Overview of the Luxembourg legal and tax opportunities and challenges related thereto
(by the LPEA Legal and Tax Young Leaders)
Jay-Z, Bernard Arnault, Serena Williams and Xavier Niel all have two things in common. They are each well known by the public and have recently sponsored the launch of special acquisition purpose vehicles (“SPACs” or “SPAC”). The amounts raised are huge. According to Deloitte and the website Statista, in June 2021, USD 105 billions where already raised in the United States (“US”) since the beginning of the year (against USD 83 billions for the entire 2020 year). In Europe, the SPAC mania does not seem to bring in the crowds the same way as it does in the US (although USD 3.9 billions have already been raised so far in 2021).
A SPAC is a company with no operational activities that is incorporated for the sole purpose of making one or more unspecified future acquisitions, typically targeting an identified industry sector or geographic region. The founders or sponsors of the SPAC will often have specific industry expertise or private equity (“PE”) experience. Once incorporated, the SPAC undertakes an initial public offering (“IPO”) and lists its shares on a public stock exchange. The funds it raises during the IPO are later used to acquire directly or indirectly a private company (or companies), resulting in the acquired operating business becoming publicly listed through notably a reverse merger (“DE-SPAC” or “DE-SPACs”).
SPACs offer a new way of going public that aligns with today’s desire for efficiency and reduced time to market. In this context, as a strong and stable financial centre, Luxembourg offers all the features to attract sponsors for the establishment of their SPACs. In fact, Luxembourg is ideally positioned to welcome SPAC vehicles listed in European Union (“EU”) regulated markets or in the US markets. Its attractiveness is mainly due to its business-oriented legal environment, a flexible and tax efficient legal framework, the ability to rely on the European passport mechanism, the presence of experts in fields specific to SPAC creations and DE-SPAC operations and its pragmatic approach to the business world and financial markets. However, although it is well-known in the US, the legal and tax framework applicable to SPACs is relatively new in Europe and, by definition, also in Luxembourg. Even though the underlying philosophy of SPACs is generally the same, the terms and conditions may vary depending on the incorporation jurisdiction and the place of the proposed listing. For the time being, there is no legal framework within the EU regarding SPACs and DE-SPAC transactions. This being said, the features and procedures result from the US practice and they are now finding a way to Europe through the application of local legal regimes.
In this article we will successively discuss (1) the concerns of PE investors over SPACs, (2) De-SPACing and triangular mergers and (3) selected key direct tax elements of SPACs.
For a better understanding, a high-level illustrative chart of the key steps and parties involved in a SPAC transaction is included below.
 https://www.statista.com/statistics/1178273/size-spac-ipo-usa/ and https://www2.deloitte.com/uk/en/insights/industry/financial-services/spacs-in-europe.html.
1.Everybody Loves SPACs except…
As mentioned above, there is a general craze about SPACs these days and PE sponsors make no exception. Out of the overall figures indicated in the introduction, US based PE firms have jumped on the bandwagon and raised not less than USD 12 billions in U.S. based SPACs in 2020 (against USD 1 billion in 2019). EU PE sponsors seem to need some more time to get going with only EUR 1.9 billion raised so far. Failing to raise money in Europe, SPACs might raise concerns for PE investors (i.e. investors investing in classical PE investment fund vehicles). Indeed, everybody loves SPACS except, PE investors, who would rather have their fund managers investing in SPACs via their funds as opposed to establishing SPACs outside such funds as new business lines.
This being said, some investors might actually see SPACs as an opportunity. Key persons involved in SPACs may have the benefit of more market exposure and higher profile in community. However, a fund manager setting up a SPAC during the life-time (or at least during the investment period) of another fund they manage might trigger a full range of issues relating to conflicts of interest, time dedication, exclusivity and management fees. Therefore, investors considering an investment in a PE fund should pay particular attention to provisions allowing the sponsor to create and manage SPACs during the due diligence process. Below is an overview of classical issues that may arise as a result of a sponsor being allowed to raise SPACs during the lifetime of a PE fund.
