Germany

Stefan Ditsch
PricewaterhouseCoopers
Germany

Comprehensive tax reform has not been on the agenda this year, unlike in 2008. However, issues such as permanent establishment and the status of tax havens did come in for attention from policy makers, reveals Stefan Ditsch of PricewaterhouseCoopers

Where there was a heavy impact on the 2008 tax year from tax law changes, such as the new earning stripping provisions or changes with respect to the loss utilisation, in 2009 the lawmakers has been relatively calm in implementing or proposing groundbreaking law changes. However, as always, there have numerous activities which are important for companies with German activities.

Reaction to financial crisis

The German government has taken the opportunity of a Citizens' Relief Bill – Health Insurance to pass proposals to relieve businesses – especially those struggling for survival during the economic crisis – from some of the disadvantages from the last corporate tax reform mentioned above.

Under the interest-limitation rules (Zinsschranke), net interest expense (excess of interest expense over interest income) is deductible up to €1 million ($1.4 million) per year. The deduction of the excess amount is limited to 30% of the taxable earnings before interest, taxes, depreciation and amortization (Ebitda). The first proposal improves the position of borrowers by raising the exemption from the interest limitation rules from €1 million a year to €3 million ($4.2 million) a year. This applies to business years starting on or after May 26 2007 and ending at any time during 2008 and 2009. It is independent of the circumstances of the borrowing.

The second change has been enacted with respect to the loss forfeiture rules. Under the law, a direct or indirect transfer of more than 25% of the shares in a German corporation to a new owner within five years leads to a prorated forfeiture of the tax loss carryforward and any tax losses occurred currently. A total forfeiture of tax loss carryforward arises if more than 50% of the shares in a German corporation are transferred to a new owner within five years. The new rule addresses, however, only those companies whose shares are acquired at any time during 2008 and 2009 in connection with a corporate recovery operation. A qualifying share acquisition does not fall under the loss relief forfeiture rules. To qualify, the corporate recovery operation must be aimed at preventing or remedying insolvency while saving the basic structure of the business. This intention will generally need to be demonstrated with a specific recovery plan setting out the nature of the problem and the measures to be taken to resolve it. The official explanation to the bill speaks of outside professional involvement in the demonstration that the recovery plan is necessary and feasible, though the bill, itself, is silent on this aspect.

The condition of saving the basic structure of the business can be met in one of three ways. Either:

the company concludes and follows a shop agreement with the employees or their representatives. This agreement must include provisions on jobs; or
the sum of the employee remuneration actually paid within the first five years after the share acquisition must at least equal 400% of the base level. The base level is the annual mean of the total remuneration paid in the five years immediately before the acquisition. There is no inflation adjustment; or
the company receives new capital from its shareholders of at least 25% of its gross assets as shown in its immediately preceding tax balance sheet. This contribution must be made within 12 months of the share acquisition. It may be formal or informal (including by debt waiver to the extent the debt still had value). Any form of repayment or dividend in 2009 to 2011 is seen as reducing the contribution. If the 25% minimum is no longer reached, the condition will be seen as unfulfilled from then on.

This is definitely a step in the right direction but unfortunately only a small step to helping companies trying to streamline or reorganise their operations in the current environment.

Revised permanent establishment decree

A reform of the Reconstructions Tax Act which came into force at the end of 2006 removed or curtailed a number of tax privileges allowing tax-free mergers and drop-downs. The finance ministry has now taken the revised rules as a basis for revising its permanent establishment (PE) decree as regards cross-border transfers in kind between a PE and its head office. Essentially, the revised text emphasises more that transfers of assets should be at arm's length with corresponding realisation of profit, over the previous acceptance that a branch and its head office, being parts of the same legal entity, cannot earn profits from one another. More specifically:

the previous provision deferring the taxation of profits on transfer of fixed assets over their remaining depreciation period has been replaced with a deferral option for five years, but restricted to asset transfers within the EU,
the previous deferral of profit realisation on transfers of current assets until final disposal to a third party has been withdrawn. Thus the transfer of produce to a foreign sales branch will lead to immediate taxation of the manufacturing profit at the head office, even though an ultimate buyer has not yet been found, and
the previous provision calling for transfers from a non-exempt foreign PE to its German head office to be at arm's length has been replaced with a requirement that such transfers be at book value.

