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1 February 2012 Tax News. Agenda on the Modernisation and Simplification of Business Tax Law in Germany The German governing coalition recently announced an agenda on the modernisation and simplification of the German business tax laws ( Agenda ) (for a full version of the Agenda please click here). The Agenda consists of 12 specific points and is to be seen against the backdrop of the German-French initiative on the bilateral harmonisation of business taxation. Below we summarise the key statements of the Agenda. 1 Introduction Already the 2009 coalition agreement of the current government contained the political statement to modernise and simplify German tax laws (for details please refer to our German Tax News from October 2009, for a copy please click here. So far little has happened, although the Agenda claims differently. The most imminent unsolved issues are the old fashioned German group taxation (Organschaft), the rigid and complex regime on the offsetting of losses including change of ownership rules and the jungle of the German Trade Tax. In 2011 the German and the French Government have kicked off an initiative on the bilateral harmonisation of business taxation. The German together with the French Ministry have very recently presented a joint study on the status quo, the differences and the convergences of both business tax systems with a focus on rates, group taxation, treatment of dividends and certain expenses, offsetting of losses, depreciations and partnership taxation (for a full version please click here). Contents 1 Introduction Key Statements Reform of Group Taxation Rules on Losses Hybrid Instruments and Entities Tightening of Stock Loan Provision ship Taxation Restrictions in relation to LBO-Transactions. 5 3 Conclusion... 5 The Agenda now picks up certain topics of this report on the one hand. On the other hand it also addresses structures that the revenue disapproves and claims to be abusive. The latter includes in particular: > proposals on the taxation of hybrid instruments in cross border situations, > tighter tax rules on stock lending, as well as > restrictions to the interest deduction in case of leveraged buy out transactions ( LBO-Transactions ). Agenda on Business Tax Law Issue 2/2012 1
2 2 Key Statements The key statements of the Agenda can be summarised as follows: 2.1 Reform of Group Taxation The current German Organschaft is undoubtedly error-prone due to its requirement of and the due compliance with a so-called profit and loss transfer agreement ( PLTA ) as well as the very formalistic approach taken by the Federal Tax Court ( BFH ) in this regard (for details please refer to our German Tax News from March 2010). Even small errors may result in significant tax consequences including the retroactive denial of the tax consolidation for a period of up to five years. Against this backdrop, the Agenda announces to introduce in the medium future a new group taxation system that meets international standards. To realise this goal, it is intended to delink the tax consolidation from the precondition of a PLTA on the one hand. On the other hand, the minimum holding requirement (currently more than 50%) shall be increased (the proposal of the joint German- French study is 95%). The government is however still undecided as to how the tax consolidation shall be achieved technically. The methods that are currently being discussed are an attribution of the overall income and a profit/loss transfer by tax relevant group contributions (i.e. Scandinavian model). The reform requires a preparation sufficiently in advance in order for the industry to adapt. Thus the Agenda foresees to put the reform only in place as of Rules on Losses The Agenda proposes an amendment to the loss carry back, restrictions on the use of final foreign losses and the monetisation of losses Amendment to Loss Carry Back In relation to the rules on offsetting of losses, the Agenda announces to increase the available amount of losses to be carried back into the immediately preceding fiscal year from currently EUR 511,500 to EUR 1 million. Furthermore, the option of the taxpayer to determine the specific amount of carry back within the maximum range shall be abolished. Going forward only the option to make use of the carry back in the full amount of EUR 1 million shall be maintained. In summary this is far from being a big deal in terms of simplifying the loss offsetting rules Restrictions on Final Foreign Losses Pursuant to the case law of the ECJ (e.g. Marks&Spencer and Lidl cases) and the BFH, final losses of foreign establishments and subsidiaries can generally be used in the home jurisdiction of the headquarter or the parent respectively. Although it is not yet entirely Agenda on Business Tax Law Issue 2/2012 2
3 clear under which factual or legal circumstances losses qualify as final, in which fiscal year they become deductible and whether foreign or domestic rules regulate their use, the rulings of the BFH tend to be too generous for the taxpayer in the view of the revenue. Therefore, the Agenda seeks to cutback the rules on the use of final foreign losses to the minimum standards under European law. The motivation is clear. The revenue fears that many foreign losses are imported into Germany eroding the German tax base. The Agenda is however silent on how the new rules might look like Restrictions on Monetisation of Losses The possibilities to monetise tax losses shall be further restricted. Under the current tax law, only the shifting of losses into profitable entities is encompassed by the change of ownership and merger rules. Moving profits into loss companies is however feasible. In order to counteract undesired structures where loss monetisation techniques have been used in an allegedly model like fashion (e.g. so-called lease tail trades), the merger tax rules shall be amended. The idea is to restrict the use of losses not only in case of the loss company being merged into the profitable company but also in a reserve merger scenario. The Agenda is however silent on the technical details. 2.3 Hybrid Instruments and Entities By using hybrid instruments such as profit participation rights in cross border transactions so-called white income might be generated if the instrument is regarded as debt at the level of the foreign issuer while it qualifies as equity in the hands of the German holder. Such structures can in principle also be used in Germany because the German participation exemption (sec. 8b KStG) is also available in cases where the instrument is treated abroad as debt (and thus payments are deductible). This is only different for constructive dividends if the constructive dividends are deductible for the taxpayer (sec. 8b para. 1 sent. 2 KStG). The Agenda foresees to extend the aforementioned provision, which effectively denies the participation exemption, to payments under hybrid instruments. In our view, the Agenda hereby concedes that sec. 8b para. 1 sent. 2 KStG is currently not applicable to hybrid instruments. This concession might strengthen the taxpayers position in on-going tax audits where hybrids are scrutinised. Moreover, there is an unofficial draft of a sec. 50d para. 11 EStG that addresses situations in the context of which private individuals who are not eligible for the dividend exemption under tax treaties might claim such benefits by the interposition of hybrid entities (namely German KGaAs or similar foreign entities). The Agenda does not mention this proposal. Agenda on Business Tax Law Issue 2/2012 3
