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The ATAD and its effect on German tax law

Following the agreement of the European Council on the Anti-Tax Avoidance Directive (ATAD) on July 12 2016, EU member states now are required to implement certain anti-tax avoidance provisions into their domestic laws by December 31 2018 and have them apply as from January 1 2019 (except for the exit tax rules), write Alexander Linn and Thorsten Braun of Deloitte.

German interest deduction limitation rules are already compliant with the ATAD

The anti-avoidance rules relate to interest deductions, exit taxation, controlled foreign corporations (CFCs), hybrid mismatches and a general anti-abuse rule (GAAR). On October 25 2016, the European Commission published a draft amendment directive suggesting changes to the ATAD that would broaden the scope of the anti-hybrid rules and extend their territorial application to arrangements involving third countries.

Because the ATAD sets only a minimum level of protection (Article 3), EU member states may introduce or retain rules that are stricter than the rules prescribed by the ATAD, subject to compatibility with primary EU law, such as the fundamental freedoms. As a result, where a member state already has implemented rules in the areas covered by the directive, these rules will need to be amended only to the extent they do not meet the minimum prescribed by the ATAD. Rules that are stricter than those in the ATAD need not be revised. Given this background, member states will have to analyse where the ATAD will have an impact on their domestic tax law. In the case of Germany, the domestic rules seem to have delivered on the blueprint for several of the measures in the ATAD.

Interest deduction limitation rules (Article 4 ATAD)

Germany introduced interest deduction limitation rules based on a 30% EBITDA limitation in 2008 (and several other jurisdictions have introduced similar rules). The rules described in the ATAD generally reflect the existing German rules, including a de minimis threshold of €3 million ($3.2 million), an asset-based group ratio calculation, some options for interest carryforwards and potential earnings before interest, tax, depreciation and amortisation (EBITDA) carryforwards.

The ATAD, however, allows member states to alternatively apply an income-based ratio rather than a group debt-to-equity ratio, which is not possible under German tax law. This group ratio test takes into account the net third-party interest expense and the EBITDA at a group level, and applies that ratio to the EBITDA of the relevant taxpayer. However, since the directive sets only a minimum level of protection, and specifically states that member states may apply either the group ratio test based on the debt-to-equity ratio or the income-based test, it appears unlikely that Germany will introduce this test as an additional 'escape clause' from the general 30% EBITDA limitation.

Accordingly, no changes to interest deduction limitations rules are expected in Germany.

Exit taxation rules (Article 5 ATAD)

Article 5(1) of the ATAD requires member states to introduce exit tax rules that address the following circumstances:

  • When assets are transferred from a head office to a foreign permanent establishment (PE);
  • When assets are transferred from one PE to another PE abroad;
  • When a taxpayer transfers its tax residence to the extent assets are no longer connected with a remaining PE; or
  • When a taxpayer transfers an entire business abroad.

The exit tax rules must be introduced into domestic tax law by January 1 2020 at the latest.

Germany already has exit tax rules covering all four situations in which member states will be required to levy exit tax, because the German rules are triggered in any situation where German taxation rights are lost or restricted. Technical amendments could be introduced to further align the domestic rules with the ATAD, but this does not seem necessary since the German rules currently meet the minimum requirements set by the ATAD.


German rules relating to the cross-border transfer of functions are not expected to be affected by the ATAD


German tax law also provides for the possibility of deferral of the payment of exit tax upon a transfer of an asset to a foreign PE by booking a deferred item in the amount of the capital gains and releasing the deferred item over a five-year period, starting in the year of the transfer. This possibility applies only in the case of a transfer to a PE in another EU member state, which arguably is in violation of the European Economic Area (EEA) agreement.

In contrast, article 5(2) of the ATAD refers to deferral that requires installment payments over five years, and also provides this deferral opportunity for transfers to EEA countries. Accordingly, German exit tax rules will need to be amended, at least for situations cases where the EEA country provides assistance in the recovery of tax claims. For other forms of transfers (e.g. the transfer of an entire business), German law already allows this option with respect to EEA countries.

To prevent double taxation, the ATAD requires member states to take into account the value of an asset that was subject to the exit taxation rules as the starting value for tax purposes, i.e. the asset will be deemed to be acquired at such a value for purposes of calculating amortisation and subsequent capital gains. Germany already has such rules for assets that are moved into the German taxing regime, which are not contingent on an exit tax being levied in the other state, so there should not be any need to amend these rules.

It is unclear whether Germany will amend its rules to allow the imposition of interest on deferred exit taxes and to request a guarantee in cases where there is a demonstrable and actual risk of non-recovery. Germany does not levy interest and in only very specific cases would require a guarantee, whereas the ATAD allows, but does not require, member states to charge interest. Also, the ATAD is silent on a 'transfer of functions', so German rules relating to the cross-border transfer of functions are not expected to be affected by the ATAD.

GAAR (Article 6 ATAD)

The ATAD requires member states to introduce a corporate GAAR. However, as Germany has a long-standing GAAR in its domestic tax law (section 42 of the General Tax Code), based on a principal purpose test, no action should be required in this area. In addition, more specific anti-abuse rules regarding targeted structures and pressure points exist in German tax law, such as the anti-treaty shopping provision in section 50d(3) of the tax code (ability to rely on treaty/directive withholding tax benefits).

