Would a private equity fund vehicle formed in your jurisdiction be subject to taxation there with respect to its income or gains? Would the fund be required to withhold taxes with respect to distributions to investors? Please describe what conditions, if any, apply to a private equity fund to qualify for applicable tax exemptions.
For funds in the form of a partnership (eg, KG), the general rules of taxation are applicable (ie, the special tax regime for corporate funds under the German Investment Tax Act, see below, is not applicable). Therefore, if the fund is structured as a partnership that is not engaged in trade or business, it is neither subject to German income tax nor German trade tax (ie, the partnership is treated as ‘transparent’ for tax purposes). Any income derived by the partnership is immediately allocated to its partners and taxed at the level of the partners in accordance with the rules of the tax regime applicable to the respective partner. On the other hand, if the fund vehicle qualifies as engaged in a trade or business, the fund itself is still not subject to German income tax, but it is subject to German trade tax.
There are no withholding tax implications at the level of the partnership itself. Withholding tax implications can arise from the underlying investments made by the fund.
Funds in the form of a corporation or of a contractual type are covered by the Investment Tax Act (investment funds). Under the opaque regime, the fund is subject to taxation in respect to certain domestic German income (in particular, dividends and real estate income, but not capital gains from the sale of securities unrelated to real estate and unrelated to a permanent establishment in Germany) at fund level (15 per cent tax rate (ie, German corporate tax)). The exemption for dividends (section 8b of the German Corporation Tax Act) is not applicable at fund level even if the relevant threshold (ie, 10 per cent) is exceeded. In addition, German trade tax may be triggered at fund level if it is engaged in trade or business in Germany (subject to a potential exemption if the fund does not engage in ‘active entrepreneurial management’ in relation to its assets).
Investment funds are required to withhold tax for the taxable income of their (domestic) investors, but not for the income from the sale of fund units.
In general, there are no tax exemptions at the level of the investment fund. In return, at the level of the investor investment fund proceeds are subject to partial exemptions depending on the respective fund type (equity fund, mixed fund or real estate fund).
At the investor level, there is a lump-sum taxation for investment fund proceeds (ie, distributions, predetermined tax bases and capital gains from dispositions or redemptions). For individual investors, the actual rate of investor level taxation depends on whether the investor holds the fund interests as part of their non-business or business assets. For individuals that hold their investment fund interests as part of their non-business assets, such items are subject to flat income tax. For individuals that hold their investment fund interests as part of their business assets, principally, the full amount of such items is subject to income tax at their personal rate. For corporate investors, the full amount of such items is subject to corporation tax. In addition, German trade tax may be triggered. The partial income taxation and the exemption pursuant to section 8b of the German Corporation Tax Act do not apply. In return, investment fund proceeds are subject to partial exemptions depending on the respective fund type. With respect to equity funds, the partial exemption is:
- 30 per cent of such proceeds for individuals that hold their investment fund interests as part of their non-business assets;
- 60 per cent for individuals that hold their investment fund interests as part of their business assets; and
- 80 per cent for corporate investors.
With respect to mixed funds, half of the applicable partial exemption rate applicable to equity funds is available. With respect to real estate funds, the partial exemption is 60 or 80 per cent of the proceeds, depending on whether the fund invests at least 51 per cent of its value in German or non-German real estate and real estate companies. In return, income-related expenses and operating expenses may not be deducted to the extent of the available partial exemption percentage. With regard to trade tax, half of the applicable partial exemption rate applies.
In addition, if the investment fund qualifies as a specialised investment fund, the fund may opt to be treated transparently for tax purposes. As a result, the fund itself would not be subject of taxation.Local taxation of non-resident investors
Would non-resident investors in a private equity fund be subject to taxation or return-filing requirements in your jurisdiction?
In general, non-resident investors of a private equity fund structured as a partnership will be subject to taxes in Germany pursuant to the German general tax rules for non-residents. If the fund is structured as a partnership having asset management status (ie, is not deemed to be in business and not engaged in business activities for German tax purposes), non-resident investors are generally (if holding less than 1 per cent indirect share in such portfolio company) not taxed on capital gains realised by the fund from the sale of a portfolio company and they are not required to file tax returns in Germany. However, income of non-resident investors might be subject to the German withholding tax (eg, with regard to dividend distributions from a portfolio corporation held by the private equity fund). A refund, an exemption or a reduction of withholding tax may depend on certain filing procedures. This may also apply with regard to certain double taxation treaties.
