3 questions to smart minds

Tax Compliance for Domestic and Foreign Private Equity Funds

For this 3 questions to Dr. Christoph Ludwig

BLL Brown Liver Finger Ludwig
Photo: Dr. Chris­toph Ludwig
21. Decem­ber 2017

The econo­mic succes­ses and attrac­tive return oppor­tu­ni­ties in private equity (PE) invest­ments combi­ned with the extre­mely low inte­rest rates on the capi­tal markets, which have been close to zero for years, are moti­vat­ing nume­rous long-stan­­ding PE inves­tors incre­asingly as well as newco­mers for the first time to broa­den their invest­ment focus and make commit­ments in dome­stic and foreign private equity funds. The taxa­tion of PE funds is not yet clearly regu­la­ted. You can read the detailed author’s article by Dr. Chris­toph Ludwig and Thomas Unger, both part­ners at BLL in Munich, on this highly topi­cal subject in the new FYB 2018 issue (from p. 22).

For this 3 ques­ti­ons to Tax consul­tant and part­ner at BLL Braun Leber­fin­ger Ludwig, Munich

1. What tax issues do inves­tors in dome­stic and foreign PE funds need to be aware of?

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.

2. Can you please tell us about key aspects of formal tax compli­ance from practice?

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.

3. How do you assess the further development?

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.”

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