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1 PKF FASSELT SCHLAGE PKF Editorial Dear Readers, recently, in connection with the VW scandal, the Süddeutsche Zeitung (a quality German newspaper) wrote that: The image of German industry is based on a sense of duty as well as regulatory compliance. Following on from this, in this issue of our newsletter, we discuss the highly relevant topics of compliance, controls and monitoring. In the Focus section, we present tax compliance in the area of payroll tax. It is precisely irregular issues such as, for example, benefits in kind that require clear processes and rules. Moreover, as part of the Corporate Finance series, we shine a light on possible defence strategies against fraud risks. A process-integrated control by the controlling department and a control that is independent of the process by the auditing department can help a business to comply with regulations or internal guidelines and, thus, to prevent financial losses or damage to a company s image. In the Tax section, now that the relevant work has been completed at the OECD level, we present the measures that have been agreed to neutralise the effects of hybrid mismatch arrangements. These are intended to prevent income remaining untaxed from a transnational overall perspective. Moreover, in the light of a new Federal Fiscal Court ruling, we discuss the recognition for tax purposes of write-downs on loans to foreign subsidiaries. Other contributions concern two equally difficult and practicerelevant issues. Firstly, if you are selling goods via electronic trading platforms, at which point does this become a commercial activity that is subject to VAT? Secondly, who becomes a copartner if use is made of the option for preferential treatment pursuant to inheritance and gift tax under a reservation of usufruct? In the Legal section, we highlight the very narrow limits within which it is possible to cancel inter-company agreements in a GmbH (German limited company) group. In another contribution, we take a close look at the Federal government s draft law on the reform of avoidance in insolvency. Will it deliver the intended improvement in legal certainty? We hope that you find this newsletter stimulating reading. Yours sincerely, Your PKF Team Contents FOCUS» Payroll tax obligations as a constituent element of tax compliance Recommendations for process design TAX OECD/G20 are combating tax evasion due to the use of hybrid mismatch arrangements What should you do?» Unsecured loans to foreign subsidiaries Writedowns are only possible to a limited extent» A commercial activity or not a commercial activity? BFH rules on VAT liability in the case of (private) sales via the internet» Gifting a limited partnership interest under a reservation of usufruct Can the exemption rules still be used? LEGAL» An inter-company agreement with a dependent German limited company (GmbH) may not be cancelled during the course of a year» Draft law on the reform of avoidance in insolvency Will this provide greater legal certainty? CORPORATE FINANCE» Defence strategies against fraud risks

2 [ FOCUS ] Payroll tax obligations as a constituent element of tax compliance Recommendations for process design As the tax and legal obligations of business owners grow ever more comprehensive, tax compliance is increasing in significance. The focus of this contribution is the area of payroll tax. 1. Compliance objectives... The compliance objectives are risk minimisation as well as enhancing efficiency and effectiveness. Therefore, under tax compliance you should include readiness to comply with the applicable tax laws as well as the effective fulfilment of tax obligations.... in the (frequently neglected) area of payroll tax Important fields within tax compliance are income tax, value added tax and the carrying out of tax audits. Payroll tax is frequently viewed as merely a pass-through item and as the responsibility of the personnel department. Yet, failures precisely in this area can cost companies dearly. This is because the risk of detection is considerable as, besides an external audit of your payroll tax, there is also the threat of a special audit by the social insurance agencies. The additional amounts that will then have to be paid will be noticeably large. II. The payroll tax compliance process (1) Risk analysis First of all, the risks should be identified and evaluated. Regular wage and salary payments are not significantly risk-prone. However, the payroll tax auditor regularly reports findings with respect to matters such as gifts and other benefits in kind to employees and third parties, company events, hospitality as well as business trips and travel expense reports. In the area of benefits in kind there is, indeed, a new Federal Ministry of Finance (Bundesministerium der Finanzen, BMF) circular, from , which relates to the flat rate of income tax that is applicable to benefits in kind pursuant to Section 37b of the German Income Tax Act. However, precisely because of the large amount of legislation there is high potential for error. (2) Process analysis After analysing the status quo, measures and guidelines should be derived on the basis of this. Frequently, in the interfaces between the personnel department, the finance department and management, responsibilities and functions are not clearly allocated and there is a lack of documentation on business processes. The following issues, in particular, should be clearly regulated: Counteract the high level of potential errors that can arise due to the large amount of legislation with an internal control system. 2 PKF newsletter November 2015

