German related-party royalty proposal conflicts with BEPS agreement, OECD tax official says

by Ninja-Antonia Reggelin

Tax experts at a German parliamentary hearing held Wednesday expressed support for the aim of draft law that would deny tax deductions for some royalty payments made by multinationals to related companies. Many, including an OECD tax official, noted difficulties applying the draft law in practice, though, and suggested that the proposal be revised.

The hearing, held by the finance committee of the German Parliament (Bundestag), concerned a draft law, “Expenses for Assignment of Rights” article 4j income tax act (EStG).

Under the proposal, deductions would be 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 and through a preferential tax regime that does not require substantial business activity, as provided for in the OECD/G20 base erosion profit shifting (BEPS) Action 5 modified nexus approach.

The proposed rule would apply 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.

BEPS conflict

Speaking at the hearing, Achim Pross, OECD Head of International Cooperation and Tax, said the draft royalty proposal had the right direction, but he questioned the necessity to apply a law for the interim period until the international consensus on preferential regimes was in place.

Pross noted that there would be a risk that other countries could feel disrespected by Germany’s bold move overruling the international agreement.

He suggested linking the draft law to the OECD work on harmful tax practices and the EU’s code of conduct group. This would simplify coherence and work for tax administrations needing to evaluate foreign preferential regimes, Pross said.

Prof. Jürgen Brandt, a judge at the Federal Fiscal Court (BFH), countered that the OECD documents and work did not represent legal documents with binding character and should only be referenced as inducement for the lawmaker.

The Federation of German Industries (BDI) expressed concern that similar initiatives of other states could have negative impact on the German economy, noting that license income paid in Germany is much higher than the fees paid abroad.

German royalties & research

BDI also warned of negative effects for Germany as a research location. The draft law would cause systematic distortions because the rules would be difficult to integrate into existing national and international law. In addition, the draft could lead to excessive burdens, the group said.

Werner Thumbs, tax director of Boehringer Ingelheim, agreed, noting that companies which undertake research activities through international cooperation and companies that receive more license income from abroad than paying license fees should not be burdened. This would, however, not be ensured by the proposed regulation, Thumbs said.

Constitutionality

Moreover, experts worried that the draft law would lead to double taxation. Reimar Pinkernell, lawyer and tax advisor at Flick Gocke Schaumburg, viewed the draft law to be unconstitutional because fundamental tax principles, such as the objective net principle, would not be adhered to. He also had concerns that the restriction could be regarded as discriminatory with regard to the EU freedom of establishment.

On the other hand, Professor Ekkehart Reimer (University of Heidelberg) and Professor Frank Hechtner (Free University Berlin) came to the conclusion that the draft law was well balanced and consistent with the aim of preventing harmful tax practices.

Profs. Reimer and Brandt did not see any serious violations of constitutional or EU law.

Peter Korn, of the Federal Court of Auditors, warned that several terms used in the legal text could lead to uncertainty in practice.

The Institute of Auditors (IDW) as well as several other experts agreed that this was especially the case concerning the definition of “substantial activity” and “preferential regimes. “

Also, Thomas Eigenthaler of the German tax union(DStG) questioned the practical implementation and application of the regulation, although, overall, he expressly approved of the draft law.

A representative of the Tax Justice Network also showed support. Marcus Henn said that as long as there is no comprehensive international solution, namely, on minimum taxation, national states have the right and duty to address the problems with national rules.

The German Federal Assembly has already debated the law and submitted its comments on March 10, which were also partly addressed during the hearing.

The Parliament and Federal Assembly must both pass the law by the beginning of July due to upcoming federal elections in September.

It is likely that the legislative process could be completed by the summer break.

List of experts:

• Prof. Jürgen Brandt, Judge at the Bundesfinanzhof
• Federal Tax Advisor Chmabger
• Federation of German Industries (BDI)
• Thomas Eigenthaler, German tax union (DStG)
• Prof. Dr. Frank Hechtner, Free University Berlin
• Institute of Auditors (IDW)
• Peter Korn, Federal Court of Auditors
• Dr. Ingo van Lishaut, Finance Ministry of Northrhine Westfalia
• Markus Henn, Tax Justice Network c/o WEED e. V.
• Dr. Reimar Pinkernell, Kanzlei Flick Gocke Schaumburg
• Achim Pross, OECD
• Prof. Dr. Ekkehart Reimer, University of Heidelberg
• Werner Thumbs, Boehringer Ingelheim