Draft Bill Would Revise Taxation of Funds and Investors

Transcription

1 Volume 69, Number 1 January 7, 2013 Draft Bill Would Revise Taxation of Funds and Investors by Andreas Rodin, Uwe Bärenz, Ronald Buge, Jens Steinmüller, and Peter Bujotzek Reprinted from Tax Notes Int l, January 7, 2013, p. 40

2 Reprinted from Tax Notes Int l, January 7, 2013, p. 40 Draft Bill Would Revise Taxation of Funds and Investors Germany s Federal Ministry of Finance (BMF) recently submitted for comment by the investment industry a ministerial draft of the Act on the Adaptation of Investment Fund Taxation in Connection With the AIFM 1 Directive to investment industry associations. The draft calls for significant changes to the tax treatment of funds and their investors and, if approved in its current form, will have a significant impact on existing structures. COUNTRY DIGEST Executive Summary The draft provides for the taxation of investment undertakings, as regulated by the July 20 draft German Investment Code (Kapitalanlagegesetzbuch), to implement the EU directive into German law. (The German Investment Code will be the legal framework both for undertakings for collective investment in transferable securities (UCITS) and for AIFs (alternate investment funds) in the future.) The BMF does not intend to implement a single tax regime for all such investment undertakings, but instead would create categories of funds solely for tax purposes that would be subject to different tax regimes. Closed-End Funds German and non-german private equity funds and other closed-end funds such as mezzanine, infrastructure, and real estate funds would be treated as nonqualifying investment funds (NQIFs). For tax purposes, differentiation is made between partnerships and corporations. The draft would not revise the general tax rules applicable to partnerships (such as German GmbH & Co. KGs). 2 German and non-german corporations such as a German limited liability corporation or joint stock corporation, a Luxembourg SCA or SA SICAV, 3 and an Irish public limited company would be subject to a new tax regime comparable to the lump sum taxation under the current German Investment Tax Act. However, taxation of actually received income is not possible (because of, for example, the reporting of certain tax information and similar factors). Open-End Funds Generally, there would be no changes to the tax regime for open-end funds that fall within the scope of the current German Investment Tax Act. However, some requirements would be introduced for a fund to qualify for this tax regime (for example, some redemption rights and investment limitations). Accordingly, open-end funds that do not fulfill those requirements would be subject to the tax regime applicable to closedend funds. Transitional Provisions The draft does not contain transitional provisions for closed-end funds organized as partnerships (see above) because their taxation does not change. The new tax rules for closed-end funds organized as corporations (see above) would enter into force on July 22, 2013, and would not be grandfathered. Such funds would be immediately subject to mandatory lump sum taxation. However, the tax regime for open-end funds that fall within the scope of the existing German Investment Tax Act and that have been or will be established before July 22, 2013, would still apply. In other words, those rules would be grandfathered. VAT on Management Fees Management fees paid by closed-end funds would continue to be subject to VAT. Outlook The provisions (including the lack of grandfathering rules) for closed-end funds organized as corporations 1 Alternative investment fund managers. 2 Limited partnerships. 3 Limited partnership or public limited company. TAX NOTES INTERNATIONAL JANUARY 7,

