This is Part 6 of Luxembourg Fund Formation, Translated: A Guide for Non-EU Fund Sponsors. Start here.

Sponsors arriving in Luxembourg hear the word “substance” early, and from more than one direction, and reasonably assume it is one requirement. It is one notion, but not one requirement. Each adviser who raises it is looking at it from a different angle, on behalf of a different audience, at a different level of your structure, and satisfying one does not necessarily satisfy the others. At home, your fund vehicles have probably never needed any of it. This piece separates them.

This is a fund formation guide, not a tax analysis. Tax substance is a subject in its own right, and your position largely depends on your assets, your investors and your own jurisdiction. What follows covers what you set up and run at formation, and flags the questions your tax adviser will ask.

The short answer: what is asked of you is that each entity in your structure is genuinely run from where it says it is: by people with the standing to decide, at meetings that actually take place in Luxembourg, with records made at the time, and on a scale that matches what the entity does. For an authorised fund manager, its regulator checks this from day one. For your general partner, your investors will look at it in due diligence; for the general partner and the holding companies below the fund, tax authorities, often not Luxembourg’s, may look years later.

Level one: the fund manager

This is what fund lawyers usually mean by substance, and it is the level where the expectations are most clearly set out in rules: a Luxembourg authorised manager is expected to have genuine local infrastructure, namely conducting officers who actually direct the business, minimum staffing in Luxembourg devoted to the key functions, a board that meets and decides, and enough of all of it to supervise whatever it has delegated. The CSSF applies what is generally known as a letter-box test: whether the manager has become a letter-box entity, one that has effectively contracted itself out of existence. Your fund lawyer will raise this when you choose the manager route. After launch, it is maintained by a host manager or by your own team.

In Cayman or Delaware terms: the SEC asks whether your adviser behaves properly, including its compliance programme, chief compliance officer, books and records. It does not require your people or your decisions to be anywhere in particular. The CSSF does. For a manager in Luxembourg, being there is part of being regulated.

Although much of the work of the manager can be delegated, what cannot be delegated is the manager’s responsibility, its key decisions, and the capacity to oversee whoever does the work. The manager may hire you to run the portfolio, but it may not hire you to be the manager.

If you appoint a host manager, meeting these requirements is the host’s legal obligation, and part of what its fee pays for. The exposure is still yours: if the host falls short, it is your fund and your investors that are affected, and as its delegate you will be subject to its oversight. Choosing the host is itself a substance decision. If you build or buy your own, it is entirely yours, and it is the recurring cost that makes the build decision serious. See Part 4: The manager question: build, rent, or stay small.

If your manager is registered rather than authorised, the regulator’s substance requirements at this level are much lighter. If it is a non-EU manager, Luxembourg imposes no substance requirements on it. Substance does not shrink as a result; it moves to the general partner. Often the same people sit behind both, and what matters is that each decision is taken by the right entity, in the right place, and recorded in that capacity. With a non-EU manager, the division of roles needs particular care: the manager takes the investment decisions it is appointed to take, but each Luxembourg entity should still take its own decisions, in Luxembourg, through its own board, and not simply record the manager’s.

Level two: the fund and its general partner

Unless you chose a regulated product, no regulator supervises this level, which is why it is routinely underestimated. Substance at this level has at least three audiences: your investors, in due diligence, asking how the general partner is governed; tax authorities, including your own, asking where its decisions are really taken; and, if something goes wrong, a court or a liquidator, asking whether its directors did their job.

A Luxembourg fund has its own governing body. In a partnership, this is usually the general partner, acting through its own board of directors; in a corporate fund, it is typically the fund’s own board. Depending on the fund documents and the manager’s appointment, some documents may be signed by the manager on the fund’s behalf, typically those carrying out investment decisions; others, usually those concerning the fund itself rather than its investments, remain with that governing body, which also stays responsible for appointing and overseeing the manager. Either way, each signature should rest on a decision actually taken by whoever holds the authority, or on an authority consciously given.

In Cayman or Delaware terms: a Delaware general partner is usually a vehicle with no staff of its own, and decisions are taken by your firm’s people, wherever they sit. A Cayman exempted limited partnership needs a general partner registered in Cayman, but registration does not by itself require decisions to be taken there. In both, the general partner is usually run from your office, and the structure is built around that. That is the habit to leave at home.

The directors on that board take real decisions and carry real exposure, including civil liability towards the company and third parties, personal liability in some cases for the company’s unpaid taxes, and criminal liability, for example for misuse of company assets. That exposure is not theoretical and it is not limited to insolvency. We have written about it separately: Director Liability in Luxembourg: Civil, Criminal & Tax Risk.

What is expected here is a board that convenes, considers what is put in front of it, and records what it decided and why. The failure pattern is not usually bad decisions. It is a broken process: decisions taken somewhere else and documented here, or taken here but not recorded in a way that shows it. In practice, three points make most of the difference:

• The signing sequence. The board’s decision comes before the documents are signed, whether at a meeting or by written resolution. Ratification afterwards is possible in law, but as a habit it raises the question whether the board really took the decision.

• Powers of attorney. Apart from Luxembourg law requiring them to be special and limited, they support substance when they carry out what the board has decided, not when they take decisions in its place.

• Written resolutions. They are widely used where the law allows and the articles provide for them, particularly for routine matters. For decisions that matter, a meeting in Luxembourg makes the stronger record.

Your fund lawyer will set this up at formation: the board, the directors, the powers and the meeting calendar. After that, it is maintained by the board itself, with its corporate secretary, usually your administrator or domiciliation agent, and by your own team, which brings it the matters to decide.