4 2.4 Tightening of Stock Loan Provision The corporate tax code already contains a special provision for stock loan and repo transactions that aims to counteract arbitrage in situations where the lender is not eligible for the participation exemption whereas the borrower benefits from said exemption. Without the special provision, such transactions would result in a tax shelter for qualifying borrowers due to the fees and manufactured payments being deductible. To prevent this, sec. 8b para. 10 KStG denies the deductibility of such expense items at the level of the borrower. The provision applies accordingly in cases where shares are lent via partnerships or partnerships are lenders, however only to the extent the partners of the partnerships are corporate taxpayers (sec. 8b para 10 sent. 6 KStG). The Agenda foresees to extend the deduction limitations to partnerships with individual partners. This might, inter alia, affect certain German private banks with individual general partners which are engaged in stock lending activities. 2.5 ship Taxation Regarding the taxation of partnerships, the Agenda highlights two issues Offsetting of Losses of Limited s The offsetting of losses of limited partners is set out in sec. 15a EStG. In a nutshell, said provision intends to allow the offset of such losses only to the extent they have economically been borne by the respective limited partner. The determination of the amount of losses borne is however based on the corporate law liability of a limited partner. To reduce complexity, the Agenda foresees to delink the loss offset from the corporate law and to base it on the partner s tax capital account instead Special remunerations of Foreign s Unlike in many other jurisdictions, so-called special remunerations (Sondervergütungen), such as interest on loans granted by a partner to its partnership, form part of the partner s profit share under German domestic partnership rules. Consequently, such interest is subject to tax as German source business income at standard rate (the flat tax does not apply). Under the tax treaties however also the interest paid by the partnership to a foreign partner is regarded as interest and thus only taxable abroad (art. 11 OECD model convention). The revenue dislikes this results but the BFH has confirmed it repeatedly. The Agenda announces to put this case law aside and harmonise the treatment of special remunerations paid to foreign partners with the one of such remunerations paid to German partners. When doing so care shall be taken that a double taxation is effectively avoided. Agenda on Business Tax Law Issue 2/2012 4
5 2.6 Restrictions in relation to LBO-Transactions One of the most important measures announced by the Agenda is the further tightening of the deduction limitations relating to interest on debt incurred in LBO-transactions. The political environment and revenue s attitude towards private equity and in particular LBO- Transactions have become less favourable over the last years. As a consequence, certain elements such as the asset administrating nature of partnerships, debt push down techniques and the treatment of carried interest and management participation structures have and are selectively being challenged in tax audits and are subject to court proceedings. In light of said climate change, the Agenda now takes a far broader approach when stipulating that the deductibility of financing costs within LBO-transactions shall be strictly limited or even excluded. The coalition is explicitly on the point that it wants to counteract structures that allow for the purchase price being financed by the company acquired. The Agenda is however silent on how this should be achieved technically. It seems that Germany wants to follow the recent trend in other countries that have recently tightened their rules on the deductibility of external and internal acquisition debt. France for instance has introduced a test based on the French acquisition company s ability to effectively control the shareholding in the target and the target itself. The Netherlands recently adopted regulations under which the deductibility of expenses for acquisition debt is denied if a certain ratio between the acquisition costs and the corresponding debt (i.e. 60%) is exceeded. There is also a working group that is looking into reforming or abolishing the partial tax exemption for carried interest (sec. 3 no. 41 EStG). If the rules will in fact be changed, we currently anticipate that the impacts should be limited to pure domestic structures. However, the further developments remain to be seen. 3 Conclusion Contrary to what the Agenda claims, it is not the big move towards modernisation and simplification. Rather the majority of the proposed changes aim at overruling case law or tackling structures that the revenue disapproves. Other projects like the reform of the financing of the municipalities and the German trade tax have been removed from the political agenda completely. In addition to the Agenda, other important initiatives in the German/European tax arena are currently the proposed reform of the investment fund tax rules and the introduction of a tax on financial transactions. It remains to be seen to what extent the measures announced by the Agenda will be implemented. In the current German political environment this will require the cooperation of the opposition parties as the governing Agenda on Business Tax Law Issue 2/2012 5
6 coalition does not have the majority in the German Federal Council (Bundesrat) which needs to approve the proposed changes of law. * * * Agenda on Business Tax Law Issue 2/2012 6
7 Contacts For further information please contact: Dr. Sebastian Benz (+49) Prof. Dr. Jens Blumenberg (+49) Dr. Thomas Elser (+49) Florian Lechner (+49) Oliver Rosenberg (+49) Author: Prof. Dr. Jens Blumenberg, Dr. Martin Haisch This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2012 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of the LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on and such persons are either solicitors, registered foreign lawyers or European lawyers. Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. Andreas Schaflitzl (+49) andreas.schaflitzl@linklaters.com Dr. Rainer Stadler (+49) rainer.stadler@linklaters.com Mainzer Landstraße Frankfurt am Main Postfach Frankfurt am Main Telephone (+49) Facsimile (+49) Linklaters.com Agenda on Business Tax Law Issue 2/2012 7
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