1. Investment funds: UCITS and AIFs
An investment fund is an undertaking which (i) does not have a general commercial or industrial purpose, (ii) pools together capital raised from its investors for the purpose of investment with a view to generating a pooled return for those investors, and (iii) where the unitholders or shareholders of the investment fund – as a collective group – have no day-to-day discretion or control.
Investment funds exist in all different shapes and sizes: from Undertakings for Collective Investment in Transferable Securities (UCITS) typically aimed at retail investors to all sorts of Alternative Investment Funds (AIFs) such as private equity funds, hedge funds, real estate funds, infrastructure funds, etc. If you want to establish an investment fund, you may wonder which regulatory framework is most suited.
All investment funds which do not qualify as UCITS are AIFs. AIFs are often non-public investment funds and can be regulated or unregulated. Belgian law also provides for a specific framework on securitisation vehicles, so-called institutional Undertakings for Investment in Receivables (UIRs). There is no regulated framework anymore for public securitisation vehicles, meaning that an unregulated Special Purpose Vehicle must be established in this case.
Choosing the right type of investment fund will therefore depend on several factors.
2. Type of investors
Which type of investors are targeted or – to put it another way – is the fund open to the general public or restricted to professional investors and/or high net worth individuals?
If the fund is to be marketed to as many as (small) investors as possible, a UCITS will most likely be your best choice. Depending on the investment objectives, a public AIF could, however, be an alternative. On the other hand, if the fund is not intended for the open market, a private AIF will be the logical choice.
As a general rule, public funds are more heavily regulated, while private funds will either benefit from a light regulatory framework or be unregulated altogether. Regulated private funds are optional, therefore leaving the possibility to establish unregulated private funds.
3. Which assets should the fund be allowed to invest in?
Closely linked to the previous criterion, the type of investment fund will depend on the assets it is allowed to invest in, or its eligible investment assets. Public funds may only invest in certain types of eligible investment assets, while private funds can – If they remain unregulated – invest in all types of assets. If a private fund opts for a regulated status, it will need to comply with the rules on its eligible investment assets as imposed by the applicable regulation.
Hence, the following types of funds can be distinguished on the basis of their eligible investment assets:
(a) Public funds
- UCITS may only invest in transferable securities and liquid financial assets;
- Public AIFs which invest in transferable securities and liquid financial assets;
- Money market funds (MMFs) which invest in short-term assets. MMFs can be structured as UCITS or AIFs;
- Public AIFs which invest in private equity, or so-called Openbare Privaks/ Pricafs Publiques, and their variant for investing in start-ups, the Openbaar Startersfonds/ Fonds Starter Public;
- Public AIFs which invest in real estate, or Openbare Vastgoedbevaks/SICAFIs publiques. This statute is, however, no longer used in practice and has been replaced by the much more suitable regime of Belgian public REITs or Openbare Gereglementeerde Vastgoedvennootschappen/ Sociétés Immobilières Réglementées Publiques. Belgian REITs are not investment funds but are subject to their own rules, providing them with more flexibility as to the activities they may undertake;
- European Public AIFs which invest in long-lived capital in order to finance tangible assets such as energy, transport and communication infrastructures, industrial and service facilities, housing and climate change and eco-innovation technologies as well as intangible assets such as education, research and development that boost innovation and competitiveness. These are so-called European Long-Term Investment Funds or ELTIFs.
(b) Regulated private funds
- Private AIFs which invest in financial instruments and liquid financial assets, including money market instruments. This type of fund may serve as a vehicle for hedge funds, although hedge funds can also take the form of an unregulated private AIF;
- Private AIFs which invest in private equity, or so-called Private Privaks/Pricafs Privées, and their variant for investing in start-ups, the Private Startersprivaks/Pricafs Privées Starter;
- Private AIFs which invest in real estate, or so-called Gespecialiseerde Vastgoedbeleggingsfondsen/Fonds d’Investissement Immobiliers Spécialisés. Private real estate funds can theoretically also take the form of Institutionele Vastgoedbevaks/ SICAFIs Institutionnelles, but here again this regime has in practice been replaced by the Belgian institutional REIT. An institutional REIT must have a public REIT amongst its shareholders for at least 25 % of its capital;
- European Private AIFs which invest in venture capital to seed start-ups, or so-called European Venture Capital Funds (EuVECAs);
- European Private AIFs which invest in social enterprises whose primary objective is to have a social impact, or European Social Entrepreneurship Funds (EuSEFs);
- The aforementioned ELTIFs could also be structured as a private fund;
- Although they do not qualify as investment funds, institutional UIRs invest in receivables and are used in securitisation transactions.
(c) Unregulated private funds
Eligible investment assets can include, for example, financial instruments and liquid financial assets, private equity, real estate, ships, forests, wine, art, cryptocurrencies, etc. and any combination thereof.
4. Should investors be able to enter and exit the fund at all times?
Investment funds can be structured as either open-ended or closed-ended. In an open-ended fund, investors may purchase and redeem units or shares of the fund at all times, while in a closed-ended fund, the investors do not have this right.
