German trade tax (Gewerbesteuer) is raised by local authorities with respect to economic activities carried out by permanent business establishments on the territory of a community/municipality. The idea is that these permanent business establishments should contribute to the cost of the local infrastructure they use. Trade tax has to be paid by all undertakings, irrespective of their legal status, if they are engaged in trading activities (gewerblich tätig) in the sense of trade tax and income tax law. Incorporated firms (Kapitalgesellschaften) are always considered to be engaged in trading activities. For partnerships (Personengesellschaft), a distinction is made with regard to their activity: if an undertaking is a partnership and it carries out exclusively asset management activities (vermögensverwaltend), it is not subject to trade tax. On the other hand, partnerships which are engaged in trading activities are subject to trade tax.

• no use of bank loans/no acceptance of collateral,

• no extensive separate organisation to manage the fund portfolio, office use not more than what a large private fortune would require7,

• no market exploitation using professional experience,

• no public offering/own-account trading,

• no short-term investment,

• no reinvestment of the proceeds of sale,

• no own commercial activity in portfolio companies (eigenes unternehmerisches Tätigwerden in den Protfoliogesellschaften),

• no commercial character or ‘commercial infection’ (gewerbliche Infektion)8.

According to the notification, Article 1 Section 19 of the MoRaKG includes a ‘clarification’ of the letter of 2003, and allegedly there is no substantial difference between the two.

• short-term sale of venture capital holdings and other holdings in companies with their legal domicile and corporate management in a State that is a contracting party to the Agreement on the European Economic Area,

• transactions involving money market instruments10; transactions involving bank deposits with credit institutions having their legal domicile in a State that is a contracting party to the Agreement on the European Economic Area; transactions involving investment participations11,

• advising a TE in which a VCC has a holding, granting loans and guarantees to a TE in which a VCC has a holding, taking out loans and issuing profit participation rights (Genussrechte) and bonds,

• reinvestment of proceeds from the sale of venture capital holdings and other holdings in companies having their legal domicile and centre of management in a State that is a contracting party to the Agreement on the European Economic Area,

• exploitation of a market using its professional experience.

Acquiring and maintaining its own business premises and a proper business organisation shall not prevent a VCC from being considered to conduct asset management activities. The activities under recital 16 above may, however, be carried out by a subsidiary which is wholly owned by the VCC.

The losses a company incurs in a tax year may normally be carried forward. This means that they may be offset against profits in future tax years. Loss carry forward enables those losses to be taken into account over the life cycle of a company. However, this can also lead to abuse in the form of ‘shell companies’ which are companies that have ceased their activities but are nevertheless sold since their loss carry forward represents a real value: purchasers of such shell companies benefit from an offsetting of future taxable profits and thus pay less tax depending on the applicable tax rate.

Germany introduced anti-abuse measures regarding the trafficking of losses in the German Corporate Income Tax Act (hereinafter: CITA). The Company Tax Reform Continuation Law of 1997 stopped the trafficking of losses in the form of shell companies. Germany tightened the anti-abuse measures by means of the 2008 Company Taxation Reform Act (Unternehmenssteuerreformgesetz 2008). This Act has an impact on all changes in direct and indirect shareholding of more than 25 % within five years. The CITA provides for a pro-rata deduction of losses if, within a period of five years, more than 25 % of the subscribed capital, membership rights, participation rights or the right to vote directly or indirectly is transferred to an acquirer. Unused losses are not deductible at all if within five years more than 50 % of the subscribed capital or of the above rights are transferred directly or indirectly to an acquirer.

The MoRaKG would relax the loss carry forward rules for TEs acquired by VCCs, as it would enable TEs with a significantly modified ownership structure to carry forward losses which would otherwise lapse under the basic rule.

• when the participation is acquired, the TE has equity of no more than EUR 20 million, or

• when the participation is acquired, the TE has equity of no more than EUR 100 million and the increase in equity in excess of EUR 20 million derives from annual profits in the four financial years preceding the sale,

• the period between the purchase and sale of the participation in the TE by the VCC is at least four years.

Up to one fifth of the loss deductible may be deducted under the arrangements for the deduction of losses of the Income Tax Act in the year of acquisition; in each of the following four years this figure shall increase by a further fifth of the deductible loss.

The MoRaKG aims to encourage private investors such as business angels to invest in TEs by offering tax advantages for the profits derived from their investment.

According to Article 1 Section 20 of the MoRaKG, the capital gains on the sale of shares in a TE shall be divided proportionally among the investors according to their participation. The resulting amount is taken into account for the income taxation of the private investors/business angels.

