On 25 November, the upcoming German government coalition revealed its political vision for Germany in the upcoming 4 years by presenting the coalition agreement. The agreement is generally good news for the international Financial Services industry, the new government proclaims the importance of the common capital market within the EU and aims to complete the banking union. The agreement is dominated by the idea of digitization and modernization but also emphasizes the importance of countering tax evasion and improper market practices.
Projects of the new government include – among others – the following:
- Issuing of electronic / crypto stocks Since June 2021, Germany is allowing the introduction of digital securities (fund units and bonds) and crypto securities (bonds only, fund units to follow soon).6 The respective rules shall be extended to equity assets.
- Facilitation of IPOs, including the issuance of dual class shares
- Extension of tax reporting obligations under DAC6 to national arrangements
- Prevent improper use of dividend-arbitrage, esp. via blockchain technology and increased exchange of information between regulatory and tax authorities
- The focus on digitized and streamlined administrative procedures as well as the combat against tax fraud - especially related to WHT on dividends - is in line with previous projects of streamlining WHT reclaims procedures.7
- Extension of WHT on German sourced income (adjustment of DTTs) and extension of interest barrier (interest rate barrier)
- Make Germany the “leading location for sustainable financing” and increase issuing of green bonds while phasing out public financial investments that contradict the goal of climate neutrality
- Reorganization of retirement financing
- The government plans to introduce (public) capital based German pension insurance with 10 bn Euro annually, to be invested in the capital market with the purpose of gaining additional funds for retirement payments.
- Creating a European reinsurance for national deposit guarantee schemes (contributions strictly differentiated according to risk and under the condition of further reduction of risk in bank balance sheets)
The new government also emphasizes that it will play an active role in the implementation of global minimum taxation.
The agreement contains many projects related to climate protection, infrastructure and digitization which cannot solely be financed by the government. It can be expected that other investors will be engaged in financing respective projects – which might be a chance for the FS industry.
New CFC rules applicable in 2022
In June 2021, Germany passed revised CFC rules to transpose the EU Anti Tax Avoidance Directive (ATAD) into national law.8 The new rules will be applicable from 1 January 2022 and might especially have an impact on Private Equity structures but are also relevant to (international) investment funds with German investors.
Investment funds as CFC entities
An investment fund subject to the German Investment Tax Act (GITA) is - similar to the previous German CFC regime - usually not considered a CFC. Exceptionally, an investment fund might classify as a CFC if more than 50% of the interest in the fund is held by a German taxpayer (and the fund investor’s - German or non-German - affiliates) and if more than one third of the transactions underlying the income of the fund are conducted with the German taxpayer (or its affiliates). This new exception might be relevant for AIFs with German investors holding a controlling stake.
Blocker function of investment funds
Under previous CFC rules, an investment fund shielded against allocation of passive income from the fund’s CFC subsidiaries to the German investor. According to the revised CFC rules, the blocker function only remains for investment funds that are not controlled by a German taxpayer (and its affiliates). If a German taxpayer (together with affiliates) holds more than 50% of the interest of an investment fund, passive income from subordinate CFCs will be allocated - on a pro rata basis - to the German investor. This legislative change might affect e.g. a controlling German investor in a fund vehicle that invests in target companies holding debt instruments. Low taxed interest income of the target companies will be allocated directly to the German investor. In contrast, if the fund vehicle receives the interest income directly and not via a target company, adverse investor taxation under CFC rules can be avoided.
Impact of revised control concept
The concept of control has been overhauled under the new CFC rules; an entity is controlled if a German taxpayer together with affiliates (under the old regime: together with other German tax payers) holds more than 50% of the entity’s capital or voting rights or is entitled to more than 50% of the entity’s profits or liquidation proceeds. As the control concept includes profit entitlement as the main criterion, debt instruments might also convey a controlling position to their holder, e.g. a certificate of a securitization company.
A further important change affects investments via partnerships. According to the new CFC rules, it is assumed that the partners of a partnership generally act in concert and therefore are treated as affiliates. Thus, if a majority interest in a target company is held by a partnership (fund vehicle) with a German taxpayer as a partner - even if the German partner only holds a minority interest in the partnership, the target company is considered to qualify as “controlled” under the new German CFC rules. The German taxpayer may prove that the partners - in fact - did not act in concert. However, it is currently unclear how this burden of proof shall be fulfilled. The assumption of control for partners of a partnership might affect especially Private Equity funds in the legal form of a partnership (e.g. Luxembourg SCS) or making investments via a partnership.
Dividends as (potential) passive income
An important change affects entities qualifying as CFCs and their equity investments. In contrast to the old rules, under the new CFC rules dividends might be passive income and thus allocated to the German investor. Predominantly, this change affects portfolio investments, i.e. dividends received from target companies in which the CFC holds less than 10% of the (target company’s) capital. Further, the new CFC rules transfer the so-called correspondence principle to the taxation of CFCs; this means that - in general - dividends are passive income (and thus allocated to the German investor) if the dividend payment reduced the target company’s income.
Introduction of check the box for partnerships in Germany
In June 2021 and for the first time ever, Germany introduced the possibility for partnerships to check the box and opt for (opaque) taxation like an entity in corporate legal form. The new rules will be applicable from 1 January 2022. The check the box regime might be interesting for (German) AIFs.
Traditionally, German AIFs and their investors - depending on investment strategy and entity structure - could chose to either be structured in corporate or contractual legal form and thus be subject to the opaque taxation rules for investment funds under GITA or be structured as a partnership and be subject to pass-through taxation under general tax rules. With the new check the box regime, Germany now offers a third potential taxation regime for AIFs structured as a partnership: to opt for opaque corporate taxation. The main benefit of corporate income taxation is the intercorporate privilege / participation exemption: capital gains from equity are 95% tax exempt, dividends are 95% tax exempt if the opting entity holds more than 10% of the (target company’s) capital.
It is advisable to evaluate on a case-by-case basis whether the advantage, e.g. the intercorporate privilege, outweighs potential disadvantages, e.g. additional local trade tax (Gewerbesteuer). The evaluation includes - among others - the following factors:
- Investor type (corporate entity, tax exempt corporate entity, private person etc.)
- Asset types
- Thresholds in equity investments
- Scope of business activity.
The new check the box regime is available for foreign partnerships as well; however, depending on the entity’s tax status in its home jurisdiction: if the partnership opted for or is anyway subject to corporate income taxation in its home jurisdiction, the partnership may opt for corporate income taxation in Germany. If on the other hand the partnership is transparent for income tax purposes in its home jurisdiction, it cannot opt for corporate income taxation in Germany. This latter condition aims at preventing the creation of artificial hybrid structures.
Besides the above described options, the check the box regime is of little relevance for the taxation of investment funds:
- partnerships that opt for corporate income taxation cannot qualify as investment funds from a German tax law perspective
- investment funds in the legal form of a partnership cannot opt for corporate income taxation
- interest in partnerships that opt for corporate income taxation are not in scope of the partial release (Teilfreistellung, sec. 20 GITA) for equity / mixed investment funds under Chapter-2 of GITA
- an interest in a partnership that opts for corporate income taxation does not qualify as a share in a corporation for the purposes of the tax rules governing the investment requirements (sec. 26 GITA) and for the calculation of the Equity Gain (Aktiengewinn, sec. 48 GITA) of Special Investment Funds under GITA (Chapter-3-Funds).
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