In order to enhance the attractiveness of Switzerland’s fund center, the Swiss Parliament decided to introduce a new fund category (so called Limited Qualified Investor Fund) by partially revising the Collective Investment Schemes Act. A major advantage of the Limited Qualified Investor Fund is that it does not require approval by the competent Swiss supervisory authority nor is it supervised by such authority. As a result, the L-QIF can be launched more quickly than conventional Swiss investment funds. The revised Collective Investment Schemes Act was supposed to enter into force on 1 August 2023. Due to various critics received during the consultation process of the revised Collective Investment Schemes Ordinance, which contains the implementation provisions for the Limited Qualified Investor Fund, the initially planned timetable was deferred and currently it is expected that the new provisions will enter into force in March 2024. The following article summarizes the background and the legislative process as well as the Swiss tax aspects of the Limited Qualified Investor Fund.
Strengthening Switzerland’s fund center
Switzerland’s fund center enjoys a high reputation among international competitors as an asset management and distribution location for investment funds. This good reputation can be attributed to innovative labor forces and to the high density of wealthy investors in Switzerland. However, Switzerland lacks compared to other jurisdictions as a production location for investment funds. Reasons for this can be found in the limited access of Swiss investment fund products to the EU market, but also in the time-consuming and costly regulatory approval processes as well as in the high 35% withholding tax burden on distributions and accumulations by Swiss investment funds.
Introduction of the Limited Qualified Investor Fund (L-QIF)
In order to enhance the attractiveness of Switzerland’s fund center, the Swiss Parliament decided on 17 December 2021 to introduce the L-QIF as part of a partial revision of the Collective Investment Schemes Act (CISA). The L-QIF is a new fund category that is based on the Luxembourg Reserved Alternative Investment Fund (RAIF). L-QIF and RAIF can be set up in different legal forms, for example as contractual or as corporate funds and both products can only be offered to a limited group of investors (qualified investors in case of the L-QIF or “well-informed investors” in case of the RAIF). Furthermore, L-QIF and RAIF neither require approval by the competent regulatory authority nor are they directly supervised by such an authority. As a result, the L-QIF can be launched more quickly than conventional Swiss investment funds and the competitiveness of Switzerland as a fund production location can be strengthened.
Status of the L-QIF legislative process
On 23 September 2022, the Swiss Federal Council opened the consultation on the draft revised Collective Investment Schemes Ordinance (CISO), which contains the implementation provisions for the L-QIF. The consultation procedure ended on 23 December 2022 and the comments received were rather critical. Some of the consultation participants criticised how the provisions in the ordinance with regard to investment restrictions of L-QIFs were interpreted. In their view, these provisions should be less restrictive considering that the L-QIF is only open for qualified investors and that the revised CISA would in principle allow for more liberal solutions in this area. Some of the consultation participants further criticised that the draft ordinance includes a large number of other restrictions that are not contained in the Luxembourg law applicable for the competing RAIF product and thus the revised CISO undermines the objective of the reform, namely to enhance the international competitiveness of Swiss investment funds.
Due to these critical comments raised during the consultation on the revised CISO, the initial introduction date of the revised CISA and the amendments to the CISO per 1 August 2023 was deferred. Implementation of the L-QIF is now expected to occur per 1 March 2024. It remains to be seen to what extent the critical comments made during the consultation process will find their way into the final version of the CISO.
Essential features of the L-QIF according to the revised CISA
The L-QIF is a Swiss collective investment scheme according to the CISA that can be set up in the legal form of one of the existing collective investment schemes. Specifically, the L-QIF can be set up as an investment company with variable capital (SICAV), as a contractual investment fund (FCP) or as a limited partnership for collective investment (KmGK). The establishment of the L-QIF as an investment company with fixed capital (SICAF) is not possible.
In contrast to the SICAV, FCP and KmGK, the L-QIF itself does not require authorisation from the Swiss Financial Market Supervisory Authority (FINMA), nor is it subject to its supervision. However, the L-QIF must be managed by an institution supervised by FINMA in order to ensure investor protection by means of indirect supervision.
The L-QIF is only open to qualified investors pursuant to CISA. These include professional clients (e.g. financial intermediaries pursuant to the Banking Act, supervised insurance companies, central banks, etc.). Qualified investors also include wealthy private clients and private investment structures set up for such clients who declare that they wish to be considered as professional clients, as well as investors with a written investment advisory or asset management contract, unless they have declared that they do not wish to be considered as qualified investors.
The investment regulations for the L-QIF are designed in a liberal manner considering that this new fund product is only open to qualified investors and considering the objective of promoting innovative fund products. The revised CISA does not impose any requirements with regard to the scope of investments or risk diversification. These liberal provisions allow the L-QIF to invest not only in traditional investments, but also in more exotic investments such as cryptocurrencies, commodities, infrastructure projects, wine or art. Due to the lack of regulations on risk diversification, the L-QIF can in principle invest all of its assets in a single investment object, taking into account the requirements to retain adequate liquidity. In comparison, the Luxembourg RAIF must maintain a 30% diversification limit.
Tax transparency of the L-QIF
The L-QIF is a collective investment scheme pursuant to CISA and therefore also a collective investment scheme within the meaning of Swiss tax legislation. Thus, the L-QIF is treated the same as other collective investment schemes (SICAV, FCP and KmGK) for tax purposes. Due to this equal treatment, the L-QIF is transparent for income and wealth tax purposes. Consequently, the L-QIF itself is not taxed. However, the taxable income and the net asset value of the L-QIF are allocated to the investors and taxed by them. Capital gains and capital repayments of the L-QIF attributed to the investors are tax-free for Swiss investors who hold their fund units as private assets.
