Over the last years, private family funds have developed significantly. Whereas off-shore or Luxembourg funds may be considered as natural first choices, Swiss collective investment schemes offer specific opportunities. Families must ensure that they are in a position to meet the requirements of the Swiss regulatory framework and should analyze possible tax benefits.
1. FAMILY WEALTH PLANNING
1.1 The Challenge
Finding the most appropriate asset holding structure for wealthy families, whose members are frequently scattered around the world, is a great challenge for any estate planner. Should the family rely on trusts, foundations, holding companies, insurance products, direct holdings or a combination of these structures?
Many difficulties may have to be overcome. The individual family members and their assets may be subject to a number of different inheritance and tax laws. Asset holding vehicles located in different jurisdictions are subject to different rules and regulations, resulting in discrepancies regarding voting rights, management, dividend policy, transfer restrictions, assets valuation or dispute resolution. Finally, a complex estate planning structure may lead to redundant compliance controls by financial institutions and advisors.
1.2 Why a Private Family Fund?
Private family funds offer in this respect a combination of benefits. They are an efficient family wealth planning instrument, especially for financial assets.
Private family funds allow the pooling of assets which may be deposited with various financial institutions, thus benefitting from economies of scale and related costs reductions. They also offer better risk diversification and access to broader investment opportunities compared to those available to individual family members.
Consolidated asset valuation and reporting are substantially enhanced with fund structures. Private family funds offer a consistent and harmonized redemption/exit policy for all family members, with increased liquidity, either through redemption possibilities or lombard credits.
An additional benefit is the supervisory function taken by the fund management company, the auditor and/or the financial market supervisory authority.
With a fund, compliance is conducted at the level of the holding of the shares in the fund, with guaranteed confidentiality regarding the holding of specific assets.
Some caution is usually required with respect to constraints resulting from the applicable regulatory regime (restrictions to investment policies, investors’ personal requirements, etc) and taxation specificities, both at the level of the fund and for the family members.
2. OFF-SHORE, EUROPEAN OR SWISS FUNDS
2.1 Many Forms of Private Family Funds
Private family funds can take various forms, depending on the family size, residence, wealth, needs, and wishes of its members. Creating a single dedicated compartment in an existing fund – a more straightforward approach, though less tailored-made – may be a more valuable option than setting up a new vehicle.
2.2 Off-Shore Funds
Off-shore funds, such as Cayman Islands or British Virgin Islands funds, generally offer a light regulatory regime and structural advantages, such as the possibility to set up a private management company, no requirement of a local main custodian, few (if any) restrictions regarding the investment policy and general documentation flexibility. Set-up and yearly costs remain low, with a good and efficient quality of services.
Known downsides are the international lesser standing of the jurisdictions and the risks characteristically inherent to the lack of substance. Limited supervision may be an advantage in terms of costs and compliance efforts, but at the same time riskier for the family members (especially for those not closely involved) and for financial partners. It is also important to take into account the increasing, more subtle, but at the same time more delicate, aversion of European and Swiss financial institutions towards off-shore vehicles, both regarding the acceptance of management/ custody mandates and compliance verifications.
2.3 Luxembourg Funds
In Europe, Luxembourg is the most common jurisdiction for setting up a fund. The Specialised Investment Fund (SIF) or the Family Wealth Management Company (Société de gestion de patrimoine familial, known as SPF) are both natural options. The SIF is subject to authorization and supervision of the Commission de Surveillance du Secteur Financier (CSSF) and enables the creation of compartments with different investment policies. The requirements to have true delegation of asset management to third-parties, one main local custodian for the fund, and a single management company, are standard regulatory constraints.
2.4 Swiss Funds
Swiss collective investment schemes offer structuring solutions similar to the ones of Luxembourg funds. Regulatory differences are minor, thus costs and taxation are decisive.
3. SWISS COLLECTIVE INVESTMENT SCHEMES – REGULATORY ASPECTS
3.1 Regulatory Framework
The Swiss Federal Act on Collective Investment Schemes (CISA) does not mention specifically "private family funds" nor does it provide for a specific and adapted vehicle for family or private wealth. Swiss open-end investment schemes nevertheless enable appropriate structuring of private family funds.
When opting for a Swiss private family fund, the following regulatory requirements must be taken into consideration:
- Third-party management: Swiss collective investment schemes are defined as assets raised from investors for the purpose of collective investment and which are managed for the account of such investors. In practice and as required by the Swiss Financial Market Supervisory Authority FINMA, the management of the assets must be truly entrusted with third-parties, which excludes - as a matter of principle - individual investment decisions by family members.
- Minimal number of investors: The CISA and its implementing ordinances do not require a minimum number of investors. In practice, however, the FINMA requires at least five investors, which is in line with Swiss tax practice.
- Investment policy: Private family funds are usually structured as "other funds for traditional and alternative investments" (in the terminology of the CISA), thus allowing the greatest flexibility as to the applicable investment policy. However, risk-diversification and liquidity rules impose certain investment restrictions, such as assets classes ratios, percentage limits as to an investment in a given fund or security, maximum holding ratio of the shares/units issued by an underlying fund or issuer and limits of investment in closed-end/ non-supervised funds.
