WR Asset Management: Choice of fund structure – Norwegian limited company, limited partnership or foreign fund vehicle?
What type of fund structure should a Norwegian fund manager choose when establishing a new alternative investment fund? This depends, among other factors, on what the fund will invest in, the target investors, the required flexibility for capital contributions and distributions from the fund, the need for confidentiality, etc.
Below, we take a closer look at the use of Norwegian private limited companies (Nw. aksjeselskaper), Norwegian limited partnerships (Nw. indre selskaper) and foreign fund structures.
Limited company – a feasible option for many
It has become increasingly common to establish Norwegian funds as limited companies. This trend mirrors developments in countries such as Sweden, where several of the leading fund managers have "onshored" their funds as Swedish limited companies (Sw. aktiebolag) (instead of, for instance, limited partnerships established in jurisdictions like Jersey).
Norwegian limited company funds are typically established by the management team/initiators through a separate project company. This entity undertakes the work and costs of establishing the fund, makes the team's investment into the fund if the fundraising is successful, and typically negotiates a right to carried interest that, inter alia, reflects the risk undertaken in the fund establishment and the particular risk associated with the team's investment (which is be subordinated in Norwegian fund's distribution waterfall).
The team/project company and external investors enter into a shareholders' agreement (fund agreement), with external investors investing as shareholders. The investors, the project company and the manager will typically have different classes of shares to reflect their distinct economic and governance rights.
The fund can either be internally managed (by the board of the limited company) or externally managed by an AIFM. External management is more common, with the manager often holding a "control" share in the limited company to maintain necessary control of the fund's board, etc.
In funds established as limited companies investors will, in principle, have voting rights etc. at general meetings by virtue of being shareholders. In practice, however, investors will from the outset grant the manager a standing proxy to act on the investors' behalf at general meetings of the fund, including subscribing for new shares, voting for distributions, etc. Combined with the increased flexibility of limited companies in recent years in regards to capital inflows and outflows, limited companies can suit the needs of most fund managers.
Nevertheless, limited companies are still less flexible than partnership structures, particularly for funds with commitment structures and frequent capital calls. Such capital calls usually need to be carried out as capital increases with registration in the Norwegian Register of Business Enterprises, dividends require normal dividend capacity, and careful consideration must be given to handling, for instance, equalisation (balancing payments between investors participating in different closings).
From a tax perspective, limited companies are relatively "straightforward". The fund pays its own taxes but is often largely exempt from tax under the Norwegian participation exemption (Nw. fritaksmetoden) (e.g. for investments in shares in companies established in Norway or the EEA). Norwegian and EEA (corporate) investors are usually exempt from Norwegian tax on their investments in the fund under the Norwegian participation exemption. Norwegian individuals pay taxes on their investments in the usual manner (currently at an effective tax rate of 38.74 per cent before shielding deduction).
However, a Norwegian limited company can be challenging if the fund invests outside the participation exemption method (e.g., in bonds, commodity derivatives or minority stakes (below 10 per cent) in limited companies outside the EEA). In such cases, the fund would be fully taxable on the relevant investment(s). A foreign fund structure may then be an attractive alternative (see below).
Limited company funds can also be challenging for investors outside the EEA. Such investors are as a starting point subject to a 25 per cent Norwegian withholding tax on dividends (though reduced to 15 per cent for, e.g., most US investors under Norwegian tax treaties). It will become even more challenging for these investors if withholding tax, in the future, is also imposed on liquidation distributions in connection with the liquidation of the fund itself. A proposal for this was put forward by a government appointed tax committee in December 2022, and it remains to be seen if this will be enacted.
Limited partnership – extra flexible, favourable for many, challenging for some
Many Norwegian funds have been established as limited partnerships over the years. This fund type most closely resembles the classic PE funds established as limited partnerships in jurisdictions like the US, Guernsey, Jersey, the UK, Luxembourg (SCSp), etc.
Norwegian limited partnerships are established with a Norwegian limited company acting as "general partner" (Nw. hovedmann) and investors participating as "limited partners" (Nw. stille deltakere). Limited partnerships are governed by a limited partnership agreement between the general partner and the investors, with significant control vested in the general partner (as the sole attendee at partnership meetings, etc.). The general partner is the only entity visible to third-parties, rendering the limited partnership effectively invisible to the outside world (for instance, it is not registered in the Norwegian Register of Business Enterprises). This also makes it possible to keep each investor confidential (including between each other). Similar to limited companies, limited partnerships can be internally managed (by the board of the general partner) or externally managed.
Limited partnerships offer more flexible capital flows than limited companies. For instance, it is not necessary to register capital increases every time capital is called from the investors to the fund, and the restrictions on dividend distributions are also more limited (owing to the limited partnership's larger ability to reclaim funds from investors if needed). This is a significant advantage for funds expecting regular inflows and/or outflows. Limited partnerships are also more flexible when conducting equalisation across multiple closings in a fund (balancing payments between existing and new investors), and there is, for example, no need for a creditor notice period when cancelling shares/capital reductions or liquidating limited partnerships. It is also simpler with a limited partnership if, for example, the fund seeks bank financing (subscription line of credit) secured against the investors' commitments.
For most Norwegian investors, it makes little difference whether a fund is established as a limited partnership or a limited company; the total tax burden is normally relatively similar. The important difference is that a limited partnership is transparent for tax purposes, meaning that investors themselves pay any tax on their share of the fund's net income, rather than the fund paying the tax itself (and thus the investors indirectly bearing the tax).
However, the tax transparency of a limited partnership is particularly significant to some investors, including foreign investors (which typically are relieved from Norwegian withholding taxes if investing in a fund established as a limited partnership, but meanwhile will need to file Norwegian tax returns and may become subject to Norwegian taxation if the fund makes taxable investments), pension funds and insurance companies, as well as tax-free foundations.
The choice between a limited company or limited partnership can, however, also, e.g., affect the deductibility of losses and expenses, taxation on the sale of fund interests (secondary transactions), and tax leakage on dividends during distributions through multiple tiers.
The different preferences of different investors sometimes results in a fund being established as multiple parallel fund vehicles, such as one limited company and one limited partnership, possibly combined with a foreign feeder to alleviate tax filing obligations, etc. that arise for foreign investors participating directly in a Norwegian limited partnership.
Foreign funds – internationally recognised and potentially tax-efficient
In certain scenarios it may make sense to establish a fund abroad. Due to higher costs, this is primarily relevant for larger funds and managers. Well-known fund jurisdictions like Luxembourg, Guernsey, Jersey and Ireland are recognised in the international investor community and are more readily "marketed" to a foreign investor compared to a lesser-known fund structure in Norway.
Additionally, foreign funds in certain jurisdictions may often offer better conditions, such as preferential tax regimes. This allows the funds to invest tax-free in a broader range of asset classes (e.g., debt, derivatives, portfolio investments outside the EEA, etc.) than Norwegian companies can. These foreign funds may - given the right conditions (including local substance in the fund jurisdiction) - themselves qualify for the Norwegian participation exemption for Norwegian investors, potentially making a foreign fund structure favourable from a tax perspective.