Tax treatment of L-QIFs with direct real estate ownership
However, an exception to the above transparency principle exists for investment funds which hold real estate directly. Same as SICAVs, FCPs and KmGKs, the real estate income of the L-QIF from direct real estate ownership is subject to corporate income tax at fund level. In this case, a reduced corporate income tax rate is applied for federal tax purposes and generally also for cantonal and communal tax purposes. Furthermore, the net asset value attributable to real estate owned directly by the L-QIF is subject to capital tax at fund level. On the other hand, income from real estate held directly by the L-QIF as well as the net asset value attributed to real estate held directly by the L-QIF are not subject to income and wealth tax by Swiss investors. Further, income from direct real estate ownership distributed or accumulated by the L-QIF in favour of its Swiss and foreign investors are not subject to Swiss withholding tax.
During the L-QIF legislative process, the Federal Department of Finance recommended excluding private individuals that are considered as qualified investors as investors of L-QIFs with direct real estate ownership. Due to the reduced corporate income tax rate which applies to investment funds with direct real estate ownership, the Federal Department of Finance feared a decline in fiscal income as wealthy private individuals in the future may increasingly start using L-QIFs for their real estate investments for tax optimisation purposes instead of holding them directly or via a real estate company. The decline in fiscal income as estimated by the Swiss Federal Tax Administration would not have compensated for the economic advantages expected through the introduction of the L-QIF. As a result, the Federal Department of Finance recommended to the Parliament to exclude private individual qualified investors as investors of L-QIFs with direct real estate ownership and the Parliament agreed to this recommendation. Thus, L-QIFs with direct real estate ownership are not available to private individual investors.
Disadvantage of the Swiss withholding tax in connection with L-QIFs
Same as SICAVs, FCPs and KmGKs, distributions and accumulations of taxable income (dividends and interest, excluding capital gains and capital repayments as well as income from direct real estate ownership) by a L-QIF are subject to 35% Swiss withholding tax. Due to this high withholding tax burden, Swiss investment funds are generally less attractive for foreign investors compared to foreign competitor products. If there is a double taxation agreement in place between Switzerland and the place of residency of the foreign investor, the foreign investor can generally reclaim 20% of the Swiss withholding tax meaning that the non-refundable part of 15% will incur as a final withholding tax burden in Switzerland. Foreign investors without treaty protection are not entitled to any Swiss withholding tax refund. In addition, the rather lengthy and complicated withholding tax refund process must be taken into account, another reason why foreign investors avoid investing in Swiss investment funds. Foreign comparable investment funds like the Luxembourg RAIF have significant competitive advantages in this respect.
However, provided that at least 80% of the taxable income of the L-QIF originates from foreign sources, foreign investors of the fund may reclaim the full 35% withholding tax from the Swiss Federal Tax Administration, even if the country of residence of such investors has not concluded a double taxation agreement with Switzerland. Upon request, the Swiss Federal Tax Administration will allow such funds to distribute or accumulate taxable income in favour of foreign investors without deducting the 35% withholding tax in the first place. In this so-called affidavit procedure, the L-QIF therefore does not have to pay any Swiss withholding tax upon distribution or accumulation.
Status of the L-QIF under treaty law
Since the L-QIF is not subject to unlimited tax liability in Switzerland, it cannot benefit from double taxation agreements concluded by Switzerland. Thus, the L-QIF itself cannot reclaim foreign withholding taxes deducted from its income (with the exception of foreign withholding taxes from certain jurisdictions with which Switzerland has concluded mutual agreements that allow Swiss funds to reclaim a portion of the foreign withholding tax withheld from these treaty jurisdictions on behalf of the Swiss investors). In this case, the investor of the L-QIF must apply for a refund from the jurisdiction in which the withholding tax was withheld provided the resident jurisdiction of the investor has concluded a double taxation agreement with that jurisdiction.
L-QIFs and Swiss stamp duty
As the L-QIF is a collective investment scheme pursuant to the CISA, it is considered as an exempt investor within the meaning of the Stamp Duty Act which contains provisions for security transfer tax and capital issuance tax. Therefore, if a L-QIF buys or sales taxable securities, the Swiss security dealer involved in the transaction does not have to levy the portion of the security transfer tax attributable to the L-QIF. The L-QIF is therefore not charged with a security transfer tax when buying or selling taxable securities. Further, the issuance of units by an L-QIF is also not subject to security transfer tax or capital issuance tax.
Conclusion
Although the L-QIF is tax transparent for income and wealth tax purposes, the high Swiss withholding tax charge on distributions and accumulations is a disadvantage compared to many foreign investment fund products, in particular for foreign investors. Tax-wise, it is expected that the L-QIF therefore will attract mainly Swiss private and institutional investors. Nevertheless, in the case of L-QIFs that predominantly invest in foreign investments, the aforementioned Swiss withholding tax disadvantage can largely be eliminated for foreign investors due to the possible affidavit procedure.
If the critics made by the consultation participants can find their way into the final version of the CISO allowing a less restrictive implementation of the L-QIF and taking into account the liberal risk diversification rules, this new Swiss fund product could prove to be an interesting alternative to existing foreign competing products and thus contribute to the desired strengthening of Switzerland as a fund production location.
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