3 COUNTRY DIGEST Reprinted from Tax Notes Int l, January 7, 2013, p. 40 are unreasonable and constitute a violation of the German Constitution. They undoubtedly will be singled out in the course of the consultation with the relevant industry associations and in the legislative procedure. Scope of the Draft In the course of the regulatory implementation of the AIFM Directive, the scope of the new investment law, in accordance with the draft German Investment Code, would be extended to all AIFs, including private equity funds and other closed-end funds. Under the draft, the new system would be implemented in German tax law. However, for tax purposes, various categories of AIFs would be introduced that differ from the classification under the German Investment Code and that are subject to different tax regimes. Qualifying Investment Funds The term qualifying investment fund (QIF) includes European harmonized UCITS, as well as some German and non-german open-end AIFs. These would remain subject to the existing German Investment Tax Act with some modifications. However, German and non-german funds would no longer be differentiated. Further, some requirements relating to product regulation would have to be fulfilled solely for tax purposes in order for an AIF to be treated as a QIF. This taxrelated product regulation is not consistent with the regulatory product regulation. In addition to preexisting requirements relating to passive investment without involvement in the management of portfolio companies and investment based on the principle of risk diversification, the following criteria would apply: The AIF must be subject to regulation in the state of its statutory seat, and the investors must have a redemption right at least once per year. This requirement is stricter than the requirements under the law in force. It must have a uniform limit of 20 percent for investments in companies that are not listed on a stock exchange. The 30 percent threshold currently applicable to hedge funds would no longer be relevant. However, the limitation applicable to non-securitized loan receivables and derivatives would be rescinded. The AIF could invest no more than 5 percent of its total capital in a single company. Further, an AIF could not hold more than 10 percent of the outstanding shares of a corporation. AIFs could borrow up to 30 percent of their value (up to 10 percent for real estate funds) short-term. Only real estate funds would be entitled to borrow up to 30 percent of their value long-term. Most of the funds established in offshore jurisdictions (such as the Cayman Islands, the British Virgin Islands, Bermuda, and the Channel Islands); all closedend funds; hedge funds; and some open-end real estate funds would no longer be treated as QIFs, and would be subject to the adverse tax regime for NQIFs (see the following section). Compared with the current situation, it may become easier for debt and derivative funds and so-called CATbond 4 funds to fall within the scope of QIF taxation. NQIFs All AIFs that do not fulfill the requirements for QIFs would be classified as NQIFs. In that respect, no differentiation would be made between German and non-german NQIFs. The proposed tax regime for NQIFs would primarily cover funds that would be treated as AIFs in the future but do not fall within the scope of the German Investment Tax Act currently in force (that is, closedend funds, including private equity funds). Further, AIFs that no longer meet the modified requirements for QIFs (see above), such as some open-end real estate funds or hedge funds, would also be treated as NQIFs. Rules of Taxation QIFs The tax rules for investment funds would basically remain the same (under the concept of limited transparency) but would be subject to some modifications. Tax Exemptions As in the past, investment funds would be treated as corporations regardless of their legal structure, provided that they are exempt from German corporate income tax and, if applicable, German trade tax; investment proceeds would be subject to taxation only at the level of investors. Investment stock corporations could receive both capital proceeds and income for asset management services rendered. The draft establishes the following framework: Income from asset management activities in the hands of internally managed investment stock corporations would be subject to taxation. However, it is unclear how the portion of the overall profits that is to be allocated to the asset management services would be determined. In particular, the allocation of costs and expenses may give rise to questions. Income allocable to company shares (that is, shares typically held by the initiators) would be subject to taxation at the level of the investment 4 Specialized catastrophe bond funds, hedge funds, and so on. 2 JANUARY 7, 2013 TAX NOTES INTERNATIONAL

4 Reprinted from Tax Notes Int l, January 7, 2013, p. 40 stock corporations. However, this rule would not apply to special investment stock corporations that exclusively issue company shares. It appears problematic that the draft includes no special rules as to the taxation of that income in the hands of the investors. In the absence of any special rules, the general tax rules for investment funds would apply; conceptually, those rules presuppose that proceeds are exempt from taxation at the fund level. Domestic Special Investment Funds The rules for domestic special investment funds essentially would remain the same. In particular, investors organized as partnerships (such as family offices) would still be able to invest in domestic special investment funds. Special rules would apply if a fund ceases to be classified as a special investment fund (see below). Open-End Investment Limited Partnerships Open-end investment limited partnerships would be introduced to make pension asset pooling by international companies more attractive. The open-end investment limited partnership is intended to be tax-transparent for tax treaty purposes in order to benefit from reduced withholding tax rates granted exclusively to pension funds. An investment in an open-end investment limited partnership would not give rise to a domestic permanent establishment of the investor. This would prevent the imposition of German tax filing or taxpaying obligations on investors solely as a consequence of the investment limited partnership deriving business income. Apart from the above, open-end investment limited partnerships and their investors would be subject to the general investment taxation rules, provided that provisions relating to domestic special investment funds including the limit of 100 on the number of investors and the exclusion of individual investors apply correspondingly. Amendments to Rules of Taxation The draft includes a number of modifications to the investment tax regime that are unrelated to the AIFM Directive, such as requests submitted by the Federal Council (Bundesrat) on modified deductibility of expenses and deemed order of distribution in connection with the annual Tax Act Losing Investment Fund Taxation Unlike the law in force, the draft provides that a fund would lose its status as a QIF during its term if: the fund s terms are amended in such a way that the fund no longer satisfies the requirements for investment fund taxation; or a significant breach of the fund s terms occurs, which is deemed to be the case if there is a breach of an investment limitation actively caused COUNTRY DIGEST by a single transaction (unless the breach is rectified within 10 business days). The draft calls for a specific proceeding to determine the loss of QIF status. At the end of the business year during which the nonapplicability of investment fund taxation has been finally determined, the relevant fund would be taxed as an NQIF (see below) for a period of three years. If a special investment fund no longer fulfills the features of a QIF because of a modification of its terms or its articles of association or because of actual breaches of its investment limitations, it would be treated as an NQIF upon expiration of the business year during which the breach occurred. Entry Into Force, Grandfathering According to the draft, the new law would enter into force on July 22, 2013, at the same time as the German Investment Code, and would apply to all funds established on or after that date. Funds established before July 22, 2013, that are subject to the existing German Investment Tax Act would continue to operate under those rules. NQIFs The tax regime for German and non-german NQIFs would differentiate between partnership-type NQIFs and corporate-type NQIFs. Partnership-Type NQIFs Partnership-type NQIFs are investment limited partnerships that do not fulfill the tax requirements of an open investment limited partnership and their comparable non-german entities. These funds are not subject to any changes. The draft merely clarifies that the general rules would apply. Tax transparency (that is, the direct pro rata allocation of the fund s items of income) would still be required and the criteria used to differentiate between business and nonbusiness activities would still apply. The draft also provides for a separate and uniform tax assessment form for these NQIFs. Corporate-Type NQIFs A completely new tax regime would be introduced for German and non-german corporate-type NQIFs that has significant disadvantages compared with the current rules. SICAVs and Asset Pools Corporate-type NQIFs include not only German and non-german corporations, but also German and non-german asset pools of a contractual type, such as Luxembourg fonds commun de placement (FCPs), that in either case do not satisfy the criteria for QIFs. The draft would resolve the issue of how to treat contractual-type non-german asset pools that do not fall within the scope of the existing German Investment Tax Act by providing for corporate treatment of TAX NOTES INTERNATIONAL JANUARY 7,

