Recently, the German Ministry of Finance (MoF) presented two new important draft pieces of tax rules in many ways relevant for the international Financial Services industry.
On the one hand, the draft bill for a Growth Opportunity Act provides for a number of tax adjustments that directly and indirectly affect the fund industry, especially important for real estate funds with German assets (interest deduction limitation). Secondly, the MOF published the draft of an application decree to the German Foreign Tax Act (AStG); it concerns the German add-on taxation regime, relevant especially for (foreign) Private Equity funds with German investors.
Draft bill of a Growth Opportunities Act
On 30 August 2023, the German Cabinet approved a draft law on the Growth Opportunities Act. The parliamentary legislative procedure is still pending. In principle, the law is to take effect from January 1, 2024.
The 287-page draft aims to expand economic opportunities, spur investment and innovation in new technologies, and bolster Germany's position as a global business hub.
With regard to the taxation of domestic and foreign investment funds in Germany under the German Investment Tax Act, there are interesting proposals:
- The draft bill proposes an amendment aimed at cross-border tax arrangements where investors invest in German real estate via a German (limited liability) corporation held by a Luxembourg fund; the intention of such arrangement is to avoid German taxation on the increase in value of German real estate. The proposed version of the law expands the definition of domestic income and subjects gains from the sale of shares in corporations with predominantly German real estate ownership to taxation. The regulation would apply to both, German and foreign corporations with predominantly German real estate, regardless of whether the corporation has its management or a registered office in Germany.The investment fund itself must determine and report the taxable income to the competent tax office. The investment fund itself must determine and report the taxable income to the competent tax office.
- Another amendment under the Growth Opportunities Act would be the further restriction on the deductibility of interest expense, which will be particularly important for real estate funds with investments in Germany via PropCos. Among others, two important changes are proposed. For real estate companies, it should be noted that the exemption limit of EUR 3 million would no longer apply per "business" (PropCo) as at present, but uniformly for a group of companies. As a result, the deductible interest expense cannot be used more than once in the future for portfolios with several PropCos. Further, the concept of expenses covered by the interest barrier would be expanded, so that costs that are economically equivalent to interest and costs incurred in connection with the procurement of financing will now also be covered. In addition, there is also a limitation of the use of interest carry forwards.
- If an investment fund invests more than 50 percent of its NAV in real estate or real estate companies, 60 percent of the investment income is currently exempt from taxation in Germany for the investor of the German RE fund, “partial real estate exemption” (80% tax exempt in case of non-German RE funds). As a result of the draft bill, investments in real estate and real estate companies would not be included in the partial real estate exemption quota if the respective in-come is subject to a low tax burden in the location of the property due to beneficial tax regulations. The draft explicitly mentions the example of the Finnish “Oy MREC”. The change proposed is disadvantageous for German and non-German real estate funds.
- The German tax law status of a “Special Investment Fund” imposes a restriction on active economic activity. Thus, special investment funds have been cautious about investing in - for example - the production of renewable energy and e-mobility charging stations to avoid losing their beneficial tax status. The draft suggests to increase the limit for active economic activity of such funds from 10% to initially 20% of the fund revenue, and later expand the limit further to fully utilize the potential of special investment funds in promoting de-carbonisation.
- The draft bill introduces an extension to domestic cases of the reporting obligation for cross-border tax arrangements known from the DAC 6 Directive.
Draft of decree to the German Foreign Tax Act
The draft of a decree to the German Foreign Tax Act incorporates changes brought about by the German ATAD Implementation Act and includes updates on transfer pricing, exit taxation, taxation of income from foreign intermediate companies, and foundations. It also addresses issues arising from developments in the economy, such as changes in business models and digitalization.
In the context of the Financial Services industry, the regulations on the add-on taxation of German investors of international Private Equity funds with income from controlled companies are of particularly high importance. Due to falling tax rates worldwide, the relevance of add-on taxation has increased in recent years. Taxpayers are often confronted with the issue of add-on taxation in the course of tax audits.
Compliance with the German foreign income tax reporting requirements regularly requires a high degree of cooperation on the part of foreign companies that are the target of German investment in order to avert negative tax consequences for the German investor. However, this burden on German investors and their affiliated target companies is further increased by the fact that the new German add-on taxation regime pursuant to the German ATAD Implementation Act introduced considerable legal uncertainty.
The new draft of the German Tax Authority comments on the details of the German add-on taxation on approx. 130 pages. While it is, in general, to be welcomed that the German Tax Authority is finally providing guidance on the application of the German add-on taxation regime after the implementation of the ATAD directive, the draft — for now — fails to provide conclusive answers with regard to several disputed issues.
Example: Acting in concert
With a view to especially Private Equity funds, regarding partnerships there is a rebuttable legal presumption of concerted action by the partners. This presents investors in investment vehicles
structured as a partnership with the challenge of disproving their interaction. The conditions to dis-prove this presumption have been controversial since the regulation was originally enacted.
- The draft mentions three examples in which a rebuttal of the legal presumption is – in principle – possible:
- if the joint purpose of the partnership can no longer be pursued;
- if there are serious differences of opinion between the partners; or
- if the joint purpose of the partnership covers the investment of capital only, the investment object is initially not concretely determined and as long as the investors do not know each other and are only entitled to information rights (so-called “blind pool”).
The wording of the draft with regard to the general requirements of concerted action remains vague and open (“may speak for concerted action”) so that a case-by-case consideration seems recommendable.
If you wish to discuss these topics, please contact:
WTS Germany