3 10 15 Which departments are involved in the payroll tax process? Where does the decision-making competence lie? Are there any final checks? What internal as well as external resources are available to the company (e.g. software, further training, tax consultants)? (3) Implementing an ICS (internal control system) Breaches of compliance regulations will not merely result in additional tax and interest payments. Increasingly, the tax authorities are undertaking investigations with a view to the possible institution of criminal proceedings. The managing director risks being accused of failing to provide proper organisational channels if internal processes are not designed to be efficient and if transparent structures are not in place in order to avoid errors. By implementing an ICS in the area of taxes, in an emergency, the company would be able to provide proof that management had fulfilled its duty of care responsibilities. (4) Procedural instructions Process redesign should be supplemented by internal procedural instructions. For example, in the area of benefits in kind there could be a specification that, on a monthly basis, the value of these benefits to staff may not exceed 44 gross, or that hospitality for employees should not exceed 60. As soon as cross-border activities have to be dealt with in terms of payroll tax, particular attention is required. If there is no permanent establishment, then close cooperation with a foreign payroll provider is necessary so that all the remuneration components are correctly reported and recorded both domestically and abroad. Having an external advisor as a permanent contact person for such tax matters can help you to achieve overall tax compliance. (5) Transparency For effective error management it is important to deal openly with mistakes in order to correct them promptly, or avoid them in future. That is why all the decision makers in the operational departments should also be made aware of potential tax issues and should approach the department in the payroll area that is responsible for the tax compliance process at an early stage. Recommendation: You can rely on support from PKF experts when you develop, or enhance your tax compliance system. Please do not hesitate to contact us for advice on how you can fulfil your tax obligations more effectively and minimise your tax risks. [ TAX ] OECD/G20 are combating tax evasion due to the use hybrid mismatch arrangements What should you do? Who for: Businesses that operate internationally. Issue: At the beginning of October, the OECD and the G20 states presented their results from 15 subprojects on combating international Base Erosion and Profit Shifting, or BEPS for short. (To learn more about the transfer pricing documentation sub-project please see the Focus section of the PKF Newsletter 06/2015). Another sub-project tackled issues that are subject to different tax treatment under the laws of several states. This results in the overall tax burden being disproportionately low (so-called hybrid mismatch arrangements ). For example, in the state where a company is registered, a payment may constitute an interest expense and, therefore, a deductible business cost. However, for the recipient of this payment in another state it may be deemed to be a dividend and will not taxed, or some form of relief will be granted. To combat this, on the one hand, the OECD/G20 recommend making changes to double taxation agreements (DTAs) between the states. On the other hand, it is proposed that national prevention rules should be incorporated into the tax laws of the individual states. Last year, for instance, Germany introduced a regulation under which the recipient of the payment is granted tax relief in accordance with the rules on dividend income (partial income rule with respect to income tax, or a corporate tax exemption) on condition that these payments are not deductible by the payment debtor. Furthermore, a work group of the Federal Government and the Länder has been striving, for more than ten months, to identify other cases of hybrid mismatch arrangements and has been discussing possible solutions. However, the extent to which actual legislative amendments will result from this remains uncertain. Recommendation: Experience shows that making adjustments to DTAs is a relatively time consuming process, however, amending national laws as a response to the OECD/ G20 recommendations, if required, is something that can be effected quickly. If you are currently November 2015 PKF newsletter 3

