Inbound Investments
Luxembourg FCP and treaty entitlement
What is it about:
The revised version of the DTA Luxembourg/Germany with effect from 1 January 2024 stipulates that a Luxembourg FCP is entitled to treaty benefits in Germany. The DTA presumes both the residency of the FCP and its status as a beneficial owner of the income.
Practical effects:
The revised provisions are particularly relevant for certain German sourced income being subject to limited tax liability, such as interest from real estate secured loans or income from deemed commercial partnerships. While this income of the FCP has typically been taxable in Germany up to now, the new regulation should, as a rule, no longer result in a German right of taxation.
In addition, the DTA provisions may also have an impact on the reimbursement of capital gains tax on German dividends, for example, if more than 15% was withheld and the deadline for reimbursement under Sec. 11 of the German Investment Tax Act (“GInvTA”) (i.e., 2 years) has expired. This is because the DTA also provides for a restriction of German withholding tax to 15% but, in contrast to Sec. 11 GInvTA, grants an application period of 4 years.
Who is affected:
Fund and asset managers of Luxembourg FCPs with German sourced income being subject to limited tax liability in Germany.
Recommendation for action:
Fund and asset managers are required to review the German investments of the FCP in order to obtain potential treaty benefits in the future.
Outbound Investments
CFC Taxation #1 - Reduction of the low taxation threshold to 15%
What is it about:
For the purposes of the German Controlled Foreign Company (“CFC”) and Passive Foreign Investment Company (“PFIC”) taxation, the low taxation threshold has been reduced from 25% to 15%. Hence, the German CFC/PFIC rules are not applicable in case the passive income of a non-German corporate entity is subject to a minimum taxation of 15% (instead of 25%).
However, the reduced tax rate is only applicable for financial years of foreign corporations ending after 31 December 2023 (i.e., in general as of FY 2024).
For financial years up to and including 31 December 2023 the low tax threshold of 25% remains unchanged.
Practical effects:
The reduction of the low tax threshold is to be welcomed. However, the problem of determining the tax base of the foreign company by applying German tax law principles remains unaffected and may still trigger CFC/PFIC taxation.
The reduction to 15% therefore does not help if, for example, there is tax-exempt income under foreign tax law, whereas taxable income is received according to German tax law.
This problem is significantly increased by the fact that particularly dividends from free float shareholdings (<10%) are considered as passive income and are taxable applying German tax law. In foreign jurisdictions, however, a tax exemption often applies to such dividends according to participation exemption rules which do not provide for a 10% shareholding.
Furthermore, there may be temporal deferrals between the recognition of income under German tax law and foreign tax law. It should also be borne in mind that the cash flow method is no longer permitted to determine the income of a foreign company for purposes of the CFC/PFIC taxation. In addition, since 2022 not only the interest barrier rules (Sec. 4h German Income Tax Act (“GITA”)) but also the complex anti-hybrid regulations of the ATAD II Directive (Sec. 4k GITA) must be considered to determine the tax base, which may create considerable difficulties and extensive proof regarding hybrid mismatches.
Who is affected: Investors as well as fund and asset managers.
Recommendation for action:
Investors as well as fund and asset managers of funds with German investors are still required to review their investment structures in light of the revised CFC/PFIC rules applicable from 1 January 2022. This applies in particular due to the partial expansion of passive income and the different treatment between foreign and German tax law.
CFC taxation #2 – Substance carve-out
What is it about:
The so-called substance carve-out can be the "last resort" to avoid the application of the CFC/PFIC taxation if the criteria are met (i.e., foreign company receiving passive income being subject to low taxation as determined by applying German tax law).
It is true that the substance carve-out is excluded if the foreign company has its main economic activity predominantly performed by third parties (so-called outsourcing). However, in the opinion of the tax authorities outsourcing to related parties in the same country is permitted. This also applies to the management of investment funds by a management company in the same country.
Practical effects:
If, for example, the CFC taxation is applicable for "controlled" foreign investment funds regarding the fund's own income based on the provisions of Sec. 7 para. 5 sentence 2 of the German CFC rules it may now be possible to avoid the CFC taxation by applying the substance carve-out. If the substance carve-out can be applied this would also result in a simplified notification obligation (compared to an extensive filing) and may also avoid the (typically complex) calculation of the CFC amount.
Who is affected:
Investors, fund and asset managers of “controlled” foreign investment funds.
Recommendation for action:
From our point of view it seems advisable, particularly in the case of single-investor funds or group funds, to analyse whether the substance carve-out can be applied if the CFC taxation could (potentially) be applicable for controlled foreign investment funds pursuant to Sec. 7 para. 5 sentence 2 of the German CFC rules.
This typically requires close coordination between the investor and the fund manager to obtain the necessary information to carry out the substance analysis.
