US and UK funds held as private assets

A Tax Guide for individual investors resident in Germany

1. Who is this guide for?

This guide is intended for individuals who are tax resident in Germany and hold investments from the United States or the United Kingdom as private assets. Nationality is generally not relevant. The same principles apply, for example, to a German, US or British citizen who lives in Germany and is tax resident there.

The guide covers ordinary investments held by private investors, especially funds held through a standard securities account. It does not cover business assets, significant corporate shareholdings with entrepreneurial influence or complex fund structures.

2. Why does it matter whether an investment is a fund?

When an investor buys an individual share, the investor acquires a direct interest in a specific company, such as Apple, Microsoft or a British listed company. When an investor buys a bond, the investor generally lends money to a company or a government.

A fund works differently. Many investors pay money into a common pool. A fund manager or a predefined set of rules determines how the money is invested. The investor does not directly own the individual shares or bonds held by the fund. Instead, the investor owns an interest in the overall fund.

Germany has specific tax rules for investment funds under the German Investment Tax Act. Individual shares, bonds and certain other securities are subject to the general tax rules for capital investments. The first question is therefore whether the investment is actually an investment fund.

3. When does an investment fund exist?

In simple terms, an investment fund exists where money from investors is pooled and invested for their benefit in accordance with a defined investment strategy.

The following features will normally be present:

• Money from different investors is pooled.
• A defined investment strategy exists, such as investing in US shares, British companies, bonds or real estate.
• The investments are made for the benefit of the investors.
• The fund is not an ordinary operating company that manufactures cars, develops software or sells goods.

It is generally sufficient that more than one investor may participate under the fund documentation. A fund does not necessarily need to have a large number of investors at all times.

For an ordinary private investor, the classification will usually be straightforward. A standard retail fund or exchange-traded fund offered by a bank, investment company or online platform will generally be treated as an investment fund for German tax purposes.

The name used abroad is not decisive. A product may have a different name in the United States or the United Kingdom and still qualify as an investment fund under German tax law.

4. Which common US and UK investments are normally funds?

Common US fund investments include Mutual Funds and Exchange-Traded Funds.

A US Mutual Fund is broadly comparable to a standard open-ended retail fund. Money from many investors is pooled and invested, for example, in shares, bonds or a mixture of different securities.

An Exchange-Traded Fund, usually referred to as an ETF, is a fund traded on a stock exchange. Many widely used index funds that track a US equity index are ETFs. The fact that the units can be bought and sold on a stock exchange in a similar way to shares does not change their basic character as fund units.

Common UK investment funds include OEICs, ICVCs and Unit Trusts. These are also collective investment vehicles and will generally be treated as investment funds for German tax purposes.

5. Which common investments are not funds?

Not every security traded on a stock exchange or linked to an index is a fund. An individual share is not a fund. An investor who purchases shares in a US or UK company acquires a direct interest in that company. A standard government or corporate bond is also not a fund. It generally represents a claim against the issuer.

An Exchange-Traded Note, usually referred to as an ETN, is also generally not a fund. An ETN is normally a debt instrument traded on a stock exchange. Even where it tracks the performance of an index or another underlying asset, it is not automatically subject to the tax rules for investment funds.

6. When is a separate review required?

The basic rules described above are sufficient for most ordinary private investors. A separate tax review is required where the investment has an unusual structure or was not acquired through a standard securities account. This applies in particular to closed-ended funds, private-equity funds, venture-capital funds, hedge funds and direct real-estate investment vehicles.

US Limited Partnerships and Limited Liability Companies should also not automatically be treated as ordinary investment funds. The same applies to retirement arrangements such as US IRAs, US 401(k) plans and UK SIPPs.

These investments are not necessarily tax-disadvantaged. However, the simplified rules for standard retail funds do not automatically apply to them.

7. How are standard fund units taxed in Germany?

For a standard investment fund held as a private asset, three types of taxable income may arise:

1. distributions,
2. advance lump-sum amounts,
3. gains on the sale of fund units.

Distributions

Where a fund pays income to the investor, the distribution is generally taxable. The relevant amount is normally the gross amount before the deduction of any foreign withholding tax.

Advance lump-sum amount

Where a fund makes no distributions or only small distributions, an advance lump-sum amount may arise. This means that part of the economic return may be taxed during the holding period even though the investor has received no payment or only a small payment. This creates so-called dry income.

Sale of fund units

Where an investor sells fund units at a profit, the gain is generally taxable. Advance lump-sum amounts already taxed during the holding period are taken into account when the units are later sold. This is intended to prevent the same income from being taxed twice.

8. Does it make a difference whether the fund distributes or accumulates income?

The distinction remains important. However, it does not determine whether the investment qualifies as an investment fund in the first place. Both distributing and accumulating funds may fall within the German Investment Tax Act.

