Venture capital is (still) booming in Germany. Not as in the US or in the UK, but nonetheless remarkable.

Here are a few comments from a German tax law perspective, if you intend to act as business angel for a German start-up (in Berlin, Cologne, Munich, Hamburg, Bremen or whereever across this country). Or if your business is looking for seed financing from VC funds or business angels.

  1. An interest rate of nil might cause German tax issues. Not SAFE (SAFE being a common US standard for CLA’s). German tax inspectors might take the view that the loan was granted for free. The use of funds free of charge could trigger a deemed taxable advantage of 5.5% p.a. of the loan amount under German gift tax laws. Each party to such agreement can be held liable to such tax charge.
  2. Upon conversion of the loan receivable into equity, the investor may be able to profit from a tax privilege. Hence, if strcuctured correctly the “profit” from converting into equity at a discount to the shares’ fair market value (e.g. 20%) should not trigger German (capital gains) taxes. (And no corporate income tax, if the investment is made through a personal holding vehicle.)
  3. If investing from abroad, please check you local tax laws. As a principle under international tax laws, the country of your (primary) residence has the right of taxation. Tax treaty to be analysed.
  4. Be aware of the “dry income” trap for any interest amounts, even if not actually paid. If the CLA wording gives the investor a claim to request (annual) payment of interest amounts prior to conversion, this can be deemed taxable interest income in Germany. Non-residents may be lucky, as such interest may not be taxable for non-residents in Germany (depending on the CLA structure however, especially on granted collaterals).
  5. Finally, from a legal perspective: To notarize or not to notarize? In practicality, most CLA’s are not signed in front of a German notary. But a German public notary will tell the investor that there are good reasons to collect a notarization in order to be able to enforce a conversion right into equity in a German GmbH. Hence, a choice to be made.