In an article in the previous issue of TAXtalk, Felix Waniek considered the effects of the 2008 business tax reform on the tax burden of corporations and shareholders.He mentioned that future sales prices of interests in partnerships and permanent establishments would potentially include an ex-post tax on accumulated profits.In this article the author focuses on the introduction of an interest cap, the new anti-loss-trafficking rule and changes to the transfer pricing regime.
Simplification of the thin-cap rules
The attempt to simplify the thin-capitalisation rules by establishing a so-called "interest cap” is one of the most delicate issues of Germany’s 2008 tax reforms.
The former thin-cap rules were considered inefficient, not workable and - worst of all - in breach of EU law.They were applicable for interest payments of corporations to substantial foreign shareholders (above 25%), exceeding a threshold of EUR 250 000 and a debt:equity multiple of 1.5:1. Where the arm’s length test was not met the payments had to be characterised as dividends and thus became taxable at both company and shareholder level.
The new interest cap rules apply to any taxable business in Germany, irrespective of its legal form. As a general rule, the new interest cap sets an annual cap of 30% of a company’s EBITDA on its net interest expenses (the amount of interest expenses less the amount of interest earned).Interest expenses that cannot be deducted have to be totalled and carried forward to the following years.In case of a transfer of the business any interest carried forward is forfeited.
There are three exceptions:
a) net interest expenses do not exceed a minimum threshold of EUR 1 million;
b) the business is part of a consolidated group;
c) the equity ratio test (escape clause) is met; and in other words the indebtedness of the business does not exceed group indebtedness by more than 1%.
The new interest cap rules target upstream and downstream inbound debt financing structures, as well as outbound financing structures.Unlike the former law, even bank financing can be covered. Therefore, when it comes to financing the new laws governing the interest cap should definitely be be taken into account.
New anti-loss-trafficking rule
The law regarding possible carry-forwards of tax losses has been tightened significantly.If-within five years - a stake of 25% or more in a German target company is transferred directly or indirectly the target’s tax losses will expire proportionally or entirely.The new anti-loss-trafficking rule was mainly introduced to prevent loss of trading via shell companies. It applies to transfers carried out on or after 1 January 2008.
Changes to the transfer pricing regime
Up until now the transfer pricing regime in Germany has been mainly governed by administrative directives.With the 2008 reform the rules have, for the first time, been codified entirely.The Foreign Relations Act now contains a definition of the arm’s length principle and a specific order of priority for determining transfer prices.Non-observance of the transfer pricing rules will lead to an increase in the taxable profit.
Additionally, the law now provides for an application of the arm’s length principle with respect to the transfer of so-called "business opportunities”.If a business opportunity is transferred as part of a business restructuring compensation must be paid according to the arm’s length principle-recognising a potential gain in the case of an outbound transfer.
A business opportunity can be any aggregation of similar operational tasks, functions such as sales, supply, marketing, research and development or financing.It does not have to be structured as an independent branch or activity.The 2008 reform represents the most far-reaching changes to transfer pricing rules since the introduction of documentation requirements in Germany.
Did tax reforms lead to a more attractive tax system? I would say yes - but not without my doubts.
On the one hand, Germany followed the international trend and lowered the nominal tax burden substantially.A nominal tax rate of 30% is by far more acceptable (from 39% before).The transfer pricing rules have finally been signed into law and some impractical rules have been replaced.Those steps make the German tax system more attractive to foreign investors.
On the other hand, the tax base has been widened at the same time.Local trade tax has gained importance and is not tax-deductible any more.The treatment of loss transfers has been limited significantly and tax neutrality between legal forms still remains wishful thinking.
Irrespective of whether the new sanctions introduced to counter tax avoidance will comply with the German Constitution and EU law or not, one thing is for sure: The amendments to the amendments will be due soon.
Source: By Felix Waniek (TaxTALK)