Capital gains arising on disposal of shares in mutual funds
Previously, capital gains derived from securities transactions were exempt from individual income tax if the individual held the securities for at least six months. The new law extends the holding period to one year. Consequently, profits realized by an individual investor on the disposal or redemption of shares in a foreign mutual fund are tax-exempt if the shares have been held for a period exceeding 12 months. However, the German tax authorities have indicated that capital gains derived from interest and related income earned by mutual funds (so-called interim profits) remain taxable. Interim profits must be calculated and published by the mutual fund on a daily basis.
The draft proposal of the new law imposed a one-year holding period for mutual fund distributions to individual investors when those distributions were paid out of capital gains derived from the sale of shares by the fund. The final version of the law does not impose a holding period on mutual funds.
Hence, capital gains from securities transactions realized by foreign mutual funds remain tax-exempt regardless of the length of time the mutual fund has held the securities (provided such securities do not qualify as financial derivatives).
Financial derivatives
While profits from individuals' direct investments in financial derivatives previously were not taxable, the new law taxes these profits if the financial derivatives are held for less than 12 months. The same rule has been introduced into the law regulating foreign mutual funds (the Auslandinvestmentgesetz). Thus, profits from financial derivatives transactions entered into by foreign mutual funds are taxable if the funds have held the derivatives for less than a year.
Although the new law does not specifically define the term 'financial derivatives,' it clearly includes futures, swaps, options, and securities that commercially resemble financial derivatives (eg warranties).
In principle, the new law also applies to financial derivatives used for hedging purposes. Profits realized from a hedge relying on financial derivatives are taxable and may not be offset against a potential loss incurred in the long position in securities that is hedged by the financial derivatives transaction.
The definition of interim profits (generally viewed as including a mutual fund's interest income, realized and accrued on a daily basis) has been extended to include profits derived from financial derivatives transactions with a holding period of less than 12 months. Interim profits are realized by the investor on its disposal or redemption of shares in a foreign investment fund.
Effective date
All provisions of the German tax reform generally are effective retroactively as of January 1 1999. However, the provisions dealing with profits derived from financial derivatives transactions (ie taxation of capital gains, inclusion into interim profits) are effective for transactions entered into after March 31 1999. Financial derivatives already outstanding on March 31 1999 remain subject to the old law even if the profits from those transactions are realized thereafter.
In addition to the provisions that specifically address the taxation of German investors in foreign investment funds, the following changes also generally affect investments in capital markets:
l The income tax rate in the highest tax bracket for individual investors will be reduced from 53% to 51% as of January 1 2000, and to 48.5% as of January 1 2002.
l Under the old law, German corporations were subject to a corporate tax rate of 30% for distributed earnings and 45% for retained earnings (plus a trade tax and solidarity tax surcharge). As of January 1 1999, the corporate tax for retained earnings has been reduced to 40%. This may affect dividends received by foreign funds from German publicly-traded stock corporations. The new government intends to reduce the corporate tax rate even further next year, possibly resulting in an effective rate of 35%. Such a change, however, is still subject to debate.
Despite the changes wrought by the tax reform act, investments in foreign mutual funds remain attractive for German investors. This applies specifically to funds that invest predominantly in stocks since those funds benefit from the fact that they are not subject to any minimum holding period for tax exempt capital gains (whereas for direct investments investors are now subject to the extended holding period of 12 months for tax-exempt capital gains).
Hans Stamm Raupach &Wollert-Elmendorff/ Deloitte & Touche, Munich