The tax advantage would only take effect in the event of a realised capital gain. The participation of private investors/business angels in TEs must be between 3 % and 25 % at any moment within the preceding five years with a maximum holding time of ten years. Each private investor/business angel is entitled to tax-free profits of up to EUR 50 000 (EUR 200 000 times 0,25) per investment, which corresponds to the maximum participation of 25 %. Hence the maximum tax advantage per business angel and per investment is approximately EUR 22 500, according to Germany’s calculations. The tax advantage would be proportionally reduced for profits above EUR 800 000 per investment, and fully disappear if total profits reached EUR 1 000 000.

The formal investigation procedure has not dispelled the doubts of the Commission concerning the alleged legal ‘clarification’ in the MoRaKG of the letter of 2003 with regard to the exemption from the liability for trade tax.

Germany estimates that this measure will imply a yearly loss of tax revenue of EUR 90 million. It explains this loss by fewer ‘faulty contractual arrangements’. The Commission does not find this justification convincing. It is indeed hard to believe that venture capital companies have such a bad knowledge of tax law that they cannot avoid such ‘faulty contractual arrangements’ and the corresponding tax liability. Furthermore, the Commission’s view is clearly confirmed by third parties, as BVK finds that the MoRaKG will further contribute to uncertainty in the sector.

In any case, the Commission notes that it is undisputed that the measure would imply a loss of State resources which would otherwise (in the previous situation) have accrued to the State. The Commission therefore concludes that the measure is granted from State resources.

• VCCs may find investors through marketing to a wide public, while this is excluded in the letter of 2003,

• VCCs may have business premises and organise their activities in a ‘business like’ (geschäftsmässig) manner, while the letter of 2003 prevents them from having a ‘substantial own organisation’ and limits the number of employees and office use to what a ‘large private fortune’ (privates Großvermögen) would normally require,

• the MoRaKG does not explicitly exclude VCCs from having a commercial activity in portfolio companies, while the letter of 2003 does not allow ‘commercial activity in portfolio companies’ as stated in recital 13.

The comments received during the formal investigation have not dispelled these doubts. Hence the Commission must conclude that the MoRaKG enlarges the potential group of beneficiaries who are not liable to trade tax as some VCCs which, under the letter of 2003, were liable to trade tax may possibly be exempt from trade tax under the MoRaKG. Therefore, the measure under examination grants a tax advantage to certain VCCs in that it allows them to carry out certain activities and still enjoy the tax liability exemption, unlike all other VCFs/PEFs, which are only subject to the letter of 2003 and would therefore become liable to tax if they carried out these activities.

Moreover, the measure grants a selective advantage only to certain VCCs falling under the scope of the MoRaKG as compared to VCFs/PEFs. Indeed, VCCs benefit from this measure only if they comply with the definition set out in the MoRaKG. Hence VCFs/PEFs with less than 70 % of their total assets in equity holding in TEs may not benefit from the measure even if they carry out substantially identical activities. The same reasoning holds for VCFs/PEFs which do not have both their legal domicile and their corporate management in Germany. As a result, VCFs/PEFs that only have a permanent business establishment in Germany cannot benefit from the MoRaKG, even if they carry out exactly the same activities as VCCs.

Therefore, only companies which belong to this limited group are relieved, by means of State resources, of a part of their operating costs (namely liability for a certain tax) which they would normally have to bear under the current legal framework. The beneficiaries of this advantage are essentially active in the provision of private equity and venture capital and are in competition with other providers established in Germany or other Member States. Consequently, this fiscal measure, by increasing the financial means available to the beneficiaries to carry out their activity, strengthens their position in relation to their competitors in the EU. The aid measure is therefore capable of affecting competition and trade between Member States.

The Commission therefore concludes that the notified trade tax measure constitutes State aid to certain VCCs within the meaning of Article 87(1) of the EC Treaty.

As stated under point 4.2, Germany agrees in principle that the re-establishment of loss carry forward for VCCs investing in TEs is selective and favours TEs and VCCs. However, Germany argues that VCCs and TEs were differentiated in an acceptable and practical manner and that the distinction is justified by objective differences between taxable persons in compliance with paragraph 24 of the Notice on Business Taxation (which states that some differentiations in the tax system may be justified by objective differences between taxpayers), because the introduction of the general restriction on the exploitation of tax losses in 2008 hit the venture capital market particularly hard.