A) Deal Allocation and Conflict of Interest
Fund managers might be tempted to allocate a deal to an independent SPAC they manage (in which they potentially have better economic terms) while that deal would have been a perfect fit for the fund.
The classical solution to tackle this and discourage the manager to favour the SPAC(s) it manages is to build strong deal allocation provisions into the fund documents having the effect of compelling the manager to allocate any deal that fits the sweet spot investment strategy of that fund in priority. Investors may also want to request reports on deal allocation (either through the annual/quarterly reports or through LPAC disclosure). The best-case scenario would of course be to have the sponsor disclosing any SPAC set-up or managed at any time to the LPAC.
B) Time Dedication
Managing a SPAC takes time. Key persons managing a fund may see their focus diffused to a SPAC because of the time they are contractually allowed to spend on that SPAC. PE investors should want to avoid situations where the fund in which they have made a large commitment is neglected by their key persons.
To this end, the fund documents should have strong time dedication and key person event provisions to ensure that key persons dedicate enough time to manage the fund in an efficient and productive fashion. In particular, investors may want the key person definition to be revised such that key persons could no longer count time spent on SPACs towards their time commitment requirements (unless formed for the benefit of the fund).
Finally, investors should be paying particular attention that SPACs are not included in the classical list of time dedication carve outs.
It always comes down to bargaining power, but investors should consider that having key persons dedicating substantially all of their business time to the fund (at least during the investment period), without SPACs being carved out, is a very LP friendly time dedication commitment.
C) Double-Dipping on Management Fees
The amount of management fees, unlike carried interest or other performance fee schemes, should be based on the reasonable operation expenses and salaries of the fund sponsor. The principle is “the bigger the fund, the lower the management fee”. This is because managers benefit from an economy of scale. This is one of the reasons why it is customary to have a step down in management fees when a successor fund is raised (alongside the fact that when a successor fund is raised, the management team will automatically spend less time on the former fund). In that vein, negotiating a management fee step down when a SPAC is raised might be a precious safeguard if one did not succeed to remove SPACs from the carve-out to the successor fund restrictions.
Requesting that any income received by key persons in connection with the SPAC should be considered “fee income” and offset against management fee is also a viable alternative.
Long story short, PE investors should pay special attention during the due diligence phase and check whether the sponsor or related persons are allowed to set up or manage SPACs outside the fund. In the affirmative, PE investors should see SPACs as successor funds and push for all classical guarantees and safeguards that one would typically request when a PE sponsor is allowed to raise and manage successor funds (starting by requesting that the definition of successor fund encompasses SPACs of course). One of the major positive takeaways of this is that the general partner will generally not be in a position to set-up or manage a SPAC before the end of the investment period or until a certain percentage of commitment (typically 70%) is invested. Other useful safeguards include requesting a preferential right to participate in SPACs and higher skin in the game amounts from sponsors to ensure that the fund will never be neglected for the benefit of SPACs.
2.De-SPACing and triangular mergers: US tax aspects vs Luxembourg legal means
The triangular merger has come under spotlight recently due to the explosive growth of SPAC transactions. Many SPACs rely upon the triangular merger for DE-SPACs. Such an operation generally involves a SPAC, a shelf company and a parent company issuing new shares.
In a “forward triangular merger”, all assets and liabilities of a target company are transferred to a subsidiary of a parent company (i.e., absorbing company). However, the shareholders of such target company receive shares of the parent company instead of shares of the absorbing company. Thus, the target company has been indirectly acquired by the parent of the absorbing company.
In a “reverse triangular merger” – a so-called A2E reorganization in the US –, a parent company incorporates a shelf company and the target company / SPAC will acquire all the assets and liabilities of such shelf company. Under the normal regime, the shareholders of the shelf company should receive shares of the absorbing company. However, in the context of a reverse triangular merger, once the shelf company is absorbed by the target company / SPAC, the shareholders of such target company / SPAC will receive shares of the parent company of the absorbed shelf company by way of conversion.
