The following article merely provides an overview of the changes made to the version now adopted by the Bundestag compared with the original government draft of March 24, 2021. For an overview of the KöMoG’s key points, please refer to our article dated April 1, 2021: Key points of the planned Corporate Income Tax Modernization Act (KöMoG).
I. Introduction of an option for corporate income tax (Art. 1a KStG-E)
The changes made to Art. 1a KStG-E in the version now passed by the Bundestag compared to the government draft are largely of a formal or technical and clarifying nature; the most important substantive changes relate to the now explicit clarification of the time of the option’s first exercise in Art. 34 Sec. 1a KStG-E as well as the regulation to avoid potential conflicts of qualification in the context of international tax law provided for in Art. 50d Sec. 14 EStG-E.
1. Overview of the formal or technical changes
The formal requirements for exercising the option have been further specified in the current version of Art. 1a Sec. 1 sentences 2 to 5 KStG-E: For example, the deadline for filing an application has now been brought forward to no later than one month before the beginning of the fiscal year for which the option is to apply for the first time, the form in which the application is to be submitted has been made binding, and the rules relating to the tax office responsible for processing the application have been further specified.
The amendment of the reference to the non-applicability of Art. 9 Sentence 3 UmwStG in Art. 1a Sec. 2 Sentence 3 Hs. 2 KStG-E – instead of Art. 20 Sec. 5 Sentences 2 and 3 and Sec. 6 UmwStG previously referred to – for the purpose of excluding a tax retroactivity with regard to the option’s exercise is merely of a dogmatic or technical nature and does not affect the content. The same applies to the changes made in Art. 1a Sec.4 KStG-E.
2. Clarification with regard to the time of the option right’s first exercise in Art. 34 Sec. 1a KStG-E
The uncertainties previously existing on the basis of the government draft with regard to the option right’s first-time exercise pursuant Art. 1a KStG-E to the effect that an option would have had to be exercised prior to the Act’s entry into force if the option right was to be exercised as early as January 1, 2022, have now been eliminated in the version of the bill adopted by the Bundestag.
It is planned to introduce a specific application rule in the form of a new Art. 34 Sec. 1a KStG draft, allowing for an application to be filed as early as in the 2021 assessment period, so that the option can now undoubtedly be exercised for the first time for financial years beginning after December 31, 2021.
This legislative clarification is expressly to be welcomed, since with regard to the previously envisaged regulation, the entry into force of the new regulations on January 1, 2022 at the same time enabling of the option right’s exercise only for fiscal years beginning after December 31, 2022, the assumption of a legislative oversight was obvious and the regulation made in Art. 34 Sec. 1a KStG-E now provides legal certainty.
3. Avoidance of non-taxed income through Art. 50d Art. 14 EStG-E
The second major change compared to the original government draft is the insertion of a new Art. 50d Sec. 14 EStG-E, which denies the creditor of capital gains pursuant to Art. 20 Sec. 1 nos. 1 and 2 EStG from shares in an opting company relief from capital gains tax if the capital gains are not subject to taxation in the other state due to a tax treatment of the opting company that differs from German law (cf. Art. 50d Sec. 14 sentence 1 EStG-E). As a consequence, the right of taxation with respect to any capital gains from the disposal of shares in the opting company will also be assigned to Germany if the capital gains in question are not subject to taxation in the other state due to a qualification conflict (cf. Art. 50d Sec. 14 Sentence 2 EStG-E).
According to the explanatory memorandum, the so-called treaty override is intended to prevent non-taxed and low-taxed income in the event of international conflicts of qualification. If, for example, an opting company resident in Germany distributes profits to a foreign corporation (with its registered office and place of management in a treaty state) and if the foreign state does not implement the German qualification of the opting company as a corporation but taxes it transparently, the distribution constitutes a dividend from a German perspective, for which Art. 10 Sec. 1 OECD-MA generally assigns the right of taxation to the foreign state, whereas from the perspective of the foreign state it is to be qualified as business profits pursuant to Art. 7 OECD-MA and would therefore not be subject to taxation in the foreign state. In this constellation, Art. 50d Sec. 14 Sentence 1 EStG-E now denies the foreign company relief from capital gains tax in order to avoid that the distribution is not taxed or is taxed too low.
Closing this taxation gap is consistent from the tax authorities’ perspective; according to the explanatory memorandum, this measure is expressly intended to meet a concern of the Bundesrat.
