The European Union ("EU") placed four countries, including the Cayman Islands, on the EU list of non-cooperative tax jurisdictions (the "EU Blacklist") on February 18, 2020. This has posed many unfavorable limitations on taxation or capital flows to numerous enterprises or individuals that choose to set up investment or holding vehicles in the Cayman Islands. For example, if the funds in the EU are utilized for reinvestment or transactions through Cayman Islands companies, such activities could be subject to strict scrutiny or even prohibited.
Fund managers accustomed to choosing the Cayman Islands as the domicile for their private equity investment funds will be plagued by such result in the face of rising uncertainties in investment plans and potentially higher tax costs for investors.
Taiwan's Limited Partnership Act came into force on November 30, 2015, which introduced the General Partners (GP)/Limited Partners (LP) structure (referred to as "limited partnership" structure in Taiwan) that is commonly adopted for the formation of private equity investment funds (including venture capital funds) internationally. Supporting policies were implemented concurrently to provide multiple institutional incentives so that the formation and operation of Taiwan's private investment funds can align with international practice, thereby optimizing Taiwan's asset management market and enhancing the momentum of private investment.
II. Institutional Incentives for Setting Up Taiwan-Domiciled Funds
In the case where Taiwanese investors are the prospective investors of a given private investment fund, the fund manager or promoter might want to consider directly choosing Taiwan as the domicile for such fund over the Cayman Islands or other offshore countries for the following reasons:
1. Flexible design of the content of limited partnership agreements
Currently, the Limited Partnership Act only sets forth minimal regulations for limited partnerships. In comparison with the practice for the formation of offshore investment funds, the Limited Partnership Act does not stipulate any other major requirements or limitations for a Taiwan-domiciled limited partnership, except for the requirement of capital contribution in the limited partnership also by a General Partner (though no minimum capital contribution is stipulated). Conversely, the concepts commonly seen in offshore investment funds, such as "capital call", "2/20 rule", "hurdle rate" and "key person clause", can all be devised in Taiwan's limited partnership agreements.
2. Limited partnership structure not new to onshore investors
In the past, the onshore investment funds in Taiwan still operated mainly in the form of "companies". In recent years, however, in the wake of the passage of the Limited Partnership Act, at least five (5) medium and large private equity investment funds have been established in the form of "limited partnership" in the Taiwan market, with a wide range of investors, including financial institutions, insurance companies, listed and OTC companies, and individuals. As such, domestic investors are becoming increasingly familiar with the structure of "limited partnership" with rising acceptance, not to mention that many large domestic investors already have a wealth of experience in investing in offshore investment funds of GP/LP structure.
3. Special registrations or filings with the government not required for setting up the fund
In addition to the Economic Substance Law enforced from January 1, 2019, the Cayman Islands also promulgated the Private Funds Law, 2020 on February 7, 2020, which is aimed at strengthening its regulatory control over private funds. For example, it requires closed-end private funds to apply for registration with the Cayman Islands Monetary Authority ("CIMA"), file an annual return, pay an annual fee and file the financial statements audited by CIMA-approved auditors within 6 months of the fund's financial year end each year. On the contrary, assuming there is no foreign investor factor, except for the general set-up registration required for any legal entity in Taiwan, no other special registration or filing obligations would apply to a private investment fund in the form of limited partnership in Taiwan.
4. The tax incentive of "pass-through tax scheme" applicable under certain conditions
In order to encourage the formation of venture capital funds in the form of limited partnership in Taiwan, Article 23-1 of the Statute for Industrial Innovation (產業創新條例) was amended to allow a venture capital fund established in the form of limited partnership to opt for the "pass-through tax scheme" when its AUM reaches NT$300 million and its fund utilization situation meets certain prescribed ratios. In other words, the venture capital funds themselves will not be levied by any tax when they have profits. Instead, tax will be levied directly on the earnings distributed to the partners and calculated in accordance with the Income Tax Act against such partners. The tax incentive provided by this "pass-through tax scheme" is also close to those enjoyed by investors under offshore fund structures.
The Cayman Islands has just been placed on the EU Blacklist. The aftermath of such development should continue to be observed and evaluated. As fund managers or promoters must consider numerous factors when selecting the domiciles for private investment funds, it is hoped that this Article can guide them to understand the institutional incentives for conducting fund formation in Taiwan and to provide a pragmatic and attractive alternative.