German Inbound-Investments after the introduction of a new German Investment Tax Act
The new German Investment Tax Act („GITA“) which entered into force as from January, 1st 2018 has led to a complete change in the taxation of investment funds with German assets. This holds also true for fund units that were acquired before 2018, since the GITA reform does not provide for comprehensive grandfathering provisions. Under the old GITA, as in force until 2017, investment funds were generally tax transparent vehicles comparable to the most tax regimes in Europe as it can be reviewed by decisions of ECJ (C-303/07, Aberdeen Property Fininvest Alpha Oy, C-338/11 to C-347/11 FIM Santander, C-190/12, Emerging Markets Series of DFA Investment Trust Company). In contrast hereto, under the new GITA, investment funds are treated as tax opaque vehicles which are themselves taxpayers and subject to taxation with certain German source income (e.g., dividends from German corporations, rental income from real estate located in Germany).
Definitive tax burden at the level of the investment fund
Such German tax triggered at the level of the investment fund is not refundable or creditable at unitholder level but is a definitive tax burden that reduces the net asset value of the fund and the investment return that could be paid as distribution to the fund investor. The taxation of the German source income at the level of the fund is completely independent from the composition (legal form, tax residence) of the unitholders. German dividends and German real estate income are at the level of the fund subject to German corporate income tax at a rate of 15%. However, capital gains from the disposal of shares in German corporations are not subject to tax at the level of the investment fund.
No German withholding tax on distributions to foreign fund investors
In order to avoid a double taxation, foreign fund investors are not subject to German limited tax liability with their fund units and distributions to foreign unitholders are therefore not again subject to German taxation. Thus, there is no German withholding tax on distributions to the foreign unitholder. The same is true regarding capital gains from the redemption / sale of the fund units. Foreign fund investors are also not obliged to file a German tax return with respect to their fund units. The only German tax on the German source income is levied at the level of the fund and not again at investor level, irrespective of the jurisdiction in which the investor is tax resident and irrespective of a tax treaty that might be concluded between Germany and such jurisdiction.
Comparison: Direct investment into German assets
From a tax planning perspective, the taxation of fund investments has to be compared with a (fictitious) direct investment of the unit holder in the assets held by the fund. Such German taxation of dividends distributed by a German corporation or German real estate income is very much subject to the tax residence and the legal form (individual, corporate) of the foreign investor. In particular the question, whether Germany has concluded a double tax treaty with such country of residence or whether such country is member state of the European Union is of utmost importance. As the case may be, German source taxation might be reduced or even limited to 0% (e.g., in case of dividends to certain other EU corporations on the basis of the EU parent-subsidiary directive). In other cases (e.g., foreign individual that realizes rental income from German real estate) the German source taxation within a direct investment is subject to progressive income tax rates of up to 47.5% and therefore significantly higher compared to an indirect fund investment. The same holds true in cases where foreign direct investors cannot fulfill substance requirements of the German anti treaty-shopping provision (Sec. 50d para 3 German Income Tax Act) in order to reduce German withholding tax on dividends in the amount of 26.4% compared to the overall tax burden at fund level in the amount of 15%.
Those examples show that the new GITA leads to an overall tax burden on certain German source income that deviates from German tax burden triggered by a direct investment of the foreign investor in German assets. One further example is the taxation of capital gains from the disposal of shares in a German corporation. A non-treaty protected foreign individual that holds a participation of at least 1% in the share capital of a German corporation is subject to up to 28.5% income tax on a capital gain realized upon the disposal of those shares. In contrast, if those shares are held via an investment fund, there is no German tax on such capital gain on fund level and also the distributions to the fund investor can be made without any German taxation.
The German legislator decided to waive the tax transparent treatment of investment funds. Investment funds with German assets are tax opaque as of 2018 onwards and themselves subject to 15% German corporate income tax on certain German source income. This is the overall German tax burden for fund investors with tax residence outside Germany. Such overall tax burden of a fund investment can be significantly lower compared to a direct investment into the German assets. In other cases the direct investment could be beneficial compared to an indirect fund investment. Foreign inbound investors should therefore check their German investments held directly or via an investment fund with a view to the new German fund rules. As the case may be, a reallocation of certain assets might be advisable. Fund managers and investment houses should consider those effects within the structuring of investment schemes with German assets.
Please contact your TAXGATE Team in case of any questions.
Dr Thomas Elser is tax partner at TAXGATE based in Stuttgart and Frankfurt.