The Corporate Tax Planning Law Review: Germany
When it comes to corporate tax planning in Germany, the focus of multinationals has clearly shifted from offensive (or even aggressive) tax structuring to more robust structures and the reduction of risks and exposures (good corporate tax citizenship). The international tax initiatives against harmful tax planning, such as the BEPS project, and in its wake the EU anti-tax avoidance directives, have certainly contributed to this development, but it is also owing to domestic tax authorities becoming increasingly inclined to commence criminal tax proceedings in regular tax audits. Last but not least, the idea of tax planning as harmful caught full public attention through LuxLeaks and Panama Papers. As a result, multinationals must increasingly consider the reputational implications of their tax structures.
This chapter initially describes the general principles of corporate taxation and corporate tax planning in Germany (see Section II). The next section outlines some of the most important tax-planning developments in the German domestic market, such as the repatriation of German-sourced profits and the taxation of corporations holding German real estate (see Section III). Section IV deals with the status of German answers to international tax developments such as the denial of interest deductions in case of hybrid mismatches, changes to the CFC rule, the taxation of the digital economy and reporting obligations for cross-border tax planning. The chapter concludes with an outlook on what will likely be forthcoming hot topics.
International developments and local responses
As set forth in the EU Anti Tax Avoidance Directive (ATAD II), Germany is planning to implement new rules to target hybrid mismatches as well as changes to its CFC regime.
In mid-2020, mandatory reporting rules will enter into force, but any intermediary (i.e., any adviser) who helps taxpayers to set up cross-border arrangements must already be aware of the reporting requirements to at least be prepared and anticipate the new rules in terms of documentation and collection of information to be reported.
While there are not yet concrete proposals on what is referred to as the taxation of the digital economy, German tax authorities have increased, until priorities shifted to covid-19 challenges, their efforts on tax audits performed jointly with the tax authorities of other countries.
i Draft ATAD II Implementation Act
On 10 December 2019, the German Ministry of Finance published a first draft bill to implement Articles 5, 7, 8, 9 and 9b of ATAD II. Some of the proposals were modified in a second draft dated 24 March 2020. This Draft ATAD Implementation Act (the Draft AIA) therefore includes, inter alia, anti-hybrid provisions to cover hybrid mismatches.
Article 9 Paragraph 2 ATAD II applies to the deduction or non-inclusion of hybrid instruments like hybrid bonds or participation rights – where payments on hybrid instruments are deductible in the state of the payer (deduction) but the state of the recipient does not qualify the payments as taxable income (no inclusion). In this context, ATAD II recommends as a primary measure (response) denial of deduction at the level of the payer, and as a secondary measure (defensive rule) taxation of payments at the level of the recipient.
As of today, German tax law 'only' contains a defensive rule, which denies the tax exemption of (95 per cent of) dividends received as far as the payments were tax deductible at the level of the payer.
According to the Draft AIA, expenses on the use of capital are not deductible if the corresponding profits are not subject to a tax, which is comparable to German taxation. In these cases, the deduction is denied at the level of the payer (primary measure by way of denial of deduction). According to the explanatory notes to the Draft AIA, this will also apply to mismatches arising from cross-border compensation payments made in securities lending transactions or repo transactions. Furthermore, the new rules also apply to 'hybrid transfers' (i.e., to transactions in which the profit of capital assets is attributable to more than one person participating in the transaction).
The explanatory notes to the Draft AIA include the example of a cross-border repo transaction in which, under German law, the respective underlying is attributed to the German seller and, therefore, the payments under the repo were treated as (deductible) interest payments, whereas under the law of the state of the purchaser, the underlying is attributed to the purchaser and, therefore, the respective payments (dividends as well as profit from the repurchase) are tax exempt. In this case, the new law would, if enacted as proposed, deny the deduction of the payments in Germany at the level of the seller. The new rules would also apply in cases of cross-border securities lending transactions, where, in Germany, the underlying security is attributed to the German borrower but, in the foreign state, the underlying security is attributed to the foreign lender. In these cases, where a manufactured dividend payment would be deductible in Germany and tax-exempt (as a dividend) in the foreign state, the Draft AIA would deny the deduction of the payment in Germany.
The Draft AIA also applies to some other hybrid mismatch scenarios, in particular to another D/NI scenario – where 'reverse hybrid entities' are treated as transparent in their state of residency but are treated as opaque (and taxable entities) in the residency state of their shareholders, to double deduction scenarios – where expenses of the same taxpayer are deductible in two different states, and to imported hybrid mismatch scenarios. However, payments without a hybrid mismatch that benefit from low taxation or no taxation at the level of the recipient under the general tax regime of the state of the recipient should not be affected by the Draft AIA.
Last but not least the Draft AIA also contains a new, and, unfortunately pretty aggressive version of the long outdated German CFC rule. The new rule, if implemented, will have a wider scope. Not only the holders of shares but also the holders of certain equity capital instruments will qualify as related parties for CFC purposes. Non-tax resident shareholders can also be subject to the new CFC rule if they hold shares in a foreign corporation in a German PE. Under the new rule, interest income always constitutes passive income for CFC purposes, the taxpayer is no longer allowed to prove otherwise. In addition, dividend income constitutes passive income under certain conditions where, for domestic dividend payments, the German participation exemption rule would not apply. Most notably, dividends income constitutes passive income if the payments are tax deductible at the level of the payer or if the taxpayer does not own at least 10 per cent of the shares in the payer. However, the threshold of 25 per cent below which low taxation is assumed will not change (i.e., foreign passive income will be subject to the CFC rule if it is taxed at an effective tax rate below 25 per cent in the source state).
