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The importance of substance and the key role of Luxembourg alternative administrators

Alternative investment funds domiciled in Luxembourg are positioned to deploy billions of euros in private capital for investment in asset classes such as private equity, private debt, real estate and infrastructure.

Investments are generally made via one or more Luxembourg and foreign corporate entities, for reasons that may include the segregation of assets, arrangement of the security package for the lending bank, flexibility with regard to a future exit, or organisation of a joint venture investment. Luxembourg companies are required to have appropriate substance.

Luxembourg as location of choice

The grand duchy is the world’s second largest fund domicile and first in Europe, and has a 56% global market share of funds distributed on a cross-border basis. Over the past two decades, it has grown into Europe's largest hub for alternative investments with €1.8trn of assets under management in regulated and unregulated vehicles, according to Preqin.

The attractiveness of Luxembourg as a fund location is linked to its flexible and diverse legal and regulatory framework, a stable tax system, the availability of a highly qualified and multilingual workforce, an investor-friendly business environment and its established fund industry infrastructure as well as political, financial and fiscal stability. The grand duchy has become a trusted and well-known jurisdiction for both investors and investment managers.

Substance is vital

Luxembourg’s alternative asset administrators play a vital part in the architecture of the country's fund industry, typically through the provision of specialised services to Luxembourg funds and their subsidiaries in the grand duchy that invest in assets located in other jurisdictions.

Luxembourg companies must have appropriate substance, which begins with robust corporate governance and the proper management of the company’s activities. Otherwise, tax benefits obtained under foreign domestic tax law or applicable tax treaties, such as reduced or zero withholding tax rates on interest and dividend payments, may be challenged by foreign tax authorities under anti-abuse legislation.

Economic substance is a topic that is high on the international tax agenda. At present, the European Commission is seeking to find a consensus to adopt the third Anti-Tax Avoidance Directive - more widely referred to as ATAD III or the 'Unshell Directive' - which focuses on substance. However, the legislation has been deadlocked by disagreements since its proposal in 2021 and it remains to be seen whether it will ultimately be approved, or in what form.

The notion of substance

The notion of substance is multi-dimensional, and its elements are interrelated. The first dimension is corporate governance, including the composition of the board of directors, the hosting of board meetings, the involvement of all directors in decision-making, and ensuring that this is carried out in Luxembourg and correctly documented.

The second element relates to physical aspects, including employees, office premises and IT systems. Based on relevant case law of the European Court of Justice, such infrastructure may be centralised at the level of either a Luxembourg company that forms part of the investment platform, a service provider in the grand duchy, or the alternative investment fund manager (AIFM).

All this feeds into the company’s functional and risk profile - the company’s substance must be appropriate to manage properly the functions undertaken and the risks assumed. Functions performed by Luxembourg companies typically include assessment of investment opportunities, implementation, monitoring and management of investments, risk management, and the repatriation or re-investment of cash.

Finally, the commercial and legal reasons for choosing Luxembourg as the jurisdiction of domicile may help to explain the underlying business rationale. This involves features of the country such as the legal and regulatory environment, capabilities of the workforce, business environment, industry infrastructure and stability. It also relates to aspects such as an investment manager’s existing business relationships, the familiarity of investors and lenders with Luxembourg, experience with the legal and regulatory system or any existing substance.

The importance of best practice

The substance of Luxembourg companies must be appropriate to the activities they perform. Anti-abuse provisions of domestic tax law and bilateral tax treaties must be consistent with EU law as interpreted by the European court. Thus Luxembourg companies should consider restrictions laid down in case law of the CJEU when determining the appropriate level of substance, although it is also imperative to consider the legislation and attitude of the tax authorities in the investment jurisdiction.

While companies may primarily have an insourcing or an outsourcing model, all Luxembourg companies will rely to a certain extent on external service providers, given that not all functions such as accounting, legal, tax advisory, compliance and reporting can reasonably be carried out in-house. Here, alternative asset administrators with their highly specialised service offerings play a key role in enabling international investors and asset managers to manage their Luxembourg investment platform in a seamless fashion.

The increasingly complex legal, regulatory, tax and compliance environment is contributing to the need for qualified service providers. Over the past decade reporting and compliance obligations have steadily increased, mostly driven by developments at the EU level. Because the substance of a Luxembourg company could be scrutinised by foreign tax authorities years after its incorporation, the proper documentation of substance over its lifetime is crucial.

L3A, together with its members, has produced a position paper covering all elements of substance and how administrators can best support their clients. For further information, you can download the document below or contact us at


L3A position paper:

Full version:

L3A Position Paper - Substance - Unabridged version
Download PDF • 894KB

Abridged version:

L3A Position Paper - Substance - Abridged version
Download PDF • 657KB


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