Qualification of a 100 % investment as a business unit

In July 2008 the Supreme Tax Court held that a company transferring its 100% investment in a US Inc to an Austrian partnership at book value did so as a sale at the higher value at which the partnership took up the asset acquired. The Austrian partnership had taken the difference to capital reserve without allowing any additional credit to the transferor. Previously, the standard practice was to treat such a difference as a hidden capital contribution, enabling deferral of the tax liability in appropriate circumstances. The finance ministry has now issued a decree accepting this part of the judgment as a precedent, but allowing taxpayers to opt for the former treatment for transfers up to June 30 2009 where this would be more favourable.
Of rather greater significance, the court also held in the same case that a sole shareholding does not rank as a business unit giving rise to a valuation option on transfer. This contradicts established practice. The ministry has instructed tax offices not to follow the ruling in other cases and has stated that the law will be changed accordingly. A transfer of a sole shareholding may therefore continue to be valued at any value between book and market agreed by the parties.
The court's final, and perhaps most radical, point overturned long-established case law in holding that a transfer of assets abroad is no longer to be taxed as a sale at market value. The original thinking was that a transfer abroad removes the asset from the German tax jurisdiction, so that any gain realised subsequently on a third-party sale would be a matter for the other country. The court has now stated that the transfer of an asset abroad does not preclude a German right to tax a subsequent gain and that taxing a deemed gain on the transfer is without a basis in the statute. The finance ministry accepts neither contention and has instructed tax offices to continue with the present practice. It is still deliberating on whether to change the statute.

Tax havens

In July the Bundesrat (Council of States) approved an Anti-Tax Evasion Act designed to encourage compliance by investors and others with business dealings in uncooperative tax havens by denying privileges to those who fail to make full disclosure of their affairs. The Act has now been supplemented with an order, passed by the cabinet on August 5, subject to the approval of the Bundesrat, but not of the Bundestag, and is to be further supplemented by a blacklist of tax havens to which the new rules shall apply. The packages include the following rules:

to disqualify business expenses paid to residents of uncooperative tax havens unless the taxpayers promptly prepares, and produces on demand from the tax office, full documentation of the transaction, its background and motives to the standard required in respect of international related-party dealings,
to make treaty relief from withholding taxes on payments to companies abroad with natural person shareholders of more than 10% resident in uncooperative tax havens conditional on full disclosure of the names and states of residence of the individuals concerned,
it requires those with bank accounts in uncooperative tax havens to authorise the tax authorities to demand information from the banks, acting in the name of the taxpayer, as a condition for the privileges of the relevant investment income and capital gains (flat rate taxation of 25%; 60% charge if earned in the course of a business activity; full exemption in the hands of a corporation). Recipients of dividends and other income from uncooperative tax havens are under enhanced disclosure obligations. Persons not otherwise required to keep books and records can be put under an obligation to do so for the next five years (with a six year retention period), if they fail to fully comply with these requirements,
all taxpayers with an income of more than €500,000 ($713,000) in any one year must retain their documents, vouchers and records for six years. This obligation begins with the year after that in which the limit is reached and ends with the sixth consecutive year in which this is no longer the case. It has nothing to do with any involvement of the taxpayer with a tax haven.

The blacklist of uncooperative tax havens has not yet been published. According to a finance ministry announcement in April it was then blank after the first exchange of information agreements or undertakings with the last of the havens deemed uncooperative by the OECD. However, the finance ministry is keeping a watchful eye on the situation, and is prepared to treat a country as an uncooperative tax haven, should it fail to live up to the ministry's expectations of a fair information exchange. Since not only Germany is taking this initiative very serious most of the potential blacklisted tax heavens are reacting and have at least started discussions with Germany.

