November 30, 2021

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Small Fund Creation - Legal, Tax and Accounting Risks

Small Fund Creation – Legal, Tax and Accounting Risks

The business of raising funds from investors and their subsequent investments in, for example, real estate, cryptocurrency, securities or start-up companies is increasing. Through our practice, we can confirm that small funds are now being created by entrepreneurs whose participation in the capital market seemed unattainable in the recent past. The availability of information, the expansion of cryptocurrencies, as well as the investment appetite associated with the growth of living standards of non-professional investors contribute to this.

Small investment fund regulation

Small funds in Slovakia face many pitfalls. The first is European regulation. This relates in particular to the coordination of the public offer of securities, the value-added tax, or the work of the so-called managers. Alternative investment funds, which generally include smaller funds. This regulation is specifically intended to prevent systemic risks and protect the retail investor.

However, the small funds themselves are only marginally regulated by European legislation, which gives member states a great deal of regulatory freedom. Many took advantage of this freedom and created an attractive legal environment for small funds. In addition to the jurisdictions of traditional trusts such as Luxembourg, Malta and Gibraltar (though Brexit), Czech legislation is also an interesting source of inspiration.

While developed foreign jurisdictions regulate several types of funds depending on the nature of the legal form, income, investors and assets in which you invest, Slovak regulations lack this diversity. Thus, small Slovak funds have freedom not only in choosing the legal form and investment strategy, but also in the smaller administrative burden associated with managing funds. On the other hand, only professional or qualified investors can invest in it.

Corporate Restrictions

Although the recent introduction of the legal form of a joint-stock company with variable capital (the so-called SICAV) has expanded the range of small investment funds available, their practical usability probably does not live up to expectations. The main reason is the irrational legal restrictions in determining the various shareholders’ rights of the fund manager and investors, as well as the problematic accounting and tax burden associated with it.

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The Slovak box environment also faces other drawbacks. traditional fund institutes like “advance interest“,”temporary profits“or”stock redemption“They don’t know our business or tax law. When setting up funds for foreign investors, we build these institutes on legal concepts – theoretical and constitutional. However, this carries with it the risk of abuse by state authorities in the future.”

Tax implications

Small investment funds with legal personality, with a few exceptions, are subject to the same tax rules as standard venture capital firms. However, this does not apply to mutual funds and legal forms of vos and ks, where special rules apply. In general, however, our tax code does not have adequate tax systems for small funds.

Operating small investment funds in Slovakia leads to a number of complications. This is why fund financiers are looking for alternatives.

adventurer Equity funds are sure to appreciate the more flexible inclusion of investment disposal losses. Crypto funds do not want to tax non-cash income on trading platforms, and the fund market will be encouraged by the broader capital gains tax exemption. The obligation to re-evaluate certain types of investments annually using the income method with a tax effect will discourage a number of potential founders of the Slovak Fund.

On the other hand, the non-taxation of dividends at the level of legal entities is also viewed very favorably in the case of portfolio investment. Aside from a kind of “local patriotism”, this is the second major driver behind some fund founders’ decision to stay in Slovakia. However, this advantage is limited by the new CFC rules and the recent expansion of the list of countries (including, for example, the United Arab Emirates), from which profits are paid tax in Slovakia at a tax rate of 35%.

small investment fund accounting

After our conference last year on creating small mutual funds, we conducted market research on accounting for small Slovak funds. From the publicly available data, we found that more than half of them do not account for the correct accounting regulations. Small fund accounting is specific and subject to different rules from what we know from double-entry bookkeeping. In addition, the ambiguity of these specific accounting rules often leads to problems of interpretation.

Fund environment will be helped by a radical reform of these rules, which will not only reflect current investment trends, but also significantly reduce the administrative burden. It is not reasonable to expect small funds to value their emerging investments annually using the discounted cash flow method.

Tax implications of foreign money

Thus, many fund founders prefer access to foreign funds. However, in addition to domestic difficulties, these must also be viewed in the context of regulatory and tax constraints in Slovakia. The distribution of shares of ownership of foreign funds in Slovakia is governed by the Collective Investment Law, the scope of which depends on the specifics of the foreign fund.

Among the tax pitfalls, for example, the CFC rules for individuals and legal entities, the so-called material requirements, Or increase tax rates when profits are returned to Slovakia.

Criminal Effects

In practice, we follow a number of founders who arrive at an unstructured structure. However, the founders of such a structure run the risk of carrying out a regulated activity (ie a fund activity) without proper authorization. This can fulfill the characteristics of not only the crime of unauthorized business, but also the newly introduced crime of money laundering.

However, the level of criminal law does not necessarily mean the founders, but in certain circumstances also the investors of the fund. These are, for example, cases in which it is relatively clear from the outside that, due to the peculiarities of the investment structure, it may be an unauthorized activity. In such a case, the behavior of an investor investing in such a structure can be considered negligent and he may be subject to criminal liability with a penalty of up to 8 years imprisonment. Of course, the criminal exposure of the founders is greater.

A law firm specializing in tax, corporate law and financial regulation. With a tax accounting firm Carpathian Provides legal, tax and accounting advice under one roof.

Small Fund Creation - Legal, Tax and Accounting Risks

Source: Higate

Peter Varga

Peter is the founder of the CARPATHIAN tax and accounting group and a law firm Highgate Law & TaxIt focuses on creating financial and legal structures for Slovak and foreign clients. Peter often lectures and writes articles on tax and financial regulation. Peter is also a member of the working group of the Ministry of Finance of the Slovak Republic for the capital market, dealing with fund regulation.

Small Fund Creation - Legal, Tax and Accounting Risks

Source: Higate

Thomas Demo

Tomasz worked for 5 years at the Bratislava branch of the international law firm Allen & Overy, focusing primarily on cross-border M&A transactions, corporate law and litigation. Tomáš is a co-founder of the law firm Highgate Law & Tax, where he focuses primarily on advising on investments in start-ups, funds and employee stocks.

In the financial advisory market, Highgate Law & Tax with CARPATHIAN provides a unique blend of legal, tax and accounting services. It is effective for the client to know in one place not only the legal and regulatory side of things, but also what are the tax and accounting implications of the intended transaction or the structure of the fund. The founders of the company previously worked for several years in the international law firms Allen & Overy andDacheng Denton.

(Public relations)