The Draft AIA has been criticised by commentators. It is, therefore, unclear when the final draft will be published and when and in which form (subject to covid-19) it will be passed by the legislator. Under the updated Draft AIA, only the new rules implementing ATAD II into German tax law, for example, the rules on hybrid mismatch arrangements, will come into force with retroactive effect as of 1 January 2020. The other new provisions will enter into force later, for example, the modified CFC rule will be applicable from the tax assessment period 2021 onwards. On 8 March 2020, the government agreed that the implementation should take place 'quickly' despite the implications of covid-19. The government is expected to pass the Draft AIA on 22 April 2020.
ii EU proposals for mandatory reporting of tax planning
On 5 June 2018, amendments to the Directive on Mutual Administrative Assistance 2011/16/EU were finally issued, according to which intermediaries, who help taxpayers to set up cross-border arrangements (which include in particular advisers on international corporate tax planning), are obliged to report these arrangements to their domestic tax authorities within a strict time frame. On 21 December 2019, the German legislator passed a bill implementing these changes into German domestic law. On 2 March 2020, the German tax administration published draft guidance on its interpretation of the new reporting obligations.
According to the new rules, an intermediary must report any cross-border tax arrangement that fulfils one of the 'hallmarks' either on a stand-alone basis (for certain hallmarks) or in connection with the main benefit test. The new provisions consider as an intermediary any person that designs, markets, organises or makes available for implementation or manages the implementation of a reportable cross-border arrangement. The German rules provide for a slightly narrower definition of the term 'intermediary' than the Directive.
The new law contains numerous so-called hallmarks, which describe all sorts of cross-border tax structures and their essential characteristics. Some of these hallmarks are particularly important for advisers. First, the use of a tax arrangement, which has a substantially standardised documentation or structure and is available to more than one relevant taxpayer without a need to be substantially customised for implementation, is mandatorily reportable. According to draft guidance, the German tax administration, however, takes the view that the sole use of standardised documentation for generic actions like the foundation of corporations, the issuance of loans and licences and the acquisition of financial instruments traded on stock markets do not constitute a reportable tax arrangement. Second, tax structures involving deductible cross-border payments between related parties are reportable in many cases. These structures must, inter alia, be reported if the payment is not subject to corporate taxation, for example, because the payment is tax exempt, it benefits from a preferential regime or the recipient-jurisdiction imposes for other reasons no taxes on it.
If the first step of the reportable cross-border tax arrangement has been implemented between 28 June 2018 and 30 June 2020, intermediaries must report the cross-border arrangement to the German tax administration until the end of August 2020. As of 1 July 2020, onwards, any reportable arrangement must be disclosed within the 30 days after the arrangement is made available for implementation, is ready for implementation or after the first step of the implementation has been made, whichever occurs first.
As of today, many aspects regarding the application of these new rules remain unclear. Furthermore, it is doubtful if the German tax administration will be able to deal with the reports forthcoming in August 2020, as there is no precedent for this reporting to tax authorities in Germany.
iii EU proposals on taxation of the digital economy
So far, the German Federal Ministry of Finance has not provided draft legislation to implement the European Commission's proposals on taxation of the digital economy. However, German commentators are already voicing concerns regarding the European proposals, focusing especially on a possible double taxation of income by the Digital Services Tax (DST) and value added tax, as well as by DST and corporate income tax. This double taxation can arise because the proposed directives themselves do not provide exemption or deduction rules. Calls for a taxation of digital businesses have recently become even more virulent, as due to covid-19 many local shops have to close whereas online shops are busier than ever.
iv Joint tax audits
The German tax authorities are increasing efforts to realise more and more joint tax audits (i.e., tax audits involving two jurisdictions carried out on the premises of multinational companies). So far, around 70 joint tax audits with German involvement have taken place. While such coordinated cross-border tax assessments can offer advantages to the taxpayers (such as avoidance of double taxation and certainty for future tax planning in general), many aspects still await clarification. Nevertheless, the growing number of (unsolved) mutual agreement procedures, especially pending in Germany, underlines the necessity for alternative dispute resolution approaches. Joint tax audits may offer such alternative ways to deal with international double taxation.
Outlook and conclusions
It should be expected that the requirements for a tax-efficient repatriation of profits from Germany into the investor's jurisdiction will remain in focus especially regarding repatriations into non-EU countries.
Share deals involving German-situs real property might become subject to tightened rules. The German legislator has been planning, for quite a long time, though, to expand the German RETT regime by lowering the threshold for harmful shareholdings in the company with the real estate from 95 per cent to 90 per cent, prolonging the holding periods from five to 10 years, and introducing a new provision regarding the transfer of shares in corporations that so far have not been subject to German RETT. Whether the German lawmakers will in fact implement the proposed tightening of the taxation of real estate transfers is unclear. If the amendments become effective as proposed, the impact on corporate tax planning involving German real estate would be substantial.
In respect of international tax developments, the mandatory reporting requirements for cross-border arrangements is probably still the hottest topic. It remains to be seen how the German tax administration will deal with the vast amount of reports taxpayers will submit as from August 2020 onwards. Another major topic in 2020 will very likely be the implementation of the ATAD into German law. The tax-planning community in Germany is excited to see how the German legislator will finally implement the anti-hybrid rules and the changes to the CFC rules into domestic law.
At the time of writing, any legislative developments are subject to measures tackling the covid-19 challenges. Hopefully, this will be off of the agenda when this chapter is updated next year.