On January 20, 2021, the federal government issued the draft law to modernize the withholding tax relief (WHT). In particular, changes have been proposed for the following tax regulations:
- new procedural rules to facilitate the German WHT;
- new specific anti-abuse rule against contract purchases and EU directive purchases;
- new transfer pricing rules.
New procedural rules for exemption from German withholding taxes
According to the draft law, the provisions on the tax deduction procedure would be regulated by a new § 50c EStG. The currently applicable procedural rules for exemption from German withholding tax would, however, generally be retained. In principle, the payer of cross-border dividends and royalties must withhold income tax on behalf of the payee even in cases where such a payment is exempt under an applicable income tax treaty or an EU directive.
The payer may not refrain from WHT if an exemption certificate has been issued prior to payment. The Federal Central Tax Office will issue such a certificate on request if the legal requirements are met. The draft law provides for the issuance of a license fee exemption certificate, even if it is unclear whether there is a tax liability. This would be a great relief for foreign licensors, which would lead to more legal certainty.
However, exemption certificates will continue to be issued only with an anticipated effect for a maximum period of three years. In addition, the draft law expressly stipulates for the first time that the payer must submit a WHT declaration “zero” if no tax is due on the basis of the exemption certificate.
From 2024, the WHT discharge procedure will be fully digitized. Every application for a WHT reimbursement or an exemption certificate must be transmitted electronically via the electronic interface of the Federal Central Tax Office. The notification is also made electronically.
New specific anti-abuse rule against contract shopping and EU shopping guidelines
The German WHT regime remains twofold: dividends and license fees that are paid to a foreign payee are initially subject to a German WHT of 15% / 25% plus a solidarity surcharge, which must be transferred without an exemption certificate being issued. The foreign payee can request a refund in accordance with the EU directive or an income tax treaty. However, the payee can be denied any exemption from the German WHT in accordance with a domestic anti-contract / policy purchasing rule.
The Court of Justice of the European Union has found in two separate cases that the current wording of the anti-abuse rule is in conflict with EU law. Therefore, the anti-abuse rule was changed to allow, among other things, a complete refutation of the abuse of a transaction. Apart from this, the draft law continues to assume that contracts will be concluded and tax avoidance in certain multi-level ownership structures.
Accordingly, a foreign recipient of dividends or license fees can only be entitled to an exemption from the German WHT if:
- Your shareholders would also be entitled to the same contract or policy if they received the tax-inducing payment directly. or
- The source of income has a significant connection with the actual economic activity of the foreign company. or
- The foreign company demonstrates that the main purpose of engaging the foreign payee is not to obtain a tax advantage. or
- The main class of shares in the foreign company is essentially and regularly traded on a recognized stock exchange.
A real economic activity is denied if the payee only receives income from royalties or dividends, if he takes an intermediate position to pass such payments on to another person, or if the payee does not have an adequately resourced business.
The proposed anti-contract / policy purchasing rule should make it more difficult to obtain WHT relief. For example, on the basis of the wording of the law, the case can be cited that a foreign shareholder is no longer entitled to discharge if his own shareholder would be subject to another legal provision (e.g. another income tax treaty), even if both are legal Provisions provide for the same type of discharge.
In addition, the proposed rule also applies in cases where the income tax treaty in question already contains an anti-contract shopping rule, such as: B. the examination of the power limitation. This would be the case, for example, according to Article 28 of the income tax agreement between Germany and the USA.
New transfer pricing rules
The most important changes relate to Section 1 (3) of the External Relations Act, which is the basic German tax rule for transfer pricing. In particular, function and risk analysis are given significantly greater weight by the draft law. On the basis of the new law, transfer pricing reviews will in future concentrate more on the actual circumstances of the individual case and to a lesser extent on the contractual agreements (substance over form).
The “most suitable transfer pricing method” must be determined on the basis of the actual functional risk profile. The hierarchy of transfer pricing methods according to the current version of the law is deleted. All transfer pricing rules apply equally, with no preference for standard methods over profit methods.
The new paragraph 3a contains statements on the narrowing of the price range. A range of (potentially) comparable values must be narrowed down regularly using the interquartile range method.
In addition, the mean value approach is only retained for the hypothetical arm-length test.
In accordance with the new section 1 (3c) of the German External Relations Act, the DEMPE concept (development, improvement, maintenance, protection and use) introduced by the BEPS project in the transfer of the Organization for Economic Cooperation and Development (OECD) was introduced introduced into German tax law. In the future, the concept of functional ownership of an intangible asset will replace the meaning of legal and beneficial ownership.
Accordingly, it is assumed that group companies that provide the performance of the DEMPE functions or contribute to it participate in the (remaining) profit that is generated with the intangible asset. Financing (for example, the development or creation of an intangible asset), on the other hand, no longer has a right to a profit sharing from the use of the intangible asset.
The concept of beneficial ownership previously proposed by the OECD is thus abandoned. As a result, the beneficial, or even rightful, owner of the intangible asset may be limited to mere routine compensation. It is expected that many multinational companies will have to reorganize their license agreements accordingly.
In particular, for every transaction related to intangible assets, the draft law requires a further examination of whether the actual profit generated with the intangible assets deviates significantly (by more than 20%) from the profit expectations on which an original valuation is based. If this is the case and no price adjustment clause has been agreed, the German tax authorities can adjust the taxpayer’s income accordingly within a period of seven years from the conclusion of the transaction. No adjustment is required under certain circumstances.
Section 1 (3b) of the Income Tax Act contains the known provisions on the transfer of functions. In order to transfer a function, the tax authorities only need to prove that either an asset or other (previously and) transferred services have been transferred. This should significantly expand the applicability of this exit tax rule. However, there will be no transfer of functions if the acquirer exercises the transferred function exclusively for the transferor and is appropriately remunerated in return with a routine service fee based on the cost-plus method.
Following a revision by the Federal Council, the OECD report on transfer pricing guidelines for financial transactions will also be largely incorporated into German domestic tax law. This is likely to have a significant impact on corporate loan and guarantee agreements, as well as the distribution of benefits in a cash pool arrangement. It is particularly worrying that future taxpayers should bear the burden of proving that the funds should be labeled as debt. Independent ratings are no longer recognized.
It is also to be expected that group financing companies will be subjected to more detailed scrutiny in future German tax audits. Most of these companies, according to the draft law, should only be intermediaries and therefore only be eligible for a routine service fee. Multinational corporations that have set up corporate finance as an “in-house bank” should look more closely at the inter-company relationships and their functional risk profile.
In addition, the definition of a “related party” is intended to extend to unrelated parties that are part of the same network organization as the taxpayer. This should be the case if the network is characterized by close strategic and operational cooperation.
Other proposed changes
The bill also proposes changes to the following tax rules:
- Obtaining WHT relief in the case of a foreign hybrid company must be tightened.
- The enforcement of tax losses in the event of legal restructuring must be tightened further.
- Additional provisions on certain tax certificates in the case of WHT on capital income to be retained in particular by financial institutions and on the exchange of information on tax regulations using the capital markets.
In particular, the proposed changes to the WHT relief in the case of a foreign hybrid company could have unjustified consequences, for example in cases where the payee is a US LLC whose shares are owned by US companies.
Legislative process
The federal government’s tax policy measures still have to be approved by the Bundestag. At this point it is still open whether and in what period of time all proposed changes will be adopted.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Sven-Eric Bärsch is a tax advisor and partner at Flick Gocke Schaumburg, Frankfurt; Lars H. Haverkamp is a tax attorney and associated partner at Flick Gocke Schaumburg, Düsseldorf.
The authors can be contacted at the following address: [email protected]; [email protected]