German tax U-turn to bolster domestic startup scene

When German finance minister Wolfgang Schäuble revealed his plans for a reform of the national investment taxation, they contained a suggestion to impose higher taxes on capital gains made from diversified holdings below 10%.

Angel investors feared they could lose money if these changes went through, as they often hold smaller shares in companies. Financial backers are able to sell their diversified holding profitably, while paying almost no taxes on the transaction, provided they reinvest their surplus. DLA Piper partner Martin Heinsius explains: "Often, business angels set up a holding through which they invest in startups. If the investment is not working capital, but fixed assets, then 95% of their profits remain tax free."

Indirect consequences
While venture houses would not have been directly affected by the proposed changes to taxation law, they could have felt the effects as well, because angel investors help companies to grow to a stage where an investment for venture capitalists becomes interesting. They inject cash at the very beginning of the business, when risk is at its highest. Only one in 10 German startups grows into a successful business; a third of them receive funding from angel investors.

The notion of increasing taxes has been dropped and the legislature now plans to increase its support for business angels and venture capital. The plans centre around INVEST, a federal initiative that provides subsidies for venture capital investments. The German government claims the programme has led to €100m of capital injections between May 2013 and August 2015.

INVEST allows for government subsidies of 20% on investments from individuals and corporations if they commit at least €10,000. The expansion will see the maximum investment sum for those subsidies raised from €250,000 to €500,000. It will also mean higher attributable allowances in cases of financial loss at divestment.

The controversial topic of taxes on capital gains from diversified holdings will be defused through the federal initiative as well. Although the investors still have to pay the tax initially, they will be able to reclaim it through INVEST.

Not far enough
BVK, the German private equity and venture capital association, is happy about the government's change of mind, but finds the plans not far-reaching enough. In a statement, the association's chairperson Peter Güllmann said: "In its coalition agreement, the government spoke out in favour of better conditions for equity and venture capital. We can see some progress, but it is still not enough to attract foreign capital and to strengthen the German venture capital funds."

Higher taxes on capital gains have been on and off the table for several years now, but were always scrapped in the face of strong opposition from investors and startups. Heinsius explains why the topic won't disappear that easily: "The reason for the planned changes was a ruling by the European Court of Justice that domestic and foreign funds have to be treated equally. Current law in Germany allows a tax exemption for domestic funds, while those from abroad have to pay corporate tax on dividends."

Natural selection
Sven von Loh, who advises founders on their business models, was not a supporter of the proposed higher taxes on capital gains, but he does not believe they would have scared off investors. Rather, it could have helped to separate the wheat from the chaff: "In the end, the higher taxes would only affect those startups with a weak business concept. Great business concepts will always find funding, regardless of the circumstances."

Looking at the German investment landscape as a whole, tax reforms point towards a wider problem that venture capital and private equity investors have been criticising for a long time: frequent changes to laws that affect investors makes involvement in German companies less attractive.

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