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3 questions to smart minds
Photo: F. Hirschmann | White & Case

Private equity funds — asset management or commercial operation?

For this 3 questions to F. Hirschmann

White & Case
Photo: F. Hirsch­mann | White & Case
9. Novem­ber 2011

In August of this year, the German Fede­ral Fiscal Court (Bundes­fi­nanz­hof, BFH) commen­ted on the tax quali­fi­ca­tion of the acti­vi­ties of a private equity fund as private asset manage­ment or commer­cial opera­ti­ons (ruling of August 24, 2011, IR 46/10).


For this 3 ques­ti­ons to Part­ner in Private Equity/M&A, White & Case (Munich office)

1. Which characteristics/indications applied for the deli­mi­ta­tion of a commer­cial and asset manage­ment acti­vity of a private equity fund before the BFH ruling?

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.

2. What is the essence of the BFH decision?

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.

3. In your opinion, what rele­vance and conse­quen­ces does the BFH ruling have for the private equity industry?

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

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