Section 42(3) of the Investment Income Tax Act (InvStG): The prior liability test as a bottleneck for alternative investments in special investment funds

The Location Promotion Act (StoFöG) has opened up the German special investment fund regime to alternative investments – yet in practice, Section 42(3) of the Investment Tax Act (InvStG) (tax pre-burden) is proving to be a key bottleneck. This article examines the issues of interpretation and evidence relating to the prior tax burden test in the context of structuring practice and sets out two demands: legislative parity between fund investments and direct investments, and an amendment to the Investment Tax Decree to include practical rules on evidence.

Background: StoFöG launches the special investment fund – the prior exposure test remains in place

Mit dem am 9. Februar 2026 verkündeten Standortfördergesetz (BGBl. 2026 I Nr. 33) dürfen sich offene inländische Spezial-AIF mit festen Anlagebedingungen nach § 26 Nr. 4 Buchst. h InvStG nunmehr grundsätzlich unbeschränkt an Alternativen Investmentvermögen beteiligen – insbesondere an geschlossenen Private-Equity-, Infrastruktur-, Venture-Capital- und Darlehensfonds in der Rechtsform in- oder ausländischer Personengesellschaften. Die frühere 10-%-Schmutzgrenze ist entfallen (vgl. hierzu bereits unseren Blog „Regional Development Act: New tax incentives for specialist investment funds in alternative investments“).

The special investment fund (Chapter 3 of the InvStG) thus becomes, for the first time, a viable vehicle for pooling private equity programmes by institutional investors, such as banks, pension funds or family offices. However, when it comes to the actual structuring work, it becomes clear that the decisive factor determining tax attractiveness lies not in the investment terms, but in Section 42(3) of the InvStG.

The prior liability test under Section 42(3) of the Investment Income Tax Act: Mechanics and economic significance

Bei körperschaftsteuerpflichtigen Anlegern bleiben Dividenden und Veräußerungsgewinne aus Kapitalgesellschaftsbeteiligungen, die über einen Spezial-Investmentfonds vereinnahmt werden, im Grundsatz nach § 8b KStG zu 95 % steuerfrei (§ 42 Abs. 2 InvStG). § 42 Abs. 3 InvStG versagt diese Begünstigung jedoch, soweit die Erträge aus einer steuerlich nicht vorbelasteten Körperschaft, Personenvereinigung oder Vermögensmasse stammen.

Section 42(3) of the Investment Income Tax Act

„Paragraphs 1 and 2 shall not apply where the income in question is investment income within the meaning of section 43(1), first sentence, items 6 and 9, and the second sentence of the Income Tax Act, derived from a corporation, association of persons or estate that has not previously been subject to tax. Corporations, associations of persons or pools of assets that are not subject to income tax, are personally exempt from income tax, or are objectively exempt from income tax to the extent that they make distributions. Sentence 1 shall not apply to pre-taxed REIT dividends pursuant to Section 19a of the REIT Act.“

Die Rechtsfolge wirkt ertragsbezogen („soweit“): Betroffen ist jeweils nur der einzelne Ertrag aus der nicht vorbelasteten Körperschaft; dieser unterliegt dann aber der vollen Körperschaft- und Gewerbesteuerbelastung von rund 30 % statt einer effektiven Belastung von rund 1,5 %. Bei Private-Equity-Strukturen ist regelmäßig die erste Kapitalgesellschaft unterhalb des transparenten Zielfonds maßgeblich, also die Akquisitions-Holding als Exit-Objekt. In der Direktanlage existiert dieser Test nicht: Wer dieselbe Beteiligung unmittelbar oder über eine transparente Fondspersonengesellschaft hält, erhält § 8b KStG ohne Vorbelastungsprüfung.

Questions of interpretation: What does „not subject to prior tax liability“ mean?

Section 42(3), second sentence, of the Investment Income Tax Act (InvStG) sets out three alternative categories. The test is an abstract status test – according to the wording, neither a minimum tax rate nor an effective tax burden is relevant:

Für die Praxis besonders bedeutsam ist die letzte Kategorie: Nach zutreffender Auffassung in der Kommentarliteratur genügt die abstrakte Steuerpflicht der Körperschaft; tatsächliche Steuerzahlungen sind ebenso wenig erforderlich wie eine Besteuerung gerade im Ansässigkeitsstaat. Nicht ausschüttungsabhängige sachliche Steuerbefreiungen – etwa typische Beteiligungsertragsbefreiungen (wie z. B. in Deutschland gem. § 8b KStG) – sind unschädlich, und zwar auch dann, wenn die Gesellschaft ausschließlich oder fast ausschließlich sachlich steuerbefreite Einkünfte erzielt, wie dies bei ausländischen Holdinggesellschaften (z. B. Lux SARL/Soparfi) typisch ist (vgl. Bindl/Stadler in Beckmann/Scholtz/Vollmer, Investment, § 42 InvStG Rz. 29; Link in Herrmann/Heuer/Raupach, EStG KStG, § 42 InvStG). Die für europäische Buyout-Strukturen typischen Akquisitions-Holdings sind danach regelmäßig vorbelastet. Eine gesicherte Verwaltungsauffassung hierzu fehlt allerdings bislang.

The real practical problem: reporting and ongoing recording in the fund’s share profit

In the case of private equity fund-of-funds, the audit workload increases exponentially: ten to fifteen target funds, each with ten to twenty portfolio companies, quickly add up to 150 to 300 holding companies per fund-of-funds commitment – a portfolio that fluctuates continuously over the life of the fund. The burden of proof regarding prior tax liability rests with the investor, coupled with an increased duty to cooperate in relation to foreign matters (Section 90(2) of the German Fiscal Code (AO)). At the same time, the investor has no contractual relationship with the entities below the fund of funds: the necessary information is held solely by the general partner of the fund of funds and by the target funds.

