DERLING partners Hannes Vallikivi, Rolan Jankelevitsh and Andres Siigur in cooperation with experts from CMS London and Luxembourg offices and ESTVCA Legal Committee prepared a report for EBRD on Estonia’s new investment fund legislation back in 2016. The report focused on regulation and taxation of private equity and venture capital funds with the aim to assess new regulation’s suitability to the market needs.
As the result of the analysis, the Ministry of Finance made several amendments to the draft law and with the Investment Funds Act of 14 December 2016, a new regime of Estonian limited partnership funds (LPF) has been enacted. LPF is an investment vehicle designed primarily for closed - end collective private equity and venture capital investments.
The new regime has been designed along the lines of the best qualities of limited partnership structures of various countries, which have been traditionally considered as attractive jurisdictions for collective private equity and venture capital investments, such as UK, Luxembourg and Jersey.
Among others, the partners have the right to regulate the following matters in the LPA:
Each LPF must have at least one general partner (GP) and one limited partner (LP). Furthermore, as it is an alternative investment fund, it must invest funds raised from at least two investors (e.g. the GP and the LP or two LPs).
An LPF may operate as a self-governed partnership or a limited partnership managed by a management company.
The assets of a self-governed LPF are managed by its GP. In the event a management company has been contracted, the management company has the authority to manage the assets according to the management agreement between the LPF and the management company.
LPs may engage in the management of the LPF according to the rights given to them by the LPA.
The GP has unlimited liability for the obligations of the LPF. The liability of an LP is limited to the amount of the LP’s contribution to the LPF, if the LP refrains from participating in the daily management of the LPF.
To provide clarity with respect to the liability of LPs, the IFA sets forth the so-called safe harbour regime, whereby an LP is considered not to participate in the daily management of the LPF if, among other things, the LP:
An LPF is established by the conclusion of its LPA and its registration with the Estonian Commercial Register (äriregister). The LPF is registered with the Estonian Commercial Register on the basis of an application executed and submitted by:
A statement by the Estonian FSA (Finantsinspektsioon) confirming that the GP or the management company has been properly registered or authorised as an alternative investment fund manager (AIFM) must be appended to the application.
An application is normally processed and the LPF is registered within five business days.
An LPF does not have to publish the identity of its LPs or the amount of the investments made by each LP.
An LPF is an alternative investment fund within the meaning of Directive 2011/61/EU (AIFMD). For this reason, at least one GP or the management company must be
An Estonian company can be registered with the Estonian FSA as an AIFM if it intends to operate as an AIFM but is not required to obtain an authorisation of AIFM according to the exception laid down in Article 3 of the AIFMD. To register with the Estonian FSA, the company must provide the FSA with information on the LPF and its planned activities. As an AIFM, it must submit its annual reports to the Estonian FSA.
The availability of a fiscally transparent fund vehicle has been widely recognised as a critical condition for creating an attractive environment for investment fund structuring. This condition has now been met in Estonia by introducing a full fiscal transparency regime applicable to LPFs.
Fiscal transparency means that an LPF is not considered a taxpayer or an Estonian resident for the purposes of Estonian tax laws, and the income earned by an LPF is immediately allocated to its investors in proportion to their stakes in LPFs.
One of the objectives of such “see-through” approach is to ensure that the foreign investors of the LPF are treated, tax-wise, in exactly the same way as when investing directly in company shares. One important consequence of fiscal transparency is that the foreign investors should normally have full access to double taxation treaties between the residence state of the investor and the source state of the respective income.
In the case of non-resident investors, the LPF’s income allocated to such investors will not be taxed in Estonia in most cases. Such income will only be taxed in Estonia in situations where the same income, should it have been earned by a non-resident directly, would be taxed in Estonia. Such situations exclusively include income from Estonian real estate (capital gain, rental and interest income). The non-resident investors will only have to declare the investment income earned through the LPF, if such income is taxable in Estonia.
An LPF itself will have to submit annual declarations to the tax authority regarding the income earned, the investors of the LPF, the share of LPF’s income allocated to each investor and the tax residence of each investor.