VAT in Europe

Combatting "Missing trader" and other forms of VAT fraud based on real or fake intra-community trade has long been a priority not only in Germany but also for the European Commission, not least in view of the need to protect the idea of the European single market from all forms of abuse. The European Commission has announced its proposal to upgrade the present strategies based on exchange of information and other forms of administrative cooperation between member states with Eurofisc, a dedicated organisational structure. Member states are to be jointly responsible for the protection of VAT revenue in all member states and are to cooperate as actively on behalf of others as they would in pursuit of their own interests. In particular, they are to allow the VAT authorities of other member states direct access to a defined set of taxpayer data held on their databases. Of major interest to traders is the proposal for an enhanced and secure system for the validation of the identity and VAT numbers given by their trading partners. This is intended to enable them to protect themselves from becoming unwitting accessories to the frauds perpetrated by others.

Taxation of benefits

An international consultancy firm arranged its regular partner meetings partially as social events in which spouses were included. Much of the cost was taxable as a benefit in kind. The firm saw the benefit as general and accounted for wages withholding tax at the flat rate of 25% available as an option for benefits generally available to all employees. The tax office refused to accept this because the benefit was only available to partners, that is, to personnel on a managerial level. The Supreme Tax Court has now confirmed the tax office in this refusal.

The court's main point was that the flat rate taxation of this type of benefit was intended as a simplification, not as a concession. The 25% rate was to reflect a typical average rate for all employees and was thus appropriate to the condition that the benefit – here, the function – be open to all staff. Participants could be stratified by function or department, but not by salary or rank. Where the benefit was only available to management-level employees, that is, to the high income earners, the 25% rate was manifestly inappropriate and could not be applied. Rather, the partners should be taxed individually, or, as in this case, at the average rate of withholding tax borne by the partners as a group.

Auditors and taxpayers at odds

In this financial crisis, the finance ministry is clear on the need to relieve businesses threatened with a cash shortage and has instructed tax offices to be lenient to taxpayers requesting relief from payment-on-account obligations in the light of failing profits. Unfortunately, the tax audit service is not taking the same, enlightened approach. Rather, tax auditors are harping on the need for stringency in the face of asserted abuse. Transfer pricing, always a tax audit favourite, is coming in for increasing attention in the wake of the enhanced documentation rules of 2003. The other hot topic is the denial of profit and loss pooling within a group – the Organschaft relief – for purely formal reasons derived from civil, not tax, law. Pooling is dependent upon a legally valid agreement combining the results of the members on the parent. If the agreement is invalid, or is improperly implemented, each group member taxes in retrospect its results in its own name. Loss deduction becomes a loss carry forward and cash taxes and interest charges are immediately payable. The newly established loss carry forward of the subsidiary will also be imperilled by the provisions to curb the sale of tax losses, should there have been a group reorganisation in the meantime. The tax auditor then has a double dip. The circle can only be squared by making sure that the Organschaft agreement is impregnable, both at civil and at tax law. It must be implemented, that is, all payments due must be made. Outstanding amounts must be covered by a properly documented loan. One point often overlooked is the company law requirement on the subsidiary to cover its prior losses first before surrendering any profit. This, too, can give a tax auditor all he needs to overturn an agreement. As one cynical taxpayer put it, "The tax auditors find the funding for the ministry's generosity."

Elections

At the end of September a new government will be elected. At this point of time tax law changes are a significant discussion point where some parties are promising tax reliefs, with others stating their view that the German government is not in a position to grant additional subsidies after all the spending and funding already done in the course of the year. However, since no clear proposals have been made the taxpayer will only know in October what will be the agenda for the next term. However, it should be clear that Germany has to be competitive in the near future to attract investments in particular from foreign investors so that the directions should be clear.

Stefan Ditsch (stefan.ditsch@de.pwc.com), partner – international tax services, PricewaterhouseCoopers, Frankfurt Germany