The case for countries - Austria The marketing of

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The case for countries - Austria
The marketing of participations in foreign private equity
funds from an Austrian tax perspective
Gerald Gahleitner, Gerald Toifl, Leitner & Leitner
16-Oct-2002
Investment in the Austrian private eq-uity market is on the rise, say Gerald Gahleitner and Gerald
Toifl of Leitner & Leitner. But there are tax issues that investors should be aware of when marketing
their funds. Toifl and Gahleitner outline the relevant tax im-plications for Austrian private and institutional investors and discuss various tax issues that might arise from in-vestments by foreign
funds in Austrian target companies.
Although Austria is geographically a small market it seems to be an attractive market for foreign
private equity and venture capital firms. The number of firms trying to market in-vestments to
Austrian residents or investing through their funds in Austrian target compa-nies is constantly rising.
Not only Austrian institutional investors but also (high net wealth) private individuals diversify their
portfolios by investing in local and/or foreign private equity funds. Both, investors and private equity
firms (including foreign investors holding stocks in private equity funds) are facing several tax
implications. This article summarizes some of them providing foreign private equity firms with the
Austrian regulatory and tax framework for a successful structuring of their Austrian activities.
The Austrian investor’s perspective
1.
General income tax principles
The tax treatment of an Austrian investor’s participation in a foreign private equity fund depends on
the legal structure of the fund. Foreign funds are usually organised in the form of a partnership, they
may, however, also be set up in the form of a corporate entity. The Austrian tax rules differ in this
respect as described below:
1.1.
Corporate investors
Austrian corporations are generally taxed on their worldwide income at the rate of 34%. Income
derived from a unit in a transparent or non-transparent foreign fund is generally categorized as
business income and taxed accordingly. However, if the foreign fund is organized in the legal form of
a EU company listed in the Parent-Subsidiary Directive or in a legal form that is comparable to the
Austrian GmbH (limited liability company) or AG (stock corporation), the international participa-tion
exemption might apply. Under the participation exemption, dividends derived from and capital gains
arising from the alienation of such a participation (which could also be unit in a foreign fund) are
exempt from corporate income tax provided that the Austrian corporate investor holds at least 25%
of the capital of the foreign fund for an uninterrupted period of 2 years.
Special rules exist for private foundations (Privatstiftungen) set up in accordance with Austrian
legislation. Private foundations are generally taxed at the rate of 34% whereas special rates and
several exemptions are available depending on the cate-gory of income. Thus, dividends and capital
gains derived by the private foundation in respect of domestic or foreign companies are tax exempt
under certain con-ditions.
1.2.
Private investors
Private individual investors can dispose of or redeem their units in a foreign fund that is organised in
the form of a corporation tax free provided that they hold a par-ticipation of less than 1% and the
holding period exceeds one year. Dividend dis-tributions by a foreign corporation (fund) would be
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subject to income tax at pro-gressive rates of up to 50%.
This high tax burden has been criticised as contradicting the free movement of capital under the EC
Treaty since dividends paid by Austrian companies are taxed at the rate of 25% only. As in the
meantime a preliminary ruling concerning the discrimination against foreign dividends has been
submitted to the European Court of Justice changes to the tax rules are very likely. Although no draft
law has been made official yet it can be expected that dividends will be subject to final (withholding) tax at the rate of 25% regardless of its domestic or foreign source from 1 January 2003.
The tax treatment of income from participation in a foreign private equity pool that is organised in
the form of a partnership depends on whether the foreign partner-ship is carrying on a trade or
business in the meaning of Sec 23 Income Tax Act or whether it is only engaged in asset
management, thus managing participations in the target companies.
If the private equity fund is regarded as carrying on a trade or business, its income (including any
capital gain from the disposal of shares) will be attributed pro rata to the Austrian private investors
and taxed in its hands as business income at progres-sive rates up to 50%. Tax treaties may,
however, change this result (see paragraph 1.3).
In the case that the object of the foreign partnership is limited to asset management any capital gain
received by this partnership is taxable in the hands of the Austrian private investor only if
the percentage of the investor’s pro rata participation in the target company amounts to at least
1 %, or
if the foreign fund disposes of such shares within a one-year holding period.
The question as to whether the foreign partnership is to be regarded as carrying on a trade or
business or whether it can be treated as a pure asset management com-pany depends on various
criteria including the following:
A trade or business is assumed if the activities of the partnership are directed towards the sale
(purchase) and resale (repurchase) of assets and if the activi-ties of the foreign fund in respect
of the
acquisition of assets are financed with debt.
