COVID-19 Coronavirus Business Impact: German Tax Administration Provides COVID-19 Coronavirus Temporary Relief for Investment Restrictions of German and Foreign Investment Funds

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The recent volatility in capital markets during the COVID-19 pandemic has created the risk that investment funds may be passively breaching investment restrictions that apply to them under the German Investment Tax Act.

The German Tax Administration published a Tax Circular on 9 April 2020 outlining some temporary relief from those investment restrictions, for both German and foreign investment funds. The circular confirms that a passive breach of investment thresholds / limitations between 1 March 2020 and 30 April 2020 is generally not considered to be a “substantial breach” of the investment restrictions, and so will not impact the tax exemptions available to German investors in the investment fund.

This update summarizes the partial tax exemptions available to German investors who hold interests in qualifying “equity funds” and “mixed funds” and the relief recently granted by the German Tax Administration to take account of the COVID-19 pandemic.

Partial tax exemptions for qualifying “equity funds” and “mixed funds” under the German Investment Tax Act

The German Investment Tax Act (“InvStG”) provides for certain partial tax exemptions including a reduction of the taxable income German investors generate from their investments in a tax opaque investment fund (Investmentfonds), known as “Chapter 2-Funds”. The exemptions apply where the relevant investment fund qualifies as an “equity fund” (Aktienfonds) or as a “mixed fund” (Mischfonds) under the InvStG. These partial tax exemptions apply to both German and foreign investment funds.

Under the InvStG, an “equity fund1 is an investment fund that invests continuously, according to its investment terms and conditions, more than 50 percent of its assets inequity capital participations”.2 This is referred to as the “equity fund capital participation quota”.3 If an investment fund substantially breaches its investment terms and conditions, and in doing so falls below the “equity fund capital participation quota”, its qualification / status as (tax privileged) “equity fund” ends (section 2 para. 6 sentence 4 InvStG).

Under the InvStG, a “mixed fund4 is an investment fund that invests continuously, according to its investment terms and conditions, at least 25 percent of its assets in equity capital participations (as defined in section 2 para. 7 sentence 1 of the InvStG). This is referred to as the “mixed fund capital participation quota”.5 If an investment fund substantially breaches its investment terms and conditions, and in doing so falls below the “mixed fund capital participation quota”,6 its qualification / status as (tax privileged) “equity fund” ends.7

In this context, “equity capital participations” are generally shares / stocks in a corporation:

  • that are admitted for official trading on a stock exchange or that are listed on an organized market8
  • non-listed shares / stocks in a corporation that is not a Real Estate Company (as defined in the InvStG) and that are domiciled in a:

(i) Member State of the EU or another contracting state of the EEA and that are subject to the taxation of revenues for corporations in that state and are not exempt from that taxation, or

(ii) third country and are subject to the taxation of revenues for corporations with a rate that is at least 15 percent in the third country and are not exempt from that taxation.9

The Circular of the German Ministry of Finance (BMF) dated 21 May 201910 provides guidance and interpretation for determining whether a breach of the investment terms and conditions is considered to be substantial.11 The BMF Circular stated that – for the purpose of simplification of the process – a substantial breach generally does not occur if an equity fund or a mixed fund in a (certain) business year falls below the applicable thresholds (section 2 para. 6 or 7 InvStG) for no more than 20 business days (bank business days) (20 business days limitation).12

Specific tax regime for “Special Investment Funds” under the German Investment Tax Act

The InvStG also provides for a specific semi-transparent tax regime for “Special Investment Funds”,13 known as “Chapter 3- Funds”, within the meaning of section 26 InvStG.

A “Special Investment Fund” is an investment fund that complies with a catalogue of criteria / investment provisions and restrictions listed in section 26 number 1 – 10 InvStG and that does not substantially breach such investment provisions and restrictions in its investment practice.

Circular of the German Ministry of Finance, 9 April 2020 – “COVID-19 relief for investment restrictions of investment funds”

On 9 April 2020, the German Ministry of Finance (BMF) released a circular14 that a passive breach by an investment fund of investment thresholds between 1 March 2020 and 30 April 2020 generally does not constitute a “substantial breach (within the meaning of 2.18 of the BMF Circular dated 21 May, 2019) of the funds’ investment terms and is not included in the calculation of the “20 business days limitation” for purposes of 2.19 of the BMF Circular.

The BMF also stated in its COVID-19 Letter that a passive breach by Special Investment Funds of investment thresholds / limitations between 1 March 2020 and 30 April 2020 is generally not considered as a “substantial breach” of the investment terms and conditions described in section 26 InvStG.

The tax exemptions available to German investors in an investment fund that qualifies as an “equity fund” or a “mixed fund” will therefore still be available despite any passive breach of the applicable investment thresholds during March and April 2020.

Regarding Special Investment Funds any passive breach of the applicable specific investment limitations during March and April 2020 is not harmful with respect to the qualification and tax status as (semi-transparent) Special Investment Fund within the meaning of section 26 InvStG.

Footnotes

1) As defined in section 2 para. 6 sentence 1 of the InvStG

2) Kapitalbeteiligungen

3) Aktienfonds-Kapitalbeteiligungsquote

4) Section 2 para. 7 sentence 1 InvStG

5) Mischfonds-Kapitalbeteiligungsquote

6) Section 2 para. 7 sentence 4 InvStG

7) Section 2 para. 6 sentence 4 InvStG

8) As defined in section 2 para. 8 sentence 1 number 1 of the InvStG

9) Section 2 para. 8 sentence 1 number 2 InvStG

10) BMF Circular addresses questions regarding the application of the German Investment Tax Act in force as of 1 January 2018 (Investmentsteuergesetz; Anwendungsfragen zum Investmentsteuergesetz in der ab dem 1. Januar 2018 geltenden Fassung (InvStG); “BMF Circular”)

11) BMF Circular, 2.18

12) BMF Circular, 2.19

13) Spezial-Investmentfonds

14) Circular on the application of the InvStG to the economic consequences resulting from the COVID-19-pandemic (Investmentsteuerliche Maßnahmen zur Berücksichtigung der wirtschaftlichen Folgen der COVID-19-Pandemie) (“COVID-19 Letter”)

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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