The FCPR: a European vehicle

The French government has recently passed new legislation (Loi de Finances pour 2002) which is intended to streamline and modernise the rules applicable to both French fonds communs de placement a risques (FCPR) and French fonds communs de placement dans l’innovation (FCPI). Although the applicable decrees have not been issued as of the date of this article, it appears that this legislation is likely to broaden the appeal of the French FCPR for European investors. This article intends to review the main characteristics of the French FCPR, as amended by the new law.

What is an FCPR?

A Fond Commun de Placement a Risques is defined in the relevant French legislation as a joint ownership of securities. It is not a separate legal entity and, for this reason, does not have the legal capacity to enter into contracts. Any contracts must be concluded by the management company on the FCPR’s behalf.

The FCPR is created by the management and the custodian. The management company has sole responsibility for the management of the FCPR including all decisions to make or to sell investments of the FCPR. The management company must be a French “societe de gestion de portefeuille” that has been approved by the French Securities Exchange Commission. The custodian has custody of the assets of the FCPR. It carries out the instructions of the management company but must verify whether the transactions it is carrying out on behalf of the FCPR are in conformity with French legislation and the by-laws of the FCPR. The custodian is generally a bank, a stockbroker or an insurance company.

The management company and the custodian must establish by-laws that are similar to a partnership agreement. The by-laws must set out the terms and conditions under which the investors will subscribe to FCPR shares; the manner in which the FCPR will operate; and the manner in which income and capital gains are allocated and distributed. Any FCPR that is open to the public at large must receive the prior approval of the COB. If the FCPR is open only to qualified investors the FCPR can be created under the COB simplified procedure and the prior approval of the COB is not required. In this second case, the management company is only required to file the by-laws of the FCPR (together with other relevant documents) with the COB within one month after the initial closing date of the FCPR.

French law provides that the liability of the investors is limited to their commitment to the FCPR. Although this is not a legal requirement, an FCPR normally requires investors to subscribe to the fund at its inception during a short subscription period. During the life of the FCPR, the by-laws can block the redemption of shares for a period that cannot exceed 10 years. Transfers of shares are normally restricted by the terms of the by-laws of the FCPR.

It is not necessary for subscriptions to be fully paid-up immediately. Payments into the FCPR can consist of an initial payment equal to a percentage of the total amount committed by the investor followed by subsequent draw-downs, called from time to time in accordance with the requirements of the FCPR.

The management company

Under French law, the management company of a French FCPR must be a French commercial company, generally a societe anonyme (SA) or a societe par actions simplifiee (SAS). In addition, under French law (and pursuant to a European directive) the central administration must be situated in France. In practice, this means that the back office and the administrative record-keeping must be situated in France.

The management company must receive the approval of the French Commission des Operations de Bourse before creating any FCPR. The approval process typically takes three months. The current rules are intended to guarantee the independence of the investment team in its management of the FCPR.

The Legal Quota

In order to qualify as an FCPR and to maintain its existence as an FCPR, an FCPR must invest 50 per cent of its assets in certain types of securities. These rules are currently set out in article L. 214-36 of the French Financial and Monetary Code. Under the new legislation, the scope of the legal quota has been broadened. The new rules state that at least 50 per cent of the FCPR’s assets must consist of securities providing “direct or indirect access” to the equity:

lof companies which are not traded on a French or foreign regulated stock market, or

lof shares of French limited liability companies (societes a responsabilite limitee or SARL); or

lof foreign companies that have a status equivalent to that of an SARL in their state of residence.

The FCPR’s assets may also consist of:

(a)shareholders’ loans granted for the term of the investment made, to companies in which the FCPR holds at least 5 per cent of the equity (up to a maximum of 15 per cent of the total assets of the FCPR). These loans are included in the Legal Quota when they are granted to companies whose shares are not listed;

(b)interests representing a financial investment in any entity formed in a member state of the OECD whose main purpose is to invest in companies whose securities are not traded on a regulated stock market (“OECD Entity”). Eligibility for the Legal Quota is determined on a look-through basis. The interests in the OECD Entity qualify for the Legal Quota only to the extent that the OECD Entity itself holds securities that qualify for the Legal Quota.

Paragraph (b) is intended to permit French management companies to create FCPRs that are fund-of-funds, since the somewhat obscure phrase “entity formed in a member state of the OECD” is intended to cover limited partnerships and other private equity investment vehicles that are formed in a member state of the OECD.