A reverse triangular merger, similar to direct mergers and forward triangular mergers, may be either taxable or non-taxable for US purposes, depending on how they are executed and other complex factors set forth in Section 368 of the US Internal Revenue Code.
Based on the latest DE-SPAC transactions announced in Luxembourg, one can reasonably argue that there is a trend to proceed by way of reverse triangular mergers when US entities are involved to achieve a tax neutral reorganization. A shelf company is created for example in Delaware (“NewCo”) by a Luxembourg parent company (which takes the form of a Luxembourg société anonyme or European company, a societas europea) and at the effective time of the merger, NewCo will be merged with and into the SPAC which will be the surviving company and shall continue as a wholly-owned subsidiary of the Luxembourg parent company after the shareholders of such SPAC have converted the stocks held in the SPAC against shares of the Luxembourg parent company.
Such US triangular mergers have no equivalent under Luxembourg laws or under those of its immediate neighbors such as France, Belgium and Germany. Therefore, this operation must necessarily follow a pre-existing known procedure. Thus, any reverse triangular merger implemented in France where the French parent company issued shares has been made by way of a share capital increase subscribed and paid by a contribution in kind, such contribution consisting in the value of the shares of the absorbing company, which will become the subsidiary of such parent company.
A parent company existing under the laws of the Grand Duchy of Luxembourg should then proceed to a share capital increase by way of a contribution in kind regardless the fact that the absorbed company is a direct or indirect subsidiary, as follows:
- the parties, notably the “PIPE” investors, the sponsors, the SPAC, the target company, the shelf company acting as the absorbed company and the Luxembourg parent company will enter into a business combination agreement, pursuant to which, among other things, the merger and the consideration of such merger will be agreed. Based on the applicable ratio, SPAC common stock issued and outstanding immediately prior to the merger effective time shall be converted into parent shares;
- for purposes of the Luxembourg law of 10 August 1915 on commercial companies as amended (the “1915 Law”), such reverse triangular merger shall, at the effective time of the merger, be treated as a contribution-in-kind of the SPAC common stock to the Luxembourg parent by the SPAC stockholders following a share capital increase realized by the Luxembourg parent using, when possible, the authorised share capital mechanism after receipt of, before the effective time of the merger, a report on the contribution in kind relating to the Luxembourg parent shares merger issuance with respect to the SPAC common stock in accordance with article 420-10 of the 1915 Law;
- discussions with the independent auditors (réviseurs d’entreprises agréé) should be initiated at an early stage to make sure that they have all the information they need regarding the merging entities generally located abroad. DE-SPAC transactions are quite intensive and stressful at some point with figures being finalized at the very last moment. The psychological dimension cannot be ignored and should be considered when hiring an independent auditor (réviseur d’entreprise agréé) as some of them prefer to not be involved in such transactions. Similarly, the Luxembourg notary who will enact the share capital increase decided at an extraordinary general meeting or who will confirm the decisions taken by the management body of the Luxembourg parent company which increased the share capital using the authorised share capital mechanism (preferred and recommended for practical and timing question) should be associated at an early stage of the transaction to make sure that the procedure will not raise unexpected issues or questions;
- the parent company initial shares should be redeemed immediately post-merger to avoid cross-participation and to achieve the proposed shareholding structure. However, any redemption of shares needs to be authorized by the articles of association prior the subscription to such redeemable shares (Art. 430-22 of 1915 law) and an equal treatment of shareholders in the same situation must be maintained. Therefore, it is recommended to create classes of shares at the incorporation of the Luxembourg parent company to provide for a specific class of redeemable shares to be redeemed immediately subject to and after the merger.
For a better understanding, a high-level illustrative chart of the key steps and parties involved in a reverse triangular merger transaction is included below.
