Tax Compliance for Domestic and Foreign Private Equity Funds
Interestingly, there are still no explicit legal regulations in Germany on the taxation of domestic private equity funds or with regard to the taxation of domestic taxpayers when they invest in foreign private equity funds. The so-called MoRaKG (“Act to Modernize the Framework Conditions for Equity Investments”) and the German Venture Capital Act (“WKBG”) were tentative attempts to create a legal framework, whereby only some parts of the MoRaKG were implemented and significant elements of the WKBG were declared inadmissible by the EU Commission in Brussels under EU state aid aspects and were therefore not allowed to be implemented.
Thus, the taxation of domestic private equity funds as well as the participation of domestic taxpayers in foreign private equity funds is still based on generally applicable rules and on the basis of the BMF letter on the “Income Tax Treatment of Venture Capital and Private Equity Funds” of December 16, 2003.
Due to the increasing involvement of existing as well as new domestic investors also in foreign PE funds, the requirement for these foreign PE funds in the case of two or more domestic participants to prepare a separate and uniform declaratory statement and to submit it to the competent tax authorities is increasing. In accordance with the statutory regulations, the German investor in a foreign PE fund must generally make its own efforts to ensure that the income can be determined in accordance with German tax laws. To the extent that the investor is not the only shareholder in a foreign PE fund subject to unlimited tax liability in Germany, additional provisions apply.
Thus, taxable income and related tax bases are to be determined “separately”. This has to be done “uniformly” for all parties involved, as far as they are relevant for taxation in Germany. Since neither the management nor the assets of foreign private equity funds are usually located in Germany, the determination of income from foreign private equity funds is made for all participants with unlimited tax liability in Germany vis-à-vis the tax office in whose district a common representative of interests (e.g. trustee or, if applicable, the tax advisor) or the most valuable part of the assets from which the income flows is located.
It is also advisable to commission separate and uniform declarations of assessment for the domestic assessment participants from a German tax advisor right at the beginning of the term of a foreign private equity fund. This approach offers the following advantages in particular for all domestic determination participants and the foreign fund management:
- Uniform qualification of the foreign private equity fund’s income and avoidance of any qualification conflicts,
- identical tax results for all German investors and
- Avoiding that the different tax advisors of the individual German investors approach the finance/management team of the foreign private equity fund with identical or at least similar questions.
The remaining gaps with regard to the preparation of joint tax returns of domestic assessment participants in foreign PE funds will close over time due to the increasing awareness of foreign fund managers, but especially about the tightened reporting requirements for foreign investments.
The intention of the German legislator to achieve comprehensive transparency on the foreign companies of domestic taxpayers is absolutely understandable against the background of the Panama Papers and other discretionary investments abroad identified in recent years. However, the design of the Tax Avoidance Prevention Act is worrying, as it makes it clear that the legislator evidently fundamentally assumes criminal energy with structures involving a third-country company. This general suspicion is both disconcerting and frightening, especially since the globalized world also requires global structures.
With regard to the repatriation of assets from third-country corporations, it is to be hoped that the tax authorities will finally abandon their refusal and, in agreement with the BFH, recognize the possibility of a tax-free repatriation of assets from third-country corporations.
About BLL Braun Liver Finger Ludwig
“Our goal is to develop individual and success-oriented solutions, each of which is geared to client-specific needs, and to solve problems in a goal-oriented manner. We know from experience that in tax, business & corporate law, in addition to professional craftsmanship, fast response times, personal contacts and a network of highly professional experts are crucial. On this basis, we are consciously a specialized team of consultants.
We comprehensively advise and represent national and international private equity funds and their (German) shareholders as well as individuals and companies in the areas of tax advice, business and corporate law.”