Anti-Tax Avoidance Directive: German Federal Ministry of Finance publishes draft law

Created by Carsten Hüning |

On 10 December 2019, the German Federal Ministry of Finance (MoF) published a draft law on the implementation of "Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market" (Anti-Tax Avoidance Directive - ATAD). The Anti-Tax Avoidance Directive applies to all taxpayers subject to corporate income tax in one or more EU member states, including the permanent establishments of companies in one or more EU member states that are resident for tax purposes in a third country.

The Anti-Tax Avoidance Directive obliges EU member states to implement into national law the minimum standards contained therein (which are explained below), whereby the member states may exceed the minimum standards. The minimum standards include general rules to prevent tax abuse, tax rules for limiting the deductibility of interest, for the transfer of assets and exit taxation, in connection with CFC rules and for neutralisation of tax mismatches in connection with hybrid arrangements.

Anti-Tax Avoidance Directive far-reaching, transfer pricing related changes 

While, according to the MoF, the existing German regulations on interest limitation as well as the general anti-abuse rule meet the ATAD’s requirements, the ATAD implementation law is intended to implement the EU's requirements on taxable disjunction and exit taxation and on hybrid arrangements as well as to reform CFC rules. 

The draft law also contains new regulations and far-reaching changes in connection with transfer pricing, which are summarised below:

Fiscal Code

Section 89a Fiscal Code - Advance pricing agreements (APAs)

  • Introduction of a new section to create a separate national legal basis which aims to increase legal certainty in cross-border contexts to avoid international disputes
  • Specification of the procedural requirements

Section 90 (3) Fiscal Code - Documentation obligations

  • Preparation of a master file in case of turnover of at least EUR 50 million (previously EUR 100 million) in the previous financial year
  • Contemporaneous TP documentation requirement: the master file must be submitted electronically to the local tax authority after the end of a financial year for that financial year

External Tax Relations Act

Section 1 External Tax Relations Act - Adjustment of Income

1.    Section 1 (2) External Tax Relations Act - Related parties

  • In addition to previous requirements, the definition of related parties also includes parties who are entitled to at least one quarter of the profit or liquidation proceeds

2.    Section 1 (3) External Tax Relations Act - Definition of the arm’s length principle

  • Determination of arm’s length price has to be performed based on underlying circumstances at the time the transaction is agreed upon
  • Strong emphasis on functional and risk analysis
  • Dismissing the current hierarchy of transfer pricing methods; the most appropriate method should be determined with regard to the comparability analysis and the availability of comparable third-party data.

3.    Section 1 (3a) External Tax Relations Act - Application of the arm's length principle

  • The interquartile range is applicable in case of limited comparability
  • If values are outside the range, the median value is considered appropriate 
  • Escape clause: Taxpayer is allowed to demonstrate that any other value is more likely reflecting the arm’s-length principle

4.    Section 1 (3b) External Tax Relations Act - Transfer of function

  • Definition of the transfer package
  • Removal of the escape clauses (opening clauses) that allow for single asset valuations in case of a transfer of function

5.    Section 1 (3c) External Tax Relations Act – Intangible assets

  • Definition of intangible assets according to OECD
  • Implementation into national law of the DEMPE concept (DEMPE: development, enhancement, maintenance, protection and exploitation of intangibles) described in the OECD Transfer Pricing Guidelines 2017 
  • The mere financing function of intangible assets must be adequately remunerated but does not entitle to a return from the intangible asset financed

Section 1a External Tax Relations Act – Financial transactions

1.    Section 1a (1) External Tax Relations Act

  • New section regarding potential corrections of interest expenses arising from financing relations within a multinational enterprise group
  • Treaty Override (rules apply irrespective of Article 9 OECD Model Convention and the respective DTA)
  • The deduction of interest expenses incurred is not permitted if the taxpayer cannot credibly demonstrate that he could have provided the debt service for the financing relationship’ entire term from the outset and that the financing is required from a business perspective and the funds are used for the business purpose , or if the MNE group’s refinancing rate is lower than the interest rate of cross-border financing with related parties

2.    Section 1a (2) External Tax Relations Act

  • Intermediation and/or on-lending of financing within a multinational group of companies is regularly considered a low-function and low-risk service, whereby the remuneration is limited to the risk-free interest rate (corresponds to the interest rate for term-equivalent governments bonds of the highest creditworthiness)
  • The scope of application includes in particular liquidity management, financial risk management, currency risk management and the activity as a financing company

Section 1b External Tax Relations Act – Price adjustment clause

  • Price adjustment clause also applies to transactions involving significant intangible assets or benefits
  • Adjustment period is 7 years and adjustment must be made in the 8th year 
  • Adjustment of the transfer price in case of a significant deviation (more than 20 % of the original profit expectation) from the underlying profit expectation

Application and further procedure

The transfer pricing rules revised and supplemented within the framework of the ATAD implementation law is to apply from the assessment period 2020. By way of derogation, the new rules for the master file’s annual electronic submission shall only apply to financial years commencing after 31 December 2020. The new rules for advance pricing agreements would apply for the first time to applications received by the tax authority after the provision’s coming into effect.

The concrete implementation of the draft law and the entry into force of individual regulations will depend on the further legislative process. Although the government draft planned for the end of December 2019 has failed for the time being, the legislative process is currently expected to be completed in March/April 2020. Even though it is currently not clear whether the law will enter into force unamended, the tax authorities’ (future) view and a planned tightening of the German regulations on international tax law is apparent from the draft law and the inherent justification.