4 newsletter benefiting from hybrid structures you should, therefore, monitor very closely the current and future legislative procedures in the states that are relevant for you. In this way you will be able to take prompt action in terms of your tax planning. For support in this respect please do not hesitate to contact your PKF consultant. More Information: The OECD report on neutralising the effects of hybrid mismatch arrangements is available in English at Unsecured loans to foreign subsidiaries Write-downs are only possible to a limited extent Who for: Companies that extend loans to their foreign subsidiary corporations. Issue: A domestic company made an interest-bearing but unsecured loan to its foreign subsidiary corporation. The subsidiary company plunged into a crisis and the business was terminated. The local tax office did not recognise the loss in value for tax purposes, as it had its basis in conduct that was inconsistent with the arm s length principle. To this end, the Federal Fiscal Court (Bundesfinanzhof, BFH), in two recent rulings, opted for the legal situation prior to 2008: On account of the group support, issuing unsecured loans in the group can be consistent with the arm s length principle. Group support gives no indication as to whether or not the subsidiary company can repay the loan obligation and, therefore, the recoverability of the loan that has been extended. However, the significance of the rulings is limited (especially in the case of purely domestic issues) because, in accordance with the current legal situation, fair value adjustments for loans to subsidiary corporations can only be offset against tax to a limited extent. If the lending company is a corporation then, since 2008, a write-down can only be considered if the transaction satisfies the arm s length test on a standalone basis, i.e. without taking the group relationships into account. In the case of income taxpayers this has similarly applied since 2015; if the arm s length test is not satisfied then only 60% of the write-down would be deductible for tax purposes. It should be noted that from the point of view of transnational tax provisions (German Law to Prevent International Fiscal Evasion (Außensteuergesetz, AStG), DTAs) unsecured intragroup loans are also subject to the arm s length test. Recommendation: Tax assessments from before 2007 that conflict with this ruling should be contested insofar as this is indeed still possible. When granting loans to foreign subsidiaries you should continue to ensure that this is on a sound arm s length basis. In the future, the requirement for collateral to be provided in the group on terms that would be obtained in an arm s length transaction could be completely eliminated we will keep you informed of any developments. More Information: The above-mentioned BFH rulings (from , case reference: I R 29/14 and from , case reference I R 23/13) are available at www. bundesfinanzhof.de. (German version only). A commercial activity or not a commercial activity? The BFH has ruled on VAT liability in the case of (private) sales via the internet Who for: Private individuals who, at least, occasionally sell goods via the internet Issue: Many people sell their personal consumer goods via the internet, e.g. on ebay. If this occurs not merely on an exceptional basis, then this raises the issue of whether this can still be deemed to be a private non-commercial activity, or whether it already constitutes a business activity and, thus, VAT liability should be presumed. In this connection, the Federal Fiscal Court (Bundesfinanzhof, BFH) ruled on a case where, in 2004 and 2005, in the course of a household clearance, the claimant was active on the ebay internet-trading platform via two seller accounts. She sold at least 140 fur coats to different buyers for approx. 90,000 in total. The BFH accepted that, in this case, the sales were liable to VAT and, in this respect, rejected that this was a private (household) clearance of a fur coat collection. The claimant s activities had nothing to do with those of a private collector, especially as fur coats are also not typical collectors items, such as, e.g. stamps, coins, etc. In addition, the BFH specifically explained that anyone who sells goods, in his/her own name, systematically, 4 PKF newsletter November 2015

5 10 15 repeatedly and with considerable organisational effort via an electronic trading platform (in this case: 140 fur coats) is engaging in a commercial activity, which is thus liable to VAT. The relevant criterion for deciding if an activity can be deemed to be commercial is, accordingly, whether or not the seller has taken active steps towards marketing and has made use of similar means. This was what the BFH assumed in the case in question. Please note: This decision is of fundamental significance as the principles that it has established can be transferred to all borderline cases where it is open to question whether an activity should still be deemed to be non-commercial, or if indeed it already constitutes a commercial one. More Information: The BFH ruling dates from (case reference: XI R 43/13) and is available online at (German version only). Gifting a limited partnership interest under a reservation of usufruct Can the exemption rules still be used? Who for: Business owners who want to transfer their companies to the next