Following the German Parliament’s approval of the Tax Act that implements the Administrative Assistance Directive and amends tax regulations (Tax Bill 2013 “light”), the German Federal Council on June 7, 2013 consented to the bill. The bill now requires the German president’s signature and publication in the Federal Gazette for enactment. We expect those formalities to occur soon. Tax Bill 2013 “light” includes several changes to current law that previously had been proposed in the draft Tax Bill 2013. The most relevant issues for MNCs are discussed below.
Amendment of RETT rules
Closing down certain RETT blocker structures
Real Estate Transfer Tax (RETT) may be triggered when an acquirer directly or indirectly unifies 95% or more of the shares in an entity owning German real estate. Prior to this amendment, RETT was not incurred when an acquirer utilized a German partnership structure to hold a greater than 95% economic stake in the real estate-owning entity provided that a third party held a minority economic stake. These RETT blocker structures have been used widely so that taxpayers would not incur RETT multiple times upon group restructurings.
Under the new bill, the RETT Act receives a more realistic economic view by considering any indirect ownership. Under the new rules, all indirect ownership in either the capital or the net assets of the real estate-owning company must be considered when determining the 95% threshold. Technically, all pro rata participations are multiplied when determining the relevant ownership percentage. Some uncertainties remain, especially for the new term “economic interest.”
The provision particularly affects RETT-blocker KG structures. These are structures where typically a German KG directly or indirectly holds 5.1% or more of the shares in a real estate-owning company and a third-party partner holds, for example, 5.1% of the KG, resulting in a minority economic ownership of only 0.26%. As a result, under current law, existing structures including a commonly used "RETT blocker" could reach the 95% threshold for RETT purposes.
Broader intra-group exemption
The existing intra-group exemption applies only to certain reorganizations as defined in the German Reorganization Act or comparable reorganizations according to the law of another European Union (EU) or European Economic Area (EEA) state. Share-for-share exchanges are not covered.
The intra-group exemption will now cover contributions such as share-for-share exchanges, and other transactions based on the bylaws of the receiving entity. Certain transactions outside Germany (and even outside the EU/EEA) might be covered as well. However, other tight requirements for intra-group exemption such as compliance with certain holding thresholds and periods remain unchanged.
The amended RETT rules apply to all transactions carried out after June 6, 2013.
Closing down hybrid financial instrument structures
In light of the EU initiative on aggressive tax planning, the legislation limits the domestic 95% participation exemption to dividends that have not resulted in a corresponding deduction for tax purposes at the level of the distributing entity.
The amendment particularly targets certain cross-border hybrid financial instruments in German outbound structures under which Germany classifies the financial instrument as equity but the foreign country treats the instruments as debt.
The participation exemption limitation applies to dividends received in fiscal years beginning after December 31, 2013.
Provisions aimed at inbound partnership structures
The Federal Tax Court has ruled that in structures where a foreign partner granted a loan to its German trading partnership (e.g., a German KG), Germany does not have the right to tax the interest income earned by the partner as it is generally not effectively connected to the partnership’s German PE, even though under domestic tax law the interest income was treated as income of the partnership. Even a treaty override introduced in Tax Act 2009 as a reaction to the court decision did not grant the right, according to a recent Federal Tax Court ruling.
The new rules are designed to overrule the recent court decision by ensuring Germany’s right to tax interest income received by a foreign partner from its German partnership. The rules also apply to other types of income received by the foreign partner from its partnership, such as royalty income.
The provisions aiming at inbound financing partnership structures apply to all open tax assessment periods.
Limitation of loss utilization opportunities following restructurings
Under the German reorganization tax act, taxpayers could undertake certain restructurings for income tax purposes with retroactive effect (giving rise to a "retroactive period" between the reorganization tax effective date and its legal effective date. Previously, profits of the transferring entity accruing in the retroactive period generally could be offset against tax losses and interest carry forwards of the absorbing entity.
The new provision aims to shut down certain tax schemes by abolishing this loss utilization within the retroactive period; however, the rule does not lead to a forfeiture of losses in the absorbing entity. An intra-group exception is available provided that both the transferring and the absorbing companies, under the German Commercial Code, belong to the same consolidated group prior to the reorganization’s tax effective date.
The loss utilization limitations are effective for all reorganizations filed with the commercial register after June 6, 2013. For those reorganizations that do not need to be registered, the new provision applies if the beneficial ownership in the underlying assets is transferred after June 6, 2013.
Introduction of AOA principles into German tax law
Until now, transactions between a head office and its permanent establishment (PE) or between PEs of the same entity generally have been disregarded for German income tax purposes. External income and expenses had to be allocated between the PE and the head office.
The bill adopts the Authorized OECD Approach's (AOA) basic principles of the separate entity approach for German PEs. Cross-border transactions between the head office and a PE or between different PEs of the same entity are recognized for income tax purposes and affect the profit allocation to a PE. The transactions must comply with general arm’s-length principles in the German transfer pricing rules, including a profit markup.
The adaption of AOA principles is effective for fiscal years beginning after December 31, 2012.
Eligibility for hybrid entities to claim a WHT refund
When a foreign hybrid entity receives German-source income (e.g., dividends or royalties), there is often a mismatch between the person being taxed on the income and the person eligible for treaty relief.
In such cases the new rules should ensure that taxpayers can still achieve treaty relief.
Under the new rules, Germany will follow the foreign classification of the hybrid entity for purposes of withholding tax (WHT) refund claims. For example, a refund of WHT levied on dividends received by a US tax resident via a disregarded LLC that is treated as a regarded entity under German domestic law may be claimed only by the US tax resident, not by the LLC.
The WHT refund rules for hybrid entities apply to income received after the new bill is enacted, i.e., after publication in the Federal Gazette.