Germany: multinationals faced increasing tax compliance obligations in 2017, uncertainty lies ahead

by Ninja-Antonia Reggelin

The German government actively addressed multinational firm tax avoidance and tax evasion during the first half of 2017, implementing its version of the OECD/G20 base erosion profit shifting (BEPS) plan agenda and reacting to the Panama Papers leaks.

These efforts came to a complete stop, though, with the parliamentary summer break in the wake of the September 24 federal elections.

The outlook for 2018 remains uncertain for multinationals operating in Germany, as efforts to form new federal government have thus far failed. Other forces, such EU tax initiatives, US tax reform, and public pressures may drive the tax agenda going forward.

Harmful tax practices and licensing of rights

The year 2017 saw the enactment of the controversial “royalties barrier“ (Lizenzschranke), which adds new article 4j “Expenses for Assignment of Rights” to the income tax act (EStG).

Under this provision, a deduction is denied for a royalty payment made to a related group company when the same payment is taxed as income to the group member at a low rate (below 25 %) and through a preferential tax regime that does not require substantial business activity.

This new law also applies to tax transparent companies, taking into consideration the tax burden of the shareholders of the creditor.

The law had been originally proposed to provide a legal definition of the OECD nexus approach to determine such business activity. However, the law now merely includes a reference to the OECD BEPS framework.

The provision applies to expenses arising from 1 January 2018, even though, through the BEPS project, OECD and G20 countries agreed to protect patent boxes created before 30 June 2016 up to 30 June 2021.

It also applies irrespective of whether a double tax treaty is in force between Germany and the other country.

German transfer pricing documentation

The German Ministry of Finance in July 2017 published final rules on German transfer pricing documentation, addressing the local and master file (Gewinnabgrenzungsaufzeichnungs-Verordnung). 

These rules compliment a bill passed in December 2016 implementing OECD BEPS action point 13 on transfer pricing documentation.

The new master file rules are based upon the OECD recommendations with small alterations. Companies are required to file if they are part of a multinational group and have an annual turnover of EUR 100 million (USD 118.7 million) or more in the previous year.

By contrast, the local file and the country-by-country report were basically already relevant for companies that had business relationships according to article 1para 4 German Foreign Transaction Tax Act (AStG). The filing threshold for the CbCR report is EUR 750 million in MNE group turnover and, for the local file, is the supply of goods of EUR 6 million or other services of EUR 600,000.

Germany’s new master file rules require a graphical representation of the MNE’s organizational structure, geographical distribution of companies and permanent establishments, a short description of the MNE’s business activity, a general presentation of the overall strategy on intangible assets (development, ownership and recovery), and a general description of financing methods.

The new provisions must be observed for all financial years beginning after 31 December 2016.

Efforts to curb tax evasion

Besides BEPS, the Panama Papers scandal also reflected on German tax legislation in 2017.

The law on combating tax avoidance and amending further tax legislation (Gesetz zur Bekämpfung der Steuerumgehung und zur Änderung weiterer steuerlicher Vorschriften), aims to address tax evasion by imposing increased transparency requirements on tax payers’ relations with third countries.

These provisions, for example, include extending the disclosure requirements for the acquisition of qualifying holdings in foreign companies and abolishing fiscal banking secrecy.

German outlook 2018

German investment tax reform enters into force 1 January 2018, profoundly changing the taxation of income realized through an investment fund. The principle of tax transparency for investment funds is replaced by taxation at fund level with partial exemption for investors.

The outlook for 2018 remains vague with ongoing efforts to form a new federal government.

To date, another coalition of Christian and Social Democrats (CDU and SPD) seems most likely. This could lead to further minor changes in tax legislation, such as ongoing OECD BEPS implementation, in areas such as mandatory disclosure rules, but no major corporate tax reforms.

However, in the light of the US tax reform, an increasing number of stakeholders are calling for reforms to ensure international competitiveness.

Also, EU projects such as the common consolidated corporate tax base (CCCTB) and anti-tax avoidance directive (ATAD) will continue to affect German tax legislation.

Major corporate income tax reliefs nonetheless remain unlikely as they are considered unpopular in times of BEPS scandals and tax leaks.

Discussions remain ongoing in Germany on the (partial) elimination of the solidarity surcharge (5.5 per cent on income) and abolishing flat rate withholding tax on capital gains.