CFC rules (Articles 7 and 8 ATAD)

Changes can be expected to Germany's CFC rules that were introduced in 1973 and have been amended frequently. The current rules are criticised for not reflecting economic reality (e.g. with setting the low-tax threshold at a rate of 25%). Even before the ATAD was finalised, the German government announced that it was working on an overhaul of the CFC rules (the details of which are still unclear). Based on the rules in the ATAD, the most notable changes that could be expected if the German legislature intends to align the domestic CFC rules with the ATAD are as follows:

  • German CFC rules define low-taxed income as income of the CFC that is subject to an effective tax burden of less than 25%. Article 7(1) lit. b of the ATAD defines "minimum taxation" as a situation where a CFC is taxed at less than 50% of the effective tax rate in the country of the parent company. However, since the ATAD prescribes only a minimum level of protection, Germany will not have to amend its CFC rules where the domestic rules are stricter than the ATAD, although it may do so as part of the ongoing discussions. Since the ATAD is not entirely clear on the role of local taxes for the low-taxation threshold (such as the German trade tax with rates between about 7% and 17%, depending on the municipality), it is unclear where the lower end of possible options for Germany would be. Germany is not expected to reduce the threshold to below 15% (the domestic corporate income tax rate); instead, some average trade tax burden likely will be considered.
  • Under German CFC rules, dividends (in general) and capital gains from the sale of shares, under certain circumstances, are treated as active income and, therefore, do not need to be considered under the CFC rules. However, based on article 7(2) lit. a of the ATAD, dividends and capital gains will have to be included under the CFC rules in the future. At the same time, however, CFC income under the ATAD will be calculated based on domestic rules (which provide for an effective 95% exemption of (most) dividends and capital gains). How such an inclusion will fit into the overall structure of Germany's existing regime remains to be seen. An isolated amendment by including this type of income in the passive income picked up by the CFC rules does not seem plausible as this would conflict with the current rules on the calculation of CFC income (where the dividend exemption rules do not apply).
  • As an alternative to the categorical approach of defining passive income, the ATAD allows member states to implement CFC rules so that they target income from non-genuine arrangements (article 7 (2) lit. b), which means that the CFC would not have owned the assets or have taken the risk if it were not controlled by a company with the significant "people functions". Such a category does not exist under German rules, and it is unlikely that Germany will substantially modify its current approach.
  • Article 8(4) of the ATAD provides that CFC income must be included in the tax period of the taxpayer in which the tax year of the controlled entity ends. However, under the current German CFC rules, the income of the CFC has to be included at the taxpayer level only after the fiscal year of the entity has ended.

Hybrid mismatches (Article 9 ATAD)

The ATAD requires EU member states to introduce rules that prevent double-deduction and deduction-no-inclusion outcomes between member states by denying a deduction in one member state. The draft amendment to the ATAD would significantly broaden the scope of the directive and would also include third country scenarios, non-taxation/non-inclusion scenarios and imported mismatches.

Germany introduced an anti-hybrid rule in 2013, under which the 95% participation exemption for dividends is denied if the payment qualifies as a tax-deductible expense for local country purposes at the level of the payer. An anti-hybrid rule for outbound payments covering double-deduction and deduction-no inclusion scenarios has been under discussion since 2014. A first draft law was published at the end of 2014, but has not been enacted.

Implementation – legislative procedures

The German legislature has announced it will introduce an anti-hybrid rule for outbound payments, in line with the BEPS recommendations and the ATAD, later in 2017. Given the rather short description in the ATAD and the broadened scope in the draft amendment, it seems likely that the German legislature will await the final wording of the amending directive before publishing a final draft act. Also, given upcoming Federal elections in the autumn of 2017, it is likely that technical work on anti-hybrid drafts will continue with a first public draft published after the new government has started the work in the new legislative period. Before then, some specific rules could be introduced, such as the draft section 4i of the Income Tax Act, which was proposed by the Upper House and would specifically target inbound structures using specific rules for German partnership taxation to create double deductions.

Germany will introduce anti-hybrid rules in line with BEPS and the ATAD in 2017

Closing remarks

Most measures described in the ATAD will not require action by the German legislature. Some changes are expected during the general overhaul of the German CFC rules, but the most eagerly-awaited and most complex measures will be the implementation of an anti-hybrid rule based on article 9 of the ATAD (as amended after the current draft amendment directive is finalised).

Alexander Linn

Director business tax – international tax
Deloitte

Tel: +49 89 29036 8558
Email: allinn@deloitte.de
Website: www.deloitte.de

Alexander Linn is a director in the business tax – international tax services group in Munich and a member of the German EU competence group. He joined Deloitte in 2007 and has worked on a variety of international clients.

He predominantly works for large and medium-sized multinational corporations and advises them on all matters of international taxation with a focus on restructurings, sustainable strategic tax planning, German anti-avoidance rules and EU law. Recent projects include several US/German restructurings and tax planning projects involving German-based companies and US-based companies.

Alexander is a regular speaker at internal and external conferences and frequently publishes articles in German and international publications. Alexander is a certified German tax adviser and holds a PhD in economics from the University of Munich.


Thorsten Braun

Director business tax – international tax
Deloitte

Tel: +49 69 75695 6444
Email: tbraun@deloitte.de
Website: www.deloitte.de

Thorsten Braun is an international tax director in Deloitte's Frankfurt office with more than 12 years of practical experience in national and international taxation.

Thorsten primarily serves multinational clients in the areas of cross-border taxation and international restructurings as well as in the areas of corporate compliance, audit support and tax provisioning.

Thorsten's clients are German-based multinational corporations and financial investors.

He graduated from Mannheim University with a master's degree in business administration. He is qualified as German Certified Tax Adviser (Steuerberater).


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