An overview of the key points of the draft law
The draft law includes a further transposition of the Anti-Tax Avoidance Directive ((EU) Directive 2016/1164):
(1) On the one hand, the European provisions on disjunction tax and on exit tax will be transposed into German law via Art. 5 ATAD along with the provisions aimed at combating hybrid mismatches via Art. 9 and Art. 9b. The transposition of Art. 5 ATAD will occur via amendments to Sections 4, 4g, 6 and 36(5) of the German Income Tax Act – Draft (Einkommenssteuergesetz-Entwurf, ESTG-E) as well as via Section 12 KStG-E and Section 6 of the External Tax Relations Act – Draft (Außensteuergesetz-Entwurf, AStG-E). The regulations under Art. 9 and 9b will be enshrined in the new Section 4k EStG-E. The concept has been generally based on the minimum standards in the ATAD.
(2) On the other hand, the German CFC rules will be reformed and modified so that they are appropriate and provide legal certainty (Art. 7, 8 ATAD). These amendments will be transposed into Sections 7 ff. AStG-E.
Disjunction tax and exit tax
Art. 5 ATAD obliges member states, first of all, to disclose and then to tax hidden reserves (upon application, taxpayers can pay the tax in instalments) in the event of a cross-border transfer of business assets, the relocation of businesses, or the departure of corporations (so-called disjunction tax). In the case of a transfer of business assets to Germany, or when corporations move there, the values established for assets by a foreign state for disjunction tax purposes will be accepted if they reflect the market value (so-called conjunction).
Furthermore, the draft law provides for a tightening of exit tax rules for taxpayers with unlimited tax liability. A departure will thus trigger capital gains tax irrespective of the country to which the taxpayer is moving. In this connection, it will be possible to spread the tax consequences over a period of seven years.
Hybrid mismatch arrangements and incongruities in the case of residency
Under Art. 9 and 9b ATAD, Member States shall be obliged to neutralise tax advantages (e.g. double non-taxation or deducting business expenses twice) that arise as a result of diverging assessments in different countries. It is necessary to ensure that
- creditors pay tax on payments that are generally deductible as business expenses for the debtor;
- expenses in another State can only be deducted if these are matched by corresponding income inclusions;
- deductible expenses and the corresponding income inclusion result in congruence in taxation in other states.
Reform of the CFC rules
The reform of the CFC rules via Art. 7 and 8 ATAD includes important changes to the German CFC rules that already exist. The following measures, among others, are planned.
(1) Adjustments to the “control” criterion – Here there has been a shift away from domestic control to a shareholder-based approach. Control would thus be deemed to exist if more than half of the shares, voting rights, capital or entitlement to profits were attributable to one shareholder alone or jointly with closely related parties. The new approach to control means that the concept of transferring add-backs, hitherto regulated in Section 14 AStG, will no longer apply.
(2) Definition of ‘harmful’ income – To this end, the catalogue of activities that are considered to generate active income will be retained. In the case of trading and service companies, the draft law provides for the concept of “harmful participation” to be extended to taxable persons in the EU/EEA.
(3) Profit distributions will continue to be classified as active income, which means that the system established under Section 8b KStG will be taken into account. Although, profit distributions from shares that are in free float as well as those that reduce the income of the distributing corporation would be considered to be passive income. For the avoidance of double taxation an amount of reduction will be introduced for profit distributions (Section 11 AStG-E).
(4) No phase-shifted attribution – In the future, the addback amount will accrue to the intermediary company at the end of the financial year and no longer in the logical second after it.
(5) Avoiding double taxation – In this regard, the draft law still provides only for the imputation method and the deduction method will cease to apply. Furthermore, there are no plans for offsetting against trade tax. The add-back amount will nevertheless still remain subject to trade tax.
(6) The threshold for low taxation will remain at 25%.
Outlook: The implementation of the draft law will not commence, as originally envisaged, on 1.1.2020 as the legislative procedure has been halted for the time being. For now, we will have to wait and see the extent to which the current draft law will still change in the course of the legislative procedure. In particular, it is still unclear whether or not the low tax threshold will be reduced – according to the draft law it is supposed to remain at the current level of 25%. Bringing it into line with the corporation tax rate of 15% is also under discussion here.