German Ministry of Finance publishes draft bill to implement ATAD
Expected to take effect from 1 January 2020
The German Ministry of Finance published a draft bill to implement the Anti-Tax Avoidance Directive into German law on Wednesday 11 December 2019. The bill will result in substantial changes to the German tax laws applicable mainly to German corporate groups with group companies outside of Germany and so-called multi-national enterprises (MNEs). The most significant points included in the draft bill are rules to: (i) neutralise hybrid mismatch arrangements; and (ii) reform the German Controlled Foreign Company legislation, commonly known as the “CFC rules”. In addition, the draft contains changes regarding exit taxation and the application of the transfer pricing rules (and the related documentation).
The implementation of rules to neutralise hybrid mismatch arrangements as well as the substantial changes to the CFC rules require careful review and could result in corporate groups urgently needing to review their existing structures as the new rules are expected to take effect from 1 January 2020, notwithstanding the fact that the full legislative procedure to implement the bill may not be completed until after that date.
Rules to neutralise hybrid mismatch arrangementsHybrid mismatch arrangements result from differences in the tax treatment of an entity or instrument under the tax rules of different jurisdictions. A hybrid mismatch occurs, for example, regarding financial instruments if an interest payment is deductible as a business expense in Germany at the level of the payor, but is treated as a tax exempt dividend at the level of the payee in another jurisdiction. A tax charge that corresponds to the deduction of the payment is missing in these circumstances.
The draft bill implements the required standard set out in the ATAD. It denies the deduction of business expenses in Germany in circumstances where there is no corresponding tax charge as a result of a hybrid mismatch arrangement. The new provisions cover other hybrid mismatch arrangements besides hybrid financial instruments. The new anti-hybrid rules equally apply to arrangements between related persons, including between an enterprise and its permanent establishment, as well as structured arrangements (which are not required to be between related persons). Furthermore, the draft bill contains “secondary counteraction” rules. Under these rules, Germany is able to deny a tax exemption for dividends if the payor’s jurisdiction has not implemented equivalent anti-hybrid mismatch rules.
The new rules are of particular relevance to all German groups with cross-border finance arrangements in place. The proposed changes will lead to increased documentary and compliance obligations.
The German CFC rules aim to counteract shifting passive income to low tax jurisdictions. The draft bill contains a variety of changes to the existing German CFC rules, but ultimately does not fundamentally change this regime which has been in place since 1972. The main changes are summarised below:
- The current German CFC rules apply where German resident taxpayers, directly or indirectly, hold more than 50% of the shares in a foreign company, even if these resident tax payers are not connected to each other. The application of the new CFC rules will require a German resident taxpayer to also take into account the interests of related persons to determine whether there is a direct or indirect holding of 50% or more. There are exceptions to this 50% threshold for certain types of passive income with an investment character, where a much lower shareholding, as low as 1% and, in some cases, even below 1%, can result in the application of the CFC rules.
- Furthermore, the CFC rules will also be applicable to persons that are only taxable on their German source income if they hold a controlled foreign company through a German permanent establishment.
- The existing German CFC rules do not apply to foreign companies that fall within the scope of the Investment Tax Act. This exemption is to be abolished, with the result that investment funds will now fall within the scope of the CFC rules. This is one of the most significant changes included in the draft bill.
- The CFC rules only apply if the passive income in question is subject to low taxation. Low taxation for these purposes is where the effective tax rate of the income is below 25%. The draft bill sticks to this definition of low tax, although due to the combination of German Corporate Income Tax and municipal Trade Tax, German resident taxpayers are effectively taxed below 25% in some areas of Germany.
- The German Foreign Tax Act contains a defined list of active income and assumes all other income to be passive. This list remains essentially unchanged. However, dividends will not be treated as active income in any circumstances under the new rules.
Germany already has exit taxation rules in place which are generally ATAD compliant. This regime will be supplemented by rules dealing with situations where Germany has taxing rights regarding certain assets and regarding deferred payments to mitigate the effect of the exit taxation. In addition, an explicit rule on advance pricing agreements has been included aimed at ensuring tax certainty regarding transfer pricing. The draft bill also contains changes regarding exit taxation and the application of the transfer pricing rules (and the related documentation).
Conclusion and outlook
It can be taken for granted that the draft bill will pass through the legislative procedure with very few changes, if any. The decisions of the German government on the draft bill are scheduled to take place next week. The legislative procedure will be completed during the course of 2020. However, the draft bill provides that the new rules will take effect as of 1 January 2020. German corporate groups with group companies outside of Germany and MNEs should review their current arrangements and structures in light of the draft bill and consider restructuring as may be appropriate. This is particularly relevant for investment funds which will fall within the scope of the CFC rules from the beginning of next year.