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Lower house of parliament approves draft business tax reform bill
Approved bill includes changes based on recommendations from the upper house
On 17 November 2023, the lower house of the German parliament voted in favor of the business tax reform bill (“Growth Opportunity Act”) that had been entered into the formal legislative process by the government on 30 August 2023 (see GTLN dated 09/04/23). The approved bill includes a multitude of tax measures covering tax incentives, individual income tax, corporate income tax, and other tax law provisions.
Compared to the draft bill that was originally introduced by the government, the following noteworthy changes are included in the bill. For the most part, these changes are based on recommendations provided by, the upper house of parliament in a statement dated 20 October 2023.
- The investment period for the proposed climate investment grant would be shortened by two months. Instead of becoming effective for investments made after 31 December 2023, the climate investment grant would now be granted for investments made after 29 February 2024. The investment period would run until 1 January 2030 as originally proposed by the government.
- 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 as originally proposed. During this period, a taxpayer would be allowed to offset 75% of current year income exceeding EUR 1 million against NOL carryforwards instead of 80%, as originally proposed. Under current rules, the offset is limited to 60% of current year income. After 2027, the 60% limitation for the offset of any remaining current year profits would be reinstated. The approved changes would apply for corporate income tax and local trade tax purposes.
- The loss carryback period for individual and corporate income tax purposes would be increased from the current two years to three years, as originally proposed, but the increased maximum amount of EUR 10 million for a loss carryback for corporate taxpayers would only be granted for 2024 and 2025 instead of becoming permanent (currently, the maximum amount of EUR 10 million is limited to losses generated from 2020 to 2023, and after 2023 the maximum amount decreases to EUR 1 million again). As from 2026, the maximum amount for a loss carryback for corporate taxpayers would be EUR 5 million. No carryback of losses is permitted for local trade tax purposes.
- For purposes of the interest deduction limitation rules, the originally proposed “de-fragmentation clause” no longer would be pursued. Under the originally proposed rule, the EUR 3 million threshold no longer would have applied 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. Since this proposal has been dropped, the EUR 3 million threshold would continue to apply on a separate per-entity basis.
- The introduction of a “maximum interest barrier rule” (see detailed description in GTLN dated 10/17/23) no longer would be pursued (the rule deleted from the approved bill). As suggested by the upper house of parliament, an amendment to the arm’s length requirement for financing relationships would be introduced in section 1 of the Foreign Tax Act instead, in order to align the German transfer pricing rules with chapter X of the 2022 OECD transfer pricing guidelines. This is based on an earlier proposal that was already discussed in 2019 as part of the ATAD Implementation Law. At that time, however, the proposal to amend the arm’s length requirement in the Foreign Tax Act had not been successful. The newly proposed sections 1 (3d) and 1 (3e) of the Foreign Tax Act would include the following amendments:
- In order to comply with the arm’s length principle for intercompany cross-border financing arrangements, the taxpayer would have to provide plausible evidence about (i) the ability to service the debt (interest and principal) during the entire term of the debt, and (ii) the financing need and the business purpose for the borrowing.
- The arm’s length character of the interest rate generally would have to be established based on the refinancing conditions that would apply with an unrelated third party and based on the credit rating for the entire multinational enterprise group. An escape clause would allow the taxpayer to argue that, based on the relevant facts, an interest rate higher than the one based on the group’s credit rating could be at arm’s length (derivative group credit rating).
- The intercompany provision of financing services, back-to-back financing arrangements, and treasury functions generally would be deemed to be low-function risk services for purposes of the arm’s length principle and for calculating an arm’s length remuneration. The taxpayer would have the possibility to prove the contrary, i.e., that a higher remuneration would be justified based on actual higher risk bearing.
- The proposed amendment to the arm’s length definition of intercompany cross-border financing arrangements would not be limited to situations where the lender does not have sufficient substance and activities as originally proposed are part of the maximum interest barrier rule. The proposed amendment would be limited to cross-border financing arrangements and would not affect pure domestic German financing arrangements. The proposed amendment would become effective as from fiscal year (FY) 2024.
- The proposed changes to certain rules for the taxation of partnerships and their individual partners would now become effective as from 2024 and not as from 2025 as originally proposed.
- The dual consolidated loss (DCL) rules for tax consolidated groups (section 14 (1) No. 5 of the Corporate Income Tax Code) would be abolished with effect as from 2024. Based on the reasoning provided by the finance committee of the lower house, the cancellation of the highly controversial rule is a reaction to the introduction of the general anti-hybrid rules/double deduction rule in section 4k of the Income Tax Code as from 1 January 2020.
- The transition period for the introduction of mandatory electronic invoicing for VAT purposes would be extended from one year to two years (1 January 2025 through 31 December 2026) for business-to-business (B2B) transactions and from two years to three years (1 January 2025 through 31 December 2027) for small companies (i.e., companies with revenue of up to EUR 800,000 in the preceding FY). The general 1 January 2025 starting date for the introduction of mandatory electronic invoicing would not change.
- The application of the reduced VAT rate for gas and heat supplies would be terminated as from 29 February 2024 instead of 31 March 2024.
- For purposes of the exemption from real estate transfer tax (RETT) for certain transactions between a partnership and its partners (sections 5 and 6 of the RETT Code), the application of the current rules would be extended through 31 December 2024. There has been some doubt whether these exemption rules would still be applicable after a change in the commercial law and a resulting change in the legal characteristics of partnerships. The one-year period is aimed at providing additional time for the legislator to perform a more detailed analysis of the consequences of the change in the legal characteristics of partnerships and to find a comprehensive solution.
- The highly criticized mandatory disclosure and reporting requirement for certain purely domestic tax planning arrangements as set forth in the original draft bill remains unchanged and, despite the high criticism, is not being abolished.
The tax reform bill still has to be approved by the upper house of parliament; a discussion and vote on the bill are scheduled for 24 November 2023. In case the upper house does not approve the bill (which seems somewhat likely), the bill would be forwarded to the conference committee of the upper and lower houses of parliament to find a compromise that would be acceptable to both chambers. Even if the conference committee needs to get involved, it might be possible to finalize the draft bill as late as the last session of the upper and lower houses of parliament in 2023, on 15 December.