After discussions that took place over several years, a new German tax regime applicable to investment vehicles was introduced in July 2016. The basic idea of the reform was to move away from the approach of the former German Investment Tax Act, Investmentsteuergesetz (InvStG), which generally provided for transparent taxation at the fund level. The old law is replaced by the Investment Tax Reform Act, Investmentsteuerreformgesetz (InvStG 2018), which provides an opaque taxation concept for investment funds (Investmentfonds) and a semi-transparent taxation concept for special investment funds (Spezial-Investmentfonds).
The Investment Tax Reform Act was published in the Federal Law Gazette, the Bundesgesetzblatt, on 26 July 20161 and entered into force on 1 January 2018. During this period, a number of legislative amendments were adopted2. In addition, the InvStG 2018 was amended again after implementation3.
This article provides an overview of the reformed investment tax regime in Germany applicable to domestic vehicles tax resident in Germany, foreign investment vehicles not tax resident in Germany, and the investors in each.
Scope of the InvStG 2018 on investment funds and their investors
Sec. 1 (1) InvStG 2018 applies to investment funds and investors in investment funds. The definition of an investment fund4 is rather broad and refers to the definition of an investment vehicle within Sec. 1 (1) of the German Capital Investment Act, Kapitalanlage-gesetzbuch (K.A.G.B.). Thus, an investment fund is a collective investment vehicle, raising funds from a certain number of investors and deploying the funds raised pursuant to a predetermined investment strategy for the benefit of investors. It carries on no business activities, whatsoever. A special investment fund is an investment fund that fulfils certain additional requirements set out within Sec. 26 InvStG5. InvStG 2018 also characterizes certain investment vehicles as investment funds that do not fulfil the requirements provided for in Sec. 1 (1) K.A.G.B. These include (i) single investor funds, (ii) tax-exempt corporations prohibited from carrying out operational activities, and (iii) alternative investment funds managed within a group.
In addition, the law provides several exceptions from the application of the InvStG 2018. With certain exceptions6, partnerships are excluded from being characterized as special investment funds under InvStG 20187. Consequently, the ordinary tax regime (e.g., the German Income Tax Act, Einkommensteuergesetz (EStG), or the German Corporate Income Tax Act, Körperschaftsteuergesetz (KStG)) is applicable. Also applicable is the Trade Tax Act, Gewerbesteuergesetz (GewStG). Additionally, domestic and foreign real estate investment trusts are excluded from the scope of InvStG 2018.
If a German investor that is subject to German tax, invests in a foreign investment fund, the foreign investment fund must be classified according to German tax principles, including InvStG 2018. The same is true where a foreign investment fund invests in assets located in Germany. The foreign vehicle is characterized under the principles of InvStG 2018.
In case of an umbrella fund composed of sub-funds with segregated liability, every sub-fund constitutes a separate taxable entity8. In the case of a foreign sub-fund, that entity will qualify as a legal body within the meaning of Sec. 2 (1) KStG and may be subject to a limited corporate income tax liability in Germany9.
Distinction between investment funds and special investment funds
If a domestic or foreign investment vehicle is subject to the InvStG 2018, a determination must be made whether the investment vehicle qualifies as an investment fund or a special investment fund. Depending upon the answer, different tax consequences follow.
The additional requirements for qualification as a special investment fund are as follows:
- The fund vehicle must not be “actively managed” and the purpose of the fund must be limited to the administration of its assets for the collective interest of its investors10.
- The fund vehicle or the fund manager must be subject to a regulatory supervision11.
- Investors must be allowed to redeem their interests, shares, or units in the fund vehicle at least once per year12.
- The assets of the fund vehicle must be diversified pursuant to risk diversification principles13.
- At least 90% of the value of the fund vehicle must be invested in specified assets (Eligible Assets), such as securities falling within Sec. 193 K.A.G.B. or other capital assets within Sec. 198 K.A.G.B., money market instruments, derivatives, bank deposits, real estate and comparable rights, participations in real estate companies, interests in another investment fund which fulfils certain requirements for qualification as a special investment fund, interests in special investment funds, participations in public/private partnership companies, precious metals, receivables, or participations in corporations if the value of these corporations can be determined14.
- Only 20% of the value of the fund vehicle can be invested in participations in corporations that are not traded15.
- The participation in shares of a corporation that are held directly or indirectly via a partnership must remain below 10%16.
- Debt obligations held by the fund must be taken up on a short-term basis and cannot exceed 30% of the value of the fund vehicle17.
- The fund vehicle cannot have more than 100 investors. Individuals may invest only if they hold their interests as commercial assets or the investment is required by regulatory law18.
