Financial Implications and Increased Documentation Obligations Tax Haven Defense Act in Germany

The newly introduced Tax Haven Defense Act (“THDA”; Steueroasenabwehrgesetz) came into force on January 1, 2022. The aim of the law is to combat tax evasion, tax avoidance and unfair tax competition with the help of tax havens. By sanctioning business relations in non-cooperative jurisdictions ("Tax Havens"), the shifting of income or the flow of money to Tax Havens is to be made more difficult and economically unattractive for companies.

Take Aways

• Companies should build the monitoring of business relationships or participations in or with reference to so-called non-cooperative jurisdictions into their internal control system so that these business relationships can already be identified at the initiation stage and an early exchange on the tax consequences can take place with the tax department or the tax advisor.
• If there are business relations or participations in or with reference to so-called non-cooperative jurisdictions, it is mandatory to set up a standardised documentation system, since according to Section 12 THDA records - similar to transfer pricing documentation - must be prepared at the latest one year after the end of the business year and must be transmitted to the locally competent tax office or the Federal Central Tax Office (Bundeszentralamt für Steuern) without request.

Which Countries or Territories are Considered Tax Havens?

The relevant jurisdictions to which the THDA applies are updated once a year at the end of the year in the Tax Havens Defense Ordinance (last updated on December 16, 2022 Link). The measures under the THDA are generally applicable as of 1 January of the following year after a state has been included in the list of non-cooperative jurisdictions.

Currently (as of December 16, 2022), the following states are on the list:

• American Samoa (since December 24, 2021),
• Anguilla (since December 21, 2022),
• Bahamas (since December 21, 2022),
• Fiji (since December 24, 2021),
• Guam (since December 24, 2021),
• Palau (since December 24, 2021),
• Panama (since 24 December 2021),
• Samoa (since December 24, 2021),
• Trinidad and Tobago (since December 24, 2021),
• Turks and Caicos Islands (since December 21, 2022),
• American Virgin Islands (since December 24, 2021),
• Vanuatu (since December 24, 2021).

EU List of Non-Cooperative States

It should be noted, however, that the domestically applicable annually updated list is based on the EU list of non-cooperative countries and territories for tax purposes (so-called "black list"), which is updated twice a year.

After the EU added four countries to its "black list" on February 14, 2023, the following countries are expected to be included in the next amending regulation:

• British Virgin Islands
• Costa Rica
• Marshall Islands
• Russia

However, it is important to keep an eye not only on the "black list", but also on the EU's so-called "grey list". This lists countries that have been given deadlines for adapting promised changes to their laws.

Both the "black list" and the "grey list" can be accessed the EU-Homage (Link).

When Does the Tax Haven Defense Act Take Effect?

The THDA applies to business relationships or shareholdings in or with reference to a non-cooperative tax jurisdiction. This also applies to assumed debt relationships with permanent establishments abroad (Section 1 (4) Foreign Tax Act (“FTA”; Außensteuergesetz)) as well as to transactions that are merely based on an agreement under company law. A shareholding relationship is therefore not a prerequisite for the law to apply.

In principle, the measures are to be applied from 1 January of the following year after a state has been included in the list of non-cooperative countries. However, individual measures are to be applied with a time lag of two or three years. The points in time from which the measures take effect are regulated in Section 3 (2) THDA.

What Are the Consequences of the Application of the Tax Haven Defense Act?

In the event of a business relationship or a shareholding in or with reference to a tax haven, the following sanctioning measures come into consideration in Germany, whereby the THDA takes precedence over double taxation agreements (Section 1 (3) THDA, keyword "treaty override"):

• Tougher taxation of additions: Income from a direct or indirect (share-)holding in a tax haven is taxed by addition in Germany, irrespective of its activity in the home country.
  This shall apply with effect from the following year after inclusion in the list.
• Withholding tax measures: The withholding tax of 15% is to be withheld on payments to a company resident in a Tax Haven based on the following benefits:

No. 1: Financing relationships, but not globally securitised and centrally administered bearer bonds and debt instruments tradable on a recognised exchange

No. 2: Insurance benefits

No. 3 Provision of services, but no transfer of use

No. 4: Trade in goods or services

No. 5: Letting/disposal of rights entered in a domestic public book or register (so-called "register cases")

There is no exemption limit, i.e. every payment leads to the deduction of withholding tax! This applies with effect from the following year after inclusion in the list.

• Measures in the case of profit distribution and sale of shares: Tax exemptions or tax concessions for income from a shareholding in a company in a non-cooperative state are denied (Section 8b Corporate Income Tax Act, relief in double taxation agreements, partial income procedure, flat rate withholding tax)
  This shall apply with effect from the third subsequent year after inclusion in the list.
• Prohibition of deduction of business expenses: Expenses from business transactions may not reduce the profit or the surplus of income over income-related expenses in Germany.
  However, this is subordinate to the aggravated attribution taxation and the withholding tax measures as well as Section 49 German Income Tax Act and the normal attribution taxation.
  The prohibition of deduction of business expenses shall apply with effect from the fourth subsequent year after inclusion in the list.

Increased Obligations to Cooperate

Furthermore, the applicability of the THDA results in increased obligations to cooperate. Records - similar to transfer pricing documentation - are to be prepared no later than one year after the end of the business year and transmitted without request to the locally competent tax office and, in cases where the requirements of Section 138a FC are met, to the Federal Central Tax Office (Bundeszentralamt für Steuern).

Section 12 THDA provides, in addition to the existing (general) duties of cooperation under Section 90 FC, for increased duties of cooperation for business transactions within the meaning of Section 7 THDA.

Pursuant to Section 12 (2) THDA, the following records must be kept:

• Presentation of the business relationships as well as underlying contracts and agreed contractual terms;
• Listing of agreements with reference to intangible assets
• The functions performed and risks assumed by the parties involved in the business relationship, the material assets used;
• The chosen business strategies as well as the market and competitive conditions that are relevant for taxation;
• The natural persons who are directly or indirectly partners or shareholders of a company in the non-cooperative tax jurisdiction with which the taxpayer has a business relationship (for an exception to this, see Section 12 (2) no. 8 THDA).

In practice, the most important consequence of a violation of the record-keeping obligations pursuant to Section 12 (3) THDA is the opening of the tax authority's power of assessment.

Conclusion

With the tax consequences resulting from the law, the legislator achieves that business relations, participations or investments in countries designated as Tax Havens are economically unviable. Particularly with regard to the countries on the "grey list" and companies with production facilities and sales companies located there, the effects are immense if they are included in the regulation, which is amended annually at the end of the year.

It is therefore strongly recommended to keep a constant eye on both the EU black and grey lists and to closely analyse the tax consequences of the THDA when selecting business partners or the local establishment of subsidiary or permanent establishments. Processes for auditing business partners and complying with possible withholding tax measures should therefore be established at an early stage.

In order to comply with the increased duties to cooperate, a standardised documentation system must be established for the business relationships concerned.