 In step 2 of the chart below the shareholders of Target transfer their shares in Target to Parent company in exchange for shares in Parent company (the “Exchange”). Such Exchange takes the form of a share capital increase of Parent company paid by contribution in kind and occurs immediately prior the effectiveness of the triangular merger. Target itself can incorporate Parent company and have its shares redeemed before Exchange.
 According to Preeti Singh, reporter at the Wall Street Journal.
 ILPA, « Private Equity Principles », Position Paper, Institutional Limited Partners Association, September 2009.
 Section 368(a)(1)(A) by reason of Section 368(a)(2)(E) of the US Internal Revenue Code.
 Private investment in public equity, i.e. process whereby after a SPAC IPO, a sponsor raises additional capital from specific investors (i.e. without running through an IPO process).
3.Riding the SPAC waves in the Luxembourg tax environment
To incentivize bold PE investors, sponsors of SPACs should not forget about tax considerations in structuring their SPACs. Otherwise, they take the risk that investors ask to get their money back and redeem their investment before any concrete acquisition or IPO of a business is performed. The below tax comments take a SPAC incorporated as a standard Luxembourg fully taxable company as a basis.
A) Set-up and IPO of a SPAC
The set-up of a SPAC generally only triggers a fixed registration duty of EUR 75 which is due upon incorporation of the company as well as on any amendments of its bylaws e.g. increase of share capital (including share premium) or decrease of share capital.
In a SPAC transaction, the sponsor usually subscribes to a specific class of shares to which warrants issued by the SPAC are attached. The warrants are exercisable upon specific events (e.g. acquisition of a target by the SPAC) at a pre-determined price (i.e. a price that could be lower than the fair market value of the SPAC). It is therefore key for the sponsors to monitor the tax exposure the warrant holder may be faced with on the gains (if any) to be realised upon the conversion of the warrants. In certain cases, it may be worthwhile to analyze whether specific exemptions or roll-over provisions may apply.
Cash raised from the investors may stay at the level of the SPAC vehicle because of uncertainties in relation to the location of the future investments over a prolonged period of time (i.e. generally 18 to 24 months). With that in mind, having SPAC vehicles established in Luxembourg requires a monitoring of the cash position of the company at all times. Indeed, without any dedicated tax regime in Luxembourg and in the absence of specific structuring mechanisms, a Luxembourg SPAC would be fully subject to incremental net wealth tax at a rate of 0.5% (0.05% for the portion of the net wealth exceeding EUR 500 millions) on the cash sitting on its bank account in view of future investments. Such a tax leakage is generally not compatible with the business model of the sponsor, temporary investments of the cash to avoid this tax leakage may be envisaged. In such case, any income received by the SPAC should be subject to the Luxembourg corporate income taxes at an aggregate rate of maximum 24.94% (for a company resident in Luxembourg city), unless specific exemptions or double tax treaty provisions apply. Alternatively, the location of the SPAC itself during the prospecting phase may change. As such, the SPAC could operate first in a cash friendly jurisdiction before moving to Luxembourg to concretize the SPAC transaction and the sought-after business acquisition. A move of the SPAC from a jurisdiction to another may also become relevant once the targeted business opportunities are identified.
B) Business combination
The purpose of a SPAC is to acquire targets through either a (cross-border) merger, share for share exchange, a share purchase or an asset acquisition. This list is obviously non-exhaustive.
It is therefore key to ensure that these various type of restructuring to which a SPAC, a sponsor and the investors could be a party to are carefully monitored from a tax perspective.
Application to the merger (i.e. with the SPAC being absorbed by a non-Luxembourg absorbing entity). In principle, the merger of a Luxembourg SPAC should be considered as a deemed liquidation of that company and as such should trigger the realization of all its assets and liabilities at fair market value (i.e. all latent capital gains should be disclosed and accordingly subject to tax in Luxembourg).
In practice, it could be envisaged that the SPAC holds a qualifying target for at least 12 months and then performs the merger at fair market value in order to benefit from the Luxembourg participation exemption regime on latent gains (if any) on its shares in the target.
