For internationally positioned corporate groups, further changes to the income tax framework are emerging. The draft of the Withholding Tax Relief Modernization Act determines an adjustment to the central anti-abuse standard for withholding tax relief (Sec. 50d para. 3 of the German Income Tax Act), which is likely to have a tightening effect, at least in part. With regard to transfer pricing, the legislator is partially taking up proposals that were already the subject of a draft bill at the end of 2019.
Bill of the Federal Government
Withholding Tax Relief Modernization Act (Abzugsteuerentlastungsmodernisierungsgesetz): This unwieldy name – in short AbzStEntModG - refers to a draft bill by the German government dated January 22, 2021. The draft plans far-reaching changes to the taxation of cross-border issues. The main focus of the bill lies in changes on the procedure for withholding, paying and certifying capital gains tax. These changes are due, among other things, to the lessons learned from the cum-ex, cum-cum and cum-fake scandals. In addition to these procedurally significant changes, the German government also plans substantive changes in the area of transfer pricing and in the relief from withholding taxes by limited taxpayers. We want to take a detailed look at the planned changes in these areas below.
Changes in transfer prices
The regulations on transfer pricing should have been extensively amended by the Anti Tax Avoidance Directive (ATAD) Implementation Act at the end of 2019. This legislative project has not yet been implemented. The new draft law takes up some, but not all, of the new provisions from the ATAD Implementation Act. The most important innovations at a glance:
- Introduction of a new legal regulation on advance agreements
- Deletion of the hierarchy of transfer pricing methods
- Strong emphasis on functional and risk analysis
- Bandwidth narrowing usually as interquartile narrowing
- Partial deletion of the escape clause in the function transfer, definition of the transfer package, shortening of the price adjustment period.
- Introduction of extensive regulations on intangible assets (definition, inclusion of the DEMPE concept [DEMPE: development, enhancement, maintenance, protection, and exploitation], price adjustment clause).
The following regulations from the first draft of the ATAD Implementation Act shall no longer be introduced:
- Lowering of the threshold for the master file from € 100 million to € 50 million
- Obligation to submit the master file to the tax office electronically on an annual basis
- Regulations on financing relationships (arm's length analysis for financing transactions, classification of financing centers as service providers)
Not all of the amendments are entirely new and, in some respects, already reflect the common administrative opinion. In some cases, the legislator has followed the wording of the transfer pricing guidelines of the OECD, the Organization for Economic Cooperation and Development, but in others it deviates from them. The concrete effects of the new regulations depend, among other things, on the business model or the type of intercompany transactions. Companies with cross-border operations should examine the new regulations and check whether there is a need to adjust their transfer pricing structures.
Changes in the relief from withholding tax
Shareholders with limited corporate tax liability and remuneration creditors may be entitled to relief from German withholding tax under EU directives or a double taxation agreement (DTA). This applies, for example, to withholding taxes on dividends and royalty payments. The provision of Sec. 50d para. 3 of the German Income Tax Act (EStG) is intended to prevent abuse in this area, in particular by making it more difficult to grant relief (for this purpose only) to intermediary companies (avoidance of so-called treaty shopping).
According to the case law of the European Court of Justice, the previous version of Sec. 50d para. 3 German Income Tax Act (EStG) violates the freedom of establishment in the case of claims under the Parent-Subsidiary Directive and is thus contrary to European law. The tax authorities have therefore already limited the scope of application of the standard by circular of the Federal Ministry of Finance. In addition, Art. 6 of the ATAD Directive now also forces the legislator to adapt this abuse avoidance standard.
Against this background, a comprehensive revision of the standard is now planned. The objective remains the denial of a withholding tax reduction for functionally weak intermediary shareholders. The new regulation provides that the claim of a foreign company does not prevail, regardless of a double taxation agreement, insofar as
- persons hold shares in it who would not be entitled to this claim if they earned the income directly (personal relief entitlement),
- and the source of income has no material connection with an economic activity of this entity (factual relief entitlement).
According to the explanatory memorandum, in contrast to the current version, the personal entitlement to relief shall not be fulfilled if the entitlement to relief of the person involved arises from another entitlement standard, e.g. another DTA or as an unlimited taxpayer. This will, for example, make so-called meandering structures (domestic shareholder of a foreign intermediate company) more difficult in the future.
There is also a threat of a tightening of the substantive entitlement to relief. In the future, a "substantial connection" of the income from the shareholding with the economic activity of the foreign corporation will be required. According to the explanatory memorandum to the law, it is required that the holding of the source of income by the corporate taxpayer fulfills an economic function in relation to its other activities. The provision of mere supportive services (e.g. in the area of accounting or legal advice) shall not be considered an economic activity in this sense.
If the entitlement to relief does not apply under this provision, abuse is legally presumed and the entitlement to relief lapses (if applicable, on a pro rata basis). It is true that the foreign corporation can obtain relief by proving that none of the main purposes of its involvement serves to obtain a tax advantage. In this respect, however, there is also a tightening of the previous legal situation. Previously, the interposition was only considered abusive if there were no economic or other significant reason for it.
The new provision shall be applied in all open cases unless the current version of Sec. 50d para. 3 of the German Income Tax Act (EStG) does not conflict with the entitlement to relief and is therefore more favorable to the taxpayer.
Outlook
The draft law has been forwarded to the Federal Council (Bundesrat) for consultation, as the law is subject to approval. It cannot be ruled out that (extensive) amendments will be made to the planned law in the further course of the deliberations in the German Bundestag and Federal Council (Bundesrat). The new provision in Sec. 50d para. 3 of the German Income Tax Act (EStG) in particular contains a large number of undefined legal terms. Further clarification would therefore be preferable.