February 17, 2021
German Ministry of Finance publishes working draft of Act to Combat Tax Avoidance and Unfair Tax Competition
The German Federal Ministry of Finance published a first working draft bill for the creation of the Act to Combat Tax Avoidance and Unfair Tax Competition dated 15 February 2021 (draft bill). The objective of the draft bill is to encourage jurisdictions deemed to enable harmful tax practices to change their behavior by way of preventing companies and individuals from maintaining business relationships with non-cooperative countries in the area of tax transparency or those with unfair tax competition.
The draft bill is intended to replace the Regulation on Combating Tax Evasion (Steuerhinterziehungsbekämpfungsverordnung) and, similarly, would set forth additional obligations for taxpayers to cooperate in terms of documentation and disclosure. Further, the draft bill would deny the deduction of expenses, relief from withholding tax and the application of certain beneficial mechanisms such as the flat rate taxation of capital income and the participation exemption. Furthermore, it is proposed to add a provision on aggravated controlled foreign company (CFC) taxation.
Whereas the existing regulations have never been of great importance since a decree of the German Federal Ministry of Finance dated 5 January 2010 stated that no state or territory met the requirements for measures under the Regulation on Combating Tax Evasion, the draft bill would rely on the European Union (EU) list of non-cooperative jurisdictions for tax purposes (the EU List).
Maintaining business relations or investments in or with reference to a non-cooperative tax jurisdiction is a prerequisite for applying any sanctions provided by the draft bill. Thus, the scope of the draft bill is currently applicable to those jurisdictions that are on the EU List: American Samoa, Anguilla, Fiji, Guam, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, US Virgin Islands, and Vanuatu. Newly added on 16 February 2021 was Dominica. The EU List is updated at least twice a year in February and October and could cover more countries in the future. For example, it is currently under discussion that Turkey may move from the "grey list" to the EU List this year if it further refuses to meet the criteria set by the EU Finance Ministers by the end of May.
Business relationships with non-cooperative jurisdictions
The provisions under the proposed Actare to be applied whenever a taxpayer maintains business relations or investments in or with reference to a non-cooperative tax jurisdiction.
The draft bill considers jurisdictions listed on the EU List to be non-cooperative tax jurisdictions within the meaning of the Act if they do not ensure sufficient transparency in tax matters (especially Organisation for Economic Co-operation and Development Common Reporting Standards), do not engage in fair tax competition that results in significantly lower effective taxation or favors offshore structures and/or do not commit to implementing the BEPS minimum standards. The draft bill provides a separate regulation determining all non-cooperative jurisdictions for purposes of the Act, and the date on which their qualification changes.
Denial of the deduction for operating costs
Expenses from business transactions with individuals or companies resident in a non-cooperative tax jurisdiction may not be deducted as operating or income-related expenses unless the income corresponding to the expenses is subject to unlimited or limited taxation in Germany.
Aggravated CFC taxation
Completely new as compared to the existing rules under the regulation on Combating Tax Evasion, stricter CFC taxation is proposed under the draft bill. According to this rule, companies domiciled in non-cooperative tax jurisdictions are deemed to be intermediate companies with all passive and active income in the case of national control within the meaning of Section 7 Foreign Tax Act (FTA). The criterion of low taxation shall be irrelevant, and the motive test is also not deemed to be applicable. Active CFC income would not be covered to the extent the deduction for the related operating costs is already denied under the new bill.
Denial of withholding tax relief
If a foreign company is generally entitled to full or partial relief from withholding tax, the relief shall not be granted if individuals resident in a non-cooperative tax jurisdiction directly or indirectly hold an interest in the company with an aggregate interest of more than 10%.
Extension of nonresident tax liability
Compared to the current regulation, the nonresident tax liability is to be extended to income from financing relationships, from insurance and reinsurance services, from the provision of other services and from trade if the income is received by a company or individual resident in a non-cooperative jurisdiction and is being deducted as an expense in Germany. The tax on the related payments is to be withheld at source at a rate of 15% and paid to the Federal Central Tax Office.
Taxation of dividends
For dividends and capital gains that stem from a corporation resident in a non-cooperative tax jurisdiction, the tax exemption for corporates pursuant to Section 8b Corporate Income Tax Act and comparable provisions in tax treaties as well as the flat withholding tax rate of 25% for individuals and the 40% exemption for partnerships do not apply. However, the taxpayer may prove that the distributions result from amounts that have already been — under the new bill — subject to domestic withholding tax at the level of the distributing company or that the deduction of expenses has already been denied for the respective amounts.
Increased obligations to cooperate
Where German taxpayers maintain business relations or investments in or with reference to a non-cooperative tax jurisdiction, the proposed new rules stipulate increased obligations to cooperate in terms of documentation and disclosure.
The new rules require for example documentation as to type, content and scope of business relations (in particular the purchase of goods or services, financing relationships, insurance relationships, transfer of use and cost allocations). Documentation must be prepared and provided to the competent tax office or, in certain cases, to the Federal Central Tax Office within one year after the end of the business year.
Where the requested data is not provided, the tax authorities are entitled to estimate based on simplified methods, which may result in an adjustment of taxable income. Within such estimates, it can generally be assumed that relevant income exists or is higher than the declared income.
Violations of the cooperation obligation may also be sanctioned as an administrative offense and a corresponding fine may be imposed.
In addition, the tax authorities can order a tax audit if the taxpayer does not meet his/her increased obligations to cooperate.
New obligations for customers according to the Financial Account Information Exchange Act
Furthermore, the proposed new Section 3a Financial Account Information Exchange Act (Finanzkonten-Informationsaustauschgesetz) would impose obligations on both existing and new account holders of reporting financial institutions. According to the draft bill, the account holders have the obligation to provide self-assessments and supporting documents correctly and completely and notify the reporting financial institutions if the relevant circumstances change.
Finally, a failure to comply with the obligations in connection with the financial account information exchanges will qualify as an administrative offense and can be sanctioned with a fine.
If enacted, the new rules are to be applied as of 1 January 2022 and irrespective of possible conflicting treaty provisions (treaty override). For jurisdictions not yet included on the EU List as of 1 January 2021 but added later, the law is to be applied as of 1 January 2023. The legislative process is expected to take place through the summer.
The planned legislation adds more meaning to changes on the EU List. It also requires closer monitoring of "grey-listed" jurisdictions such as Turkey and the possibility that it is added to the EU List.
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