On 9 July 2021, the German Ministry of Finance (“BMF”) issued two decrees related to securities lending transactions (and comparable repurchase or spot-transaction scenarios):
- addressing the general topic of the tax-legal allocation of securities out on loan, including the perspective of financial accounting.
- addressing specifically the tax-legal impact of so-called Cum/Cum-Transactions.4 Besides the general evaluation of such transactions, the decree explicitly targets the role of German investment funds under the German Investment Tax Act in force until 31 December 2017 (“GITA 2004”) and – importantly – the role of custodian banks.
As a general rule under a securities lending transaction, German tax law assigns an asset – and the respective income streams – to the civil law owner of the asset (e.g. to the borrower of the asset). However, in situations where another person is able to exclude the civil law owner from exercising ownership rights over the asset for the general operating life of an asset, the tax-legal ownership of the asset and its streams are allocated to that person, the so-called economic owner (e.g. the lender of the asset).
According to the new guidance, the allocation of economic ownership from the civil law owner to the economic owner of the asset requires an evaluation of all circumstances of the single case as to whether the position of the civil law owner is a mere formal one because chances and risk associated with the asset are not finally transferred to the borrower, e.g. due to hedging against potential loss in value of the asset. Especially the following criteria are mentioned as indicators:
- The borrower holds the asset for a short holding period (usually less than 45 days).
- The securities lending leads to a tax benefit and the lending fee is determined in accordance with this tax benefit, considering also other transactions, which have a material connection with the securities lending.
- The borrower does not enjoy a liquidity advantage from payments under the transactions, e.g. because payments are executed simultaneously and in equal amounts.
- The borrower is not allowed to exercise voting rights usually attached to stocks out on loan.
- The borrower has a weak legal position, e.g. because the lender has the right to terminate the lending contract upon short notice (3 business days).
The main consequences are the following:
- The security out on loan – also in the context of financial accounting – is continuously allocated to the lender.
- A dividend (or other type of income) paid while the security is out on loan is taxable income of the lender (usually 15-25% WHT).
- In the case of a Cum/Cum-transaction involving a German investment fund under GITA 2004, WHT that was reimbursed to such fund (or not levied at source) has to be repaid by the German investment fund.
- Besides the German investment fund, the custodian paying out the dividend might be held liable for the WHT repayment, unless it can prove that the incorrect levy of WHT was based on neither intent nor gross negligence.
- Additionally, custodian banks might be held liable in other constellations of Cum/ Cum-Transactions, especially if they offered Cum/Cum-Transactions as an investment model.
Even if the above described criteria are not fulfilled, the same consequence may be applied if a securities lending transaction is in scope of the German general anti-abuse rule (GAAR). This shall be the case where the main economic background of a transaction is obtaining a tax benefit. In this case, taxes will be due as if an economically and legally appropriate structure had been employed, i.e. usually leading to taxable income for the lender and WHT reclaims from the tax authorities.
Previous administrative guidance on this topic generally denied the applicability of German GAAR, if the borrower obtained a positive pre-tax return from the transaction. The BMF now denying this general opportunity for exculpation suggests that the tax authority will take a closer look at the single transactions.
It is advisable for custodians and investment funds under GITA 2004 to monitor their risk of assessments from tax authorities.
The two administrative decrees are applicable in all open cases.
Draft administrative guidance on income tax treatment of crypto assets
On 17 June 2021, the German Ministry of Finance published a first draft version of administrative guidance regarding the income tax treatment of crypto assets. The draft decree focuses on crypto currencies and their respective income streams, but also covers other types of tokens.
The guidance does not specifically target the topic of investment funds and their crypto investments. Thus, general German tax rules will be applicable, possibly leading to tax advantages of crypto investments via investment funds (tax deferral effect) compared to the direct investment in crypto assets, especially in the case of standard retail investment funds (so-called Chapter-Two-Funds within the meaning of the German Investment Tax Act). However, from 2 August 2021 onwards, crypto assets are now an eligible asset class also for the 2nd German tax law category of investment funds, the Special Funds (or so-called Chapter-Three-Funds under GITA).
Though it is generally appreciated that the Ministry tries to clarify the field of crypto asset taxation, the draft decree reveals the discrepancy between innovative, crypto based assets and German tax law with its rather physical asset affinity.
In a nutshell, the decree applies the wording of the law to all tax events relevant in the life-cycle of a crypto asset. The decree clarifies that all activities with respect to crypto currencies are relevant for income tax purposes, i.e. mining, staking, airdrops are considered tax relevant events. For example: if staking is performed as part of a business activity, the value of the coins gained from staking is to be reported as operating revenue. For private investors, the coins from staking are taxable as other income.
Remarkable and important especially for private crypto investors is the extension of the vesting period from 1 year to 10 years. Usually, the private investor can realize a tax-free gain from selling his (crypto) asset after a holding period of 1 year. This tax-free holding period is extended to 10 years, in the case of generating additional income from the asset. The guidance clarifies that staking, lending and other activities generating additional income lead to such extension of the vesting period. Though this view is in line with the wording of the law, the Ministry might want to remember that the respective revision of the law (i.e. the extension of the vesting period from 1 to 10 years) was introduced to prevent a specific fact pattern of tax abuse, which is not comparable to the economic activity related to crypto assets.
In August 2021, the draft decree was discussed with the industry groups concerned. Though the Ministry faced harsh criticism from the industry, it did not give up on the before described positions. However, the Ministry will continue its work on crypto taxation. It remains to be seen how this work will develop under a new Government after federal elections are held in Germany in September.
If you wish to discuss these topics, please contact: WTS Germany, Frankfurt