Legal situation before the Fund Jurisdiction Act
While in other European countries the management of venture capital and private equity funds is usually exempt from VAT, in Germany VAT was regularly charged. This already appears questionable regarding the extensive European harmonization of VAT through the VAT System Directive. For example, the ECJ has already ruled that the management of real estate funds subject to special state supervision was exempt from VAT (ECJ of 09.12.2015, Fiscale Eenheid, on the then still applicable Art. 13 Part B letter d No. 6 of the Sixth VAT Directive, now Art. 135 (1) letter g VATystRL).
The linchpin of the issue is § 4 No. 8h UStG, which provides for the exemption from VAT of the management of certain fund companies. Before the Fund Jurisdiction Act came into force, this VAT exemption was limited to undertakings for collective investment in transferable securities (UCITS) and comparable alternative investment funds (AIF). In this context, it was regularly disputed when an AIF was to be considered comparable to a UCITS. On the basis of the VAT Application Decree (section 4.8.13), the tax authorities – with a questionable interpretation regarding the aforementioned ECJ case law – predominantly denied the comparability of typical private equity and venture capital funds. As a result, a turnover tax liability of the management fee was regularly assumed for these fund companies.
Since venture capital and private equity funds are generally not entitled to deduct input tax, the turnover tax represented an effective burden for them and thus a measurable disadvantage for the investors. This made Germany unattractive as a fund location in European comparison.
The new legal situation
Section 4 No. 8h UStG was expanded by the Fund Jurisdiction Act. It now covers the management of “venture capital funds” in addition to the management of UCITS and comparable AIFs. However, it remains unclear what is meant by a venture capital fund, as this term is not defined.
In a recommendation of the committees of the Bundesrat of 22 February 2021, the Bundesrat already suggested to define the term venture capital fund more precisely in the further legislative process. Legal certainty must be created for tax practice. Furthermore, it must be ensured that the new regulation is compatible with Union law. However, unfortunately, a definition of the term did subsequently not find its way into the law.
The term is also not used in other laws. In particular, unlike its reference to UCITS, the legislator has not referred to established regulatory categories. However, it is obvious that the term venture capital fund also covers private equity funds in addition to venture capital funds, which are undoubtedly covered. Private equity funds essentially differ from venture capital funds in that they are aimed at portfolio companies at a later stage of development. However, it is often not possible to draw a clear distinction and both forms of investment are likely to be venture capital.
This also suggests itself when looking at the previous use of the term. In 2004, for example, the provision of § 18 para. 1 no. 4 EStG on the taxation of carried interest was introduced by the Act on the Promotion of Venture Capital, without differentiating between venture capital and private equity funds. The tax authorities have also already taken a position in connection with doubtful questions of the so-called PE decree, as the term venture capital companies or venture capital funds is used there and includes both private equity and venture capital funds (OFD Magdeburg of 05.04.2006 – S 2240 – 58 – St 214).
A broad interpretation of the term “venture capital fund” also seems necessary under EU law. A regulation which selectively favors certain enterprises and thus distorts competition regularly constitutes illegal state aid within the meaning of Article 107 TFEU. The classification of a norm as impermissible aid leads to its nullity. Venture capital and private equity funds also compete with each other among investors and – at least in later financing rounds – also among portfolio companies. An understanding of the norm that includes both groups in the term venture capital fund therefore also appears necessary under EU law.
Conclusion
The efforts of the legislator to strengthen Germany as a fund location are extremely welcome. With the extension of the VAT exemption for management fees, the legislator is also addressing exactly the right point, as this regularly represents the decisive practical disadvantage, especially in comparison with Luxembourg fund companies. Whether the goal pursued with the law can ultimately be achieved is essentially also a question of the legal certainty of the new regulation, because an uncertain legal situation entails considerable risks for affected fund companies. It is therefore desirable that clarity is created in a timely manner through a definition of the term venture capital fund that also meets the requirements of EU law. This has a significant impact on the innovative strength in our country, because young innovative companies are often dependent on financing by investment companies and these often invest in “their home country”.
This article was first published in: Handelsblatt online, Tax Board, 8 July 2021 (in German)