First, the Commission emphasises that the measure is clearly linked to a loss of State resources and is therefore granted through State resources. This tax loss benefits TEs and VCCs since they are the beneficiaries of this measure. The more generous terms for tax deduction of loss carry forward which apply to TEs if they are acquired by VCCs constitute an economic advantage for these two groups of companies as it allows them to realise tax savings. Indeed, TEs benefit from loss carry forward since it enables them to offset a loss and thus pays less tax, which would otherwise be excluded by the anti-abuse rules. VCCs are also almost direct beneficiaries in the sense that other purchasers cannot benefit from the additional offsetting.

As the tax saving is essentially only available if VCCs invest in TEs, the measure also favours TEs indirectly. Indeed, it constitutes an incentive for VCCs to invest in TEs rather than other companies that may be targeted by venture capital investors on the basis of purely economic considerations. TEs are thereby in a position to receive risk capital in amounts and under conditions that would not have been the case without the measure. The measure is thus capable of indirectly reinforcing the capital base of TEs.

It also seems appropriate to reject Germany’s argument according to which, even if it cannot be excluded that the definition of TEs covers firms in difficulty, this measure does not represents an advantage for such companies. Indeed, Germany argues that if a TE is in difficulty, it will not make profits that would offset its losses and could be taxed. So it is irrelevant whether or not such a firm can exploit the losses of earlier periods. As a result, according to Germany, the MoRaKG does not offer any advantage to firms in difficulty as defined by Community law. The Commission finds that this argument is not plausible, since an acquirer of a firm in difficulty or of a ‘shell company’ may in fact be particularly interested in the loss carry forward for tax purposes.

These advantages are capable of affecting trade and competition. For VCCs, the Commission examined this requirement with regard to the trade tax rule in recital 71. With regard to TEs, the Commission notes that these companies can operate in any economic sector, including those that involve or could involve intra-Community trade. Therefore, the economic advantage granted to them is apt to affect competition and trade between Member States.

Secondly, the Commission notes that the measure is undisputedly selective.

Thirdly, the Commission finds that Germany has not succeeded in demonstrating that the measure is compatible with the nature and logic of the German tax system. Even if it were true that the venture capital market were particularly affected by the restriction on exploitation of tax losses and thus justified special treatment, the Commission finds that the distinction drawn up by Germany between taxpayers is not justified by this reasoning since only part of the venture capital sector is exempted from the prohibition on loss carry forward. If Germany’s claims were correct, there would be no objective reason for non-VCCs not to benefit from the measure when they invest in the same TEs. However, non-VCCs only benefit from the measure in the rare case when they acquire a participation in a TE from a VCC. These views are also confirmed by BVK’s comments in point 5.2.

Moreover, the measure does not seem to comply with the nature and logic of the German tax system as Germany has not demonstrated why VCCs would be particularly affected by the restriction on the exploitation of tax losses when they invest in TEs and not when they carry out the same activity of providing capital to other companies such as partnerships which might also have difficulties in accessing risk capital (notably young innovative companies).

The Commission notes furthermore that when Germany tightened the anti-abuse measures on loss carry forward by means of the 2008 Company Taxation Reform Act, as stated in point 2.4.1, it set out the new general tax regulation in this area. By allowing more generous terms for loss carry forward for a selected group of companies, these anti-abuse measures would be partly reversed; this does not seem to be justified by the nature and logic of the tax system in force since 2008.

The Commission therefore concludes that the notified measure on loss carry forward constitutes State aid to TEs and VCCs within the meaning of Article 87(1) of the EC Treaty.

As stated under point 4.3, Germany claims that since the beneficiaries are natural persons, the measure cannot constitute State aid. Germany also claims that the measure has no verifiable and quantifiable advantage for TEs and hence has no impact on the price of shares. The tax amount saved by private investors is quite small and granted only in the event of a successful exit by the investor. Therefore, as Germany argues, the measure is likely to have only a limited incentive effect for individuals to invest in TEs. Hence it would also have a limited distortive effect on competition between TEs and non-TEs.

As stated under point 2.1, this measure implies a loss of State resources estimated by Germany at EUR 30 million per year. The measure is therefore granted through State resources.

Therefore, the Commission concludes that the income tax benefit measure is selective and favours a limited number of companies by giving them better access to risk capital than under normal market conditions. This advantage is granted through State resources because it is basically the loss of tax revenues that creates the market incentive for private individuals to provide capital to TEs rather than to other enterprises that would normally have been targeted on the basis of the prospects of return on the investment that they offer.

The extent to which this aid could affect competition and trade between Member States is set out in recital 77 above.

The Commission therefore concludes that the modified income tax benefit measure constitutes State aid to TEs within the meaning of Article 87(1) of the EC Treaty.