- The fund vehicle’s investment conditions must provide for an extraordinary termination right for the special investment fund if the requirements of Sec. 26 (8) InvStG 2018 are not met19.
- The foregoing requirements must be set forth in the general investment conditions of the fund vehicle20.
Each of the foregoing requirements must be met in order for the fund to be considered a special investment fund. Consequently, if any single requirement is not met, qualification as a special investment fund is unavailable. If all the special investment fund requirements are met at the beginning of the year but not at a later date, the special investment fund is deemed to be dissolved and newly established as an investment fund21. This may result in the realisation of hidden reserves.
Taxation of investment funds
Corporate income tax
Under the prior investment tax system, a German investment fund was fully tax transparent, i.e., there was no taxation at the level of the investment fund. In comparison, foreign investment funds investing in Germany did not benefit from the tax exemption available to German investment funds. Thus, it was highly disputed whether the dichotomy in tax treatment infringed a fundamental freedom of the E.U. Law.
Now, however, both domestic and foreign investment funds are subject to German corporate income tax (C.I.T.) at a rate of 15%, plus a 5.5% solidarity surcharge, Solidaritätszuschlag, on the C.I.T. amount, resulting in an effective C.I.T. rate of 15.825%. This taxation at the level of the investment fund was a key element of the investment tax reform in 2018. Tax is imposed on certain income that is derived from German sources. In some cases, German trade tax (“G.T.T.”) will be imposed, too. Consequently, C.I.T. Is imposed with respect to:
- Income derived from participations in German corporations, inländische Beteiligungseinnahmen;
- Income derived from German real estate, inländische Immobilienerträge; and
- Other domestic German income, sonstige inländische Einkünft, which is subject to a limited German income tax liability22.
Capital gains derived from the sale of equity participations in German corporations are tax-exempt23.
For German dividends and any other German income subject to withholding at source, the final C.I.T. liability is settled when the tax is withheld at source. With respect to income payable to an investment fund, the withholding tax rate, which is generally 26.375 %, is reduced to 15% (corporate income tax of 14.218% plus a solidarity surcharge of 0.782%). To obtain the benefit of the reduction in withholding tax rate, the paying agent must be provided with a confirmation of the status of the fund, Statusbescheinigung24. If an applicable income tax treaty provides a lower rate of withholding tax, the lower treaty rate generally will apply. In either event, expenses associated with the participation income are not deductible for tax purposes25.
German income that is subject to taxation at the investment fund level and not subject to withholding tax at source is generally taxed at the general C.I.T. rate of 15.825%. Related expenses incurred at the fund level are deductible for tax purposes26.
For certain investors, such as non-profit and charitable entities, the InvStG 2018 provides for a full tax exemption applicable at the level of the investment fund27. Upon application, and subject to further requirements28, the income of the investment fund allocable to these investors is tax-exempt at the level of the investment fund such that no effective taxation will occur.
In addition, a partial exemption is provided at the level of the investment fund in two circumstances29:
- The investor is a public body, in which case, the interest or shares are not part of a commercial business of the public body.
- The investor is a tax-exempt corporate body, Versorgungswerke, or a pension, Pensionskassen. In each such case, a tax exemption is available if (i) the shares are held by a foreign corporate body that is comparable to a German tax-exempt corporate body and (ii) that foreign corporate body has its place of management and statutory seat in a country that provides for administrative cooperation.
Investment funds that maintain a permanent establishment in Germany are generally subject to G.T.T. as well as C.I.T. G.T.T. rates range from approximately 12% to 18%, subject to several exceptions:
- Foreign investment funds that do not maintain a permanent establishment in Germany are not subject to G.T.T.
- G.T.T. is not imposed if and to the extent the income from actively managed assets does not exceed 5% of the overall income of the investment fund30.
- An investment fund is not subject to G.T.T. if it has a business purpose that is limited to the investment and management of assets for the joint account of the investors and the fund does not actively manage its assets, aktive unternehmerische Bewirtschaftung, to a material extent.
For purposes of the last exception, the InvStG 2018 does not provide guidance to determine when an investment fund actively manages its assets. Nonetheless, an administrative decree issued many years ago31 as well as the recently published administrative decree regarding questions on the application of the InvStG 201832 state that, while the general principles developed by case law for distinguishing between commercial and non-commercial activities are not directly on point, an activity that is clearly non-commercial under the case law cannot be regarded as active management of assets when such activity is carried out by an investment fund. In addition, where there is a participation in a real estate company, the active management of the real estate company is not considered to be active management of assets33.