Application to the share for share exchange (i.e. with the SPAC acquiring the majority of the shares in the target in exchange of issuance of shares to the shareholders of the target). In principle from a Luxembourg perspective, the exchange of an asset for another asset should be treated as a sale of the shares in target at their fair market value followed by a purchase of the shares in the SPAC. Hence, the shares held by the SPAC in the target should be acquired at fair market value, at the date of such acquisition. Going forward, it will then be key to monitor that the conditions of the Luxembourg participation exemption could apply to any proceeds (i.e. dividend, capital gains, liquidation proceeds) to be realized by the SPAC from its equity investment in the target.
Application to the acquisition of shares in a target followed by the liquidation of the SPAC. In principle, the liquidation of the SPAC should trigger the realization of all its assets and liabilities at fair market value (i.e. all latent capital gains should be disclosed and accordingly subject to tax in Luxembourg), unless a specific exemption applies. In the case at hand, considering that the SPAC should hold shares in target prior to the liquidation, it will then be key to monitor that capital gains in target could benefit from the exemption from taxation based on the Luxembourg participation exemption regime (i.e. careful attention has to be put on the 12 months holding period conditions). Alternatively, to the extent possible, the liquidation of the SPAC could be done immediately after the acquisition of target to limit the increase in value of such shares that might otherwise be subject to Luxembourg corporate taxes.
C) Cash distribution
One of the key tax aspects when it comes to listing a company concerns the withholding tax suffered upon cash distributions, in particular dividends which in Luxembourg are in principle subject to a 15% withholding tax (17.65% on a grossed-up basis), to remunerate the shareholders. If it is the intention of the sponsor that the Luxembourg SPAC is not dissolved, that point is of particular relevance.
The Luxembourg income tax law provides for an exemption from withholding tax on dividend distributions under certain conditions. These conditions are generally not met by retail investors directly investing their savings on the stock-exchange or holding a limited stake in the company or by certain corporate shareholders (e.g. tax-exempt funds). In the same vein, double tax treaties display a reduced withholding tax rate on dividends, but are similarly subject to the fulfillment of certain conditions and generally exclude minor and retail shareholders. This could make an investment less appealing in the light of the inherent capital risk and potential loss in value of the shares and limit the reach of the listed company.
That being said, Luxembourg withholding tax may not necessarily be a final burden at the expense of the shareholder, to the extent the tax can be credited against its income tax incurred in its country of residence on the same dividend income. However, in a cross border environment, avoiding double taxation via the credit mechanism is often an administrative burden and can in addition result in treasury issues (i.e., if it has to pre-finance its income tax before being in a position to claim a refund in accordance with the withholding tax suffered abroad or if it resides in a country without a comprehensive double tax treaty with Luxembourg to mitigate double taxation).
An alternative to dividends, commonly seen among listed companies, particularly for those listed in the US, is the repurchase by the listed company of its own shares which are subsequently held in treasury (so-called “treasury shares”). In this sense, as opposed to a share capital decrease performed against consideration, the amount of the aggregate share capital remains unchanged since the repurchased shares are not cancelled by virtue of the transaction.
These plans for repurchase of shares are generally announced by the company to the market alongside the expected price that will be paid, and the objective followed by the governance.
The management of the company may for example want to increase the market price of its shares if it considers that it is undervalued and has fallen below the intrinsic value of its net equity, in order to give a signal to the market aiming for a correction. This is especially relevant when the company’s offer provides for a premium it will pay on top of the average market price as it stands before the plan. As an extension and extra benefit, the company may enjoy a capital gain on its own shares, in the event the market price subsequently increases and to the extent these shares remain tradeable after the repurchase.
A case law from the Luxembourg Administrative Court is of interest to shed a light on the anticipated tax treatment of a share buyback operation, as it confirms that the transaction is to be assimilated to a disposal (i.e., an alienation) by the shareholder of its shares.
