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Dr Tillman Kempf and Cécile Robin, CMS Hasche Sigle, Germany
Dr Tillman Kempf is a Partner with CMS Hasche Sigle, Germany, and Cécile Robin is a trainee lawyer
The upcoming reform of German fund taxation leads to a number of important changes which asset managers and investors need to be aware of. For the first time, Germany is creating a level playing field between German and foreign funds.
The purpose of the reform consists in eliminating the risk of incompatibility with European Union (“EU”) law, in particular in connection with the free movement of capital (Articles 63 and 65 of the Treaty on the Functioning of the European Union (“TFEU”)), preventing the establishment of tax-driven fund structures and reducing the administrative burden as well as the complexity of the fund taxation rules.
Coming into force on January 1, 2018, the new law affects in principle any Undertakings for Collective Investment in Transferable Securities (“UCITS”) and Alternative Investment Funds (“AIF”). However, funds established in the legal form of a partnership are excluded from the scope of application. Hence, partnerships continue to be treated as transparent vehicles under the general German income tax rules.
Two main changes should be pointed out. First, the Investment Tax Reform Act (the “Act”) provides for a new standard fund tax regime, which is based on treating funds as opaque for tax purposes. Second, the current semi-transparency system has been modified and its scope of application has been reduced to so-called special investment funds ( Spezial-Investmentfonds).
The new law introduces a standard tax regime which provides for taxation to take place on two levels: the fund level and the investor level.
As from the January 1, 2018, funds will be subject to tax on German dividends, German real property income and certain other income from German sources. Such tax liability applies to any fund in scope of the Investment Tax Act, including German funds.
German and foreign UCITS and AIF will bear the identical tax burden, i.e., 15 percent on German dividend income and 15.825 percent on German rental income and certain other German source income.
As regards German dividend income, funds will not benefit from the participation privilege whereby effectively 95 percent of a dividend remains exempt if a 10 percent shareholding threshold is satisfied.
Under the new standard tax regime, funds are in principle opaque for tax purposes. As a consequence, investors are taxed on distributions (including distributions that are economically a repayment of capital), a lump-sum amount ( Vorabpauschale) and capital gain realized upon sale/redemption of fund shares.
Generally speaking, investors are taxed on the lump-sum amount only if the fund does not pay out actual distributions. The amount is limited to the so-called basis interest rate (which is fixed by the German Ministry of Finance based on the interest rate of public bonds) and capped at the fund's actual performance.
In order to balance out the tax incurred on the fund level, a partial exemption ( Teilfreistellung) is introduced. The scope of exemption depends both on the fund category and the type of investor. The exemption applies to distributions, to the lump-sum amount as well as to capital gains upon sale/transfer of fund shares.
As far as equity funds, i.e., funds with an equity quota of at least 51 percent, are concerned, the basic exemption for the income tax of individual investors is 30 percent of the income derived from the fund. It amounts to 60 percent for business investors subject to income tax, and 80 percent for investors subject to corporate income tax.
With respect to “mixed” funds ( Mischfonds), i.e., funds which invested in equities to at least 25 percent, the exemption is half that of equity funds.
Eventually, the applicable rates regarding real estate funds (at least 51 percent invested in real estate) and international real estate funds (at least 51 percent invested in non-German real estate) amount to 60 percent and 80 percent respectively (irrespective of the type of investor).
For German trade tax purposes, the above exemption rates are halved.
It can be expected that asset managers will adapt investment policies so as to ensure that investors benefit from the partial exemption to the maximum extent possible.
Under the former semi-transparent tax regime, extensive tax reporting had to be prepared and published in Germany.
In view of the costs triggered by such a reporting duty, it was often perceived as a disincentive to market funds in Germany. Under the new standard tax regime, the tax reporting obligations are abolished.
Pursuant to Chapter 3 of the Act, the special funds and their investors are subject to a special tax regime provided some specific conditions are fulfilled.
The Act provides a conclusive list of conditions to be fulfilled for a fund to be qualified as a special fund.
Firstly, the fund's objective needs to be limited to the investment and management of its assets; the fund may not engage in an entrepreneurial activity with regard to its assets.
On top of that, the fund must stick to certain criteria with respect to assets, redemption rights and specific investment restrictions. At least 90 percent of the value of the assets shall consist in certain eligible assets, such as securities, derivatives or shares of funds that essentially comply with the same restrictions. It should also be pointed out that not more than 100 investors may invest in the fund and that natural persons must not invest in special investment funds, neither directly, nor indirectly via a partnership.
In principle, a special fund may be subject to tax in the same manner as a fund under the standard tax regime. However, in practice, it can be expected that special funds will make use of the so-called transparency option in relation to German dividends and an option to deduct withholding taxes on German real estate income/other German source income.
Consequently, a special fund can be set up in such a way that no German taxation occurs on the fund level.
Under the new provisions, the investors are taxed on distributed earnings and deemed distributed earnings as well as on capital gains realized upon sale or redemption of fund shares.
Deemed distributed earnings ( ausschüttungsgleiche Erträge) include dividends, interests, and other types of investment income (except for certain capital gains from securities and derivatives) as well as rental income and capital gains derived from real estate (save for German dividends and real estate income in relation to which the transparency option/withholding tax option has been exercised).
As regards the capital gains realized upon the redemption of fund shares, certain exemptions apply with respect to gains from equities and earnings from real estate exempt under a double tax treaty.
Germany has implemented a substantial reform of its fund taxation rules. The reform provides new opportunities, in particular for non-German asset managers, as a number of the obstacles and disadvantages of the former tax regime are removed. Existing funds should be reviewed in order to determine necessary amendments to the structure and investment policy with a view to the reform.
Dr Tillman Kempf is a Partner with CMS Hasche Sigle, Germany and Cécile Robin is a trainee-lawyer graduate of Paris II Panthéon-Assas University (International Taxation).Email: firstname.lastname@example.org
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