ISLA celebrates lending tax amendments
26 January 2018 Berlin
Image: Shutterstock
The German Federal Ministry of Finance has re-drafted its guidance on the application of the new provisions of the German Investment Tax Act 2018 (GITA 2018), following an outpouring of concern from the securities lending industry over threats to market stability.
As of 1 January, GITA 2018 included a taxation of income from securities lending and repos relating to an investment fund under the Manufactured Dividend Rule.
The new taxation drew criticism from the securities financing market, including the International Securities Lending Association (ISLA), which accused it of being unclear and a threat to German market liquidity.
Commented on the recent amendments, ISLA CEO Andy Dyson said: “We believe it’s important for the market to get clarity around these new rules and we believe the latest statement from the German tax authorities is a major step in that direction."
"We will of course continue to work with regulators and other stakeholders on this issue over the coming months.”
The Ministry of Finance’s latest draft responds to the four key areas first raised by ISLA and Eurex, as an acutely affected party, in a letter sent to the German Federal Ministry of Finance in early December 2017.
The four areas related to the transactions in scope; the tax base; the collection of tax; and double tax treaties.
In the letter ISLA stated: “Due to a lack of clear understanding across the industry, lenders may determine that the risk of lending securities is no longer low and therefore will withdraw from the market, rather than accept a higher level of risk or uncertainty.”
According to EY spokespersons acting on behalf of ISLA in the negotiations with the German ministry, in terms of the transactions in scope, only the income from securities lending and real repo transactions between a lending investment fund and any counterparty conducted over the relevant dividend record date are in scope.
Transactions completed before, or entered into after the dividend record date, in absence of a real dividend payment and therefore consequently in absence of the manufactured dividend payment, will be treated as out of scope.
For the tax base in accordance with the purpose of the manufactured dividend rule of preventing the potential for a tax arbitrage through substituting the 'genuine' dividends with manufactured dividends, the guidance 'caps' the tax base to the gross dividend the lender would have received if it had not lent the securities.
This ruling aims to ensure that lending fees and other income due to the lender from the transaction are subject to tax only insofar as the agreed-upon manufactured dividend is lower than the ‘genuine’ dividend.
For the collection of tax, the guidance states that the tax be collected by way of withholding, unless the borrower is a non-German resident, due to the fact that the German tax authorities cannot enforce the withholding obligation.
In such a case, the lender is required to file a German corporate tax return and declare the relevant income received before it is assessed by the responsible tax office.
The new guidance highlights that, even though the German borrower is required to withhold, the lender still has a filing obligation, if the borrower has not withheld as required.
EY noted in its analysis that the guidance statements regarding the mechanisms for the collection of the tax obviously take into consideration the concerns regarding the authority of the German tax legislator to impose a withholding obligation on a non-German borrower and the predictable deficits in enforcing and monitoring the compliance of such withholding obligations.
Regarding the the issues of double tax treaties (DTT), ISLA and EY highlight that “the guidance remains silent on the question”.
The guidance does clarify that the German borrower must withhold at the applicable statutory withholding tax rate, leaving to the lender to file a tax refund request, if it wishes to claim benefits under the applicable DTT.
When central counterparties (CCPs) are involved in the transactions by the way of contract novation interposed between the original borrower and lender, the guidance follows from an economic approach, that the interposition of the central counterparty between the original lender and borrower should be ignored.
The tax consequences of CCP-transactions should be the same as before the novation, meaning if there was still a direct legal contractual relationship between the original lender and borrower.
The German Federal Ministry of Finance is accepting comment on the new draft until 15 February.
The full guidance released by the Ministry (in German only) can be found here.
As of 1 January, GITA 2018 included a taxation of income from securities lending and repos relating to an investment fund under the Manufactured Dividend Rule.
The new taxation drew criticism from the securities financing market, including the International Securities Lending Association (ISLA), which accused it of being unclear and a threat to German market liquidity.
Commented on the recent amendments, ISLA CEO Andy Dyson said: “We believe it’s important for the market to get clarity around these new rules and we believe the latest statement from the German tax authorities is a major step in that direction."
"We will of course continue to work with regulators and other stakeholders on this issue over the coming months.”
The Ministry of Finance’s latest draft responds to the four key areas first raised by ISLA and Eurex, as an acutely affected party, in a letter sent to the German Federal Ministry of Finance in early December 2017.
The four areas related to the transactions in scope; the tax base; the collection of tax; and double tax treaties.
In the letter ISLA stated: “Due to a lack of clear understanding across the industry, lenders may determine that the risk of lending securities is no longer low and therefore will withdraw from the market, rather than accept a higher level of risk or uncertainty.”
According to EY spokespersons acting on behalf of ISLA in the negotiations with the German ministry, in terms of the transactions in scope, only the income from securities lending and real repo transactions between a lending investment fund and any counterparty conducted over the relevant dividend record date are in scope.
Transactions completed before, or entered into after the dividend record date, in absence of a real dividend payment and therefore consequently in absence of the manufactured dividend payment, will be treated as out of scope.
For the tax base in accordance with the purpose of the manufactured dividend rule of preventing the potential for a tax arbitrage through substituting the 'genuine' dividends with manufactured dividends, the guidance 'caps' the tax base to the gross dividend the lender would have received if it had not lent the securities.
This ruling aims to ensure that lending fees and other income due to the lender from the transaction are subject to tax only insofar as the agreed-upon manufactured dividend is lower than the ‘genuine’ dividend.
For the collection of tax, the guidance states that the tax be collected by way of withholding, unless the borrower is a non-German resident, due to the fact that the German tax authorities cannot enforce the withholding obligation.
In such a case, the lender is required to file a German corporate tax return and declare the relevant income received before it is assessed by the responsible tax office.
The new guidance highlights that, even though the German borrower is required to withhold, the lender still has a filing obligation, if the borrower has not withheld as required.
EY noted in its analysis that the guidance statements regarding the mechanisms for the collection of the tax obviously take into consideration the concerns regarding the authority of the German tax legislator to impose a withholding obligation on a non-German borrower and the predictable deficits in enforcing and monitoring the compliance of such withholding obligations.
Regarding the the issues of double tax treaties (DTT), ISLA and EY highlight that “the guidance remains silent on the question”.
The guidance does clarify that the German borrower must withhold at the applicable statutory withholding tax rate, leaving to the lender to file a tax refund request, if it wishes to claim benefits under the applicable DTT.
When central counterparties (CCPs) are involved in the transactions by the way of contract novation interposed between the original borrower and lender, the guidance follows from an economic approach, that the interposition of the central counterparty between the original lender and borrower should be ignored.
The tax consequences of CCP-transactions should be the same as before the novation, meaning if there was still a direct legal contractual relationship between the original lender and borrower.
The German Federal Ministry of Finance is accepting comment on the new draft until 15 February.
The full guidance released by the Ministry (in German only) can be found here.
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