Investment funds on the scrapheap?

The bill in­tro­du­ces dif­fe­rent ta­xa­tion re­gimes for mu­tual funds and spe­cial funds. For mu­tual funds the bill pro­vi­des for a 180 de­gree change in the ru­les go­verning Ger­man and for­eign mu­tual funds. In case the law also pas­ses the Ger­man Lo­wer House the new ru­les are to be ta­ken into con­side­ra­tion ge­ne­rally star­ting from Ja­nu­ary 1, 2018 on­wards.

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Cur­rent fund ta­xa­tion law in Ger­many is ba­sed on the trans­pa­rency prin­ci­ple, which me­ans that in­ves­tors pay ta­xes on in­come from the as­sets held by the fund as if they held those as­sets di­rectly. The fund its­elf is tax ex­empt, and there is only ta­xa­tion at the in­ves­tor le­vel.

The fund ta­xa­tion re­form does away with this pass-th­rough ta­xa­tion. In its place, the bill in­tro­du­ces a 15% cor­po­rate in­come tax on mu­tual funds for do­mestic di­vi­dends, ren­tal in­come, gains on the dis­po­sal of Ger­man real es­tate and other Ger­man source in­come. Tax-ex­empt in­ves­tors such as cha­ri­ta­ble foun­da­ti­ons can ap­ply for a tax ex­emp­tion for the fund. Un­like the si­tua­tion in a di­rect in­vest­ment, gains on the dis­po­sal of Ger­man real es­tate are to be ta­xed if the fund has held the real es­tate for more than 10 years. Howe­ver, chan­ges in the va­lue of real pro­perty un­til De­cem­ber 31, 2017 that had been held for more than 10 years are to be grand­fa­the­red and thus ex­empt from this rule. Re­gar­ding fu­ture va­lue chan­ges the new rule can re­sult in tax di­sad­van­ta­ges for pri­vate in­ves­tors in Ger­man real es­tate funds. If the ob­jec­tive busi­ness pur­pose of the fund is to in­vest in and ma­nage its cash, and it does not ac­tively en­gage in com­mer­cial busi­ness, it will re­main ex­empt from trade tax.

At the in­ves­tor le­vel, dis­tri­bu­ti­ons and gains on sale or re­turn will be ta­xed at the flat-rate wi­th­hol­ding tax, as in­vest­ment in­come for a pri­vate in­ves­tor or as ope­ra­ting in­come for in­vest­ments in busi­ness as­sets. Howe­ver, since funds fre­quently dis­tri­bute very little in­come or none at all, a lump sum tax must be paid in or­der to avoid tax de­fer­ral ef­fects. This re­places the cur­rent ta­xa­tion of deemed dis­tri­bu­ti­ons, which are de­ter­mi­ned and publis­hed by the funds. The lump sum tax is ba­sed on the risk-free mar­ket in­te­rest rate and is cal­cu­la­ted using a sim­ple for­mula. In or­der to avoid dou­ble ta­xa­tion, any lump sum ta­xes al­re­ady paid du­ring the ow­nership of units in the fund are off­set against the gain from the sale or re­turn of the fund units.

The cor­po­rate in­come ta­xa­tion at the fund le­vel, the wi­th­hol­ding tax on the fund’s for­eign in­come, and the tax ex­emp­tion of cer­tain in­come when an in­vest­ment is held di­rectly are to be ta­ken into ac­count th­rough a par­tial ex­emp­tion of the ta­xable in­come. This ex­emp­tion will de­pend on the in­vest­ment fo­cus of the fund. For pri­vate in­ves­tors, it amounts to 30% for equi­ties funds that con­ti­nue to in­vest at least 51% of their va­lue in sha­res, and 15% for blen­ded funds (at least 25% of the va­lue in­ves­ted in sha­res). Real es­tate funds that con­ti­nue to in­vest at least 51% of their va­lue in real es­tate are en­tit­led to a par­tial ex­emp­tion in the amount of 60% or 80% when they in­vest so­lely in for­eign real es­tate. If the fund units are held as a part of ope­ra­ting as­sets, the par­tial ex­emp­tion ra­tes for equi­ties and blen­ded funds ap­ply to the per­so­nal or cor­po­rate in­come tax. Only half of the par­tial ex­emp­ti­ons are ap­plica­ble for trade tax pur­po­ses.

The new ru­les are to take ef­fect on Ja­nu­ary 1, 2018. A fic­ti­tious sale-and-purchase is pro­vi­ded for at the in­ves­tor le­vel, pur­su­ant to which exis­ting units in in­vest­ment funds will be deemed to be sold at the last re­purchase price de­ter­mi­ned in ca­len­dar year 2017 as of De­cem­ber 31, 2017 and then re­purchased on Ja­nu­ary 1, 2018. If this re­sults in a ta­xable gain, in­ves­tors will not pay tax on the gain un­til they ac­tually sell their units. If the in­ves­tor ac­qui­red the units be­fore Ja­nu­ary 1, 2009 and could have sold them tax-free un­der the cur­rent laws, va­lue chan­ges ge­ne­ra­ted as of Ja­nu­ary 1, 2018 will be gran­ted a €100,000 ex­emp­tion when the units are sold.

In many ca­ses the re­form will li­kely re­sult in a hig­her tax bur­den. Cri­tics on the pro­po­sed bill have par­ti­ally re­sul­ted in amend­ments of the now enac­ted bill. But even if the tax re­gime be­co­mes more bur­den­some, re­tail funds will li­kely re­main a re­ason­able in­vest­ment al­ter­na­tive be­cause of the pos­si­ble risk di­ver­si­fi­ca­tion, es­pe­cially as in­te­rest ra­tes re­main low. The ru­les for spe­cial in­vest­ment funds will con­ti­nue un­der the same semi-trans­pa­rent re­gime as be­fore.