German Update – German Federal Ministry of Finance Release Draft Guidance

The German Federal Ministry of Finance released a draft yesterday of the eagerly expected guidance on the application of the new provision of the of the German Investment Tax Act 2018 (“InvTA 2018”) introduced on 1 January 2018 (taxation of income from securities lending and repos relating to Investment Fund pursuant to sec. 6 para. 2 and para 3 no. 2 InvTA 2018 also referred to as the “Manufactured Dividend Rule”).

The draft was prepared in response to the four topics ISLA raised in their letter submitted on 5 December 2017 (and by Eurex) which was sent yesterday to the attention of various industry associations.

The guidance released by the Ministry (in German only) can be found here

The partners at EY, Petar Groseta and Dr. Marcus Helios, have provided ISLA with a memorandum  see link  summarising the key points and adding some additional comments, extracts of which are as follows:

EY Memo Manufactured Dividend Rule – Draft Gudiance_ News25Jan2018

Transactions in Scope – confirms that only the income from securities lending and real repo transactions between a lending Investment Fund and any counterparty conducted over the relevant dividend record date are in scope of sec. 6 para. 2 and para. 3 no. 2 InvTA 2018. Transactions completed before, or entered into after the dividend record date, in absence of a real dividend payment and therefore consequently in absence of the manufactured dividend payment, will be treated as out of scope.

Tax Base – in accordance with the purpose of the Manufactured Dividend Rule of preventing the potential for a tax arbitrage through substituting the “genuine” dividends with manufactured dividends, the Guidance “caps” the tax base to the gross dividend the lender would have received if it had not lent the securities. This approach ensures that lending fees and other income due to the lender from the transaction are subject to tax only insofar as the agreed-upon manufactured dividend is lower than the “genuine” dividend.

Collection of Tax – the guidance states that the tax be collected by way of withholding. However, recognizing the fact that the German tax authorities cannot enforce the withholding obligation, the Guidance provides that no withholding is required if the borrower is a non-German resident. In such a case, the lender is required to file a German corporate tax return and declare the relevant income received. The tax is then assessed by the responsible tax office. Furthermore, the Guidance highlights that, even though the German borrower is required to withhold, the lender still has a filing obligation, if the borrower has not withheld as required. EY comments that the Guidance statements regarding the mechanisms for the collection of the tax obviously take into consideration the concerns regarding the authority of the German tax legislator to impose a withholding obligation on a non-German borrower and the predictable deficits in enforcing and monitoring the compliance of such withholding obligations.

Double tax Treaty (“DTT”) – the Guidance remains silent on the question, whether manufactured dividends should qualify as “Dividends” pursuant to the Art. 10 or “Other Income” pursuant to Art. 21 of an applicable DTT. However, the Guidance does cover important DTT issues by clarifying that the (German) borrower must withhold at the applicable statutory withholding tax rate, leaving to the lender to file a tax refund request, if it desires to claim benefits under the applicable DTT. Likewise, the Guidance instructs the foreign lenders which must file a tax return (because the foreign borrower was not required to withhold, or the German borrower failed to do so), to claim treaty benefits as a part of their tax return filing. EY added that many common corporate type Investment Funds types such as Luxembourg SICAV, U.S. RIC, U.K. OEIC or Irish plc, to name but a few, are typically eligible to claim benefits under the applicable DTT, including the “Other Income” article. The lenders should therefore closely analyse their treaty position and claim treaty benefits if they feel eligible.

CCP – In the case of transactions, where a central counterparty (e.g. Eurex Clearing) is, by the way of contract novation interposed between the original borrower and lender, the Guidance follows from an economic approach, that the interposition of the central counterparty between the original lender and borrower should be ignored. Hence, the tax consequences of CCP-transactions should be the same as before the novation, i.e. as if there was still a direct legal contractual relationship between the original lender and borrower.

The German Federal Ministry of Finance indicated that it would welcome any comments regarding the draft by 15 February 2018. The industry bodies and other interested parties are therefore encouraged to provide comment letters to the Ministry if they see a need for further clarifications. ISLA will be reviewing the guidance in detail and will no doubt be responding.

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