generation while potentially also making use of the currently still favourable gift tax rules. Issue: Ever since the submission of the governmental draft of the amended inheritance and gift tax regulations it has been clear that the hitherto applicable extensive preferential tax treatment for business assets would continue until at the latest. The transfer of limited partnership interests through gifting under a reservation of usufruct for the former owner could be a suitable model, in cases of early transfer of business assets, for securing the benefits under the current exemption rules. However, an 85%, or 100% tax exemption for the transferred assets can only be achieved if the beneficiary also becomes a co-partner in the business. In this respect, the Federal Fiscal Court (Bundesfinanzhof, BFH) recently ruled in the following case. A father who hitherto had been the sole limited partner transferred for no consideration and under a reservation of usufruct three-quarters of his limited partnership interest to his son and one-quarter to the latter s mother. It was agreed that the father, as the usufructuary, would also be able to exercise the voting rights for the limited partnership interests encumbered with usufruct. The BFH decided that the tax-free allowance (in accordance with the old legal situation prior to 2008) for the acquisition of partnership interests could not be granted. As the father was still entitled, on a contractual basis, to the voting and co-administration rights attached to the limited partnership interests that had been gifted, the beneficiaries would be unable to develop any co-partner initiatives and, thus, could not be viewed as co-partners. Moreover, the fact that, prior to the gifting, the son was already the sole shareholder in the German limited company (GmbH) that acted as the general partner did not change anything. This is because it is precisely the shareholding that is acquired that has to confer the position of co-partner on the beneficiary (and not a different circumstance). Please note: In 2009, sections13a and 13b of the German Inheritance Tax Act replaced the hitherto applicable system of preferential tax treatment with new exemption regulations. However, in this case, too, the stake in a partnership also ranks as a business asset that qualifies for preferential tax treatment so that the statements by the BFH made in respect of attaining co-partner status can be applied. More Information: The BFH ruling from the was published online on under case reference: II R 34/13. It can be called up at: de (German version only). [ LEGAL ] An inter-company agreement with a dependent German limited company (GmbH) may not be cancelled during the course of a year Who for: Companies in the legal form of a German limited liability company ( GmbH ) that want to cancel an inter-company agreement (especially a profit transfer and control agreement) with another GmbH during the course of the year. Issue: While, in practice, GmbH s are frequently parent companies, or subsidiary companies, the GmbH Act does not include any provisions on inter-company agreements. That is why in the specialist literature and in court decisions, for quite some time now, it has been controver- November 2015 PKF newsletter 5

6 newsletter sially discussed whether or not these agreements can be mutually cancelled during the course of a year. In its ruling from , the Federal Court of Justice (Bundesgerichtshof, BGH) affirmed the prevailing opinion that an inter-company agreement with a dependent GmbH can only be cancelled at the end of a financial year, or another contractually determined accounting period. The BGH applied the provisions of the German Stock Corporation Act (Aktiengesetz, AktG ) (Section 296(1)(1) of the AktG ) analogously to GmbH s, as the protective purpose pertains to the same extent in the case of a dependent GmbH. The BGH argued that settlement on the basis of accounts simplifies the process of determining any claims by minority shareholders and essentially serves the interests of legal certainty and legal clarity. Recommendation: You should also take account of the ruling in the case of the cancellation of other inter-company agreements (e.g. group cost allocation and service agreement). Should the situation so require, by shortening the business year you can then mutually cancel such agreements with the dependent company during the course of a year. This will require a prior amendment to the subsidiary s partnership agreement in order to change the financial year to the cancellation date. Insofar as there is good cause, an extraordinary termination during the course of the year in the GmbH group is always permissible. More Information: The BGH ruling from (case reference: IX ZR 384/13) is available at (German version only). Draft law on the reform of avoidance in insolvency Will this provide greater legal certainty? Who for: Creditors as well as employers and employees in the case of a challenge to a pre-insolvency transaction. Issue: On , the Federal government passed a draft law on the reform of avoidance in insolvency. The focus here is as follows: (1) Challenging transactions because of wilful