The German Ministry of Finance has published a final version of its decree on the minimum capital to be attributed to branch banks for tax purposes.
The German Ministry of Finance has just released the final version of its new decree referred to as "Administrative Principles for the Attribution of Capital to Branches of International Banks". The Administrative Principles are designed to implement Part II of the OECD Discussion Draft on the Attribution of Profits to Permanent Establishments ("PEs") of Banks issued in March 2003 and replace the relevant section in the Administrative Principles for the Determination of Profits to be Allocated to a PE published in 1999. Whilst decrees of this nature bind the tax authorities rather than the taxpayer, they give a considerable degree of certainty, at least on matters of calculation. The new Administrative Principles apply to both German branches of foreign banks and foreign branches of German banks and contain the following provisions:
As a first step it has to be determined which of the bank's risk-weighted assets and market risk positions have to be allocated to the branch based on the functions actually performed by the branch (Allocation of Assets & Positions).
As a second step the risk-weighted assets and market risk positions allocated to the branch have to be valued under the German regulatory rules or equivalent rules as applicable in the country of the head office (Valuation of Assets & Positions). Positions hedged intrabank and intrabank current accounts are to be eliminated.
As a third step, the decree suggests two basic methods to determine the capital to be attributed to a branch for tax purposes:
1. The first and primary method is similar to the BIS ratio approach suggested by the OECD. It allocates the total bank's equity between the head office and its branches based on the proportion of the risk-weighted assets and market risk positions of the individual branch to the total risk-weighted assets and market risk positions of the bank as a whole (equity pro-rating method).
2. The second method, which is generally only to be applied, if the first method leads to an economically unreasonable result, is similar to the quasi-thin capitalization approach suggested by the OECD. It requires the branch to have the same amount of capital as would be required, for regulatory purposes of an independent bank operating in the host country taking into account the risk-weighted assets and market risk positions allocated to the branch (arm's length approach).
In applying either of the methods, at least a minimum capital, calculated as follows, has to be attributed to the branch for tax purposes: The minimum capital equals 8.5% of the total of the risk-weighted assets and market risk positions allocated to the branch. The minimum capital can be reduced to 4.5% depending on the mixture of the core capital (tier 1) and additional capital (tier 2) of the bank as a whole.
The Administrative Principles provide for simpler rules for small banking branches and new branches.
The new rules for the Attribution of Capital to Branch Banks are to be applied from 1 January 2005. The old provisions for the determination of bank branch capital (as included in the Administrative Principles for the Determination of Profits to be Allocated to a PE) expired on 31 December 2000. There are transitional provisions to be applied during the period after the expiry of the old provisions and 1 January 2005. These transitional provisions generally require the branch to have the minimum capital calculated using the second method.
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