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28.04.2015
German Tax and Legal News

German Venture Capital Bill

As the number of start-up companies is decreasing in Germany and the government has not yet taken action regarding the introduction of a venture capital law, the Federation of German Venture Capital Companies has proposed a bill for a venture capital law.
The proposed measures are taking the interest of all involved parties equally into consideration and could make Germany more attractive as a location for investment and innovation on an international level.

The number of start-up companies in Germany has been sinking over the past years. This is also true in the hi-tech sector which is particularly important for the future sustainability of a country. A functioning venture capital market could lead to more young innovative companies (so-called start-ups) in the internet economy or biotechnology industries of the future, for example. Venture capital plays an important role in financing innovative companies which have a high capital requirement for research and development.

There is also a clear commitment to venture capital in the coalition agreement of the new German federal government, pursuant to which Germany is to become an internationally attractive investment location for venture capital with a separate venture capital law to be passed. Further it shall also become more attractive to invest in young (growing) companies and venture capital investments shall benefit from investment grants.

As yet, however, no action has followed the announcements made in the coalition agreement to pass a venture capital law. In January 2015 the Bundesverband Deutscher Kapitalbeteiligungsgesellschaften (BVK – Federation of German Venture Capital Companies) presented a bill for a venture capital law recommending proposals to improve the framework conditions and to promote venture capital designed to prompt the federal government to take action.

I. Main Points and Criticism of the Bill by the Federation of German Venture Capital Companies

The BVK bill proposes measures which should have a positive effect on both, the start-up companies which are to be financed, the venture capital funds which provide the financing and the investors which provide the investment in such funds.

1. Measures for Young Innovative Companies

a)  Research Payment

A so-called research payment anchored in the German Income Tax Act (Einkommensteuergesetz – EStG) would enable companies to be subsidized in their innovation efforts even if they are still making a loss. Young companies in innovative industries would receive a payment on 50 % of their expenses (up to a maximum amount of EURO 1 million) for research and development.

The proposed research payment is directly targeted at generating a competitive advantage for start-up companies located in Germany. This measure would increase the funds available to young innovation companies for research and development and therefore have a direct positive effect on promoting innovation.

b)  Patent Box

The so-called patent box would generate advantages for innovative companies to choose Germany as their location. Proceeds from utilizing intellectual property should be taxed at a lower rate if there are substantial business activities in Germany.

There are already preference regulations for the fiscal treatment of income from the use of intellectual property (so-called patent boxes) in several countries. Such regulations are therefore an important aspect in the choice of location. The proposed regulation would therefore be a suitable factor in making Germany more attractive as a location for innovative ideas.

c)  Maintaining the Possibility to Carry Forward Losses

There are often considerable fiscal losses to be carried forward particularly in the initial phase of capital-intensive start up companies. Such losses tend to decline with investment phases in the initial stages since the new contributions from the investors can be classified as so-called “harmful acquisitions” pursuant to § 8c KStG where applicable. Although the regulation in § 8c KStG was supplemented with the so-called hidden reserves clause, among other things, in December 2009 already whereby losses which are carried forward are maintained in the amount of the hidden reserves and companies with venture capital investments can generally also take advantage thereof. However it is often the case for companies financed with venture capital that such hidden reserves are not present in the early phase due to the lack of foreseeable business prospects or assessing the amount of hidden reserves generates premature potential for conflicts between the start-up company and investors.

The BVK bill foresees a modification of § 8c EStG whereby losses which are carried forward will also be maintained if there is a change of shareholder. The competitive conditions for start-up companies in Germany will therefore be brought into line in comparison with other EU states.

2. Measures for Venture Capital Funds

a)  Statutory Provision of Fiscal Transparency

The BVK bill foresees a statutory provision on the fiscal transparency of funds in order to improve conditions for the location of venture capital funds. Under fiscal law the activities of venture capital funds will therefore not be considered as commercial but will instead be classified as asset management which will have significant effects on the fiscal transparency of the fund and therefore on a double tax burden – in part – between the fund and its investors.

