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.
- 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.
- 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.)
- 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.
- 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).
- 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.