On 22 July 2013, the Luxembourg government registered a draft law with the Luxembourg Parliament on the creation of a private foundation called a "patrimonial foundation" (Draft Law No 6595 on the Patrimonial Foundation). With this law, if adopted, Luxembourg will create its first orphan legal vehicle which will be able to be used in the areas of investment structuring and investment governance, as well as for estate planning purposes.

Similar to the concept of the trust, the patrimonial foundation will be able both to:

However, unlike the trust, the patrimonial foundation will have its own legal personality separate from the legal personality of its founder and its beneficiaries. Incorporated as a legal person by virtue of the draft law and as a vehicle by execution of a public notarial deed, the legal existence of a foundation will be very difficult, and almost impossible, to challenge as a sham. In addition, with the benefit of this legal personality, the patrimonial foundation will be easily recognised in civil law jurisdictions.

Unlike the trust, the foundation will hold its own assets in its own name (not in the name of a trustee). Unlike the trust, the administration of the patrimonial foundation will be similar to the administration of a corporate vehicle, with the draft law providing for a skeleton of mandatory provisions to be applicable, which will need to be fulfilled in order for the foundation to be properly incorporated and administered. Apart from these compulsory provisions, the draft law leaves it to the contractual freedom of the founder to determine other aspects linked to the administration of assets and the general functioning of the foundation.

The draft law that has been registered with the Luxembourg Parliament is still in its early stages, of course, and some features of the proposed vehicle may change during the legislative process (though hopefully not to such an extent as to render the vehicle either less attractive towards its proposed use, or as a challenging alternative to the institution of the trust).

The main legal characteristics of the patrimonial foundation are that the foundation will be:

Under the draft law, the patrimonial foundation must be incorporated by a Luxembourg public deed and have its seat in Luxembourg. At incorporation the foundation assets must be a minimum of EUR50,000, payable in cash or by contribution in kind. The patrimonial foundation can:

However, as a general rule the foundation cannot have any commercial, industrial or agricultural activity.

An innovative point is that the draft law provides for the possibility for the foundation to issue certificates, which may track the economical benefits of one or several of the foundation assets and, as such, achieve a split between legal ownership and economical benefit of the assets. This possibility is another important difference with the trust, as this technique is very efficient if a split between controlling issues and economical benefit has to be achieved.

The draft law keeps a balance between the freedom of the founder to structure his wealth and plan his estate, the protection of the foundation assets and the protection of the interests of the founder and of the beneficiaries. In this respect the issue and the transfer of the certificates are subject to certain conditions. The certificates:

In addition, the transfer of the certificates from the first owner is limited to the circle of the founder and the beneficiaries, their patrimonial entities, legal vehicles or trusts, and their successor or heirs.

The draft law provides for a list of matters which must be included in the public deed at incorporation of the foundation. The list includes information on:

Other issues may be addressed in the public deed or in separate private documents (extra-statutory documents) if this possibility has been provided for in the deed of incorporation.

Only a limited number of the matters contained in the deed are made available for public knowledge. Excerpts of the deed of incorporation are registered with the Luxembourg Registrar of Companies and published. Details on the identity of the founder and the beneficiaries are not available for public knowledge. Of course, this information must be available at the seat of the foundation and may be communicated to persons or authorities legally entitled to receive such information. For compliancy reasons and for legal security, the board of directors is further obliged to maintain complete corporate records on all matters concerning the foundation, and in particular complete information on beneficial ownership and know-your-customer provisions in line with the latest Financial Action Task Force (FATF) recommendations.

The patrimonial foundation is administered by a director, or by a board of directors, composed of natural or legal persons that have the broadest powers to fulfil the object of the foundation. For those foundations that own more than EUR20 million or that have more than five beneficiaries, the draft law provides for the fact that the management of the foundation must be placed under the control of a supervisory board composed of natural persons only. In such a case the foundation also has an obligation to submit its accounts to the control of an external auditor. In all other cases it is left to the contractual freedom of the founder to provide for a supervisory board and determine its powers, as well as to determine the nomination or revocation procedure of the members of the supervisory board.

Due to the patrimonial foundation's orphan nature, the draft law provides for special powers to be either reserved to the founder or attributed to the Luxembourg courts. A special emphasis must be made on the reserved powers of the founder. One of the merits of the draft law is to clarify, from the beginning, the legal nature of these powers in the sense that the draft law clearly determines that these powers are personal to the founder, meaning that they cannot be inherited or passed on to the heirs of the founder or other persons entitled, except if determined differently by the founder in the deed of incorporation.

