The German Federal Parliament and the German Federal Council recently passed a tax bill (“2018 tax bill”). The 2018 tax bill covers a broad range of amendments to the German tax law.
A choice of areas that are of particular interest for multinational corporations (“MNCs”) will be discussed in this article. It will also touch on other legislative developments that MNCs may be particularly interested in, but that did not enter the 2018 tax bill.
Extending Nonresident Capital Gains Taxation Treatment
It is a common understanding in international taxation that any capital gain from the disposal of real estate is taxed in the state where the property is located (asset deal), as does Germany. The result differs where shares by a nonresident (e.g. SpanishCo) in a foreign corporation (e.g. DutchCo) that mainly possesses German real estate are disposed (share deal).
Only if the seller holds 1 percent or more of the shares in a corporation at any point in time in the preceding five years and subject to the condition that the corporation that is disposed has either its legal seat or place of management in Germany a tax nexus is given.
Under the rules of the 2018 tax bill, the tax nexus will be expanded to cover real estate investment structures by adding a further tax nexus for Germany’s nonresident taxation that does not depend on the seat or place of management of the corporation that is disposed:
- the seller held 1 percent or more of the shares in the corporation at any point in time in the preceding five-year period;
- the corporation’s assets consist, directly or indirectly, of more than 50 percent of real estate located in Germany at any point in time in the preceding 365 days (real estate percentage to be determined based on book values; German real estate that is held indirectly has to be included);
- the shares in the corporation were attributable to the nonresident seller when the 50 percent threshold was exceeded; and
- the disposal of the shares occurs after December 31, 2018.
The capital gains will be taxable in Germany to the extent they result from built-in-gains that arise after December 31, 2018. Treaty specifics need to be considered.
For individuals owning shares in respective real estate property structures, the new rules should be of relevance. For nonresident investors invested via a corporate entity, the outcome could be different: Based on recent jurisprudence of the German Federal Fiscal Court (Bundesfinanzhof), a nonresident corporate taxpayer that incurs a capital gain from the disposal of corporate shares is entitled to a 100 percent participation exemption relief for the capital gain.
Germany’s rule whereby 5 percent of a capital gain from the sale of corporate shares is deemed taxable shall not apply to nonresident corporations. Further legislative developments in this respect should be monitored.
Modification of German Loss Forfeiture Rules
Setting the Scene
A direct or indirect transfer of more than 25 percent but not more than 50 percent of the shares in a corporation to an acquirer or a group of acquirers within a five-year period results in a pro-rata forfeiture of the corporation’s tax losses. If more than 50 percent are subject to a harmful ownership change, the tax losses forfeit entirely. The loss forfeiture rules also apply to interest carryforwards incurred under Germany’s interest limitation rules.
Specific exceptions from the loss forfeiture rules do exist (e.g. group and built-in gains exception). Moreover, a specific “business continuity rule” was introduced for share transfers occurring after December 31, 2015 on the basis of which tax losses can be preserved upon application. This regime is subject to tight business continuity conditions.
Pro-rata Forfeiture Unconstitutional
A modification of the loss forfeiture rules by means of the 2018 tax bill was necessary as the German Federal Constitutional Court (Bundesverfassungsgericht) had ruled a loss forfeiture for transfers of less than 50 percent of the shares to be unconstitutional. The legislator accordingly repealed the loss forfeiture rules for transfers that do not exceed the 50 percent threshold.
The repeal applies retroactively to any losses that had forfeited for periods beginning after December 31, 2007 and applies similarly to future transfers. Whilst this could be good news for taxpayers, the new legislation requires, for harmful pro-rata ownership changes in the past, the respective tax assessments still to be open to amendments under German procedural tax law to benefit from its enactment.
For harmful share transfers of more than 50 percent the 2018 tax bill has no impact. However, affected groups should be aware that a case dealing with harmful ownership changes of more than 50 percent is pending at the Federal Constitutional Court. Subject to the facts, keeping tax assessments open might be advisable.
Reinstatement of the Restructuring Exception
A formerly introduced restructuring exception (Sanierungsklausel) was suspended for harmful ownership changes effected after December 31, 2007 based on a view taken by the European Commission in 2011.
Following the European Court of Justice’s (“CJEU”) decision as of June 28, 2018 against the European Commission’s view, the 2018 tax bill reinstates the restructuring exception for ownership changes after December 31, 2007. As a basic concept, tax losses shall be preserved where the ownership change is performed with the intention to restructure the business to overcome insolvency or over-indebtedness while maintaining the fundamental structures of the business.
Whilst the rules outlined above qualify as “good news,” taxpayers must be aware of the various technical conditions and documentation requirements that exist in case one of the exceptions shall be relied upon.
German Tax Group (Organschaft)—Variable Compensatory Payments
The establishment of a German tax group requires, inter alia, that the controlling company holds the majority of the voting rights in the controlled company and that the controlled company transfers its entire profit to the controlling company on an annual basis.
