.
Furthermore, the CSSF recently published a new circular extending AML-KYC requirements for funds and their managers who will need to adapt and improve documentation quality around subscription tax. Funds also need to reflect on existing procedures concerning this tax and its various exemption possibilities.
ESG funds enjoy subscription tax reduction
From 1 January 2021, the individual compartments of UCITS (Part I) and UCI (Part II) have been able to benefit from a reduced subscription tax rate on their part of total net assets investing in taxonomy-aligned sustainable assets.
This means that the subscription tax rate can decrease by a minimum of 0.01% or up to a maximum of 0.04% depending on the net assets invested in environmentally sustainable funds. For example, if a fund invests more than 35% but less than 50% in taxonomy-aligned sustainable assets, the subscription tax rate decreases from 0.05% to 0.02% for this ESG compliant part of the compartment’s NAV.
To take advantage of this reduction, an external auditor must certify the calculation method of the previously calculated percentage of NAV invested in sustainable assets. In addition, this percentage must be published in the fund’s annual report or in a separate reasonable assurance report.
Accordingly, Part I and Part II investment funds should evaluate and analyze their portfolios to identify the proportion invested in taxonomy-aligned assets. Even though obtaining all underlying information to calculate the exact percentage is currently a challenge, this reduction creates a strong incentive for investors and funds to continue to invest more in sustainable assets.
New circular brings additional documentation requirements
The CSSF recently published Circular 20/744 which imposes further documentation requirements concerning subscription tax and its quarterly returns.
This means that there might be a reporting obligation to the Financial Intelligence Unit for subscription tax, if a fund, or its manager, do not have adequate and sufficient information on investors’ status. Furthermore, the investors’ status must comply with legal requirements governing the subscription tax.
The Circular, therefore, requires extended documentation obligations and aims to increase control by the tax authorities and the CSSF. Audits will focus on whether:
- the funds have adequate documentation and due diligence for their investors
- there are proper contracts in place
- tax returns and possible exemptions have been prepared in a correct and appropriate manner
It’s not one-size-fits-all
While subscription tax applies to various Luxembourg investment fund vehicles, not all of them are subject to the same tax rate. A reduced subscription tax rate of 0.01%, or even a full exemption, may apply to UCITS and UCI.
Moreover, alternative investment funds (e.g. SIF) already benefit from a reduced subscription tax rate of 0.01% with a possible tax exemption for certain money market funds, microfinance funds and pension funds. In contrast, under certain conditions, other fund vehicles (e.g. SICAR or RAIF) do not pay subscription tax at all.
All fund vehicles should evaluate whether applied and declared exemptions are lawful and properly documented as the CSSF and the tax administration are increasingly checking whether funds have applied for the exemptions correctly and whether they actually qualify for them.
The CSSF Circular 20/744 even includes a reporting obligation for a SICAR not investing in securities representing “risk capital” but still benefitting from a favorable tax regime.
Staying on track
Luxembourg subscription tax has certainly turned a few heads over the last few months.
The possible reduction of the tax rate for UCITS and UCI on their part of taxonomy-aligned sustainable investments offers a great opportunity to achieve an overarching goal of sustainability, and further sets strong incentives for funds and investors in Luxembourg.
Nonetheless, more stringent documentation requirements under the CSSF Circular 20/744 admittedly pose challenges for funds.
So, what do funds, and management companies need to do? They must ensure there is clear documentation and due diligence when it comes to investors, signed contracts, accurate tax returns and requested exemptions in relation to subscription tax.