The FCPR must comply with the Legal Quota as from the end of the second accounting period of the FCPR and must continue to comply with the Legal Quota until the later of the end of the fifth accounting period or the date on which the FCPR commences its pre-liquidation period.

When the securities of a portfolio company are admitted for trading on a regulated stock market, they continue to be included in the Legal Quota for a period of five years following the date of such admission. Quoted securities of companies listed on one of the high-growth regulated stock markets of the European Economic Area or on a compartment of high-growth stocks of such markets can also be included in the Legal Quota for up to five years.

The Tax Quota

In order for French investors to benefit from tax advantages in France, the FCPR must also comply with the tax quota defined in article 163 quinquies B of the French Tax Code (the “Tax Quota”). This article states that, in addition to the conditions listed in the previous section, the securities included in the Legal Quota must be issued by companies:

lwhose registered office is in a member State of the European Community;

lthat perform one of the activities set out in article 34 of the French Tax Code (commercial, industrial or craft activities); and

lthat are subject to corporate income tax under ordinary conditions and at the normal rate or that would be subject to tax under the same conditions if the activity were performed in France (the “Eligible Companies”).

Securities of holding companies that provide “direct or indirect access” to the capital of such Eligible Companies will also be included in the Tax Quota if the companies meet certain conditions. In particular, the holding company in which the FCPR invests must have their registered office in a member state of the European Community and must have as its sole purpose the holding of interests in Eligible Companies (the “Eligible Holding Companies”) or in other Eligible Holding Companies who hold only Eligible Companies (the two-tier rule).

Thus, the FCPR will allow French investors to benefit from tax advantages if 50 per cent of its assets are comprised of securities included in the Legal Quota and issued by Eligible Companies or Eligible Holding Companies.

French taxes applicable to French investors

Corporate investors will be entitled to favourable rates on long-term capital gains, provided that they hold their FCPR shares more than five years. In addition, French corporate investors will enjoy a significant tax deferral as France will begin taxing distributions made by the FCPR to French corporate investors only once they have been reimbursed in full for their investment in the FCPR. Any corporate investors who hold their shares less than five years will be taxed at the end of each fiscal year on a mark to market basis on any increase in the “liquidation value” during that year of the FCPR shares that they hold.

French individuals will be entitled to full exemption from income tax (but will be subject to a tax rate of 10 per cent miscellaneous social contributions) provided they hold their shares more than five years and reinvest any distributions received during that five-year blocking period. If they choose not to block their shares during a five-year period, any capital gains distributed by the FCPR will be subject to tax at the favourable rate applicable to capital gains (currently 26 per cent).

French taxes applicable to foreign investors

Foreign investors are generally not subject to capital gains tax in France on the sale of shares of a French company unless they hold, or have held at any time in the past 5 years, directly or indirectly, shares entitling them to more than 25 per cent of the profits of that French company.

The percentage of ownership is computed on a “look through” basis, i.e. each shareholder is deemed to own his/her pro rata share of each portfolio company and this is added to any shares of the portfolio company that the investor may own directly (e.g., because of a co-investment). Many bilateral income tax conventions France has signed with its trading partners eliminate the tax on capital gains realised from the sale of shares of French companies even if the foreign investor owns more than 25 per cent of the company being sold.

If the Fund realises a capital gain on the sale of a “foreign” (i.e. non-French) company, the country in which that company is resident may impose a tax, by withholding or otherwise, on the gain realised. The investor may be able to request reimbursement under the treaty (if any) between its country of residence and the source country of the income if such reimbursement is permitted by the terms of the applicable treaty.

George Pinkham

George S Pinkham is senior partner of the Paris office of SJ Berwin and head of the office’s fund formation group.

Working in international tax in New York, Pinkham moved to Paris in 1980. In 1985,

he joined Salans Hertzfeld & Heilbronn, founding their New York office before returning to Paris in 1988.

Pinkham specialises in private equity transactions, including LBO and LMBO acquisitions by private equity funds, acquisition structure, senior and subordinated debt and incentive agreements for management, and in the creation of funds within France (FCPRs and SCRs) and abroad (US and UK partnerships and offshore structures).

The fund formation group advises French, English and American investment structures investing in or outside of Europe.

A member of the tax and legal sub-committee of EVCA, and the legal affairs committee of AFIC, the French private equity association, Pinkham regularly advises AFIC with the drafting of legislation or regulations regarding French FCPRs.