Venture capital funds are often not established in the form of a corporation but rather as a partnership where there already is fiscal transparency. However, statutorily regulated transparency of venture capital funds would give greater legal certainty, particularly to foreign investors, without leading to less tax income.

b)  VAT Exemption for the Fund Management

A general duty to pay VAT on the management fees of a venture capital fund applies due to the Federal Ministry of Finance classifying the management fees as services due for payment (rather than shareholder contributions). This leads to a definitive tax burden on a venture capital company with asset management due to the lack of a possibility to deduct input tax.

As is also customary in other EU states the BVK bill therefore proposes a VAT exemption for the fund management in order to make Germany more attractive as an economic location for venture capital funds. This would make it more attractive for investors and be an incentive for the fund management to choose Germany as its location.

c)  Modifying the Regulatory Framework of the Venture Capital Industry

The venture capital industry recently received a new regulatory framework with the Capital Investment Code (Kapitalanlagegesetzbuch - KAGB). The BVK bill makes proposals about which legal uncertainties based on legal inconsistencies in the national regulations in relation to the European Regulation on European Venture Capital Funds (Regulation No. 345/2013) could be eliminated. Furthermore the KAGB regulations are to be aligned to the requirements of the venture capital industry. This is necessary with respect to transferring corporate interests under hereditary law, for example, from so-called (semi-)professional investors to private investors leading to the heirs leaving the company pursuant to the current legal situation which compromises the continuity of investors that the industry desires.

Aligning national law and EU law from a legal point of view would create legal certainty and thus raise the competitive ability for Germany as a location for venture capital funds. The above regulation on the full hereditability of a venture capital interest would allow the continuity of investors to be maintained and therefore lead to the investor basis being strengthened.

3. Measures for Investors

a)  Roll-over and Accelerated Depreciation

In the USA investors in start-up companies often make use of the possibility to obtain a tax deferral or even exemption for profits from the sale of so-called “qualified small business stocks” as long as said profits are in turn re-invested in such “qualified small business stocks”. There are also similar incentives in Great Britain for investments in young companies with the SEIS (“Seed Enterprise Investment Scheme”).

In fact applicable German law does offer possibilities to transfer sales proceeds either to new investments and therefore effectively obtain a tax deferral or pocket them tax-free. A commercial business angel can therefore transfer to new interests its profit up to an amount of EURO 500,000 from the sale of an interest in domestic business assets held for at least six years pursuant to applicable law under the terms of § 6b Subsection 10 EStG (so-called roll-over) and therefore postpone paying tax on the profit until the time of the sale of the re-investment.

Pursuant to the proposed BVK bill tax incentives should motivate investors to make more venture capital investments. A roll-over of sales profits in the event of re-investments should motivate the investors to continue investing. The regulation foresees that sales profits can be transferred to a new interest up to an amount of EURO 1 million with the sales profits initially not being taxed. Taxes on profits should therefore be deferred as long as there are re-investments in other start-up companies until the profits are no longer invested in new start-up companies.

As an alternative to the roll-over possibility the BVK bill also proposes accelerated depreciation on investments. It will therefore be possible to obtain straight-line depreciation on investments for five years which should lead to more investments.

It is of particular importance to create incentives for investors to invest in such companies. The possibility of rolling over sales profits if they are re-invested as well as the alternative proposal of accelerated depreciation on investments in young companies is designed to generate more private capital. Both proposed measures would not lead to taxes being lost but only to them being deferred.

II. Assessment

It should be emphasized in a very positive sense that the BVK bill deals with important parameters in the venture capital market. The proposed measures encourage young innovation companies, venture capital companies and investors to an equal extent. Introducing such a venture capital law could make Germany more attractive as a location for investment and innovation on an international level and in the longer term and stimulate the market for young and growing companies as well as generate increased investment and innovation in Germany.

Contact

Frank Silberberger
Director

fsilberberger@deloitte.de
Tel.: 030 25468-137

Dirk Janzen
Manager

dijanzen@deloitte.de
Tel.: 030 25468-225

Contact

Frank Silberberger
Director

fsilberberger@deloitte.de
Tel.: 030 25468-137

Dirk Janzen
Manager

dijanzen@deloitte.de
Tel.: 030 25468-225

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