Proposed German Legislation Would Eliminate Tax Discrimination for Foreign Funds

Washington, DC, July 22, 2003 - The German Finance Ministry recently introduced legislation that would eliminate tax discrimination with respect to foreign funds.

Background
In late 2002, the lower house of the German Parliament passed tax legislation that would have imposed a tax on capital gains that presently are tax free, and would have levied the tax in such a way that significantly favored investments in German funds over investments in non-German funds. The German Parliament's upper house rejected the legislation, and the German Government determined to redraft the legislation.

On April 11, 2003, the lower and upper houses of the German Parliament passed a revised tax bill that did not contain any provisions relating to the taxation of capital gains of funds and their investors.

The new tax legislation would eliminate the current distinction in German tax law among different categories of foreign investment funds (i.e., white, grey, or black investment funds), and the tax treatment would depend on whether the fund can provide investors and tax authorities with information on the basis for taxation.

Currently, German investors are taxed on only half of the dividends they receive from German funds (the "half-taxation" method) but are taxed on all of the dividends received from foreign funds. Under the proposed Investment Taxation Act, dividends received by individuals from foreign funds would be eligible for the half-taxation method. For institutional investors, dividends arising from foreign funds would be tax-free.

The proposed legislation would also impact the taxation of capital gains. Under current law, individual investors are taxed on the capital gain arising from the sale of fund shares held less than 12 months. While they are taxed under the half-taxation method for capital gains from domestic funds, they are currently fully taxed on the total capital gain arising from the sale of foreign fund shares. Under the proposed legislation, the equity gain arising from the sale of foreign fund shares would also be eligible for the half-taxation method for individual investors. In order to implement the capital gain provisions for foreign funds, the proposed legislation would require all funds to calculate and publish the equity gain of the fund on a daily basis. Moreover, under the proposed legislation, accumulated and distributed capital gains would be tax-free to individual investors and certain accumulated and distributed capital gains would be tax-free to institutional investors.

If enacted, the proposed legislation would apply with respect to foreign funds beginning January 1, 2004. The final votes on the Investment Tax Act are expected to be in November.

ICI Position
The Institute has expressed strong support for the German Parliament's decision not to adopt tax provisions relating to capital gains of fund shares, which would have discriminated against foreign funds. In an earlier comment letter, the Institute expressed its concerns with the legislation, and noted that it might be contrary to European law because it constitutes a restriction on capital movements.

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