The Action Plan of European Commission

As part of the Action Plan for a fair and efficient taxation of companies the European Commission drafted a directive for rules against tax avoidance practices.

On 28 January 2016, the European Commission has published the draft of the council directive laying down rules against tax avoidance practices that affect the functioning of the internal market (COM (2016) 26 final). In principle, the Federation of German Industries (Bundesverband der deutschen Industrie, BDI) welcomes the initiative of the European Commission to harmonize the company taxation in the European Union (EU) and to create uniform minimum standards for the implementation of the OECD-Action Plan against base erosion and profit shifting (BEPS) within the EU. Due to consistent terminology and definitions as well as coordinated approaches the risk of double taxation in the EU may be limited.

At the same time, the European Commission has to ensure that Europe remains competitive as a community of several states. Investments and cross-border activities should not be constrained by the new tax rules and standards. Therefore, the European Commission should not go beyond the recommendations defined by the OECD/G20. Nevertheless, the extensive reform of the tax systems for cross-border activities of companies will almost inevitably be connected with double taxation and disputes. All the more important are binding dispute settlement mechanisms. This is missing at present. Therefore, the proposals of OECD/G20 and European Commission should be amended accordingly.

On a worldwide level, Germany has already strict regulations in its domestic tax law with regard to anti-abuse rules against tax avoidance practices by companies today. Many suggestions of the European Commission are closely in line with the German legislation. However, in some points there are shortcomings that need to be improved. The most crucial are: Article 4 – Interest limitation rule The tax allowance in the amount of € 1 million for unrestricted interest deduction as proposed by the European Commission is too low. The amount may be appropriated with respect to the smaller size of many companies in Eastern Europe. However, in Germany many SMEs would be captured by this rule. Therefore, the EU Member States should define the tax allowance/tax exemption limit by themselves in order to fit the economic situation of their domestic companies. Third party financing should be not included in interest limitation rules.

Article 7 – General anti-abuse rule

The general anti-abuse rule is broadly defined. This creates legal uncertainty and room for misinterpretation which needs to be clarified by additional comments and judgments. To avoid a large number of disputes, the European Commission should describe the potential abuses clearer. This would also avoid impending conflict with existing double taxation agreements and provide greater legal certainty for companies. Germany has already such general anti-abuse rule in its domestic tax law.

Article 8 – Controlled foreign company legislation

This provision is intended to prevent that companies’ profits can be left in affiliated companies (subsidiaries) without operational responsibility or no activity in low-tax countries. Such gains should therefore be added to domestic income in order to raise the taxation to a higher (domestic) level. However, controlled foreign company (CFC) rules will not apply if the foreign company has an active business or the company’s principal class of shares is regularly traded on a stock exchange market. Whether an active business exists depends on the portion of so-called passive income such as interest, royalties, dividends etc. In case that the passive income is more than 50 percent CFC rule apply. But gains typically vary. Germany has a similar scheme in which the active business have to be demonstrated through substance requirements. This good practice should be maintained and adopted in the EU Directive. Besides, CFC rules shall not apply between EU Member States (where a company is resident in a Member State) or a country that is party to the EEA Agreement or a permanent establishment of a third party country’ company which is situated in a Member State.

Article 10 – Hybrid mismatches

Hybrid mismatches arise if two countries give a different legal characterization to the same taxpayer (hybrid company) or the same payment (hybrid instrument) and this leads to a situation where a deduction of the same payment, expenses or losses occurs in both states (double deduction) or there is a deduction of the payment in one state but no corresponding inclusion of the same payment to taxable income in the other state. In such cases the legal characterization of the Member State in which the payment has its source shall be decisive. This proposal creates more legal certainty in hybrid mismatch situation.