Investment Funds Held Across the German-American Border

The Investment Tax Act reaches fund units irrespective of where the fund is established. A German resident holding an American index fund in an American brokerage account is taxed under it exactly as a holder of a German fund would be.

The charge has three elements: distributions, the annual deemed minimum return, and the gain on disposal, each reduced by the partial exemption that depends on the fund’s equity content. The deemed return is the element that surprises, because it arises in a year in which nothing was sold and nothing was distributed. It is capped at the actual increase in value, so a falling market produces none, but a rising market produces a cash tax liability on an unrealised gain.

Because an American broker withholds nothing for Germany, the income is declared on the German return and assessed afterwards, rather than settled at source as it would be with a German bank. The flat rate is 25 per cent plus the solidarity surcharge, a combined 26.375 per cent, and church tax where applicable. The saver’s allowance is 1,000 euros, or 2,000 euros for a jointly assessed couple.

Since 1 January 2025 fund units can also fall within the German exit tax where the conditions of section 19(3) InvStG are met, which is a further reason to settle the position before a move in either direction.

A passive foreign investment company is a foreign corporation of which 75 per cent or more of gross income is passive, or 50 per cent or more of assets produce passive income. Essentially every non-American mutual fund, UCITS and exchange-traded fund meets the test.

The default regime allocates excess distributions and disposal gains across the holding period, taxes each earlier year at the highest ordinary rate then in force and adds an interest charge for the delay. Form 8621 is filed for each holding, which for a portfolio of a dozen European funds means a dozen forms.

The elections that would improve the position are usually unavailable in practice. The qualifying electing fund election requires annual information European funds do not supply, and the mark-to-market election is open only to marketable stock. Holding American funds through an American broker avoids the regime entirely, where that remains possible, but brings the German Investment Tax Act charge instead.

Relief from double taxation runs through the foreign tax credit, and a credit requires tax on the same income in the same year. The German deemed return is taxed in a year in which the American system recognises nothing, so there is no American liability for the German tax to be credited against. The American charge on disposal then falls in a year in which the German tax has already been paid and possibly expired for credit purposes.

This is not a drafting gap in the treaties but a consequence of two systems recognising income at different moments. Neither the income treaty of 29 August 1989, as amended by the protocol of 1 June 2006, nor the estate and gift treaty addresses it.

The practical consequences follow from that. Individual securities, rather than funds, sit in both systems without either regime applying. Where funds are held, the choice of jurisdiction for the fund should follow the holder’s residence rather than the adviser’s habit. And a portfolio assembled before a move is worth reviewing before the move rather than after it, because a disposal made while still resident in one country is taxed under one system only.

There is no fund that is tax-efficient on both sides of this border. Germany taxes the holder annually on a return the fund has not paid, and the United States taxes the holder of a foreign fund under a regime whose escape routes European funds cannot satisfy. Because the two charges fall in different years, the foreign tax credit does not reconcile them, and the decisions that matter are taken before a change of residence rather than after it.