Shortly before the end of the current legislative period, the lower house of the German parliament (Bundestag) passed two significant tax bills: on 21 May 2021 both the ATAD Implementation Act (ATAD-IA) and the Corporate Income Tax Modernisation Act (CIT-MA) were approved. The required approval of the upper house of German parliament (Bundesrat) is considered to be a formality and is expected by the end of June this year.
ATAD Implementation
The implementation of the EU Anti-Tax Avoidance Directive 2016/1164 (ATAD) into German tax law has been controversial from a political perspective for a long time. The German Federal Ministry of Finance (BMF) had already presented a draft bill in December 2019 (for further details see here), followed by a revised version in March 2020 (for further details see here). According to reports, the two main points of contention within the government coalition were the low tax threshold within the ‘Add Back Taxation’ rules (that is the German controlled foreign company or ‘CFC’ rules) (Section 8(5) German Foreign Tax Act (GFTA)) and the comprehensive revision of the so-called ‘Departure taxation’ rules pursuant to Section 6 GFTA, which were not required by the ATAD. Under the ‘Departure taxation’ rules, if German unlimited tax liability ends due to an expatriation (or the realisation of substitute provisions), this leads to a deemed disposal of shareholdings in a company of at least 1% held as private assets. In March 2021, the governing parties reached an agreement on both points, in each case to the detriment of the taxpayer. Following the decision on 21 May 2021, the legislative process is now close to completion. In doing so, the lower house essentially followed the government draft published in March 2021.
The most important aspects are:
- Anti-hybrid provisions: The core of the ATAD implementation is the introduction of regulations addressing hybrid mismatch arrangements (in particular Section 4k German Income Tax Act (GITA)). Hybrid arrangements are based on so-called ‘qualification conflicts’. In the case of hybrid financial instruments, a qualification conflict exists, for example, where a cross-border payment may be regarded in Germany as interest for the payer but, under the laws of the other country, the payment is treated as the receipt of a dividend for the payee. In such case, the business expense deduction for the interest in Germany may not be matched by a corresponding taxable amount in the jurisdiction of the payee (which is common as a number of jurisdictions have wide-ranging tax exemptions for dividends). In such situations, Germany will deny the deduction of business expenses under new Section 4k GITA. Within the framework of the ATAD-IA, provisions will be introduced which eliminate the consequences of qualification conflicts in both inbound and outbound cases. The new provisions will apply retroactively from 31 December 2019. Section 4k GITA will in principle affect all expenses made after 31 December 2019. An exception applies if the legal basis for such expenses was established before 31 December 2019. Such expenses only fall within the scope of the anti-hybrid rules if they are based on a continuing obligation (e.g. loan or licence agreement) and they could have been avoided without significant disadvantages.
- Add Back Taxation/CFC rules: The aim of the Add Back Taxation rules is to counteract the shifting of passive income to low-taxed foreign countries by using subsidiaries. The ATAD-IA provides for various ‘technical’ adjustments to these provisions, which have existed since 1972, in Section 7 to 13 GFTA. However, the fundamentals of the German CFC rules otherwise remain intact. As a result of the Add Back Taxation rules, low-taxed passive income is included in the tax base of the domestic shareholders. It was politically controversial whether the proposed low tax threshold of 25% – which is very high by international standards – should be reduced. In the end, the legislator opted to maintain the level at 25%. The new regulations will apply for the first time for the tax year 2022.
- Exit and Departure taxation: The German exit taxation rules applicable to business assets will be aligned with the requirements set out in the ATAD. More significant, however, is the complete revision of Section 6 GFTA. In the event of the termination of an individual’s unlimited tax liability due to departure (or various substitute provisions), the revised provision presumes a sale of qualified shareholdings in companies of at least 1%. In the case of relocations within the EU/EEA, the tax was previously assessed but then deferred without interest or security until the actual disposal of the shareholding. Instead, for relocations after 31 December 2021, payment is now to be made in seven annual instalments (generally against security) in EU/EEA cases.
Corporate tax modernisation
Furthermore, the lower house of the German parliament has also passed the CIT-MA. This is intended to allow a German partnership to be treated as a corporation on application from 1 January 2022. The change is likely to be relevant for German companies as well as for inbound investors (for further details, see here).
Outlook and recommendations for action
The new tax laws discussed above still require the approval of the upper house of the German parliament. However, in both cases this is considered to be a formality and is expected at the end of June. As a result there is now a need to review existing structures, especially with regard to the anti-hybrid rules and the Add Back Taxation rules, and to restructure if necessary. Moreover, as the anti-hybrid rules will apply retrospectively from 1 January 2020, these rules are required to be reflected in tax returns for the 2020 tax year. From a business perspective, the tax climate in Germany is becoming more complex. This has also already been shown by the new German anti-treaty shopping provision affecting withholding relief under tax treaties or EU directives (for further details see here). Taxpayers must therefore design their activities even more carefully with regard to German tax law in order not to suffer any disadvantages through the application of one of the now numerous provisions combatting legal abuse. This increasingly complicated tax landscape requires taxpayers to have robust tax compliance systems to ensure the correct application of the law.