Formal Tax Compliance for Domestic and Foreign Private Equity Funds
The trend already outlined by me in the FYB Financial Yearbook 2010, namely that the tax authorities are increasingly approaching individual German investors and requesting them to submit a separate and uniform declaratory statement, has accelerated. In our daily consulting practice, we have noticed a considerable increase in such requests, in which the tax authorities have also started to inform the investor about the other German investors known to the tax authorities and to request the submission of a joint tax returnwith reference to the relevant legal provisions in the German Tax Code.
Domestic investors generally show an increased interest in systematically working through this issue, as there have been repeated cases of qualification conflicts in various foreign private equity funds in recent times, in which private investors have classified the income as asset management income, while institutional investors (sometimes in parallel) have treated this income as business income due to diverging tax interests.
The coordination process between the various domestic investors is time-consuming and in some cases also laborious, since this conflict of interest is in the nature of the different tax objectives, the investors may only learn about each other many years after the closing of the fund and the first tax return filed, and the various investor groups are reluctant to deviate from their own qualifications (which are sometimes also supported by corresponding expert opinions). — The royal road out of this qualification dilemma remains the commissioning of the preparation of the tax return for the German determination participants by the management team of the foreign private equity fund, as this avoids the coordination and reconciliation problems described above.
Due to the further BMF letter issued in spring 2010 on the reporting obligation of foreign shareholdings, we had dealt intensively with the effects and the problems in the practical implementation for private equity companies in the FYB Financial Yearbook 2011. At the same time, we contacted the highest authorities of the federal and state tax authorities in order to work out viable solutions for the reporting obligations of foreign shareholdings, in particular for the private equity industry, and to define these solutions together with the tax authorities.
In the course of lively and interdepartmental discussions, initial partial successes have been achieved so far, at least at the Bavarian level, since, on the initiative of the Bavarian Ministry of Finance, the reporting deadline for foreign shareholdings in the draft Tax Simplification Act 2011 was not to end until five months after the end of the calendar year in which the reportable event occurred. It was learned from government circles that the undisputed parts of this legislative package are to be codified by the end of the year.
In addition, a number of key points have still not been clarified, with regard to which we have now approached Mr. Fahrenschon, the Bavarian Minister of Finance, directly for further coordination and clarification. Fahrenschon is known as a committed supporter of the private equity industry. We assume that this topic will be taken up again after the political summer break and that we will hopefully be able to present a practicable reporting system in the near future.
With FATCA (Foreign Account Tax Compliance Act), the US tax authority IRS (Internal Revenue Service) intervenes directly in all transactions with US sources. Accordingly, in the future, among other things, all private equity funds that receive returns from U.S. sources must register with the IRS or enter into a “contract” with the IRS and report the U.S. persons involved as well as certain related data or submit a corresponding negative declaration. Otherwise, a 30% penalty tax will be withheld on reflows (i.e. not only income, but now also sales proceeds in addition to interest and dividends) from the USA. According to current knowledge, this “penalty withholding tax” cannot be refunded even after the fact. In this respect, there would then be a definitive taxation, which would affect all shareholders of the respective private equity fund, regardless of whether US taxpayers are involved or not. — Regarding details of regulation and in particular the requirements to avoid punitive taxation, I refer to the relevant article in the upcoming FYB Financial Yearbook 2012.