Withholding tax relief modernization act, as of March 2021
Selected Topics: Procedure of relief from capital gains tax (sec. 50c ITA-D) as well as restructuring of sec. 50d (3) ITA
On March 17th, 2021 the German government started the legislation procedure on the draft law on the Withholding Tax Relief Modernization Act by transferring the draft bill to the Parliament. The goal of the draft law is to simplify and accelerate the process of relief from withholding tax, as this procedure is very complex and lengthy. Moreover, it aims to counteract abusive arrangements to obtaining tax benefits. In the following, we will summarize the contents of the draft, which are important for internationally engaged groups of companies, and provide further recommendations for action. For further information with regards to the banking sector we would like to refer to the Financial Services Tax publication, dated January 28th, 2021.
THE NEW SEC. 50C ITA-D: SUBSTANTIVE CHANGES IN COMPARISON TO SEC. 50D ITA (CURRENT VERSION)
The rules of procedure of the current sec. 50d (1) and (2) Income Tax Act (ITA), which affect the process of relief from withholding tax and the tax deduction according to sec. 50a ITA on the basis of sec. 43b and 50g ITA (EU Parent Subsidiary Directive / EU Interest and License Directive) or a double taxation treaty (DTT), is transferred into sec. 50c ITA-D (draft). According to the draft, in 2023 there will be a fully digitalized application for exemption and refund from withholding tax process, an electronic processing of those applications on behalf of the Federal Central Tax Office and an electronic retrieval of notices.
Additionally, two aspects are regulated, which enable the debtor of capital gains or remuneration to renounce from withholding or paying capital gains tax or the tax according to sec. 50a ITA. Firstly, this is the case when the debtor has an exemption certificate issued by the Federal Central Tax Office. Secondly, the draft states a minimum limit for income according to sec. 50a (1) No. 3 ITA (licensing or comparable cases) of EUR 5,000 per calendar year. If the remuneration paid by the debtor to the same person with limited tax liability does not exceed this limit, the debtor may refrain from withholding and paying the tax. This is limited to cases of relief based on a DTT. The obligation to file a tax return remains in both cases.
In cases where the existence of a tax withholding obligation is uncertain, it should be possible in the future to issue an exemption certificate without first having to obtain legal clarification of the withholding tax obligation.
Another significant change is that the exemption certificates will not be valid retroactively from the date of application with the Federal Central Tax Office. Instead, the exemption certificate will be valid starting on the day of its issuance. However, the previously required minimum validity of one year is no longer mandatory. This allows taxpayers to apply for the exemption certificate even if the requirements are only met for a short period of time.
Finally, it should be noted that the submission of a certificate pursuant to sec. 45a (2) ITA is an indispensable prerequisite for the purpose of the reimbursement of capital gains tax. According to the draft, it will not be possible for the Federal Central Tax Office to waive this requirement.
SEC. 50D (3) ITA-D: REVISION OF THE NATIONAL ANTI-TREATY SHOPPING RULE
After the European Court of Justice ruled in its verdict dated December 20th of 2017 that sec. 50d (3) ITA in the former version violated Article 49 of the Treaty on the Functioning of the European Union (freedom of establishment) and the current version of the provision at least partially restricts the freedom of establishment according to the verdict of the European Court of Justice dated June 14th of 2018, the draft law now attempts to implement these judgements into national tax law. In addition, the draft refers to the necessary adaptation of the provision under EU law as a result of art. 6 of the ATAD.
In principle, sec. 50d (3) ITA-D has a two-step structure, which will be presented in the following:
In a first step, the basic suspicion of an abusive structure is defined: This abusive structure exists if, i) the shareholder (new: or the beneficiaries) cannot claim relief under the same provision and ii) if the company does not generate the income, which is subject to withholding tax in connection with its own economic activity. The generation and forwarding of income to shareholders or beneficiaries is not considered as own economic activity. Activities, which are not performed with an appropriately equipped business establishment are also not considered as own economic activities (so-called “passing-through structures”). Shareholders in the sense of the new wording “beneficiaries” are now not only shareholders according to civil law but also persons who fulfill the same function for tax purposes.
If there is a suspicion of abuse, this might be refuted in the second step in some individual cases, if the main purpose of the arrangement was not to obtain a tax advantage. Therefore, the shareholders’ relief entitlements under other provisions (sec. 43b ITA or DTT) only apply within the scope of this counterevidence, according to the draft. Also, according to the draft, in contrast with the current version of sec. 50d (3) ITA, all non-tax reasons including those arising from a group relationship, must be considered.
The exception of sec. 50d (3) ITA in the form of the stock exchange clause continues to apply to the foreign corporation if a significant and regular trade is taking place at the stock exchange. A restriction to the previous version applies in cases where only the shareholders of the foreign corporation are listed on the stock exchange. If in these cases, there is no personal entitlement to relief pursuant to sec. 50d (3) sent. 1 no. 1 ITA-D, the exemption rule can’t be used in the future.
APPRAISAL OF THE PLANNED AMENDMENTS TO SECTION 50D (3) ITA-D
While the logic of the current version of sec. 50d (3) ITA was maintained in sec. 50d (3) ITA-D, the new provision, as described above, contains both intensifications and facilitations at the same time: On the one hand, the first requirement of para. 3 tightens the anti-treaty-shopping rule, as the basic suspicion against the foreign shareholders is fulfilled even if they had a comparable claim to relief based on another provision. On the other hand, the possibility to prove the contrary represents a possible relief and is certainly welcomed.
ENTERING INTO FORCE
The aforementioned electronic application and assessment procedure is supposed to come into force from the year 2023 onwards, as the necessary technical requirements still have to be implemented.
The applicability of the new sec. 50d (3) ITA-D is generally intended for all cases that are still open. In order to avoid an inadmissible retroactive effect, the draft law provides for a more favorable test, as long as the flow of investment income or remuneration took place before the new version came into force.
NEED FOR ACTION
In particular, the fact that the exemption certificates can no longer become valid retroactively starting from the date of receipt of the exemption application by the Federal Central Tax Office but only from the date of issuance of the exemption certificate, requires in practice that the application is brought forward in time in order to prevent from having to go through refund proceedings. It remains open, to what extent faster processing of applications can be achieved as a result of the digitization of processes.
Against the background of the planned revision of sec. 50d (3) ITA, it is advisable to analyze at an early stage whether the substance requirements are met in each individual case.
EFFECTIVE SUPPORT BY BDO
Please feel free to contact your BDO contact person in order to identify the need for action. We will be happy to work out an individual recommendation for you. If necessary, we will work with our colleagues from our respective BDO Member Firms from our international network in more than 160 countries.