European Commission Consults on Cross-Border Taxation of Venture Capital Funds

As part of its ongoing effort to facilitate cross-border venture capital investment, the European Commission has begun a consultation on the cross-border taxation of venture capital funds and investors. Mainly, the Commission is following up on a report from the Venture Capital Tax Expert Group that identified three obstacles to venture capital investment, all of which may lead to the double taxation of venture capital investors. The Commission is also driven by the assertion of the venture capital industry that tax issues are a significant obstacle to cross-border venture capital investment. Established by the Commission, the Expert Group was composed of government and business tax experts from EU Member States.

The first obstacle identified by the Expert Group arises because it is generally necessary for the venture capital fund manager to be personally present or have a representative present in the Member State into which an investment is made, in order to assist in the management of the target company. The fund manager may carry out management functions in the country where the investment is made, including selection of investments, due diligence, and contract negotiations.

This local presence may mean that the Member State in question will treat the fund manager as a branch or even a permanent establishment of the fund and apply taxation accordingly. If the country where the fund and investors are located also applies taxation to the return on the investment, noted the Commission, the relevant double taxation treaties may not provide for a credit for the tax imposed on the branch in the Member State. As a solution to this problem, the expert group suggested that the tax authorities treat the local activities of a venture capital fund manager as those of an independent agent.

The second tax obstacle that the Expert Group identified was the fact that venture capital funds may currently be treated in very different ways for tax purposes by different Member States. For example, one Member State may treat a fund as transparent for tax purposes, looking through the fund to tax the individual investors, while another may treat the fund as non-transparent and therefore taxable in its own right.

This mismatch in tax treatment may cause difficulties in the application of double taxation treaties and consequent unrelieved double taxation. To address the issue, the Expert Group suggested the mutual recognition of the classification for tax purposes of the legal forms of venture capital funds under which all Member States would recognize the tax classification and tax treatment applied by the home country of a venture capital fund.

The third tax obstacle is the fact that investors in transparent venture capital funds may currently have to file individual claims with foreign tax authorities for any cross-border double taxation treaty relief to which they are entitled. This can be difficult in practice due to the complexity of the claim procedures, observed the Commission, and may mean that many investors will not claim the relief to which they are entitled. The Expert Group therefore proposed allowing venture capital funds to claim tax treaty relief on behalf of their investors.

As it considers the proposals set forth by the Expert Group, the Commission seeks input from a wide range of stakeholders, including investors, businesses, tax authorities and Member States. Any legislative and regulatory proposals resulting from the Commission’s consultation will be informed by the principle that any tax measure to facilitate cross-border venture capital investment should increase legal certainty for investors and remove discrimination and double taxation. In addition, in line with the EU's goal of combating tax avoidance and evasion, any such tax measure would have to ensure that Member States' taxing rights are safeguarded and that no tax loopholes are created.

To address regulatory issues and to remove obstacles to cross-border fund raising that venture capital funds currently encounter, the Commission in late 2011 proposed  a Regulation on venture capital funds. The Regulation foresees that following a simple registration in its home Member State, venture capital fund managers would be able to market the qualifying funds under their management in all EU Member States including in their home State. This proposed Regulation does not address tax issues.