New draft bill from the Federal Ministry of Finance could make taking stakes in tax advisory firms more difficult for financial investors

According to the current draft (7^th August) of the Ninth Act to Amend the Tax Advisory Act (the “Act”) (Referentenentwurf eines Neunten Gesetzes zur Änderung des Steuerberatungsgesetzes ‒ StBerG) published by the German Federal Ministry of Finance (Bundesministeriums der Finanzen ‒ BMF), a practice that has so far been common regarding the prohibition on external ownership and external interests in tax advisory firms may soon become impossible: namely, holding interests in German tax advisory firms through multi-tiered structures involving foreign audit firms.

The reason these ownership structures have become more common in recent years is the prohibition on external ownership and external interests set out in section 55a(3) of the Act. Under this rule, third parties who are not members of the tax advisors profession are not eligible to be shareholders in a tax advisory firm, and shares cannot be held for such third-parties.

Up until now, however, financial investors have been able to invest indirectly in German tax advisory firms. The core element of these investment models was a foreign EU-based audit firm that acted as a shareholder of a German audit firm, which in turn held shares in the tax advisory firm. Since section 55a of the Act currently only considers audit firms with direct investments, it was possible for financial investors to invest indirectly ‒ by holding a stake in the audit firm ‒ if that audit firm was based in a country whose laws did not have a strict prohibition of third-party ownership (similar to the Act) or investment in such firms. Recently, these kinds of structures have increasingly been set up with the involvement of EU audit firms recognised in Luxembourg as Luxembourg law does not prohibit investment by non-professional firms.

Significant changes in the draft bill

The key amendment in the newly published draft bill ‒ crucial for these types of arrangements ‒ concerns a minor, but highly significant, addition to the second sentence of section 55a(1) of the Act. Section 55a of the Act governs the ownership and capital structure of tax advisory firms. Under current rules, recognised audit firms (section 55a (1)(3) of the Act) and recognised bookkeeping firms (section 55a (1)(4) of the Act) can, among other things, be shareholders in a tax advisory firm.

The draft provides for the following to be inserted after sentence 2 of section 55a(1) of the Act: “In the cases referred to in points 3 and 4 of sentence 1, the investing firm must fulfil the recognition requirements of point 1 of sentence 1 of section 53(2).”

Section 53 of the Act governs the recognition of tax advisory firms by the Chambers of Tax Advisors (Steuerberaterkammern). Point 1 of sentence 1 of section 53(2) of the Act reads: “Recognition must be granted where (1.) the professional firm, its shareholders and members of management and supervisory bodies fulfil the requirements of sections 49, 50, 51(5), 55a and 55b. (…)”.

This amendment is set to have far-reaching implications: In future, audit and bookkeeping firms will only be permitted to hold shares in a tax advisory firm if they themselves meet the recognition requirements under point 1 of the first sentence of section 53(2) of the Act. This means:

In multi-tiered structures, any audit firm investing in a tax advisory firm must itself fulfil the referenced requirements, notably those concerning capital and ownership structure under section 55a of the Act.

The partners of an audit firm investing in a tax advisory firm must themselves comply with section 55a of the Act.

This requirement could also apply to EU audit firms. This is because neither the wording of the amendment nor the explanatory memorandum contains any restriction to the effect that this requirement should apply only to multi-tiered structures established in Germany.

Effects on previously permitted investment models

Under the new rules, the investment chain described above would no longer be allowed if the EU audit firm did not itself meet the required standards. In practice, this will usually be the case since many jurisdictions do not have any limitation on the group of eligible shareholders comparable to section 55a of the Act, and in particular do not have a ban on third-party ownership or investment. As a result, the planned provision would effectively ban an ownership structure that is currently both possible and permitted.

Purpose of the amendment: tightening the rules for multi-tiered investments

The draft’s explanatory memorandum states that its aim is to “clarify” the current provisions, but in reality the requirements for multi-tiered investment structures are being substantially extended.

