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German tax planning: Anti-hybrid financing measures

Germany has acted before the OECD’s final recommendations on hybrid mismatches by including anti-hybrid financing measures in the 2013 Annual Tax Act. Oliver Wehnert and David Martiny of EY explore whether the German legislation is producing the results the government wants and look at how the law should change, as well as assessing the likelihood of this happening.

Summary: OECD Action 2

On March 19 2014, the OECD published two public discussion drafts on BEPS Action 2: Neutralise the effects of hybrid mismatch arrangements. One discussion draft included the recommendation for domestic law while the second draft dealt with treaty issues. In these two papers the OECD makes several recommendations as to how the effects of hybrid mismatch arrangements can be neutralised. BEPS Action 2 calls for the development of "model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect of hybrid instruments and entities".

In case of hybrid financing instruments the primary rule recommendation is that countries which grant a tax exemption or reduced tax rate of dividend income do not grant the tax exemption or reduced tax rate as far as the payment was deducted at the level of the payee. In the event that the mismatch is not attributable to a dividend exemption in the country where the recipient is resident, the hybrid mismatch rule would require the recipient to re-characterise the payment made under the instrument as ordinary income to the extent such payment gave rise to a deduction at the level of the payee and the hybrid mismatch rule in the country where the payee is resident did not apply to the financial instrument.

New German law

With the Federal Law Gazette (Gesetz zur Umsetzung der Amtshilferichtlinie sowie zur Änderung steuerlicher Vorschriften) which came into effect on June 26 2013, Germany introduced certain changes to the German tax law aimed at neutralising the effect of hybrid instruments even before the OECD's draft recommendations were published.

"The new German rules go much further than the recommendations of the OECD as they are not only applicable for hybrid financing but cover all dividend payments independent from the underlying shareholding structure"

In section 8b Corporate Tax Act (CTA) a correspondence principle for dividend income and a new treaty override rule were introduced. Corresponding changes in the German Income Tax Act were made as well.

According to section 8b paragraph 1 sentence 1 CTA dividends received do not increase the taxable income of a company. Thus, dividends are generally tax exempt (only 5% of the dividends received are treated as non-deductible expenses and increase the taxable income). Until 2013 the tax exemption was applicable independent from the treatment of dividend payments at the level of the payee. This led to the situation that in certain hybrid structures, dividend payments were treated as deductible expenses at the level of the payee (for example, interest expenses) and the dividend income was tax exempt at the level of the shareholder.

To avoid such situation in the future a new sentence 2 was introduced into section 8b paragraph 1 CTA. According to the new sentence 2 the tax exemption for dividends received shall only apply as far as the payment did not decrease the income of the payee. Additionally a new sentence 3 was introduced according to which a tax exemption for dividend payments based on a double tax treaty is subject to the conditions of the new sentence 2 as well.

According to the preamble of the law the different treatment of payments or income in different countries can lead to a situation in which certain income is not taxed in any country. Such financing instruments are well known and subject to various discussions in international boards (for example, OECD, Directorate-General for Taxation and the Customs Union of the EU) which have been discussing the different qualification of payments leading to income which is not subject to taxes on various occasions in recent years.

Consequences of the application of the new rules

The consequences of the applicability of the new rules are that payments which led to a deduction at the level of the payee would be subject to German corporate tax plus solidarity surcharge independent from the qualification of such payment as dividend or not. Foreign withholding taxes can be credited against the German corporate tax liability (section 26 paragraph 6 CTA). As hybrid financing payments are often taxed at a rather high withholding tax rate in many jurisdictions it needs to be noted that the maximum credit is the corporate tax at a current tax rate of 15% and thus, in many cases withholding taxes may only be partly credited and may lead to additional costs. Whether or not the payments are subject to trade tax depends on the facts and circumstances of each individual case.

The possibility to credit foreign withholding taxes leads to the situation that the non-application of the tax exemption may not be disadvantageous in some cases given the 5% taxation of dividend income in Germany. Only if the operating expenses in connection with the payments are higher than 5% of the payment and the foreign withholding taxes are lower than 14.25% will the effective taxation of such payments be higher than it would have been if the tax exemption was applied.

The new rules apply only if the payment actually led to a deduction in the country of origin. If the payment was treated as non-deductible based on the domestic law (for example, interest expenses are treated as non-deductible due to earning stripping rules) the tax exemption in Germany would be granted.


Due to the wording of the new rules there is a risk that mere timing differences may lead to a denial of the tax exemption for dividend payments received […] According to the OECD recommendation, timing issues should not lead to a denial of the tax exemption at the level of the recipient

Scope of application

The new German rules go much further than the recommendations of the OECD as they are not only applicable for hybrid financing but cover all dividend payments independent from the underlying shareholding structure. Additionally the rules not only apply for cross-border transactions but for dividend payments within Germany as well and may lead to a double taxation.

Although the cases in which the new rules may be applicable for payments within Germany are limited, in certain situations – for example if payments are originally qualified as deductible expenses and only at a later stage within a tax audit such payments are reclassified as dividends and therefore non-deductible – the rules could apply.

