July 12, 2023
German Federal Ministry of Finance publishes draft BEPS 2.0 Pillar Two implementation bill and accompanying measures
On 10 July 2023 the German Ministry of Finance (MoF) published a revised draft bill that is based on the initial discussion draft dated 20 March 2023 (details on the initial discussion draft can be found here).
Major changes from the initial discussion draft include a top-up tax compensation mechanism within the minimum tax group, addition of various provisions from the Administrative Guidance of the Inclusive Framework published in February 2023, and details on penalties.
Furthermore, the draft bill provides for accompanying measures to align the implementation of a Global Minimum Tax with current German tax rules and simplify the rules. Most significantly, these measures would abolish the German royalty deduction limitation rule, lower from 25% to 15% the low-tax threshold for German controlled foreign company (CFC) tax purposes and the carve-out of CFC income from German trade tax.
Major deviations from the initial discussion draft
Top-up tax compensation mechanism
The initial discussion draft dated 20 March 2023 already provided for the introduction of a minimum tax group comprising all German resident Constituent Entities. The minimum tax group parent is responsible for the submission of the tax return and owes any German top-up tax. For this purpose, any German top-up tax due is allocated from the German Constituent Entities to the German minimum tax group parent. The July draft bill confirms that German Constituent Entities whose top-up tax amounts are allocated to the minimum tax group parent have a legal obligation to pay a compensation to the minimum tax group parent. This also applies to top-up tax refunds to the minimum tax group parent, which must be compensated by the latter to the Constituent Entities. The compensation claims do not increase or reduce income under the German Income Tax Act or the German Corporate Income Tax Act.
Provisions from the Administrative Guidance
The draft bill includes the following provisions from the February Administrative Guidance:
Provisions on penalties
The penalty provisions in the draft bill would impose penalties up to €30,000 per instance for failure to properly submit the minimum tax report. However, no penalty is applied if the taxpayer proves that reasonable measures justifying a late or wrong submission of the minimum tax report ("penalty relief") have been taken.
For the first time, the draft bill also proposes making changes to existing German tax rules when the Global Minimum Tax begins to apply from 2024. Under the current draft bill, companies that are not in-scope of the Global Minimum Tax would also benefit from the accompanying measures.
Abolishment of the German royalty deduction limitation
The German royalty deduction limitation rule (Sec. 4j German Income Tax Act) partially or wholly disallows the deduction of related-party royalty payments preferentially taxed, directly or indirectly, at the recipient level under a non-OECD (non-nexus) compliant preferential tax regime at an effective rate of below 25%. With the introduction of the Global Minimum Taxation, the German royalty deduction limitation rule would be abolished. According to the explanatory notes provided by the MoF, this is justified due to the numerous internationally coordinated measures against profit shifting, such as the Global Minimum Taxation.
Reduction of the low-tax threshold for German CFC purposes
The low-tax threshold for German CFC purposes in the German Foreign Tax Act is currently set at 25%. The draft bill foresees a reduction of the low tax threshold from 25% to the future global minimum tax rate of 15%. This measure is intended to align German CFC taxation with Global Minimum Taxation regarding the taxation of foreign activities.
Exclusion of CFC income from German trade tax
To date, CFC income is subject to both German income tax and trade tax. To harmonize German CFC taxation and Global Minimum Taxation regarding the taxation of foreign activities, the draft bill excludes CFC income from taxable income for Trade Tax purposes.
For comments on the draft bill, the MoF has set a rather short deadline of 21 July 2023. After this deadline, it is expected that the formal legislative procedure will be opened by way of issuance of a formal governmental draft in late summer. The bill will likely not become law before December 2023.
The full text of the draft bill is available on the MoF website and may be accessed directly here.
For additional information with respect to this Alert, please contact the following:
Ernst & Young GmbH, Germany
Ernst & Young LLP (United States), German Tax Desk, New York
Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor