July 22, 2013
The deadline for the implementation of the European Union Directive 2011/61/EU on Alternative Investment Fund Managers ("AIFMD") into German law expires on July 22, 2013. Across Europe, the EU member states are currently amending their national investment laws to transpose the requirements of the AIFMD into national law. Earlier this month, Germany has followed suit and adopted a new Capital Investment Act (Kapitalanlagegesetzbuch — "KAGB"), which replaces the current Investment Code (Investmentgesetz — "InvG") with effect as of July 22, 2013. Any fund vehicles or fund managers who have marketed in the past, or intend to market in the future, to Germany-based investors will need to familiarize themselves with this extensive codification of German investment law.
I. The General Approach Taken by the German KAGB
The rules under the KAGB substantially exceed the minimum requirements set forth by the AIFMD. The KAGB is not just a piece-meal transformation of the AIFMD requirements, but has a much broader, more ambitious reach. It aims to provide an overreaching, unified codification of the investment law in Germany for open-end funds and, for the first time, closed-end funds. In a nutshell, the KAGB provides rules for all types of investment funds and their managers.
On the one hand, the KAGB replaces the existing InvG, which, inter alia, effected the harmonization of national rules based on the Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). As the KAGB replaces and updates the current InvG in its entirety and introduces a new nomenclature and terminology, even those provisions in the existing legal regime applicable to investments in UCITS which are moved into the KAGB in materially or predominantly unchanged form will require legal advisors and other industry participants to re-familiarize themselves with the new terminology and changed systematic structure of the law.
On the other hand, the KAGB seeks to regulate previously unregulated "alternative investment funds" ("AIF") and their managers ("AIFM"). It is in this area of the law where the KAGB transposes the parameters of the AIFMD into national German law. It is important to note that even sophisticated market participants who are well familiar with the AIFMD itself and/or its implementation into national law in other jurisdictions will be well-advised to take a closer look at the KAGB and its peculiarities if they intend to continue to market to investors based in Germany. Germany has opted for a number of further reaching national rules that differ from the AIFMD and partially impose certain stricter requirements that may come as a surprise to practitioners who are only familiar with the AIFMD itself.
II. Selected Key Points
Differentiations by Types of Investors and/or Types/Locations of AIF and AIFM
The KAGB, to the extent it deals with AIF and their managers, provides for a stratified system of regulation that differentiates, inter alia, along the lines of the types of investors that are being addressed (professional vs. semi-professional vs. private investors), the type and location of the fund and its manager (Germany-based vs. European Economic Area ("EEA")-based vs. non-EEA-based AIF and managers) and rules that affect the AIFM and other provisions that affect the AIF that is being marketed by the AIFM.
The Marketing of AIF
The existing rules on the marketing (Vertrieb) of AIF are modified which is another area where the affected industry circles are well-advised to familiarize themselves with the rules of the KAGB. In particular, and subject to the applicability of certain grandfathering rules, the current, relatively relaxed rules on private placements in Germany will be abandoned by July 21, 2014 at the latest. Further changes to the marketing rules will be implemented when the European passport mechanism will be introduced (most likely sometime in late 2015). Furthermore, the KAGB introduces various notification and information requirements vis-à-vis the German Federal Financial Supervisory Authority ("BaFin") incumbent on managers of an AIF that is being marketed in Germany. The AIF themselves that are being marketed in Germany also have to be in compliance with the special requirements for the many different categories of AIF which the KAGB provides for.
As far as a number of foreign-based AIF and AIFM are concerned, which previously only engaged with a few sophisticated Germany-based high net worth or institutional investors under the former private placement regime in such a way that the German rules on prospectus requirements were not triggered, the KAGB may require them to deal directly with German regulatory bodies for the first time.
III. Consequences for the Legal Practice and First Practical Experiences
As the KAGB in part differs from the AIFMD and is brand new, there are currently very few authoritative guidelines and virtually no precedent case law. BaFin has only just started publishing its own guidelines and FAQs in the past couple of weeks. Several key concepts surrounding the scope of the law, the applicability of the grandfathering rules, the practicalities surrounding depositaries (Verwahrstellen) and the exact reach of the broad definition of "marketing" in the KAGB are currently still subject to debate among legal scholars. As a consequence, there is still considerable uncertainty as to how the KAGB rules will be applied in practice and, in particular, how BaFin will deal with the initial wave of administrative changes and AIF product notifications that is to be expected after the entry into force of the KAGB on July 22, 2013.
First practical cases have mainly focused on the applicability of the KAGB rules to existing funds structures which had already started their marketing activities prior to the KAGB entering into force. Depending on where in its life-cycle an AIF was when the KAGB entered into force on July 22, 2013, the grandfathering rules suspend certain requirements that will be applicable to AIF which are first marketed in Germany after July 22, 2013. Further exemptions from the applicability or certain rules of the KAGB may exist in the case of single-investor funds and in cases where the AIF is not actively marketed in Germany by the AIFM but contact is initiated by the Germany-based (semi-professional or professional) investor by way of reverse solicitation.
As time progresses, we would expect that the practical focus will be moving away from the scope of the interim regime provided for by the grandfathering rules towards the implications that the regular KAGB provisions on marketing, licensing, risk control, depositaries, accounting, remuneration and other topics will have on the introduction of new AIF in the German market after July 22, 2013 but before the introduction of the European passport mechanism.
In view of the fact that most of the AIF in question, which will now fall within the scope of both the AIFMD and the national implementation measures like the KAGB, were previously unregulated in major markets like the United Kingdom and the United States of America, the KAGB and corresponding other laws in the EU member states are likely to create considerable additional administrative layers and the need for tailored advice for many market participants.
IV. New Investment Tax Regime
In tandem with the regulatory implementation of the AIFMD into German law by virtue of the KAGB, the German legislator plans a corresponding fundamental reform of the German investment tax regime, which may also have an impact on existing fund structures. Based on the governmental draft of the German Act on the Adoption of Investment Fund Taxation in Connection with the AIFM Directive (the "Investment Tax Draft") as of January 30, 2013, the scope of the tax regime of the existing German Investment Tax Act (Investmentsteuergesetz) is proposed to be expanded to cover all AIF, including private equity funds and other closed-end funds which are currently unregulated.
Unlike the KAGB, the Investment Tax Draft has not been implemented in time before July 22, 2013. The Investment Tax Draft passed the Lower House of the German Parliament (Bundestag). However, the Upper House of the German Parliament (Bundesrat) submitted the Investment Tax Draft to the Conciliation Committee of the Lower and Upper Houses of Parliament (Vermittlungsausschuss von Bundestag und Bundesrat) which has ceased its negotiations on the Investment Tax Draft on June 26, 2013.
As a reaction to the new investment tax regime not being adopted prior to the national implementation deadline in the AIFMD, the German Ministry of Finance introduced on July 18, 2013 certain transitional rules pursuant to which the former InvG (which is abolished as of July 22, 2013 for regulatory purposes) is deemed to remain in force for German tax purposes. This means that the current German Investment Tax Act will still apply to investments funds which are being established after July 21, 2013 if they qualify as an investment fund under the (then abolished) German InvG. Therefore, only open-end funds, which are subject to supervision in the state of their statutory seat or where the investor has a redemption right, but not the typical private equity funds, continue to be subject to the (interim) German investment tax regime.
However, if the currently stalled new investment tax regime as contemplated in the Investment Tax Draft is adopted prior to the elections to the German Bundestag on September 22, 2013 or at a later point in time in 2013, it will be possible that the Investment Tax Draft could enter into force with retroactive effect as of July 22, 2013.
As a consequence, it is relevant for the structuring of new investments to be aware of the proposed new investment tax regime:
With respect to open-end funds that are already subject to the current German Investment Tax Act, there will be, in principle, no changes to the tax regime of limited tax transparency. However, the requirements for an open-end fund, which will be established after the new investment tax regime has come into force, to benefit from this tax regime will be tightened: In a change from the current rules, the open-end fund must be subject to supervision in the state of its statutory seat and the investor must be entitled to a right of redemption at least once a year. Furthermore, the Investment Tax Draft provides for mandatory limitations for investments in listed companies and investments in one and the same corporation as well as for short-term loans. Contrary to the current rules, the open-end fund may also lose its privileged tax status if the fund no longer complies with the mandatory investment limitations.
Irrespective of whether or when the Investment Tax Draft will come into force, since March 1, 2013, a corporate investor can no longer benefit from the participation exemption with respect to dividend income, unless the open-end fund qualifies as a special fund (Spezialfond). This will be true even if the investor holds an indirect shareholding via the fund of more than 10% in the distributing corporation.
German and non-German private equity funds and other closed-end funds (such as mezzanine or real estate funds) will be regulated by the Investment Tax Draft for the first time for German tax purposes, whereby the tax regime will depend on the fund’s legal form. If the closed-end fund is structured as a partnership (which is usually the case), there will be no changes to the taxation rules currently in force (except for the abolishment of the participation exemption for portfolio dividends). The fund will be treated as transparent and the criteria used to differentiate between business activities and pure asset management remain applicable.
However, if the closed-end fund is organised as a corporation (e.g. German GmbH, Luxembourg SICAV, Irish PLC) or a contractual type fund (e.g. Luxembourg FCP or French FCPR), the fund may face changes to its tax regime, despite the fact that the originally planned lump-sum taxation is no longer included in the Investment Tax Draft. In principle, the general tax rules for investments in corporations (including the abolishment of the participation exemption for portfolio dividends) apply. However, with respect to corporate and non-corporate business investors this will only be true if a EU/EEA fund does not benefit from a tax exemption, or, provided the fund is resident outside the EU/EEA, this fund is subject to corporate income tax of a least 15%.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you regularly work or the following lawyers in our Munich corporate transactions group:
With regard to further details on the investment tax reform, please contact the following lawyers in our Munich tax group:
© 2013 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.