Executive summary

On 5 December 2024, the German Ministry of Finance (MoF) published the long-awaited final decree regarding the application of the German anti-hybrid rules. While the draft decree issued in July 2023 did not provide detailed practical guidance and mostly covered basic structures, the final version clarifies a couple of open questions in terms of the relevance of a controlled foreign corporation (CFC) regime and the application of the dual-inclusion exemption.

Nonetheless, the illustrative examples remain basic in nature and German tax authorities' view on various questions that are highly relevant in practice still remain uncertain. In particular, no additional clarification was included on the concrete documentation obligations. Taking into account that the application of the German anti-hybrid rules requires detailed knowledge regarding foreign entities' tax positions and the applicable tax law, it is likely that the rules will remain topics of discussion, in that the MoF rules do not clearly state what documents and evidence should be provided.

The rules are particularly relevant for certain disregarded United States (US)-outbound structures and should be analyzed in detail on a case-by-case basis.

Detailed discussion

Background

The German anti-hybrid rules were enacted in 2021 through the European Union (EU) Anti-Tax Avoidance Directive (ATAD) Implementation Law. The anti-hybrid rules (Sec. 4k Income Tax Act (ITA Sec 4k)) generally apply to all expenses accruing after 31 December 2019, focusing on a potential whole or partial denial of deductibility for expenses in Germany to the extent the resulting earnings are not taxed at all or — in the case of financing transactions — are low taxed due to a hybrid mismatch or twice-claimed deductions (deduction/non-inclusion and double-deduction outcomes). The deduction of expenses may further be disallowed to the extent there is an imported mismatch (i.e., a deduction/non-inclusion or double-deduction mismatch occurs in a foreign state and is imported to Germany).

Due to their complexity, the German anti-hybrid rules have generated multiple questions. Following the publication of the draft decree on 13 July 2023, many of those questions remained open and, thus, the interested public requested sent comment letters to the MoF requesting further clarification. With the issuance of the final decree on 5 December 2024, some answers to those open questions were provided, though for others uncertainty remains. (See EY Global Tax Alert, German Federal Ministry of Finance publishes draft decree regarding the application of anti-hybrid rules, dated 18 July 2024.)

Personal scope

ITA Sec. 4k primarily targets intra-group transactions in which a tax benefit results from a hybrid-mismatch between related parties. Participations, voting rights and profit participation rights of parties acting in concert are cumulated when determining the relevant related-party threshold (25% or more). Therefore, although individual participation would not result in the qualification as related party, the cumulation of various participations could meet the related-party threshold. Because the term "acting in concert" is not defined in German tax law, it was unclear whether the rebuttable presumption that all partners of a partnership are deemed to be acting in concert, which is contained in the German Foreign Tax Act, would apply analogously to ITA Sec. 4k. The MoF rejects this position and, according to the decree, acting in concert requires coordinated action of at least two parties that aims at achieving a hybrid-mismatch arrangement outcome.

Relevance of foreign CFC regimes

To qualify as deduction/non-inclusion mismatch, income corresponding to German expenses must not be subject to taxation — more specifically, not included in any tax base. In this respect, the decree states that the level at which the income is subject to taxation is not determinative (i.e., whether at the level of the income recipient or any other level). The MoF outlines in the decree that the inclusion of income in a CFC regime is sufficient to qualify as actual taxation in this respect. For CFC regimes implemented in EU member states in accordance with EU Directive 2016/1164, this subject-to-tax exemption always applies. However, the MoF takes the position that income inclusion under CFC regimes that determine their tax base by consolidating profits and losses of all, or certain, foreign controlled entities, cross-entity or cross-border (so-called blending systems) is not sufficient for the subject-to-tax exemption to apply. Although not referenced explicitly, the US-global intangible low-taxed income (GILTI) and other minimum taxation regimes that are based on blending principles are not expected to qualify as CFC regimes that can prevent a nontaxation.

In contrast, the decree states that the inclusion of expenses within a foreign CFC regime does not constitute a double deduction, irrespective of whether the expenses are included in a CFC, or a minimum-taxation regime, even if based on a blending system.

Dual-inclusion exemption

Under the dual-inclusion exemption, expenses remain deductible even in the case of a relevant mismatch if, and to the extent that, these expenses are only offsetting income that is subject to taxation in both Germany and the other jurisdiction. A link between the expenses from the hybrid transaction and the double-included income is not required.

The MoF acknowledges that there could be cases in which income is taxed in Germany but the corresponding expenses are not recognized in the other jurisdiction due to the hybrid nature of the German entity (e.g., payments from a US shareholder to its disregarded German subsidiary where the transaction is disregarded for US tax purposes). Although not explicitly mentioned in the wording of the German tax law, the MoF has included a relief possibility in the decree under which income from such inclusion/no-deduction mismatch would generally qualify as dual-included income for purposes of the exemption. In this respect it should be noted that the application of the relief is at the sole discretion of the German tax authorities and, therefore, not binding.

Other key considerations for application of German anti-hybrid rules

Expenses for financing transactions are not tax deductible to the extent the income is subject to a relevant non- or lower taxation at the recipient level due to a mismatch of either instrument qualification or asset allocation.

Cost of goods sold (COGS) in a distribution company are generally not considered "expenses" in the sense of the German anti-hybrid rules according to the decree, except for cases in which the distribution activity leads to a loss.

An exception applies in double-deduction outcome cases if the taxpayer demonstrates that there is no effective double deduction due to the application of a foreign anti-hybrid rule. In the case of hybrid mismatches with other EU jurisdictions, compliance requirements are simplified due to the harmonized ATAD implementation. Absent any indications to the contrary, it is assumed, according to the decree, that the mismatch is already addressed in the other EU jurisdiction. In the case of a hybrid mismatch with a third country (e.g., the US), this has to be analyzed on a case-by-case basis.

This exception also applies to imported mismatch scenarios in which other EU jurisdictions are involved. However, the decree notes that this cannot be assumed where the German anti-hybrid rules go beyond the ATAD minimum standard (e.g., with respect to the relevant related-party threshold where the ATAD is 50% but Germany requires at least 25%).