5 COUNTRY DIGEST Reprinted from Tax Notes Int l, January 7, 2013, p. 40 such pools. Hence, such pools could be subject to limited tax liability on their German-source income. However, this conflicts with the transparency established in Germany s income tax treaties with several countries. Mandatory Lump Sum Taxation The taxable income at the level of an investor in a corporate-type NQIF would consist of all distributions plus 70 percent of the difference between the first and the last redemption or market price fixed for the relevant business year, provided that at least 6 percent of the last redemption or market price is subject to tax. The mandatory lump sum tax would apply to unrealized profits as well as profits that are realized but retained. The draft does not establish how the market price would be determined. While this proposal resembles the existing lump sum tax regime, it is intended to be mandatory (in other words, income actually received would be taxable; otherwise a deduction of losses would not be possible). This raises constitutional concerns. Impact of Taxation at Fund Level The amount taxable under the mandatory lump sum tax system would be taxed like a dividend at the investor level (partial income taxation for individuals holding their shares as part of their business assets, or a tax exemption under section 8b of the Corporate Income Tax Act for corporate shareholders), but only in the case of an effective tax burden of 15 percent at the level of the corporate-type NQIF. If the effective tax burden is less than 15 percent, the full amount would be taxable. A flat-rate withholding tax (abgeltungsteuer) would apply to private investors regardless of whether there is a tax burden at the level of the corporate-type NQIF. Inadequate Provisions to Avoid Double Taxation As a matter of logic, the application of mandatory lump sum taxation to both unrealized and realized (but retained) profits results in double taxation. It can be argued that this would be a constitutional violation unless provisions were introduced to prevent double taxation. However, the draft contains no provisions to exempt distributions from tax to the extent of any retained profits that were already subject to tax. Moreover, although the mandatory lump sum tax would apply to unrealized profits, the draft does not address how to deal with subsequent decreases in value. Only when fund interests are disposed of by a private investor would the transferor deduct the excess of the total taxable income over all distributions actually received upon determining the capital gain. The draft does not address sales of fund interests that belong to the business assets of the disposing investor, nor does it address the outcome when an investor continues to hold its investment in the fund until its dissolution. Entry Into Force, Grandfathering The provisions for the NQIFs and mandatory lump sum taxation are also intended to take effect on July 22, The draft s grandfathering rules for QIFs would not apply to NQIFs that do not fall within the scope of the current German Investment Tax Act. Accordingly, all SICAV or FCP structures that have not previously been treated as foreign investment funds would be subject to mandatory lump sum taxation. VAT The current VAT exemption for the management of investment funds would be adapted to conform to the draft s revised terminology. However, the anticipated exemption is only intended to apply to QIFs, and not to NQIFs. The scope of the VAT exemption would thus remain mostly unchanged. In particular, the management fees of private equity funds and other closedend funds would still be subject to VAT. Andreas Rodin, Uwe Bärenz, Ronald Buge, Jens Steinmüller, and Peter Bujotzek, P+P Pöllath + Partners, Frankfurt and Berlin 4 JANUARY 7, 2013 TAX NOTES INTERNATIONAL