Until very recently, the German tax characterization (debt or equity) of so-called Additional Tier 1 Capital instruments issued under the new regular capital framework for banking institutions (the so-called Basel III framework) was uncertain. On March 13, the German tax authorities announced that they plan to address this issue in a circular that will confirm the debt treatment. This clarification is in line with the practice in a number of other important tax jurisdictions and has been well received by the German financial institutions. 

German Domestic Anti-Abuse Rules Regarding the Taxation of Partnerships Possibly Unconstitutional

In recent years, the German legislature introduced a number of special anti-abuse provisions that seek to deny certain tax benefits of a tax treaty or an EU tax directive in cases of perceived and actual abuse. The German domestic anti-treaty shopping provisions that deny such benefits dependent on whether the taxpayer meets certain specific substance requirements are a prominent example. 

The German Federal Tax Court (Bundesfinanzhof), the highest tax court, took the view that these provisions constitute unconstitutional treaty override and has referred a specific case to Germany's Constitutional Court (Bundesverfassungsgericht) and has requested that a specific anti-abuse provision applicable to the taxation of international partnerships be declared void.

It is widely expected that theBundesverfassungsgericht will follow the arguments of the Bundesfinanzhof and will decide that the specific provision is void and can no longer be applied. Such decision would potentially also affect other anti-abuse provisions included in German domestic law.

German Constitutional Court Issues Ruling on Retroactivity of Tax Laws

On December 17, 2013, the German Constitutional Court (Bundesverfassungsgericht) issued a decision in respect to a tax law that had retroactive effect when it was enacted. 

International tax observers are always concerned about the practice of the German legislature to enact tax laws with retroactive effect. Under German law, a distinction must be made between true retroactive effect and pseudo retroactive effect. The latter is permitted and applies when a legislator changes the law before a relevant tax period is completed. With respect to the income and corporation tax, the tax period is completed at the calendar year-end. Consequently, changes to the tax law during a calendar year (in many cases at the end of a calendar year) that will be effective as of the beginning of the same year are permitted under constitutional law and are referred to as "pseudo retroactive." One may well dispute whether such changes are in fact pseudo retroactive, but it has been the longtime position of the German Constitutional Court. 

In cases where the tax year is already completed, a retroactive change to the tax law is generally not permitted and is referred to as "true retroactive." However, there are some exceptions to this rule. In the past, the legislature enacted laws retroactively and argued that the new law does not change the legal position of the taxpayer because the new law is only a clarification of existing law. Thus, it has retroactive effect and should be applicable to all open cases.

The Constitutional Court has now taken the position that the unclear wording of the existing law does not justify the retroactive implementation of a new law because such wording can be interpreted by the courts. Thus, there is no need for the legislature to protect the public from the existing law. Further, the legislature has no right to determine how a law is to be interpreted simply by enacting a new law retroactively. It may, however, change the law going forward and clarify the content.

Through this decision, the Constitutional Court narrowed the cases where the implementation of law with retroactive effect is permitted under German law.

German Tax Court Rules on Termination of Fiscal Unity under International Reorganization

In November 2013, the German Federal Tax Court (Bundesfinanzhof) held that an intra-group reorganization involving the transfer of shares in a German subsidiary does not constitute a good cause to terminate the fiscal unity (Organschaft).

According to the German Corporate Income Tax Act, the formation of a fiscal unity that enables the netting of profits and losses of the parent and its subsidiary is based on a corporate agreement. The tax law stipulates that such agreement requires a minimum term of five years. As an exception to this five-year minimum term, the law permits an early termination based on good cause. Generally, the sale and transfer of a subsidiary is such good cause and has been recognized by the German tax authority when the five-year minimum term has not been adhered to. 

In contrast to long-standing practice, the German Federal Tax Court now holds that an internal share transfer does not qualify for a termination for good cause. Consequently, if the five-year minimum term is not respected, the fiscal unity will be invalid and not effective from the very beginning. The affected entities will be treated as if no fiscal unity had ever existed and will be taxed on a stand-alone basis. The German Federal Tax Court does not comment on third party transactions. 

This new case law will affect many group internal reorganizations since the fiscal unity is a very common structure to optimize the tax bill. The adherence to a five-year minimum term will become a crucial issue in such cases.