This revision of German VAT law is particularly important for international asset managers with offices in Germany and international investment advisors.
The Financing for the Future Act (“Zukunftsfinanzierungsgesetz, ZuFinG”), applicable from 1 January 2024, brings significant changes to the German tax landscape, specifically in the realm of the management of Alternative Investment Fund (AIF). Notably, management services provided to all AIFs will now be VAT-exempt in Germany.
This legislative amendment seeks to establish a level playing field in terms of VAT treatment, aligning Germany with other key fund jurisdictions.
VAT exemption in detail
Under the current national regulations in Germany, the VAT exemption encompasses a limited scope of investment funds, only funds that are in line with the EU UCITS Directive and comparable (e.g. regulated, open-ended) Alternative Investment Funds addressed to the retail market, including venture capital funds.
As of 1 January 2024, all AIFs, irrespective of their set-up and the nature of their investments, will benefit from the VAT privilege. It is not possible for the AIFM to opt into the VAT regime voluntarily.
The term “management services” encompasses all services provided by the German Capital Management Company (“KVG” or AIFM) to the funds it oversees, for which the management company charges a fee. The VAT exemption covers not only the services provided by the AIFM itself but also third-party services like those of a delegated (international) asset manager and other services, if closely related to the asset management function (such as portfolio managements services) but also fund accounting services. However, services related to the distribution of fund units of the AIF will usually not be covered by the exemption for funds management services, but could fall within the scope of the exemption applicable to the intermediation in shares (e.g. Private Equity funds organized as a German GmbH or GmbH & Co. KG).
Consequences of VAT exemption
Positive impact on AIF
The abolition of VAT on asset management services introduces a substantial cost-saving measure for German AIF structures, thereby increasing the available capital for investment for the benefit of the fund investors. Furthermore, the exemption may also have a positive effect on the so-called “hurdle rate” of the performance remuneration of the fund initiators.
Negative impact on AIFM (loss of input VAT deductibility)
However, the VAT exemption results in the loss of input VAT recovery for the KVG to the extent that it renders tax-exempt services. This affects all VAT-taxable input services of the KVG, including legal and tax advisory costs, travel expenses, supplies, and other services not borne by the fund as fund expenses, particularly potential payments by the KVG for rent and lease agreements.
Practical considerations (e.g. rented office space of the AIFM)
Affected German asset managers and investment advisors of AIFs lose their right to recover input VAT, necessitating a review of existing service agreements with regard to potential price adjustment clauses or statutory compensation claims (cf. Sec. 29 of the German VAT Act).
Rental agreements should also be scrutinized for clauses on contractual penalties or compensation claims that may arise, as the VAT exemption named may lead to a breach of rent / lease obligations, triggering liability for damages, for example, when an AIF manager acts as the lessee of office space. This is because the new VAT exemption for the AIF manager simultaneously limits or eliminates the lessor's entitlement to input VAT deduction. Rent / Lease agreements frequently contain respective provisions imposing liability to the lessee for such damages. These negative consequences cannot be avoided by the AIFM opting into the VAT regime voluntarily.
Conclusion
While the VAT-related amendments initially seem positive, particularly in enhancing the appeal of the German fund domicile and ensuring competitive fairness, it is essential for the AIFM to monitor the impact of this change on VAT recovery. Contingent input VAT deductibility should be incorporated into financial planning, lease agreements scrutinized, and outsourcing scenarios reviewed to proactively address potential challenges.
If you wish to discuss these topics, please contact: WTS Germany
