Annual Tax Act 2018 - BMF publishes draft bill

On 25 June 2018, the German Federal Ministry of Finance (BMF) published a draft bill for a Annual Tax Act 2018 ("JStG 2018") was published. Among other things, the draft bill also contains important changes in the area of international tax lawthe Investment taxation and the Corporate taxationwhich we summarise briefly below:

• Inbound investments by non-residents in domestic real estate via foreign corporationsAccording to the current legal situation, non-resident taxpayers are liable to tax in Germany on gains from the sale of at least 1% shares in corporations (Section 17 EStG) if the corporation is a company with its registered office or place of management in Germany. The legislator now also wants to include the sale of shares in foreign corporations (e.g. Luxembourg holding companies in the legal form of an SARL) by non-residents for tax purposes if the share value was based directly or indirectly on more than 50% of domestic immovable assets at any time during the 365 days prior to the sale. The following are to be covered by this limited tax liability also under 1% investments in such property companies. In this way, the German tax authorities intend to exercise a taxation right that has already been granted to Germany in some double taxation agreements (e.g. DTA Luxembourg), but which Germany has not yet exercised under national regulations. The new regulation is to be applied for the first time to gains from the sale of shares where the sale took place after 31 December 2018, but only insofar as the gains are based on changes in value that occurred after 31 December 2018. Existing inbound investment structures in German real estate that have been set up with a view to realising tax-free gains on the sale of shares in Germany should be reviewed. In addition, a share and property valuation as at 31 December 2018 will be required in order to take account of the planned transitional regulation. We will analyse the effects of this new regulation as part of our TAXGATE Academy Real Estate Day 2018 which will take place on 5 July 2018 in our Stuttgart office.

• Permissibility of variable compensation payments in the context of a consolidated tax group for income tax purposes for outside shareholders: A profit consolidation for income tax purposes (so-called tax group) requires that the entire profit of the subsidiary (controlled company) is transferred to the parent company (controlling company) on the basis of a profit and loss transfer agreement. A consolidated tax group can be established from a shareholding of more than 50% (voting rights); in this case, however, the outside shareholders usually receive a compensation payment; in the case of a stock corporation, they must receive at least a fixed compensation payment. According to recent supreme court rulings from 2017, variable compensation payments generally prevent the recognition of a consolidated tax group, even if they are granted in addition to a fixed compensation payment, as is still regulated in many profit and loss transfer agreements. The legislator now wants to regulate the possibility of agreeing variable compensation payments without prejudice, whereby these must be agreed and paid in addition to a fixed compensation payment (section 304 para. 2 sentence 1 AktG). Furthermore, the total compensation payments may not exceed the profit share that would have accrued to the outside party without the profit transfer. Finally, the variable compensation payment must be economically justified according to reasonable commercial judgement. The new regulation should also be applied in favour of the taxpayer for assessment periods prior to 2017. Existing equalisation arrangements must nevertheless be reviewed to ensure that they comply with the new regulations. Otherwise, tax groups are at risk of failing retrospectively, with high additional tax payments. Pending objection and, in particular, legal proceedings relating to this issue must be delayed and kept open until the new regulations have come into force. Otherwise, there will be no retroactive preferential treatment. It is currently still unclear what will happen to profit and loss transfer agreements that do not comply exactly with the planned new legal regulation.

• Investment fund investments by controlled companies. Since the reform of the InvStG from 01.01.2018 ("InvStG 2018"), fund investors can benefit from so-called Partial exemptions (section 20 InvStG) on distributions from investment funds. The partial exemption rates differ depending on whether the investor is a corporation or a natural person (business assets or private assets). In the context of a consolidated tax group for income tax purposes, the profits of the controlled company (corporation) are recognised for tax purposes at the level of the controlling company or, if the controlling company is a partnership, at the level of the investors behind the controlling partnership. § Section 15 para. 2a KStG as amended by the JStG 2018 is intended to appropriately regulate that in the case of fund investments by a controlled company, the partial exemptions are not applied when determining the income of the controlled company (so-called gross method), but only when determining the income of the controlling company. The latter is deemed to be the investor for the purposes of taking partial exemptions into account in the tax assessment (section 20 (4) InvStG). If the controlling company is a partnership, the exemption rates are to be taken into account depending on the legal form of its partners (natural person, corporation). The new regulation is to be applied for the first time for the 2019 assessment period.