Taxation of investors
German resident investors in an investment fund are subject to taxation on distributions, Ausschüttungen, from the investment fund, capital gains from a sale or redemption, Gewinne aus der Veräußerung von Investmentanteilen, of interests or shares in the investment fund, and any minimum annual advance lump-sum amount, Vorabpauschale. The tax rules regarding each of these taxable events are as follows:
- Distributions: Distributions to a German resident investor are subject to taxation in the fiscal year in which the distribution is paid to the investor, or if earlier, reported by the investor.
- Capital gains: Capital gains are subject to taxation in the fiscal year in which the proceeds are received or credited for the account of the investor. The capital gain is the excess of the proceeds received from the disposal over the sum of (i) the acquisition costs comprised of the amount invested and related costs and (ii) any advance lump sums that were subject to taxation during the period of ownership.
- Advance lump sums: Advance lump sums are taxable on the first working day following the close of a calendar year. An advance lump sum is the amount by which the distributions made by the investment fund within a calendar year fall below the annual basic income for that calendar year. The annual basic income is generally calculated by multiplying the redemption price, Rückgabepreis, for the interests or shares at the beginning of the calendar year by 70% and applying the base rate, Basiszins34. The amount of the basic income is limited to the amount by which the last redemption price for the calendar year exceeds the sum of (i) the redemption price at the beginning of the calendar year plus (ii) all distributions paid during the calendar year to the investor. In the year in which the interests or shares are acquired, the advance lump sum is reduced by one-twelfth for each full month preceding the month of acquisition.
For persons that are not residents of Germany, no income tax or C.I.T. liability should arise. Dividends, capital gains, and advance lump sums are regarded as capital income35. Such capital income derived from a fund investment is not subject to income tax or C.I.T. according to the German Income Tax Act.36
Partial tax exemption
Because German investment funds are taxed in Germany, the InvStG 2018 provides for certain partial tax exemptions (Teilfreistellungen) for investors that are subject to German tax on income received from an investment fund. Distributions, capital gains, and advance lump sums may be partially tax-exempt depending on the investment policy of the investment fund and the tax status of the investor37:
- Income realized from equity funds: Equity funds, Aktienfonds, are investment funds for which equity participations in corporations represent more than 50% of the fund value at all times throughout the year38. An investor in a fund that qualifies as an equity fund is entitled to a partial exemption on the income realized from the fund. The exemption is 30% in the case of an individual holding the interests or shares as a private asset, 60% in the case of an individual holding the interests or shares as a business asset, and 80% tax-exempt in the case of an investor that is subject to C.I.T.
- Income realized from mixed funds: Mixed funds, Mischfonds, are investment funds for which equity participations in corporations represent at least 25% of the fund value at all times throughout the year39. An investor in a fund that qualifies as a mixed fund is entitled to a partial exemption on the income realized from the fund. The exemption is allowed at one-half of the percentages applicable to an investor in an equity fund.
- Income realized from real estate funds: Real estate funds, Immobilienfonds, are investment funds for which investments in real estate or real estate companies represent more than 50% of the fund value at all times throughout the year40: If the investment fund qualifies as a real estate fund, a tax exemption of 60% is allowed for all investors. The tax exemption is increased to 80% if investments in foreign real estate or foreign real estate companies represent more than 50% of the fund value throughout the year41.
For G.T.T. purposes, only one-half of the tax-exemption percentages set forth above are allowed42. If an investment fund fails to qualify as an equity fund, mixed fund, or real estate fund – as would be the case for a debt fund – no tax exemption is applicable.
Special investment funds
Taxation of special investment funds
In general, special investment funds are subject to the same tax regime as investment funds. Thus, special investment funds qualify as tax opaque entities and are subject to C.I.T. with respect to income43. Subject to certain exceptions, the tax consequences set forth above generally apply to special investment funds. The exceptions are as follows:
- No tax exemption is applicable at the investment fund level if non-profit organizations and charitable entities are investors in the investment fund.
- Special investment funds may opt for transparent taxation, frequently referred to as the transparency option, Transparenzoption. Income subject to German withholding tax that is derived from participations in German corporations and other German income subject to withholding at source44 may be exempted from tax at the level of the special investment fund if the fund irrevocably declares to the payor that tax certificates should be issued to the investors rather than the special investment fund itself45. In such cases, the investors are generally treated as recipients of the income that is subject to withholding tax at source46. No tax is collected at the level of the special investment fund. Depending on the tax status of the investor, the respective paying agent might not be obliged to withhold tax47.
