In July 2021, the Fund Jurisdiction Act (Fondsstandortgesetz) extended the VAT exemption in section 4 No. 8 lit. h) of the German VAT Act (Umsatzsteuergesetz – UStG) to the management of “venture capital funds”. However, the amendment lacked a legal definition, which meant that it was previously unclear which funds were covered.
At the beginning of March, the Federal Ministry of Finance (Bundesministerium für Finanzen (BMF)) has published a draft letter on the adjustment of the Value-added Tax Application Decree (Umsatzsteueranwendungserlass – UStAE). In particular, it is to be specified under which conditions a fund is considered a venture capital fund.
Definition of venture capital funds
Accordingly, venture capital funds must fulfil the following requirements:
- It is an AIF (i.e. not a UCITS) that invests directly or indirectly more than 50% at the time of the first venture capital investment in young, innovative growth companies (target companies).
- The target companies must meet the following requirements:
- At the time of the first venture capital investment, it is a maximum of twelve years old since the company was founded.
- It is a small or medium-sized enterprise (SME) at the time of the first venture capital investment.
- It has its seat in the EEA.
- It is continuously economically active (with the intention of making a profit).
- All risk-bearing forms of financing, i.e. obviously equity as well as mezzanine instruments, can be considered as permissible investment instruments.
- The target companies must meet the following requirements:
- It is subject to the same competitive conditions as UCITS and is subject to special state supervision (e.g. the German Financial Supervisory Authority – Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)) or is registered as a “qualifying venture capital fund” within the meaning of Regulation (EU) No 345/2013 (European Venture Capital – EuVECA – Fund).
Since the “time of the first venture capital investment” is partially set out as a prerequisite, we understand that subsequent investments in target enterprises do not threaten the eligibility for the VAT exemption, even if the respective requirements are no longer met at the time of the subsequent investment. However, an unambiguous formulation or clarification would be desirable.
It is unclear whether it is an (additional) requirement that the target enterprises are “innovative” and if so, when this is the case. Since this is not specified in more detail, we do not consider it to be a separate requirement.
It is worth noting that a “qualifying venture capital fund” or EuVECA Fund does not automatically qualify as a venture capital fund but must also meet the above requirements. While this should often be the case, it does not necessarily have to be.
Concretisation of the VAT exemption welcome, but: unlawfulness under European law?
As an interim result, it can be stated that despite some ambiguities, the prerequisites for the VAT exemption would in principle be relatively easy to fulfil and it could therefore apply not only in theory, but also in practice.
However, the question arises as to whether the exemption from VAT is in conformity with European law. Doubts already arose in this respect during the legislative process. The background is that the tax exemption was originally granted for the management of UCITS (undertakings for collective investment in transferable securities). It was then extended to AIFs (alternative investment funds) comparable to UCITS in 2018 due to the ruling of the European Court of Justice (ECJ) of 9 December 2015, C595/13, (Fiscale Eenheid X). According to the corresponding explanatory memorandum, which has found its way into the UStAE, comparability requires in particular the fulfilment of the following conditions:
- The AIF is subject to comparable special State supervision.
- The AIF addresses the same group of investors, i.e. (also) retail investors.
- The AIF is subject to the same competitive conditions or comparable obligations and controls.
- The AIF has issued units to several investors.
- The return on the investment will depend on the results of the investment made by the managers during the period in which the unitholders hold such units.
- Unitholders are entitled to the profits realised by the AIF and to the gain resulting from an increase in the value of their unit or share and bear the risk associated with the management of the assets pooled therein.
- The investment of the collected capital shall be made in accordance with the principle of risk diversification for the purpose of risk spreading.
The tax authorities consider open-ended special AIFs with fixed investment conditions according to section 284 of the German Investment Code (Kapitalanlagegesetzbuch – KAGB) as also eligible for preferential treatment, irrespective of points 2 to 4 (circle of investors, competitive conditions, number of investors).
There are now voices that cast doubt on the conformity of the isolated extension of the VAT exemption to the management of venture capital funds with European law. This is to be agreed with insofar as the member states are permitted – within the limits set by European law – to define the “special investment funds” benefiting, but not to favour only certain “special investment funds” and not others (no cherry picking). Consequently, the question will have to be asked whether the isolated extension only to open-ended special AIFs with fixed investment conditions was or is okay in this respect – this one is of course gratefully accepted by the industry, in which this type of fund is widespread.
In our opinion, the VAT exemption should be extended to all investment funds that are managed by a licensed manager. We understand the ECJ rulings in such a way that for the comparability with a UCITS or for the existence of a “special investment fund” eligible for preferential tax treatment, it is only relevant that it is also an investment fund within the meaning of section 1(1) KAGB or Article 4 (1) a) of Directive 2011/61/EU (AIFMD), which is subject to special State supervision.
Thus, in the aforementioned 2015 ruling (Fiscale Eenheid X), the ECJ replied that ‘Article 13B(d)(6) of Sixth Directive 77/388/EEC must be interpreted as meaning that investment companies such as those at issue in the main proceedings, in which capital is collected from several investors who bear the risk associated with the management of that capital, are not to be regarded as investment companies. 6 of the Sixth Directive 77/388/EEC must be interpreted as meaning that investment companies, such as the companies at issue in the main proceedings, in which capital is collected from a number of investors who bear the risk associated with the management of the assets collected in those companies for the purchase, holding, management and sale of immovable property with a view to making a profit, are to be regarded as investment companies, which is to be distributed to all the unit-holders in the form of a dividend, such unit-holders also deriving a benefit from the increase in the value of their unit, may be regarded as ‘special investment funds’ within the meaning of this provision, provided that the Member State concerned has made such companies subject to special State supervision.‘
Thus, in our opinion, the ECJ, at least in this ruling – to which reference is usually made – is not concerned with redemption rights, the group of investors or the number of investors. The tax authorities also do not exclude closed-end funds from the eligibility for preferential treatment. At least for the open-ended special AIFs with fixed investment conditions according to section 284 KAGB, for which there can naturally be no retail investors and often there is only one investor, it apparently, they see no obstacle to the VAT exemption.
In our view, there are therefore no fundamental reasons against a VAT exemption for all investment funds whose management requires a permit or licence with corresponding state supervision as a consequence. The main objective of the VAT exemption for the management of UCITS was not to place indirect fund investments in a worse position than direct investments in securities. This objective must be sensibly applied to all funds, regardless of the investment objects, redemption rights, the investor cirle and the number of investors. In particular, a restriction of the eligibility for preferential treatment to mutual funds, i.e., funds that (also) address small investors, is not appropriate, especially since special funds often ultimately look after the interests of retail clients (e.g. funds of insurance companies and pension funds).
In any case, the legislator and the tax authorities should, as far as possible, create certainty that the VAT exemption for venture capital funds will continue to exist at least until further notice and that it would not cease to apply retroactively even if it were later determined to be non-compliant with European law. This is the only way to effectively achieve the goal expressly set by the legislator of promoting Germany as a fund location and, in particular, of promoting young growth companies (start-up companies) with competitive financing options via venture capital investments.
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