The distributions to a non-resident investor of an investment fund will not be taxable in Germany and will not be subject to withholding tax. As a result, non-resident investors who make German investments via (domestic or foreign) investment funds only have to bear a German tax burden, as far as there is a taxation at fund level (fund input side). The German non-taxation of distributions to non-resident investors (fund output side) is completely independent of which assets the fund holds, in which country the investor is domiciled and whether there a double taxation agreement is applicable.Local tax authority ruling
Is it necessary or desirable to obtain a ruling from local tax authorities with respect to the tax treatment of a private equity fund vehicle formed in your jurisdiction? Are there any special tax rules relating to investors that are residents of your jurisdiction?
It is desirable to obtain a binding ruling from the local tax authorities on the tax classification of the fund to increase the level of comfort of both investors (including foreign investors) and fund managers as the tax status may not be clear (also depending on the investment strategy). If the fund is structured as a partnership, an advanced tax ruling should ideally ensure that the asset management criteria are met from the point of view of the tax administration. For investment funds under the German Investment Tax Act that want to be taxed transparently, it may be desirable to obtain a binding ruling to ensure that the criteria for a specialised investment fund are fulfilled. In certain cases, rulings regarding VAT treatment can be obtained.
There is no special treatment of income from a fund in the form of a partnership. The income is taxed at the level of German-resident investors in accordance with the general rules applicable to the respective investor and the respective type of income. Domestic and foreign investors of investment funds are formally treated equally. However, the partial exemption rates provided in the German Investment Tax Act only benefit German investors, because foreign investors are generally not subject to any tax obligation in Germany at the level of the investment fund investor.Organisational taxes
Must any significant organisational taxes be paid with respect to private equity funds organised in your jurisdiction?
There are no significant organisational taxes (including no stamp duties) required to be paid with respect to private equity funds organised in Germany.Special tax considerations
Please describe briefly what special tax considerations, if any, apply with respect to a private equity fund’s sponsor.
The carried interest of a sponsor of an asset managing (ie, non-trading) private equity fund is not subject to German trade tax. In addition, there is a 40 per cent income tax exemption, resulting in an effective rate of income tax of around 28.5 per cent, if certain cumulative criteria are fulfilled (in particular, the fund must qualify for asset management status and the carried interest must be paid only after the investors have had all their invested capital paid back). Otherwise, such income is generally fully taxable at normal German income tax rates.
In general, the management fee payable to the managing partner of a fund was subject to the German VAT until end of 2017 (regardless of whether such management fee is structured as a priority profit share). According to the revised German VAT Act as of 2018, the management of UCITS and of certain AIFs that are comparable to UCITS, are exempt from VAT. The German VAT Act does not stipulate which types of AIF are comparable to UCITS. The German tax authorities have established criteria that must be fulfilled in order to benefit from the VAT exemption (eg, the AIF has to offer shares to the same group of investors and be subject to similar obligations and controls as UCITS). In addition, it was clarified that open-ended special AIF will be exempt from VAT without fulfilling the established criteria, whereas the administration of closed-ended AIF will only be exempt from VAT if certain previously established criteria were cumulatively met.Tax treaties
Please list any relevant tax treaties to which your jurisdiction is a party and how such treaties apply to the fund vehicle.
Germany has signed tax treaties with most OECD states and with many other states. Because of tax transparency, such treaties generally do not apply to a fund structured as a partnership, but directly to its partners. For the specific taxation under a tax treaty, it may be relevant whether the fund qualifies as a commercial or asset-managing partnership and if there is any permanent establishment. If the fund vehicle is structured as a corporation, such tax treaties generally apply to the corporate fund itself. However, each case must be carefully assessed for tax consequences arising from the applicable treaty and the relevant rules in each jurisdiction (eg, whether there is an applicable treaty override).Other significant tax issues
Are there any other significant tax issues relating to private equity funds organised in your jurisdiction?
Depending on the structure of the fund and its assets, different German tax regimes apply. The structure of the specific investment may have far-reaching tax consequences at the fund level, but also at the investor level (eg, the structure may be relevant for the question whether the income of a foreign investor in a German is taxable (and subject to German tax filings), subject to withholding tax or whether double taxation treaties apply). The German tax landscape is complex and subject to constant change. Thus consulting experienced tax counsel regarding the establishment and investment activities of the fund as well as fund investments by investors is highly recommended.