The sale and purchase of shares by the Austrian private investor is regarded as a trade or
business if the
activities of the partnership are similar or comparable to banking activities.
The establishment of specific organisation and offering (banking) services to the public in some
cases
followed by the sale and purchase of stock for the account of third parties is indicative for the
existence
of a trade or business.
By applying these criteria to foreign private equity partnerships, one may conclude that the way a
private equity fund generally structures its activities will prevent a classification as a partnership
carrying on a trade or business in terms of Sec 23 In-come Tax Act.
1.3.
Applying tax treaties
Generally, private equity firms are set up in the legal form of a partnership that will be considered as
transparent for Austrian and foreign income tax purposes. In such a case, income derived by the
private equity fund will be attributed to and taxed in the hands of the Austrian private or corporate
investor. The tax treatment will de-pend upon the classification of the activities of the fund as well as
the residence of the target vehicle.
In general, the two following situations have to be distinguished:
be
The private equity fund is considered to carry on a trade or business: The Austrian investor will
deemed as having a permanent establishment in the state of the fund’s residence. In a treaty
situation, the
income of the fund at-tributed to the Austrian investor will generally be exempt in Austria as
most of its
tax treaties provide for the exemption with progression method. In a non-treaty case, tax
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authorities might
under certain conditions provide for a unilateral relief.
The private equity fund is engaged in asset management activities: The look-through approach
will be
applied to the foreign partnership. Thus, the investor will be taxed according to its participation
on capital
gains derived by the pri-vate equity fund from the alienation of target companies. The treatment
of a
particular portion of the capital gain will depend on the residence of the target company. Under a
tax
treaty between the residence state of the target com-pany and Austria, such gain will, in most
cases, be
seen as taxable in Austria only, but will in general not be taxed under Austrian domestic rules.
In the case of a characterization conflict that might arise from different treatment of partnerships in
Austria and the state of their residence, Austrian tax authorities committed themselves to the
proposals made by the OECD Partnership Report in 1999. If different tax treatment results in double
taxation of income, Austria will follow the classification of the source state and grant exemption for
foreign source income. On the other hand, Austrian tax authorities will be reluctant to provide for an
exemption of foreign income that is either non-taxed or considered as dividends or interest that is
taxable at source only. In such a case, the exemption will be re-placed by a foreign tax credit.
2.
The application of Sec 42 Investment Fund Act (InvFG)
2.1. The InvFG constitutes the legal framework for Austrian investment funds. Its Sec 42 contains
special rules as to the tax treatment of income derived from a foreign legal entity that is considered
as falling within the scope of this provision. Thus, it is potentially applicable to foreign private equity
funds and may have negative tax consequences for Austrian investors.
2.2. The special tax regime applies if the foreign entity, in which the Austrian investor holds a
participation, is classified as a foreign investment fund. Such a fund is deemed to exist if the foreign
entity by law, statutes, or actually structures its in-vestments under the principle of risk
diversification. The legal form of the entity is of no relevance. Undertakings for investments in real
estate are generally exempt from the application of this provision. It should be noted, however, that
the Aus-trian government has prepared a draft law that provides for a similar tax regime ap-plicable
to collective investments in (foreign) real estate.
2.3. The Ministry of Finance has issued various guidelines and rulings from which it could be
concluded that tax authorities assume foreign private equity funds as gen-erally being covered by
Sec 42 InvFG. In its view, the application of Sec 42 InvFG is not excluded by the fact that the foreign
private equity fund primarily invests in participations, in which an Austrian investment fund is
generally not allowed to in-vest. For instance, an Austrian investment fund may not invest in limited
liability companies or the investment in such a company may not exceed a certain thresh-old. If a
foreign private equity fund structures its investments in various participa-tions (e.g. in more than
five target companies as exemplified in a ruling issued in 2001 by the Ministry) it is very likely that
provisions of the Investment Fund Act will be applicable. However, local tax authorities are
sometimes willing to grant rulings that exclude the application of Sec 42 InvFG if the foreign
investment fund has a certain influence on the management of the target companies.