In our view, however, it is regrettable that the legislator has obviously decided against eliminating further ambiguities at the interfaces with international tax law. In particular, it has not regulated the reverse case of a positive qualification conflict, i.e. a potential double taxation triggered by the option’s exercise. In this context, please refer to the Bundesrat’s suggestion in its opinion of May 7, 2021 (Bundesrat paper 244/21 (resolution)). The Bundesrat had, however, raised the question of how it can be ensured that the opting company is eligible for an income tax treaty and thus enjoys treaty protection.
Furthermore, in its opinion of May 7, the Bundesrat also suggested a further examination of whether an opting company should be covered by the personal scope of application of the Parent-Subsidiary Directive and the Interest and Royalties Directive. In addition, the question was raised, for example, as to how undisclosed reserves formed in Germany by co-entrepreneurs abroad should be treated in the course of exercising the option, i.e. how the relation to Art. 6 of AStG (German Foreign Transaction Tax Act) and Art. 4 Sec. 1 Sentence 3, Art. 16 Sec. 3a EStG should be structured in detail.
It would have been desirable for the legislator to have used the reform of corporate income tax law to put the option model directly on a solid basis. However, since this was hardly possible in the short time available – and especially in view of the complexity of a large number of consequential problems arising from the creation of the option – it is already foreseeable that Art. 1a KStG-E (and regulations associated with it) are likely to be the subject of further corrective legislation in the near future or will require supplementary regulations in accompanying letters by the German Ministry of Finance.
4. Digression: Now explicit (partial) disallowance of the preferential treatment provisions of Art. 5 and 6 GrEStG for opting companies
The consequential amendments to Art. 5 and 6 of the German Real Estate Transfer Tax Act (GrEStG), which were not yet provided for in the government draft, represent a significant new provision that is particularly relevant for consulting practice.
The amendments to Art. 5 Sec. 1 and Sec. 2 GrEStG adopted by the Bundestag exclude the applicability of the preferential tax regime applicable to partnerships in cases where the real property is transferred to a partnership that opted for corporate income taxation pursuant to Art. 1a KStG-E less than five years ago – or less than ten years ago after the entry into force of the real estate transfer tax reform. In addition, the exercise of the option pursuant to Art. 1a KStG is now expressly deemed, pursuant to Art. 5 Sec. 3 Sentence 3 GrEStG-E, as reduction of the transferor's share in the joint ownership assets if the option is exercised within the five- or ten-year period. Similarly, Art. 6 Sec. 3 Sentence 3 GrEStG-E excludes the applicability of Art. 6 Sec. 1 GrEStG if a property is transferred from a joint ownership to a company that opted for the option pursuant to Art. 1a KStG-E less than five – or soon ten – years ago.
According to the explanatory memorandum, the new provisions made with regard to Art. 5 GrEStG are constitutive provisions, since the GrEStG, as a result of the civil law’s authoritative nature for the purposes of this Act, generally assumes the aforementioned standards’ applicability to opting companies, which would, however, subsequently allow (abusive) tax arrangements. At the same time, however, the legislator clarifies that the assumption pursuant to Art. 5 Sec. 3 Sentence 3 GrEStG-E should only apply when Art. 5 Sec. 3 Sentence 1 GrEStG is applied; in all other respects, the civil law participation in the joint ownership’s assets remains in force when the GrEStG is applied in the context of further transfers. The amendments provided for in Art. 5 Sec. 1 Sentence 2 and Sec. 2 Sentence 2 of the GrEStG-E relate to the case where the option pursuant to Art. 1a KStG-E is initially exercised and the property is subsequently transferred to the joint ownership; this is intended to counteract the formation of shelf companies. The new provision contained in Art. 6 Sec. 3 Sentence 3 GrEStG-E also pursues this purpose, but for constellations in which the real estate is transferred from a joint holding to an opting company.
When weighing up the pros and cons of exercising the option pursuant to Art. 1a KStG-E, it is therefore imperative from an advisor's point of view to also consider whether exercising the option will lead to a transaction triggering real estate transfer tax and whether the real estate transfer tax triggered as a result will not outweigh the tax advantages resulting from exercising the option.
II. Replacement of the adjustment items in case of additional and reduced transfers by tax groups (Art. 14 Sec. 4 KStG) by a so-called deposit solution
The amendments provided for in Art. 14 Sec. 4 KStG have been adopted unchanged from the government draft; the same essentially applies to the provisions provided for in Art. 34 Sec. 6e KStG-E regarding the mandatory reversal of any negative adjustment items through profit or loss as of January 1, 2022.
