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16 February 2023

Germany's updated EU list of non-cooperative jurisdictions may trigger significant German tax consequences for business relationships with Russia

  • For the first time, the European Union (EU) list of non-cooperative jurisdictions in combination with the German Tax Haven Defense Act may have significant tax consequences for a relevant number of German businesses. There are still many German entities that have substantial business relationships (e.g., holdings) with Russia.
  • The Council of the EU put Russia on the updated EU list of non-cooperative jurisdictions, issued 14 February 2023. This automatically triggers comprehensive tax-related defensive measures in Germany as of 2024.
  • German taxpayers should carefully review the impact of the new list to their business relationships with Russia and in particular consider potential documentation requirements and defensive measures that will likely apply as of 2024.

Executive summary

On 14 February 2023, the Council of the EU (Council) updated the EU list of non-cooperative jurisdictions for tax purposes and added British Virgin Islands, Costa Rica, Marshall Islands and Russia to the Annex I (the so-called blacklist) of the EU List. With these additions, the list now consists of 16 jurisdictions: American Samoa, Anguilla, Bahamas, British Virgin Islands, Costa Rica, Fiji, Guam, Marshall Islands, Palau, Panama, Russia, Samoa, Trinidad and Tobago, Turks and Caicos Islands, US Virgin Islands and Vanuatu.

Assuming that the German Federal Government will incorporate these amendments into the domestic Tax Haven Defense Act Regulations by the end of 2023, this would trigger German tax consequences for business relationships with these jurisdictions as of 2024. Among others, these would include aggravated controlled foreign company (CFC) rules, an extension of nonresident tax liability, denial of treaty benefits as well as increased obligations to cooperate. Moreover, an increased taxation of dividends and capital gains and a denial of the deduction for operating costs would apply.

Detailed discussion

German Tax Haven Defense Act

The decision to amend the EU list on 14 February 2023 may trigger significant tax consequences for businesses active in Germany since the EU finance ministers chose to put Russia on the list for the first time. Although the EU has implemented several sanctions against Russia since the Russian aggression against Ukraine started in February 2022, there are still relevant business relationships between both countries that would be affected by the defensive measures under the German Tax Haven Defense Act. Unlike many other EU Member States, Germany applies a comprehensive set of defensive measures against business relationships with listed countries that apply automatically in stages after the EU list is transposed into domestic law.

Implementation into domestic law

For purposes of the German Tax Haven Defense Act, non-cooperative jurisdictions are included once a year in a German regulation. This includes the date on which they qualify as non-cooperative jurisdictions under German law and are, consequently, subject to defensive measures (see below). In general, the measures are triggered as from the beginning of the following year after a jurisdiction has been included in the regulation, provided that the jurisdiction is not removed before the expiry of this deadline. Furthermore, a denial of a dividend exemption shall be applied only from the beginning of the third year after the jurisdiction has become part of the regulation and a denial of the deduction of operating costs shall be applied only from the beginning of the fourth year after the jurisdiction has become part of the regulation, provided that the jurisdiction is not removed before the expiry of this deadline.

Defensive measures

If the regulation is, as in recent years, updated at the end of 2023 to include the four newly listed jurisdictions (as well as additional jurisdictions that may be added to the list in October 2023), the following defensive measures would apply on business relationships with these jurisdictions as of 2024 (different timing may apply if the fiscal year is different than the calendar year).

  • Stricter CFC rules: Companies domiciled in non-cooperative tax jurisdictions are deemed to be intermediate companies subject to German CFC rules with their entire income (i.e., not only passive income) in the case of national control within the meaning of Section 7 Foreign Tax Act (FTA). The motive test is not deemed to be applicable.
  • Nonresident tax liability is extended to income from financing relationships, from insurance and reinsurance services, from the provision of other services and from trade or from royalty income and capital gains relating to rights registered in a public German book or register 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 covered payments is to be withheld at source at a rate of 15% and paid to the Federal Central Tax Office.
  • Treaty benefits are denied (treaty override).
  • Increased cooperation obligations: Taxpayers would be required, e.g., to provide 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.

Deferred defensive measures

If the jurisdictions are not removed from the EU list and subsequently from the German regulation, further defensive measures would apply.

  • (Generally) as of 2026: For dividends and capital gains that stem from a corporation resident in a non-cooperative tax jurisdiction, the domestic participation exemption and comparable provisions in tax treaties as well as the flat withholding tax rate of 25% for individuals and the 40% exemption for individuals do not apply. However, the taxpayer may prove that the distributions result from amounts that have already been — under the German Tax Haven Defense Act — 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.
  • (Generally) as of 2027: 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 a specific expense is subject to taxation in Germany or covered by (extended) CFC rules.

Further implications

The EU list of non-cooperative jurisdictions also has importance for the obligation to report cross-border tax arrangements (DAC6) and the upcoming public country-by-country reporting that is currently in the final phase of German legislation and will apply on fiscal years beginning after 21 June 2024.

Annex II and outlook

Furthermore, the Council updated the Annex II of the EU list (so-called gray list) and decided to remove four jurisdictions (Barbados, Jamaica, North Macedonia and Uruguay) and to add three jurisdictions (Aruba, Curaçao and Albania). The rest of Annex II remains unchanged. The Council will continue to review and update the EU List twice per year, with the next update due in October 2023.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young GmbH , Germany

Ernst & Young LLP (United States), German Tax Desk, New York

Document ID: 2023-0291

 

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