2.4. The tax treatment under Sec 42 InvFG depends on whether the fund has disclosed its overall
income to the Austrian Ministry of Finance. If proof on actual income of the fund is submitted to the
Ministry and if the foreign fund is admitted to and ac-tually offered for public subscription (i.e. a
white fund) the Austrian investor will be taxed on actual profits derived by the fund and attributed to
him. Only 20% of the capital gain would be taxable. In the case that the fund is not admitted to or
actually offered for public subscription, but actual profits are disclosed to the Minis-try (i.e. a grey
fund), the overall income of the fund would be taxable. Thus, capital gains will be included in the tax
base. In the remaining cases, the Austrian investor is deemed to receive the higher of the 90 % of
the difference between the first and the last repurchase price fixed in the calendar year and 10 % of
the last repurchase price fixed in the calendar year as taxable income (i.e. a black fund). If the unit
is sold the difference between the repurchase price fixed at the time of sale and the last repurchase
price fixed in the past calendar year but at least 0.8 % of the repur-chase price fixed at the time of
sale for each month commenced in the calendar year is to be declared as taxable income.
As difficulties will arise in practice with respect to the necessity to disclose income or to be admitted
to public offering, the foreign investment fund will be generally characterized as a black fund.
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2.5. The income determined in such a way and attributed to the corporate investor is taxed as
business income at the rate of 34%. The international participation exemption is neither applicable to
the distributions made by the fund to the corporate in-vestor nor to the capital gains derived from
the alienation of the participation units.
Private investors are considered as deriving interest income in respect of securities. According to the
existing rules, progressive tax rates up to 50% apply. As a result of the developments on the EU
level (i.e. pending case on discrimination against foreign dividends, proceedings initiated by the
European Commission against Austria on the tax treatment of foreign investment funds), discussions
have started to-wards equal treatment of certain income from capital derived from domestic and
foreign investment funds. Among others, proposals have been made to tax such in-come at a final
(withholding) rate of 25%. Such developments might, in certain cases, eliminate or mitigate
detrimental tax treatment of investments in black funds.
3.
The establishment of an Austrian parallel fund (side-pool)
3.1. In order to avoid disadvantages for the Austrian investor resulting from characteri-zation of the
foreign entity as an investment fund followed by the application of Sec 42 InvFG, the activities of the
investor could be structured by setting up an Austrian parallel fund. Such a parallel fund could be
established in the legal form of a limited partnership (Kommanditerwerbsgesellschaft) that invests
into target companies parallel to the main fund. In such a structure, no unit in the main for-eign
investment fund as required by Sec 42 InvFG will be held by the Austrian in-vestor. The structure is,
however, feasible only if the parallel fund does not qualify as fund-of-funds as in such a case the
issue of Sec 42 InvFG would again arise. Regulatory issues will further have to considered when
implementing a parallel fund structure.
3.2. The Austrian limited partnership will, under an appropriate structuring, generally not be
treated as carrying on a trade or business under the principles described above (see para 1.3 ).
Thus, capital gains derived by an Austrian private investor will be tax exempt provided that the
investor’s pro rata participation in the target company is less than 1% and the one year holding
period has expired.
3.3. As the Austrian limited partnership will not be qualified as carrying on a trade or business the
Austrian side-pool could also be used as an attractive investment vehicle for foreign investors or
private equity firms. As long as the Austrian limited partnership does not maintain an office in
Austria foreign investors would not be subject to any tax liability. It is, nonetheless, recommendable
to obtain a ruling from the competent tax authority in order to confirm that in a specific structure the
Austrian limited partnership does not result in a (limited) tax liability for foreign investors.
3.4. However, the Austrian parallel fund structure seems to be acceptable to private equity firms
only if the carried interest can be withdrawn without triggering Austrian tax. Various techniques can
be used to reach this aim. For instance, the private equity firm might enter into a silent partnership
agreement with the Austrian parallel fund. As alternative, the latter may issue participation rights to
the foreign fund. Under either agreement, the private equity firm would receive a remuneration for
its services provided to the Austrian side-fund, which is determined by a certain percentage of the
partnership’s profit or the amount of carried interest. Under certain conditions, no tax liability will
arise in Austria. As re-characterization of profits arising from participation rights or from a silent
partnership into tax exempt capital gains is common in some jurisdictions, detailed examination of
tax consequences at the level of each partner of the private equity firm is necessary.
3.5. In principle, services offered by the foreign private equity fund may constitute taxable events
for Austrian VAT purposes or result in a source taxation if the fund or the person carrying out such
services is resident in a non-treaty state. In most cases, the VAT and income tax liability might be,
however, avoided by careful tax planning.
The penetration of the Austrian market by foreign private equity firms
1.