The fact that it is the issuing company itself which is the acquirer of the shares does not change the economic nature of the transaction. In contrast, the Court has outlined that a share buyback is prima facie not to be analyzed as a dividend distribution, provided that the price paid is arm’s length. In the presence of a listed company widely held by unrelated shareholders, advertising to the market an upcoming share buyback operation, one can reasonably assume the arm’s length condition to always be met. Except if the repurchase price would be overstated among related parties, no withholding tax should be incurred on a share buyback.
At investor level, this may obviously trigger all sorts of tax considerations. To just name a few, a Luxembourg tax resident individual would be subject to Luxembourg capital gains tax, which can be exempt in case its total participation represents 10% or less of the share capital of the listed company and if the repurchase is executed after more than six months (as opposed to so-called speculative gains realized within six months).
For non-resident shareholders, the capital gain could as well trigger Luxembourg taxation, if the repurchase occurs within six months and covers a participation of more than 10% of the share capital, unless the shareholder is protected by a double tax treaty with Luxembourg giving exclusive taxing rights to the country of the transferor.
In any case, such operation has to be carefully reviewed before implementation on a case by case in light of the overall transaction.
In order to secure the tax position of the Luxembourg SPAC, it may appear relevant to submit an advance tax agreement to the tax authorities to confirm the tax treatment of a given transaction. This procedure should however be followed before implementing the structure and may take a few months before obtaining a reply from the tax authorities.
In application of the law of 25 March 2021 which implements the Council Directive (EU) 2018/822 (“DAC 6 Law”), cross-border arrangements that took place after 25 June 2018 and that come within the scope of at least one of the hallmarks included in the DAC 6 Law may need to be reported under the mandatory disclosure regime. The reporting regime limits the number of reportable cross-border arrangements through the adoption of a threshold condition (i.e. the main benefit test “MBT”). This means that many of the hallmarks only trigger a reporting obligation to the extent an arrangement meets the MBT reducing the risk of excessive or defensive filings.
More specifically, based on the hallmark E.3, transfers of functions, risks or assets that are projected to reduce profits by at least 50% over the next three years should be automatically reported (i.e. the MBT does not apply to this hallmark). The DAC 6 Law does not give a more precise definition of the E.3 hallmarks. Here also, a tailor-made analysis has to be made to confirm whether such hallmark is met in the case of a business combination.
Thanks to its operational (e.g. geographical, AAA country, historical financial hub, multilingual and specialized workforce), regulatory (e.g. Luxembourg financial regulator used to adapt to new financial products and protect investors, presence of the Luxembourg green stock exchange), legal (e.g. flexible and large corporate tool box to align all parties interest in a SPAC transaction such as promote mechanism, etc) and direct tax features, Luxembourg is definitely one of the places to be to launch a SPAC or locate a DE-SPAC transaction in Europe.
However, as is usual with new financial products, a tailor-made review and analysis is always needed when it comes to launching a SPAC or implementing DE-SPAC transactions.
From a Luxembourg direct tax perspective, key attention must be given to the taxation of warrants or shares issued at discount. Moreover, the net wealth tax position of the SPAC and the tax impacts of a potential cross-border merger, and cash repatriation must be monitored. One would also need to carefully review the VAT treatment of the flows (e.g. fees) related to a SPAC transaction. To make the jurisdiction even more attractive for SPAC transactions and with a view not to miss the SPAC trend, Luxembourg should envisage to establish a favorable domestic tax regime for SPACs. An eighteen months start-up net wealth tax exemption could, for example, be a perfect start in this respect.
 In a nutshell, these conditions to be cumulatively met provide for a minimum direct 10% ownership or an acquisition price of EUR 1.2 million. The shareholder shall also notably be a company resident in an EU Member State or in a country with which Luxembourg has concluded a double tax treaty, that is fully liable to a comparable tax.
 Decision n°39193C issued on 23 November 2017 by the Luxembourg Administrative Court