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Tax Reporting for Private Funds Sold in Germany: Moving in the Right Direction

After much pressure from powerful industry groups, the German ministry of finance has now indicated that private equity funds should not fall within the definition of ‘investment funds’ as referred to in the German Investment Act. If confirmed by an official pronouncement, this means that private equity funds will now not be required to publicly report a detailed list of assets, according to Marcia MacHarg and Patricia Bauernfeind Volhard of Debevoise & Plimpton.

Powerful German industry groups, the Federal Association of Investment and Asset Management (Bundesverband Investment und Asset Management e.V.) and the Association of Foreign Banks in Germany (Verband der Auslandsbanken in Deutschland e.V.) have been lobbying the Ministry of Finance ("BMF") to provide relief, particularly for privately placed investment funds. In an important first move, the BMF has issued a preliminary letter addressed to the Federal Association of Investment and Asset Management, responding to various questions. The letter provides some clarification on the reporting and other provisions of the Investment Tax Act with respect to all funds falling within the definition of "investments funds" under the German Investment Act; all such investment funds are taxed as provided in the Investment Tax Act. In its letter, the BMF indicates that private equity funds should not, in principle, fall within the definition of "investment funds" under the Investment Act, which would mean that the Investment Tax Act does not apply. The letter is not an official pronouncement; official guidance is expected from the BMF before the end of this summer at which time the statements below will be subject to confirmation based on the official pronouncement.

Key aspects of the recent BMF informal letter are:

Privately placed investment funds will not have to prepare and publish in the Federal Gazette a detailed annual report disclosing, for example, a list of assets and trading strategies. Publicly offered funds are required to do so. We argued that no policy would be served by forcing private funds, sold to sophisticated investors, to comply with regulations designed for the retail investing public.

Privately placed investment funds will still have to publish in the Federal Gazette tax reporting information in German and in accordance with German accounting requirements specified in the Investment Tax Act. Our clients generally do not object to providing the tax information to meet German accounting requirements (which are not identical to, but can be adapted from, K-1s). They are, however, relieved not to be made to publish "annual report" types of information provided to their private investors.

Target funds in hedge funds of funds structures (as well as target funds in other fund of funds structures) are not required to publish any information in Germany. One of the biggest issues for sponsors of funds of hedge funds was the apparent requirement under the new law that underlying target funds would be required to publish information. We noted this major issue in previous memoranda to our clients.

Target funds in a fund of fund structure, whether publicly or privately sold in Germany, will need to provide to the sponsor of the fund of funds their annual reports and tax information prepared in accordance with German accounting principles pursuant to the Investment Tax Act. However, the target funds are not required to publish their own tax information (or their annual reports which usually include lists of assets and proprietary information relating to investment strategies) in the Federal Gazette. It is sufficient if the fund of funds reports and publishes in the Federal Gazette its own annual report and tax information on a consolidated basis. Importantly, the fund of funds is not required to disclose the trading strategies and assets of the target funds.

With respect to private equity funds, the BMF agrees in principle with the proposal made by the Association of Foreign Banks in Germany that foreign private equity funds, which are not subject to a regime comparable to the German Investment Act, should not fall under the definition of "investment funds" under the Investment Act and, accordingly, should not be subject to the Investment Tax Act. However, the BMF expresses the view that the final answer to this issue requires a statutory amendment to the Investment Act. Nonetheless, it is expected that private equity funds will be taxed in accordance with general German tax principles and that they will not have to comply with the reporting requirements of the Investment Tax Act. Without legislation, however, some uncertainty remains about the tax treatment of private equity funds in Germany.

Copyright © 2004 Debevoise & Plimpton

Debevoise & Plimpton, an international law firm, was founded in 1931. The firm, which now has more than 500 lawyers, provides international services in corporate, litigation, tax, and trusts and estates law. Debevoise & Plimpton offices are located in New York, Washington, DC, London, Paris, Frankfurt, Hong Kong and Moscow