Typical structures
Foreign private equity firms may choose to set up a local business in Austria in or-der to evaluate the
market, to negotiate with the target companies or to advise the foreign head office on suitable
targets. Instead, the firm may decide to operate in the market from a base outside of Austria (e.g.
Switzerland or Germany).
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The following description of tax consequences is based on the following situation: A foreign private
equity fund that is organised in the form of a limited partnership (LP) and thus, deemed transparent
for income tax purposes invests into Austrian target companies. It is further assumed that the
private equity firm becomes a limited partner in the foreign fund. The following focuses on tax issues
arising for partners of the limited partnership.
2.
Austrian source taxation
Foreign investors are, in their capacity as partners of the LP, subject to Austrian income tax if they
derive certain income from Austrian sources. In particular,
2.1 Capital gains are in general taxed if
such gains are treated as income from a trade or business and attributed to the permanent
establishment
or the permanent agent that the LP may have in Austria, or
such gains originate from the sale of a participation in a resident company provided that the
investor’s pro
rata share amounts to at least 1% or is held for less than 1 year.
2.2
Passive income
Any dividends distributed by an Austrian company to the foreign LP are treated as being distributed
to the foreign investor according to its foreign pro rata share. The investor is subject to a withholding
tax at the rate of 25% that might be, however, reduced by a tax treaty between Austria and the
state of the investor’s residence.
Interest is generally not subject to any income or withholding tax according to Aus-trian domestic
law.
3
Permanent establishment or permanent agent
As mentioned above, a foreign investor holding a participation in the foreign LP will be taxed in
Austria if the investor carries out a trade or business through an Austrian permanent establishment
or an Austrian permanent agent.
The decision as to whether the foreign investor carries out a trade or business de-pends mainly on
the activities of the LP as well as other activities of the investor. Based on the guidelines described
above, a private equity fund mainly engaged in asset management will not be regarded as carrying
out a trade or business. How-ever, the activities of the investor might themselves qualify as business
activities. In such a case, the investor would be subject to Austrian tax only if an Austrian permanent
establishment or a permanent agent is maintained in Austria for the acquisition or sale of
participations in Austrian companies.
Private equity firms having an office in Austria for purposes of evaluating the market and potential
target companies will usually avoid the permanent establishment issue by reducing the functions of
the local office to pure advisory activities. Neither should the staff of the foreign private equity firm
have the authority to dispose of the local premises of the Austrian entity nor should it be granted
any authority to negotiate contracts concerning the acquisition or the sale of participations in the
name of the fund. In such a case, the local staff would only provide auxiliary services to the foreign
head office, which has the power to decide on the acquisition or on the sale of a specific participation
in a target company. The taxable income of the local entity is then calculated on a cost-plus basis. In
addition, a situation should be avoided such that employees of the head office negotiate contracts at
premises of local target companies. In other words, the employee having an authority to bind its
head office shall not physically act on the Austrian territory otherwise a permanent establishment will
be created.
4.
Application of tax treaties
If a foreign private equity fund is set up in a state having a tax treaty with Austria the question
arises as to whether the LP will be granted protection under the tax treaty. In such a case, Austrian
tax authorities will follow principles developed in the OECD Partnership Report. Thus, the tax
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treatment of the partnership in the state of its establishment as well as the attribution of
partnership’s income under the domestic rules of the state of the partners’ residence will have to be
considered.
If the LP is treated as transparent for tax treaty purposes and its income is attributed to partners
under the domestic rules of their residence state Austria as a source state will have to consider its
treaties with the residence states of the partners. If the LP is treated as a corporation and thus, nontransparent entity for income tax purposes Austria as a source state will apply the tax treaty with the
state of the LP’s estab-lishment. In the case that a tax treaty contains a provision similar to Art 13
(4) of the OECD-Model Convention, Austria would have to exempt such capital gains from taxation
even though the foreign investor’s pro rata share in the Austrian tar-get company exceeds 1%.
Copyright © Leitner & Leitner
Gerald Gahleitner, LLM (London) is a tax lawyer in the Linz office and can be contacted at +43 732
7093-303 or [email protected]. Gerald Toifl is tax lawyer in the Vienna office
and can be contacted at +43 1 7189890-531 or [email protected].
Leitner & Leitner was established in 1959 as a certified public accountants and tax con-sulting
company. It currently employs a staff of around 300 employees and has offices in Vienna and Linz as
well as subsidiaries in Czech Republic, Slovak Republic, Hungary and Slovenia. For futher information
please visit www.leitner-leitner.com
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