The biggest economy in Europe is heavily targeted by international
asset managers. However, although more than 5,000 foreign funds are
registered for public marketing, the overall market share is still
relatively small. The reasons for that are manifold and could be much
better understood by distinguishing the retail from the institutional
market. In the retail space, investors have still a strong but
unrealistic expectation regarding the state pension system and nearly
any German retail bank owns significant asset management businesses.
Institutional investors are keen to invest in German domiciled
institutional funds (Spezial-Sondervermögen). Although Sondervermögen
are not fully in line with the UCIT-directive, they provide a great
assurance in terms of investor protection. There is also a great amount
of flexibility to influence the fund management and favourably
accounting treatments. Despite of the facts outlined above there are
serious discussions to change the tax environment covering investment,
hedge and open real estate funds.
Table 1 illustrates the status quo of the German investment fund market.
|Type of funds
||Number of funds
||Net assets in million € (per February 29 2012)
|Mutual funds (except real estate funds)
|Real estate funds
|Total mutual funds
|Institutional funds (except real estate funds)
|Real estate funds
|Total Institutional funds
In total the German investment fund market is worth €1.5 trillion
($1.87 trillion). €688.482 billion net assets are administrated in the
mutual fund market (43.89%) while the institutional fund market manages
€880.579,6 billion (56.11%). The institutional fund market is strongly
dominated by German investment companies holding €856.487,3 billion
(97.26%) whereas in the mutual fund market the stake of foreign
investment funds is €281.665,9 billion (40.89%) compared to €407.176,1
billion (59.11%) net assets in German investment funds.
Equity funds [€228.684,7 billion (33.20%)], bond funds [€185.379,8
billion (26.91%)], multi-asset funds [€118.840,70 billion (17.25%)] and
real estate funds [€85.071,40 billion (12.35%)] administrate the biggest
stake in the German mutual fund market.
Germany is obviously difficult to capture for foreign asset managers
and the proposed changes of the tax environment could also change it in
Under the Investment Tax Act, foreign and domestic funds are seen as
transparent vehicles as long as certain criteria are met. Transparent in
this respect means a favourable tax treatment for investors, often even
more attractive than an equal direct investment. In simple math, the
transparent system creates one level playing field.
Distributions and deemed distributions are to be calculated due to a
high sophisticated set of rules but normally only once a year. Based on
the duration of the calculation of the net asset value of the funds,
three different tax figures are to be calculated and published. Compared
with the reporting for funds in the other European countries it is seen
The proposed rules would lead to a radical change due to a decrease
of complexity which is seldom enough in Germany. Based on the concept on
the table, retail products are to be taxed in a very simple way. Any
distribution is taxable without any exception. The tax figures
correlating with the net asset calculation of the funds would be
abolished. The calculation of the deemed distribution income would
follow the logic in Table 2.
|Table 2: Determination scheme of the additional lump sum tax basis
|Difference between the redemption price between the beginning and the end of the year is positive (increase of value)
|Redemption price of the beginning of
the year × 80% of the "basis interest rate"1) (“minimum taxation
amount”) > Total distribution amount of all distributions during the
||no additional lump sum tax basis
|Increase of value + amount of distribution(s) > Minimum taxation amount
||no additional lump sum tax basis
|“Minimum taxation amount” less distribution amounts
||“Minimum taxation amount” in amount of the increase of value
|1 The “basis interest
rate” is the interest rate according to paragraph 203 II Valuation Act
(market interest) and is published by the Ministry of Finance each year.
For 2011 this rate was 3.43%.|
From a technical standpoint, the proposed rules could represent one
of the few tax reforms which would effectively lead to decrease in
complexity what is great news. However, the reform is also to be
evaluated from a product perspective.
The proposed rules would exclude hedge funds from the Investment Tax
Act. This would mean to apply the ordinary taxation rules for direct
investments or partnerships. In both cases it would be even more
difficult to distribute shares of hedge funds into the German market as
the tax treatment would be less attractive and the administrative burden
for hedge fund managers is likely to be duplicated.
Exchange Traded Funds (ETFs) were the investment product of the last
two years as they were underrepresented in institutional portfolios. The
proposed changes would not only stop this trend but also cancel it. The
proposed rules would abolish the transparent system with its many
beneficial treatments. Thus, any distribution and capital gain due to
the disposal of fund shares would be fully taxable for institutional
investors. In practice, this could make a massive difference in terms of
the after tax return. The following example illustrates the potential
impact. A German domestic institutional investor is invested in a
physically replicating Euro Stoxx 50. Under the transparent system the
effective tax rate is around 3% where under the proposed rules 25% is
due. Of course, this example represents the worst possible outcome of
the reform but it illustrates that retail products in the institutional
space are then outdated.
The abolishment of the existing transparent systems applies not only
for ETFs but for all retail products. It is obvious that institutional
investors are likely to sell foreign retail products. It is fair to say
that German domestic retail products would also not provide a different
tax result. The question is what institutional investors do to buy those
strategies they found in the retail space previously? Basically, two
situations look most realistic. Rather than purchasing unattractive
retail products, direct investments could become more common. Even more
realistic, the Spezial-Sondervermögen is used as a wrapper for the former retail strategies.
For private investors investment funds as such are only one out of a
kind of products. Traditionally, life insurance products and ordinary
savings accounts are the biggest competitors of investment funds. Active
private investors prefer structured notes, also known as certificates.
Due to the very complicated calculation of the various tax bases
relevant for any distribution and deemed distribution, it is hard to
predict what the reaction of the wider retail market will be. However,
it is plausible to take the view that short term reactions will not be
significant where well informed private investors may prefer structured
notes even more than in the past.
The timeline for the proposed changes is not explicitly outlined in
the proposal, but due to the latest developments, any significant change
in 2012 should not be realistic anymore. Due to the fact of the
election of the lower house of the German parliament in 2013, this could
even mean that significant changes are to be expected not before 2014.
However, there is a proven track record of the German law maker to
introduce new laws in the week before Christmas – every year.
Tel: +49 69 9585 6259
Markus is a tax partner in Frankfurt and the asset management tax
& legal leader at PwC Germany. He has also been on short-term
secondments to New York and Hong Kong/Beijing. Markus is known for his
innovative articles and is a regular speaker at conferences on asset
management issues. He has experience in: Collective investments,
investment funds, hedge funds, private equity funds, real estate funds
and special funds. He also focuses on operational tax issues for
financial services clients.