On 2 December 2016, the Act for the implementation of the amendments of the EU Administrative Cooperation Directive and of further measures to counter base erosion and profit shifting - having been approved by the Lower House of Parliament (Bundestag) on 13 July 2016 - with some amendments also passed the Upper House of Parliament (Bundesrat). It was published in the Federal Law Gazette on 23 December 2016 and therefore has become the new law in Germany. The act is supposed to be a first step of the German tax legislator to implement the outcome of the BEPS Action Plan published by the OECD into German domestic tax law. In the following, we briefly outline the main changes with relevance for multinational companies.
Under the new legislation, CbC reporting obligations apply to all German-based multinational groups (i.e. groups with at least one non-German parent/subsidiary or permanent establishment). The parent of the multinational group (i.e. the Reporting MNE) is obliged to file a CbC report to the German Federal Tax Office (Bundeszentralamt), provided the consolidated revenue of the group amounts to at least EUR 750 million. This obligation applies for the first time to the first FY commencing after 31 December 2015.
A German-based member of a multinational group headquartered in another country is not subject to the filing of a CbC report, in general. It is anticipated that the German Federal Tax Office will be provided with the respective CbC report via the exchange of information process. However, the foreign parent of the multinational group may also order the local group member to submit the report on their behalf to the Tax Office. Furthermore, in situations where the German Federal Tax Office is not able to obtain the CbC report filed by the foreign parent in its country of residence, the local group members are obliged to provide the report to the Tax Office. This obligation does not arise where the local group members do not have access to the report prepared by the parent; in this case they need to notify the Tax Office accordingly within a certain time frame. These "surrogate filing" alternatives apply to financial years commencing after 31 December 2016 only.
CbC reports are to be submitted within 12 months after the ending of the FY to which it relates. Furthermore, any German company needs to declare in its tax returns, whether it is:
- The Reporting MNE (i.e. parent of a multinational group)
- Delegated by a foreign MNE parent to file the CbC report in Germany on its behalf
- As a member of a multinational group included in a CbC report filed in a foreign country; if so, information needs to be provided on who and where the CbC report will be filed or has been filed
These notification requirements also apply to German permanent establishments of a foreign parent or member of a multinational group. Non-compliance with the filing obligations may lead to a penalty of up to €5,000.
Exchange of information
The main background of the act is to implement the amendments of the EU Administrative Cooperation Directive in German domestic tax law. This Directive now covers in particular the obligation to automatically exchange information about mutual agreements and binding rulings relating to cross border transactions , transfer pricing arrangements agreed between the tax authorities and multinationals , and the CbC reports.
The information exchange is quite comprehensive and also covers any mutual agreement following a tax field audit. The tax authorities are enabled to request additional information on a case-by-case basis. However, in case a bilateral or unilateral transfer pricing arrangement relates to a third country, an exchange of information amongst the member states of the EU is only permissible if the double tax treaty (DTT) concluded by the respective member state of the EU and the third country allows such information exchange and the competent authority of the respective third country has agreed to the information exchange.
Trade tax treatment of passive income derived by a CFC
In any case of a German outbound-investment the rules on controlled foreign companies (CFCs) are to be observed. These rules aim at including income generated in a non-German entity controlled by German investors in the German tax base of the investors, provided certain criteria are met. These criteria are, in brief: a significant shareholding by German investors (in general more than 50%), generation of certain "passive" income of the CFC, low taxation of the respective income in the foreign country. If these criteria are met cumulatively, the income derived by the CFC is allocated to its German investor(s) in proportion of their participation.
The German Federal Fiscal Court (decision dated 11 March 2015) concluded that this income inclusion applied for German corporate tax purposes only, but not for trade tax purposes. Rationale for this decision was that, in general, only income sourced within Germany is subject to German trade tax.
In order to counter this decision the new law contains an amendment of the German CFC rules: In the future, any CFC income is deemed to be derived within Germany despite its actual source; thus, it will be subject to trade tax as well.
Trade tax treatment of passive income derived by a foreign PE or partnership
Under most of the DTTs concluded by Germany, any income through a foreign permanent establishment (PE) is exempt from German taxation. By overriding the treaties, § 20 (2) FTA prescribes that the exemption may be replaced by an inclusion of income combined with a crediting of foreign taxes. This applies if any income of a foreign PE was subject to CFC income inclusion (see above) had the PE been a controlled foreign company.
Prior to the law change now enacted this "switch-over clause" did not have to be observed for the determination of the trade tax base - again going back to the principle that only income sourced within Germany should be subject to trade tax. The new law now considers any low-taxed passive income - disregarding of its actual source - to be derived in a German PE, thereby subjecting it to trade tax as well. This applies disregarding the existence of any DTT; it is, however, not applicable to cases where the foreign PE or partnership carries out own genuine economic activities relating to the passive income.
