Qualified investor funds (QIFs) are tax-driven investment vehicle structures which were created in the Czech Republic in 2006. At that time, QIFs introduced significant potential tax benefits for property investors in the country but were not often utilized because of a number of structural restrictions and administrative burdens. In 2009, the Czech Republic parliament liberalized the QIF rules making them a more appealing investment or holding vehicle option. As a result, there was a significant increase in interest in QIFs in 2009, and we expect to see many more of them in the future.
A QIF is a joint stock company or mutual fund that receives a special license to operate as a QIF. The equity capital of a QIF must be at least CZK50 million (approximately €2 million) and must be contributed no later than the one year anniversary of the receipt of its license. The fund must also diversify its investments. According to a nonbinding paper of the Czech National Bank, a single asset (such as an office property or development project) may represent no more than 50 percent of the fund’s total investments. Though the law does not provide a transitory period during which the fund may have a single investment, the Czech National Bank has previously allowed a substantial grace period in specific cases to diversify investments.
To invest in a QIF, an investor must be a financial or public institution or a legal entity or natural person which declares in writing that it has experience in capital market investments. Each investor must invest a minimum of CZK1 million (approximately €40,000) in the fund. A fund may have no more than 100 qualified investors. The law does not prescribe a minimum number of investors, but the Czech National Bank has stated through nonbinding papers that two investors are sufficient and that they may be related parties (and a QIF may even be established by a single founder for a limited period of time). The shares of a QIF cannot be offered for sale publicly.
A QIF is required to complete registration and obtain an approval from the Czech National Bank for its special status. Following the recent statutory amendments, this process has been simplified for a QIF that retains a registered investment company to manage the fund. One primary consequence of this recent change was to allow QIFs to satisfy the requirement to have certain specially qualified persons as executives of the fund – now, these individuals may work for an investment company that is retained by the QIF as well as by other funds. Additionally, the Czech National Bank’s consent is no longer required for changing ownership of the fund which is managed by the investment company. Both of these changes have materially simplified the operation and ease of exit limitations that were established in 2006. The Act provides only general guidelines with respect to a fund’s investments and operations, and therefore a fund has substantial flexibility in establishing its investment strategy, which is prescribed in the fund’s governance documents.
The benefit of the QIF structure is that such funds are subject to a 5-percent corporate income tax instead of the standard 19-percent rate. There is some discussion about the potential risk that in the case of a limited number of investors from one investment group, the financial authorities might try to set aside this beneficial tax treatment by arguing that the structure is only a circumvention of relevant tax laws. This argument has not been tested yet, but the most logical interpretation would seem to be that so long as the fund is compliant with the rules (and nonbinding recommendations) set forth by the Czech National Bank it is entitled to be taxed as a QIF. The same concern has also been raised with respect to funds with insufficient diversification of investments. Here, the argument for a higher rate seems more credible since the QIF in such case is essentially noncompliant with qualifying requirements.
As noted above, a QIF may operate as either a mutual fund or an investment fund. A mutual fund may be founded only by a licensed investment company, which then manages its assets and sells shares to investors. It is not a separate legal entity, but rather a pool of investments and property. A mutual fund may be open-ended (i.e. the owners of its shares have the right to sell them back to the investment company upon their request at their current value) or close-ended (i.e. the investment company does not buy back shares but rather settles investments upon dissolution of the fund). In either case, the investor may sell its investment in the QIF to a third party prior to dissolution. Unlike the case with investment funds, in-kind contributions by investors wishing to acquire shares in mutual funds are not permitted. Mutual funds are especially well-suited for individuals because no income tax applies at the time of disposition if the investor held the shares for a minimum of six months.
An investment fund (i.e. a separate legal entity) operates only on a closed-end basis. A new legal entity must be established and licensed prior to the inception of its business – an existing company may not obtain a license. It typically takes about four to five months to establish such an investment fund and obtain all the necessary approvals from the Czech National Bank. However, existing assets held by an investor may be contributed to a newly established investment fund as an in-kind capital contribution. This too is a substantial change in the law as investors now have both a tax neutral and more practical way to fund the capital requirements of a QIF in a restructuring transaction. Another tax neutral way to move existing assets into an investment fund is through a merger or other corporate reorganization, provided the investment fund is the surviving entity. In the case of an investment fund, an individual must hold the shares for a minimum of two years prior to exit in order to qualify for a tax exemption of profit, and its total shareholding cannot exceed 55 percent of all of the fund’s shares.
Unlike the case with mutual funds, investors in investment funds have the option of managing the fund themselves (assuming they, or individuals the fund hires directly, meet the Czech National Bank requirements) or retaining a separate investment company to do so. Engaging an investment company as the fund manager enables the investor to significantly reduce its direct administrative burden, though with some loss of control.
The only business activity an investment fund may engage in is collective investment. Accordingly, a QIF may not acquire trade licenses or directly perform development activities. It may only acquire and hold assets for the purpose of achieving profit. However, a QIF that has invested into property that is to be developed may engage a developer that would perform the development activities on its behalf. It is important to note that the 5-percent profit tax applies only to the QIF and not to any subsidiary companies in which the QIF may own an interest.
Regardless of whether a QIF is a mutual fund or an investment fund, it must make semi-annual filings with the Czech National Bank and contract with a bank to act as depository for the fund. The depository monitors certain fund activities and processes all fund payments.
At the end of the day, investors must weigh the benefits of lower taxation against the additional administrative and regulatory burdens of a fund structure. Given the tax differential today, more and more investors are taking a very serious look at QIF structures.