By:
Shanak Patnaik
New York
In 1985, the Council of Ministers of the then-European Economic Community adopted Directive 85/611/EC (the "Directive"), which established uniform standards for the regulation of open-ended investment funds, or undertakings for collective investment in transferable securities ("UCITS"). The Directive contains several rules regarding the operation of a UCITS, the most important of which set forth comprehensive restrictions concerning its investment policies. Other rules concern how UCITS must be structured, the documents that must be provided to potential investors and the information that must be included in a UCITS prospectus.
The advantage of obtaining UCITS status is that once an investment fund has been certified as meeting the UCITS requirements by the securities regulatory authority of the Member State in which it has been formed, it may be offered for sale in the other Member States, subject only to the local marketing laws of each jurisdiction. While these marketing laws may be extensive, thus reducing the managers' ability to market the UCITS freely throughout the European Union ("EU"), the Directive represents an effort to ensure that the regulatory authorities of one Member State treat a UCITS established in another Member State on equal footing with domestic investment funds. If a decision is made to market a UCITS in another Member State, the managers of the UCITS may avail themselves of the Directive by translating certain documents into the language of the second Member State and submitting such documents to that Member State's regulatory authorities. The regulatory authorities of the second Member State then have two months from the date of submission in which to object to the documentation, and any objections only may be made on very limited grounds.
Since the adoption of the Directive, Luxembourg has become a popular domicile for open-ended investment funds. If a fund is organized in Luxembourg, it must be authorized by the Institut Monataire Luxembourgeois ("IML"), which oversees investment funds, banks and other financial institutions, before it may commence operations. The IML only will give such approval once it has approved the fund's constitutional documents and choice of custodian. Constitutional documents include (i) the prospectus, (ii) the management regulations or articles of association, (iii) the custodian agreement, (iv) the investment management agreement, (v) the distribution agreement, (vi) the nominee service agreement and (vii) the administration agreement.
If the managers so choose, the UCITS may be set up in an "umbrella" structure. In an umbrella fund, various sub-funds or portfolios may be created to operate as distinct entities. Accordingly, a UCITS may have several sub-funds, each of which may have different investment philosophies, dividend policies and investors.
Under Luxembourg law, a UCITS may be organized under a contractual or a corporate form. The contractual form is called a Fonds Commun de Placement ("FCP"), while the corporate form is called a Societe d'Investissement Capital Variable ("SICAV"). An FCP may be defined as an undivided collection of assets which are managed on behalf of its joint owners. It is formed pursuant to its management regulations, which essentially represent a three-way contract among a fund's (i) Luxembourg management company, which has been specially formed for the purpose of managing the fund, (ii) bank custodian and (iii) investors. The FCP's activities are governed by its management regulations and its prospectus. Although the FCP is not a corporate entity, its owners are liable only to the extent of their capital contributions. A SICAV is a separate legal entity in the nature of a corporation whose capital varies and is equal to its net asset value. The SICAV is managed by its board of directors and its activities are governed by its articles of association and its prospectus.
From a decision-making point of view, the managers of an FCP have slightly more discretion than the managers of a SICAV. For example, a SICAV may be liquidated or merged only upon shareholder approval, while an FCP may be liquidated or merged by decision of the management company (provided that the management regulations do not provide otherwise). Similarly, in an FCP, the management company will make decisions regarding distributions in accordance with the dividend policy stated in the management regulations. Conversely, distribution decisions in a SICAV generally are made by the shareholders upon proposal of the board of directors. (However, if the articles of association so provide, the board may declare interim dividends.)
Both FCPs and SICAVs may be organized as umbrella funds as opposed to a single portfolio. If the fund initially has a single portfolio structure, it may be converted into an umbrella. The management company may make the decision as to whether the FCP will be converted from a single portfolio into an umbrella; however, the shareholders must make this decision if a SICAV is to be so converted. Once an umbrella structure exists, neither the management company of an FCP nor the board of directors of a SICAV is restricted in its ability to add or liquidate sub-funds.
A SICAV is a little more flexible than an FCP with regard to borrowing. SICAVs and FCPs may only borrow up to 10% of their net asset value on a temporary basis. However, a SICAV may also borrow up to 10% of its assets to purchase immovable property, although the total amount borrowed by a SICAV may not exceed 15% of its assets.
The fact that an FCP, unlike a SICAV, is not considered a separate legal entity may give rise to important tax consequences. FCPs are often considered transparent in that they act on behalf of their owners. A notable exception to this occurs under U.S. tax law, which considers a normal FCP to be an association taxable as a corporation and thus not tax-transparent. Consequently, an FCP might not be able to claim benefits deriving from any tax treaties into which Luxembourg may have entered. However, each of the FCP's owners (or unitholders) might claim the benefit of a treaty between his home country and the country in which the taxable investment was made. This benefit might be available either by means of the fund claiming refunds or reduced withholding from the source country of the income, or by means of the unitholder claiming a credit or exemption in his home jurisdiction.
In theory, as a separate legal entity, a SICAV should be able to invoke tax treaties existing between Luxembourg and countries in which investments are made. However, Luxembourg tax authorities have taken the position that a SICAV may not be considered a resident company of Luxembourg within the definition of such tax treaties. As a result, the tax authorities of both Luxembourg and the other party to a particular treaty must agree as to whether a SICAV may benefit under the terms of that treaty. Currently, only a handful of countries allow SICAVs to claim this benefit.
Even if a SICAV may not have an advantage over an FCP with regard to tax treaties, it may have another important advantage. Since an FCP is not a separate legal entity, its gains and losses may be imputed to its unitholders by their home jurisdictions and thus taxed immediately. (Some jurisdictions, such as Germany, may tax their nationals on their pro rata portion of gains, regardless of whether the fund is organized as an FCP or a SICAV.) On the other hand, in the absence of special legislation, as exists in the United States and England, a SICAV may accumulate its gains and thus defer taxes at the investor level until such time as distributions are made to its shareholders. The SICAV is not penalized by double taxation in this situation since Luxembourg's taxes on a UCITS are applied equally regardless of whether the UCITS is an FCP or a SICAV.