In this respect, the criticism we have already voiced with regard to Art. 34 Sec. 6e KStG-E remains that the resulting assumed sale of a shareholding with the consequence of (favorable) compulsory taxation is, in our opinion, too far-reaching and that the formation of a reserve in order to mitigate the tax burden does not appear suitable to adequately avoid unjustified tax burdens due to the envisaged ten-year reversal period.
III. Globalization of the Reorganization Tax Act (“UmwStG”) with regard to the conversion of corporations (Art. 1 UmwStG, Art. 12 Sec. 2 and Sec. 3 of the Corporation Tax Act (“KStG”))
The amendments envisaged in the government draft with regard to the UmwStG, i.e. specifically the repeal of Art. 1 Sec. 2 UmwStG and the associated deletion of Art. 12 Sec. 2 and Sec. 3 KStG, were also adopted by the Bundestag in unchanged form, which is to be welcomed.
Despite the partly massive criticism expressed by the Bundesrat in its opinion of May 7, 2021, which was accompanied by the request for a temporary deferral of the amendments envisaged with regard to the reorganization tax law, tax-neutral reorganizations will also be allowed in third country cases in future. However, despite concerns regarding such decision’s compatibility with the freedom of movement of capital pursuant to Art. 63 TFEU, which is also applicable to third-country companies, the facilitation of a tax-neutral exchange of shares or other contributions pursuant to Art. 20 et seq. UmwStG is now as before not intended in the context of third countries.
However, it is noteworthy from a practical point of view that Art. 27 Sec. 18 UmwStG-E has been adopted unchanged from the government draft. Due to such provision’s ruling, that Art. 1 UmwStG-E is to be applied for the first time to conversions and contributions with a tax transfer date after December 31, 2021, the third-country company concerned may have to prepare a separate closing balance sheet as of January 1, 2022, as the wording of the application provision, which is very clear in this respect, expressly excludes the applicability of the revised Art. 1 UmwStG to conversions with a tax transfer date on December 31, 2021. Here, too, one could have assumed the existence of a legislative oversight – mirroring the applicability of the option provision under Art. 1a KStG-E. However, the version now adopted by the Bundestag makes it clear that this is the consequence desired by the legislator.
IV. Conclusion and outlook
The changes provided for in the draft bill’s version now passed by the Bundestag with regard to the option model pursuant to Art. 1a KStG-E, the replacement of the adjustment items in case of a tax group’s additional and reduced transfers by the so-called deposit solution, as well as the reorganization tax law’s globalization are, for the most part, expressly to be welcomed. However, particular caution is now required in the light of the new provisions concerning Articles 5 and 6 of the German Real Estate Transfer Tax Act (GrEStG) in connection with real estate transfers involving opting companies, as in this respect there has been a departure from the civil law approach actually prevailing in real estate transfer tax law with regard to the opting company’s legal form.
In our view, however, it is questionable whether the introduction of the option model in particular would not have required a longer lead time. The criticisms and requests for review raised by the Bundesrat in its statement of May 7, 2021, have highlighted many weaknesses in the planned regulation and the consequential problems and inconsistencies it has caused. Since the version of the law now passed by the Bundestag has only addressed some of these aspects and the Bundesrat’s substantive criticisms have essentially only been taken into account in the form of Art. 50d Sec. 14 EStG-E, the impression remains that Art. 1a KStG-E is a regulation that has been drafted hastily and has not been fine-tuned in detail to the extent a new legislative regulation of this scope would actually have required.
Although it cannot be entirely ruled out that the Bundesrat could refuse to give its consent to the KöMoG due to the fact that the concerns expressed in its opinion were largely ignored, we believe it is more likely that the Bundesrat will also pass the bill at the end of June and that the new regulations will be able to enter into force as planned on January 1, 2022. This is supported in particular by the fact that, due to the remaining time in this legislative period, it is virtually impossible to convene a mediation committee and that, in light of the principle of discontinuity, refusal of approval by the Bundesrat would therefore mean the (temporary) end of the KöMoG. It remains to be seen how the practice will deal with the (consequential) problems which are already apparent, and which may still arise, as well as whether and to what corrections the legislator or, by way of decree, the BMF will decide.
Many thanks to my co-author Dr. Christiane Krüger, LL.M.