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Government approves draft business tax reform bill
On 30 August 2023, the German government approved a draft of a business tax reform bill (“Growth Opportunity Act”), which was published by the Ministry of Finance (MOF) on 12 July 2023. The draft bill was stalled for two weeks due to discussions in the governing coalition unrelated to the content of the draft bill but has now been successfully approved. The draft bill aims to increase growth opportunities for the German economy, enable investments and innovation in new technologies, and strengthen the competitiveness of Germany as a business location. The measures included in the 291 pages of the draft bill (including legislative material) provide for simplification through increased thresholds and allowances and many smaller measures rather than a comprehensive or fundamental overhaul of the existing rules.
Compared to the original draft bill (see GTLN dated 07/14/23), the following noteworthy changes are included in the approved draft bill:
The investment period for the proposed climate investment grant would be extended for two years from the date the law becomes effective until 1 January 2030 (rather than until 1 January 2028 as proposed in the original draft bill).
The proposed broadening of the existing R&D tax incentive would remain unchanged; however, for small and medium-sized companies, a 10% increase of the R&D tax incentive would be available (i.e., 35% of qualifying expenses instead of the general 25% rate). For sole proprietorships, the deemed hourly remuneration for services provided by the sole proprietor would be increased from EUR 40 to EUR 70 for purposes of the R&D tax incentive.
The minimum taxation rules limiting the offset of a net operating loss (NOL) carryforward against current year profits would be relaxed from 2024 to 2027. During this period, a taxpayer would be allowed to offset 80% of current year income exceeding EUR 1 million against NOL carryforwards instead of 60% under current rules. After 2027, the 60% limitation for the offset of any remaining current year profits would be reinstated. The original proposal included a complete suspension of the minimum taxation rules from 2024 to 2027 and an increased threshold of EUR 10 million for which no offset restrictions would have applied after 2027. The proposed changes would apply for corporate income tax and local trade tax purposes.
For purposes of the interest deduction limitation rules:
- The stand-alone clause would remain available and not be abolished as originally proposed; however, the conditions for its application would be tightened. Under the stand-alone clause, the general 30% EBITDA (earnings before interest, taxes, depreciation, and amortization) limitation does not apply to companies that are not part of a group.
- The escape clause would not be abolished as originally proposed but remain available based on slightly different conditions. The opinion of the tax authorities regarding the “harmful shareholder financing criterion” for purposes of the escape clause would be introduced into the law in order to react to a 2015 taxpayer friendly decision of the federal tax court. Under the escape clause, the interest deduction limitation rules do not apply where a German borrower’s equity ratio does not fall short by more than 2% compared to the group’s worldwide equity ratio.
- The exception from the interest deduction limitation rules where annual net interest expense is less than EUR 3 million would remain available as a threshold with a cliff (i.e., once the EUR 3 million of annual net interest expense is met or exceeded, the full amount is subject to the 30% EBITDA limitation) and not be modified as a true exception (i.e., application only to annual net interest expense that meets or exceeds EUR 3 million) as originally proposed. As originally proposed, the exception would not apply to the extent annual net interest expense was increased by the utilization of interest carryforwards. Furthermore, the EUR 3 million threshold would no longer apply on a separate per-entity basis but on a group basis where one person or persons acting in concert control various entities that are engaged in the same business (“de-fragmentation clause”). This amendment of the current rules is still included in the approved draft bill.
- The proposed changes to the interest deduction limitation rules would become effective for expenses in fiscal years that begin after the approval of the proposed law by the lower house and that do not end before 1 January 2024.
The introduction of a “maximum interest barrier rule” as included in the original draft bill would remain unchanged. The approved draft bill clarifies though that any changes to the floating maximum interest rate would apply for purposes of the maximum interest barrier rule one month after the change in the Civil Code (the applicable base rate in section 247 of the Civil Code is updated twice a year on 1 January and 1 July). The explanatory notes to the proposed law have been tightened, as the explanatory notes now include a statement that the substance and activity carve-out would be available only if the activities at the level of the lender are related to the specific financing activity, i.e., the specific loan provided to a German borrower. It is now stated that the lender must have the ability and the authority to control or to bear the risk of the financing activity in question. In order to meet this condition, it is required that the decision makers at the level of the lender have the necessary experience and competencies and access to all the required information. The explanatory notes also specify how to prove that the conditions of the group escape are given, i.e., how to prove that the creditor and the ultimate group parent entity (in case of a group) would have been able to borrow only for an interest rate that exceeds the maximum interest rate as provided by the maximum interest barrier rule. Based on the explanatory statement, such proof can be provided based on the refinancing rate of the ultimate parent entity or a database study at the ultimate parent entity level at the time when the respective financing arrangement with a German borrower is concluded. Bank offers or offers from other third-party lenders are not seen as being acceptable. If the escape clause is applicable, the maximum rate acceptable under the maximum interest barrier rule should be the most favorable rate that the German creditor or the ultimate parent entity could have achieved. The maximum interest barrier rule should be applicable for interest expense triggered after 31 December 2023 and not starting from the assessment period 2024 as provided in the original draft bill.
The proposed changes to certain rules for the taxation of partnerships and their individual partners in the original draft bill would be partially withdrawn.
The proposed mandatory disclosure and reporting requirement for certain purely domestic tax planning arrangements as set forth in the original draft bill remains unchanged. However, the effective date was changed to 31 December of the fourth year following the date the law becomes effective. The MOF would announce the effective date at least 12 months in advance.
The proposed tightening of the rules in section 15 of the Reorganization Tax Code (RTC) for tax-neutral demerger transactions would be described in more detail and certain technical details have been updated in the approved draft bill as compared to the original draft bill. Indirect share transfers in one of the companies that is involved in the demerger transaction to a third party would now explicitly qualify as a harmful transaction for purposes of the tax-neutral demerger. The amended section 15 RTC would become applicable for transactions where the required application with the commercial register is filed after 14 July 2023.
The approved draft bill now includes the (re-)introduction of a declining balance depreciation for moveable assets that are acquired between 1 October 2023 and 1 January 2025 (such a declining balance depreciation had been temporarily introduced in the past as a COVID-19 support measure for the period 1 January 2020 until 31 December 2022). The maximum amount of the declining balance depreciation would be limited to 2.5 times the applicable straight line depreciation rate and a maximum of 25% annually.
In addition, a declining balance depreciation for residential buildings within the EU acquired or built between 1 October 2023 and 30 September 2029 would be introduced. The applicable annual depreciation rate for the declining balance depreciation for real estate would be 6%.
The approved draft bill abolishes certain real estate transfer tax exemptions for the transfer of real estate between partners and their partnerships. The abolishment of these rules is justified in the explanatory notes due to changes in civil law regarding the legal features of partnerships.
The draft bill is now going to be introduced into the formal legislative process where it would require the consent of the upper and lower houses of parliament. The upper house is expected to discuss the tax reform bill in its first session after the summer recess on 29 September 2023. It is expected that the tax reform bill will be finalized and approved by the upper and lower houses before the end of the year.