To say that the German government’s tax initiatives have not been well-received is to put it mildly. Just three months after being narrowly re-elected, the German government has managed to slip 22 percentage points behind the opposition in opinion polls following a series of proposed tax reforms. But the German government faces more than just the wrath of its people, because among those lobbying against the tax policies are Europe’s fund management associations, and 11 European and US fund managers. And support for their cause is growing.
The BVI Bundesverband Deutscher Investment-Gesellschaften, Germany’s investment fund association, FEFSI (Fédération Européenne des Fonds et Sociétés d’Investissement), the pan-European umbrella organisation of the investment funds industry of the 15 Member States of the EU, and the IMA (Investment Management Association), representative of the UK unit trust and investment management industry, have joined forces to reverse the German government’s proposed legislation that would essentially see foreign funds discriminated against, hindering progression towards a single European financial market.
Current legislation in Germany has already been criticised for discriminating against non-German investment funds. Legislation introduced only in 1998 states that investors in non-German funds are taxed on all dividend income, paid or accumulated by the fund, while investors in German funds are taxed on only half of dividends.
Now proposed legislation has further aggravated foreign fund managers and their representative associations in the shape of capital gains tax. Previously, capital gains at the fund and investor level were exempt from tax, but government proposals are calling for taxation at both levels – a quasi-double tax - applying the same discriminatory rulings as with current legislation.
At the fund level, when equities are sold, investors in a non-German fund will be liable to capital gains tax at their marginal rate (a maximum of 47% in 2003) on all realised gains from the fund’s underlying equities. Investors in a German fund, however, will be liable to capital gains tax on only half of all realised gains.
For investors selling their fund holdings, the story is no different. Investors will be taxed at 15% on the entire gain derived from a non-German fund’s disposal of equities, and only on half of the gain derived from German fund’s disposal of equities.
According to research consultancy, Financial and Economic Research International (FERI), such discriminatory tax treatment, which, if approved, could become operative in February 2003, would affect 30% of German retail assets. “These are funds managed by our members,” says Rudolf Siebel, deputy managing director of the BVI, explaining the decision to take a pro-active role in fighting the government.
Over 14.4% of German retail assets are non-domestic funds run by foreign managers – with JP Morgan Fleming and Fidelity boasting the largest share. Little wonder then that 11 foreign fund managers with business in Germany have joined together to start their own campaign alongside the organisations.
If investors have to pay twice as much capital gains tax for funds run by foreign managers than for domestic funds, then, “appetite for foreign funds will slow down,” says Thomas Balk, president of Fidelity Investment Services, and one of the campaign’s co-ordinators.
Alan Ainsworth, deputy chairman of UK’s Threadneedle Investments goes one step further to say that, if passed, the legislation could even render foreign funds “unsaleable” in Germany.
Dedicated to seeing the proposal reversed, the group of 11 have started up a ‘fighting fund’, to pay for their campaign, whereby each will contribute to the cost of launching a public relations campaign in the European media.
Joining Fidelity Investment Services and Threadneedle Investment Services are: Franklin Templeton Investments, Gartmore Investment Management, Goldman Sachs Asset Management Europe, Henderson Global Investors, JP Morgan Fleming Asset Management, Jupiter International Group, M&G International Investments, Merrill Lynch Investment Fund Managers, and Schroders Investment Management.
The fund-manager coalition has also joined the BVI, FEFSI and IMA in writing a letter of complaint to the European Commission. The detrimental effect that the legislation would have on foreign fund management businesses operating in Germany contradicts Germany’s obligations under European Union law, believes the lobby group, and would “act against the commitment of EU governments to liberalise the single market for financial services in Europe”.
“We cannot allow local governments to destroy the spirit of a single European market,” says Balk. “It is outrageous, and beyond imagination that any government could do this.”
Says Siebel: “It is a matter of principle. For 30 years, Germany worked on an equal footing with foreigners. Why the change? We are supposed to be working towards a unified European capital market.”
Adds Balk: “Ten years ago, non-domestic business was quite small, but now cross-border business has become so important. Germany is a large and important country within Europe, and the fear is that it will set a negative precedent for other countries, and then domestic fiscal issues will start to damage the progress that has been made.”
The German government says that it is aware of the discrimination of both the current legislation and the proposed legislation, and claims it will. “This is ridiculous,” says Siebel. “Why would a government introduce a law only to get rid of it 12 months later? It makes no sense to do so. Surely it is better not to introduce the legislation in the first place. ”
The BVI is also concerned for welfare of German investors, who would essentially see their choice removed. The proposed law also favours direct investments, as those investing directly in equities will be liable to capital gains tax of only 15% on 50% of gains achieved from the sale of equities. Heimann, a German law and tax consultancy firm fears that saving with investment funds will lose attractiveness in comparison to other financial products such as life insurances or direct investments.
Explains Siebel: “Investors in life assurance do not have to pay capital gains tax for 12 years, so it is obvious that investment funds will lose business.”
With discrimination at two levels – against non-domestic funds, and investment funds as a whole, Siebel feels that what is needed is “a creation of a new and level playing field”.
With regards to a plan of action, Siebel says the BVI, FEFSI and the IMA are in talks with the Bundestag (the lower house of parliament) and the Treasury. “We weren’t able to quash the proposals on 20 November before going to the parliament’s lower house, but we will continue to apply pressure until the hearing in mid-January, but we need to do this in a meaningful way in order not to confuse investors.”
It is easy to be pessimistic about how successful the lobby group will be, given that the powerful German Länder (the federal state authorities) will resist a reversal – being the main beneficiaries of the proposed tax. The backing of the European Commission also appears unforthcoming. When FEFSI complained to the Commission about Germany’s current tax laws two years ago, no changes were made.
Balk remains confident, however, citing Spain and Austria as examples of where government attempts to implement discriminatory laws against foreign players have been quashed by lobby group pressure.
Siebel is also quite optimistic that the discriminatory elements of the proposed capital gains tax law will not be passed by parliament in February, but admits that capital gains tax itself is with a “highly likely to be unavoidable”. “The general feeling at the moment is that people have accepted that there will be a capital gains tax in some form. The German government is under financial pressure, and tax revenues are needed, but there is a light at the end of the tunnel. The capital gains tax cannot be avoided altogether, but we still see a good chance for changes regarding the discrimination against foreign funds. I am confident that the government and the fund management community will reach a compromise.”