Preventing tax avoidance and unfair tax competition

On 15 February 2021 the Federal Ministry of Finance published the ministerial draft of a law to prevent tax avoidance and unfair tax competition (see the draft here). The law essentially concerns the introduction of an Anti-Tax Haven Act (Steueroasen-Abwehrgesetz – “StAbwG”).

Aim of the Act

The draft of the Act aims to eliminate tax havens. Non-cooperative fiscal jurisdictions are be asked to make changes with a view to implementing and complying with international standards in the area of tax. This applies in particular to business relations with and in states and territories on the EU list of non-cooperative countries and territories for tax purposes (“blacklist”). There are currently 12 states on the blacklist, including Panama, the Seychelles (as well as American Samoa, Anguilla, Dominica, Fiji, Guam, Palau, Samoa, Trinidad and Tobago, US Virgin Islands, Vanuatu). Turkey is currently being observed and considered as a possible future candidate for the blacklist. Yet the EU Member States could not agree unanimously at their last meeting in February 2021 to include Turkey on the blacklist.

The new provisions are set to replace those introduced in 2009 with the Anti-Tax Evasion Act in the areas of income tax, corporation tax and the tax code, as well as the Anti-Tax Evasion Regulation.

Definition of non-cooperative fiscal jurisdictions

A fiscal jurisdiction is considered non-cooperative if it is listed on the EU’s blacklist of non-cooperative countries and territories for tax purposes, as amended, and that fiscal jurisdiction

• does not guarantee adequate transparency in tax matters (section 4(1) Draft StAbwG), or
• operates unfair tax competition, especially with low or zero taxation even without economic activity or presence in the relevant fiscal jurisdiction (section 5(1) Draft StAbwG), or
• has not concluded an obligation to implement the minimum standards of the OECD/G20 Base Erosion and Profit Shifting Project (BEPS) to combat profit erosion and shifting (section 6(1) Draft StAbwG).

Legal consequences and restrictions on business relations in and with non-cooperative fiscal jurisdictions

If a taxpayer maintains business relations or investments in or in relation to an non-cooperative  fiscal jurisdiction, the tax restrictions range

• from non-deductibility of income-related costs or business expenses (section 8 Draft StAbwG),
• stricter controlled foreign corporations (CFC) rules (section 9 Draft StAbwG),
• denial of withholding tax refunds (section 10 Draft StAbwG) and
• denial of tax exemptions (section 11 Draft StAbwG).

a) Non-deductibility of income-related costs or business expenses (section 8 Draft StAbwG)

Expenses arising from transactions with natural persons, entities, associations of persons or property belonging to a non-cooperative fiscal jurisdiction shall not be deducted as income-related costs or business expenses. This does not apply only exceptionally to the extent that the income corresponding to the expenditure is subject to unlimited or limited tax liability in Germany.

b) Stricter controlled foreign corporations (CFC) rules (section 9 Draft StAbwG)

In the context of the stricter rules on CFC rules, companies established in the non-cooperative fiscal jurisdictions are deemed to be controlled companies with their entire (i.e., also non-passive) income if the conditions laid down in section 7 of the Foreign Taxation Act are met. The nature of the income, the fulfilment of what is referred to as the “motive test” or the existence of low taxation is irrelevant. Only income or parts of income derived from active activities and which have been subject to the prohibition of deduction under section 8 of the StAbwG shall be excluded from the scope of the stricter tax CFC rules.

c) Withholding tax measures (section 10 Draft StAbwG)

In addition, a restriction on tax relief shall apply, for example on the basis of provisions in double tax treaties, where natural persons resident in a non-cooperative fiscal jurisdiction hold a share, directly or indirectly, of more than 10% in total. Relief may be granted in such cases only if the expanded conditions for cooperation laid down in section 12 of the Draft StAbwG are met.

It also provides for an extension of limited tax liability within the meaning of section 49 of the German Income Tax Act to natural persons and corporations resident in non-cooperative fiscal jurisdictions. This includes, but is not limited to, income from financing relationships (e.g. loan relationships and finance leases), insurance or reinsurance services, the provision of services (such as legal and advisory services and online advertising), and the trading of goods or services, to the extent that the income-related costs or business expenses corresponding to such income would have to be taken into account by another taxpayer in the context of a domestic tax assessment. In that context, the taxation of the recipient of income is given priority over the prohibition on the deduction of operating expenses or income-related costs under section 8 of the Draft StAbwG.

d) Limitation of tax exemption of dividends and capital gains (section 11 Draft StAbwG)

Furthermore, dividends from a corporation established in a non-cooperative fiscal jurisdiction are not, in principle, exempt under section 8b (1) of the German Corporate Income Tax Act or under a double tax treaty participation exemption. The same applies to capital gains on shares in corporations which are tax resident in non-cooperative fiscal jurisdictions, which are also not to be covered by the tax exemption in section 8b (2) of the Corporation Tax Act or double tax treaty exemptions. On the other hand, the tax exemption applies to distributions under section 8b (1) of the Corporation Tax Act insofar as the taxpayer proves that the distributions result from amounts which have already been taxed at source in accordance with section 10 of the Draft StAbwG or to which the prohibition of deduction under section 8 of the Draft StAbwG has already been applied.

Types of tax concerned

The provisions of the StAbwG are to apply to all taxes and tax refunds administered by federal and regional authorities and municipalities, in particular corporate income tax, income tax and trade tax. On the other hand, the restrictions do not apply to VAT (including import VAT and import and export duties and excise duties, section 2(1) of the Draft StAbwG).

The provisions of the StAbwG are intended not only to take precedence over the provisions of double tax treaties (treaty override, section 2(2) of the Draft StAbwG), but also to those in the Tax Code and other tax laws (section 2(3) of the Draft StAbwG).

Increased cooperation duties

The Act also provides for increased cooperation duties which go beyond those set forth in section 90 German Tax Code (section 12 Draft StAbwG). This applies in particular to a detailed presentation and documentation of the business relations and contractual relationships, the essential assets used, the business strategies chosen, the market and competitive conditions and the individuals who  directly or indirectly hold a participation in the company resident in the non-cooperative fiscal jurisdiction. The records must be reported to the competent tax authority and, in certain cases, to the Federal Central Tax Office.

Entry into effect

The provisions are intended to be applied for the first time as of 1 January 2022 (section 13(1) Draft StAbwG).

Further development

The associations will now have the opportunity to comment. The draft law may also be seen as a first harbinger of the upcoming federal election campaign this year. It is therefore questionable whether the Act can be concluded before the end of this legislative period. In any event, some CDU/CSU finance politicians have already commented critically on the draft, which does not necessarily improve its implementation before the federal elections. The further development thus remains to be see.

Impact in practice

Comparable rules as contained in the draft are currently being driven forward in other EU Member States too. If numerous EU Member States implement similar laws, structures including fiscal jurisdictions on the blacklist must be checked for their advantageousness.

But also in political terms, the implementation of these tax changes would give the EU more clout in negotiations with tax havens, since being on the blacklist can lead to considerable tax drawbacks for the respective jurisdictions as a business location.