- With regard to income derived from German sources and not subject to withholding at source (i.e., income derived from real estate), a tax-exemption at the level of the special investment fund is applicable if the fund withholds 15% of the respective income and pays it to the competent German tax authority48.
Taxation of investors in special investment funds
At the level of the investor, the income derived from the investment in the special investment fund is generally treated as capital income, unless the income is subject to withholding at source and is directly allocated to the investor49. As that type of income is not subject to a limited C.I.T. liability when received by persons resident outside of Germany, generally no C.I.T. liability arises in Germany50. In the case of income not subject to withholding at source (i.e., income derived from real estate), no German taxation would take place, as the 15% withholding tax at the fund level would be refunded to the foreign investor because no German tax liability would exist. To prevent this result, such income is re-characterised51 as real estate income or other domestic income within the meaning of Sec. 49 (1) EStG. Income that is subject to withholding tax at source is not re-characterised. In either set of circumstances, the income of the investor is subject to a limited income tax liability in Germany.
In the context of tiered investment funds or special investment funds, income derived from German real estate or other German sources is characterised as real estate income within the meaning of Sec. 6 (4) InvStG 201852. The tax exposure of at the investor level may be summarized as follows:
- Where the upper-tier fund is an investment fund and the lower-tier fund is a special investment fund, the income is subject to C.I.T. at the level of the upper-tier investment fund.
- In comparison, where the upper-tier fund is, itself, a special investment fund, the withholding obligation of the lower-tier special investment fund is suspended. In that case the upper-tier special investment fund takes on the withholding tax obligation for its investors. Those investors are thereby treated as having directly received the real estate income of the lower-tier special investment fund53. This real estate transparency option (Immobilien-Transparenzoption) has the effect of directly allocating the income of the lower-tier special investment fund to the investors in the upper-tier special investment fund. If the investor in the upper-tier special investment fund is another special investment fund, a further real estate transparency option is permitted54.
Without transparency option
As the income within the meaning of Sec. 6 (2) InvStG 2018 is subject to taxation at the level of the special investment fund, no re-characterisation of income occurs at the level of the investors. Thus, with respect to persons that are not German tax residents, no limited C.I.T. liability arises.
For investors who are tax resident in Germany, the income derived from the special investment fund is generally 60% tax-exempt for C.I.T. purposes insofar as the income derives from participation income55. If the investor is subject to C.I.T. in Germany and the special investment fund cannot claim a reduction in the withholding tax rate according to a tax treaty, the tax exemption for C.I.T.-purposes is increased to 100%56.
The treatment of the income for G.T.T purposes is somewhat different. For G.T.T. purposes, such income is generally fully taxable except for income derived from participations in certain corporations57.
Income derived from German real estate or other taxable German sources58 is generally 20% tax-exempt for C.I.T. and G.T.T. purposes59. This tax exemption is increased to 100% for C.I.T. and G.T.T. purposes when (i) the investor is subject to corporate income tax in Germany and (ii) the special investment fund cannot claim a reduction in the withholding tax rate under a tax treaty60. In sum, German real estate income of a special investment fund that has not opted for transparent taxation is generally subject to tax of 15.825% at the level of the special investment fund, whereas a full tax exemption might be applicable at the level of the German investor.
The reform of investment taxation in Germany offers investors and fund providers many tax advantages. The tax burden in Germany can be greatly optimised by means of forward-looking fund structuring that takes into account the respective investors and the intended investments. In particular, the existence of two different taxation concepts offers various possibilities for optimising the position arising under German tax law. Therefore, if an investment in German assets or a sale of fund units to German investors is sought, optimisation of the fund structure from a German tax law perspective is highly recommended.
1 Act on the Reform of Investment Taxation (Gesetz zur Reform der Investmentbesteuerung (Investmentsteuerreformgesetz, herein InvStRefG) (19 July 2016), Federal Law Gazette I, p. 1730 (2016).
2 Act on the Implementation of the Amendments of the E.U. Mutual Assistance Directive and on further measures against profit reductions and shifting (Gesetz zur Umsetzung der Änderungen der EU-Amtshilferichtlinie und von weiteren Maßnahmen gegen Gewinnkürzungen und – verlagerungen), Art. 18 (20 Dec. 2016), Federal Law Gazette I, p. 3000 (2016) and Act on the prevention of tax circumvention (Steuerumgehungsbekämpfungsgesetz, herein StUmgBG), Art. 10 (23 June 2017), Federal Law Gazette I, p. 1682 (2017).
