On 23 April 2014 the German Federal Ministry of Finance released a circular regarding certain open issues in connection with the AIFM Tax Act (the "Circular").
In particular, the Circular deals with eligible assets for qualifying investment funds. Hence, the Circular is important for specialized investment funds that invest in closed-end funds such as private equity and infrastructure funds.
I. Executive Summary
The statements in the Circular that are most relevant for investments of specialized investment funds in closed-end funds can be summarized as follows:
1. Generally, partnership interests are still eligible assets for specialized investment funds subject to certain restrictions.
2. Shares in corporations are still eligible assets subject to the pre-existing rules. However, in the future a specialized investment fund may only hold shares that represent less than 10% of the share capital of the corporation.
3. If assets qualify as "securities" for regulatory purposes such qualification also applies for tax purposes. Hence, specialized investment fund may invest in certain assets that would otherwise not be eligible e.g. due to the legal form of the underlying investment.
Generally, interests in closed-end funds organized as partnerships are still eligible for specialized investment funds. In the future a distinction has to be made between non-business and business partnerships.
1. Non-Business Partnership
The Circular clarifies that interests in non-business partnerships are, in principle, eligible for qualifying investment funds. Whether or not such interest is an eligible asset must be determined on a look-through approach, i.e. it depends on the assets held by the partnership.
With respect to investments in private equity funds organized as non-business partnership a specialized investment fund particularly must make sure when making such investment that the restrictions for an investment in corporations are satisfied (cf. section III below) to the extent such private equity fund holds shares of corporations.
2. Business Partnership and 10% Threshold
Interests in business (including deemed business) partnerships still can be acquired within the threshold for non-eligible assets, i.e. up to 10% of the value of a specialized investment fund.
III. Shares of a Corporation
1. Corporate Type Non-Qualifying Investment Funds
Under the circular closed-end funds organized as corporations (so-called corporate-type non-qualifying investment funds, e.g. Luxembourg SICAVs or Irish PLCs) are eligible for specialized investment funds. However, specialized investment funds have to comply with certain restrictions:
a. 20% Threshold
A specialized investment fund may only invest up to (and including) 20% of its value in shares of a corporation.
Under the circular interests in a business partnership that may be hold up to 10% of the value of a specialized investment fund (cf. section II. 2 above) must also be included in this 20% threshold for shares of corporations. In our opinion this is not covered by the law. Nevertheless, specialized investment funds will have to comply with this requirement in practice. This means that an investment in closed-end funds is only eligible up to (and including) 20% of the value of a specialized investment fund. However, this is virtually in line with the previous law (20% threshold for business participations).
b. 10% Threshold
A specialized investment fund may only hold shares that represent less than 10% of the share capital of the corporation. This may give rise to problems in case of investment platforms organized as corporations where a specialized investment fund holds 10% or more of the shares of such corporation.
2. Active Business?
Under the Circular the German Federal Ministry of Finance holds the view that a qualifying investment fund may only hold shares of corporations that operate an "active business". Accordingly, "passive offshore corporation" should not be an eligible asset.
In our view this is not in line with the statutory requirements. However, with respect to non-qualifying investment funds our understanding of this statement is that shares of corporate-type non-qualifying investment funds are nevertheless eligible. This is in line with the previous practice of the German tax authorities. Under this practice closed-end fund qualified as "business participations".
Under the Circular the German Ministry of Finance clarifies that the regulatory definition for the term "securities" is also applicable for tax purposes. Accordingly, interests of closed-end funds that qualify as "securities" for purposes of the German Capital Investment Code are also eligible assets for tax purposes irrespective of the legal form and the investment strategy of the underlying investment.
In particular, it should be possible to structure shares of Luxembourg SICAVs or Irish PLCs organized as corporations as "securities" in most cases. However, under the Circular the 20% and 10% threshold for shares of corporations (cf. section III. 1 above) are applicable even if the respective shares qualify as "securities".
It is still unclear if units in a closed-end fund of a contractual type (such as a Luxembourg FCP, a French FCPR or an Italian Fondo Chiuso) are eligible for specialized investment funds. However, based on the circular such units should qualify as eligible assets if they are structured as securities (which, in principle, should be possible).
V. Additoinal Issues
The Circular clarifies the following additional points:
- Units in qualifying investment funds (e.g. UCITS structured as such) are eligible assets without regard to the restrictions applicable to corporations even if such funds are organized as corporations.
- Under the Circular the "acquisition of legal title" shall be relevant for the cut-off date for the grandfathering rules for business participations and pre-existing investment funds. However, making a binding commitment and a partial contribution is sufficient for "acquisition of legal title". This statement only makes sense with respect to business participations. With respect to pre-existing investment funds our understanding of the circular is that at least one investor must have "acquired legal title" of a unit of the respective fund until and including the relevant cut-off date (23 December 2013).
- A change in the investment policy of a pre-existing investment fund to be in compliance with the new requirements under the German Capital Investment Code should not interfere with the treatment of such fund under the grandfathering rule.
- The German Ministry of Finance clarifies that investment funds established between 21 July 2013 and 23 December 2013 (including) fall within the scope of the grandfathering rule provided that they satisfy the criteria of the abolished German Investment Funds Act.
VI. Open Issues
There are certain important points that are not covered by the Circular.
In particular, the treatment of funds of a contractual type (such as a Luxembourg FCP, a French FCPR or an Italian Fondo Chiuso) that are non-qualifying investment funds in connection with the entry into force of the AIFM Tax Act is still unclear. Under the new rules such funds are deemed to be corporate-type non-qualifying investment funds. Under the previous rules such funds were often treated as tax transparent. However, there are no transitional or grandfathering rules for such funds under the AIFM Tax Act. Hence, the impact of the entry into force of the AIFM Tax Act on such funds is still an open issue.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.