Private equity funds — asset management or commercial operation?
The question of whether a private equity fund is engaged in asset management or commercial activities has been assessed by the tax authorities uniformly throughout Germany in recent years in accordance with the criteria set out in the BMF letter of December 16, 2003 (BStBl I 2004, 40). Accordingly, a private equity fund was typically engaged in asset management activities if (i) the investments were financed mainly from equity, (ii) the management of the Fund did not require extensive organization, (iii) the Fund did not make use of a market and did not act on behalf of third parties using professional experience, (iv) the fund did not offer investments to a wider public or act on behalf of third parties, (v) the fund held the investments for at least the medium term of three to five years, (vi) the Fund distributed, rather than reinvested, the proceeds of dispositions made; and (vii) the Fund did not actively participate in the management of the target companies.
The BFH first clarifies that the question of whether a private equity fund in the form of a (in this case foreign) partnership is engaged in asset management or in commercial activities is based on the same delimitation criteria as for comparable domestic companies, in particular securities trading. Accordingly, the taxpayer’s activity only exceeds the limit to commercial activity if the taxpayer behaves “like a trader”, i.e. “exhibits behavior unusual for private asset management”. Venture capital and private equity funds, on the other hand, were previously subject to the principles specifically outlined by the tax authorities and addressed above.
Admittedly, the BFH did not have any reason to do so in the case it decided, but it is interesting to note that, apart from listing the BMF principles, it did not find any confirming words on the BMF principles on the demarcation of commercial activities and asset management activities of private equity funds in its ruling.
On the contrary, following the BFH’s ruling, there is now legal uncertainty compared to the time before the ruling with regard to the question of what specifically makes the activity of private equity funds “commercial” and what makes it “asset management”. This is because the BFH at least expresses doubts about the characteristics addressed in question 1 above and listed in the BMF letter from 2003, the presence of which, in the opinion of the tax authorities, should typically constitute an asset-managing activity of private equity funds. Even if all the criteria drafted by the tax authorities and applied to German and foreign private equity funds are met, the BFH is of the opinion that there are obviously cases which nevertheless qualify for a “commercial activity”. The BFH also makes its doubts about the tax authorities’ criteria clear by classifying the characteristics applied by the tax authorities as contoured principles as “tending towards asset management”. The BFH does not provide any further details in this regard.
The BFH’s ruling does not indicate any legal doubts about the previous practice of the tax authorities on the tax qualification of the activities of private equity funds, which is supported by the BMF letter. However, it is clear from the ruling that the BFH has doubts about the criteria established by the tax authorities. In this respect, the BFH’s ruling leads to considerable legal uncertainty. It is thus necessary to sharpen the criteria used by the tax authorities to characterize asset-managing activities, which, according to the BFH, have at most a tendency effect. It would be desirable for the tax authorities to comment on the BFH’s statements in the short term. Above all, however, the legislator is called upon more than ever to establish a regulation on the tax qualification of private equity fund activities in order to create legal certainty