Significant recent changes in tax law: Germany

• Tax planning and consultancy - Briefings

28-02-2014

New Double Tax Treaty between Germany and Luxembourg

The new Double Tax Treaty (DTT) for the avoidance of double taxation and the prevention of fiscal evasion in respect to taxes on income and on capital between Germany and Luxembourg entered into force on 1 January 2014. The DTT mainly corresponds to the OECD Model Tax Convention.

In accordance with the OECD Model Tax Convention, the permanent establishment article of the new DTT takes the Authorised OECD Approach into account, according to which a permanent establishment should be treated as a separate and independent company for the purposes of determining profit.

Under the new DTT, the withholding tax rate for intercompany participations has been reduced from 10% to 5% and the required minimum shareholding of the parent company in the subsidiary that is paying the dividend intercompany participation percentage has been reduced from 25% to at least 10% of the capital of the company paying the dividend. However, dividend payments to partnerships and investment companies are expressly excluded from this withholding tax reduction. The withholding tax rates for interest (exclusive right of taxation of the country of residence) and for licenses remain unchanged at 0% and 5% respectively.

For real estate investments in Germany it is important to consider that Germany now has the right to tax any gains from the sale of shares in companies owning real estate in Germany provided that the value of the assets of these companies consists of at least 50% of German real estate.

Tax Treaty consequences of investing in (German) partnerships - new discussion draft

The German ministry of finance has recently published a discussion draft for a circular letter on the Tax Treaty consequences of investing in partnerships. This draft reflects material discrepancies between rulings of the federal tax court and lower tax courts in recent years and the still applicable circular letter published by the ministry of finance in 2010.

A commonly used partnership structure in Germany is a so called limited liability partnership with a limited liability company as its general partner (so called “GmbH & Co. KG”). According to German tax law such limited liability partnership is regarded as a trading partnership just because of its structure and regardless of its actual business activities. 

This legal form has been used for certain tax structuring.  Now, the tax authorities share the view of the federal tax court and lower tax courts in the draft circular letter that the tax treatment of the partnership depends on whether it is actually trading or not eg managing assets.

The income of a trading partnership is treated as the trading income of the partners earned through the permanent establishment in the country of the partnership is located.  The income of other partnerships is attributed to the partners in accordance with the applicable profit sharing ratio without requalification.

Any conflict with the other state are resolved by the switchover provisions of German law substituting the credit method for the exemption method of avoiding double taxation where adherence to the exemption method would lead to effective exemption in both states.

Purchase of own shares by a company - new circular letter

The ministry of finance recently published a circular letter which outlines accounting treatment for tax purposes following a share buyback. This is a very helpful guide for intercompany transactions as well as exit situations. Basically, the German tax authorities now follow the accounting principles as provided for in the German commercial code. In addition to these accounting principles certain tax specific issues apply:

• Where a company a purchases its own shares for more than their nominal value, payment is to be regarded as a capital repayment up to the total nominal value amount and then as a dividend thereafter. If distributable reserves are insufficient, the excess is a repayment of capital reserve.
•  If the shares are purchased for less than their nominal amount, the difference is to be set off against the share capital from the capitalization of revenue reserves. Remaining amounts are to be taken from the capital reserve.
• For the seller’s, the sale of the shares in the company to the company should be regarded as a sale of an asset and therefore subject to capital gains taxation. Consequently no withholding tax on a constructive dividend from the sale of those shares applies.  
• If the company sells its own shares then this does not create a tax relevant gain or loss. The nominal value of this sale reduces the deduction from the issued share capital. An excess receipt should be taken from the capital reserves and a deficit is to be deducted from a positive balance on that account. Any remaining deficit is a balancing item representing capitalization of reserves.

Profit distribution which is not proportionate to the shareholder’s shareholding - new circular letter

A distribution of profits by a company to its shareholders whereby a shareholder receives a higher dividend than he should receive according to his shareholding in the company and another shareholder receives a lower dividend than he should receive according to his shareholding in the company can be made for various reasons. The federal tax court has previously ruled that such dividends that are disproportionate from the participation in the company are accepted for tax purposes and does not constitute tax avoidance even if undertaken for tax purposes. This ruling of the federal tax court has been accepted as a prevailing precedent in subsequent tax proceedings before lower tax courts.

Generally, the tax authorities do not like these rulings. The ministry of finance published a circular letter on 17 December 2013 which summarizes several criteria which have to be fulfilled before disproportionate dividend distributions will be accepted by tax authorities. These criteria are more strict than what has been accepted by the tax courts.

The criteria includes:

• If the company is a limited liability company ("GmbH") then the disproportionate dividend has to be expressly provided for in the articles of association or the articles of association have to expressly allow for the shareholders to pass a resolution permitting such distribution.
• If the company is a stock corporation ("Aktiengesellschaft") then the articles of association need to expressly provide for a dividend distribution that is disproportionate to the shareholding structure. A clause permitting the stock corporation shareholders to approve such distribution is not sufficient.
• The disproportionate dividend distribution must be made for remarkable economic and reasonable reasons which are not focused on tax advantages.