A number of German taxpayers have used non-German partnerships for tax optimization of certain income (e.g. royalty, rental income). In view of the above law change these structures may - without according adjustment - no longer lead to the desired result in the future.
Trade tax treatment of dividends received in fiscal unity
In general dividends received by a German corporation are effectively 95% exempt from corporate tax in Germany. For trade tax purposes , under certain conditions dividends are deducted from the tax base by way of specific abatement (Kürzung) if certain prerequisites are fulfilled. However, the initial amount for the trade tax base is the income determined for corporate tax purposes where, in case of a stand-alone company, the 95% dividend income exemption is already factored in. Therefore, for trade tax purposes no (further) deduction of the dividend is to be considered.
Within a fiscal unity the income determination for corporate tax purposes takes place individually at level of each entity of the group, but the dividend income tax exemption is (cumulatively) applied at parent level. Hence, at subsidiary level the dividend income is fully included in the initial amount of the trade tax base. Therefore, on 17 December 2014 the Federal Fiscal Court decided that dividend income is to be fully deducted from the trade tax base without any add-back for non-deductible items. Bearing the high amounts at stake this (albeit small) tax reduction used to form an interesting planning opportunity for multinational companies.
The new law now changes the German Trade Tax Act in order to subject also the dividend income derived by a subsidiary in a fiscal unity to the 5% add-back for trade tax purposes. Hence, in order to achieve a similar trade tax benefit as obtainable in the past, other structuring alternatives need to be pursued.
Adjustment of unilateral switch-over clause
The German tax laws - inter alia - contain a unilateral switch-over clause relevant for double treaty cases where under the provisions of the treaty in Germany income is to be exempted from tax but - due to a different interpretation of the respective DTT - in the source country likewise is tax exempt or taxable at a reduced tax rate only. In these cases of qualification conflict, the laws prescribe - by way of treaty overriding - that the exemption method be replaced by the credit method in order to avoid double taxation.
In two decisions (dating 20 May 2015), the Federal Fiscal Court refused to apply the switch-over if only items of income remained untaxed or taxed at a low rate and not the income in its entirety. The new law now includes a clarification that the switch-over clause is to be considered even if in the source country only parts/items of the income are not subject to tax or subject to a low tax due to a qualification conflict. The same is supposed to apply to switch-over clauses included in DTTs concluded by Germany.
Treatment of special business expenses
The German taxation concept for partnerships - leading to an inclusion of certain income and expense items incurred at partner level - has often been used for German inbound planning to create deductions of business expenses at the German partnership level without inclusion in the tax base of the partner resident in a foreign country (D/NI case) or a double deduction at the foreign partner's level (DD case). A new rule has been introduced in the German Income Tax Act aiming at a prevention of such D/NI and DD cases resulting from the German taxation concept for partnerships. Therefore, taxpayers which have used the German partnership rules to claim an expense deduction in Germany might have to adjust their structures to safeguard the intended result.
Anti-treaty shopping for dividend stripping
In the past dividend stripping structures have been implemented aiming at the application of a reduced withholding tax rate provided by a DTT on dividends paid by a German corporation. One main feature of these structures used to be a short-term transfer of shares prior to a dividend payment to a person who was eligible to a reduced withholding tax rate with a re-transfer of the shares subsequent to the dividend payment to the initial shareholder who was not entitled to such reduced withholding tax rate. The German tax legislator now introduced a minimum shareholding period which is required to be fulfilled if a person desires the application of a reduced withholding tax rate. This new rule constitutes yet another treaty override rule to avoid illegitimate DTT benefits.
Outlook: Only the first step
The new legislation is the first measure of the German tax legislator to incorporate certain parts of the BEPS Action Plan in German domestic tax law. Obviously the new legislation covers only some of the topics discussed by the OECD. For the near future in particular the implementation of the European ATA Directive will direct the conversion of BEPS Actions in German tax laws. A major further change in German tax law is expected by the implementation of an anti-hybrid mismatch rule.
Furthermore, the German tax legislator initially intended to incorporate a new rule into German tax laws resulting in the taxation of any capital gain in case of a disposal of shares by a non-German taxpayer in a German company that predominately (over 50%) owns domestic real estate. This proposal did not make it to the final version of the law. However, as it is generally in line with the allocation of taxation rights under the DTTs recently concluded by Germany and, likewise, the OECD model tax treaty, the proposed change in German tax law is likely not to be "off the table" but just postponed.
For further details, please contact the authors.