Foreign hedge funds have not typically been acquired directly by German investors to date. This was due in particular to the fact that these funds were often categorised as "black" funds with a lack of tax transparency due to the lack of publication of the German tax bases in accordance with Section 5 InvStG. The investor was subject to punitive taxation in accordance with Section 6 InvStG, which had the character of substance taxation due to a fictitious minimum assessment basis of 6% p.a. (cf. on this and the ECJ case law issued in this regard Elser/Thiede, NWB-EV issue 3/2015, p. 104). Institutional investors who did not want to do without this asset class had to utilise complex access structures or packaging solutions in order to be able to invest in hedge funds without incurring tax liability.
From 2018, such arrangements will no longer be necessary. According to the Investment Tax Reform Act (InvStRefG) of 19 July 2016, German investors are no longer reliant on foreign funds to determine, disclose and publish German tax bases. The new investment taxation only covers distributions from the fund and gains from the sale of the fund unit at the investor level, i.e. the fund income side or the determination of the fund's income (in accordance with German tax principles) is no longer relevant. In addition to the payments received from the fund at investor level, an annual advance lump sum is also taxed at investor level in the case of reinvestments - to counteract deferral advantages (cf. in detail Elser/Thiede, NWB-EV issue 9/2016, p. 299). Investors therefore only need four pieces of information for their tax return: (i) the amount of the distribution, (ii) the fund unit value at the beginning of the calendar year, (iii) the fund unit value at the end of the calendar year and (iv) the qualification of a fund as an equity, mixed, property or other fund. This information is comparatively easy to obtain. In future, it will therefore be much easier to invest in foreign funds that were previously classified as non-transparent and that do not provide a German basis of taxation. The declaratory, time-consuming treatment of so-called distribution-equivalent income for accumulating foreign investment funds will also become superfluous in future.
This opens up much broader investment opportunities for German investors to invest in funds that previously qualified as non-transparent from a tax perspective and for this reason alone were often not even part of the investment universe available to asset managers. This applies in particular to US hedge funds, whose management has typically shown no willingness to prepare German tax reporting.
If the previously non-transparent fund also qualifies as an equity fund within the meaning of the InvStG as amended under the new rules, attractive partial exemptions will also apply at investor level. For private investors, 30% of income from equity funds (distributions, gains from the sale of fund units, advance lump sum) is tax-free; for corporations as investors, as much as 80% of income is tax-free. However, classification as an equity fund requires that at least 51% of the fund assets are continuously invested in equity investments in accordance with the fund's investment conditions. Many hedge funds will already fail to provide such proof, as the documentation of a hedge fund typically does not provide for any restrictions for the fund management in this regard. In the event that the investment conditions of an investment fund do not contain sufficient information on exceeding the thresholds, the investor can prove that the investment fund actually exceeded the investment limits continuously during the financial year (section 20 (4) InvStG as amended). However, this presents investors with the same old problems: they will not be able to provide this evidence due to the lack of information provided by the fund management.
Another obstacle is the current wording of the law, according to which a fund only qualifies as an equity fund if it physically invests in shares or other equity investments. For those hedge funds that invest in derivatives, futures, etc. in addition to equities, the partial equity exemption is therefore likely to be difficult to achieve. However, the same also applies to pure equity funds that only invest in a synthetically replicating manner (e.g. swap ETFs). However, the discrimination against these funds, which invest by means of derivatives with equity underlying, is not appropriate; it is to be hoped that the legislator will make improvements here or at least remove the discrimination by way of a decree.
An in-depth insight into the changed tax framework for the acquisition of different types of funds and the resulting consequences for a tax-optimised product design is offered by the WM seminar "Tax-efficient fund products and tax reporting under the new investment tax law" 27 September 2016 in Frankfurt am Main
Dr Thomas Elser is a tax consultant at TAXGATE, a tax law firm specialising in transactions, investments and tax compliance.