3.2 Contractual Fund vs. SICAV
There are two types of open-end investment schemes which can be considered for Swiss private family funds: the contractual fund and the SICAV.
The contractual fund, the longstanding form for Swiss funds is not a legal entity. Rather, it is based on a contract between the investors, the fund management company and the custodian bank.
The SICAV, introduced in 2007, is a separate legal entity. Its initial capital is contributed by "entrepreneur shareholders" who must be disclosed to and approved by the FINMA. Subsequently, investor shareholders may join. The SICAV’s supreme governing body is the general assembly, and it must have a board of directors with at least three members. The operations and asset management process are similar in both forms of funds. Indeed, in practice, a SICAV must appoint a FINMA licensed management company for its operations, as the FINMA does not admit truly self-managed SICAVs. Both a contractual fund and a SICAV may delegate the asset management services to asset managers subject to prudential supervision.
There are however substantial differences among the two legal forms which are relevant for structuring private family funds.
The SICAV offers more vetting and control rights to the family members. As shareholders and possible board members, they (or their appointed representatives acting as board members) have a direct and enforceable right to remove the fund management company and thus the asset managers. With a contractual fund, some control provisions may be found in an additional sponsorship agreement between family members (as promoter) and the fund management company, but compliance with the principle of "third-party management" must be maintained.
The SICAV may prove a more viable vehicle in the event of a family dispute and may impose accrued liability on its service providers to the extent that some of its representatives are appointed to the board of directors.
The contractual fund offers more flexibility with respect to amendments to the fund documentation and changes to the services providers. With a SICAV, board or even shareholders decisions may be required depending on the issues at stake.
Confidentiality may play a role in choosing either form. As mentioned above, the identity of "entrepreneur investors", i.e. some or all family members, must be disclosed to the FINMA. Even if FINMA is of course bound by a confidentiality duty, this is to be compounded with no disclosure requirement for the contractual fund.
3.3 Other Structuring Aspects
Stand-alone funds, or umbrella funds with various subfunds, can be considered. Stand-alone funds offer more flexibility with respect to investments, as all sub-funds of an umbrella fund must comply with the applicable investment restrictions and ratio. Conversely, the umbrella fund allows appointing one asset manager per sub-fund, with easier control and monitoring by the fund management company. It further enables family members to choose among various sub-funds with different investment and risk profiles.
Another structuring alternative is to appoint certain asset managers as sub-custodians of the assets they manage. Costs and risks factors must be considered in this respect.
To the extent that all family members (or their related subscription vehicles) are considered as qualified investors, some exemptions from formal CISA obligations can be obtained, such as an exemption from preparing a prospectus or from publishing the NAV of the fund.
4. SWISS COLLECTIVE INVESTMENT SCHEMES – TAX ASPECTS
The analysis of tax impacts must be conducted at various levels, namely in connection with the liquidation of existing holding structures, the subscription in the fund (generally made as an in-kind contribution), the tax treatment of the fund itself and, finally, the taxation of the investors.
As a matter of principle, Swiss funds are transparent under Swiss tax rules (save for the SICAF and real estate funds). Therefore, income and capital taxes are not levied at the level of the fund itself, but rather at the level of the investors. The tax treatment of the investors will therefore depend on their place of residence.
Swiss funds are entitled to obtain the refund of any Swiss withholding tax levied on income from Swiss investments.
In addition, the fund’s income on foreign investments may be subject to foreign taxes at source. As a matter of principle, Swiss funds are not entitled to refunds based on Swiss double taxation treaties. However, Switzerland has entered into some agreements allowing for such refunds, e.g. with France, the UK and Germany. If a double taxation treaty is not available, the refund must be obtained directly by the investors where possible.
As a rule, Swiss funds must levy a Swiss withholding tax of 35% on income distributions to investors. However, if the fund can prove that more than 80% of the income distributed to the investors comes from foreign sources, the Swiss tax authorities may authorize the distribution without deduction of Swiss withholding taxes ("affidavit procedure"). Combined with the right of the Swiss fund to obtain the reimbursement of Swiss/foreign taxes at source, this may – compared to a direct holding of assets – prove very attractive for foreign family members.
No Swiss issuance or transfer stamp tax is levied on subscription. However, shares in Swiss funds are Swiss securities the transfer of which is subject to Swiss transfer stamp tax.
Swiss funds are tax exempt investors from a transfer stamp tax viewpoint. Where the custodian of the fund’s assets is a Swiss bank, this can represent a significant saving.
Private family funds are an efficient family planning instrument for financial assets. They allow for an appropriate pooling of assets, with economies of scale, risk-diversification and enhanced liquidity for family members.
Swiss collective investment schemes represent an interesting opportunity for wealthy families who are attracted by the strong and reliable Swiss regulatory framework for collective investment schemes. The size of the pool of assets must be substantial to justify the set-up and ongoing operating costs. The portfolio must be mainly composed of standard financial investments (e.g. equities, fixed income and funds) to comply with regulatory investment restrictions.
Compared to a direct holding of financial assets, the Swiss tax framework applicable to Swiss funds may prove efficient with respect to Swiss and foreign taxes at source on income realized by the fund and the subsequent distribution to investors.