According to the memorandum, there are in practice “ambiguities with regard to the interpretation of the second sentence of section 55a(1) of the Act. Specifically, the rule is that where legal requirements relate to shareholders or management members, these must be met by the shareholders and management members of the firm holding shares. This is especially relevant to the question of whether the shareholders of an audit or bookkeeping firm ‒ which itself holds shares in a tax advisory firm (or, in the case of a multi-tiered structure, the shareholders of firms that themselves hold shares further up the chain) ‒ must also meet the requirements that apply to a tax advisory firm. To preserve independence, a firm should only be allowed to hold shares in a tax advisory firm under very strict conditions. Only those firms that themselves meet all the basic requirements set for tax advisory firms are to be permitted to become shareholders. The amendment to the first sentence of section 55a(1) of the Act is intended to make it explicitly clear that the requirements applying to tax advisory firms must also be met by any recognised audit or bookkeeping firms holding shares.” (see p. 99 of the draft)

The resistance of the Federal Chamber of Tax Advisors (Bundessteuerberaterkammer) to the investment structures described above ‒ and its desire to bring an end to these arrangements as soon as possible ‒ is likely the main motivation behind this draft, more so than any alleged need for clarification of the professional regulations. After all, both the Tax Advisors Act and the German Auditors Code (Wirtschaftsprüferordnung) expressly permit multi-tiered investment structures. It is precisely these structures that the draft, as the explanatory memorandum makes clear, is primarily aiming to address.

Significant doubts regarding compatibility with European law and constitutional requirements

This helps to explain why the draft appears to have been hastily assembled. In its current form, there are serious concerns about whether it complies with both EU law and constitutional requirements.

The draft does not clarify whether the new provision will apply to EU audit firms (see above). If it does, the change will conflict with the “home country principle” set out in the EU Audit Directive.

The Directive provides that the ownership and capital structure of EU audit firms is governed solely by the law of their home Member State, while these firms must nevertheless be recognised in Germany. This would no longer be the case if EU audit firms were required to comply with the more stringent professional requirements for tax advisers under the Tax Advisors Act. Indirectly imposing German professional standards on foreign firms would mean that the Act sets requirements for the ownership structure of entities governed by their own national law. This is incompatible with EU law.

There are constitutional concerns relating to the protection of legitimate expectations. The new requirements would apply as soon as the law comes into force. Structures already in existence should continue to benefit from grandfathering, meaning they would still be assessed under the existing legal regime and remain permissible for now. From a constitutional perspective, legal effects must not be imposed by statutes before those statutes are officially promulgated. Otherwise, there is generally a breach of the prohibition on retroactive legislation. However, “genuine” retroactive effect may be permissible if there is no legitimate expectation deserving protection. According to the established case law of the German Federal Constitutional Court (Bundesverfassungsgericht), this applies where anyone relying on the previous law should have expected a change at the time affected by the retroactive legislation. For this purpose, the case law usually refers to the date the law is passed by the Bundestag. In exceptional cases, however, the decision of the Federal Cabinet may be taken as the relevant date. Allowing the Cabinet decision as an alternative reference point is intended to prevent “announcement effects” and “windfall effects”, which could undermine the effectiveness of the new law.

The draft does not provide any exceptions or transitional provisions for existing structures. Even for structures protected under previous law (grandfathered), if changes are made retrospectively, the Chamber of Tax Advisors could review them for compatibility with the new legal situation. If these structures do not meet the tougher requirements, recognition could be withdrawn from an authorised professional firm under section 55(3)(1) of the Tax Advisors Act. Under the current draft, this is expected to apply even if the actual chain of ownership ‒ from EU audit firm to domestic audit firm to tax advisory firm ‒ remains unchanged. However, if there are simple changes in ownership, these trigger notification duties to the chambers and may then result in a review by the chamber.

Conclusion and outlook

Although this is currently only a draft, which is already facing strong opposition, the move clearly shows that the Ministry of Finance is heeding the Federal Chamber of Tax Advisors’ criticism and intends to restrict multi-tiered structures involving investors from outside the profession in future. It remains to be seen whether and in what form the draft will actually be adopted. However, it is clear that the window of time for implementing such structures may become much narrower. Although, according to the Ministry of Finance’s website, “the draft mostly takes up the content of the earlier bill to revise the rules on limited and unpaid commercial assistance in tax matters (Bundestag printed paper, 20/8669), which became obsolete at the end of the last legislative period, it currently does not include the relevant changes to section 55a of the Tax Advisors Act.” Nevertheless, interdepartmental coordination could follow swiftly. Investment structures involving foreign holding companies should therefore be reviewed for possible risks in light of the planned legislation, and new structures should be implemented swiftly.

It is already conceivable that tax advisory services may no longer be provided by tax advisory firms, but instead by auditors or audit firms, which, under section 3 of the Tax Advisors Act read in conjunction with section 44b(1) of the Auditors Act, themselves have unlimited authority to provide assistance in tax matters.