In addition, there is a formal prerequisite for its application that is often overlooked in the discussion: Under section 48(2), first sentence, of the InvStG, the tax exemption under section 42(1) to (3) of the InvStG applies only if the special investment fund calculates and discloses the fund’s share profit – or if the investor provides evidence of it. Pursuant to section 48(1) of the InvStG, this calculation must be carried out at each valuation of the fund’s assets – i.e. on each valuation day – as an absolute value in euros per unit. As the fund’s share profit reflects only the income and changes in value eligible for relief under Section 42(1) and (2) of the InvStG, the pre-tax classification under Section 42(3) of the InvStG must be incorporated into this calculation on an ongoing basis – for each valuation date and each equity investment – be incorporated into this calculation. This substantive documentation issue thus has a procedural counterpart in fund administration: private equity holdings are typically valued only quarterly and with a considerable time lag, whilst the fund management company must update the share profit on each valuation date. The law does not specify how to deal with delayed reporting from target funds, interim exits and retrospective reclassifications.

Need for reform I: Legislative equivalence between fund investments and direct investments

§ 42 Abs. 3 InvStG führt zu einer strukturellen Schlechterstellung der Fondsanlage gegenüber der Direktanlage: Dieselben Exit-Gewinne, die im Direktbestand über § 8b KStG ohne jede Vorbelastungsprüfung zu 95 % steuerfrei bleiben, unterliegen im Spezial-Investmentfonds einem Statustest mit erheblichen Nachweislasten. Diese Ungleichbehandlung ist steuersystematisch bedenklich, denn sie widerspricht dem Grundsatz der Entscheidungsneutralität der Besteuerung (so ausdrücklich auch Bindl/Stadler in Beckmann/Scholtz/Vollmer, Investment, § 42 InvStG Rz. 33).

It also runs counter to the stated aim of the Location Promotion Act: It makes no sense to use the StoFöG to create new opportunities for Germany as a fund location in terms of investment conditions – whilst at the same time erecting objectively unjustified barriers in terms of tax consequences that do not exist in direct investment, which is functionally identical. Anyone wishing to promote fund investment must not treat it less favourably for tax purposes than direct investment. We therefore advocate that Section 42( 3 of the Investment Income Tax Act (InvStG) to be reviewed as part of the next amendment and for fund investment to be placed on an equal footing with direct investment – for example, by aligning it with the framework of Section 8b of the Corporation Tax Act (KStG) or, at the very least, by restricting the provision to specific arrangements involving untaxed vehicles.

Need for Reform II: Amending the Investment Tax Exemption to include practical rules on providing evidence

Irrespective of any legislative solution, the tax authorities should ensure legal certainty in the short term. The Investment Tax Ruling (BMF letter of 21 May 2019, as amended by supplementary letters) has so far only clarified Section 42(3) of the Investment Tax Act (InvStG) in specific instances, primarily in relation to REITs. There is a complete lack of guidance on the key issues in the practice of alternative investments. It would be desirable to supplement the relief, in particular with the following points:

• Clarification of the constituent elements of the offence: Bestätigung, dass die abstrakte Ertragsteuerpflicht genügt und dass nicht ausschüttungsabhängige sachliche Befreiungen (Schachtelprivilegien, Participation Exemptions) unschädlich sind.
• Positive/negative list: A (non-exhaustive) list of typical legal forms and regimes – pre-determined / non-pre-determined / case-by-case – would considerably simplify the classification of hundreds of holding companies and reduce the number of contentious individual assessments.
• Standardised list of supporting documents: Festlegung, welche Unterlagen in Zweifelsfällen den Nachweis der Vorbelastung erbringen (z. B. Ansässigkeitsbescheinigung, Statuten bzw. Registerauszug, lokale Veranlagungsnachweise) und in welchen Fällen strukturierte Bestätigungen des Fondsmanagers oder eines Tax-Reporting-Dienstleisters ausreichen.
• Simplification and materiality rules: Limiting the requirement for full evidence to holdings relevant to exit or distribution, and protecting legitimate expectations in the case of plausible, documented manager confirmations – combined with a clear default rule for cases where clarification is not possible.
• Simplifications in the calculation of share profits (Section 48 of the Investment Income Tax Act): Practical rules for determining the fund’s share profit on the valuation date for illiquid private equity holdings – such as updating figures based on the most recent available target fund reporting, with adjustments made as new valuations become known, as well as clarifications regarding the treatment of prior-period classifications and subsequent reclassifications within the share profit.
• Blind pool arrangements: Guidance on the treatment of new subscriptions, where the future ownership structures are, by their very nature, not yet determined, including the interplay with the binding information requirement under Section 89(2) of the German Fiscal Code (AO).

Conclusion and recommendation for action

The Location Promotion Act has opened the way for special investment funds to make alternative investments – Section 42(3) of the Investment Fund Act (InvStG) determines whether this route is actually taken in practice. Pending the legal equalisation of fund investments and direct investments, or an amendment to the legislation, the following applies: Anyone wishing to bundle private equity programmes within a special investment fund should quantify the pre-existing exposure for each target fund programme prior to subscription, based on the jurisdictional profile of the investment structures; make reliable reporting commitments from the fund manager a condition of subscription; clarify the administrability of the fund’s share gains (Section 48 of the Investment Income Tax Act) with the capital management company at an early stage, and obtain binding guidance to resolve any outstanding questions of interpretation. Whether the fund solution is more cost-effective than a direct investment is always a matter to be assessed on a case-by-case basis and should be examined in a structured manner in advance.