Proof of partial investment tax exemptions as part of the tax return - abuse of structuring pursuant to Section 42 AO?

Drafting of the investment conditions in accordance with German tax requirements as a prerequisite for the application of partial exemptions at the level of the German investor

The central element of the new fund taxation is the standardised mitigation of double taxation (fund level and investor level) through the granting of so-called "tax holidays". Partial exemptions at investor level. However, the prerequisite for this is that the fund fulfils the German tax requirements for qualification as an equity, mixed or real estate fund.

In particular, this requires the Investment conditions of the fund be drafted accordingly. Investment limits for "equity investments" and "real estate", each defined according to the understanding of German tax law, must be observed.

Foreign funds in particular, in which German investors often only play a minor role, often do not make the necessary adjustments to the fund documentation to comply with German tax law. As a result, the partial exemptions are not applied at the level of the German investor, which leads to an objectively unjustified disadvantage for these fund investments if the corresponding funds would actually fulfil the requirements of an equity or real estate fund with partial exemption privileges based on their investment activity.

Proof of fund qualification as part of the investor's tax return

The legislator has recognised this and therefore - also out of European law reasons - In addition, the German Investment Tax Act provides for the possibility for investors to provide individual proof of the partial exemption requirements upon application when submitting their tax return. For this purpose, the investor must provide evidence that the investment limits have actually been continuously exceeded (section 20(4) InvStG). The investor may exercise the right to apply for tax exemption for a specific investment period. The investor is not obliged to exercise this option (see also Man, in: Weitmauer et al., KAGB, § 22 InvStG, margin no. 5) nor is there an obligation to provide evidence once it has been provided in the following year.

Rather, the legislator has explicitly provided for the case of a non-application in the following year in section 22 (1) sentence 2 InvStG. As this changes the partial exemption rate, a fictitious sale (and new acquisition) of the fund unit ensures that the hidden reserves/hidden charges in the fund units are properly recognised at the respective partial exemption rate before and after the change in the fund qualification (see in detail Elser, in Beckmann/Scholtz/Vollmer: Investment Handbook, 415 § 22).

Failure to provide evidence in the following year as an abuse of tax planning pursuant to Section 42 AO?

Notwithstanding the clear legal provisions outlined above, the German tax authorities intend to recognise any failure to submit an application in accordance with section 20(4) InvStG as an abuse of tax planning pursuant to section 42 AO and, on this basis, continue to apply the fiction of disposal, i.e. the previous partial exemption rate, if (i) no significant changes in the investment behaviour of the investment fund are apparent, (ii) the investor would still be able to provide evidence in accordance with section 20(4) InvStG with the same or slightly greater effort and (iii) external circumstances indicate that the investor is failing to provide evidence in order to benefit from the change in the partial exemption rate. § 20 para. 4 InvStG with the same or slightly higher effort and (iii) the external circumstances indicate that the investor is failing to provide evidence in order to gain an advantage from the change in the partial exemption rate (see draft InvSt decree, June 2018, margin no. 22.7).

Obviously, the tax authorities are concerned that fund investors in loss-making situations will deliberately not exercise the option to apply so that a realised reduction in value can be taken into account in full, i.e. without a reduction in the amount of the partial exemption. This concern may be understandable, although every tax option is associated with the consequence that the taxpayer exercises it with the aim of optimising their tax burden. If the tax authorities are bothered by this, they must influence the legislator to abolish the option or make it subject to conditions. To abolish an option by administrative means by classifying the exercise or non-exercise of an option as "tax structuring abuse within the meaning of Section 42 AO" goes beyond the scope of the tax law. § However, classifying the exercise or non-exercise of an option as an "abuse of tax planning within the meaning of Section 42 AO" is going in the completely wrong direction.

According to Section 42 (2) AO, an abuse of structuring exists if (i) an inappropriate legal structuring compared to an appropriate structuring (ii) leads to a tax advantage not provided for by law. Exercising an option in the context of the tax declaration is not a legal arrangement, and certainly not an inappropriate one. Moreover, the exercise of a tax option introduced by the legislator can never lead to a tax advantage not provided for by law.

As a result, a clear legal situation, even if it may have undesirable effects from the point of view of the tax authorities, cannot be eliminated by administrative means by ordering an abuse of structuring in accordance with Section 42 AO. The tax authorities should reconsider their legal opinion in this regard before adopting the Investment Tax Decree.

Yours TAXGATE Team will be happy to provide you with further information at any time.

 Dr Thomas Elser is a tax consultant and partner at TAXGATE, a law firm specialising in transactions, investments and tax compliance.