• Qualification as an equity fund under the InvStG 2018:
  • Previously, in order for an investment fund to qualify as an equity fund, which led to significant partial exemptions on distributions, the so-called advance lump sum pursuant to Section 18 InvStG and gains from the sale of fund units (e.g. 80% for taxable corporations as fund investors), the equity fund had to invest at least 51% of its assets in equity investments (e.g. shares) on an ongoing basis. The legislator has now reduced this requirement and now only requires that "more than 50%" of the assets are invested in equity investments. The amendment, which has already been applied by the tax authorities for foreign investment funds by way of a decree, is intended in particular to take account of the fact that the documentation of foreign investment funds often only provides for a "predominant investment" in shares and to contribute to a standardisation of the application of the law (i.e. also for domestic investment funds). In addition, it is also intended to prevent investors from utilising the previous relief by way of remission only in the event of a gain and claiming a deduction in full in the event of a loss. The new regulation does not result in domestic investment funds having to amend their investment conditions again, as the previous regulation (at least 51% capital participation) fulfils the new requirement all the more.
  • In addition, the legislation clarifies that only the value of the assets held by the investment fund (assets) is used to calculate the equity participation ratio and that the liabilities of the investment fund are not taken into account. The net asset value may only be recognised as assets in the case of funds that are permitted to take out a maximum of 30% in short-term loans (e.g. UCITS funds).
  • The new regulation is intended to apply to income accruing to the investor after the date on which the draft bill was submitted to the Bundesrat by the Federal Government. 

• Relief for funds of funds with regard to partial exemptionsThe InvStG 2018 has so far penalised funds of funds, as shares in target equity funds were only recognised at a flat rate of 51% of the fund unit value when determining the equity participation ratio in accordance with the wording of the law. A fund of funds that only holds, for example, 10% of liquid assets in addition to a target equity fund (100% shares) would therefore not qualify as an equity fund. To resolve this objectively unjustified disadvantage, the tax authorities have already issued a decree (BMF dated 14 June 2017) Simplifications for funds of funds which are now to be codified in law with certain modifications:
  • Actual capital participation rate of the target fund on the valuation dateIn future, an umbrella investment fund will also qualify as an equity fund if it is obliged under its investment conditions to invest in target investment funds in such a way that the equity fund equity participation ratio is achieved on an ongoing basis and the investment conditions stipulate that the umbrella fund shall base this on the actual equity participation ratios published by the target funds on each valuation day (e.g. by a financial information service provider such as WM Datenservice) (direct or indirect investment in equity participations). The same applies to funds of mixed funds (at least 25% equity investments). WM-Datenservice already offers corresponding fields for this, which can be filled in by the target fund and which the fund of funds can access. The prerequisite for this legislative simplification is that the target fund carries out a valuation at least once a week. This is intended to avoid arrangements in which investments are made in target funds that only carry out a valuation once a year, for example, and only show a high equity participation ratio at this time.
  • Higher minimum capital participation ratio in the target fund documentationIn other respects, units in target equity funds are only recognised as equity investments in the amount of 51% of the fund unit value (for target mixed funds in the amount of 25% of the fund unit value, unless the target fund states a higher minimum equity investment percentage than 51% (or 25%) in its investment conditions. In the latter cases, the target investment fund share is deemed to be an equity investment to the extent of this higher percentage. The provision is not designed as an option, as otherwise it would only be utilised in the case of positive investment income. In contrast, the partial exemption is intended by the legislator to be applied uniformly in the case of gains and losses.
  • For property funds of funds the legislator only provides for the aforementioned simplification (higher minimum property ratio in accordance with the target fund documentation). It is not possible to rely on an actual property ratio provided on each valuation date.
  • In practice, it can be assumed that, when selecting their target funds, funds of funds will ensure that the target funds fulfil the requirements for making use of the above-mentioned simplifications. Conversely, many target funds (e.g. equity ETFs) that want to be attractive for funds of funds will also be orientated towards these framework conditions.
  • The new regulation concerning funds of funds is also to apply to income accruing to the investor after the date on which the draft bill was submitted to the Bundesrat by the Federal Government.

• Stricter prevention of abuse through cum/cum transactions with tax-privileged investors: Since the 2016 tax year, Section 36a of the German Income Tax Act (EStG) stipulates that capital gains tax can only be offset against dividends received when shares are sold around the dividend record date if the investor bears a certain minimum risk of a change in value during a holding period of at least 90 days (Avoidance of so-called cum/cum transactions). Certain tax-exempt investors (e.g. charitable foundations) are generally exempt from capital gains tax. By supplementing the provisions on the exemption from capital gains tax deduction, the legislator wants to prevent tax-privileged investors from being used to carry out so-called cum/cum transactions without the restrictions of Section 36a EStG applying. According to the planned new regulations, dividends to tax-privileged investors will initially be subject to 15% capital gains tax if the income exceeds EUR 20,000 and the investor has not been the beneficial owner of the shares for at least one year without interruption. Affected tax-privileged investors can then apply for a refund of the withheld capital gains tax if they can prove to the tax office that they fulfil the requirements of Section 36a EStG with regard to beneficial ownership, minimum holding period and minimum risk of changes in value. The regulation on the imputation restriction is already to be applied for the 2018 assessment period.

Yours TAXGATE team is at your disposal for further information at any time