On 5 June 2013 the Mediation Committee of the German Bundestag and Bundesrat has proposed important changes in German tax law. The changes had been discussed for nearly one year. It is expected that the Bundestag and Bundesrat will consent to the proposals shortly. Some of the most important changes are summarized below.
I. Business Partnerships / Exit Taxation
To avoid German exit taxation on hidden reserves in corporate shares (section 6 Foreign Tax Act) those shares were often transferred before the taxpayer's move to a foreign jurisdiction into a German partnership, which as such was not necessarily actively engaged in business but, due to very specific German rules, treated as being engaged in business (deemed/ tainted business partnership).
Thereby, shares should have remained subject to German tax and, thus, prevent German exit taxation. According to the Federal Tax Court's permanent case law, however, the mere deemed / tainted business of a partnership is held not relevant under tax treaty law. Following the move to a foreign jurisdiction, only the new residence state has the right to tax hidden reserves in the corporate shares.
The new section 50i Income Tax Act (ITA) particularly relates to those structures. Despite tax treaty rules Germany should keep the right to tax, if shares were transferred before the official announcement of the new law into a mere deemed / tainted business partnership ("Old Cases") and will be sold with profit following the taxpayer's move.
The new rule only relates to "old cases". Especially because of this it raises many questions. The new rule may also have implications for other structures, in particular in the private equity business with domestic or foreign partnerships interposed, which as such are not actively engaged in business but, according to German tax law, are (respectively: were) treated as only deemed / tainted business partnerships.
Because of the new rule, at least with regard to the future, German tax administration may not be able to adhere to its former position according to which deemed / tainted business partnerships generate business income under tax treaty law.
II. Taxation of hybrid Capital Instruments
The principle of corresponding taxation will be extended to so-called hybrid capital instruments for Corporate Income Tax purposes.
Hybrid capital instruments are – due to their terms and conditions – qualified as debt in a foreign state and as equity in Germany, since Germany and foreign countries do not classify equity and debt on the basis of uniform criteria. The different classification may result in the deduction of the payment as operating expense (interest) in the source state and as dividend in Germany being subject to preferred or non taxation in the hands of the recipient.
This shall be avoided by extending the system of corresponding taxation to the hybrid capital instruments, i.e. the 95% participation exemption of dividend income for Corporate Income Tax purposes shall only be applicable to the extent the dividend received was not tax deductible at the distributing corporation's level. Taxpayers may have to provide evidence regarding the tax qualification abroad in order to achieve preferred dividend taxation in Germany.
The new rule will generally apply as of 2014 (in case the fiscal equals the calendar year).
III. Real Estate Transfer Tax
Structures to avoid Real Estate Transfer Tax (RETT) in case of share deals by using RETT blockers are not possible anymore. RETT will be triggered in the future if a person acquires, directly or indirectly, at least 95% of the economic interest in a real-property owning entity (sec. 1 para. 3a RETT Act). An indirect shareholding will be calculated by multiplying the participations in the capital and / or in the assets of the entities involved. Thus, it is no longer possible to avoid RETT by using a partnership as RETT blocker with a third party as a minority partner in that partnership.
It might be problematic that, given the wording of the new rule, (i) existing RETT blocker structures and (ii) structures in which the 95% threshold was already reached and, thus, triggered RETT, may also be affected in case of future restructurings. Therefore, the RETT situation should be carefully examined in the context of future restructurings.
Moreover, the RETT exemption for intragroup restructurings will be extended: In future, RETT relief may, under certain conditions, not only be granted for restructurings pursuant to the German Reorganisation Companies Act but also to asset hive-downs or other asset transfers based on the company's articles.
The new rules regarding RETT will be applicable to transactions that will be executed following the day of the final decision of the German Bundestag.
IV. Amendment of the German Inheritance and Gift Tax Act (IGTA)
Furthermore, in order to avoid so-called "Cash GmbHs" the Mediation Committee proposes an expansion of the catalogue of harmful non-business assets in sec. 13b par. 2 sentence 2 IGTA. The proposed catalogue includes cash, business assets, monetary as well as other claims (so-called liquid funds). However, harmful non-business assets are only recognized if they exceed, after deduction of debt, 20% of the business' total value. The exemption limit has thus been raised from 10% to 20% compared to previous proposals.
Possibly harmful claims also comprise claims originating from business operations (e.g. receivables from goods and services). Debts to be deducted include, according to our view, obligations and all accruals/ reserves.
Businesses offering financial services as well as businesses with the primary purpose of financing affiliated companies as defined in sec. 15 German Stock Corporation Act (e.g. cash pool businesses) are exempt from these changes.
Similar to previous proposals, the amendment intends to clarify that the aggregate wage regulation also applies to holding structures where the holding itself employs less but the total group more than 20 employees.
These regulations shall come into force as of the day after the decision of the German Bundestag on the aforementioned committee proposal. Until this date, the wide structuring possibilities currently available for business and wealth succession may still be used.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.