Distributing fund

A distributing fund regularly pays income to the investor. These distributions are taxable.

Accumulating fund

With an accumulating fund, income remains within the fund. It is not paid out to the investor and will generally increase the value of the fund units. An advance lump-sum amount may arise even though the investor has not received a payment.

Partly distributing fund

A fund may distribute part of its income and retain the remainder. If the distributions are lower than the statutory base amount, an additional advance lump-sum amount may arise.

Automatic reinvestment

Some funds or brokers formally pay out income and automatically reinvest it in additional fund units. For tax purposes, this is generally not the same as genuine accumulation. There will normally be two separate transactions:

1. a taxable distribution,
2. the subsequent purchase of additional fund units.

9. What is the advance lump-sum amount?

The advance lump-sum amount is intended to prevent taxation of an accumulating fund from being postponed completely until the fund units are sold.

It is calculated, in simplified terms, on the basis of the value of the fund units at the beginning of the year and an annually determined base interest rate. Distributions made by the fund are taken into account. The advance lump-sum amount is also limited by the actual positive performance of the fund, including distributions. An advance lump-sum amount does not therefore arise automatically every year.

It may be reduced or eliminated in particular where

• the fund makes sufficiently high distributions,
• the value of the fund has not increased, or
• the actual increase in value is only small.

Advance lump-sum amounts already taxed reduce the taxable gain when the investor later sells the fund units.

10. What is the tax rate?

Private investors are generally subject to the German flat-rate tax on investment income. The tax rate is 25%, plus the solidarity surcharge and, where applicable, church tax. However, for certain funds, only part of the income is taxable. The remaining part is exempt. This is referred to as a partial exemption.

An equity fund must permanently invest predominantly in shares in accordance with its investment terms. A mixed fund must also meet a defined minimum equity investment ratio, although the threshold is lower.

Where a standard ETF or retail fund is held through a German bank, the relevant fund category will often be taken into account automatically. Where the fund is held through a foreign brokerage account, the investor should check whether the necessary information on the fund category is available.

11. What changes if the securities account is held abroad?

German securities account

Where US or UK funds are held through a German bank or broker, the investor will usually have little additional work. The bank will generally calculate

• tax on distributions,
• any advance lump-sum amount,
• taxable gains or losses on sale,
• the relevant partial exemption,
• the German tax deduction.

The investor should nevertheless retain and review the annual tax certificate and the individual transaction statements.

Foreign securities account

Where the securities account is held in the United States, the United Kingdom or another country, German tax will generally not be withheld.

The investor must therefore normally report the income in the German income tax return. The German tax form known as Anlage KAP-INV is particularly relevant. Foreign brokerage statements may not be sufficient. They will generally have been prepared under the rules of the relevant foreign country and may not include all the information required for the German tax return.

12. Which records should investors retain?

Private investors with a foreign securities account should collect and retain the relevant records on an ongoing basis. Reconstructing the information several years later may be difficult and time-consuming. The following information is particularly important:

• exact name of the fund,
• ISIN or another security identification number,
• precise unit or share class,
• information on whether the fund distributes or accumulates income,
• purchase and sale statements,
• acquisition costs,
• gross distributions before foreign tax,
• foreign withholding taxes,
• automatic reinvestments,
• value of the fund units at the beginning and end of the year,
• advance lump-sum amounts already taken into account,
• information on whether the fund is an equity fund, mixed fund or real-estate fund.

Where the fund is held through a German securities account, the bank will provide a large part of this information.

13. What should be considered in relation to foreign withholding taxes?

Foreign tax may be withheld from income arising from US or UK investments. Whether and to what extent the foreign tax may be credited in Germany must be reviewed in the individual case.

It is important to distinguish between two situations:

• Where foreign tax is deducted directly from a distribution paid to the investor, a German foreign tax credit may be available.
• Where tax is incurred within the fund itself, for example on dividends received by the fund from companies in its portfolio, the investor will generally not be able to claim that tax personally.

The complete tax and brokerage statements should therefore be retained.

14. Are there any additional reporting obligations?

A standard small investor with diversified fund holdings will usually not have additional reporting obligations merely because the investment is foreign. However, a separate notification to the German tax authorities may need to be considered for larger investments.

This may be relevant in particular where

• the investor holds at least 10% of a foreign fund or other foreign entity, or
• the total acquisition costs of the investment in the same foreign fund or entity exceed EUR 150,000.

Relief may apply to certain small shareholdings in regularly traded listed investments.

Anyone who has invested a significant amount in a single foreign fund should therefore obtain a separate review. Reporting income in the annual tax return does not automatically replace a separate notification where one is required.

15. Short checklist for private investors

Before preparing the German tax return, the following questions should be answered:

Glossary

Author: Peter Scheller - German Tax Adviser - Master of International Taxation - Certified Advisers on customs and excise taxes

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