The open-ended or closed-ended structure will depend on the liquidity of the fund’s investment assets. UCITS and AIFs which invest in financial instruments will therefore be open-ended, while all other funds, such as private equity funds and real estate funds, will be closed-ended. As an exception, ELTIFs can, under certain strict conditions, be structured as open-ended instead of closed-ended.
Finally, in order to provide a certain degree of liquidity for their investors, public closed-ended funds must trade their shares on a stock exchange, except for public ELTIFs. A stock exchange listing is not required for private closed-ended funds nor for open-ended funds, whether public or private.
5. Legal form: investment company or common fund?
Another distinction to be made between investment funds is their legal form. All investment funds can, or sometimes must, take the form of an investment company with legal personality. Sometimes the law allows the fund to take the form of a common fund, which is a contract between the investors and does not have legal personality of its own. Contrary to Anglo-Saxon legal systems, there are no trusts under Belgian law and hence Belgian investment funds cannot be created as unit trusts.
Where it is possible to choose between investment companies and common funds, this will impact the management structure. Common funds must always appoint an external management company (ManCo), while investment companies can be either self-managed or managed by a ManCo.
Furthermore, investment companies can only assume a limited number of company forms.
6. The management of the investment fund: licensed or registered?
A final yet important aspect of investment funds is the distinction between product level (the fund) and management level. As noted above, all investment funds must be managed either externally or, where allowed, internally. ManCos of UCITS will need to be licensed with the regulator. Self-managed UCITS do not need to be licensed as manager, but the UCITS will be licensed in its capacity of investment fund.
For AIFs, the situation is slightly different. All managers of AIFs, i.e., both AIF ManCos and self-managed AIFs, must in principle be licensed as AIFM. Therefore, self-managed AIFMs will be licensed as manager and licensed or registered as an investment fund, depending on whether the AIF is public or private and regulated. Unregulated private funds do not trigger a registration requirement as a fund, although their management will be regulated.
An important exception to the license requirement for AIFMs is the registration regime for small-scale AIFMs managing private AIFs. If the AIFM has assets under management (AuM) of no more than EUR 500 million and investors may not redeem their shares during an initial period of five years, or if the AIFM has AuM of no more than EUR 100 million if it uses leverage, it may opt to be registered. Registration is far less burdensome than licensing. The registration regime is also a requirement for EuVECAs and EuSEFs.
Finally, institutional UIRs will also be either self-managed or managed by a ManCo. The ManCo needs to be licensed (no registration possible) and the institutional UIR, whether externally or self-managed, registered.
7. Tax treatment: investment company vs. common fund and regulated vs. unregulated
From a tax point of view, an important distinction that has to be made is the distinction between investment funds taking the form of an investment company and investment funds taking the form of a common fund. The legal form will determine the tax status of the investment fund itself.
In case the investment fund takes the form of an investment company, the investment fund will be subject to corporate income tax at the standard income tax rate. Such an investment fund will however only be taxed on a limited corporate tax base if the investment fund is regulated (except for EuVECAs, EUSEFs and ELTIFs), i.e., on the total of abnormal or benevolent advantages received and disallowed expenses, other than depreciations and capital losses on shares and the financing cost surplus not classified as professional cost and the secret commissions tax.
EuVECAs, EUSEFs and ELTIFs that are established as an investment company will, however, not benefit from this limited corporate tax base. If the investment company chooses to remain unregulated, the aforementioned limited corporate tax base does not apply either.
In case the investment fund takes the form of a common fund, the investment fund does not have legal personality and, as such, will not be subject to corporate income tax. The income of the investment fund will then in principle be immediately taxable in the hands of the investors (as if the fund does not exist) following a full tax transparency regime, irrespective of any distribution to the investors. An exception to this rule exists.
The tax regime applicable to the investors also depends on the legal form of the investment fund, but additionally depends on whether the investor is an individual or a company.
Dividend and interest distributions to individual investors in an investment fund taking the form of an investment company will, normally, be subject to the standard withholding tax rate of 30%. Share capital reductions/reimbursements will, in principle, not be taxable, unless the investment fund has retained earnings/reserves. Capital gains on shares are not taxable if they are realized in the normal management of a private estate. Again, an exception to this rule exists. Liquidation and redemption bonuses are not subject to withholding tax, although an exception to this rule exists as well.
All income received by companies investing in an investment company will be subject to corporate income tax at the standard rate. As a general rule, the income received from such an investment company cannot benefit from the participation exemption, unless certain conditions are fulfilled. Deviations exist for certain types of investment funds. Furthermore, normally a 30% withholding tax applies to dividend distributions. Such withholding tax is however creditable against the corporate income tax due and even refundable.
In case of a common fund, individual investors will immediately be taxed on the underlying income earned by the fund. The taxation of the different types of possible income will equal the taxation that would apply if the investor had been investing directly. Under certain circumstances, an exception to the full transparency regime may apply. Corporate investors are also immediately taxed on the underlying income.
Although the rules enumerated above in general apply to all investment funds, specific tax rules may apply in case of certain types of investment funds.