At the end of last year, the legislator introduced a new Section 4i EStG with effect from the 2017 tax year, which prohibits the deduction of financing expenses as special business expenses for certain externally financed inbound acquisition structures using partnerships (Section 4i EStG). The aim is to prevent the double deduction of operating expenses ("double dip") in connection with an investment in a German partnership. The measure is related to the OECD's "BEPS" project (cf. Elser, International Transaction Structuring, in: Oestreicher (ed.), BEPS - Base Erosion and Profit Shifting, 1st edition 2015, NWB Verlag).
Example:
A foreign investor (e.g. in the legal form of a Luxembourg corporation, hereinafter "LuxCo") acquires all limited partnership interests in an operating German limited partnership ("KG"). LuxCo takes out an interest-bearing bank loan to finance the purchase price for the KG shares.
LuxCo is subject to limited corporation tax on its participation in the KG; the KG itself is subject to trade tax. For the purposes of German taxable profit determination, the bank loan taken out by LuxCo is to be classified as negative special business assets and recognised in a special balance sheet of LuxCo in the KG. This means that the interest payable by LuxCo to the bank is included in the German taxable profit calculation and is deductible as operating expenses for trade tax purposes (at 75 %, cf. Section 8 no. 1 GewStG) and for corporation tax purposes.
The interest on the bank loan can now also be a (tax-deductible) operating expense for LuxCo under foreign tax law. In this case, there would be a double reduction in profits in Germany and abroad, which the legislator wants to prevent. According to § 4i EStG, expenses of a partner in a partnership (here: interest expenses of LuxCo) may not be deducted as special business expenses if these expenses also reduce the tax base in another country (here: tax base of LuxCo in Luxembourg) (§ 4i sentence 1 EStG). In DBA cases (such as Luxembourg in this case), the scope of application of this provision is generally not open if the foreign DBA state exempts the income from the KG as permanent establishment income and also allocates the interest for the bank loan to this tax-free permanent establishment income. In these cases, there is no reduction in the tax base abroad. In addition, the prohibition of deduction in accordance with Section 4i sentence 2 EStG should not apply if the expenses reduce income of the same taxpayer that is subject to both domestic taxation and actual taxation in the other country. The legislator's intention in making this exception is to rule out an overriding effect of the provision in cases of tax credit and in non-DBA cases.
According to its wording, the provision cannot only apply to foreign partners of a German partnership. Domestic co-entrepreneurs held by non-resident taxpayers (e.g. a German GmbH as a partner in the partnership) who acquire an investment in a German KG with external financing may also be covered by the prohibition on the deduction of business expenses, e.g. if the foreign partner can treat the domestic co-entrepreneur (GmbH) as fiscally transparent under foreign tax regulations and, as a result, the interest expenses directly reduce the foreign tax base.
The new regulation must be observed for inbound acquisitions of German partnerships. This also applies in particular to commercial partnerships with domestic real estate holdings. The tax deductibility of financing expenses in connection with partnerships cannot be answered in future without knowledge of the tax treatment abroad.
Dr Thomas Elser, TAXGATE, Stuttgart and Frankfurt
