Although
At the end of June 2008,
Ambitious new laws of this kind were bound to draw criticism. It is a groundbreaking piece of legislation — and it would not be
The new legislative measures date back to the coalition agreement that was entered into by the governing Christian Democratic Union and Social Democratic Party in 2005, which provided for the encouragement of private equity investment. So what do the new laws actually regulate? The WKBG is, as its name already suggests, tailored to capital investments in young companies. It is intended to improve the framework conditions of private equity financing of young, innovative, high-technology companies. The Act defines venture capital investments as investments in non-listed companies of no more than 10 years of age with a company capital of no more than E20m (£15.7m). The companies also have to be within the European Union (EU) or the European Economic Area (EEA). The target company may not have issued shares which are admitted for the purpose of trading in an organisation or included in a comparable market. If the target company issues shares, it loses its status as qualified target company three years after inclusion or admission of the shares for the purpose of trading in an organised or comparable market.
The WKBG classifies the operations of a venture capital investment company having the legal form of partnership, as operating an asset management company for tax purposes, provided it limits itself to the acquisition, keeping administration and sale of target companies or other incorporated companies with registered office within the EEA. However, the WKBG also contains strictures of commercial activities. If these apply, the principle of private asset management is overstepped. It is detrimental for tax purposes, for example, if a venture capital investment company acquires, keeps, manages or sells stock money market investments, cash in bank or investment certificates in the issue of sections 47 to 50 of the Investment Act; if venture investments are acquired and sold on a short-term basis; if a market is exploited by use of professional experience; or if target companies are advised or provided loans or sureties or take out loans or issues participation rights or bonds. However, there is no adverse tax effect if these activities are carried out by 100% subsidiary which must be a corporation.
Most remarkably, asset management companies are considered subject to trade tax in general, once commercial activities besides asset management are carried out. The same applies if the asset management company holds a participation in a commercial partnership. In these circumstances, the venture capital investment company and its investor will become subject to trade tax regarding their incomes from their participations. Foreign investors are subject to restricted taxation on their profit share and they are obliged to file a tax return in
If a venture capital investor is classified as an asset management company, trade tax is levied on the level of the company and its investors do not gain income from trade under the Income Tax Act. Foreign investors are, for the purposes of their income gained, solely taxable in their home country in accordance with the tax regulations applicable to them and will not become subject to (restricted) taxation in
What remains interesting for the purposes of taxation is that upon acquisition of shares of a target company by the venture capital investor, any losses of the target company may be retained, provided and to the extent that the target company’s business assets contains hidden reserves. Even the sale of the company would not lead to the extinction of those losses, provided the investment had been held for a period of at least four years.
According to the WKBG, venture capital investment companies are put under the control of the Federal Financial Supervisory Authority to which they must apply for admission. Admission as a venture capital investment company requires the company to have at least two professionally adequate company directors and an inland registered office and management. The company is also required to have a capital of at least E1m (£789,570). The objective of the company may only be the acquisition, keeping, management and sale of venture capital investments. The share of venture capital investments must be at least 70% of the total value of assets managed by the company; a single venture capital investment must not exceed 40% of the total assets of the company. Venture capital investments must not be held for more than 15 years and must not make up more than 90% of the company capital of each target company.
Because investing in venture capital investment companies is risky, the legislator does not welcome small investors and the minimum tranche has been set to E50,000 (£39,478). The Equity Participations Act (UBGG) has been amended in the context of the MoRaKG. The competence for the supervision of private equity investors has not changed; it remains with the federal states.
Finally, the legislator has enacted the Limitation of Risks Associated with Financial Investments Act. This contains a variety of protection measures and is not limited to the activities of venture capital companies. However, it concerns the activities of all financial investors.
One objective of the Act is to enhance legal certainty and transparency in the ambit of financial investments. This is done by the introduction of stricter notification requirements. Investors will be required to disclose the objective of their investment and the origin of the funds allocated for the purpose of acquisition of shares of the target company once the scale of the acquisition reaches or exceeds 10% of the target company. Moreover, the legislator intends to increase the transparency of the share register by amending the Stock Corporation Act. An investor holding stock in another company will now be required to disclose to the company all data that is to be published in the share register in accordance with the Stock Corporation Act. Failure to do so could result in the loss of voting rights for six months. Another objective of the Act is to prevent undesirable developments in the private equity sector. The provisions of the Securities Trading Act (Wertpapierhandelsgesetz) and the Securities Acquisition and Takeover Act (Wertpapierubernahmegesetz) are extended by a specification of the definition of ‘acting in concert’. Any concerted acquisition of shares and any concerted actions of investors shall be covered.
The experts almost unanimously agree that these legislative measures are indeed a step in the right direction. However, they are still not sufficient to eradicate tax discrimination of private equity financing vis-a-vis foreign capital financing, which will once more be aggravated by the introduction of the withholding tax in 2009. Criticism is particularly founded on the fragmentation of different legal provisions for private equity. The legislator has missed the opportunity to establish a coherent and integrative venture capital market in
Michael Fischer is a partner at Reed Smith in
GermanyJuly2008