As no abusive structure is necessary for the application of the new rules, the rules might apply for mere equity financing structures as well. Dividend payments from a Brazilian subsidiary to its German shareholder were tax exempt at the level of the shareholder under the former law. Due to the new rules such dividend payments could be taxable in Germany if the interest on net equity (INE/juro sobre o capital próprio) is applied in Brazil and thus, the dividend payment led to a deductible expense at the level of the Brazilian entity. Such an interpretation would not be in line with the aim of the law but is nevertheless possible based on the wording and may therefore be applied by the German tax authorities. The Belgium notional interest deduction on the other hand should not lead to the applicability of the new rules as the deduction is based on the equity of the proceeding tax period and not on the earnings.

Open questions on the new rules

A question remains as to who is responsible for proving the non-deductibility of the payments done by a company if the tax exemption for such payments is claim. According to section 88 paragraph 1 General Tax Code the tax authorities are required to investigate all facts and circumstances which are the basis of the taxation. Nevertheless, with respect to cross-border transactions the taxpayer has to prove all favourable facts and circumstances (section 90 paragraph 2 General Tax Code). Insofar as the German tax authorities might require the taxpayer to prove for all dividends received that the payments were not treated as deductible at the level of the payee, this would lead to an increase of reporting obligations.

As the new rules do not require any minimum shareholdings they generally apply for all dividends received. The recommendations of the OECD foresee an application of the rules only if a minimum shareholding of 10% is met. At least in cases in which a German shareholder has minority shareholdings in foreign subsidiaries only, it might be difficult if not impossible for him to provide proof of the non-deductibility of payments.

Due to the wording of the new rules there is a risk that mere timing differences may lead to a denial of the tax exemption for dividend payments received. If a payment was treated as deductible in the year the German tax resident shareholder receives the payment, the tax exemption on dividends might be denied regardless of whether the deductibility is only temporary or not. According to the OECD recommendation, timing issues should not lead to a denial of the tax exemption at the level of the recipient.

The new rules apply independent from the fact whether or not Germany has a right of taxation according to an applicable double tax treaty (section 8b paragraph 1 sentence 3 CTA). As a consequence of this treaty override Germany taxes an event even though the right of taxation is not with Germany based on the respective double tax treaty. This could lead to a situation in which Germany contradicts tax incentives other countries grant to taxpayers.


As the rules were only introduced in 2013 it is currently not clear how the new rules will be interpreted by the German tax authorities. So far we have only seen a few cases in which the German tax authorities have actually denied the tax exemption for dividends received by a German taxpayer due to the payment being treated as deductible expenses at the level of the payee. Nevertheless, from a tax planning perspective the new rules have already led to actions as several German resident taxpayers no longer use hybrid instruments for financing of foreign investments. Thus, the government's objective for introducing the new rules is met.

The current law needs certain changes in order to be practical. The wording is far too broad and should be amended in a way that only the cases of hybrid mismatches are being covered. It should be clearly stated that timing differences will not lead to an applicability of the new rules. A limitation of the rules to cross-border transactions should be considered to avoid the risk of double taxation in Germany. It is furthermore recommended that the tax exemption of dividends received is generally accepted by the German tax authorities and the taxpayer will not be obliged to prove that the payment was not deducted at the level of the payee. Only if the tax authorities have reasons to believe that a payment may be treated as deductible they may require a proof from the recipient. Otherwise the burden of proof that a payment was treated as deductible should be with the tax authorities.

The current German rules only cover hybrid financial instruments while hybrid entity payments and reverse hybrid and imported mismatches are not covered and thus, only a limited part of the OECD recommendations are implemented. In the legislative procedures for the 2015 Annual Tax Act the second chamber of the German Parliament (Bundesrat) has requested to introduce certain other measures in the German tax law to avoid hybrid mismatches. The aim was to change the German tax law to avoid income which is not subject to taxes at all and double dip structures. Although the proposed changes did not make it to the final law the German government promised to consider the proposed changes in the BEPS discussions, so it can be assumed that once the final OECD recommendations are published the German tax law will be changed accordingly.

Oliver Wehnert



Partner – ITS transfer pricing – EMEIA TP leader & head of practice GSA


Tel: +49 211 9352 10627



Oliver Wehnert is an international tax partner in the Düsseldorf office of EY. He is EY's EMEIA transfer pricing leader and also heads EY's transfer pricing practice in Germany, Switzerland and Austria. He joined EY in 1998 after spending six years at PwC. He is a certified tax consultant and completed his MBA at the University of Paderborn in 1992.

Oliver Wehnert has vast experience in client services on transfer pricing design, international tax planning for intangible transfers, operating model effectiveness projects as well as controversy cases in scope of mutual agreement procedures and bi- and multi-lateral advance pricing agreement projects. Oliver Wehnert is focused on German based multinational enterprises interacting with their subsidiaries in particular in North America, Asia & Pacific as well as Europe. His biggest clients are multinational enterprises in the pharmaceutical, chemical, consumer products and automotive industry.

David Martiny



Senior manager – ITS transfer pricing


Tel: +49 211 9352 21151



David Martiny works as a senior manager in EY's Transfer Pricing service line in Düsseldorf. David is a lawyer and certified tax adviser. After studying law at the Ruprecht-Karls University in Heidelberg and passing the bar exam in 2006, David joined the tax department of a Big 4 firm in Düsseldorf. David worked for more than seven years in the international tax service line and had a main focus on international financing and structuring as well as M&A projects. His clients consisted of mid-size to large German and international multinational companies. During that time David has advised on a large number of outbound and inbound financing structures, including structures using hybrid arrangements. After leaving his former employer, David worked as a tax manager for international tax and M&A for a large German corporate. David joined EY in October 2014.

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