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One step forward...01/02/2002. Source: SJ Berwin.
 Germany's recent tax reforms will cause a surge in European M&A and buy-out activity – eventually. But in their current form they will also affect investors and the private equity industry in some rather unfortunate ways, says SJ Berwin
Many of the much-heralded German tax reforms became effective at the beginning of this year. As is now well known, the headline change is a provision that will allow German corporations to dispose of shareholdings without paying tax on the gains - a move which is designed to improve Germany's international competitiveness, at least in part by giving German industry the flexibility to restructure. It is widely expected that the new rules will result in increased M&A activity across Europe, and there are some early signs of this. Although it may take longer, and there are other reasons why the surge may be delayed, it seems very likely that buy-out funds will benefit from the new opportunities available.
But for the private equity industry, the changes could turn out to be a very mixed blessing. Discussions are continuing - and lobbying is intense - but the current draft of a regulation which classifies private equity and venture capital partnerships for tax purposes could make it very difficult for them to be established in Germany on a truly tax transparent basis.
Industry lobbying has improved the position, and further representations are being made to the German tax authorities, but if these representations are not accepted, the impact for the German industry could be very serious. The effect would be to turn many German private equity partnerships into ‘trading' partnerships for tax purposes, which would make investing in them significantly less tax efficient than it is at present for German pension funds, private investors and funds of funds, and for many non-German investors.
The changes would also affect carried interest holders - possibly very seriously - although the impact on them remains unclear until further announcements are made.
There is another related change, which causes problems for some individual investors in ‘non-trading' funds, and - crucially - for the buy-out teams themselves. They now (as previously) have to pay tax on the sale of a ‘substantial' shareholding, but the threshold at which a shareholding becomes substantial has gone down from (at least) ten per cent to one per cent. This means that individuals investing directly in a company (the buy-out team) or through a partnership who have an interest in excess of one per cent will pay half rate capital gains tax on the sale of the underlying investment. That is significantly worse that the previous position, when there was no tax at all to pay.
Some of these adverse effects could be alleviated by tax structuring, but that is not the point. It is a shame that the full impact of a very helpful tax reform is being diluted. The tax authorities should pay close attention to the industry's vociferous lobbying.
It seems clear that no further news will emerge until March. In the meantime, the uncertainty for those raising funds is very unfortunate.
This is an extract from a weekly bulletin produced by SJ Berwin providing an update of legal and tax developments relevant to the European private equity community. If you would like to be added to its mailing list please send an e-mail to sjbnetworks@sjberwin.com
Copyright © 2002 SJ Berwin
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on its services to the private equity industry please contact Jonathan Blake or Simon Witney in its London office +44 (0)20 7533 2222 or visit our website at www.sjberwin.com
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