disadvantage According to Section 133 of the German Insolvency Code (Insolvenzordnung, InsO ), a legal act undertaken by the debtor, within ten years before filing an application to open insolvency proceedings, with the intention to disadvantage its creditors can be challenged. Furthermore, the so-called addressee of a notice of avoidance (i.e. the person with whom the debtor concluded the transaction that disadvantaged the creditors) has to have been aware of the debtor s intention to do so at the time of the act. It is intended to reduce the time limit for challenging transactions because of wilful disadvantage to four years. In addition, it should become more difficult to contest transactions where the creditor received only what it was owed, so-called congruent coverage (Section 130 of the InsO ). These transactions will only be contestable if the insolvency creditor had realised that the debtor was already insolvent (up to now, knowledge of imminent illiquidity was sufficient). Moreover, the draft law provides for restrictions to challenging transactions because of wilful disadvantage in the case of privileged cash transactions (Section 142 of the InsO ). A cash transaction shall be deemed to be privileged if performance by a creditor takes place immediately (30 days between the performance and the payment of the fee) and is of equivalent value (in retrospect, the performance has to have been of use to the debtor). In future, challenging transactions because of wilful disadvantage in the case of cash transactions will only be possible if the debtor acted in a way that was unfair and the insolvency creditor had realised this. (2) Remuneration as an incontestable cash transaction In principle, even wage and salary payments are contestable in insolvency. According to the draft law, a cash transaction shall be deemed to be privileged (cf. above) if the period between the performance of the work and the payment of the wage/salary is no more than three months. The majority of wage/salary payments will thus be deemed to be privileged cash transactions and will be exempted from contestability in accordance with Section 130 of the InsO and a challenge on the grounds of wilful disadvantage will become more difficult. Recommendation: As the legislative procedure has not yet been completed criticism can already be clearly heard further developments should be monitored. We will keep you informed in this respect. More Information: The Federal government s draft law is available online at (German version only). 6 PKF newsletter November 2015

7 10 15 [ CORPORATE FINANCE ] Defence strategies against fraud risks Who for: Business owners and members of corporate management committees. Issue: The English term fraud covers fraud, embezzlement and other white-collar crimes committed at companies. Numerous studies have shown that even at German companies white-collar crime is not uncommon. Whether or not a company is at risk of becoming a victim of white-collar crime depends less on the sector, the ownership structure (public or private), or its legal form than on the structure ture of the company, i.e. who has the opportunity to commit fraud and to what extent and whether or not mechanisms for control and prevention are in place. A typical fraud risk situation that can be found in medium-sized enterprises is, for example, the case of a buyer who is allowed to negotiate and place orders as well as to authorise payments. An effective defence strategy against fraud risks could be based on the so-called three lines of defence model. According cording to this, internal controls should serve to uncover and prevent misconduct Three lines of defence as an effective throughout the business processes, strategy to protect against fraud risks controlling provides a safe framework and internal auditors uncover cases of fraud and by suggesting improvements ensure that the first two lines of defence become even more secure. (1) Internal controls The essential conditions for preventing fraudulent acts in a company can already be created through organisational measures alone by incorporating controls directly into the business processes. Examples of this are the proper separation of functions, or requiring approval processes. (2) Controlling A key responsibility of controlling is providing management with reliable and consistent information. In the context of fraud prevention, the data have to NG CONTROLLING INTERNAL AUDIT INT CO INTERNAL CONTROLLS be checked and any relevant anomalies have to be clarified. If the controller has ensured that the figures are reliable, reconcilable and consistent then his/her underlying critical attitude plays a role. This is generally viewed as an integral part of his/her role in the company. The controller has to scrutinise the substance of any developments, or anomalies when a comparison is made with the data from the previous year, or with benchmarks etc. In this case, gentle but insistent probing serves not only to guarantee the reliability of the information but it is, above all, a control procedure. (3) Internal audit Internal controls and controlling are an integral part of the processes and are performed