3 Act for the avoidance of V.A.T. losses when trading goods on the Internet and for the amendment of other tax regulations (Gesetzes zur Vermeidung von Umsatzsteuerausfällen beim Handel mit Waren im Internet und zur Änderung weiterer steuerlicher Vorschriften), Art. 15 (11 Dec. 2018), Federal Law Gazette I, p. 2338 (2018).
4 Sec. 1 (2) InvStG 2018
5 Cf. below under Distinction between investment funds and special investment funds.
6 The exceptions include partnerships, which can be qualified as Undertakings for Collective Investments in Transferable Securities or as pension funds within the meaning of Sec. 53 InvStG 2018.
7 Sec. 1 (3) InvStG 2018.
8 Sec. 1 (4) InvStG.
9 Sec. 6 (1) InvStG.
10 Sec. 15 (2), (3) and 26 InvStG 2018.
11 Sec. 26 (1) InvStG 2018.
12 Sec. 26 (2) InvStG 2018.
13 Sec. 26 (3) InvStG 2018.
14 Sec 26 (4) InvStG 2018.
15 Sec. 26 (5) InvStG 2018.
16 Sec. 26 (6) InvStG 2018.
17 Sec. 26 (7) InvStG 2018.
18 Sec. 26 (8) InvStG 2018.
19 Sec. 26 (9) InvStG 2018.
20 Sec. 26 (10) InvStG 2018.
21 Sec. 52 (1) InvStG 2018.
22 Sec. 49 (1) EstG.
23 Sec. 6 (2) InvStG.
24 Sec. 7 (3) InvStG.
25 Sec. 6 (7) InvStG.
26 Sec. 6 (7) InvStG.
27 Sec. 8 (1) InvStG 2018.
28 The tax exemption is granted if the investor holds the shares in the investment fund for at least three months (Sec. 8 (4) no. 1 InvStG 2018) and meets the requirements for withholding taxes according to Sec. 36a EStG (Sec. 8 (4) no. 2 InvStG 2018). Furthermore, the investment fund must file an application for the exemption and provide certain proof with regard to the tax status of the investor and his holding period (Sec. 9 (1) InvStG 2018).
29 Sec. 8 (2) InvStG 2018.
30 Sec. 15 (3) InvStG 2018.
31 Federal Ministry of Finance, InvStG i.d.F. des AIFM-StAnpG; hier Auslegungsfragen zu Sec. 1 Absatz 1b no. 3 InvStG, IV C 1 – S 1980-1/13/10007 :003 (3 Mar. 2015), Federal Tax Gazette I, p. 227 (2015).
32 Federal Ministry of Finance, Investmentsteuergesetz; Anwendungsfragen zum Investmentsteuergesetz in der ab dem 1. Januar 2018 geltenden Fassung, IV C 1 - S 1980-1/16/10010 :001 (21 May 2019), not yet offi-cially published.
33 Sec. 15 (2) s. 2 InvStG 2018.
34 Sec. 18 (4) InvStG.
35 Sec. 20 (1) no. 3 EstG.
36 Sec. 49 (1) EStG.
37 Sec. 20 InvStG 2018.
38 Sec. 2 (6) InvStG 2018.
39 Sec. 2 (7) InvStG 2018.
40 Sec. 2 (9) InvStG 2018.
41 Sec. 20 (3) no. 2 InvStG 2018.
42 Sec. 20 (5) InvStG 2018.
43 Sec. 6 (2) InvStG 2018.
44 Sec. 30 (5) InvStG 2018.
45 Sec. 30 (1) InvStG 2018.
46 Sec. 31 (1) s. 1 InvStG 2018.
47 Depending on whether a tax withholding is suspended according to the provisions of Sec. 44a EStG, which, inter alia, is the case if the investor is a non-profit or charitable entity.
48 Sec. 33 (1) InvStG 2018 in conjunction with Sec 50 InvStG 2018.
49 Sec. 20 (1) no. 3a EstG.
50 Sec. 49 (1) EstG.
51 Sec. 33 (3) and (5) InvStG 2018.
52 Sec. 33 (2) and (4) InvStG 2018.
53 Sec. 33 (2) InvStG 2018.
54 Sec. 33 (2) s. 4 InvStG 2018.
55 Sec. 42 (4) s. 1 InvStG 2018.
56 Sec. 42 (4) s. 2 InvStG 2018.
57 Sec. 26 no. 6 s. 2 InvStG 2018: certain real estate companies, certain public private partnerships and cer-tain renewable energy companies.
58 Sec. 6 (5) InvStG 2018 in conjunction with Sec. 49 (1) EstG.
59 Sec. 42 (5) s. 1 InvStG 2018.
60 Sec. 42 (5) s. 2 and (4) s. 2 InvStG 2018.