EUROPE – The European Commission has begun a legal procedure against what it calls Germany’s “discriminatory” tax treatment of dividends from foreign funds.

“The European Commission has decided to send an official request for information to Germany regarding what appears to be discriminatory tax treatment of dividends on foreign investment funds,” the Commission said in a statement.

It said the total amount of dividends on foreign funds is taxable, as compared to only half the amount of dividends on German funds.

“The Commission is concerned that this treatment will have a negative impact on the ability of foreign funds to sell shares in Germany, particularly since it seems that a recently drafted German bill would, if adopted, apply the same tax discrimination to capital gains.”

The move backs non-German fund managers who had claimed the proposals were discriminatory. Eleven top firms joined forces to express their disapproval in a letter to the Financial Times earlier this month. They had the backing of FEFSI, the European federation of investment funds, and BVI, the German mutual fund association.

The Commission has sent Germany a request for information in the form of a letter of formal notice - the first stage of the infringement procedure. Germany has two months to reply.

Frits Bolkestein, European Commissioner responsible for taxation issues, said: "We cannot establish an integrated capital market by 2005 if discriminatory tax barriers are maintained.

“The Commission, as guardian of the Treaties, is determined to monitor the situation and, if necessary, take action against any measure still standing in the way of a single market for investment funds in Europe.”

Sheila Nicoll, deputy chief executive of the Investment Management Association, said: “While the Commission can only take action against existing discriminatory legislation, we cannot see how the German government can now go ahead with its proposed new legislation which would amplify the discrimination between German and non-German funds.

“If the existing legislation is not changed until 2004, as proposed by the German government, the damage would already have been done, to the detriment of German investors, and it would look as if the German government was taking unfair advantage of the time delays inherent in the Commission’s procedures.”