Fund and asset managers should therefore prepare themselves for any enquiries from investors in connection with such substance carve-out.
Place of business and place of management
New BMF circular dated 5 February 2024 on permanent establishments and place of management
What is it about:
In its circular dated 5 February 2024 the German Federal Ministry of Finance ("BMF") amended it's opinion on permanent establishments (Sec. 12 German Fiscal Code (“GFC”)) and the place of management (Sec. 10 GFC).
With regard to the place of management it is stated, for example, that in the case of management activities at several locations the activities must be weighted in order to determine the (main) place of management. If equivalent management functions are carried out at different locations, there are several places of management.
Regarding permanent establishments it is stated, for example, that the home office activities of an employee do not regularly constitute a permanent establishment of the employer. This should also apply in relation to double taxation agreements.
However, regarding executive employees it is stated that the above principles do not necessarily apply. Rather, a permanent establishment may exist if an employee exercises management functions and these convey the company's power of disposal.
Practical effects:
If, for example, a foreign investment vehicle has a permanent establishment in Germany many tax issues and consequences regularly arise. If the management of a company is located in Germany, for example, its distributions could be subject to German capital gains tax (26.375%).
Who is affected:
In particular fund and asset managers of foreign funds and investment vehicles if employees work in Germany and German investors of foreign investment vehicles if, for example, they participate in the management of a fund (e.g., member of the board of directors).
Recommendation for action:
Even if the tax authorities repeat many principles already known, fund and asset managers as well as investors should continue to review their investment structures with regard to any permanent establishments and carefully document the respective activities of the persons involved in order to avoid costly subsequent investigations and (unfavorable) tax surprises.
Tax return of special-investment funds
Draft: Fourth Act to Reduce Bureaucracy for Citizens, the Economy and the Administration
1. Extension of the submission deadline for filing the separate and uniform assessment of the taxation bases of special investment funds from four to eight months
What is it about:
The deadline for submitting the declaration for the separate and uniform determination of the tax bases (“Tax Return”) is four months after the end of the fund’s financial year. If a resolution on a distribution is passed within this period, the Tax Return must be submitted within four months after the date of the resolution. It is planned to extend the deadline to eight months after the end of the fund’s financial year.
Practical effects:
The amendment standardizes the deadline irrespective of the chosen appropriation of earnings.
Currently, there is a discrepancy in the deadline between distributing and accumulating special investment funds: accumulating special investment funds have four months to submit the Tax Return, while distributing special investment funds have up to eight months if, for example, they do not decide on a distribution until the fourth month after the end of the financial year.
Who is affected:
Fund managers of domestic and foreign special investment funds.
Recommendation for action:
Fund managers should examine possible implications for subsequent processes (in particular contractual delivery deadlines and service level agreements).
2. Introduction of independent late surcharges for late submission of Tax Returns for special investment funds
What is it about:
The Investment Tax Act is to contain a separate regulation for calculating the late surcharge in the event of late submission of the Tax Return. This is to be set at 0.0625 per cent of the distributed and deemed-distributed income for each month of delay. This applies irrespective of any tax exemption at investor level.
Practical effects:
The amendment now creates an independent standard for determining and setting late payment surcharges, so that uncertainties that have arisen in practice regarding the amount of the late payment surcharge to be set can no longer occur.
Who is affected:
Fund managers of domestic and foreign special investment funds.
Recommendation for action:
Fund managers must ensure that the Tax Return is submitted on time. Otherwise, there is a risk of considerable additional financial burdens due to the imposition of late surcharges.
3. Clarification that the special investment fund and not the fund manager is obliged to submit the Tax Return
What is it about:
It is envisaged that the special investment fund itself will be obliged to submit the Tax Return. Currently, this is generally the responsibility of the fund manager.
Practical effects:
The amendment does not result in any major practical changes as the group of persons obliged to file the Tax Return under applicable law (usually the fund manager) generally corresponds to the legal representative.
Who is affected:
Fund managers of domestic and foreign special investment funds.
Recommendation for action:
Fund managers should review whether the legal representative corresponds to the person being obliged to file the Tax Return or whether a change in processes may be necessary.
4. Announcement of assessment notices to the legal representative
What is it about:
It is envisaged that all administrative acts and notifications relating to the Tax Return are to be notified to the legal representative of the special investment fund.
Practical effects:
The envisaged regulation restores the previous status quo. Due to a presumably inadvertent change in the German Fiscal Code, each investor in the fund must currently be notified or an authorised recipient must be appointed. In practice this has led to considerable organisational challenges.
Who is affected:
Fund managers of domestic and foreign special investment funds.
Recommendation for action:
Fund managers should check whether processes have already been adapted to the (probably inadvertent) change to the German Fiscal Code. If so, the effects of the envisaged new regulation should be monitored.
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