German Tax Law
The German Federal Ministry of Finance released FAQ on German tax reliefs due to the COVID-19 pandemic. Taxpayers are thus given a quick overview of tax reliefs adopted by the German tax authorities as well as their view on the application of certain tax provisions during the pandemic. You can find the FAQ here (in German).
The FAQ reflecting the current status as of 30 April 2020 and are to be continuously updated. For further information see the website of the German Federal Ministry of Finance (in German).
Extended Retrospective Effect also of Contributions to Corporations and Conversion into a Partnership Ahead
A draft bill published on 6 May 2020 provides for an extended period for the retroactive effect of
- a contribution of businesses (aggregated assets) or shares to a corporation and
- a conversion of a corporation into a partnership
from eight to twelve months. This would enable reorganizations with a retroactive effect of up to twelve months for German tax purposes.
This already applies to mergers and split ups as well as split offs of corporations.
For further information
The Draft Bill dated 6 May 2020 (in German) you can find here.
The “Law on Measures in Corporate, Cooperative, Association, Foundation and Property Ownership Law to combat the effects of the COVID-19 Pandemic” dated 27 March 2020 (in German) you can find here.
Profit and Loss Transfer Agreements
A tax group for German corporate and trade tax purposes requires that the profit and loss transfer agreement between the parent company and the subsidiary is duly executed. This includes that a loss compensation (or profit transfer) claim is generally settled in time. Taxpayers should be aware that the common practice of executing a loss compensation or profit transfer claim by
- converting the compensation claim into a loan or
- offsetting it against cash pool accounts
requires for German tax purposes that the parent company would have been able to compensate the losses of its subsidiary.
Against the background of potential liquidity shortages, parent companies should focus hereon to avoid the tax group becoming invalid (from the start of the tax group in the worst case).
Home Office – PE Risk?
If due to COVID-19 employees of enterprises being tax resident in Germany work from their home office located abroad, a permanent establishment (“PE”) could be established their pursuant to both foreign domestic law and the respective Double Tax Treaty (“DTT”). The enterprise would then become subject to compliance obligations (e.g., registration, delimitation of income, filing of tax returns, etc.) in the PE country. If as a German resident partnership purposes (e.g., GmbH & Co. KG) establishes a foreign PE by a home office, its partners could become liable to limited taxation in the PE country and subject to compliance obligations (see above) in this state. Hence, comprehensive documentation in relation to the reasons and the activities in a respective home office to support arguments against a PE in future disputes with the tax authorities abroad to mitigate tax liability in such other country.
Depending on the duration of the pandemic, the use of a home office and, if applicable, the instructions given by the employer to work in a home office, could result in the establishment of a PE, particularly, if the criteria of a certain durability and the de facto power of effective control of the employer regarding the home office are met. With reference to the Commentaries on art. 5 of the 2017 OECD Model Tax Convention, margin no. 18 f. (also applicable to DTT in existence before 2017), for instance, the Austrian Ministry of Finance (see EAS 3415) considers a home office of an employee of a German company as a PE under certain circumstances.
According to its analysis of tax treaties dated 3 April 2020, the OECD clarified its previous interpretation and stated that government directives should be considered as force majeure and not an enterprise requirement. However, insofar as it appears required for medical reasons to send employees in their home office even without such governmental directive, the PE risk would be given. The Commentaries on the OECD Model Tax Convention usually has no legal binding effect, i.e., it leaves margin for interpretation by individual states. Therefore, the companies should record the reasons for the mandatory requirement of activities in a home office and check the conditions for the establishments of a PE according to the respective domestic law.
From a German point of view, it must be taken into account that the case law shows a tendency towards the de facto power of disposal over the premises of a third party (see, e.g., Fiscal Court of Berlin-Brandenburg, judgment of 21 November2019, 9 K 11108/17, pending at Federal Fiscal Court, Az. IR 10/20).
Employees that habitually conclude or broker contracts on behalf of an enterprise (including directors a limited corporation) could also trigger a dependent agent PE (permanent representative) of such enterprise in their respective home country. According to the OECD, for activities being “habitual”, a certain degree of permanency is required, which is accessible to different interpretations of the respective country.
Travel restrictions – Tax residency of corporations
A corporation with management located in Germany is tax resident here and, therefore, its worldwide income is subject to German taxation. If, due to travel restrictions, members of the board of a foreign enterprise (being classified as a corporation from the German tax perspective) perform their board decisions in Germany, a management PE could be established. This should give rise to a (second) tax residency of the enterprise, i.e., in Germany. Amongst other things, the enterprise would then (also) become subject to extensive compliance obligations. Furthermore, this could result in the loss of potential tax advantages provided by the foreign domestic law and linked to the effective place of management (e.g., group taxation). In addition, due to the relocation of the place of effective management, a massive liquidity burden could arise due to exit taxation provisions (similarly at the time of a later relocation of such management PE abroad). If such relocation is detected in a future tax audit, there might also the risk of criminal proceedings.
There is also the risk of double taxation due to double residency. According to art. 4 para 3 of the OECD Model Tax Convention (so-called tie-breaker rule), this could be remedied through a (time-consuming) mutual agreement procedure between the participating countries. Without conducting such procedure, however, the company is denied access to the benefits of the DTC.
The risk that substance requirements will not be met due to the relocation of the place of effective management (especially in the case of holding companies based abroad) may also result in significant tax distortions among shareholders based in Germany.
The determination of the place of effective management is a factual matter. In order to reduce the PE risk, as far as factually as well as under company law possible, board meetings should either be postponed or the individual decision-making powers may be (temporarily) transferred to persons who are resident in the foreign country who need to demonstrate that they do so. A joint decision that may be required for the transfer of powers, taken e.g., by video conference, should also be documented carefully in order to reduce the risk of a change of the place of effective management.