In our last newsletter we mentioned that securities-lending should not be taken into account when calculating the equity ratio of the respective investment fund that acts as the lender of the securities.

The German Ministry of Finance has now circulated a draft circular regarding the treatment of income from securities-lending at the investment fund level.

The most important clarification relates to the fact that investment funds (including Luxembourg funds) have to file a tax declaration in Germany in order to disclose taxable income, especially when the fund receives, under a securities lending agreement, a substitute payment from a foreign borrower
 

We have summarised the essential parts of this draft letter:

1. Scope of taxable income
   
   - With regard to the German Investment Tax Act 2018, taxable income from securities-lending and Repurchase operations (Repos) are categorised as income from a German tax point of view. The income includes all services arising from the transfer of shares. These are not only fees from loans and repurchase agreements (e.g. securities-lending) but also compensation payments (e.g. manufactured dividends) for missed dividends from the lenders or other services (e.g. interest on securities transferred as a security).
   - Nevertheless, the amount of tax to be levied on the compensation payment (e.g. the manufactured dividend) is capped at the amount of the gross underlying dividend payment. For instance, if, within a securities-lending transaction, the borrower of the securities receives a gross dividend of 100, is obliged to pay a manufactured dividend of 90, and is paying a lending fee of 20, then the taxation will be capped at 100. Consequently, in this example, the taxes to be paid will be 15 (i.e. 100*15%).
   - The purpose of these changes is to avoid tax evasion. Fees and compensation are therefore not subject to tax if there is no entitlement to domestic investment income in the transfer period (i.e. in the absence of initial dividend payment and related manufactured dividend). 
   
   
2. Levy of withholding tax (WHT)
   
   - Those responsible for levying WHT are the debtors of investment income (e.g. borrowers paying a manufactured dividend under a securities-lending transaction).
   - Normally the obligation to levy WHT would also be related to the foreign WHT debtor and foreign performing entities. But since it is not possible for the German tax authorities to enforce the levy of the WHT on foreign debtors, no levy of WHT will occur in the case of a foreign debtor.
   - Only domestic taxable persons are obliged to levy WHT in general. This also applies in particular to cases where the investment fund (which receives the fees) would be entitled to reimbursement under a double taxation agreement.
   
   
3. Assessment obligation in the absence of tax levy
   
   - The draft circular clarifies that the lender of the shares has the obligation to file a corporate tax return if the latter received a compensation payment for which (1) no tax has been levied, (2) not enough tax has been levied, or (3) an erroneous reimbursement of the levied WHT has been performed. A tax return shall also be filed if Germany has no taxation right under the respective double tax treaty.
   - The obligation to file a tax return also applies in cases where the lender receives compensation payments and/or fees from a foreign debtor who has no obligation to levy WHT. 
   
   
4. Transactions performed through clearing entities
   
   The draft circular clarifies that when the legal obligations arising out of securities-lending transactions/repossession agreements are transferred to a clearing entity, the latter does not constitute a party to the transaction from a German tax law point of view. Therefore, the clearing entity does not fall under the obligation to levy any WHT upon settlement of the compensation payments. Nevertheless, the clearing entity should inform the parties of the transaction (i.e. lender and borrower) that no tax obligation has been transferred to the clearing entity according to the German Investment Tax Act.

We are currently analysing the impact of this draft circular on Luxemburgish funds in cases of corporate tax return filing. On one hand, we see an advantage as the tax basis will be reduced by costs and loss carry forwards. On the other, the effective tax rate will potentially increase to 15.825% instead of 15% as the solidary tax of 5.5% on the corporate tax (15%) is applicable in corporate tax returns. This is not the case when the tax is levied directly at source as the tax rate is than capped at 15%.

KPMG is able to help you fulfil the tax declaration obligations in Germany for your investment funds.

Please contact us if you have questions.

Any tax advice in this communication is not intended or written by KPMG to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing, or recommending to another party any matters addressed herein.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.