Germany could face fund exodus

A move by the German government to attract investments through tax changes could backfire and trigger a large withdrawal of funds from the country by removing a tax break on long-term holdings, according to a German fund manager.

Under the new regulation, expected to begin in 2009:

The corporate tax will be cut from 38.6 per cent down to 29.8 per cent.

To help recoup some of the loss in tax revenues, all investors will be forced to pay a 25 per cent withholding tax on dividends generated by investments regardless of their duration.

Government officials expect the reform will cost the German state 5 billion euros (about U.S. $6.76 billion) a year, for the first four to five years; but say it will also empower the economy.

Helmut Knestel, a fund manager at Bavaria-based German Capital Management AG, is less sanguine about the benefits of the new regulations:

A 100,000 euros (about U.S. $135,332) investment, for example, in a fund yielding 8 per cent a year for the next 30 years could turn into about 900,000 euros (about U.S. $1,218,046) with the current tax regime.

Under the reformed system, however, investors could end up with just 650,000 euros (about U.S. $879,669).

As a result, investors will take steps to protect their investments before 2009, says Knestel:

Long-term investors are likely to avoid the tax by increasing their investments in funds before the end of 2008.

They may also choose funds of funds to avoid paying out 25 per cent tax every time they change investments.

Others will look abroad for opportunities in what he said could result in a significant capital exodus from the country, which has already suffered in the last few years from competition from countries such as Luxemburg.

Source: Germany could face 'fund exodus' with tax reform due in 2008/09 – fund manager, Forbes, May 10, 2007.

For text: http://www.forbes.com/business/feeds/afx/2007/05/10/afx3705729.html

For more on International Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=26

FMF Policy Bulletin/ 15 May 2007