Alles klar?

A NEW SAFE HARBOUR RULE ISSUED THIS SUMMER HELPS GERMAN INVESTORS DETERMINE WHETHER OR NOT THE TAXMAN WILL PENALIZE INVESTMENTS IN FOREIGN PRIVATE EQUITY FUNDS

As a group, German institutional investors are not known for their large footprint in the private equity asset class. Historically, their appetite for investing in foreign private equity and venture capital funds has been limited, in no small part because the fiscal rules governing such investments were so complicated and ambivalent that many institutions thought it best to not even bother.

Until now. In June 2005, the German tax authorities issued a revenue ruling to provide guidance on the country's new Investment Tax Act (Investmentsteuergesetz) which replaced the Foreign Investment Fund Act (Ausland-Investmentgesetz) last year.

Guidance was needed because the new Act, aimed primarily at mutual funds, was still unnervingly ambiguous as to whether or not foreign private equity vehicles were in fact subject to it. This mattered because investors in funds falling within the scope of the Act will be taxed heavily unless the funds in question comply with burdensome reporting and disclosure requirements. One of these requirements is to publish certain information about the funds on the German Federal Electronic Gazette, a website operated by the government.

What the latest ruling has clarified is that foreign vehicles organized as ?partnerships? never qualify as a ?fund? for the purposes of the Investment-Tax Act. The ruling exempts foreign private equity and venture capital limited partnerships, collateralized debt obligations and REITS, but it doesn't include hedge funds.

According to a memorandum published in June by Debevoise & Plimpton, the law firm, foreign limited partnerships are treated as ?partnerships? even if the general partner is a corporation. US limited liability companies (LLCs) may be treated either as a partnership or as a corporation depending on circumstances. However, incorporated entities such as a US ?Inc.?, an English ?Limited?, an Irish or English ?Unlimited Liability Company? and, importantly, a Luxembourg ?SICAV? will not qualify as partnerships and accordingly will continue to be potentially vulnerable to punitive taxation.

According to Friedrich Hey, a partner in Debevoise & Plimpton's Frankfurt office, the clarification will have a significant impact:?For a German investor to get the tax position wrong can be a career-ending mistake, so until now, the tax regime came up in every discussion about investing in a foreign fund. Now that there is this black and white rule, investors no longer need to get their lawyers to massage the language [in the partnership agreement] in order to reach the requisite comfort.?

General partners keen to have German institutions in their investor base should take note. Offering them the right structure may well trigger an uncharacteristically enthusiastic response.