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Lower House of Parliament adopts Annual Tax Act 2010
On 28 October 2010, the Lower House of Parliament (Bundestag) adopted the Annual Tax Act 2010, which contains several tax law changes that may affect foreign investors in Germany. The Act will be discussed in the Upper House on 26 November 2010, but may be referred to a consultation committee because of controversies relating to some of the proposed rules. The most important tax measures in the Act are as follows:
- Calculation of built-in gains under the change-in-ownership-rule: A new exception to the change-in-ownership rule was introduced on 1 January 2010, according to which a loss carryforward can survive a change in ownership to the extent there are built-in gains in the loss company’s assets (i.e. to the extent the fair market value of the shares exceeds the tax equity of the entity transferred). The Annual Tax Act 2010 stipulates that the built-in gains must derive from assets that are taxable in Germany (rather than assets that are located in Germany, as worded previously). Accordingly, built-in gains in non-tax-exempt foreign branches (e.g. in the absence of a treaty) will be able to qualify for the exception.
Furthermore, where the loss company has negative equity, the amount of built-in gains that protect loss carryforwards from forfeiture will be determined as the difference between the (negative) equity and the fair market value of the business assets of the entity, rather than the fair market value of the shares in the entity.
Both changes will apply retroactively as from 1 January 2010.
- Exit tax rules: Under the amended rules, a transfer of assets held by a German corporation or partnership to a foreign permanent establishment (PE), a transfer of a business abroad and a cross-border migration of a corporation will trigger exit taxation on the entire built-in gain. This amendment is a reaction to several Federal Tax Court (BFH) decisions on the right to tax built-in gains upon a transfer of assets and businesses abroad. By stating that neither the transfer of a single asset nor the transfer of a business as such results in a loss of Germany’s taxing right, the BFH held that there is no legal basis to tax built-in gains on assets transferred at the time of the transfer. The law change aims at preventing the situation in which the German tax authorities have to track assets transferred abroad and tax the built-in gains upon realization. The amendment provides that a transfer of assets or a business will trigger exit taxation, regardless of whether the transfer affects Germany’s right to tax the built-in gain. As is already the case in a transfer of assets, gains on the transfer of a business triggered by the application of the rule may be spread over a five-year period upon application of the taxpayer, provided the business is transferred to an EU/EEA-Member State to which the EU Mutual Assistance Directive applies. The amended rules will apply to all open assessments, regardless of when the transfer took place.
- Transfer of electronic bookkeeping abroad: The Annual Tax Act will eliminate the restriction that permits the transfer of electronic bookkeeping only to an EU/EEA country, so that bookkeeping will be able to be transferred to any country provided certain requirements are met. The requirement that the foreign country to which the bookkeeping is transferred must consent to electronic access for the German tax authorities also will be abolished. However, taxpayers will still need to meet the cooperation obligations and disclose the physical location of the IT system, and the German tax authorities will need to be able to access the system electronically. Last, but not least, the collection of tax must not be put at risk by transferring the bookkeeping abroad. The relaxation of the rule shall apply from the day after the official publication of the Annual Tax Act 2010.
- Extension of partial tax refund to nonresident corporations: The 40 % refund of withholding tax for nonresident, non-treaty-protected corporate taxpayers will be extended to apply to withholding tax on all investment income (e.g. withholding tax levied on profit-participating loans and silent partnerships). Given that corporate taxpayers intending to rely on the rule would have to demonstrate their substance based on the same requirements as set forth by the German anti-treaty shopping rule, the practical relevance of the rule has been proven to be relatively limited. The amended rule will apply retroactively to all investment income received after 31 December 2008.
- Restriction of CFC rules: The definition of what constitutes “low taxation” for German CFC purposes will be broadened to take into account tax credits and refunds at the shareholder level when determining whether the effective tax rate abroad falls below the 25 % threshold. According to the official explanations to the draft of the Annual Tax Act 2010, this change specifically targets taxpayers that earn passive income via corporate entities in Malta, because these entities currently fall outside the scope of the German CFC rules as a result of certain features of the Maltese tax system. Accordingly, the rules on the computation of the income to be allocated will be amended. Tax refunds and credits to which the shareholder is entitled will reduce the amount of local tax incurred on the foreign company’s profits. Since local tax payable generally reduces the profit to be included under the CFC rules, a reduction of local tax payable for tax refunds ultimately should lead to higher profits to be included in the German shareholder’s tax base under the CFC rules. Both amendments will apply to profits earned by foreign CFCs in fiscal years starting after 31 December 2010.
- Legally binding character of memoranda of understanding: The Ministry of Finance will be granted authority to publish decree laws to transpose into domestic law general memoranda of understanding (MoUs) between tax authorities under the mutual agreement procedure in tax treaties. This will make MoUs legally binding on the courts (currently, MoUs are legally binding only on the tax authorities).
- Tax treatment of interest on tax refunds: Interest paid on refunds of overpaid taxes will qualify as investment income, meaning that such interest will constitute taxable income. This measure responds to a recent decision of the Federal Tax Court in which the Court deviated from its own long-standing case law and held that interest income on a refund of overpaid tax does not constitute taxable income if the underlying tax itself is a nondeductible expense (see Deloitte Tax-News). According to this case law, interest received by the taxpayer as a result of a tax refund was taxable income, while interest paid by the taxpayer due to a late assessment was a nondeductible expense. With the law change, the legislator intends to restore the status quo ante. The amended rule will apply to all open cases.
- Electronic system for wage tax deductions: The introduction of the new electronic system of wage tax which will replace the traditional system based on wage tax cards in hard copy would be deferred until 1 January 2012 (originally scheduled for 1 January 2011). The validity of wage tax cards issued for 2010 would be extended for one year. After 2010, hard copies of wage tax cards would no longer be issued.
The Annual Tax Act 2010 also includes other changes, the most significant of which relate to the taxation of investment funds, the rules on the flat tax on investment income for individuals, VAT and the Inheritance Tax Act.
On 28 October 2010, the Lower House also adopted the act accompanying the 2011 budget, which amends the air traffic tax, the insolvency act, the energy tax and the parental leave allowance.
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