The reserved powers of the founder are not extensively listed in the draft law and could address a variety of issues. The areas that we anticipate will be reserved are:

In addition to the general rules concerning the competence of the Luxembourg courts, the draft law attributes to the Luxembourg courts several particular competencies, including:

The draft law provides for the obligation of the foundation to keep regular accounts and, in certain circumstances, to proceed with an audit of its accounts. However, due to the fact that the use of a foundation is limited to private clients and their assets, the required reporting on the accounts is limited and the draft law neither provides for:

From a tax point of view, the patrimonial foundation is considered a Luxembourg tax resident and benefits from a proper tax status. As a general rule, the foundation is subject to income tax at the normal rate.

However, income derived from movable assets (such as dividends, interests or capital gains realised on non-substantial movable assets after a six-month holding period, or proceeds derived from insurance policies) will be tax exempt. This tax treatment has been determined in order to make the tax treatment of the foundation as close as possible to the tax treatment applicable to resident private individuals in Luxembourg. Income on immovable assets located in Luxembourg (whether rental income or capital gains) is taxed at normal rates. As regards wealth tax, the foundation is not submitted to a wealth tax on its assets, the same as for resident private individuals, as wealth tax was abolished in Luxembourg for private individuals in January 2006.

Capital transfers to the foundation will be taxed with a fixed registration fee. The same applies to capital transfers from the foundation to the founder.

However, for income tax purposes, capital transfers from the resident founder to the foundation may be taxed as capital gains as of the date of transfer, the transfer being considered for income tax purposes as a realisation at the level of the founder. It is important to note here the fact that the draft law contains a more general amendment to the applicable tax law concerning the acquisition price of substantial participations which, if the draft law is adopted, will correspond to the market value of the participation as of the day the individual became a Luxembourg resident.

At the level of the resident beneficiaries, all income received from the foundation will be taxed as normal income. Capital transfers from the foundation received by a resident beneficiary are taxed depending on whether they were made during the lifetime of the founder or after his death. If the transfers are made during the lifetime of the founder they will be subject to donation tax. If the capital transfers are made after the death of the founder they will be subject to an inheritance tax at a level varying and depending on the family links (ranging in Luxembourg from 0% to 40%). The same principles apply to the non-resident beneficiary in the presence of immovable assets held by the foundation which are located in Luxembourg.

The draft law does not address any issues on succession law. The applicable law will be the Luxembourg succession laws for the estates of all individuals resident in Luxembourg as of the day of death (except if they have opted, where possible, for another law to govern their estate) and for those non-resident Luxembourg citizens who have applied for the law of their nationality to govern their estates under the EU measures permitting this (Regulation (EU) 650/2012 on jurisdiction, applicable law, recognition and enforcement of decisions and acceptance and enforcement of authentic instruments in matters of succession and on the creation of a European Certificate of Succession (Succession Regulation)).

As a civil law country, Luxembourg succession laws provide for several compulsory provisions among which are the concept of forced heirship and the prohibition of inheritance agreements.

Under certain circumstances, the incorporation of a foundation could be viewed as the conclusion of an inheritance agreement. Where that is the case, the incorporation of the foundation would be considered to be invalid, since under Luxembourg civil law the penalty for creating a prohibited inheritance agreement is to render that agreement null and void.

The other succession law issue concerns the evaluation of the free portion in the presence of forced heirship rights. Under Luxembourg laws, the disposable portion is not calculated as of the day of the disposition or the gift, but as of the day of the death of the deceased. The forced heirship rights are determined after the fictive addition of all lifetime gifts and their evaluation as of the day of death to the estate of the deceased. This provision makes it impossible at the day of incorporation of a foundation, or the day of endowment of the assets into a foundation, to correctly determine the disposable portion.

Luxembourg estate laws will not always be applicable in connection with the incorporation of a patrimonial foundation. The foundation is, in this respect, in no weaker a position than other estate planning arrangements such as trusts, since compulsory succession rules also apply to these other arrangements.

The developments described within this article concern the provisions of a draft law which, of course, could still be amended during the legislative process. The civil law aspects outlined above may yet be addressed, or, a worst case scenario, the draft law may never actually be enacted into legislation (though this second scenario is not presently expected).

What does remain certain, however, is that the draft law is eagerly, and impatiently, anticipated by all the professionals in the legal and financial sector, who predict that this new vehicle will prove a big success and provide an alternative structure to challenge the institution of the trust.