Level three: the holding companies

Below the fund sit the companies that actually own the assets, receive the income and, where relevant, claim treaty benefits. In Luxembourg these are usually SOPARFIs: ordinary, unregulated companies, most often a Sàrl, used to hold and finance investments. Being ordinary taxable companies is what lets them use Luxembourg’s treaty network and the EU directives, and it is also why their substance matters.

Tax questions arise at every level, but this is where they concentrate, because this is where the money moves. This is also where this article stops: the tax analysis belongs to your tax adviser, and the questions below are a starting point for that conversation. For each company, your adviser will ask:

• Is it entitled to the treaty rate or exemption it claims, given who runs it and how?

• Does it do more than pass proceeds up the chain?

• If it lends within the group, does it meet Luxembourg’s own expectations for companies that do?

These questions come when the holding chain is designed, and again at each acquisition or financing. If the answers are wrong, the cost is tax that was not in the model, found years later, at exit.

The facts that answer them are the same ones set out for the general partner above: a board that actually decides, in Luxembourg, with records made at the time. Each company is judged on its own and in proportion to what it does: a single-asset holding company does not need to look like the general partner, but it does need a board that decides. If the Luxembourg board cannot say no, it is not deciding.

What actually satisfies all of this

The facts overlap, even though the tests differ. In practice:

• People who decide. Directors and officers with the standing, information and authority to disagree with you, and at least the theoretical willingness to. Typically a majority based in Luxembourg, often professional directors alongside one sponsor representative.

• Meetings that occur where they say they occur. With the people who are supposed to be there, considering material they received in advance. On a calendar set at formation, and whenever a real decision is taken.

• Records made at the time. Minutes that show reasoning, not just resolutions. This is the cheapest substance available and the most commonly neglected.

• Something to administer. An entity with bank accounts it operates, contracts it is party to, and functions it performs is easier to defend than one whose only activity is signing.

• Service providers who support the board, not replace it. Your administrator and domiciliation agent can prepare papers, keep records and run the calendar. They cannot take the decision.

• Proportionality. Each entity is expected to be adequate for what it actually does, not to look like an authorised manager.

What does not

The recognisable failure patterns, in roughly the order we encounter them:

• Directors who are appointed to sign rather than to decide, and who have never declined anything

• Board packs written in New York and circulated the evening before a meeting in Luxembourg

• Decisions taken on a call between the sponsor and its advisers, then minuted in Luxembourg as though the board reached them

• One person holding every function across every entity in the chain

• Minutes that record outcomes without reasoning, produced in batches after the fact

None of these is fraudulent. All of them are ordinary shortcuts taken by busy people, and all of them look identical to the thing the rules were written to catch.

In Practice: the question we ask sponsors is not whether their structure has substance. It is whether, three years from now, someone could reconstruct from the records who decided what and when. If the answer is no, the substance may exist and still be unprovable, which, in front of a regulator or a tax authority, is the same thing.

The level everyone forgets

Here is the pattern worth taking away.

A sponsor appoints a reputable host manager that meets every CSSF expectation, and considers substance dealt with. Beneath the fund sit three holding companies that exist to own assets and route proceeds, with the same two nominee directors, no employees, no operations, and no records beyond annual resolutions.

The regulator is unlikely ever to look at those companies. The tax authority in the country where the asset sits, at exit, very well might, and that is where the treaty claim is being made and where the money is.

Your fund lawyer stops at the fund. Your tax adviser designs the holding chain but does not run it. The gap between them is where this problem lives, and nobody owns it unless someone is asked to.

The Bottom Line: substance is not a box the CSSF ticks at launch. It is one set of facts, looked at by different audiences at different levels of your structure, and the level fund lawyers usually mean by substance is the one least likely to go wrong: it is written down and supervised. The risk sits below it. Build the structure so that each entity is adequate for what it actually does, and keep records good enough to prove it years later, because you will be asked when the people who were there have moved on.

Common questions

Is substance a tax question?

Partly. At the fund manager, it is a regulatory question for the CSSF; below it, the consequences are mostly tax ones. Either way, the facts are created by how you set up and run the structure: who sits on which board, where meetings happen, what is recorded. That is a formation and governance question, and it is best settled before your first closing.

If I use a host manager, is substance their problem?

At the fund manager level, the obligation is the host’s, and part of what you pay for, but the exposure is still yours. At the fund, the general partner and the holding companies below, it is entirely yours.

Do I need employees in Luxembourg?

At the fund manager level, there are staffing expectations. At the general partner and holding company level, there is no general Luxembourg rule requiring employees: the question is whether the entity is adequate for what it does. Some tax tests, including those applied abroad, may expect more, and that is a question for your tax adviser.

Are nominee directors a problem?

Professional directors are entirely normal and often improve governance. Directors who do not receive information, do not deliberate and have never declined anything are a different matter, and the distinction is visible in the records.

Is the EU still planning common substance tests after ATAD 3?

Not yet. The EU’s attempt to set common substance tests through ATAD 3, the proposed Unshell Directive, was abandoned in 2025, but the idea was not. It is currently being discussed in the DAC recast (the EU’s tax reporting rules), part of the Commission’s June 2026 Tax Simplification Package alongside the Tax Omnibus, and would apply years from now, if adopted. Nothing in it applies today: substance is still judged case by case.

Who checks the holding companies?

Rarely the CSSF. Usually a tax authority, in Luxembourg or abroad, usually years later, usually at exit.

Next in this series – Part 7: What it costs, and how long it really takes.

Last updated 19 October 2026.

Disclaimer: Library articles are provided for general information purposes only and do not constitute legal advice. Accessing or relying on them does not create a lawyer-client relationship. Readers should seek advice on their specific circumstances before acting.