The new investment tax decree has been circulating as a draft version since the end of March 2017 and has been submitted to the associations for comment. The volume of over 50 pages alone shows that there is a huge need for clarification regarding the application of the InvStG from 2018.

An initial analysis shows that the tax authorities are prepared to offer appropriate and practicable solutions for many application issues. The system change as at 1 January 2018 is associated with the introduction of a non-transparent taxation regime for mutual investment funds, whereby taxes can be levied not only at fund level but also on the fund unit holder (cf. Elser/Thiede, NWB E+V 2016, p. 299 ff) and, depending on the type of fund and the utilisation of profits, completely different tax effects arise. In addition to the future independent, partial corporation tax liability of the investment fund, the core of the reform is the case-by-case relief for the investor through partial exemptions as part of the capital gains tax deduction or in the assessment.

The question of when to apply a partial exemption will therefore be of central importance for the effective return on a fund investment in future. An example of this is the partial exemption for equity funds: The partial exemption rate here is 30% for natural persons with shares held as private assets; 60% for shares held by natural persons as business assets and even 80% for corporations as investors. Whether an equity fund exists is therefore a central question of demarcation on the product side, which cannot be so easily derived in all cases from the statutory limit of at least 51% capital participation quota alone. The following points, among others, must be regulated in detail:

  • How is the equity participation ratio determined on an ongoing basis, which active and passive breaches of the limits are harmless with regard to qualification as an equity fund?
  • What is the effect of hedging transactions?
  • How will synthetically replicating funds (e.g. ETFs) be categorised in future?
  • How is the equity participation ratio determined for funds of investment funds?

Shareholding quota

Classification as an equity or mixed fund is initially based on the investment conditions, whereby the quota must be adhered to on an ongoing basis and the fund manager must be required to fulfil the corresponding asset allocation on a sustainable basis. In the event of significant and permanent breaches of the investment conditions, the fund loses its status. However, in certain cases, the BMF allows such "breaches of limits" to be disregarded for tax purposes in the event of short-term breaches of the asset limits. This solution is practicable, as at least unintentional breaches of the asset limits due to changes in value would be harmless. This flexibility is particularly important in the case of hardly foreseeable high price losses. However, the fund manager should then take "possible and reasonable measures" to restore the required ratio. A compliance mechanism should be installed on the KVG side that can provide appropriate documentation in the event of a subsequent external audit.

Hedging transactions

In the opinion of the BMF, hedging transactions are not detrimental to the existence of an equity fund. This follows from the fact that hedging transactions have no effect on the tax burden of income from equity investments. It remains to be seen what effect this will have on product design if there is a strong incentive to obtain the partial exemption for equity funds and funds can ultimately also represent the risks of other asset classes through the composition of equities and hedging transactions.

Synthetically replicating ETF

In the case of exchange-traded index funds, where the index is replicated synthetically via swaps, the BMF believes that equity funds should not qualify. This would be a significant disadvantage for such investments, which is not in line with the system of the law. This is because these investments, which are undoubtedly equity funds in economic terms, are also subject to a prior income tax burden, as ultimately only a dividend reduced by the capital gains tax can be delivered under the swap. It would therefore be welcome if this were taken into account in the further course of the reform implementation and thus economically sensible and extremely successful forms of investment were not arbitrarily penalised. When structuring ETFs, on the other hand, the currently foreseeable legal consequences should be taken into account as a precautionary measure as long as there are no signs of subsequent improvements.

Fund of investment funds

A fund of funds is an investment fund that primarily invests in other investment funds. With regard to the effective tax burden of the fund investment, the question arises as to the conditions under which a fund of funds can claim partial exemptions. According to the current wording of the law, investment units in target equity funds are only regarded as privileged equity investments at the level of the fund of funds up to 51% of their value (even if the target fund invests exclusively in equities, for example). Accordingly, a fund of funds would only benefit from the partial equity exemption if it were itself almost fully invested in equity funds or other equity investments. Even a liquidity reserve would be detrimental. This result is not appropriate, as a tax disadvantage would only arise due to a fund of funds structure.

However, the BMF is expected to soften this strict interpretation, as the investment conditions of the target investment funds can be used for the capital participation ratio of funds of funds. Furthermore, it should not be objectionable if the actual capital participation ratios published on each valuation day are used as a basis for determining the partial exemption requirements for funds of funds. For the managers of funds of funds, this poses the challenge of ongoing monitoring of downstream participation ratios in their target investments in order not to jeopardise possible tax advantages. When structuring funds of funds, investment conditions and target investments should therefore be selected in such a way that the requirements for the partial equity exemption can be met even in the event of fluctuations in value or changes in the equity participation ratios of the target investment funds.

Your Investment Tax Team has comprehensively analysed the new application rules for the reform of investment taxation and is also available to you at any time with experts in investment and supervisory law, both in the implementation of the reform and in fund structuring for institutional and private investors.

Contact person:

Dr Thomas Elser Tobias Stiegler Dr Frank Thiede

Further reading:

  • Elser/ Thiede, BMF opens up the possibility of correcting the punitive taxation of fund investments - Reaction to ECJ (Case C-326/12) - Investors should examine tax reduction options, in: NWB Erben + Vermögen issue 03/2015, p. 104

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