at regular intervals. An internal audit, by contrast, is a check by a member of staff employed by the com- pany but who operates independently of these processes. The internal audit department provides support to a company s management with respect to the monitoring function and also reports directly to it. There are no absolute dividing lines between controlling and internal audit. However, due to its steering function, controlling has a future-oriented focus, while the primary focus DIT of internal audit is the performance of retrospective checks. Internal audit should uncover any irregularities and, at the same time, increase the risk for offenders of being discovered. A distinction is made between the following main functions: Financial Auditing Checks in the areas of finance and accounting including cost accounting are part of the traditional scope of auditing. In this way, a key part of the information system is covered. Operational Auditing Audits of the set-up organisation (organisational structure) and the workflow organisation as well as assessments in respect of the effectiveness, efficiency and security. Recommendation: Furthermore, it would be advisable to involve your annual auditor as an important external authority. The primary focus of an external auditor is not fraud detection, nevertheless, as part of the annual November 2015 PKF newsletter 7

8 newsletter audit, procedures are carried out that could uncover cases of fraud, or potential fraud risks. Therefore, we would recommend a coordinated approach between internal audit and the annual auditor. For medium-sized enterprises who do not wish to pay for their own internal audit department, there is the possibility of purchasing this as a service on a flexible basis. In this way, you will be able to obtain an external assessment of any general process weaknesses as well as recommendations for appropriate optimisation and, thus, enhance the possibilities for effectively countering fraud. [ IN BRIEF ] Time limit for applying for an assessment on the basis of the most favourable provision for the taxpayer in the case of investment income In principle, the investment income of income taxpayers is subject to a withholding tax at a rate of 25%. Taxpayers whose personal tax rate is below this level are able to apply, in their tax return, to pay tax on this income at their individual tax rate. In the opinion of the Federal Fiscal Court (ruling from , case reference: VIII R 14/13), in principle, submitting this application is only possible until a formal and legally valid tax assessment is in place. A subsequent application, for example in connection with a voluntary late declaration of capital gains, is only permissible if it was not the fault of the taxpayer that the income was belatedly made known. Tax measures for the promotion of aid for refugees Special tax relief will be granted for any measures carried out between and in relation to the support, care and integration of refugees. In particular, it will be possible to submit simplified donation receipts for cash donations. Moreover, the possibility will be opened up for associations and local initiatives to collect and pass on donations for refugees (Federal Ministry of Finance circular from , case reference: IV C 4 S 2223/07/0015:015; for an information sheet (in German) please visit [ AND FINALLY ] You cannot keep out of trouble by spending more than your income. Abraham Lincoln ( ), US President Impressum PKF FASSELT SCHLAGE Partnerschaft mbb Wirtschaftsprüfungsgesellschaft Steuerberatungsgesellschaft Rechtsanwälte Berlin Platanenallee 11 Tel Braunschweig Theodor-Heuss-Str. 2 Tel Duisburg Schifferstraße 210 Tel Frankfurt Ulmenstr Tel Hamburg Jungfernstieg 7 Tel Köln Gereonstraße Tel Haldensleben Hagenstr. 38 Tel Halle Bernburger Straße 4 Tel Helmstedt Bötticherstr. 51 Tel Montabaur Aubachstraße 13 Tel Potsdam Am Lehnitzsee 5 Tel Rostock Am Vögenteich 26 Tel Zell (Mosel) Schlossstraße 34 Tel Please send any enquiries and comments to: pkf-nachrichten@pkf.de The contents of the PKF* Newsletter do not purport to be a full statement on any given problem nor should they be relied upon as a subsitute for seeking tax and other professional advice on the particularities of individual cases. Moreover, while every care is taken to ensure that the contents of the PKF Newsletter reflect the current legal status, please note, however, that changes to the law, to case law or adminstation opinions can always occur at short notice. Thus it is always recommended that you should seek personal advice before you undertake or refrain from any measures. *PKF Fasselt Schlage is a member firm of the PKF International Limited network and, in Germany, a member of a network of auditors in accordance with Section 319 b HGB (German Commercial Code). The network consists of legally independent member firms. PKF Fasselt Schlage accepts no responsibility or liability for any action or inaction on the part of other individual member firms. For disclosure of information pursuant to regulations on information requirements for services see Picture credits: Title: d4_392; p. 2: Gregory_DUBUS/beisde istockphoto 8 PKF newsletter November