Germany publishes final anti-hybrid rules guidance

What happened?

The German Federal Ministry of Finance published on December 9 the final decree on its interpretation of the German anti-hybrid rules, which apply generally to all expenses incurred after December 31, 2019. The decree includes some changes to the draft version, which was published in July 2023 (see our PwC Insight).

Why is it relevant?

The decree includes statements regarding the impact of foreign controlled foreign corporation (CFC) regimes on the German anti-hybrid rules, which are also relevant for the US global intangible low-tax income (GILTI) rules.

Actions to consider

Multinational companies with German subsidiaries should analyze the decree’s impact on the deductibility of expenses in Germany. Businesses also should comply with the documentation requirements for the treatment of transactions under foreign law, as required by the decree.

Background

The German anti-hybrid rules apply to expenses that give rise to (1) deduction without inclusion outcomes (D/NI) caused by a hybrid mismatch, (2) double deduction outcomes (DD), and (3) imported hybrid mismatches. Except for certain expenses that are covered by a grandfather rule, the German anti-hybrid rules generally apply to all expenses (including costs of goods sold and deemed expenses) incurred after December 31, 2019.

New guidance

The published decree is the final guidance from the German tax authorities on the anti-hybrid rules. Below are some key amendments to the draft version that was published in 2023:

• Impact of foreign CFC taxation on D/NI outcomes: Based on the decree, income that is taxed under a foreign CFC taxation regime is considered to be ‘included income’ and no D/NI outcome would arise, if the foreign CFC taxation is a CFC taxation within the meaning of the EU anti-tax avoidance directive (ATAD). Therefore, if income is taxed under a non-EU CFC taxation, it may be required to compare such foreign CFC taxation with the CFC taxation rules under the ATAD. The draft decree did not include this requirement.
• Impact of US GILTI and Pillar Two rules on D/NI outcomes: Contrary to the above, if income is only included under a foreign tax regime that provides for a ‘blending’ of income, losses, and taxes of all or several CFCs, such income is not considered ‘included income’ under the decree. This may include US GILTI as well as Pillar Two regimes. Therefore, based on the decree, an inclusion of income for US GILTI or Pillar Two purposes is not expected to constitute the existence of ‘included income.’
• Dual inclusion income for disregarded payments: Based on the decree, income that is taxed in Germany but not in the foreign jurisdiction due to a hybrid mismatch may – regardless of the non-taxation of the income in the foreign jurisdiction – in certain cases constitute dual inclusion income, provided such income gives rise to a ‘No-Deduction/Inclusion outcome.’ Note that such treatment is contrary to the wording of the law. However, the German tax authorities appear to apply an economic view and grant such relief to avoid unfair outcomes. The draft decree did not include such relief.

Example: US Inc. owns 100% of the shares in a German GmbH. The GmbH is disregarded for US tax purposes. The GmbH has third-party expenses that give rise to a double deduction. The GmbH provides services to its parent, US Inc. The payments received by the GmbH for such services are taxable in Germany but are not taxed in the United States (disregarded payments). Even though the income of GmbH is not subject to US tax, it may constitute dual inclusion income because the payment is taxed in Germany but non-deductible in the United States (No-Deduction/Inclusion outcome).

• Impact of foreign CFC rules, US GILTI, and Pillar Two rules on DD outcomes: Under the decree, a double deduction does not arise if expenses are tax deductible for German tax purposes and for purposes of a foreign CFC taxation. This is contrary to the draft decree (but now in line with the legislative materials), which said that a foreign CFC taxation gives rise to a double deduction.

Moreover, based on the decree, no double deduction would arise if expenses are tax deductible under a foreign tax regime that provides for a ’blending’ of income, losses, and taxes of all or several CFCs. This may include US GILTI as well as Pillar Two regimes. Therefore, a deduction of expenses for US GILTI or Pillar Two purposes is not expected to give rise to a double deduction based on the decree. The draft decree did not include any specific reference to US GILTI or Pillar Two in relation to double deductions.

Furthermore, below are some other key observations without changes to the draft decree:

• Imported hybrid mismatch rule: Based on the decree, this rule applies even if there is no economic connection between the expenses of the German taxpayer and the ‘hybrid’ expenses. Therefore, the application of the imported hybrid mismatch rule is not limited to mere ‘back-to-back’ scenarios, and it would be required, under the current interpretation, to analyze a variety of payments between non-German entities.

Example (based on an example in the decree): A German corporation pays interest to its affiliated foreign B Co. B Co makes royalty payments to another related foreign entity, resulting in a D/NI outcome. The interest income and royalty payment of B Co are not economically connected but are netted when determining the income of B Co. The interest payment of the German corporation would be nondeductible according to the draft decree under the imported hybrid mismatch rule.

• Non-taxation under CFC rules: Based on the decree, the German anti-hybrid rules also apply if there is a nontaxation under a foreign CFC taxation, provided such nontaxation is triggered by a hybrid mismatch and the income is not taxed in any other jurisdiction. Based on this, a payment to an entity that is not taxed in its jurisdiction (e.g., because it is tax resident in a zero-tax jurisdiction) might under certain conditions still be covered by the German anti-hybrid rules based on the view of the German tax administration.
• Documentation requirements: The decree states that taxpayers must comply with the extended rules for cooperation under German law to document the treatment under foreign tax law. These rules require that documents are provided to the German tax authorities that allow the determination of the respective transaction under foreign law (such as foreign accounting documents or statements of the treatment of the transactions by foreign tax authorities). If taxpayers do not comply with these documentation requirements, the tax authorities may assume that the German anti-hybrid rules apply, and expenses are not deductible.