The Stock Company Act sets basic conditions for a valid tax group that need to be considered beside separate requirements stemming from the Corporate Tax Law. Accordingly, the mandatory terms are governed by a bilateral profit and loss agreement that must be concluded between controlled and controlling company that not only must satisfy legal aspects outlined in the Stock Company Act, but also conditions set by the German tax administration.
As a further condition, tax groups are only tax-valid if the entire profit of the controlled company is transferred to the controlling company.
Given that the entire annual profits get transferred to the controlling company under the profit and loss transfer agreement, external minority shareholders in a controlled company are entitled under the Stock Company Act to compensatory payments. So far, only a fixed compensatory payment or a variable compensatory payment that is solely based on the controlling company’s profit has been accepted for German tax purposes.
In case the profit and loss transfer agreement includes a different determination of the compensatory payment (e.g. where the variable compensatory payment is determined based on the controlled company’s profit) it bears the risk of non-acceptance of the tax group. The non-acceptance has been confirmed by recent jurisprudence of the Federal Fiscal Court. With the 2018 tax bill, the legislator now explicitly allows, under certain circumstances, that variable compensatory payments that are paid in addition to a minimum fixed payment may also be based on the controlled company’s profit. This rule will also apply to prior years that are still open to amendments under German procedural tax law.
The current legislative measure once again deals with one of many disputed issues surrounding Germany’s interplay between the Stock Company Law and the German tax requirements and reactively adds a further casuistic case to the German tax group rules.
It is time that the legislator revives the initiative to work on tax group reform (große Organschaftsreform) in order to avoid the frequent disputes between taxpayer and tax administration that can be experienced and which so often must be decided by the Federal Fiscal Court.
Online Marketplace Liability
The VAT section of the 2018 tax bill focuses on e-commerce. To address reports on tax evasion in the online trading business involving nonresident traders, an “online marketplace liability” is enacted. When making deliveries via on online marketplace, the trader generally is liable to German VAT but enforcement has been difficult if the traders have not registered for VAT purposes.
Under the 2018 tax bill, the operator of an online marketplace may be held liable for VAT on deliveries beginning or ending in Germany that are effectuated over the marketplace. Operators of an online marketplace are required to collect information on the supplier such as name, address, VAT ID, place of origin and destination, time of delivery, sales price.
The EU Commission had previously enacted the EU e-Commerce Directive, which also aims at removing competitive disadvantages of tax compliant entrepreneurs vis-à-vis traders that do not register themselves for VAT purposes. While new legislation based on the EU Directive is expected not to be effective before 2021, the German rules introduce an online marketplace liability already from March 2019 (for traders from non-EU/European Economic Area ("EEA") countries)) and from October 2019 (for traders from Germany and other EU/EEA countries).
The 2018 tax bill includes further changes to VAT law, including changes based on the EU e-Commerce Directive.
What Else to Expect
A separate bill is being drafted by the legislator that will deal with changes to the German real estate transfer tax (“RETT”). The discussed amendments are focused on share deals:
- Reduction of the RETT-threshold from today’s 95 percent to 90 percent (earlier in the year a threshold as low as 75 percent was discussed but raised questions about constitutionality);
- Extension of the monitoring period for indirect or direct partnership transfers from five to 10 years;
- Extension of the RETT-concept applicable for German real estate owned by partnerships to corporations: RETT would be triggered if within a 10-year monitoring period 90 percent or more of the shares are transferred to new shareholders.
It remains to be seen whether a first draft will still be issued in 2018 and from which effective date the rules are intended to apply.
German-headed groups are particularly interested to learn details regarding the anticipated revisions to the German CFC rules. The German legislator is obliged to transform certain requirements of the EU Anti-Tax Avoidance Directive into German law. In doing so, the legislator also aims at a general modernization of German CFC rules, e.g. with regards to the taxation rate that is considered to qualify as a “low taxation.” This rate is still 25 percent and does not reflect the international developments over the last decade. No legislation for revised CFC rules has been included in the 2018 tax bill.
A first draft is expected at the beginning of 2019.
While the 2018 tax bill includes a variety of tax law changes in different areas, this article has focused on some of the most significant changes for MNCs. MNCs should consider the following:
- Nonresident investors should review their portfolio to determine whether they own shares in corporations that owns significant German real estate. Due to the extension of the nonresident capital gains taxation treatment to shares in non-German real estate-rich corporations, such investors might become subject to German nonresident taxation regarding capital gains from the sale of such shares.
- In case of tax losses forfeited on a pro-rata basis due to a direct or indirect ownership change of more than 25 percent it should be reviewed whether benefiting from the new legislation that has retroactive effect is possible. Depending on the facts it would be recommended to take action already prior to December 31, 2018 to avoid statute of limitation.
- Germany’s tax group requirements remains—as in prior years—a hot topic as the risk exposure from failure could be significant. A review of the fulfillment of the conditions is advisable. The 2018 tax bill once again stresses the complexities taxpayers face if they want to form a tax group in Germany.
- Nonresident suppliers selling goods to German customers via an online marketplace should determine their VAT position in Germany and prepare to provide the required information to the marketplace operators.
Kais Mouldi is a Partner and Tim Wagener is a Manager, International Tax Services, PwC Germany