By notifying the MoRaKG before implementing it, the German authorities fulfilled their obligations under Article 88(3) of the EC Treaty. Given that all the measures in the MoRaKG pursue a common objective of supporting the provision of private venture capital to companies, the Commission analysed their compatibility with the common market on the basis of the rules established in the RC Guidelines.

As stated in point 7.1.1, the trade tax measure constitutes State aid to VCCs. However, this measure does not explicitly provide incentives to VCCs to undertake risk capital investments, it merely enables them to have greater financial resources at their disposal, that they may use for any purpose (i.e. increased benefits distribution to their partners).

Unlike the present measure, under the RC Guidelines, State aid in the form of risk capital cannot be granted to large enterprises, firms in difficulty or firms in the shipbuilding, coal and steel industry. The trade tax measure, on the other hand, could benefit such undertakings, especially large enterprises. Therefore, the scope of this measure is not compatible with the Guidelines.

The measure cannot be considered to be compatible with Chapter 4 of the RC Guidelines because the specific conditions for the application of this Chapter are not fulfilled. For instance, Chapter 4 requires that the maximum level of investment tranches may not exceed EUR 1,5 million per beneficiary over a period of 12 months. The measure under examination does not contain such a ceiling. Moreover, the RC Guidelines also require that the measure be restricted to providing financing up to the expansion stage for small enterprises or up to the early stage for medium-sized enterprises. These provisions are not met because TEs can be large undertakings.

The measure does not comply with the cumulation and reporting requirements set out in Chapter 6 and point 7.1 of the RC Guidelines.

Finally, the Commission is not in a position to assess the measure’s compatibility under Chapter 5 of the RC Guidelines. Indeed, according to the RC Guidelines, State aid must target a specific market failure for the existence of which there is sufficient evidence. Germany has not submitted any evidence that TEs are affected by a particular market failure.

The Commission therefore concludes that the trade tax measure is not compatible with the common market.

As set out in point 7.1.2, the measure on loss carry forward constitutes State aid at VCC and TE level. The form of the aid measure is a fiscal incentive within the meaning of point 4.2(d) of the RC Guidelines.

For the same reasons as highlighted above in recitals 92, 93, 94 and 95, the Commission cannot consider the present measure to be compatible with the common market as it meets neither the exclusion criteria of point 2.1 of the RC Guidelines, nor the cumulation and reporting requirements referred to in Chapter 6 and point 7.1 of the Guidelines, nor the conditions set out in Chapter 4 of the Guidelines; neither is there any evidence of a particular market failure affecting TEs and VCCs that would allow the Commission to launch a detailed assessment of the compatibility of these measures under Chapter 5 of the RC Guidelines.

This measure does not exclude the purchase of existing shares (replacement capital) in TEs. Replacement finance is, however, excluded by the definition of venture capital in the RC Guidelines.

Furthermore, the Commission notes that restricting the tax advantage to VCCs investing in incorporated enterprises appears to contradict the declared objective of the measure, namely to promote risk capital. Indeed, young innovative companies in need of risk capital might take legal forms other than that of incorporated companies. Hence, young innovative companies in the form of a partnership would not benefit from the measure.

The Commission therefore concludes that measure on loss carry forward is not compatible with the common market.

As set out in point 7.1.3, the income tax benefit measure constitutes indirect State aid at TE level. Since the measure creates incentives for private investors to invest in TEs, it may favour risk capital investments pursuant to point 4.2(d) of the RC Guidelines.

For the same reasons as highlighted above in recitals 92, 93, 94 and 95, the Commission cannot consider the present measure to be compatible with the common market as it meets neither the exclusion criteria of point 2.1 of the RC Guidelines, nor the cumulation and reporting requirements referred to in Chapter 6 and point 7.1 of the Guidelines, nor the conditions set out in Chapter 4 of the Guidelines; neither is there any evidence of a particular market failure affecting TEs and VCC that would allow the Commission to launch a detailed assessment of the compatibility of these measures under Chapter 5 of the RC Guidelines.

Therefore, the Commission concludes that the income tax benefit measure as it stands cannot be considered compatible with the common market on the basis of the RC Guidelines. However, the measure should have only a limited distortive effect on competition between TEs and non-TEs given that the incentive granted to individuals for providing capital in favour of TEs is relatively limited and thus presumably the advantage granted to TEs will also be limited. Moreover, the measure is capable of having a general positive effect in the sense of stimulating the provision of risk capital to companies which may be in need of risk capital, on the basis of a proper economic assessment. Indeed, private investors will select the TEs at issue on the basis of the prospect of making a return on their investment. Therefore, the Commission finds that the measure may be adjusted to the requirements of the RC Guidelines by ensuring that the conditions in Article 3 below are met.