Germany Facing Up To Hedge Fund Phenomenon - Maybe

by Ulrika Lomas, Tax-News.com, Brussels

10 July 2003

The German Ministry of Finance is about to release details of its proposed new regime for investment funds, which will attempt to address the legal and tax disadvantages suffered by investment funds - including especially hedge funds - under the current laws.

The Ministry is planning two specific bills: The Investment Act 2003, which will restate the Law on Investment Companies (KAGG) and the Law on the Sale of Foreign Investments (AIG); and an Investment Tax Act 2003 which will lay down the rules for the tax treatment of investments in funds in Germany.

Among much else, the laws, which are scheduled to become effective at the beginning of 2004, will provide the legal foundation for establishing and selling hedge funds in Germany. The Investment Act, details of which the Federal Ministry of Finance plans to announce in July 2003, will contain a special section with regulations for hedge funds. This will enable creation of the first legal framework for hedge funds in Germany. Thereafter shares can be sold in hedge funds launched by both domestic and foreign companies - both leveraging and short selling will be permitted.

The law will distinguish between single hedge funds and funds of hedge funds. It's expected that shares of a single hedge fund may not be sold to retail investors, but shares of a fund of hedge funds may be sold without restriction. No distinction will made between domestic and foreign funds in this respect (what would have been difficult under EU rules). Nor is it planned to put restrictions on particular strategies. A sales prospectus will have to be issued for funds of hedge funds, but not for single hedge funds.

Among other things the sales prospectus will have to name the individual target funds in which the fund-of-funds manager invests. In addition, the manager will need to pay special attention to controlling and monitoring the target funds. The fee structure of the fund of hedge funds will also have to be disclosed. The Ministry of Finance also indicated that the prospectus must contain an explicit warning concerning the risk of total loss of the investment in hedge funds.

Although details of the Investment Act 2003 are already fairly well defined, the terms of the Investment Tax Act 2003 are still very unclear. Major changes are needed to the current tax treatment of investment fund products, and it is as yet quite unclear that the authorities are willing - or indeed able, given current fiscal difficulties - to be as brave as market conditions require.

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