CFC taxation in case of capital investment companies pursuant to the German Investment Tax Act 2004

Good news for investors in (foreign) capital investment companies (Kapital-Investitionsgesellschaften) pursuant to the former German Investment Tax Act: On December 18, 2020, the Bavarian State Tax Office (Bayerisches Landesamt für Steuern) published a circular concerning the application of the CFC taxation pursuant to the German Foreign Tax Act (Außensteuergesetz – “CFC Rules”) in case of capital investment companies pursuant to Sec. 19 of the German Investment Tax Act 2004, which includes certain easement provisions in favour of the investors. The letter, which has reportedly been coordinated at federal and state level, can be found here.

In case of fund vehicles not structured as partnerships, the former German Investment Tax Act 2004 in force until 31 December 2017 principally differentiated  between tax-semi-transparent (special) investment funds and tax-opaque capital investment companies. As capital investment companies qualified, among others, closed-ended alternative investment funds (e. g. closed-ended Luxembourg SA SICAV-SIF).

According to the special provision of Sec. 19 para. 4 of the German Investment Tax Act 2004, the CFC taxation was applicable in case of (foreign) capital investment companies. The add-back amounts (Hinzurechnungsbeträge) were attributed to the investors immediately following the end of the investment company’s financial year. For instance, in case of a financial year corresponding to the calendar year, the add-back amounts for 2016 were attributed for tax purposes on 1 January 2017 (Sec. 10 para. 2 of the German Foreign Tax Act 2004).

With the transition to the German Investment Tax Act 2018, shares in capital investment companies were deemed to be disposed of with the expiry of 31 December 2017 and newly acquired on 1 January 2018 (Sec. 56 para. 2 of the German Investment Tax Act 20018). As part of the deemed disposal , the investors were able to deduct any add-back amounts which have been attributed until then in order to avoid a double taxation of the passive income (as add-back amounts on the one hand and as a capital gain on the other hand as the passive income had increased the value of the shares in the capital investment company) (Sec. 3 No. 41 lit. b) of the German Income Tax Act).

It was yet unclear whether the add-back amounts that had been attributed on 1 January 2018 can already be deducted when determining the notional capital gain as of 31 December 2017. According to the wording of the law, this would not be the case since, since only add-back amounts that are deemed to have been realised in the financial or calendar year of the capital gain (here: 2017) or in the previous seven financial or calendar years can be deducted. This means that the attribution of the add-back amounts for the financial year 2017 had actually occurred one day too late. In view of the German tax authorities, an additional aspect needs to be considered: As of 1 January 2018, the German Foreign Tax Act were no longer applicable to investment funds (which in principle also includes former capital investment companies) (Sec. 7 para. 7 of the German Foreign Tax Act). Therefore, according to the – in our view incorrect (see below) – opinion of the Bavarian State Tax Office, in case of future distributions or disposals, pursuant to Sec. 3 no. 41 of the German Income Tax Act, the add-back amount realised on 1 January 2018 must not be considered as being deductible from future distributions or capital gains.

However, according to the circular of the Bavarian State Tax Office, the add-back amount as of 1 January 2018 may rightly be deducted when determining the notional capital gain as at 31 December 2017. This shall be subject to the condition, however, that the taxpayer proves that the add-back amount has been taxed; the form of evidence of which is not specified. In our view, the tax assessment pursuant to Sec. 18 of the German Foreign Tax Act must suffice for this purpose (according to Sec. 3 no. 41 sent. 2 of the German Income Tax Act).

Prior to taking into account the notional capital gain as at 31 December 2017, investors may deduct the add-back amounts as of 1 January 2018 in case of distributions made by the capital investment company in the (short) financial year ending on 31 December 2017. In this respect, a (second) deduction from the notional gain on the sale is excluded.

Pursuant to the easement provisions published by the Bavarian State Tax Office, as of 1 January 2018, the deduction of the add-back amounts is limited to the total amount of (i) the distributions in the (short) financial year ending on 31 December 2017 and (ii) the notional capital gain as of 31 December 2017. Unused add-back amounts may no longer be used for distributions or capital gains pursuant to the German Investment Tax Act 2018 and are therefore forfeited. In our opinion, this conception is incorrect. First, such a restriction is contrary to Sec. 3 no. 41 of the German Income Tax Act. Secondly, the application of this provision is also not excluded by the special statutory provisions of the German Investment Tax Act 2018 (unlike, e.g., Sec. 3 No. 40 of the German Income Tax Act, see Sec. 16 para. 3 of the German Investment Tax Act 2018). According to our interpretation, this can also not be depicted from the wording of mn. 56.4 of the Investment Tax Decree of the German Federal Ministry of Finance dated 21 May 2019, which is cited by the Bavarian State Tax Office in its circular. Hence, to the extent investors have unused add-back amounts after application of the easement provision, we recommend to appeal against the corresponding tax assessment notices or keep them open.